Last night I had the pleasure of attending the Boston Bar Association’s annual Law Day Dinner as the guest of Ruberto, Israel & Weiner. Congressman Barney Frank, chair of the House Financial Services Committee, was the featured speaker. His remarks seemed fairly off-the-cuff, but contained some insight into what the financial service industry can expect in new regulations.
I had never heard Congressman Frank speak live before, and found myself impressed that he was much more of a “thinker” than he comes across on television (I didn’t realize it before, but he holds both undergrad and law degrees from Harvard). The bulk of his remarks focused on issues regarding the rule of law and the relationship between the judiciary and the legislature in protecting minority rights.
Frank ventured into the regulatory realm in several areas. I thought he made a good point in that financial innovations may require new forms of governance. He professed a strong belief in the compatibility of regulations and free markets, saying that free markets need laws, and pointed to a host of laws (anti-trust, banking reforms of the 1930s, etc) that fostered free markets. I have to admit to a sense of unease that the Congressman did not seem to recognize any limitations to this concept — one definitely got the feeling that more regulation was always better in his eyes. As I’ve written before, I think it would be useful to make a distinction between rules of market governance which assist the function of free markets, and regulation that restricts market activity in the name of some other goal. Frank also highlighted that those opposing regulations often exaggerated the costs and risks; here he set up a “straw man,” citing those who had claimed that “everyone’s going to move to London” in the wake of Sarbanes Oxley. I don’t know any who made such blanket claims, but the fact of the matter is that the U.S. lost a competitive edge in the IPO and exchange listing race, and Sarbanes Oxley has certainly been a factor in driving companies into the private equity arena, which is plagued by higher leverage and less transparency.
The Congressman gave one example of regulatory reform that he felt was critical — requiring originators of certain mortgages to retain a principal interest in the loan, doing only a partial securitization. This specific reform is wrapped up in a number of items in HR 1728 which Frank co-sponsored and passed the House last month (there’s a good overview here). Again, the Congressman set up a bit of a “straw man,” saying that he knew he was on the right track when he heard complaint from those who had no capital; this is a bit disengenuous, since the GSEs which the Congressman oversaw played a huge role in facilitating that type of originator.
Securities backed by loans where originators retain an interest are known as “covered bonds.” These are fairly common in Europe — it’s interesting to note that there is not even a regulatory framework for covered bonds in the U.S. I came across an interesting analysis of why the U.S. lags in this area — not surprisingly, market distortions caused by the existence of GSEs like Fannie and Freddie Mac impeded this area.
I walked away from the evening with 2 thoughts: 1) Barney Frank is a very smart guy, and 2) there’s a great risk of our policymakers making the kind of mistakes that smart people make — figuring they are more clever than the market and can dictate better outcomes. Perhaps this is just politics, but the Congressman certainly did not acknowledge the role that previous government policies had played in distorting market incentives. While I was gratified that Frank appeared much more thoughtful than he is sometime caricatured in the financial world, I would have preferred a better sense of balance in his approach – the regulatory picture is much more complex than he positioned it. A more comprehensive approach would acknowledge that, yes, in some areas we need more market governance, but some of our woes have also been the result of too much or downright bad regulation.