The Obama administration's regulatory reform proposal includes many positive features, but it ultimately will not make the financial system safer for the simple reason that it conceals responsibility rather than holding regulators accountable for their failures. The basic story of this crisis was not that the regulatory authorities lacked the ability to rein in this disaster before it was too late. Rather, the basic story is that the regulatory authorities -- most importantly the Fed -- opted not to use their power to rein in the housing bubble. The discussion of financial issues has largely worked to hide the centrality of the housing bubble to the crisis. If there had been no credit default swaps, collaterized debt obligations, subprime or Alt-A mortgages, but the housing bubble had still grown to $8 trillion, we would be pretty much in the same economic situation that we are today. Residential construction would have collapsed due to a huge glut in the market and consumption would have plunged as a result of the loss of $8 trillion in household wealth. The financial problems created by failed regulation do complicate the picture, but the fundamental picture is a very simple one of a collapsed bubble sending demand plummeting. Politicians and regulators have a direct interest in portraying the crisis as being the result of an inadequate regulatory apparatus rather than failed regulators, because failed regulators should get fired. However, by not holding failed regulators accountable, this reform proposal is setting the grounds for the next crisis. Even a perfect regulatory structure will not work, if the regulators do not do their job. They will not have an incentive to do their job, if there are no consequences for not doing their job. In this case, we have seen the most disastrous possible regulatory failure -- this is like the drunken school bus driver who gets all his passengers killed driving into oncoming traffic -- and no one is held accountable. The message to future regulators is therefore to simply go along with the powers that be (i.e. the financial industry) and you will never suffer any negative consequences. It is remarkable that this perspective is completely absent from the coverage of President Obama's regulatory reform proposal. The media failed dismally in its coverage of the housing bubble. They appear to have learned nothing from this failure.
--Dean Baker
