Erwin Giron

New financial rules might not prevent next crisis

Originally published: May 23, 2010 2:40 PM
Updated: May 23, 2010 9:24 PM
By The Associated Press DANIEL WAGNER (AP Business Writers), STEVENSON JACOBS (AP Business Writers)

Quick Summary

Sweeping financial overhaul will change many rules, but loopholes could allow another crisis

WASHINGTON - (AP) - The most sweeping changes to financial rules since the Great Depression might not prevent another crisis.

Experts say the financial regulatory bill approved by the Senate last week, and a similar bill that passed the House, include loopholes and gaps that weaken their impact. Many provisions depend on the effectiveness of regulatory agencies - the same agencies that failed to foresee the last crisis.

A big reason for the bill's limitations is that banks and industry groups lobbied against rules they felt would reduce their profit-making ability.

The financial sector's influence in Washington reflects its enormous donations and lobbying. Over the past two decades, it's given $2.3 billion to federal candidates. It's outdone every other industry in lobbying since 1998, having spent $3.8 billion.

Here's how the bills, which must be reconciled and approved by the full Congress, might address some causes of the financial crisis, and some of the bill's perceived weaknesses:

- Derivatives:

The problem:

Banks used these investments to make speculative bets that helped inflate the housing market. Once home values crashed, these derivatives - and related side bets - magnified the financial crisis.

The value of a derivative depends on the price of an underlying investment. Examples include corn futures, stock options and mortgages.

The solution: The legislation would, among other things, require that many derivatives be traded on exchanges, as stocks are, so they are visible to regulators.

Why it might not work:

Business groups led by the U.S. Chamber of Commerce and the Business Roundtable lobbied successfully to dilute the rules. They argued that exchange-trading would make it too costly for companies other than banks to use derivatives.

The bill exempts companies that use derivatives to reduce the risk of fluctuations in interest rates and commodity prices. Experts say this exception could be exploited. Companies could, for example, find ways to combine traditional business activities with purely financial investment through the use of derivatives.

- Weak regulation of banks and other financial firms:

The problem:

Before the crisis, some regulators failed to recognize risks taken by banks they were supposed to oversee. Some companies sidestepped oversight entirely.

The solution: The legislation would eliminate one regulator, the Office of Thrift Supervision, criticized for lax oversight. And it would tighten oversight of large financial institutions that could threaten the system.

Why it might not work:

Smaller banks could still choose their own regulator. These banks would likely seek out the most lenient oversight.

Key advocates for that loophole were the Independent Community Bankers of America and the American Bankers Association.

The Senate voted against capping how much banks can bet relative to their reserves. It left that up to the same regulators who failed to properly monitor banks' risk-taking before the crisis.

One reason the system of regulators escaped more drastic changes, lawmakers say, was that regulators lobbied to protect their agencies' authorities. For example, Federal Deposit Insurance Corp. Chairman Sheila Bair fought changes that could limit the FDIC's authority.

- Too-big-to-fail institutions:

The problem:

After bad bets on housing and other risky investments caused the collapse of Lehman Brothers, the government pumped billions into the largest banks to keep the system afloat.

The solution: The overhaul would let regulators close banks whose collapse could threaten the system.

Why it might not work:

The Senate bill lets regulators decide whether to protect the creditors of failed banks. Creditors might take a too-rosy view of a banks' finances if they feel they have nothing to lose in a failure. They might still lend to weak banks and raise the cost of eventually closing them down.

The bill does little to prevent big banks from getting bigger, meaning taxpayers might have to intervene again. A Democratic amendment to limit the size of banks was rejected amid opposition from banks such as Goldman Sachs.

- Consumer protection

The problem:

Risky lending to homeowners who couldn't pay helped inflate the housing bubble. Some of the worst offenders were nonbank lenders.

The solution: A new consumer protection watchdog would police banking products and ban those deemed too risky - no matter who offers them.

Why it might not work:

The consumer watchdog's authority would be confined to firms with at least $10 billion in assets. Thousands of community banks wouldn't be supervised by the agency. Nor would many nonbanks.

The Chamber of Commerce has led the push to limit the reach of the consumer agency. The payday lending industry and the National Automobile Dealers Association have joined the effort.

- Credit rating agencies

The problem:

Credit rating agencies gave safe ratings to high-risk mortgage investments that later imploded.

The solution: The Senate bill would end banks' ability to choose the agencies that rate their investments. An independent board, appointed by regulators, would choose the rating firms.

Why it might not work:

The big firms - Standard & Poor's, Moody's Corp. and Fitch Ratings - would still be paid by the banks whose products they rate. That means the ratings could be influenced by those banks.

Others have questioned whether regulators should choose which agencies rate which financial products. Regulators themselves missed warning signs leading to the crisis.

____

Jacobs reported from New York. Associated Press Writer Jim Drinkard contributed to this report.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

This quarter brought a mixed bag of results, with some slightly disappointing numbers on a national basis, but some bright spots in several large California markets.

The year-over-year rate of home value depreciation continued to shrink in March, even as home value changes remained negative on a month-over-month basis. The monthly rate of depreciation stayed unchanged from the prior month (see Figure1).

Year-over-year change in the Zillow Home Value Index (ZHVI) was -3.8% in March, marking the shallowest change in home values since August 2007, while home values fell 0.3% from their February levels. Rates of monthly depreciation have been relatively flat since January after worsening somewhat in late 2009 (the lowest level of monthly depreciation in recent years was reached in October, -0.21%).

We'd been hoping that we would see depreciation rates trend further toward zero during the first quarter, and the fact that this expectation hasn't materialized leads us to move our target for a national bottom in home values to the third quarter (previously the target was Q2). Home values declined year-over-year in 106 of the 135 metropolitan statistical areas (MSAs) tracked by Zillow this quarter.

The number of homeowners losing their homes to foreclosure in March increased to 0.11% from a February level of 0.10%. This is another record in Zillow's data beginning in 2000. Negative equity remains high with 23.3 percent of all single family homes with mortgages underwater, up from 21.4 percent in fourth quarter.

Five California markets - LA, San Diego, San Francisco, Santa Barbara and Ventura - continued their streak of slightly positive monthly change. All five of those markets turned positive last April or May, and home value levels at that time may prove to have been the bottom point. The markets have experienced between 3.1-3.9% appreciation in home values since their low points last year, but sustained total drops in home values of 30-36% between their market peaks and their low point last year.

We have no real change in near-term expectations: foreclosures, negative equity, and side-lined sellers getting back into the market now will keep supply up and upward price pressure at a minimum. An L-shaped recovery with little price appreciation is getting closer, but we still expect to see a few more months of sustained decline. After that, expect small changes in home values up and down from month to month.