What's missing from Obama's financial reforms
Government's distortion of the housing market needs fixing as much as Wall Street.
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He also needs to put new curbs on another street: Pennsylvania Avenue.
A prime cause for the housing bubble that led buyers, mortgage brokers, banks, hedge funds, and investors to lose their senses about risk – and bring the world economy to its knees – lies with Washington's housing policy, and the powerful industry lobbies that push it.
Over the decades, Congress, the Federal Reserve, and successive administrations have cranked up the property market with various favors until owning a home became a social necessity and the government had a stake in making sure home prices defy market gravity by always rising. Even after this crisis began, lawmakers included a large tax credit for first-time home buyers in the stimulus package.
The long accumulation of home-buying benefits and the creation of a false impression that houses are safe investments contributed to a bubble that burst in 2006-07, popping every other bubble wedded to it and exposing flaws in financial institutions that also bought into this wild risk-taking.
Mr. Obama only obliquely hinted at this fundamental cause in his speech Wednesday in announcing the reforms. He cited "structural weaknesses" and schemes that were "built on a pile of sand." By not tackling this most fundamental root of the crisis, however, his reforms will only go so far to keep the finance industry and consumers from making similar mistakes.
Yes, his proposed Consumer Financial Protection Agency might help would-be home buyers avoid buying a mortgage they can't understand or afford.
Yes, his reforms will improve the work of investment rating agencies that failed to assess the risk of mortgages that were "bundled" into securities.
Yes, the exotic investments of hedge funds that also bought into risky mortgages will be more transparent.
Yes, institutions "too large to fail" may possibly not be allowed to again load themselves with bubble-like assets such as risky mortgages.
And, yes, a coordinating body between the government's alphabet soup of financial regulators may be able to spot systemic risks that individual regulators failed to see as the housing bubble grew.
Lawmakers need to reverse their 1980 decision to abolished laws against usury that prevented mortgages above a certain rate from even being made. And they need to look at how the 1977 Community Reinvestment Act became a vehicle for easy home lending in the 1990s.
Most of all, Congress must reduce or eliminate the income tax preferences, such as mortgage-interest deductions and special treatment for capital gains on home sales.
The failures of regulators were many before this financial crisis. The Fed, for instance, didn't spot problems in mortgage lending or its own role in loose credit. The Office of Thrift Supervision didn't see AIG's problems in insuring mortgage-backed securities.
Obama's reforms are the easy fixes, assuming regulators can spot future bubbles in any asset market and have the courage to curb them. Much will depend on the level of transparency and whether regulators keep ahead of market innovations.
But the overlooked lesson learned from this crisis is that Washington cannot have too heavy a hand as a promoter in one market, be it housing or something else.
Government distortion can be as damaging as individual greed.