Why Does Our Financial System Need Reform?

Treasury Secretary Tim Geithner and the Obama Administration are pushing for powers to regulate all aspects of the financial system.  These areas include hedge funds, private firms, and derivatives.  They also want the power to intervene with any company to make sure their collapse will not bring down the financial system.

While these ideas sound great, especially in the middle of the crisis we’re in, they are misguided attempts to intervene, when intervention is the last thing we need.  The perfect example of the need to get involved when it was not necessary was the Sarbanes-Oxley Act after the Enron case.  Everyone wanted regulation, so we strapped every publicly traded company with the huge burden of archiving every piece of data for 7 years.  However, the executives that were in charge of Enron were found guilty of fraud, and the company was bankrupted and dissolved.  The system for weeding out Enron worked, but our government felt the need to act, so they did.

In the current crisis, if we did not bail everyone out, would we need to regulate hedge funds, private equity firms, and derivatives?  Those were fringe investments to begin with, but since the Federal Reserve made credit cheap and easy to obtain, they became too large.  Warren Buffet even called the derivatives market the “financial weapons of mass destruction.”  If we let them fail and liquidate their assets, they would go back to being fringe investments only for specialty firms or the super rich people of the country.

By propping them up, we now have the need to regulate them.  By regulating them, we are acknowledging their existence as a major part of the financial system, when they should only be bit players.  Our system needs to be cleansed of these bad investment vehicles and instead we are implementing rules to legitimize them.

Also, the power to intervene with any company by the Treasury Department is setting a dangerous precedent for the future.  They want the power to take over a company and sell off assets before the company collapses.  Looking at how well the bailouts and toxic assets plans have gone, I question whether they really know what is best for our system to begin with.  Why not just let the companies go bankrupt and liquidate their assets letting the market set the prices?

Also, I question whether these reforms and protections will really help.  We all knew the derivatives market was a problem waiting to happen, and all of the financial geniuses who are now calling for regulation just sat back and watched.  The SEC had rules to prevent things like Enron from happening, but it still happened.  Madoff kept a ponzi scheme going for decades and the SEC couldn’t figure it out.  How can we expect our government to regulate when they have failed us so far?  If another bank does commit fraud or crooked accounting and it slips through the cracks, can we sue the government for their lack of oversight?

These broad government regulations just give us a false sense of security because we think the government is looking out for us.  That gives us the impression that they are watching what funds are doing, and they know that their investments are legitimate.  We fail to do our own due diligence because we think the government already has for us.  Then we will again be burned when the government fails to regulate like they promised.

We need to let the market liquidate the bad investments and let the companies that made these decisions fail.  Once that happens, we can see how widespread the problem was and if there is a need for sweeping regulations.  If anything, we need to regulate the Federal Reserve to make sure that our boom-bust economic policy comes to an end.  We can treat the symptoms (hedge funds, private equity and derivatives) only after we treat the cause of the cancer, which is the Federal Reserve.

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