Greenspan and Barofsky on Mending the Financial System

I don't know how much credibility Alan Greenspan still has when it comes to financial regulation, but the comments he makes in this FT column about the inadequacies of Dodd-Frank seem mostly right to me. It is true, and very important, that the act...

fails to capture the degree of global interconnectedness of recent decades which has not been substantially altered by the crisis of 2008.

The ridiculous complexity of the new regime--the US now has more regulators, not fewer--compounds this problem by making co-operation among regulators in different countries much more difficult. Unfortunately, though, the piece has little to say about remedies, beyond musing about a return to the "simpler banking practices of a half-century ago". (Simpler banks aren't going to help much if financial activity just shifts to shadow banks. They aren't going to reduce the apparently excessive share of financial activity in GDP either, for the same reason.)

Right or wrong, Neil Barofsky's outspoken criticisms of Tarp will carry more weight. Overall, I think he is too hard on the policy, piling on the criticisms and mentioning almost in passing that it "was instrumental in saving the financial system at a relatively modest cost to taxpayers". That's not nothing, I should have thought. He is plainly correct about the worsening of moral hazard and the failure to deal with "too big to fail"--but this charge is better directed at Dodd-Frank than at Tarp. The best treatment for moral hazard, as I have previously argued, is much higher capital requirements (internationally applied) than most regulators currently envisage.

Barofsky is dead right, though, about the failure to deal adequately with foreclosures.

[The Home Affordable Modification Program] has been a colossal failure, with far fewer permanent modifications (540,000) than modifications that have failed and been canceled (over 800,000). This is the well-chronicled result of the rush to get the program started, major program design flaws like the failure to remedy mortgage servicers' favoring of foreclosure over permanent modifications, and a refusal to hold those abysmally performing mortgage servicers accountable for their disregard of program guidelines. As the program flounders, foreclosures continue to mount, with 8 million to 13 million filings forecast over the program's lifetime.

Treasury Secretary Timothy Geithner has acknowledged that the program "won't come close" to fulfilling its original expectations, that its incentives are not "powerful enough" and that the mortgage servicers are "still doing a terribly inadequate job." But Treasury officials refuse to address these shortfalls. Instead they continue to stubbornly maintain that the program is a success and needs no material change, effectively assuring that Treasury's most specific Main Street promise will not be honored.

I wrote about this recently ("Mortgage chaos is hurting the US recovery"). House prices in the US are still falling; the foreclosure problem continues to get worse. If we do get a double-dip recession, this will most likely be why.

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