Obama's Financial 'Reform' Doesn't Fix Anything By John Lott Published July 15, 2010
The 2,319 page financial regulation bill that just passed Congress is filled with vague, complicated language.
Some language will weaken our financial system and make it less efficient.
Other language appears to mandate racial and gender employment quotas in dozens of Federal agencies.
In the name of making sure that there is not another financial crisis, the bill does nothing to address what caused the mortgage problems created by government regulations that forced banks to make risky loans that they didn't want to make.
It does nothing to rein in the $400 billion in losses created by government entities Fannie Mae and Freddie Mac.
What Democrats don't understand is how everyone from farmers to small and large companies use derivatives to decrease their risks. When a farmer plants his crops in the spring he has to worry about what the price of his crops will be when they are harvested in the fall. If prices plummet before the harvest occurs, farmers face real financial peril. So farmers sell a portion of those crops even before they plant them. They know what price they will get and they greatly reduce their risk. That is what a derivative is.
The same thing happens when Southwest Airlines agrees to the price that it will pay for jet fuel months in advance.
Among the new rules is that these derivative transactions must be standardized and traded on exchanges.
Democrats claim that this will make deals more transparent. But what business is it of the government whether the farmer or Southwest Airlines makes that deal with another company or over an exchange?
If farmers and companies really benefit from using these exchanges, why does the government have to force them to make agreements that way?
What should be obvious is that the costs of trading derivatives will increase. The contracts traded over these exchanges will also not be as flexible as they are now.
Making derivatives more costly is simply another way of saying that the cost of farmers and companies buying insurance will rise. When some farmers stop buying this higher cost insurance will anyone seriously argue that really reduces their financial risks?
Regulations that restrict bank size ignore one critical question: why are the banks the size that they are now?
The most likely reason is that the most efficient banks grew, the ones that could offer customers the best services at the lowest costs attracted more customers.
Larger banks presumably could also offer services that smaller banks couldn't.
So how does forcing banks to have higher costs and be less efficient make them less risky? Won't that make them more likely to go out of business?
Proponents of regulating derivatives point to the losses from AIG or Goldman Sachs supposedly ripping off its customers. A simple solution for AIG would have been to let it go bankrupt and make shareholders bear that loss.
For Goldman Sachs, even if the questionable fraud charges are true, the fraud could presumably occur with any financial instrument, not just derivatives.
Just as President Obama is driving oil rigs out of American waters to other nations, he is going to drive some financial operations overseas.
He is going to raise company costs and make it costly for them to buy insurance.
We have yet another example of government financial regulations begetting more regulations. Regulations that force financial institutions to make risky mortgages remain in place.
John R. Lott, Jr. is a FOXNews.com contributor. He is an economist and author of More Guns, Less Crime (University of Chicago Press, 2010).
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