Wanted: Old principles, not new institutions

Treasury Secretary Timothy Geithner has had trouble garnering Beltway support for President Barack Obama’s proposed overhaul of financial regulations, which the secretary and his boss want Congress to consider after the August recess.

Geithner should stop trying to convince lawmakers and regulators to create new financial regulatory institutions. Ensuring adequate financial regulations doesn’t require such creations. Instead, what’s needed is a rigorous, consistent application of old principles.

Consider the debate about whether the nation needs a systemic-risk regulator to protect the economy from market excesses.

Proponents, including Geithner, argue that such a regulator is needed because today no official has responsibility for the whole financial system. Under the White House’s proposal, the Treasury Department, supported by a council of other regulators, would monitor all financial markets to protect the economy from systemic meltdown, while the Federal Reserve would monitor important financial institutions, with a similar goal.

But Americans didn’t watch the global economy fall into peril last year because we lacked a systemic-risk regulator. Rather, the nation risked entering a depression, and taking much of the rest of the world with it, because regulators and lawmakers with ample authority and information consistently failed to apply traditional regulatory principles to changing markets.

Consider credit derivatives, which exacerbated the financial crisis that started in 2007. Through these derivatives, financial companies could expose themselves and financial markets to tremendous risks with no money down.

To wit: Insurer AIG exposed itself to a half-trillion dollars in potential losses by offering investors in certain securities — including mortgage securities — a guarantee that they wouldn’t lose any money if the securities faltered.

Such promises exposed the economy to untenable risk. But regulators could have drastically reduced this risk by applying old regulatory principles to new markets.

If regulators had required AIG and other companies to put down, say, 20 percent of the value of the promises they made in cash, the firms would have thought twice about amassing the obligations they did.

Such requirements would not have been revolutionary. Since the 1930s, two regulatory agencies, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), have placed limits on borrowing for securities speculation.

In the late 1990s, the CFTC’s then-chairman, Brooksley Born, tried to limit borrowing in new derivatives markets. But in 2000, instead of agreeing, lawmakers, strongly encouraged by the Fed, removed the agency’s discretion to impose such regulations on credit derivatives and other new instruments.

Similar examples abound in many areas of the credit crisis. Thanks to Great Depression-era rules, stock purchasers can’t borrow 100 percent of the purchase price of an equity security — but home purchasers, circa 2005 and 2006, could borrow 100 percent of the purchase price of a home, distending the real estate bubble.

Washington, D.C., should understand that notwithstanding a few gaps that should be filled in, regulatory institutions largely failed not because of some fault in their structure or discretionary authority, but because they didn’t apply longstanding safeguards to new markets — or, in the case of the housing market, to newly speculative markets.

Instead of pushing bureaucratic rearrangements, then, Geithner and his boss should remind lawmakers that regulators’ mission is to apply and enforce longstanding principles. These include, but are not limited to, uniform, consistent limits on borrowing, both within financial markets and across financial companies.

Moreover, regulators must keep doing this job as markets continue to evolve, and lawmakers must let them do so, even as memories of the financial crisis fade.

Geithner and Obama likely could garner conservative support for such an effort. Conservatives, after all, are supposed to apply well-tested ideas and principles to new challenges.

Nicole Gelinas is a Manhattan Institute senior fellow and author of the forthcoming book “After the Fall: Saving Capitalism from Wall Street — and Washington.”