A rarity....financial sense in Washington

In flipping through the channels I came across an interesting program on CSPAN-2 about the Securities & Exchange Commission Agenda.

The thing that caught my attention on this program was something the main speaker, Dan Gallagher of the SEC, said that to me seemed quite sensible, and illustrates one of the many side-effects of the Federal Reserve's policy of keeping interests rates artificially low:

I think a focus on fixed income especially in a 0 percent interest rate environment.  Right, where we are watching investors chase yield  in crazy places where they don't want to be either.  Right.  They'd rather be in an interest bearing CD but they can't be so they are in junk bonds and munis.

This is exactly the same sort of incentive that helped lead to the financial crisis in 2008.  Government policy led banks and other financial institutions to chase yields in places they would rather not be.  As government agencies like Fannie Mae and Freddie Mac took over more of the mortgage business, banks had to take on more risk to stay in business.  Once those riskier mortgages, which Fannie Mae and Freddie Mac then packaged up and resold in order to comply further government rules that 50% of loans be sub-prime mortgages, began to default the whole system began to break down.  For more on the causes of the financial crisis, check out this presentation by John Allison, who was the head of one of the largest financial institutions in the country during the crisis.  Well worth watching in its entirety.

Later in the program he answered a question regarding the diversity of the American financial services industry and the danger of  "implementing 400 rules is that you will begin picking winners and losers among financial firms" and suffocating the way American entrepreneurs access financial services, he said:

You've touched a cord I've been talking a lot about lately in less formal settings, but to me the issue is capital markets versus the banking markets.  What I fear coming out of the crisis, what you see in Dodd-Frank, what you in the EU directives and international bodies, like FSB here or FSOC domestically is sort of the bank regulatory view of the world taking over the capital markets.  Right the notion of de-risking and safety and soundness.  It sounds great when you come out of the crisis.  When you have seen hell and come back.  the last thing you want to do is engage in risking taking or to encourage risking taking.  As a regulator to allow it to happen at all.  Because you got burned in whatever narrative about the crisis.  But as you know the capital markets are all about risk.  Without risk we don't have the capital markets.  You have to put your capital at risk if you want to get a return.  We can't de-risk them.  Money market funds are a good example, when you start talking about silly things like capital buffer, de-risking something at 50 basis points that might kill the product.  Right at the risk of killing the product it doesn't make any sense.  But this is the mind set that's pervading.  It is something we all have to watch.  Because soon enough, if there are not enough opportunities to take risk and get a return. You know, the economy is bad enough now, lets see how it does after that mind set takes over. [ed. any errors in this transcription are mine.]

It is good to know that at least one person at the SEC realizes that implementing more poorly thought out rules and regulations could and likely will have negative consequences to the nation's economy.  For more of how Dodd-Frank will likely damage the economy, check out this article.