Regulating Financial Services—More or Less?

January is Financial Wellness Month. Economics, finance, and banking are areas of vital consumer interest, but, unfortunately, ones that have been neglected in the average consumer's education. Since 1999, two pivotal moments played heavily in the recent financial fiasco. In both cases, the decision for less regulation played a significant part. The first was when large banks got their wish and won the repeal of provisions of the Glass-Steagall Act, which prohibited bank holding companies from owning other financial companies, such as Wall Street investment banks.

The second was the decision to forego the regulation of over-the-counter derivatives transactions between sophisticated parties as futures under the Commodity Exchange Act. It would have dire consequences related to a derivative security call, the Credit Default Swap.

Traditionally, the mortgage industry operated using proven rules. To get a loan without government support, you needed 20 percent down or mortgage insurance. A borrower needed to have gross income of which 28 percent would cover the principal, interest, taxes, and insurance of a mortgage payment.

Federal backing made for smaller down payments. Home ownership became a reality for the majority of our population. Then the creative finance CEOs in big investment firms on Wall Street decided that the money was too easy to ignore, and that loan-to-value and gross-income requirements were unnecessary. They bundled these subprime mortgages into "AAA rated" investments and sold them in the U.S. and around the world. Eventually, even Fannie Mae and Freddie Mac participated as well because the new class of aggressive investors didn't want to bother with old-fashioned lending of the type they facilitated.

The money used to buy a large portion of the portfolios of these mortgages was borrowed with money backed by the government through the FDIC, since investment banks could own commercial banks and vice versa. Bank regulators overlooked the potential lack of value of these bank assets. Part of the reason no one worried was that these investments were supposedly 100% backed by non-regulated large insurance companies (such as AIG), which they were not.

While unwise regulations are dangerous, regulation isn't our enemy. Regulation exists and is necessary, like it or not. The key is not blathering on about freedom but to have the discussion, weigh the options and make good choices based on sound policy and reason. To oppose regulation because all government involvement in private enterprise is bad, is to not enter the conversation.

Learning Activity: Assign students to take either the Pro or Con side of the issue: "Should the U.S. government impose more regulation of the financial sector?"

Students should address the essential questions for critical thinking (you can substitute others) included with both sides of this issue, citing at least three resources.

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