The subprime mortgage implosion will mark the end of the era of financial market deregulation, if Representative Barney Frank, Democratic chairman of the U.S. House Financial Services Committee, has his way.
The 26-year Congressional veteran from Massachusetts kicked off hearings into the credit-markets mess this month. But he had already made up his mind to back increased federal control over nonbank mortgage issuers and dealers. His next goal: to force greater disclosure from hedge funds, many of which borrowed heavily to buy subprime securities, sometimes with disastrous results.
Frank acknowledges that House Democrats' oversight initiatives may bog down in the Senate, but he is convinced that after 12 years of effective Republican control of Congress, Wall Street needs taming. He spoke with Institutional Investor Contributing Editor Craig Mellow.
1 How should Congress respond to the subprime mortgage crisis?
We're going to put the same kind of regulation on all mortgage originators as we have on banks, which did a much better job. We're going to put some liability on the packagers of secondary mortgages, and we're going to increase the ability of the Federal Housing Administration to be a subprime mortgage insurer.
There was resistance to some of these things earlier in the year, but that has faded. The broader question now has to do with spillover into the broader markets -- hedge funds, private equity, Chinese money and all this liquidity. Innovations have outstripped regulation. The job is to think about how to update regulation to match that.
2 How does this play into the issue of regulating hedge funds and derivative instruments?
The needle has moved to where we want -- at the very least-- more information. When Treasury and the Fed are both as surprised as they have been by recent events, clearly there is not enough information. Should hedge funds be regulated as much as mutual funds? No, I don't think so. To some extent what we have now is an investors' strike. How do you break a strike? You negotiate. So it's time to bring the investors in.
3 How about the debate on whether hedge funds and private equity investors are undertaxed?
I don't think the crisis has a big effect on taxation. There will be fewer profits to tax, but that's not our fault. You can make an argument that venture capital for start-ups deserves some kind of incentive. But I don't see how taxing the profit you make from managing other people's money causes a problem.
4 Is the solution to turn back the clock on decades of financial deregulation?
Absolutely. We've had the worst of both worlds, with great innovation accompanied by deregulation. We're not going to stifle innovation. But the time has come now to think about how regulation keeps up with it. We were told that if we put on any lender liability or packager liability, we would kill the secondary market for mortgages. Well, the secondary market for mortgages just died, and people are so worried about the unpleasant surprises they got in that market that they're worried about investing elsewhere. What we can do with reasonable regulation is provide a level of quality assurance to alleviate those fears. The right level of regulation reinforces the market.
5 Which are the most important measures you are discussing?
There ought to be an overwhelming sense now that we need to know more about what's going on in these markets. The second thing is some sense of responsibility for what you pass on. Yes, liquidity is a great thing, and there is going to be some diminution of responsibility when you sell something, or otherwise nobody would ever sell anything. But it can't be 100 percent, as it now is.