You may remember the posting I did on the Volcker Rule (28th July – “82 year old holds key to banking regulation in the US”) which talked about the role of former Fed Chairman Paul Volcker in the Dodd–Frank Wall Street Reform and Consumer Protection Act – 2010. The implementation of the Act is currently being discussed by members of the Financial Crisis Inquiry Commission. Vice Chairman Bill Thomas suggested that the regulatory architecture being created might stifle financial innovation and used the metaphor of a child playing in the snow. He said:
I often think, you know, you’ve got the cartoon of the child who’s going to go out in the snow so the mother puts on one layer, two layers, three layers, and it finally then is allowed to go outside and play and it can barely move getting outside. You can set up a structure to make sure that it doesn’t happen, but how do you keep the flexibility to allow the system to function? Where are we in terms of your concerns — Dodd-Frank legislation, providing some additional tools, comfort level, and now understanding better and more importantly, if we are now not going to have these crisis interventions when we do fail, unwinding structures in a reasonable way?
Ben Bernanke later in the hearing had a metaphor of his own. He likened the subprime crisis to the dangerous bacterium E. coli, suggesting that the housing crisis was simply the catalyst that exposed deep-seated susceptibillity in the financial markets.
If we had a healthy, strong, stable, financial system, it could’ve accepted this problem without creating such a major crisis, so I believe very strongly that it wasn’t subprime lending per se, although obviously that was a bad thing and caused significant problems, but rather it was the fact that the system as a whole had structural weaknesses. And so if you like, the E. coli got into the food supply and that created a much bigger problem.
The report is due to be completed on 15th December. Click here for the New York Times article.