With regard to regulatory reform within the financial services sector, U.S. Secretary of the Treasury Timothy Geithner had this to say, “Not modest repairs at the margin, but new rules of the game.”
Clearly American’s current economic woes cannot be blamed on any one factor. but a lack of effective regulatory oversight is widely believed to be one of the primary causes. The existing regulatory structure is based on a traditional banking model and has not been able to keep up with the rapid changes taking place within the financial sector, such as the growing prevalence of asset-backed securities.
Another weakness in the regulatory system has to do with the fact that regulation was typically focused on individual institutions with little consideration given to the potential for a “domino effect” that could threaten the entire system. When larger firms began to fail, they quickly took their smaller counterparts down with them. Although these small firms might have been quite stable on their own under normal conditions, they were not adequately positioned to survive once the markets began to suffer significant downturns.
But regulatory failure is only a part of the big picture. Greed played a big role as well. From Wall Street to Main Street, Americans made bad decisions prompted by avarice rather than good sense. The sub-prime mortgage crisis is a perfect illustration.
Wall Street fell in love with mortgage-backed securities and wanted more. However, the pool of adequately qualified homebuyers was quickly drained dry. Banks responded by lowering the standards regarding who could be approved for a mortgage and how much they could borrow. Americans responded by buying huge homes they should have known they couldn’t afford.
If the country is going to get through this crisis and come out stronger on the other side, it will require more than just regulatory reform. On both an institutional and an individual level, Americans need to rethink the “play now, pay later” approach and stop being driven by cupidity. It’s not enough to change the rules – Americans have to change the way they play the game. “It’s time to pay the piper”.