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Obama administration misses a teachable moment on financial reform

Americans simply can’t relate to Wall Street. It’s really too bad. The investing and lending activities emanating from “the Street” have played an important role in powering our economic engine. Commercial and investment banks have been a source of capital for both established companies and start-up firms and any clogging of the financial system that provides these firms with needed capital has a trickle down effect on the average American’s employment, his ability to finance a home, and her ability to retire comfortably.

What most Americans don’t get is how commercial and investment banks are able to generate economic growth and realize seemingly enormous profits. What is particularly troubling to a significant number of Americans is how, during an economic downturn, can an investment firm such as Goldman Sachs continue to make profits. Why, asks Joe the Plumber, is my house value falling while an investment bank sees its assets receive a boost, due in part to an infusion of funds from my government?

These questions have received greater emphasis because of a civil complaint filed by the U.S. Securities and Exchange Commission against Goldman Sachs alleging fraud. The SEC accuses Goldman of failing to disclose that certain parties were betting against an increase in value of a collateralized security that Goldman sold to others.

In addition to Goldman’s new legal troubles, citizen skepticism and cynicism found no relief in U.S. Treasury secretary Timothy F. Geithner’s statements yesterday before the House financial services committee. Mr. Geithner described Lehman Brothers’ participation in a “shadow banking” industry that saw financial bets made by poorly collateralized banks and investor runs on the money market funds that held shares in these banks.

Mr. Geithner conducted his usual song and dance description of Wall Street banks as the spawn of the devil, insinuating that the banks’ attempts at hedging against losses on their balance sheets by using derivatives was a bad idea. Mr. Geithner then proceeded to pat himself on the back twice, reminding us that he was the president of the Federal Reserve Bank of New York during the Bush administration’s attempt to bailout AIG and Lehman. This intervention was right because, as Mr. Geithner reminds us over and over again, the lifelines thrown to these companies helped to keep the train from going over the cliff.

Too bad neither he, as the New York Fed’s president, the Bush administration, and now the Obama administration were really looking out for consumers. If they were, they could have explained how the same types of market-based techniques used to hedge the bets of the big banks could have been used by homeowners to protect their home values.

Specifically, homeowners can purchase home equity protection, paying a premium equal to one percent to three percent of a house’s value at time of purchase. Based on a geographic index of prices, if the house value falls, the homeowner would receive a payment to make up the difference in the value at purchase and the lowered estimated value at the time of a sale or refinance. Instead of spending billions to say, “See. We are pretty cool because we saved you”, the Obama administration could promote the consumer purchase of this protection thus avoiding any grandiose “too big to fail” consumer protection programs.

Unfortunately I don’t see this administration promoting market-based consumer protection policy anytime soon. That type of policy just doesn’t buy votes.