Star Tribune

October 6, 2008

Whenever a man-made disaster occurs, whether a bridge collapse or a financial crisis, we have a responsibility to find out why it happened and how to make sure it does not happen again.

America's current financial crisis is an indictment of eight years of failed economic policies from the Bush administration and irresponsible business practices on Wall Street. The administration allowed Wall Street to operate like a Wild West gambling hall awash in funny money. At the 11th hour, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson had to step in as the house managers to shut the game down.

The emergency financial legislation passed by Congress will provide help for the immediate crisis. We must hope it will succeed in averting an economic catastrophe that would force millions of Americans to lose their jobs, their homes and their retirement savings.

This crisis also highlights the urgent need to overhaul our nation's framework of financial supervision and regulation to protect the American people against another crisis in the future.

It does not necessarily take more regulation, but it will require smarter regulation and people in charge who are willing to enforce the rules.

When prosecuting crimes, law enforcement must be just as sophisticated and innovative as the crooks. The same principle should apply to policing high-fliers in the financial world.

Unfortunately, America's financial regulators have simply not kept up with the risky products and complex transactions in the modern financial markets. It's like the financiers are speeding their Ferraris down Wall Street, while the financial cops try to chase them in a 1933 Ford.

There are three key reforms that would help bring our system of financial regulations into the 21st century.

•First, we need to insist on transparency in financial transactions.

Since the 1980s, a vast shadow financial world has developed, involving trillions of dollars. These sophisticated transactions are so opaque and disconnected from underlying assets that hardly anyone, whether investor or regulator, can accurately gauge the risk. Many financial institutions, including the bulk of our banks in Minnesota, have been smartly conservative about these deals. But that is not true across the country.

Most controversial are unregulated "credit default swaps." These transactions need to be brought out of the shadows with public disclosures and limits. In addition, the accounting principles used by companies need to accurately measure the value of assets and debt. Warren Buffett's investing maxim is that you buy what you know. But if the books are cooked, there is no way to know.

We also need to reform how securities are rated. In the current crisis, securities rated as "AAA," almost as good as gold, turned out to be toxic assets with almost no value. Someone clearly needs to do a better job.

•Second, we need a backstop for any future mess, so Wall Street rather than Main Street pays the cleanup bill.

One idea is to create a fund that would collect risk-adjusted fees from financial institutions. The next time a financial institution is in trouble, the rescue would be paid for from this reserve fund.

To discourage excess leverage, financial institutions would also be required to meet more stringent capital requirements. This should apply to all financial institutions, including hedge funds, insurance companies and so-called special investment vehicles.

•Finally, our regulatory system should be streamlined.

The current patchwork of regulatory agencies is outdated. Decades ago, it made sense to have different agencies because financial firms were limited to certain types of business. They had to "stay in their lane." Today's financial system functions more like a superhighway. Financial firms speed back and forth between investing, banking and insurance. Regulators see only their small territories, and nobody is responsible to watch out for the system as a whole.

More unified regulation may come from consolidating the many different agencies into one or a few that can be more effective.

Economist John Kenneth Galbraith once observed that every financial crisis, whether the Dutch Tulip Mania of 1637 or the Great Crash of 1929, has "involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment."

The current crisis is no different. To protect the economic interests of all Americans, the federal government must supervise and regulate the markets so debt does not get out of scale.

As we work our way out of the worst financial crisis since the Great Depression, we must act now to update our regulatory framework so it is suited to the financial challenges of our times.

Amy Klobuchar, D-Minn., is a member of the U.S. Senate and serves on the Joint Economic Committee in Congress.