No Consensus on Financial Reform

After the health care reform, the next major item on the agenda of the Obama administration is reforming the financial system. With the catastrophic events of the last two years fresh in the memory, no one can disagree on how important it is to make the financial system more robust and avoid future crises.

Even though most lawmakers largely agree on what caused the financial crisis, they are finding it very difficult to build consensus on what concrete steps should be taken to improve the financial system. The Republicans seem to have made up their mind to reject almost anything that is put on the table by the government.

Some prominent economists and policymakers have argued that large banks should be split up into smaller entities. They argue that this way we would not have banks that are too large to fail. This would prevent the need to spend large amounts of taxpayers’ money to bail out financial institutions. There was a huge uproar back in late 2008 and early 2009 when hundreds of billions of dollars were spent on supporting the same banks that put the economy on the brink of collapse because of their excessive risk taking.

The opposite camp argues that the main problem with the financial system is not that banks are too large; instead, it is poor regulation that is promoting excessive risk taking by bank executives. They point out that for a few decades after the Second World War the financial system was quite stable because of strong regulation on how banks used their funds. The example of Canada is also often cited, which has stringent regulations governing the functioning of banks. The financial industry in Canada is concentrated with a few large banks but the country was largely immune to the financial crisis.

A major problem in enacting any strong regulation against the financial industry is that every time a major proposal is made, there is fierce opposition from the financial lobby. The lobby is one of the strongest in Washington and has close connections with lawmakers on both sides of the political divide.

There is no doubt that it could be a stern test for the Obama administration to pass a bill that would radically transform the financial industry. If the way the health care bill was passed is anything to go by, it is going to be another long and hard struggle.

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