By Ryan Wynne

Both the U.S. Senate and House passed versions of financial regulatory reform bills intended to protect consumers and prevent financial fallouts that could cause another recession. Before President Barack Obama can sign the bill into law, the two versions of the bill must be reconciled.

Support for the bills is mixed. Some lawmakers think it goes too far, while others don’t think it goes far enough. In fact, Sen. Maria Cantwell, D-Wash., voted against the Senate version of the bill, which passed in a 59-39 vote.

“While this bill takes much needed steps to help prevent a crisis of this magnitude from ever happening again, it fails to close the very same loopholes in derivatives trading that led to the biggest economic implosion since the Great Depression,” Cantwell said in a press release.

But there is another perspective. Hart Hodges, director of Western Washington University’s Center for Economic and Business Research, said he thinks some kind of reform should take place, but that the timing is not right. The reason: We are just too close to the crisis and not enough discussion has occurred regarding the ramifications of regulations proposed in the bills, he said.

Among many other things, the bills include regulation of derivatives (betting on future movement of securities), formation of a group of regulators to look for risky behaviors and assignment of a federal regulator to enforce rules that protect consumers.

That doesn’t sound so bad, but Hodges is concerned. Not enough time has been spent thinking about the ways banks and other financial institutions will respond to regulations, and that’s critical because they will respond, he said.

A market built on innovation

Hodges also worries about the implications regulations could have on innovation, which markets encourage, he said. Innovation stems from people trying to make something quicker, easier or from someone trying to make more money. By its nature, innovation creates change, he said. Regulation, by its nature, tries to create predictability and certainty, but the world isn’t predictable Hodges said. Without innovation (disruption), a market would be stagnant, he said.

“Innovation is a good thing, but innovation can rock the boat,” Hodges said.

Right now, effects of regulating innovation are still unknown, he said.

“Innovation is disruptive, and regulating it is really hard to do if you don’t understand it,” Hodges said.

One of those innovations is derivative trading, and Mark Wallace, a financial adviser at Bay City Financial Services, said he isn’t sure that is a sustainable practice. But, for the past 20 years, banks have made money off of trading derivatives, he said.

In the long run, regulation could be a good thing, Wallace said, “but in the short term it could be a shock to the system.”

Wallace agreed with Hodges that some kind of regulation should occur, but said he is confident that at the end of the day Congress would create something that works.

“I think the end product will be what is necessary to provide the right amount of regulations, but that remains to be seen,” Wallace said.

Concerns

Whatever those new regulations end up being, Hodges is afraid they will almost certainly impose costs on consumers because consequences haven’t been thoroughly thought through, he said.

Not only that, he said, rules designed to address current problems could quickly become outdated. For example, he said, rules can be created that would reduce or eliminate predatory lending, but those rules deal with problems we understand through experience.

“It’s a much more difficult task to write rules that minimize the impacts of problems you haven’t imagined yet,” Hodges said.

Like Hodges, Wallace has concerns. He is worried about the government taking regulations too far and isn’t quite sure how regulations will affect the market. There is a possibility that regulations could cause reduced return rates on investments, that banks would end up charging higher interest rates on loans, and that increased regulation would reduce efficiency and increase costs, Wallace said.

Still, with all his concerns, Wallace said banks should be more heavily regulated.

“Basically, our banks have been left to police themselves,” Wallace said. “They were given free rein to take a lot of risks.”

As we have seen, if one of the big institutions fails, that failure can have ramifications that affect everyone, he said. Wallace said the government shouldn’t go too far, but we do need something in place.