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June 30, 2009

New Finance Rules Could Create More Problems

We Should Learn From History

In a Wall Street Journal article from a couple of weeks ago (http://online.wsj.com/article/SB124524649229423271.html), the Obama Administration has urged regulators to overhaul the financial system in an attempt to soften the economic blows of booms and busts. Many in the Democratic Party believe that lack of government regulation led to all of the problems associated with the financial crisis and that more regulation is needed. However, liberals need to understand that regulations can cause more problems than what they intend to solve.

For example, in the past decade, Congress passed the Sarbanes Oxley Act to closely regulate corporate accounting and transparency of publicly traded companies. One of the rules that Sarbanes Oxley latched onto was mark to market accounting. This forced companies to account for their assets based on the values that they would sell for today, as opposed to a rolling average or some sort of mechanism that stabilizes the value of these assets.

This mark to market rule allowed for the bubbling of the housing market. Furthermore, with artificially rising valuations, banks were able to lend more money based on inflated asset values. This created an economic bubble which burst when the economy turned south. Now, mark to market is not the sole cause of the economic crisis, but it certainly was a regulatory mechanism which helped exacerbate it.

We must be careful in overhauling the financial system so that we do not create regulations that increase the likelihood of bubbles. We must also be careful not to abolish any existing regulations which may promote capitalism or effectively regulate the system.

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