Financial Rule Overhaul Must Consider Effects

The Obama administration's proposals to overhaul financial regulations sound good in principle: the goal is to prevent large banking and financial firms from becoming so burdened with risky investments that they again threaten the health of the entire economy.

But the administration and Congress should be wary of rushing too quickly into a new regulatory scheme without a careful examination of all of its effects. The administrative landscape is littered with laws and regulations that have proved to have unwise unintended consequences.

Case in point: Sarbanes-Oxley, a federal law that imposed much stricter accounting and reporting requirements on U.S. corporations in the wake of the Enron collapse in the early years of this decade. The cost of compliance has been huge, and the law has been seen as a hindrance to forming new companies. And now the U.S. Supreme Court has taken a case that challenges the constitutionality of the part of the law that sets up the agency that administers the act.

Certainly, it makes sense to strengthen the ability of the government to require sounder balance sheets of major financial institutions, and to make sure lenders in the mortgage market retain some risk so they have an incentive to have sound lending practices.

But rules and standards must be clear; in the first few years of Sarbanes-Oxley, they weren't, which led to confusion and extra costs.

And the administration must restrain Congress from its eagerness to micromanage corporations on items such as executive pay. As State University of New York accounting professors Richard Gifford and Harry Howe have noted, an attempt to put a lid on executive pay in the 1990s by eliminating tax deductions for salaries over $1 million led to the creation of huge stock options for executives, which in turn led to short-term thinking and fiddling with corporate income statements.

There are limits to the ability of even the best regulators to foresee all the results of their handiwork.

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