Silence Is Golden: The Financial Markets and the State of the Union

The president will probably not say very much about the financial system in this year’s State of the Union address. This is a tribute both to our recovery from the financial crisis and the extensive work that has been done on revamping our system to avoid a fiasco of this magnitude in the future.

I wish that he would highlight a comprehensive plan to restore the housing finance system by replacing Fannie Mae and Freddie Mac or very substantially altering their roles and removing them from effective government ownership. However, this is not politically attractive and he will probably not choose to use his limited bargaining chips to achieve this. We may well be stuck with the unsatisfactory status quo for many years. Politicians are caught in a bind. They recognize that Fannie and Freddie cannot be restored to their former, very dangerous roles and they want to reduce the government’s current bloated role in housing and the attendant risk to taxpayers. On the other hand, middle class voters determine elections and they highly value subsidies that make mortgages cheaper. Any solution that truly cuts back on government guarantees will also make mortgages more expensive and harder to obtain. It is easier politically to keep kicking the can down the road.

I hope that the president avoids populist rhetoric attacking Wall Street, but it may be difficult to resist including some swipes at a group hated by voters. The Administration has actually supported quite balanced approaches to restoring our financial system, embracing comprehensive changes to make the existing structures safer while avoiding radical “solutions” that could do real damage to the economy. However, inflaming popular passions could inadvertently fuel some of the damaging proposals out there that are based on the mistaken belief that little has been done to make the financial system truly safer. In reality, the total impact of the legal and regulatory changes that are in process will be quite large and should substantially reduce the danger from future financial crises. (It will never eliminate them as long as humans are in charge of markets and of their regulation. Herd behavior inevitably produces bubbles from time to time.)

In the end, the best we can hope for on the topic of financial regulation in this State of the Union address is probably silence.