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Congress not addressing repos, Fannie, Freddie

Some experts are cautioning The New York Times that financial crisis legislation being developed in Congress may not make important changes needed – mainly to fix the repurchase market, Fannie Mae and Freddie Mac – and, if so, will not prevent the next crisis.

From the New York Times article:

Gary B. Gorton, a finance professor at Yale, said the financial system would remain vulnerable to panics because the legislation would not improve the reliability of the markets where lenders get money, by issuing short-term debt called commercial paper or loans called repurchase agreements or “repos.”

The recent crisis began as investors nervous about mounting subprime mortgage losses started demanding higher returns, then withholding money altogether. The government is now moving to prevent abusive mortgage lending, but Mr. Gorton said investors could just as easily be spooked by something else.

The flight of investors is the modern version of a bank run, in which depositors line up to withdraw their money. The banking industry was plagued by runs until the government introduced deposit insurance during the Great Depression. Professor Gorton said the industry had now entered a new era of instability.

“It is unfortunate if we end up repeating history,” Professor Gorton said. “It’s basically tragic that we can’t understand the importance of this issue.”

Treasury Secretary Timothy F. Geithner agreed in April testimony before the House Financial Services Committee that “more work remains to be done in this area,” but he said that regulators could address the issue without legislation. The government plans to require lenders to hold larger reserves against unexpected losses and to require that they keep money on hand to meet short-term needs.

David A. Skeel Jr., a corporate law professor at the University of Pennsylvania, said it would be a mistake for Congress to leave the drafting of these standards to the discretion of regulators.

“Regulators working right now will be tough,” Professor Skeel said. “But we know from history that as soon as this legislative moment passes, the ball is going to shift back into Wall Street’s court. As soon as the crisis passes, what inevitably happens is that the people that are paying the most attention are the banks.”

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