Obama's Wall St. Reforms: Timid at Best

A congressional oversight panel (COP) appointed to monitor the Wall St. bailout (TARP) outlined a few of the problems so far in its second report (released yesterday) including:

• The shifting rationale for a program that amounts to dumping hundreds of billions of dollars on the companies that got us into the mess, along with a continuously changing approach and no guarantee that it will actually stabilize financial markets or help those most impacted, including "homeowners threatened by foreclosure, people losing their jobs and families unable to pay their credit cards," let alone protect the interests of taxpayers or bring confidence back for shareholders.

• Although Treasury responded to a first round of questions from the COP, "it did not provide complete answers to several of the questions and failed to address a number of the questions at all." For example, the panel "still does not know what the banks are doing with taxpayer money." In other words, the Treasury's handling of the bailout is starting to make Paul Bremer's mismanagement of Iraq's reconstruction project (remember the bricks of $100 being thrown around without any accountability?) look like a small corner-store stickup. Perhaps the panel could recommend that Congress hire Stuart Bowen to set up shop over at the Treasury. At the same time, Congress could start asking why Treasury's strategy "appears to involve allocating the majority of the $700 billion to "healthy banks," banks that have been assessed by their regulators as viable without federal assistance."

So, we have to ask why Obama is asking for more money to be disbursed when the first $350 billion has been allocated without accountability, and the Treasury department reportedly isn't in a rush to receive it.

We seem to be headed for a triple-failure response to the crisis:

First: A poorly-managed bailout (TARP),

Second: A stimulus package that most economists agree will not be enough to revive the economy and, with a good portion going out in the form of corporate tax breaks instead of shovel-ready projects, may not even be enough to stop the hemorrhaging of jobs.

Thirdly, and perhaps most importantly: The absence of any serious debate over financial regulatory reform.

Congress is too tied up with the stimulus package to take on this latter responsibility with anything like the seriousness it deserves.

Maybe that will change with the incoming administration. After all, it was Obama who said in his March 27 speech at Cooper Union that, "To renew our economy and to ensure that we are not doomed to repeat a cycle of bubble and bust again and again and again, we need to address not only the immediate crisis in the housing market, we also need to create a 21st-century regulatory framework."

Let's hope so, but so far there is no evidence for it. All of Obama's speeches have focused on the stimulus package and fiscal (rather than regulatory) policy, with little more than a nod to the idea that some kind of reform needs to occur in the mortgage markets. Not much more than that. The danger is that they will move quickly to pass something simple, especially with a G20 summit coming up in April that puts additional pressure on the new administration to demonstrate new leadership. And so, the drum is beginning to beat in Washington for Congress to quickly reform the current patchwork of regulations by giving the Fed expanded authority over banking regulations, a move that could be disastrous.

I could be wrong about this, but if I'm not, let's hope Obama is smart enough to resist any such proposal.

For one, if we want strong regulators we need to house them in public institutions. Just as Treasury Secretary Paulson has suggested that Fannie and Freddie will fail if they have to serve two masters - shareholders and the public, whose interests often conflict -- so many of the other institutions responsible for getting the economy back on track must be redesigned to more capably represent the public interest.

If we want to get beyond the ideological fixation with deregulation that so many (including Alan Greenspan) have finally acknowledged failed to keep the system from doing itself in, then we need to put our faith and support behind strong public regulatory institutions, instead of the now-discredited Self-Regulating Organizations like FINRA and the AICPA.

Another example of this is the credit rating agencies, which essentially function as the government's surrogates. To make sure they certify investment grade securities, they should be made public utilities or non-profits. (The same thing should have been said about the auditing function, which was left with the accounting firms after Enron. Instead, they were left to form a cartel that is now pushing to insulate itself from any accountability through civil liability caps.)

We need to recognize up front that the Fed is NOT as currently designed a purely public institution and therefore debate whether the Fed's authority for bank regulation should be expanded (in which case it probably needs to be reformed to be more publicly accountable) or whether we need to come up with alternative, like some kind of coordinating body responsible for allocating authority, smoothing inter-agency collaboration, and preventing the kind of regulatory arbitrage witnessed in recent years by the shape-shifting financial institutions.

Either way, simply assuming that turning more power and regulatory authority over to the Fed would be to ignore a number of critical facts: a) It wouldn't guarantee that the Fed will protect other interests besides the big commercial banks and bank holding companies. The Fed was never intended to protect the interests of consumers, homeowners or even shareholders (the SEC's job). As anyone familiar with the ways of Washington know well, single institutions can have vicious internal policy fights, especially if different divisions represent constituencies whose interests can sometimes conflict. Anyone who believes the Fed should be charged with protecting homeowners might want to review its history of enforcement of the Community Reinvestment Act; anyone who thinks the Fed can clean up Wall St. might be forgetting how it helped block the regulation of derivatives when proposals were brought up in Congress. (To be fair, the SEC under Arthur Levitt and others were aggressively opposed to derivatives regulation, and their view may have held greater weight.)

Another problem is b) that the Fed is even less transparent than the SEC and other regulators (ever try to send a FOI request to the Fed?) The advantage of the Fed is that it is not publicly funded. But that's the disadvantage, too - it's easy to imagine that it will claim (as it has in the past) that it is not a public agency, and therefore exempt from public oversight and control.

If you want an example of how opaque the Fed is, check out former House Financial Services Staffer Robert Auerbach's history, "Deception and Abuse at the Fed," in which he describes how Alan Greenspan and other powerful Fed officials blocked Congress from providing oversight by falsely declaring - for 17 years - that it had no transcripts of its hearings.

Finally, there's an inherent and obvious conflict of interest at issue here: The fact is that the Fed is too intertwined with the big banks themselves to adequately regulate them. E.g. the majority (6 of 9 directors) of the governing boards of the regional reserve banks are selected by the banks themselves.

If we're going to give the Fed more power, then it's clear that the Fed itself needs to made more public. However, unless Congress is willing to undertake a broader examination of the issue, we won't see any other alternatives put on the table, and very little resistance to the notion that elevating the Fed's authority is a good idea to begin with.

Bank regulation is a complex and important issue, and at a time when the financial services sector is the most powerful -- constituting some 30% of the economy (27.4 percent of all of corporate America's profits in 2007, not including GE Finance, GMAC and other corporate financial divisions); in a time of crisis so much is at stake that we need much more from Congress than a simple rush-to-fix-it proposal.

That's why the first thing Congress should do (and could have done a long time ago) in this area is empanel a commission to examine a variety of important questions, including the elimination (or at minimum proper regulation) of derivatives; strengthened consumer and taxpayer protections; structural regulation and antitrust questions (including how to prevent regulatory arbitrage and the dangers of cross-sector integration); and the elimination of offshore tax haven scams.

What we need is something like a combination of the Pecora commission that Ron Chernow so wisely reminded us about, and the Temporary National Economic Committee, which began to examine the structure of various industrial sectors back in the late 1930s. (Hopefully we don't have to get that far into a depression before Congress does something like that.)

It's an old truism in Washington that how a crisis is solved is determined by the terms of the debate. It's also true that he who pays the piper plays the tune. Although candidate Obama proclaimed his independence from corporate lobbyists and PACs, we learned in today's WSJ (who used data compiled by Public Citizen) that "90% of donations (to Obama's inauguration) received so far have been raised by well-heeled fund-raisers, including Wall Street executives whose companies have received billions of dollars in federal bailout money." As a group, people affiliated with Wall Street firms donated $5.7 million through financial service industry bundlers.

It looks like "Government Sachs" has yet to be sacked.

Thus, we should be automatically suspicious of any proposals coming out of Washington, starting with Obama's recent request that Treasury release the second $350 billion. But we should also be wary of any proposal for financial regulatory reform that makes a laughable lunge for simplicity, especially if they don't come after fierce debate.

As economist Robert Kuttner, author of Obama's Challenge (and a new report that explains how we should strive to reform the financial regulatory system) said here last week, "the issue isn't whether to regulate or not, but the character of regulation."

We are often told that Heraclitus once said, "character is destiny." Judged by his appointments and the direction and timidity of the proposals coming out of the transition team, so far the character of the regulations being proposed by Obama seem destined to fail...C'mon, Mr. Obama, step it up! What we need is more than a nudge. We need a strong regulatory push.

Comments

[cam]

Picture the economy as a great drainage basin with money precipitating into it. Rivulets become streams which become tributaries then rivers and eventually drain into a vast ocean of capital. If money doesn't fall then the river will run dry.

Top down economic theory claims that river can run backward. Bottom-up theory tries to make sure money evaporates from capital so it can precipitate over the drainage basin. Naturally, the people who control the capital try to stop it evaporating. In other words, they try convert real capital to financial capital and hold it as such.

If we conflate capital and gross domestic product then there are three ways to evaporate capital: i)consumer investment, ii)government spending, iii)exports minus the value of imports. Of these, currently only government spending is a viable option.

If the government simply prints money it will result in inflation, effectively a tax on financial capital. Add to this a direct tax on financial capital and you will soon have a growing economy. The art lies in making sure that money precipitates at the base of the economy.

[humblediplomat]

The TARP may be the biggest financial scam in history. Imagine the largest corporations in the world getting billions and billions of taxpayers dollars for free with no strings attached.
If you want to help the "economy" don;t you mean workers, so why not give them the money directly instead of to the rich and hope it trickles down even though it hasn't trickled much in the past 8 years. Workers would spend the money on what they really need and that would help businesses grow if those businesses are providing a necessary service at a good price. If a business like a bank is just providing rip off credit card rates, and ARMs then those are not services our economy needs.

The TARP will just bankrupt the US Treasury in record time and could lead to the privatization of parks, roads bridges and security as there will be no tax dollars to pay for their upkeep.

[fisharefreinds]

This was a great article and even I could follow it! Thank you for writing it!
Thirdly, and perhaps most importantly: The absence of any serious debate over financial regulatory reform.

I would like to see brokers held to the same legal regulations as Doctors--can't say lawyers cause they run the show and sueing a lawyer is the same as trying to whistle against the wind.

[DiogenesOfAlaska]

In my opinion, the tarp and the stimulus are clearly of immediate concern and that they have so far been sub-optimally managed or outlined is because the new administration isn't in office yet.

But both may still work out fine, with the appropriate refinements and oversight.

That regulation has so far not been discussed much is certainly bad, but I doubt that there is even the smallest likelihood that the deregulators will receive much attention in the forthcoming decade. It is evident now that markets left to their own devices have failed.

The fact that the discussion is only slowly gaining in pace isn't too dangerous, I think. The design of the new regulatory regime matters most, and its immediate (as opposed to long-term) effect consists mostly in the trust it inspires. And that trust mainly depends on whether it is arrived at in the right process of consultation between practicing regulators and central bankers, academics, law-makers, and representatives of financial institutions.

Yes it is of the utmost importance that this process is not allowed to be obstructed or delayed. But it is taking place, and the more rationality and prudence and foundation in valid argument there is in this process, the more trust it inspires.

It is happening already. And there is no basis for light-touch regulation now. Even the most fervent believers in markets must regulate, just to save markets from melting down. No way out this time around.

[scannerman]

"To regulate or deregulate, that indeed is the rub. If you put yourself in the public's rather holey shoe's, you want regulation. If you put yourself in the banker's rather expensive shoe's, you do not. If you put yourself in Congress's finely crafted shoe's, well that depends on which side your own. Now. Put yourself in President-elect Obama's rather hot shoe's. If Mr. Obama doesn't know how to navigate, he better learn fast, because I haven't even mentioned the media's running shoe's. While I need a pair of shoe's right now, I believe I'll wait to see which one's come out on top.

[PastorAgnostic]

great article. Spot on.

And I think today's horrific market is a reflection of his timidity.

[cayuse]

US economy DOES NOT HAVE AGGREGATE DEMAND

Corporations have had the largest profits over the last 8 years. Unfortunately the money has gone to Dividends to the rich. There has been little or no corporate spending. There has been loss in jobs.

First we need cut off dividends which redistributes the wealth to the rich and does not reward the worker for genius and labor. Then we need to make sure all Corporations pay 35% tax unless they spend on Capital Expenditures or Labor. IT IS THAT SIMPLE. Corporations are the only ones who create jobs. Consumer spending increase AGGREGATE DEMAND

[000Jade000]

Cayuse, I used to agree with you re: corporate taxes. I don't anymore. I now think that corporate taxes should be ABOLISHED. The perspectives of Robert Reich and Lester Throw of MIT have shaped this new view of mine.

Reich's views are that:

1) corporate taxes, as they stand, give the false impression that corporations PAY taxes, which perpetuates the myth that they are PEOPLE. (They are NOT people, but hide behind "no taxation without representation.")

2) whatever corporate taxes ARE paid are in reality indirectly paid by the company's consumers, shareholders, and employees--which perpetuates inequality and, again, gives the public the false impression that corporations pay taxes

3) on inequality--interest payments made by corps on their debt are deductible from the corporate income tax while dividend payments are not...creating incentive for corps to overrely on debt financing and to retain earnings instead of distributing them as dividends. The result is that corporations accumulate huge sums of money and uses it to purchase other companies or buy back its stock shares. Money is NOT redistributed to shareholders as dividends.

[000Jade000]

4) Thurow's view is that the tax should be abolished and shareholders should pay personal taxes on corporation profits made on their behalf. Corps would then be revealed to be partnerships of shareholders and corporations would withhold taxes owed based on the shareholder's tax bracket from their "corporate" earnings. Shareholders would receive an annual W-2-like form to determine how much income should be added to their other streams of income and how much income tax has been withheld. Corps. would then have no artificial incentive to retain earnings and taxes would be lower for lower-income shareholders; higher for higher-income shareholders.

You can read more about Reich's position here: http://www.bloggernews.net/119016

One of the outcomes of abolishing corp. taxes would be kicking them out of our democracy, which is what we really need.

[Erdgeist]

The solution is not complex -- except that most economists have their heads in the abstract sands of supply-side economics refusing to pull them out. TARP was such an exercise in supplying the supply side that loans out money. In addition, giving a loan to GM and Chrysler was another example of supplying the supply side.

Thus far, no jobs have been created buy supplying the supply side with tons of cash. And this is the real conundrum: how to we get demand going? It isn't going. No economic model of which I am aware has proven a supply side fix to actually work.

The British economist, John Maynard Keynes, paid attention to the demand side. He also advocated a temporary "revenue tariff" to provide capital to the government to provide jobs, etc., so that taxes wouldn't have to be raised and the country wouldn't have to accrue a huge debt to stimulate the economy. So where are the professors of economics on this one? Have they actually read Keynes?

[Rule Of Law]

Dismantle the FED. Break up Goldman. Shut down the Wall Street Casino. Return the right of minting and distributing the People's money to the People through their Congressional Reps as required by the Constitution.

[kaski]

There would be no corporate or Federal income taxes if Congress were to overturn the 1913 Federal Reserve Act which gave power over our central banking system to several American families, (Rockeffelers, Morgans, Warburgs, Duponts, Schiffs, Rothschilds...). President Wilson regretted signing the Federal Reserve Act of 1913 into law. He later realized that he had given control over our government to these several American families.
"I am a most unhappy man. I have unwittingly ruined my country. Agreat industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefor, and all of our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world, no longer a Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men." Woodrow Wilson

[Samshade77]

I don't think that is an actual qoute by Woodrow Wilson, There is no proof of him ever saying that. Please site your source. Thank you.