For Whom the (Trading) Bell Tolls: Reforming Wall Street to Protect Main Street
In the heat of the debate about the need to fundamentally reform the way financial markets operate, both here in America and abroad, one crucially important point risks getting lost: the stakes for the middle class.
Too often, debates like these end up with the regulators on one side and those whom they would regulate on the other. When the debate is focused on obscurities like over-the-counter derivatives and accounting standards, it becomes that much easier for the rest of us to tune out and let the vested interests fight it out among themselves.
But when it comes to reforming our financial system, sitting this one out would be a big mistake. If we get this wrong, the damage will reverberate far beyond Wall Street.
It's all too easy to see why failing to reform our financial system could be so devastating to the middle class. Just look around: the origins of this Great Recession were the unchecked excesses and reckless behavior in the financial industry, as easy money and flimsy underwriting gave rise to a massive housing bubble. When the bubble burst, the financial structure supporting this expansion turned out to be a house of cards, and as that house collapsed, the shock waves were felt not just on Wall Street, but around the world.
So how exactly do these troubles in our financial system affect middle-class families? Lots of ways--and none of them good.
Most immediately, there are tons of middle-class jobs associated with residential housing, from construction to furnishings to real estate, and many of these jobs have been lost. (Employment in residential construction and contracting, for example, is down one million jobs off of its peak). Next, most middle-class homeowners, for whom homes are their most valuable asset, have taken a big hit to their wealth, with home prices down over 30%. The huge spike in foreclosures--another symptom of the bust--is a major contributing factor here: studies show that when a home is foreclosed, the price of nearby homes can fall as much as 9%.
Then there's the impact of the credit crunch on business activity, on loans, and once again, on jobs. As much as it sometimes seems as if Wall Street and Main Street exist on different planets, they're intimately connected. Whether it's a loan for a home, a car, or a college education--or just credit for a small business to keep its shelves stocked--the credit freeze born of the collapse of the housing bubble is a chill that continues to be felt throughout this nation. What starts as a risky derivatives trade in the boardroom of a New York skyscraper can all too easily end up as a distressed conversation around the kitchen table in a middle-class home in Wisconsin.
And there's another crucial piece of fallout from all of this bubble-driven speculation, one that has been particularly damaging to the middle class: financial bubbles are associated with income growth bypassing low- and middle-income families and accumulating at the very top of the income scale. Before the crash, in 2007, the wealthiest 1% of households received 23.5% of all income, the highest share on record going back to the early 1900s. But there was one ominous exception: 1928, the year before the crash that began the Great Depression, when 23.9% of the income went to the top 1%. That bubble didn't end too well either, as you may have heard.
And while the top was surfing the big wave, the middle class was treading water and the poor were drowning. Despite years of economic growth and solid productivity in the last economic expansion, the median income went nowhere and poverty rose. Incredibly, according to Census Bureau data, real median household income in 2008 was about $1,000 lower--that's right, I said lower--than it was a decade before.
For all of these reasons, President Obama is proposing the most significant overhaul of the financial system since the 1930s. From the perspective of middle-class families, the reforms we've proposed have a clear mission: to create and enforce common-sense rules of the road that will ensure we're not back here again a few years from now.
For example, the Consumer Financial Protection Agency we've proposed would, if created, enforce fair rules to eliminate the misleading terms, hidden fees, and exploding interest rates that some banks use to pad their profit margins at the expense of ordinary Americans.
This kind of abuse is a big problem for middle-class families. During the housing bubble, banks and mortgage lenders routinely drew families into mortgages they didn't understand and couldn't afford. Some of these mortgages looked affordable at first, but their interest rates skyrocketed after a few years; others gave homeowners the option of interest-only payments for the first few years, without mentioning that this "option" had a good chance of leaving the homeowner with an underwater and unaffordable mortgage a few years down the road.
The Consumer Financial Protection Agency would also regulate the practice of charging exorbitant hidden fees on credit and debit cards. For years, rather than seeing genuinely transparent competition on price and service, we've seen banks seeking to profit from credit card lines by burying fees in the fine print. For example, banks will make $27 billion this year just from the overdraft fees they charge on debit cards. We want to stop the practice of charging misleading or abusive hidden fees so that consumers know what they'll be paying and can choose the product that offers the best price and terms.
Another key aspect of reform is to prevent what's come to be known as "systemic risk." One reason we ended up in the mess we're in is that financial institutions around the world became tightly linked, owing huge sums to each other in contracts built on massive amounts of debt and supported largely by the assumption that home prices could defy gravity forever.
Those links meant that the failure of one financial institution could threaten the entire system. President Obama's reform plan puts regulation in place to oversee these linkages and to ensure that the financial system borrows and lends responsibly instead of relying on excessive leverage to take on huge risks in search of huge profits.
Still, even with these safeguards, it's important to be prepared in case we once again find a major financial institution on the brink of collapse. In the aftermath of the Great Depression, we faced a similar problem: when one bank failed, there were runs on other banks, creating a destructive domino effect. To deal with this problem, Congress created the Federal Deposit Insurance Corporation. And for years, the FDIC has successfully prevented bank runs by efficiently shutting down failed banks while guaranteeing that the customers' deposits (up to $250,000) will be safe even if the bank fails.
But in the case of today's big "non-bank" financial institutions, like Lehman Brothers or AIG, we don't have these same options. Our reform plan introduces a crucial new function that would let regulators safely shut down troubled financial institutions without endangering the financial system, a function called "resolution authority." This proposal would help deal with the problem of financial institutions that are "too big to fail" by making sure that regulators can allow any institution to fail, but in a way that incurs minimal costs to taxpayers and doesn't cripple the system.
The President summed this all up eloquently: "Though they were not the cause of the crisis, American taxpayers through their government took extraordinary action to stabilize the financial industry. They shouldered the burden of the bailout and they are still bearing the burden of the fallout - in lost jobs, lost homes and lost opportunities."
In other words, the debate over financial regulatory reform must not be an isolated debate solely involving regulators and traders. The outcome of these reforms must not be ceded to the lobbyists fighting for the status quo. These are kitchen table, wallet, pocketbook, and lunch-pail issues, directly linked to the prosperity of the middle class.
Every day that stock markets open for trading on Wall Street, they ring the opening bell. Remember this: when it comes to financial regulatory reform, ask not for whom that bell tolls. It tolls for thee.
Jared Bernstein is Chief Economist to Vice President Biden, and Executive Director of the Middle Class Task Force
Cross-posted from the White House blog, The Briefing Room.
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If the big-moneyed interests were prevented from controlling the outcomes of our elections, we might get the right people in power who put the proper emphasis on regulations and oversight. Perhaps, then we could enjoy times of financial stability.
What you are hearing Jared, is that most of us here are irate because of the revelation of what the financial system has wrought upon all of us. It is beyond surreal how it could have regressed to this wild wild west state. I read what Geithner will say shortly.
http://www.house.gov/apps/list/hearing/financialsvcs_dem/testimony_-_sec_geithner.pdf
However, I have little faith in it. The regulatory world is essentially frozen in rhetoric. Naked short selling, flash trading, high frequency trading are being discussed, but goes on till the words stop flowing and the hammer comes down. By then, millions will again be subtracted from us all. Goldman now accounts for 50% of the market volume. Interest rates for consumer debt is raised without much ado, but it goes on till the regulations kick in, by which time, more consumers are left crushed by the burden. People are losing their homes, the bank will sell them short to someone rather than work with the homeowner for the loss write off.
We see all this, but it takes forever for the government to move. With every day wasted, another one of us is abandoned in the dust.
Only time I can think of the government moving fast, is when the banks faced a crisis. The speed and the massive cavalry that kicked in was truly mind numbing. It is too bad you do not move as fast and as decisively when its just people.
Wall St. and the monetary financial derivative debt based economic system can not be reformed. It is a killing machine. Usury and speculation in every financial transaction is unsustainable. The Global economy demands: Usury, speculation, forced trade, perpetual war, trillions in bailouts, outsourced industry and jobs, unemployment in the millions, cost cutting in medical and education is taking the population to its' doom. Lyndon LaRouche is calling for the complete termination of the debt based global system to be replaced by the American credit system. www.larouchepac.com
Larouche? If he wants to be king, run for office. This is a democracy. You cannot negate the one who who won with painting a Hitler mustache on him. That's not a valid vote.
The origins of the Great Depression was the Big Government monopoly sticking its regulatory face everywhere and dismantling any financial system (smoot-hawley tarrifs on imports, 90% income tax rates, huge government spending for temporary jobs, restricting money supply to private business, etc.)
Get it out of our face and we can recover. Otherwise like any monopoly it'll move us closer to Cuba or Zimbabwe, which is fine if you're on the committee.
Write it up. I got a title for you. Call it "History Revised" by Philclock. Good luck.
Already been written up, two examples:
"FDR's Folly: how Roosevelt and his New Deal prolonged the Great Depression" by Jim Powell
"The Forgotten Man" by Amity Schlaes
President Obama is too much of a political coward to do the right thing. Time and again, Obama has talked tough, only to make backroom deals and have his lackeys quitely inform the "right people" that Obama didn't really mean what was said. Obama is just another political hack. Don't make excuses for his political calculations.
Mr. Bernstein,
Please don't fall into the bi-partisanship trip and negotiate away any traces of significant reform and then end up with 0 or 1 Republican votes like what happened with the stimulus package and is now happening with health care. I am starting to lose interest in donating or supporting the Administration's causes when they campaign progressive and then let the Republicans and Blue Dogs water down the actual bills.
The reason for the construction bubble and the following crisis is globalization. Construction remained the only real industry in the US where the people and banks could invest - it's kind of hard to outsource construction. But construction without a real economy to support and serve is a losing proposition. People have to have jobs and enough income to pay the mortgages. Globalization blew that oversees. Reckless banking and inadequate financial regulation are equally to blame, but these is largely recognized, while the role of globalization is always skipped over. There were bubbles before, but what made this (and the next) so severe is globalization.
Not globalization, cheap debt (the FED) and borrowing too much money.
It's called living beyond your means. Very simple.
We are small business owners in construction. An audit was performed by our general liability insurance and billed to our broker two months ago, even though we switched to a reputable company in January. The broker, a small fraction of a man wasn't even a broker. He was a "retailer" and another company held the policy. I discovered through a horrid sequence of events we'd been had for about $50,000 and these guys have their cover courtesy of the US House of Representatives. I'm mortified to live in a country where this is possible.
If you want to protect America, rid us of insurance companies!!!
No way, I'm in real estate too and I want to buy financial coverage for liability, construction risk, etc. And I want LOTS of insurance companies in the game, more to pick from, more competition.
I go through brokers, but always review in detail the policy issued by whichever insurance company I select, and demand proof of payment from the insurance company itself.
If you had a reliable insurance company, sounds like you got shafted by the brokers, not the insurance company.
It was the broker, but the insurance company threatened to investigate us for fraud and report us to the IRS in an email unless we paid the balance right away and no one believed we never got the audit from the shady broker. Like an insurance company never heard of a shady broker. It was surreal, and we know to be more careful, but it's all over and done with now. The insurance company, Great American, won't even respond to us now. They do have their money though. And we had no claims because our guys are the best.
The best check on corporate power continues to be the citizens of the United States. Allowing consumer agencies to sue for abuses like the ACLU does for civil liberties abuses would be a big step and allowing class action lawsuits (I was 2 for 2 on these when I lived in California) would be a wonderful check on power. Creating government agencies is always a problem because they usually end up supporting the industry they are trying to control as corporations will load the agency up with supporters of that industry. That is why regulation is so dangerous and really helps prevent competition from small business. Then, there is the fractional banking system run by the Federal Reserve that is the real problem. This issue needs to be looked at. The Fed needs to be eliminated once and for all. If Obama wants real reform, he should be looking into this and supporting the Ron Paul, Bernie Sanders bill.
Good points, except for class action lawsuits which throw in irrational costs into any decision I make, and that's no fair! (eg, i can sue you for any reason, like xarbon dioxide from your breath has contributed to global warming and a heat wave that caused a draught that affected by crop production. I could win billions; no downside to loss, I don't have to pay defendent's costs).
I for one, don't believe that you mean any of this! The status quot is all that really matters to Obama's masters. Sorry, but the middle class is abandoning the Dems and Obama.
What middle class?
Whatever emasculated reform finally emerges will then be phased in over some absurdly long period, so as to not be too disruptive to those "sensitive geniuses" on Wall Street.
I have yet to see any bold action by Obama on middle class ills, only bloviation. And by the way, how's that magnificent forclosure rescue program of his doing? There must be dozens of families giving thanks right now! When it come to bailing out real persons, and not corporate fictions of a person, the administration begins breaking open the penny rolls.
The Obama administration is one of the most corrupt in US history. They talk a good talk but then pass corporate welfare piled on corporate welfare wrapped in corporate welfare.
We have to vote them all out.
And elect exactly whom? Republicans? Weren't they the ones that deregulated the financial industry to the detriment of the world? Weren't they the ones that borrowed money to wage war while giving the richest 1% of the country not just one but two huge tax cuts? Weren't they the ones that went into a country that had NOTHING to do the the Twin.Towers? Who in their right mind would borrow the money to wage wars?
I didn't vote for Republicans last year. I voted for someone who promised fundamental change. If someone you voted for repeatedly breaks their promises to you, the correct thing to do is vote them out of office. The Republicans got the message after George senior broke his no new taxes pledge. Maybe the Democrats will learn the lesson if Obama gets voted out.
Regulating the banks that are too big too fail? Wasn't that what regulators were doing at the time of the crash? The only meaningful way to manage systemic risk that the big banks created is to break them up. Glass-Steagall prevented certain types of banking combinations precisely because such combinations created systemic risk.. It needs to be re-enacted, but it won't be.
But I really lost all hope for meaningfull reform in the banking sector when Obama made that utterly ridiculous comment about executive pay which drew a comparison between NFL players, Silicon Valley entrepreneurs and banksters. Duh. Mr. President.! Football players and SV entrepreneurs do not create systemic risk. I do not care if football players make a lot of money, they cannot bring down the financial system. I do not mind if people who took what I call start up risk become billionaires--SV entrepreneurs created something of value and they create jobs for highly skilled people. Imagine a big bank adopting--let alone trying to live by--the Google slogan "Don't be evil".
Banksters are not going to be persuaded to play nice in exchange for a beer summit or in response to Presidential finger-wagging. The proposed financial consumer agency is little more than window-dressing. Beneath the surface, NOTHING is changing.
I will say it again ad nauseum. Glass-Steagall was a crucial protection.
What made Obama's comment even more ridiculous is that we actually do cap NFL player salaries.
"President Obama is proposing..."
"... the reforms we've proposed..."
Please add more substance and strategy if you write on this again. There are endless nice sounding proposals. All the talk sounds just great but it doesn't mean anything in the real world. I can't go to work every day and merely just propose that I do this and that today to save the world and expect to make a living. So what have you done? You are "chief economist to Biden." So please inform us of what you or Biden or President Obama have actually done, or are in the process of doing, to ensure these proposals are implemented.
"...the reforms we've proposed have a clear mission: to ensure we're not back here again a few years from now."
Yes. Obviously that is what is called for. But again, what has anybody done to ensure that these proposals will be implemented?
Well said. The truth is that Obama is far less concerned about real reform than he is about an ever rising stock market. Obama has bent over backward to help the banks, and they in return have used their enormous profits to prop up the stock market. Obama is too much of a coward to seriously ask for meaningful reform. If he actually demonstrated that he was not going to continue with teh massive subsidies of Wall Street, that might spook the stock market, and where would the public's confidence (and Barack's approval rating) be then?
Jared, does Obama still have faith in his existing regulators?
http://www.bloomberg.com/apps/news?pid=20601039&sid=a903JQKwJEiY
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