The most important thing to know about the 1,500-page financial reform bill passed by the Senate last week -- now on he way to being reconciled with the House bill -- is that it's regulatory. If does nothing to change the structure of Wall Street.
The bill omits two critical ideas for changing the structure of Wall Street's biggest banks so they won't cause more trouble in the future, and leaves a third idea in limbo. The White House doesn't support any of them.
First, although the Senate bill seeks to avoid the "too big to fail" problem by pushing failing banks into an "orderly" bankruptcy-type process, this regulatory approach isn't enough. The Senate roundly rejected an amendment that would have broken up the biggest banks by imposing caps on the deposits they could hold and their capital assets.
You do not have to be an algorithm-wielding Wall Street whiz-kid to understand that the best way to prevent a bank from becoming too big to fail is preventing it from becoming too big in the first place. The size of Wall Street's five giants already equals a large percentage of America's gross domestic product.
That makes them too big to fail almost by definition, because if one or two get into trouble -- as they did in 2008 -- their demise would shake the foundations of the financial system, even if there were an "orderly" way to liquidate them. Because traders and investors know they are too big to fail, these banks have a huge competitive advantage over smaller banks.
Another crucial provision left out of the Senate bill would be to change the structure of banking by resurrecting the Depression-era Glass-Steagall Act and force banks to separate commercial banking (the classic function of connecting lenders to borrowers) from investment banking.
Here, too, the bill takes a regulatory approach instead. It includes a provision barring banks from "proprietary trading," or making market bets with their own capital. Even if this regulation were tough enough (and the current Senate bill requires various delays and studies before it's applied), it would not erode the giant banks' monopoly over derivatives trading, adding to their power and inevitable "too big to fail" status.
Which brings us to the third structural idea, advanced by Senator Blanche Lincoln. She would force the banks to do their derivative trades in entities separate from their commercial banking.
This measure is still in the bill, but is on life-support after Paul Volcker, Tim Geithner, and Fed chair Ben Bernanke came out against it. Republicans hate it. The biggest banks detest it. Virtually every major Wall Street and business lobbyist has its guns trained on it. Almost no one in Washington believes it will survive the upcoming conference committee.
But it's critical. For years the big banks have relied on taxpayer-funded deposit insurance to backstop their lucrative derivative businesses. Obviously they want the subsidy to continue. Bernanke argues that "depository institutions use derivatives to help mitigate the risks of their normal banking activities." True, but irrelevant. Lincoln's measure would allow banks to continue to use derivatives. They just could not rely on their government-insured deposits for the capital.
Requiring banks to do derivative trading in separate entities would force them to raise extra capital. But if such trading is so useful, banks should foot the bill, not taxpayers. Bernanke and others say the measure would give foreign banks a competitive advantage. Even if he is right, since when is it up to taxpayers to guarantee profitability at America's largest banks relative to foreign ones?
The trading of derivatives is not so crucial to the US economy that taxpayers should subsidize the practice. If the past two years have taught us anything, the lesson is just the opposite. Derivatives can generate huge risks unless carefully regulated.
Wall Street's lobbyists have fought tooth and nail against these three ideas because all would change the structure of America's biggest banks. The lobbyists won on the first two, and the Street has signaled its willingness to accept the Dodd bill, without Lincoln's measure.
The interesting question is why the president, who says he wants to get "tough" on banks, has also turned his back on changing the structure of American banks -- opting for a regulatory approach instead.
It's almost exactly like health care reform. Ideas for changing the structure of the health-care industry -- a single payer, Medicare for all, even a so-called "public option" -- were all jettisoned by the White House in favor of a complex set of regulations that left the old system of private for-profit health insurers in place. The final health care act doesn't even remove the exemption of private insurers from the nation's antitrust laws.
Regulations don't work if the underlying structure of an industry -- be it banking or health care -- got us into trouble in the first place. Wall Street's big banks are just too big, and their ability to draw on commercial deposits for investment banking activities, including derivatives, will make them even bigger. It will also subject the economy to greater and greater risks in the future. No amount of regulation can cure that.
Similarly, the underlying system of private for-profit health insurance is a key driver of America's bloated and ineffective health care delivery. We can try to regulate it like mad, but no amount of regulation will cure this fundamental problem.
A regulatory rather than structural approach to deep-seated problems in complex industries like banking and health care is also vulnerable to the inevitable erosion that occurs when industry lobbyists insert themselves into the regulatory process. Tiny loopholes get larger. Delays get longer. Legislative words are warped and distorted to mean what industry wants them to mean.
Both Senate and House financial reform bills exempt "customized" derivatives from the exchanges, for example, but leave it to regulators to define what contracts will be excused. Yet many of the derivatives that caused the most trouble (read: Goldman Sachs and other banks' deals with AIG) might well be thought of as customized. Another potential problem: in assigning consumer protection to the Fed, the bill puts it under Fed chiefs who in the past displayed a patent disregard of such safeguards (read: Alan Greenspan).
Inevitably, top regulators move into the industry they're putatively trying to regulate, while top guns in the industry move temporarily into regulatory positions. This revolving door of regulation also serves over time to erode all serious attempt at overseeing an industry.
The only way to have a lasting effect on industries as large and intransigent as banking and health care is to alter their structure. That was the approach taken to finance by Franklin D. Roosevelt in the 1930s, and by Lyndon Johnson to health care (Medicare) in the 1960s.
So why has Obama consistently chosen regulation over restructuring? Because restructuring Wall Street or health care would surely elicit firestorms from these industries. Both are politically powerful, and Obama did not want to take them on directly.
A regulatory approach allows for more bargaining, not only in the legislative process but also, over time, in the rule-making process as legislation is put into effect. It's always possible to placate an industry with a carefully-chosen loophole or vague legislative language that will allow the industry to continue to go on much as before.
And that's precisely the problem.
This post originally appeared at RobertReich.org.
Frank to chair financial reform committee
Financial reform could turn on Blanche Lincoln's re-election bid in Arkansas ...
The Glass-Steagall Act was born in the Depression Era, but it served America and the world well for more than sixty-five years! That re-enacting Glass-Steagall isn't the centerpiece of Democratic financial reform today makes me want to get an energetic progressive leader to replace Obama--a nuanced mediator and moderate--as the head of the Democratic ticket in 2012. Howard Dean may be our only hope--and I'd surely want you and Bill Richardson back in the thick of things, plus Bernie Sanders joining in. Having Obama in office instead of McCain is nice. We need great, not just nice.
And given the jittery state of financial companies and the markets, a second crisis is well within the realm of possibility.
That might or might not be fair but that's how it works. Thus there is enormous political risk in going beyond moderate regulatory reform.
a bigger crash may well come and when it does future generations will ask, why did they not restructure the finance industry after the first crash?
start / join local non-profit credit unions!
stop buying corporate products of all kinds!
start growing your own food and share with neighbors!
that's the ONLY way we the people can bring real change.
Historically, the common method of restructuring these swine has been violent and bloody. This will only happen, however, after their unregulated, parasitic greed has destroyed the host nations. Now if we had a democracy........
Republicans, by their very definition, have always been corporatist. Democrats, for a short period of historical time (from the '30s until the early '70s) represented some sort of liberal/progressive bulwark against corporatist excess.
However, ever since the American right-wing began their counterrevolution in the '70s (funded by wealthy industrialists like Coors, Mellon-Scaife, etc.), the Democrats have been gradually infiltrated and taken over.
They're still marginally preferable to the Republican madness, and there are still a few genuine good guys left (Feingold, Sanders, Kucinich), but it's getting damned-near impossible to defend them anymore.
I was thrilled to get someone anti-war, who would do something to change the economy, and fix health care. Instead we got someone who is continuing unwinnable wars in the middle east, again at enormous expense, who squandered a once in several generations chance to fix health care, and someone who came in at after the worst recession since the Great Depression and left all the systems intact for the next one to occur. Instead we got someone whose first efforts were to preserve intact in crises everything everything that caused them. I didn't want a black George Bush.
Right now there is so little distinguishing the democrats from the republicans that Americans are getting more or less the same thing under different names. One party caters more openly to religion than another, and the other one is less willing to admit how beholden it is to corporate money and ideals. Whoopee.
You completely omitted one of the most critically important factors that is absolutely needed in order to point us to a more fair and orderly market.---- the use of algorithmic flash trading.
This flash trading is now the elephant in the room that now creates the ability to dominate the market (= on a moment-to-moment basis cream off every last drop of investment dollar that the private investor can put into the market, directly and as "managed" retirement accounts).
This type of computer trading is an entirely new phenenon that can not be controlled by reinstatement of Glass-Steagall or by regulation of where and how derivatives trading is performed.
This will be a tough nut to crack.
There is no way to come out intact playing against such odds.
In the mean time, it is foolhardy to put any personal money into the market, particularly for betting against the Megabanksters who are playing a strictly OPM game. (Other Peoples Money, including the Taxpayers)
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if there's anything the American people have learned about Mr.Obama, especially his supporters is that he does not like confrontation and avoids it all costs hence this bill is just another redux of the HCR bill and, just as the Earth orbits the Sun, we can all expect the same to happen with the Energy bill.