The Financial Re-Regulation Agenda

As the Federal Reserve and Treasury Department careen from one financial meltdown to another, desperately trying to hold together the financial system -- and with it, the U.S. and global economy -- there are few voices denying that Wall Street has suffered from "excesses" over the past several years.

The current crisis is the culmination of a quarter century's deregulation. Even as the Fed and Treasury scramble to contain the damage, there must be a simultaneous effort to reconstruct a regulatory system to prevent future disasters.

There is more urgency to such an effort than immediately apparent. If the Fed and Treasury succeed in controlling the situation and avoiding a collapse of the global financial system, then it is a near certainty that Big Finance -- albeit a financial sector that will look very different than it appeared a year ago -- will rally itself to oppose new regulatory standards. And the longer the lag between the end (or tailing off) of the financial crisis and the imposition of new legislative and regulatory rules, the harder it will be to impose meaningful rules on the financial titans.

The hyper-complexity of the existing financial system makes it hard to get a handle on how to reform the financial sector. (And, by the way, beware of generic calls for "reform" -- for Wall Street itself taken up this banner over the past couple years. For the financial mavens, "reform" still means removing the few regulatory and legal requirements they currently face.)

But the complexity of the system also itself suggests the most important reform efforts: require better disclosure about what's going on, make it harder to engage in complicated transactions, prohibit some financial innovations altogether, and require that financial institutions properly fulfill their core responsibilities of providing credit to individuals and communities.

(For more detailed discussion of these issues -- all in plain, easy-to-understand language, see these comments from Damon Silvers of the AFL-CIO, The American Prospect editor Robert Kuttner, author of the The Squandering of America and Obama's Challenge, and Richard Bookstaber, author of A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation.)

Here are a dozen steps to restrain and redirect Wall Street and Big Finance:

1. Expand the scope of financial regulation. Investment banks and hedge funds have been able to escape the minimal regulatory standards imposed on other financial institutions. Especially with the government safety net -- including access to Federal Reserve funds -- extended beyond the traditional banking sector, this regulatory black hole must be eliminated.

2. Impose much more robust standards for disclosure and transparency. Hedge funds, investment banks and the off-the-books affiliates of traditional banks have engaged in complicated and intertwined transactions, such that no one can track who owes what, to whom. Without this transparency, it is impossible to understand what is going on, and where intervention is necessary before things spin out of control.

3. Prohibit off-the-books transactions. What's the purpose of accounting standards, or banking controls, if you can evade them by simply by creating off-the-books entities?

4. Impose regulatory standards to limit the use of leverage (borrowed money) in investments. High flyers like leveraged investments because they offer the possibility of very high returns. But they also enable extremely risky investments -- since they can vastly exceed an investor's actual assets -- that can threaten not just the investor but, if replicated sufficiently, the entire financial system.

5. Prohibit entire categories of exotic new financial instruments. So-called financial "innovation" has vastly outstripped the ability of regulators or even market participants to track what is going on, let alone control it. Internal company controls routinely fail to take into account the possibility of overall system failure -- i.e., that other firms will suffer the same worst case scenario -- and thus do not recognize the extent of the risks inherent in new instruments.

6. Subject commodities trading to much more extensive regulation. Commodities trading has become progressively deregulated. As speculators have flooded into the commodities markets, the trading markets have become increasingly divorced from the movement of actual commodities, and from their proper role in helping farmers and other commodities producers hedge against future price fluctuations.

7. Tax rules should be changed so as to remove the benefits to corporate reliance on debt. "Payments on corporate debt are tax deductible, whereas payments to equity are not," explains Damon Silvers of the AFL-CIO. "This means that, once you take the tax effect into account, any given company can support much more debt than it can equity." This tax arrangement has fueled the growth of private equity firms that rely on borrowed money to buy corporations. Many are now going bankrupt.

8. Impose a financial transactions tax. A small financial transactions tax would curb the turbulence in the markets, and, generally, slow things down. It would give real-economy businesses more space to operate without worrying about how today's decisions will affect their stock price tomorrow, or the next hour. And it would be a steeply progressive tax that could raise substantial sums for useful public purposes.

9. Impose restraints on executive and top-level compensation. The top pay for financial impresarios is more than obscene. Executive pay and bonus schedules tied to short-term performance played an important role in driving the worst abuses on Wall Street.

10. Revive competition policy. The repeal of the Glass-Steagall Act, separating traditional banks from investment banks, was the culmination of a progressive deregulation of the banking sector. In the current environment, banks are gobbling up the investment banks. But this arrangement is paving the way for future problems. When the investment banks return to high-risk activity at scale (and over time they will, unless prohibited by regulators), they will directly endanger the banks of which they are a part. Meanwhile, further financial conglomeration worsens the "too big to fail" problem -- with the possible failure of the largest institutions viewed as too dangerous to the financial system to be tolerated -- that Treasury Secretary Hank Paulson cannot now avoid despite his best efforts. In this time of crisis, it may not be obvious how to respect and extend competition principles. But it is a safe bet that concentration and conglomeration will pose new problems in the future.

11. Adopt a financial consumer protection agenda that cracks down on abusive lending practices. Macroeconomic conditions made banks interested in predatory subprime loans, but it was regulatory failures that permitted them to occur. And it's not just mortgage and home equity loans. Credit card and student loan companies have engaged in very similar practices -- pushing unsustainable debt on unreasonable terms, with crushing effect on individuals, and ticking timebomb effects on lenders.

12. Support governmental, nonprofit, and community institutions to provide basic financial services. The effective governmental takeover of Fannie Mae, Freddie Mac and AIG means the U.S. government is going to have a massive, direct stake in the global financial system for some time to come. What needs to be emphasized as a policy measure, though, is a back-to-basics approach. There is a role for the government in helping families get mortgages on reasonable terms, and it should make sure Fannie and Freddie, and other agencies, serve this function. Government student loan services offer a much better deal than private lender alternatives. Credit unions can deliver the basic banking services that people need, but they need back-up institutional support to spread and flourish.

What is needed, in short, is to reverse the financial deregulatory wave of the last quarter century. As Big Finance mutated and escaped from the modest public controls to which it had been subjected, it demanded that the economy serve the financial sector. Now it's time to make sure the equation is reversed.

Comments

[joebhed]

Yeah.
You can do those twelve things, and we will still be broke.

Or, you can do this one thing, as a tribute to Jefferson, Franklin, Madison and Lincoln.
And get us the F out of debt.
And our politics out of the hands of what Pres. Van Buren called THE MONEY POWER.

http://www.monetary.org/amacolorpamphlet.pdf

We need the monetary reform that FDR was unable to bring forward.

Have the government create new money through credits, and after it is deposited in bank accounts, let the bankers lend it out at 100 percent reserves.

The rest is peepeedickin'.

[cit-i-zen]

Well, yes and no. Undoubtedly the government went too far with its hands-off approach over the last quarter-century or so. But a lot of that deregulation was good, too. Typically, crises breed hasty regulatory overreaction with many negative unintended consequences. We need to strike a balance here between giving capitalists enough freedom from intervention so that they may innovate and create jobs and wealth for all, and, on the other end of the scale, making sure that the free market is regulated enough so that it does not eat itself. Shareholders should impose limits on management compensation, not government.

For more check out this post on my blog, Citizen:
http://cit-i-zen.blogspot.com/2008/09/role-of-regulation-was-fdr-conservative.html

[joebhed]

Read your posted link.

With some agreement, FDR was a fiscal conservative.
And much disagreement.

FDR didn't fight to preserve the free markets in money - cause that's what we're talking about here.
He wanted a government-run solution in money creation.
He wanted to ensure a non-repeat of the 1929 monetary contraction, leading to the depression.

His colleagues introduced the Bill for debt-free money, known as the Chicage Plan, but the bankers killed it.
One reform too many.

What people don't realize about the currently-evolving debacle is that it didn't matter who was in power. Either we had ANOTHER monetary bubble, or the jig was up.
Democrat or Repub. No diference.

The problem is systemic within the debt-money system of the private bankers.
It's the same all over the world.

FDR was forced to pass the problem on to future generatons, not by his conservative leanings, but by his powerlessness in the face of the banks.

The only question left for us is - have we YET met the enemy?.

Or, do we try to pass it on again.

[Aaror]

You know, when I went to college we had a professor who taught us to throw away the credit card applications which were placed all over the campus. I did so for 4 years, and always felt good doing it. When they re-wrote the bankruptcy laws, it was so that college kids who got credit cards would be debt slaves. If you are in college, do your fellow students a favor, throw out the applications.

[DrPaulProteus]

Along with point #9, how about some sort of anti-trust style regulation that prevent any one of these companies from becoming "too big to fail" in the first place? If it's "too big to fail" and the government will just bail it out if it looks like it will fail, they can do whatever they please with no risk. These hypocrites claim to value competition -- preventing companies from becoming too big will ensure competition among more and smaller companies.

Regarding point #10, you write:
"The repeal of the Glass-Steagall Act, separating traditional banks from investment banks, was the culmination of a progressive deregulation of the banking sector."
I see what you mean, but there's nothing "progressive" about it.

[dukeitout]

I agree with the 12 recommendations you list. But I would add one more. Rules are just words unless they are enforced. To assure enforcement it is extremely important that we provide sufficient oversight. Oversight is performed by people looking over the shoulders of Wall Street and Big Finance. Load up with qualified staffs to assure the world of commerce is operating by the rules; and punish the incompents and crooks when they are discovered. The crooks will protest oversight. The incompetents have no clue.

[dadw5boys]

WOW !!!!!

YOU MEAN REINSTATE THE OLD LAW ?

THE LAW THAT PHIL GRAHAM HIDE A BILL TO DEREGULATE IN AN APPRORIATION BILL AND SNEAKED IT PAST EVEN THOUGH THE BILL HAD BEEN VOTED DOWN 3 TIME BEFORE WHE IT STOOD ALONE.

A BILL THAT SENATOR PHIL GRAHAM WAS PAID $ 750,000.00 TO GET PAST BY THE SWISS BANK WHERE HE AND HIS WIFE ARE BORAD MEMEBERS.

[Baltotoast]

The problem here is you are trying to solve for the symptom, not the cause. Virtually all of these problems can be traced back to the government's policy - both democratic and republican - to increase home ownership. Congress and other policy makers encouraged financial market innovation (i.e. let borrowers have something other than a 30 year fixed mortage with 20% down) and pushed Freddy and Fanny to make more loans. Don't blame the investment banks, they were just the willing executioners of government policy.

This regulation discussion is classic barn door/horse. What is needed is an honest examination of government policy direction.

[whiteaglesoaring]

Have you noticed that the prices of commodities have been falling and the dollar rising while the financial markets have been in such disarray? It doesn't seem logical, does it. JS Kim has written about this, posted at http://www.real-debt-elimination.com/real_money/crimes_of_the_economy/law_of_supply_and_demand_is_dead_for_silver_and_gold.htm under the title, "Fraud in Global Economy: The Law of Supply and Demand Is Dead for Gold and Silver". He provides evidence that these commodities have not been following the venerated Law of Supply and Demand. He reveals that the markets are NOT free markets and that the financial markets are corrupt and fraudulent. "The most likely culprits of this manipulation are all members of the U.S. President"s Working Group on Financial Markets (the SEC, the Commodities Futures Trading Commission, the U.S. Treasury, and the U.S. Federal Reserve). A massive disconnect between the price of gold and silver in physical markets and the price in paper futures markets, of the extent that happened last month, either means that the Law of Supply and Demand has just been proven to be invalid, or that massive fraudulent manipulation just occurred."

If you think that the "market" is an organic, self-regulating system, you might find that such beliefs are really naive and self-destructive.

[wsblake]

the average american does not get the concept of deregulation- its meaningless to most- what obama has to emphasize over and over again is the cost of a totally unnecessary war- 3 trillion dolllars-3 trillion dollars-3 trillion dollars- 3 trillion dollars

[DrPaulProteus]

If the average American can't understand it, let me explain it simply for them:
Deregulation: Taking what was defined by law as a crime and making it legal.

[Puzio1972]

Danny Diaz should have checked before he accused Joe Biden of voting
FOR the Gramm-Leach-Bliley Act on national television MSNBC with Nora
O'Donnell today.
http://www.govtrack.us/congress/vote.xpd?vote=s1999-105
Biden actually voted NO. Danny went so far as to say, "Is Obama going
to say Biden was wrong for voting with McCain on the
Gramm-Leach-Bliley Act?." This is your head of communications? That's
awful.

[joebhed]

very true.

and, surprised at Danny on this.

[dwlb]

The problem is that banks are too big to fail, but the millions of families facing foreclosure are too small to care for. The dreams of college aspirants applying for loans are too unimportant to matter.

The government bailouts of AIG, Freddie Mac and Fannie May is just corporate welfare. Yet again, the government is scrambling to save capitalism from a crisis of its own making. If they are going to save wall street, why not leverage the firms that have been "taken over" to help working class and middle class people. How could they do that? We need to propose an answer quickly.

[Carolab]

Uh huh. The Federal Reserve private bankers are going to regulate themselves. Sure.

[MyNameIsJames]

Can you get this to the Obama campaign and the DNC? Please!