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The 14th Banker

The 14th Banker

Posted: June 11, 2010 05:50 AM

Baby Steps on Banking Regulation

What's Your Reaction:

These are the functions of banks in the economy per Joe Stiglitz.

But the criteria for judgment are clear: the new law must curb the practices that jeopardized the entire global economy, and reorient the financial system towards its proper tasks - managing risk, allocating capital, providing credit (especially to small- and medium-sized enterprises), and operating an efficient payments system.

What we have now is an overly complex system. Complexity contributes to the opportunity for looting.

Going into this week, here was the score per NYT.

First, a little optimism from article linked above.

"We're on the verge of legislating sweeping reforms of our financial system, to fix what was broken in our system, recognizing that those failures in the United States were very consequential to the world as a whole," Timothy F. Geithner, the Treasury secretary, said last week before leaving to meet with G-20 financial ministers in South Korea.

And a little more optimism from today's news on Huffpo:
The House and Senate have reached "conceptual agreement" on strengthening what's known as the Volcker Rule in the Wall Street reform bill, House Financial Services Chairman Barney Frank (D-Mass.) said after a conference committee hearing Thursday.

Why do I not hear howling from Wall Street? Major bank stocks were up 3% to 4% on the day. I guess I am a skeptic because I'm rather sure that neither the Treasury, nor the Congress, know what problem to fix.

From the 1991 book, Den of Thieves, by James Stewart:

"It began quietly, gained momentum, turned into a torrent, and was soon generating millions--billions--in profit. It was so successful it seemed it couldn't be stopped, regulated, or contained. Investors were lured by its siren song: higher profits with lower risk...The rich prospered and the gulf between them and the poor widened dramatically. Government reaped the growing tax revenues and otherwise did little or nothing...And then it all came to a halt. Experts turned out to be wrong. Once again, investors were reminded that higher returns are always accompanied by higher risk. The soaring values were illusory, simply the manifestation of another of history's economic bubbles..."

This quote was referring to a prior iteration of a financial bubble, the junk bonds house of cards that fueled a previous collapse.

Regulation is an answer, it is not the answer. Restoring a balance of power between the public and our largest corporations is an answer. Restoring the power of the prosecutor by providing clear criminal laws and the legal firepower to enforce them is an answer. Holding not just institutions, but individuals legally responsible is an answer. Restoring a stigma to white collar crime is an answer. Understanding management systems and how they corrupt is an answer. By all these things, bringing risk and reward into a proper relationship and eliminating moral hazard is an answer. There are many answers, and they must all be pursued. Having a regulation package ready for President Obama is great. It is a first step on a long journey.

It is a journey that is more consequential than just fixing an industry. It has consequences for every American and most citizens of the world. Unemployment is high. Europe is reeling. Government debt is spiraling. Currencies are volatile.

The solutions we need are a financial system that has trust and that properly allocates resources so that the productive capacity of our economies can grow in a steady, non inflationary way, without excessive business cycles like the one that has tens of millions unemployed or sub optimally employed.

I remain skeptical that we won't be back again is six months with the promise of this reform overwhelmed by market forces in a fundamentally unbalanced system with risks only slightly moderated.