A senator is calling for the break-up of megabanks and a firmer separation between Main Street banking and Wall Street trading, joining the ranks of leading economists and business titans demanding aggressive financial reform far beyond what the Obama administration and Democrats in Congress are pushing.
In a Thursday morning speech on the Senate floor, Sen. Ted Kaufman (D-Del.) blasted the "incrementalism" approach to fixing the nation's broken financial system, laid bare by a financial crisis that wiped out trillions of dollars in wealth and sent the economy into a tailspin not seen since the Great Depression.
Rather than nibbling around the edges, Kaufman wants to impose strict limits on financial firms' activities; significantly cut them down in size; and wants Congress to act more forcefully because federal banking and securities regulators failed to protect the public from an increasingly dangerous financial industry.
The fact is, he intoned, "the government's response to the financial meltdown has only made the industry bigger, more concentrated and more complex."
Because of that, "[f]inancial regulatory reform is perhaps the most important legislation that the Congress will address for many years to come," said Kaufman, Vice President Joe Biden's replacement in the Senate. Otherwise, "if we don't get it right, the consequences of another financial meltdown could truly be devastating."
Simon Johnson, former chief economist of the International Monetary Fund, professor at the MIT Sloan School of Management and contributing editor to the Huffington Post, said it's "the speech for which we have been waiting."
Excerpts below...
Kaufman on the need for fundamental reform:
I start by asking a simple question: Given that deregulation caused the crisis, why don't we go back to the statutory and regulatory frameworks of the past that were proven successes in ensuring financial stability?...
Mind you, this is a financial crisis that necessitated a $2.5 trillion bailout. And that amount includes neither the many trillions of dollars more that were committed as guarantees for toxic debt nor the de facto bailout that banks received through the Federal Reserve's easing of monetary policy...
Given the high costs of our policy and regulatory failures, as well as the reckless behavior on Wall Street, why should those of us who propose going back to the proven statutory and regulatory ideas of the past bear the burden of proof? The burden of proof should be upon those who would only tinker at the edges of our current system of financial regulation...
Congress needs to draw hard lines that provide fundamental systemic reforms, the very kind of protections we had under Glass-Steagall. We need to rebuild the wall between the government-guaranteed part of the financial system and those financial entities that remain free to take on greater risk...
The notion that the most recent crisis was a "once in a century" event is a fiction. Former Treasury Secretary Paulson, National Economic Council Chairman Larry Summers, and JP Morgan CEO Jamie Dimon all concede that financial crises occur every five years or so.
Kaufman on the growth of megabanks:
Most of the largest banks are products of serial mergers. For example, J.P. Morgan Chase is a product of J.P. Morgan, Chase Bank, Chemical Bank, Manufacturers Hanover, Banc One, Bear Stearns, and Washington Mutual. Meanwhile, Bank of America is an amalgam of that predecessor bank, Nation's Bank, Barnett Banks, Continental Illinois, MBNA, Fleet Bank, and finally Merrill Lynch.
Kaufman on the failure of regulators:
Regulatory neglect, however, permitted a good model to mutate and grow into a sad farce...
In fact, one of the primary purposes behind the securitization market was to arbitrage bank capital standards. Banks that could show regulators that they could offload risks through asset securitizations or through guarantees on their assets in the form of derivatives called credit default swaps (CDS) received more favorable regulatory capital treatment, allowing them to build their balance sheets to more and more stratospheric levels.
While this was a recipe for disaster, it reflected in part the extent to which the and complexity of this new era of quantitative finance exceeded the regulators' own comprehension...
In the brief history I outlined earlier, the regulators sat idly by as our financial institutions bulked up on short-term debt to finance large inventories of collateralized debt obligations backed by subprime loans and leveraged loans that financed speculative buyouts in the corporate sector.
They could have sounded the alarm bells and restricted this behavior, but they did not. They could have raised capital requirements, but instead farmed out this function to credit rating agencies and the banks themselves. They could have imposed consumer-related protections sooner and to a greater degree, but they did not. The sad reality is that regulators had substantial powers, but chose to abdicate their responsibilities.
Kaufman on Too Big To Fail and the government's response during the crisis:
This provided them with permanent borrowing privileges at the Federal Reserve's discount window - without having to dispose of risky assets. In a sense, it was an official confirmation that they were covered by the government safety net because they were literally "too big to fail"...
We haven't seen such concentration of financial power since the days of Morgan, Rockefeller and Carnegie...
By expanding the safety net -- as we did in response to the last crisis -- to cover ever larger and more complex institutions heavily engaged in speculative activities, I fear that we may be sowing the seeds for an even bigger crisis in only a few years or a decade...
Because of their implicit guarantee, "too big to fail" banks enjoy a major funding advantage - and leverage caps by themselves do not address that. Our biggest banks and financial institutions have to become significantly smaller if we are to make any progress at all.
Kaufman on current financial reform proposals:
Unfortunately, the current reform proposals focus more on reorganizing and consolidating our regulatory infrastructure, which does nothing to address the most basic issue in the banking industry: that we still have gigantic banks capable of causing the very financial shocks that they themselves cannot withstand...
While no doubt necessary, [resolution authority] is no panacea. No matter how well Congress crafts a resolution mechanism, there can never be an orderly wind-down, particularly during periods of serious stress, of a $2-trillion institution like Citigroup that had hundreds of billions of off-balance-sheet assets, relies heavily on wholesale funding, and has more than a toehold in over 100 countries.
There is no cross-border resolution authority now, nor will there be for the foreseeable future...
Yet experts in the private sector and governments agree - national interests make any viable international agreement on how financial failures are resolved difficult to achieve. A resolution authority based on U.S. law will do precisely nothing to address this issue...
While I support having a systemic risk council and a consolidated bank regulator, these are necessary but not sufficient reforms - the President's Working Group on Financial Markets has actually played a role in the past similar to that of the proposed council, but to no discernible effect. I do not see how these proposals alone will address the key issue of "too big to fail."
Kaufman on separating Main Street banking from Wall Street trading:
Massive institutions that combine traditional commercial banking and investment banking are rife with conflicts and are too large and complex to be effectively managed...
To those who say "repealing Glass-Steagall did not cause the crisis, that it began at Bear Stearns, Lehman Brothers and AIG," I say that the large commercial banks were engaged in exactly the same behavior as Bear Stearns, Lehman and AIG - and would have collapsed had the federal government not stepped in and taken extraordinary measures...
By statutorily splitting apart massive financial institutions that house both banking and securities operations, we will both cut these firms down to more reasonable and manageable s and rightfully limit the safety net only to traditional banks. President of the Federal Reserve Bank of Dallas Richard Fisher recently stated: "I think the disagreeable but sound thing to do regarding institutions that are ['too big to fail'] is to dismantle them over time into institutions that can be prudently managed and regulated across borders. And this should be done before the next financial crisis, because it surely cannot be done in the middle of a crisis."
A growing number of people are calling for this change. They include former FDIC Chairman Bill Isaac, former Citigroup Chairman John Reed, famed investor George Soros, Nobel-Prize-winning-economist Joseph Stiglitz, President of the Federal Reserve Bank of Kansas City Thomas Hoenig, and Bank of England Governor Mervyn King, among others. A chastened Alan Greenspan also adds to that chorus, noting: "If they're too big to fail, they're too big. In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."
WATCH Kaufman discuss derivatives:
Watch Kaufman discussing Greenspan and Too Big To Fail: