05/24/2010 05:08 pm ET Updated May 25, 2011

Financial Reform: "Too Small to Succeed"

The financial reform legislation currently winding its way through the Congress is a step in the right direction but it retains too much of the status quo that brought down the economy in the first place. The key problem, as many economists have been telling us, is that the top financial institutions remain "too big to fail." Congress can enact all the regulations it wishes but even the best written rules won't be enough to prevent another financial meltdown.

The George W. Bush Administration showed us quite clearly that government regulatory agencies are only as good as the people who are appointed to run them. We need to understand that "regulatory capture" has become a way of life in Washington. The current reforms don't go nearly far enough.

For example, if more than one of the Wall Street titans go down simultaneously (which is likely) you'll see the same gazillionaire bankers coming to Washington, hats in hand, saying that if they don't get an even bigger bailout than last time the whole economy will crash. The six biggest financial institutions have become even bigger and more consolidated than before the bailouts of 2008 making it more likely they will continue to be able to hold the economy hostage. There's nothing in the current legislation to prevent Washington from socializing their losses.

The top financial firms are so international in scope and unruly in size that even the most skilled CEOs and Directors cannot adequately manage their far-flung empires meaning that operations that can bring down the system can go on for years without being detected or even understood.

These large and variegated financial corporations, once championed as more efficient due to their "supermarket" quality, are so rife with conflicts of interest among their army of traders, analysts, and managers that they cannot be trusted with the health and direction of the world economy. As they so disastrously demonstrated with the housing bubble they will always seek their own advantage despite the consequences of their actions. The incentive structure is totally wrong. The individuals who run these giant financial corporations are seeking bonuses and compensation without giving a second thought to the long-term catastrophe their short-term actions are setting up.

No, these "too big to fail" corporations need to be broken up into smaller entities that can be more readily managed and torn apart if need be in "receivership" if reckless investment behavior brings them down. Before the collapse they were smaller than they are today and they already have cost 11 million Americans their jobs and created full-fledged fiscal crises at the local, state, and federal levels.

Larry Summers, Timothy Geithner, Chris Dodd, and Barney Frank are wrong to believe these corporations don't have to be chopped up. Joseph Stiglitz, Nouriel Roubini, Simon Johnson, and Dean Baker are right that they do. Unless these institutions are cut down to size we're only setting up the country (and the world) for the next economic meltdown.

President Obama has sent out a lot of mixed signals on what is the single most important issue facing the nation and his presidency. Nothing can be accomplished by way of economic "recovery" or addressing the problems of global climate change or a hundred other concerns if we're still going to be beholden to the likes of Goldman Sachs and Citigroup. Obama has not communicated to the American people either the gravity of the situation, i.e. tossing the economic royalists out of their positions of power in Washington, or the steps that need to be taken to make sure what happened in 2007-2008 will not happen again.

The President looked foolish recently when he called for more offshore oil drilling shortly before British Petroleum's "Deepwater Horizon" rig explosion began killing off the Gulf of Mexico. His Interior Department under Secretary Ken Salazar appears hapless and ineffective in the face of the tragedy in the Gulf. In a sense, the spill has become "Obama's Katrina." Why would anyone trust BP to clean up this mess? I think BP is deliberately underestimating the amount of oil gushing into the Gulf so the company's "suits" can later go to court and make the claim that they just didn't know what the scope of the thing was -- like the lack of WMD in Iraq and the financial meltdown "nobody could have seen it coming" and "everybody got it wrong" -- as a means to deflect BP's liability for the epic level of damages they're going to be sued for.

It's already clear that the Obama Administration isn't going to make any major effort to address the grotesque economic inequality in America that has emerged over the course of the past 30 years. Obama's education policy under Secretary Arne Duncan (who never taught a class in his life) vilifies the teachers' unions as thoroughly as anything coming from the American Enterprise Institute. Obama claims to be "pro-union" but not if the workers who are organized happen to be teachers. Has anyone in the Administration bothered to read Diane Ravitch's new book?

Obama and the Democratic Congress have not launched any new anti-poverty programs even though millions of Americans are really hurting in an economic environment that isn't going to improve for most working people for a long, long time. The States are in the process of dismantling public institutions that took a half-century to build as a result of the crushing budget deficits they face. After the Republicans win their 30 or so seats in the House of Representatives this November Obama is going to be forced to make more concessions to the Far Right anti-government crowd. He'll be tempted to "triangulate" as Clinton did in the 1990s and with the same results: weakening the Democratic Party coalition that brought him to power by demoralizing its base.