Dead on Arrival: Financial Reform Fails
The House-Senate reconciliation process is still underway and some details will still change. But the broad contours of "financial reform" are already completely clear; there are no last minute miracles at this level of politics. The new consumer protection agency for financial products is a good idea and worth supporting—assuming someone sensible is appointed by the president to run it. Yet, at the end of the day, essentially nothing in the entire legislation will reduce the potential for massive system risk as we head into the next credit cycle.
Go, for example, through the summary of "comprehensive financial regulatory reform bills" in President Obama's letter to the G-20 last week [pdf].
The president argues for more capital in banking—and this is a fine goal, particularly as the Europeans continue to drag their feet on this issue. But how much capital does his Treasury team think is "enough"? Most indications are that they will seek tier 1 capital requirements in the range of 10 to 12 percent—which is what Lehman had right before it failed. How would that help?
"Stronger oversight of derivatives" is also on the president's international agenda but this cannot be taken seriously, given how little Treasury and the White House have pushed for tighter control of derivatives in the US legislation. If Senator Lincoln has made any progress at all—and we shall see where her initiative ends up—it has been without the full cooperation of the administration. (The Wall Street Journal today has a more positive interpretation, but even in this narrative you have to ask—where was the administration on this issue in the nine months of intense debate and hard work prior to April? Have they really woken up so recently to the dangers here?)
"More transparency and disclosure" sound fine but this is just empty rhetoric. Where is the application—or strengthening if necessary—of antitrust tools so that concentrated market share in over-the-counter derivatives can be confronted. The White House is making something of a show from Jamie Dimon falling out of favor, but all the points of substance that matter, Dimon's JPMorgan Chase has won. The Securities and Exchange Commission is beginning to push in the right direction, but the reconciliation conference looks likely to deny them the self-funding—Commodity Futures Trading Commission (CFTC) and Federal Deposit Insurance Corporation (FDIC), for example, collect fees from the industry—that could help build as a regulator. At the same time, the conference legislation would send a large number of important questions to the SEC "for further study." None of this makes any sense—unless the goal is to block real reform.
The president also asks for a "more effective framework for winding down large global firms" but his experts know this is politically impossible. The G-20 (and other) countries will not agree to such a cross-border resolution mechanism—and this was an important reason why Senators Sherrod Brown and Ted Kaufman argued so strongly that big banks had to become smaller (and be limited in how much they could borrow). Now administration officials brag to the press, on the record, about how they killed the Brown-Kaufman amendment. These people—in the White House and around the Treasury—simply cannot be taken seriously.
And as for "principles for the financial sector to make a fair and substantial contribution towards paying for any burdens," this is a sad joke. This is not an oil spill, Mr. President. This is the worst recession since World War II, a 40–percentage point increase in government debt (attempting to prevent a second Great Depression), loss of at least 8 million jobs in the United States, and a painfully slow recovery (in terms of unemployment)—not to mention all the collateral damage in so many parts of the world, including Europe. Could someone in the White House at least come to terms with this issue and provide the president with a sensible and clear text? Honestly, as staff work, this is embarrassing.
There is great deference to power in the United States, and perhaps that is appropriate. But those now calling the shots should remember that they will not be in power forever and—at some point in the not too distant future—there will be a more balanced assessment of their legacies.
Simply claiming that the president is "tough" on big banks simply will not wash. There are too many facts, too much accumulated evidence, pointing exactly the other way. The president signed off on the most generous and least conditional bailout in world financial history. This is now widely understood. The administration has scrambled to create some political cover in terms of "reform"—but the lack of substance here is already clear to people who follow it closely and public perceptions will shift quickly.
The financial crisis of fall 2008 revealed serious dangers have developed in the heart of the world's financial system. The Bush-Obama bailouts of 2008–09 confirmed that our biggest banks are "too big to fail" and the left, center, and right can agree with Gene Fama when he says: " 'too big to fail' is perverting activities and incentives."
This is not a leftist message, although you hear people on the left make the point. But people on the right also increasingly understand what is going on—there is excessive and abusive power at the heart of our financial system that completely distorts markets (and really amounts to a hidden, unfair, and dangerous taxpayer subsidy).
This administration and this Congress had ample opportunity to confront this problem and at least wrestle hard with it. Some senators and representatives worked long and hard on precisely this issue. But the White House punted, repeatedly, and elected instead for a veneer of superficial tweaking. Welcome to the next global credit cycle—with too big to fail banks at center stage.
Also posted on Simon Johnson's blog, Baseline Scenario.