Friday, April 23, 2010

Taking the Cure

"Governments... deemed it unwise to be sane at a time when sanity exposed one to ridicule, condemnation for spoiling the game, or the threat of severe political retribution."
-- John Kenneth Galbraith, The Great Crash of 1929
President Obama's speech on Financial Reform at Cooper Union yesterday had the look of going through the motions. As a speech we thought it was uninspired, superficial, and largely toneless. His audience wasn't any better. The bankers and brokers applauded mechanically, grinned stiffly, and kept their justifiably cynical thoughts to themselves.

For Obama's part, "the president ... struck a note of conciliation with an industry that has contributed generously to his party, beseeching bankers to work with him to forge a new regulatory structure." Steve Benen says it was like a lawyer addressing a "skeptical jury."

We thought it more resembled what could pass these days for a TV reality Church Show: synthetic, choreographed piety from a Puritan pastor received by a congregation of sinning bankers with imperfect contrition and phony remorse. You could almost see the tycoons squirming impatiently in the pews and licking their chops in their eagerness to throw a few bucks in the collection plate and hurry back to their desks to resume their wicked ways.

Paul Krugman has it right: The financial reforms pending in the Senate, which come up for debate on Monday -- assuming near unanimous Republican opposition can be overcome -- are a necessary "first step." They would make investment financing "safer." But they won't shrink any of the investment firms who are "too big to fail."

Robert Reich agrees. He -- and most other economists, left and right -- have been making a strong case that much remains to be done after the current bill is passed. "The Dodd bill now being considered in the Senate is a step in the right direction," he says. But three more steps are need to achieve truly effective Wall Street reform -- steps the President largely ignored in yesterday's address.

In Reich's words, Congress needs to pass additional laws that --
1. Require that trading of all derivatives be done on open exchanges where parties have to disclose what they’re buying and selling and have enough capital to pay up if their bets go wrong. The exception in the current bill for so-called “unique” derivatives opens up a loophole big enough for bankers to drive their Ferrari’s through.

2. Resurrect the Glass-Steagall Act in its entirety so commercial banks are separated from investment banks. The current bill doesn’t go nearly far enough. Commercial banks should take deposits and lend money. Investment banks should be limited to the casino we call the stock market, helping companies issue new issues and making bets. Nothing good comes of mixing the two. We learned this after the Great Crash of 1929, and then forgot it in 1999 when Congress allowed financial supermarkets to do both.

3. Cap the size
of big banks at $100 billion in assets
. The current bill doesn’t limit the size of banks at all. It creates a process for winding down the operations of any bank that gets into trouble. But if several big banks are threatened, as they were when the housing bubble burst, their failure would pose a risk to the whole financial system, and Congress and the Fed would surely have to bail them out. The only way to ensure no bank is too big to fail is to make sure no bank is too big, period. Nobody has been able to show any scale efficiencies over $100 billion in assets, so that should be the limit.
If the past four years have taught us anything, it is that a Wall Street banker's greed is like an alcoholic's thirst: it is never slaked. The bankers and brokers almost drove the American economy off a cliff again, just as they did in 1929. Assuredly, they will do it again. Indeed, there are ample signs they've already resumed their sinful ways.

Every effective measure to stop them needs to be taken by Congress. Pious sermonizing and appeals to civic virtue just won't work with Wall Street, no more than they do with chronic drunks. The nation needs all of Wall Street to take the cure -- and, as always, cures can hurt.

As Krugman writes today, "[R]eform actually should hurt the bankers. A growing body of analysis suggests that an oversized financial industry is hurting the broader economy. Shrinking that oversized industry won’t make Wall Street happy, but what’s bad for Wall Street would be good for America."
minor edit 4-23 am

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