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Beyond The Banks

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February 4, 2010

I recently saw the movie Food, Inc. and was struck by the idea that there are some fundamental problems that span just about every situation where government corruption and ineptitude have facilitated an industry’s efforts to crush the interests of consumers.  At approximately 36 minutes into the film, Michael Pollan explained how government efforts to prevent abuses in the food industry are undermined by the fact that the government always relies on the “quick fix” or “band-aid” approach, rather than a strategy addressed at solving a systemic problem.  In other words:  government prefers to treat the symptoms rather than the disease.

As I thought about Michael Pollan’s remark, I was immediately reminded of our financial crisis.  In that case, the solution was to bail out the “too big to fail” financial institutions.  As legislative proposals are introduced to address the systemic problems and prevent a recurrence of what happened in the fall of 2008, the lobbyists have stepped in to sabotage those efforts.

There were two other factors discussed in Food Inc. as presenting roadblocks to effective consumer-protective legislation:  the revolving door between the industry and Washington, as well as “regulatory capture” — a situation where government regulators are beholden to those whom they regulate.

We have seen the impact of these two factors in the financial area and they have been well-documented.  The “revolving door” was the subject of two recent essays by John Carney at The Business Insider website.  Carney discussed “The Banking Blob” as a secret club of Senate staffers and Wall Street lobbyists:

Staffers on the powerful Senate banking committee are part of what is known as “The Banking Blob,” a person familiar with the matter told us.  The Banking Blob is made up of current banking committee staffers and former staffers who are now bankers or lobbyists.  They frequently socialize together, often organizing happy hours and parties.

“They move in a pack.  They socialize together,” the person says.  “Hell.  They even inter-marry.”

The Blob is made up of both Republican and Democratic staffers.  Outsiders tend to think the Blob members view themselves as “cooler” than other Capitol Hill staff members.  Often a job on the banking committee leads to a well-paying job for a Wall Street firm or a position at a K-Street lobbyist law firm.

Carney had previously discussed the problem of Senate banking committee staffers who see their job as simply a stepping stone to a lucrative banking job:

The allure of banking is hardly a mystery.  The money is better.  Far better than the government wages paid to Capitol Hill staffers.  After years of toiling in government service, many staffers dream of a better life in one of the leafy neighborhoods that are so posh you cannot get there on DC’s Metro.     . . .

“Everyone talks about people going from Goldman to government.  But the problem is the other way.  Too many staffers go from Capitol Hill to banking.  And even more aspire to make that move.  It corrupts the process,” the staffer told us.

The third problem  — “regulatory capture” — is best epitomized in the person of “Turbo” Tim Geithner.  Joshua Rosner recently dissected Turbo Tim’s often-repeated claim that he has always worked in “public service”.  Rosner demonstrated that the only sector that has been “serviced” by Geithner was the banking industry:

Secretary Geithner can keep repeating his assertion he has worked in public service his whole life.  Never mind that this calls into question his tangible market experience, this claim begs the question:  How does he define working in the public service?

Geithner’s last job, as the President of the New York Fed highlights that question.

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The New York Fed is not government-owned.  Most people fail to recognize this fact.  Simply, the Federal Reserve Board (responsible for monetary policy, with a dual mandate of full employment and price stability) is an independent part of the federal government, while the New York Fed is a shareholder-owned or private corporation.  In other words, where the Federal Reserve Board is www.frb.gov, the District Bank is www.newyorkfed.org. Historically, the New York Fed has been among the most profitable shareholder-owned corporations in the world.  Yet it keeps the details of its shareholders’ ownership information private.  What we do know is that its owners include precisely those institutions it is tasked to regulate and supervise and those it has obviously failed to adequately supervise.  Unlike the other District Banks of the Federal Reserve system, which have overseen their banks quite well, the New York Fed’s concentration of the largest banks, coupled with its unique role of managing the market operations of the entire Fed system, has built a culture where it sees itself as a market participant and peer to those firms it regulates.

The President of the NY Fed is chosen by, paid by and reports to the private shareholders of that private institution.  Only three of the nine Directors of the Board of the New York Fed are chosen by the Federal Reserve Board and, until this year, the NY Fed’s Chair — chosen by the Federal Reserve Board in Washington — was a former Chairman of Goldman Sachs who still sits on Goldman’s Board.

*   *   *

In truth, Geithner’s ineffectiveness in his role as NY Fed President and his current political posturing — without any policy substance to directly address too-big-to-fail or the Fed’s flawed powers to bailout firms — seems to have resulted from design rather than accident.

*   *   *

If being a public servant is funneling unreasonable amounts of taxpayer capital, without market discipline, to the largest and most poorly managed banks, then Geithner’s selection as Secretary of Treasury makes sense.

One important lesson to be learned from our government’s inability to do its job regulating the financial sector, is that this failure is primarily caused by three problems:

  • An unwillingness to address a systemic problem by choosing, instead, to focus on “quick fixes”;
  • A revolving door between government and industry;
  • Regulatory capture.

Legislators, consumer advocates and commentators should focus on these three problem areas when addressing any situation where our government proves itself ineffective in preventing abuses by a particular industry.



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