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Building A Consensus For Survival

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March 29, 2010

In my last posting, I focused on the fantastic discourse in favor of financial reform presented by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, in a speech before the U.S. Chamber of Commerce.  In addition to Hoenig’s speech, last week brought us a number of excellent arguments for the cause that is so bitterly opposed by Wall Street lobbyists.  On the same day that Thomas Hoenig delivered his great speech to the U.S. Chamber of Commerce, Deputy Treasury Secretary Neal Wolin also addressed that institution to argue in favor of financial reform.  I enjoyed the fact that he rubbed this in their faces:

That is why it is so puzzling that, despite the urgent and undeniable need for reform, the Chamber of Commerce has launched a $3 million advertising campaign against it.  That campaign is not designed to improve the House and Senate bills.  It is designed to defeat them.  It is designed to delay reform until the memory of the crisis fades and the political will for change dies out.

The Chamber’s campaign comes on top of the $1.4 million per day already being spent on lobbying and campaign contributions by big banks and Wall Street financial firms.  There are four financial lobbyists for every member of Congress.

Wolin’s presentation was yet another signal from the Treasury Department that inspired economist Simon Johnson to begin feeling optimistic about the possibility that some meaningful degree of financial reform might actually take place:

Against all the odds, a glimmer of hope for real financial reform begins to shine through.  It’s not that anything definite has happened — in fact most of the recent Senate details are not encouraging – but rather that the broader political calculus has shifted in the right direction.

Instead of seeing the big banks as inviolable, top people in Obama administration are beginning to see the advantage of taking them on — at least on the issue of consumer protection.  Even Tim Geithner derided the banks recently as,

“those who told us all they were the masters of noble             financial innovation and sophisticated risk management.”

Yep.  That was our old pal and former New York Fed President, “Turbo” Tim Geithner, making the case for financial reform before the American Enterprise Institute.  (You remember them — the outfit that fired David Frum for speaking out against Fox News and the rest of the “conservative entertainment industry”.)  Treasury Secretary Geithner made his pitch for reform by reminding his conservative audience that longstanding advocates of the “efficient market hypothesis” had come on board in favor of financial reform:

Now, the recognition that markets failed and that the necessary solution involves reform; that it requires rules enforced by government is not a partisan or political judgment.  It is a conclusion reached by liberals and by conservative skeptics of regulation.

Judge Richard Posner, a leader in the conservative Chicago School of economics, wrote last year, that “we need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.”

And consider Alan Greenspan, a skeptic of the benefits of regulation, who recently said, “inhibiting irrational behavior when it can be identified, through regulation,   . . .   could be stabilizing.”

No wonder Simon Johnson is feeling so upbeat!  The administration is actually making a serious attempt at doing what needs to be done to get this accomplished.

Meanwhile, The New York Times had run a superb article by David Leonhardt just as Geithner was about to address the AEI.  Leonhardt’s essay, “Heading Off the Next Financial Crisis” is a thorough analysis, providing historical background and covering every angle on what needs to be done to clean up the mess that got us where we are today — and to prevent it from happening again.  Here are some snippets from the first page that had me hooked right away:

It was a maddening story line:  the government helped the banks get rich by looking the other way during good times and saved them from collapse during bad times.  Just as an oil company can profit from pollution, Wall Street profited from weak regulation, at the expense of society.

*   *   *

In a way, this issue is more about human nature than about politics.  By definition, the next period of financial excess will appear to have recent history on its side.

*   *   *

One way to deal with regulator fallibility is to implement clear, sweeping rules that limit people’s ability to persuade themselves that the next bubble is different — upfront capital requirements, for example, that banks cannot alter.  Thus far, the White House, the Fed and Congress have mostly steered clear of such rules.

Congratulations to David Leonhardt for putting that great piece together.  As more commentators continue to advance such astute, sensible appeals to plug the leaks in our sinking financial system, there is a greater likelihood that our lawmakers will realize that the economic risk of doing nothing far exceeds the amounts of money in those envelopes from the lobbyists.



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The Best Argument For Financial Reform

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March 26, 2010

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, spoke out in favor of financial reform on Wednesday in a speech before the U.S. Chamber of Commerce.  The shocking aspect of Hoenig’s speech is that it comes from the mouth of a member of the Federal Reserve’s Open Market Committee (FOMC) which sets economic policy.  Beyond that, Hoenig brutally criticized what has been done so far to tilt the playing field in favor of the megabanks, at the expense of smaller banks.  Here are some choice bits from what should be mandatory reading for everyone in Congress:

As a nation, we have violated the central tenants of any successful system.  We have seen the formation of a powerful group of financial firms.  We have inadvertently granted them implied guarantees and favors, and we have suffered the consequences.  We must correct these violations.  We must reinvigorate fair competition within our system in a culture of business ethics that operates under the rule of law.  When we do this, we will not eliminate the small businesses’ need for capital, but we will make access to capital once again earned, as it should be.

*   *   *

The fact is that Main Street will not prosper without a healthy financial system.  We will not have a healthy financial system now or in the future without making fundamental changes that reverse the wrong-headed incentives, change behavior and reinforce the structure of our financial system.  These changes must be made so that the largest firms no longer have the incentive to take too much risk and gain a competitive funding advantage over smaller ones.  Credit must be allocated efficiently and equitably based on prospective economic value.  Without these changes, this crisis will be remembered only in textbooks and then we will go through it all again.

Hoenig’s speech comes at a time when the Senate is considering a watered-down version of financial reform that has been widely criticized.  Economist Simon Johnson pointed out how any approach based on U.S. authority alone to “resolve” or break up systemically dangerous banks would be doomed because “there is no cross-border agreement on resolution process and procedure — and no prospect of the same in sight”.

Blogger Mike Konczal expressed his disappointment with what has become of the Financial Reform Bill as it has been dragged through the legislative process:

It’s funny, I know what a good financial reform bill becoming a bad financial reform bill looks like through this process.  I’ve seen bribes and more bribes and last-minute giveaway changes.

The notion that bribery has been an obstacle to financial reform became a central theme of Karl Denninger’s enthusiastic reaction to Hoenig’s speech:

All in all it’s nice to see Thomas Hoenig wake up.  Now let’s see if we can get CONgress to stop opening the bribe envelopes, er, ignore the campaign contributions for a sufficient period of time to actually fix this mess, forcing those “big banks” to get that leverage ratio down to where it belongs, along with marking their assets to the market.

Thomas Hoenig provided exactly the type of leadership needed and at exactly the right time to give a boost to serious financial reform.  We can only hope that there will be enough responsible, ethical people in the Senate to incorporate Hoenig’s suggestions into the Financial Reform Bill.  If only  . . .



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Lacking Reform

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January 4, 2010

David Reilly of Bloomberg News did us all a favor by reading through the entire, 1,270-page financial reform bill that was recently passed by the House of Representatives.  The Wall Street Reform and Consumer Protection Act (HR 4173) was described by Reilly this way:

The baby of Financial Services Committee Chairman Barney Frank, the House bill is meant to address everything from too-big-to-fail banks to asleep-at-the-switch credit-ratings companies to the protection of consumers from greedy lenders.

After reading the bill, David Reilly wrote a commentary piece for Bloomberg entitled:  “Bankers Get $4 Trillion Gift from Barney Frank”.  Reilly seemed surprised that banks opposed this legislation, emphasizing that “they should cheer for its passage by the full Congress in the New Year” because of the bill’s huge giveaways to the banking industry and Wall Street.  Here are some of Reilly’s observations on what this bill provides:

—  For all its heft, the bill doesn’t once mention the words “too-big-to-fail,” the main issue confronting the financial system.  Admitting you have a problem, as any 12-stepper knows, is the crucial first step toward recovery.

— Instead, it supports the biggest banks.  It authorizes Federal Reserve banks to provide as much as $4 trillion in emergency funding the next time Wall Street crashes.  So much for “no-more-bailouts” talk.  That is more than twice what the Fed pumped into markets this time around.  The size of the fund makes the bribes in the Senate’s health-care bill look minuscule.

— Oh, hold on, the Federal Reserve and Treasury Secretary can’t authorize these funds unless “there is at least a 99 percent likelihood that all funds and interest will be paid back.”   Too bad the same models used to foresee the housing meltdown probably will be used to predict this likelihood as well.

More Bailouts

— The bill also allows the government, in a crisis, to back financial firms’ debts.  Bondholders can sleep easy  — there are more bailouts to come.

— The legislation does create a council of regulators to spot risks to the financial system and big financial firms. Unfortunately this group is made up of folks who missed the problems that led to the current crisis.

— Don’t worry, this time regulators will have better tools.  Six months after being created, the council will report to Congress on “whether setting up an electronic database” would be a help. Maybe they’ll even get to use that Internet thingy.

— This group, among its many powers, can restrict the ability of a financial firm to trade for its own account.  Perhaps this section should be entitled, “Yes, Goldman Sachs Group Inc., we’re looking at you.”

My favorite passage from Reilly’s essay concerned the proposal for a Consumer Financial Protection Agency:

— The bill isn’t all bad, though.  It creates a new Consumer Financial Protection Agency, the brainchild of Elizabeth Warren, currently head of a panel overseeing TARP.  And the first director gets the cool job of designing a seal for the new agency.  My suggestion:  Warren riding a fiery chariot while hurling lightning bolts at Federal Reserve Chairman Ben Bernanke.

The cover story for the December 30 edition of Business Week explained how this bill became so badly compromised.  Alison Vekshin and Dawn Kopecki wrote the piece, explaining how the New Democrat Coalition, which “has 68 fiscally conservative, pro-business members who fill 15 of the party’s 42 seats on the House Financial Services Committee” reshaped this bill.  The New Democrats fought off proposed changes to derivatives trading and included an amendment to the Consumer Financial Protection Agency legislation giving federal regulators more discretion to override state consumer protection laws than what was initially proposed.  Beyond that, “non-financial” companies such as real estate agencies and automobile dealerships will not be subject to the authority of the new agency.  The proposed requirement for banks to offer “plain-vanilla” credit-card and mortgage contracts was also abandoned.

One of my pet peeves involves Democrats’ claiming to be “centrists” or “moderates” simply because they enjoy taking money from lobbyists.  Too many people are left with the impression that a centrist is someone who lacks a moral compass.  The Business Week story provided some insight about how the New Democrat Coalition gets … uh … “moderated”:

Since the start of the 2008 election cycle, the financial industry has donated $24.9 million to members of the New Democrats, some 14% of the total funds the lawmakers have collected, according to the Center for Responsive Politics.  Representative Melissa Bean of Illinois, who has led the Coalition’s efforts on regulatory reform, was the top beneficiary, with donations of $1.4 million.

As the financial reform bill is being considered by the Senate, the U.S. Chamber of Commerce has stepped up its battle against the creation of a Consumer Financial Protection Agency.  The Business Week article concluded with one lawmaker’s perspective:

“My greatest fear for the last year has been an economic collapse,” says Representative Brad Miller (D-N.C), who sits on Frank’s House Financial Services Committee.  “My second greatest fear was that the economy would stabilize and the financial industry would have the clout to defeat the fundamental reforms that our nation desperately needs.  My greatest fear seems less likely … but my second greatest fear seems more likely every day.”

The dysfunction that preserves this unhealthy status quo was best summed up by Chris Whalen of Institutional Risk Analytics:

The big banks pay the big money in Washington, the members of Congress pass new laws to enable the theft from the public purse, and the servile Fed prints money to keep the game going for another day.

As long as Congress is going through the motions of passing “reform” legislation, they should do us all a favor and take on the subject of lobbying reform.  Of course, the chances of that ever happening are slim to none.



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