September 17, 2009
In my last posting, I predicted that President Obama’s speech on financial reform would be “fine-sounding, yet empty”. As it turned out, many commentators have described the speech as just that. There weren’t many particulars discussed at all. As Caroline Baum reported for Bloomberg News:
At times he sounded more like a parent scolding a disobedient child than a president proposing a new regulatory framework.
“We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis,” Obama said in a speech at Federal Hall in New York City. (“You will not stay out until 2 a.m. again.”)
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Obama warned “those on Wall Street” against taking “risks without regard for consequences,” expecting the American taxpayer to foot the bill. But his words rang hollow.
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But you can’t, with words alone, alter the perception — now more entrenched than ever — that the government won’t allow large institutions to fail.
How do you convince bankers they will pay for their risk-taking when they’ve watched the government prop up banks, investment banks, insurance companies, auto companies and housing finance agencies?
They learn by example. The system of privatized profits and socialized losses has suited them fine until now.
Although the President had originally voiced support for expanding the authority of the Federal Reserve to include the role of “systemic risk regulator”, Ms. Baum noted that Allan Meltzer, professor of political economy at Carnegie Mellon University, believes that Mr. Obama has backed away from that ill-conceived notion:
“The Senate Banking Committee doesn’t want to give the Fed more power,” Meltzer said. “I’ve never seen such unanimity, and I’ve been testifying before the committee since 1962.”
Ms. Baum took that criticism a step further with her observation that the mission undertaken by any systemic risk regulator would not likely fare well:
Bankers Outfox Regulators
It is fantasy to believe a new, bigger, better regulator will ferret out problems before they grow to system-sinking size. Those being regulated are always one-step ahead of the regulator, finding new cracks or loopholes in the regulatory fabric to exploit. When the Basel II accord imposed higher risk- based capital requirements on international banks, banks moved assets off the balance sheet.
What’s more, regulators tend to identify with those they regulate, a phenomenon known as “regulatory capture,” making it highly unlikely that a new regulator would succeed where previous ones have failed.
At this point in the economic crisis, with Federal Reserve chairman Ben Bernanke’s recent declaration that the recession is “very likely over”, there is concern that President Obama’s incipient attempt at enacting financial reform may already be too late. A number of commentators have elaborated on this theme. At Credit Writedowns, Edward Harrison made this observation:
If you are looking for reform in the financial sector, the moment has passed. And only to the degree that the underlying weaknesses in the global financial system are made manifest and threaten the economy will we see any appetite for reform amongst politicians. So, as I see it, the Obama administration has missed the opportunity for reform.
More important, the following point by Mr. Harrison has been expressed in several recent essays:
Irrespective, I believe the need for reform is clear. Those gloom & doom economists were right because the economic model which brought us to the brink of disaster in 2008 is the same one we have at present and that necessarily means another crisis will come.
At MSN’s MoneyCentral, Michael Brush shared that same fear in a piece entitled, “Why a meltdown could happen again”:
Some observers say it’s OK that a year has gone by without reform; we don’t want to get it wrong. But the political reality is that as the urgency passes, it’s harder to pass reforms.
“We have lulled ourselves into the mind-set that we are out of the woods, when we aren’t,” says Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at Boston University School of Law. “I don’t think time is our friend here. We risk losing the sense of urgency so that nothing happens.”
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Douglas Elliott, a former JPMorgan investment banker now with the Brookings Institution, thinks the unofficial deadline for financial-sector reform is now October 2010 — right before the next congressional elections.
That leaves lawmakers a full year to get the job done.
But given all the details they have to work out — and the declining sense of urgency as stocks keep ticking higher — you have to wonder how much progress they’ll make.
On the other hand, back at Credit Writedowns, Edward Harrison voiced skepticism that such a deadline would be met:
You are kidding yourself if you think real reform is coming to the financial sector before the mid-term elections, especially with healthcare, two wars and the need to ensure recovery still on politicians’ plates. Obama could go for real reform in 2011 — or in a second term in 2013. But, unless economic crisis is at our door, there isn’t a convincing argument which says reform is necessary.
At The Washington Post, Brady Dennis discussed the Pecora Commission of the early 1930s, which investigated the causes of the Great Depression, and ultimately provided a basis for reforms of Wall Street and the banking industry. Mr. Dennis pointed out how the success of the Pecora Commission was rooted in the fact that populist outrage provided the fuel to help mobilize reform efforts, and he contrasted that situation with where we are now:
“Pecora’s success was his ability to crystallize the anger that a lot of Americans were feeling toward Wall Street,” said Michael Perino, a law professor at St. John’s University and author of an upcoming book about the hearings. “He was able to create a clamor for reform.”
But Pecora also realized that such clamor was fleeting
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“We’ve passed the moment when there’s this palpable anger directed at the financial community,” Perino said of the current crisis. “When you leave the immediate vicinity of the crisis, as you get farther and farther away in time, the urgency fades.”
Unfortunately, we appear to be at a point where it is too late to develop regulations against many of the excesses that led to last year’s financial crisis. Beyond that, many people who allowed the breakdown to occur (Bernanke, Geithner, et al.) are still in charge and the players who gamed the system with complex financial instruments are back at it again, with new derivatives — even some based on life insurance policies. Perhaps another harbinger of doom can be seen in this recent Bloomberg article: “Credit Swaps Lose Crisis Stigma as Confidence Returns”. Nevertheless, from our current perspective, some of us don’t have that much confidence in our financial system or our leadership.
The Next Big Fight
October 1, 2009
On Tuesday September 29, H. David Kotz, Inspector General of the Securities and Exchange Commission, issued two reports, recommending 58 changes to improve the way the agency investigates and enforces violations of securities laws, as a result of the SEC’s failure to investigate the Bernie Madoff Ponzi scheme. The reports exposed a shocking degree of ineptitude at the SEC. On September 10, Mr. Kotz testified before the Senate Banking Committee. You can find the prepared testimony here. (I suggest starting at page 8.) Having read that testimony, I wasn’t too shocked at what Mr. Kotz had to say in Tuesday’s reports. Nevertheless, as Zachery Kouwe explained in The New York Times, the level of bureaucratic incompetence at the SEC was underestimated:
The extent of dysfunction at the SEC has been well-documented. Back on January 5, I wrote a piece entitled: “Clean-Up Time On Wall Street”, expressing my hope that the incoming Obama administration might initiate some serious financial reforms. I quoted from Steven Labaton’s New York Times report concerning other SEC scandals investigated by Mr. Kotz last year. My posting also included a quote from a Times piece by Michael Lewis (author of Liar’s Poker) and David Einhorn, which is particularly relevant to the recent disclosures by Inspector General Kotz:
This sentiment was echoed on Tuesday by Barry Ritholtz at The Big Picture website:
Financial expert Janet Tavakoli explained in a presentation to the International Monetary Fund last week, that regulatory failures in the United States helped create an even larger Ponzi scam than the Madoff ruse — the massive racket involving the trading of residential mortgage-backed securities:
As Simon Johnson and James Kwak explained in The Washington Post, the upcoming battle over financial reform will be hard-fought by the banking industry and its lobbyists:
Our new President must know by now, that sinking a three-point shot is much easier than the juggling act he has undertaken with health care reform, the wars in Iraq and Afghanistan as well as his recent quest to help Chicago win the bid for the 2016 Olympics. If Mr. Obama can’t beat the health insurance lobby with both the Senate and Congress under Democratic control — how will the voters feel if he drops another ball in the fight for financial reform? Thanks to Harry Truman, the American public knows where “the buck stops”. The previously-quoted Washington Post commentary looked even further back in history to explain this burden of leadership:
Let the games begin!