The predominant criticism of the so-called “financial reform” bill is its failure to address the problems caused by the existence of financial institutions considered “too big to fail”. In an essay entitled, “Creating the Next Crisis” economist Simon Johnson discussed the consequences of this legislative let-down:
On the critical dimension of excessive bank size and what it implies for systemic risk, there was a concerted effort by Senators Ted Kaufman and Sherrod Brown to impose a size cap on the largest banks – very much in accordance with the spirit of the original “Volcker Rule” proposed in January 2010 by Obama himself. In an almost unbelievable volte face, for reasons that remain somewhat mysterious, Obama’s administration itself shot down this approach. “If enacted, Brown-Kaufman would have broken up the six biggest banks in America,” a senior Treasury official said. “If we’d been for it, it probably would have happened. But we weren’t, so it didn’t.”
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The US financial sector received an unconditional bailout – and is not now facing any kind of meaningful re-regulation. We are setting ourselves up, without question, for another boom based on excessive and reckless risk-taking at the heart of the world’s financial system. This can end only one way: badly.
One would assume that an important lesson learned from the 2008 financial crisis was the idea that a corporation shouldn’t be permitted to blackmail the country with threats that its own financial collapse would have such a dire impact on society-at-large that the corporation should be bailed out by the taxpayers. The resulting problem is called “moral hazard” because such businesses are encouraged to act irresponsibly by virtue of the certainty that they will be bailed out if their activities prove self-destructive.
Gonzalo Lira wrote a piece for the Naked Capitalism blog, explaining how the moral hazard resulting from the “too big to fail” doctrine is facilitating a state of corporate anarchy:
In a nutshell, in this era of corporate anarchy, corporations do not have to abide by any rules — none at all. Legal, moral, ethical, even financial rules are irrelevant. They have all been rescinded in the pursuit of profit — literally nothing else matters.
As a result, corporations currently exist in a state of almost pure anarchy — but an anarchy directly related to their size: The larger the corporation, the greater its absolute freedom to do and act as it pleases. That’s why so many medium-sized corporations are hell-bent on growth over profits: The biggest of them all, like BP and Goldman Sachs, live in a positively Hobbesian State of Nature, free to do as they please, with nary a consequence.
Good-old British Petroleum – the latest beneficiary of the “too big to fail doctrine” — can rely on its size to avoid any sanctions it considers unacceptable because too many “small people” might lose their jobs if BP can’t stay fat and happy. Gonzalo Lira’s analysis went a step further:
Worst of all, BP realizes that, if it finally cannot get a handle on the oil spill disaster, they can simply fob it off on the U.S. Government — in other words, the people of the United States will wind up cleaning BP’s mess. BP knows that no one will hold it accountable — BP knows that it will get away with it.
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This era of corporate anarchy is reaching a crisis point — we can all sense it. Yet the leadership in the United States and Europe is making no effort to solve the root problem. Perhaps they don’t see the problem. Perhaps they are beholden to corporate masters. Whatever the case, in his speech, President Obama made ridiculous references to “clean energy” while ignoring the cause of the BP oil spill disaster, the cause of the financial crisis, the cause of the spiralling health-care costs — the corporate anarchy that underlines them all.
This era of corporate anarchy is wrecking the world — literally, if you’ve been tuning in to images of the oil billowing out a mile down in the Gulf of Mexico.
Mr. Lira discussed how a leadership void has been helping corporate anarchy overtake democratic capitalism:
Obama is a corporatist — he’s one of Them. So there’ll be more bullshit talk about “clean energy” and “energy independence”, while the root cause — corporate anarchy — is left undisturbed.
The failure of President Obama to take advantage of the opportunity to address this “root cause” in his Oval Office address concerning the Deepwater Horizon disaster, inspired Robert Reich to make this comment:
Whether it’s Wall Street or health insurers or oil companies, we are approaching a turning point. The top executives of powerful corporations are pursuing profits in ways that menace the nation. We have not seen the likes not since the late nineteenth century when the “robber barons” of finance, oil, and the giant trusts ran roughshod over America. Now, as then, they are using their wealth and influence to buy off legislators and intimidate the regions that depend on them for jobs. Now, as then, they are threatening the safety and security of our people.
One of my favorite commentators, Paul Farrell of MarketWatch, recently warned us about the consequences of allowing corporate anarchy to destroy democratic capitalism:
The rise of uncontrolled corporate greed killed the “Invisible Hand,” the “soul” of capitalism that Adam Smith saw in 1776 as a divine force serving “the common good.” Today the system has no moral compass. Wall Street’s insatiable greed has destroyed capitalism from within, turning America’s economy into a soulless zombie.
The “Invisible Hand” Adam Smith saw as essential to capitalism in “The Theory of Moral Sentiments” died in endless battles fought by 261,000 lobbyists each wanting a bigger piece of the $1.7 trillion federal budget pie plus favorable laws protecting, vesting and increasing the power and wealth of their special interest clients. Future historians will call this ideological battle replacing democracy the new “American Capitalists Anarchy.”
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As a New York Times reviewer put it: Nations like “China and Russia are using what he calls ‘state capitalism’ to advance the interests of their companies at the expense of their American rivals.” Global pandemic?
Unfortunately while America wastes trillions to bail out inefficient too-stupid-to-fail banks, our competition is bankrolling healthy state-controlled corporations to destroy us . . .
If we ever reach the point when the watered-down “financial reform” bill finally becomes law, the taxpayers should insist that their government move on to address the “root cause” of corporate anarchy by taking up campaign finance reform. That should be one hell of a fight!
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.
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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.
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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.
Comments Off on The Best Argument For Financial Reform
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”.
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 . . .
When a stranger in a tinfoil hat tells me that the sky is falling, I don’t pay attention to him. On the other hand, when credible sources warn of an upcoming economic collapse as a result of our government’s financial ignorance — I listen.
Simon Johnson is a professor of Entrepreneurship at MIT’s Sloan School of Management. From 2007-2008, he was chief economist at the International Monetary Fund. He recently co-authored an article for CenterPiece with Peter Boone entitled, “The Doomsday Cycle”. Their essay began with this observation:
Each time the system runs into problems, the Federal Reserve quickly lowers interest rates to revive it. These crises appear to be getting worse and worse — and their impact is increasingly global. Not only are interest rates near zero around the world, but many countries are on fiscal trajectories that require major changes to avoid eventual financial collapse.
What will happen when the next shock hits? We believe we may be nearing the stage where the answer will be — just as it was in the Great Depression — a calamitous global collapse. The root problem is that we have let a “doomsday cycle” infiltrate our economic system . . .
The essay contains a number of proposals for correcting this problem. One of them involves tripling the requirement for core capital at major banks to 15-20% of assets. They concluded with this warning:
Last year, we came remarkably close to collapse. Next time, it may be worse. The threat of the doomsday cycle remains strong and growing.
Of course, the fact that scares me is that our government doesn’t give a damn. We aren’t likely to see any changes in capital requirements or anything else that was suggested in that article.
Niall Ferguson is a professor of economic history at Harvard. He recently wrote an article entitled, “Complexity and Collapse — Empires on the Edge of Chaos”. It was published in the March/April 2010 issue of Foreign Affairs magazine. The piece began with this summary:
Imperial collapse may come much more suddenly than many historians imagine. A combination of fiscal deficits and military overstretch suggests that the United States may be the next empire on the precipice.
Niall Ferguson’s essay inspired Paul Farrell of MarketWatch to write a commentary on Ferguson’s piece, summarizing the highlights, while driving home this message:
Dismiss his warning at your peril. Everything you learned, everything you believe and everything driving our political leaders is based on a misleading, outdated theory of history. The American Empire is at the edge of a dangerous precipice, at risk of a sudden, rapid collapse.
* * *
His message negates all the happy talk you’re hearing in today’s news — about economic recovery and new bull markets, about “hope,” about a return to “American greatness” — from Washington politicians and Wall Street bankers.
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“The Consummation of Empire” focuses us on Ferguson’s core message: At the very peak of their power, affluence and glory, leaders arise, run amok with imperial visions and sabotage themselves, their people and their nation. They have it all.
Fortunately, Mr. Farrell included some advice for those of us who are wondering about how to survive an economic collapse: Head for the hills. Here’s what he had to say:
At this point, investors are asking themselves: How can I prepare for the destruction and collapse of the American Empire? There is no solution in the Cole-Ferguson scenario, only an acceptance of fate, of destiny, of history’s inevitable cycles.
But there is one in “Wealth, War and Wisdom” by hedge fund manager Barton Biggs, Morgan Stanley’s former chief global strategist who warns us of the “possibility of a breakdown of the civilized infrastructure,” advising us to buy a farm in the mountains.
“Your safe haven must be self-sufficient and capable of growing some kind of food … well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc. Think Swiss Family Robinson.” And when they come looting, fire “a few rounds over the approaching brigands’ heads.”
A reading of Paul Farrell’s article about Barton Biggs from July of 2009, reveals a more comfortable assessment of a crisis which may be 40 or 50 years in the future. Professor Ferguson’s essay has apparently given Mr. Farrell a greater sense of urgency about the disaster ahead. Here’s the assessment Mr. Farrell gave last summer:
But how to invest for the “End of Civilization” coming around 2050? The next 40 years will be confusing: Accelerating struggles between aging populations and disenchanted youth, soaring commodity prices, global warming, peak oil, food shortages, famine, blackouts, rationing, civil disorder, increasing crime, worldwide jihads, riots, anarchy and other dark scenarios of a tomorrow with “warfare defining human life.”
Compare and contrast that view with the concluding remark from Mr. Farrell’s recent piece:
You are forewarned: If the peak of America’s glory was the leadership handoff from Clinton to Bush, then we have already triggered the countdown to collapse, the decade from 2010 until 2020 … tick … tick … tick …
You have just read the views of some intelligent men who are warning us that a huge disaster may lie just around the corner. Yikes!
The month of March brings us three new books about the financial crisis. The authors are not out to make apologies for anyone. To the contrary, they point directly at the villains and expose the systemic flaws that were exploited by those who still may yet destroy the world economy. All three of these books are available at the Amazon widget on the sidebar at the left side of this page.
Regular fans of the Naked Capitalism blog have been following the progress of Yves Smith on her new book, ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. It will be released on March 2. Here is some information about the book from the product description at the Amazon website:
ECONned is the first book to examine the unquestioned role of economists as policy-makers, and how they helped create an unmitigated economic disaster.
Here, Yves Smith looks at how economists in key policy positions put doctrine before hard evidence, ignoring the deteriorating conditions and rising dangers that eventually led them, and us, off the cliff and into financial meltdown. Intelligently written for the layman, Smith takes us on a terrifying investigation of the financial realm over the last twenty-five years of misrepresentations, naive interpretations of economic conditions, rationalizations of bad outcomes, and rejection of clear signs of growing instability.
In eConned (sic), author Yves Smith reveals:
–why the measures taken by the Obama Administration are mere palliatives and are unlikely to pave the way for a solid recovery
–how economists have come to play a profoundly anti-democratic role in policy
–how financial models and concepts that were discredited more than thirty years ago are still widely used by banks, regulators, and investors
–how management and employees of major financial firms looted them, enriching themselves and leaving the mess to taxpayers
–how financial regulation enabled predatory behavior by Wall Street towards investors
–how economics has no theory of financial systems, yet economists fearlessly prescribe how to manage them
Michael Lewis is the author of the wildly-popular book, Liar’s Poker, based on his experience as a bond trader for Solomon Brothers in the mid-80s. His new book, The BigShort: Inside the Doomsday Machine, will be released on March 15. Here is some of what Amazon’s product description says about it:
A brilliant account — character-rich and darkly humorous — of how the U.S. economy was driven over the cliff.
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Michael Lewis’s splendid cast of characters includes villains, a few heroes, and a lot of people who look very, very foolish: high government officials, including the watchdogs; heads of major investment banks (some overlap here with previous category); perhaps even the face in your mirror. In this trenchant, raucous, irresistible narrative, Lewis writes of the goats and of the few who saw what the emperor was wearing, and gives them, most memorably, what they deserve. He proves yet again that he is the finest and funniest chronicler of our times.
Our third author, Simon Johnson, recently co-authored an article for CenterPiece with Peter Boone entitled, “The Doomsday Cycle” which explains how “we have let a ‘doomsday cycle’ infiltrate our economic system”. The essay contains a number of proposals for correcting this problem. Here is one of them:
We believe that the best route to creating a safer system is to have very large and robust capital requirements, which are legislated and difficult to circumvent or revise. If we triple core capital at major banks to15-25% of assets, and err on the side of requiring too much capital for derivatives and other complicated financial structures, we will create a much safer system with less scope for “gaming” the rules.
Simon Johnson is a professor of Entrepreneurship at MIT’s Sloan School of Management. From 2007-2008, he was chief economist at the International Monetary Fund. With James Kwak, he is the co-publisher of The Baseline Scenario website. Johnson and Kwak have written a new book entitled, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. Although this book won’t be released until March 30, the Amazon website has already quoted from reviews by the following people: Bill Bradley, Robert Reich, Arianna Huffington, Bill Moyers, Alan Grayson, Brad Miller, Elizabeth Warren and others. Professor Warren must be a Democrat, based on the affiliation of nearly everyone else who reviewed the book.
Here is some of what can be found in Amazon’s product description:
. . . a wide-ranging, meticulous, and bracing account of recent U.S. financial history within the context of previous showdowns between American democracy and Big Finance: from Thomas Jefferson to Andrew Jackson, from Theodore Roosevelt to Franklin Delano Roosevelt. They convincingly show why our future is imperiled by the ideology of finance (finance is good, unregulated finance is better, unfettered finance run amok is best) and by Wall Street’s political control of government policy pertaining to it.
As these authors make the talk show circuit to promote their books during the coming weeks, the American public will hearing repeated pleas to demand that our elected officials take action to stop the mercenary financial behemoths from destroying the world. Perhaps the message will finally hit home.
If you are interested in any of these three books, they’re available on the right side of this page.
An ever-increasing number of people are paying close attention to a gentleman named Simon Johnson. Mr. Johnson, a former chief economist at the International Monetary Fund, now works at MIT as Professor of Entrepreneurship at the Sloan School of Management. His Baseline Scenario website is focused on the financial and economic crises. At the Washington Post website, he runs a blog with James Kwak called The Hearing. Last spring, Johnson turned more than a few heads with his article from the May 2009 issue of The Atlantic, “The Quiet Coup”, in which he explained that what happened in America during last year’s financial crisis and what is currently happening with our economic predicament is “shockingly reminiscent” of events experienced during financial crises in emerging market nations (i.e. banana republics and proto-capitalist regimes).
On October 9, Joe Nocera of The New York Times began his column by asking Professor Johnson what he thought the Wall Street banks owed America after receiving trillions of dollars in bailouts. Johnson’s response turned to Wednesday’s upcoming fight before the House Financial Services Committee concerning the financial reforms proposed by the Obama administration:
“They can’t pay what they owe!” he began angrily. Then he paused, collected his thoughts and started over: “Tim Geithner saved them on terms extremely favorable to the banks. They should support all of his proposed reforms.”
Mr. Johnson continued, “What gets me is that the banks have continued to oppose consumer protection. How can they be opposed to consumer protection as defined by a man who is the most favorable Treasury Secretary they have had in a generation? If he has decided that this is what they need, what moral right do they have to oppose it? It is unconscionable.”
This week’s battle over financial reform has been brewing for quite a while. Back on May 31, Gretchen Morgenson and Dan Van Natta wrote a piece for The New York Times entitled, “In Crisis, Banks Dig In for Fight Against Rules”:
Hotly contested legislative wars are traditional fare in Washington, of course, and bills are often shaped by the push and pull of lobbyists — representing a cornucopia of special interests — working with politicians and government agencies.
What makes this fight different, say Wall Street critics and legislative leaders, is that financiers are aggressively seeking to fend off regulation of the very products and practices that directly contributed to the worst economic crisis since the Great Depression. In contrast, after the savings-and-loan debacle of the 1980s, the clout of the financial lobby diminished significantly.
In case you might be looking for a handy scorecard to see which members of Congress are being “lobbied” by the financial industry and to what extent those palms are being greased, The Wall Street Journal was kind enough to provide us with an interactive chart. Just slide the cursor next to the name of any member of the House Financial Services Committee and you will be able to see how much generosity that member received just during the first quarter of 2009 from an entity to be affected by this legislation. The bars next to the committee members’ names are color-coded, with different colors used to identify specific sources, whose names are displayed as you pass over that section of the bar. This thing is a wonderful invention. I call it “The Graft Graph”.
On October 9, Simon Johnson appeared with Representative Marcy Kaptur (D – Ohio) on the PBS program, Bill Moyers Journal. At one point during the interview, Professor Johnson expressed grave doubts about our government’s ability to implement financial reform:
And yet, the opportunity for real reform has already passed. And there is not going to be — not only is there not going to be change, but I’ll go further. I’ll say it’s going to be worse, what comes out of this, in terms of the financial system, its power, and what it can get away with.
* * *
BILL MOYERS: Why have we not had the reform that we all knew was being — was needed and being demanded a year ago?
SIMON JOHNSON: I think the opportunity — the short term opportunity was missed. There was an opportunity that the Obama Administration had. President Obama campaigned on a message of change. I voted for him. I supported him. And I believed in this message. And I thought that the time for change, for the financial sector, was absolutely upon us. This was abundantly apparent by the inauguration in January of this year.
SIMON JOHNSON: And Rahm Emanuel, the President’s Chief of Staff has a saying. He’s widely known for saying, ‘Never let a good crisis go to waste’. Well, the crisis is over, Bill. The crisis in the financial sector, not for people who own homes, but the crisis for the big banks is substantially over. And it was completely wasted. The Administration refused to break the power of the big banks, when they had the opportunity, earlier this year. And the regulatory reforms they are now pursuing will turn out to be, in my opinion, and I do follow this day to day, you know. These reforms will turn out to be essentially meaningless.
Sound familiar? If you change the topic to healthcare reform, you end up with the same bottom line: “These reforms will turn out to be essentially meaningless.” The inevitable watering down of both legislative efforts can be blamed on weak, compromised leadership. It’s one thing to make grand promises on the campaign trail — yet quite another to look a lobbyist in the eye and say: “Thanks, but no thanks.” Toward the end of the televised interview, Bill Moyers had this exchange with Representative Kaptur:
BILL MOYERS: How do we get Congress back? How do we get Congress to do what it’s supposed to do? Oversight. Real reform. Challenge the powers that be.
MARCY KAPTUR: We have to take the money out. We have to get rid of the constant fundraising that happens inside the Congress. Before political parties used to raise money; now individual members are raising money through the DCCC and the RCCC. It is absolutely corrupt.
As we all know, our system of legalized graft goes beyond the halls of Congress. During his Presidential campaign, Barack Obama received nearly $995,000 in contributions from the people at Goldman Sachs. The gang at 85 Broad Street is obviously getting its money’s worth.
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:
Many on Wall Street and in Washington were surprised that some of Mr. Kotz’s proposals, like recording interviews with witnesses and creating a database for tips and complaints, were not already part of the S.E.C.’s standard practice.
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:
Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.
Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors.
This sentiment was echoed on Tuesday by Barry Ritholtz at The Big Picture website:
The agency is supposed to be an investor’s advocate, the chief law enforcement agency for the markets. But that has hardly been how they have been managed, funded and operated in recent years.
Essentially the largest prosecutor’s office in the country, the SEC has been undercut at every turn: Their staffing was far too small to handle their jurisdiction — Wall Street and public Corporations. Their budgets have been sliced, and they were unable to keep up with the explosion in corporate criminality. Many key positions were left unfilled, and morale was severely damaged. A series of disastrous SEC chairs were appointed — to be “kinder and gentler.” Not only did they fail to maintain SEC funding (via fines), but they allowed the worst corporate offenders to go unpunished.
Gee, go figure that under those circumstances, they sucked at their jobs.
* * *
The bottom line of the SEC is this: If we are serious about corporate fraud, about violations of the SEC laws, about a level playing field, then we fund the agency adequately, hire enough lawyers to prosecute the crimes, and prevent Congress critters from interfering with the SEC doing its job.
To be blunt: So far, there is no evidence we are sincere about making the SEC a serious watchdog with teeth.
Congress sure hasn’t been. Staffing levels have been ignored, budgeting has been cut over the years. And it’s the sort of administrative issue that does not lend itself to bumper sticker aphorisms or tea party slogans.
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:
Wall Street disguised these toxic “investments” with new value-destroying securitizations and derivatives.
Meanwhile, collapsing mortgage lenders paid high dividends to shareholders (old investors) and interest on credit lines to Wall Street (old investors) with money raised from new investors in doomed securities. New money allowed Wall Street to temporarily hide losses and pay enormous bonuses. This is a classic Ponzi scheme.
* * *
Had regulators done their jobs, they would have shut down Wall Street’s financial meth labs, and the Ponzi scheme would have quickly choked to death from lack of monetary oxygen.
After the Savings and Loan crisis of the late 1980’s, there were more than 1,000 felony indictments of senior officers. Recent fraud is much more widespread and costly. The consequences are much greater. Congress needs to fund investigations. Regulators need to get tough on crime.
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:
The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.
* * *
Even back in April, the industry was able to kill Obama’s request for legislation allowing bankruptcy judges to modify mortgages. Five months of profits later, the big banks are only stronger. Is Obama up for this fight?
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:
During the reign of Louis XIV, when the common people complained of some oppressive government policy, they would say, “If only the king knew . . . .” Occasionally people will make similar statements about Barack Obama, blaming the policies they don’t like on his lieutenants.
But Barack Obama, like Louis XIV before him, knows exactly what is going on. Now is the time for him to show what his priorities are and how hard he is willing to fight for them. Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can’t blame it all on the banking lobby.
As I write this, President Obama is preparing another fine-sounding, yet empty speech. His subject this time is financial reform. You may recall last week’s lofty address to the joint session of Congress, promoting his latest, somewhat-less-nebulous approach to healthcare reform. He assured the audience that the so-called “public option” (wherein a government-created entity competes with private sector healthcare insurers) would be an integral part of the plan. Within a week, two pieces of political toast from the Democratic Party (Nancy Pelosi and Harry Reid) set about undermining that aspect of the healthcare reform agenda. This is just one reason why, on November 2, 2010, the people who elected Democrats in 2006 and 2008 will be taking a “voters’ holiday”, paving the way for Republican majorities in the Senate and House. The moral lapse involving the public option was documented by David Sirota for Danny Schechter’s NewsDissector blog:
House Speaker Nancy Pelosi for the first time yesterday suggested she may be backing off her support of the public option – the government-run health plan that the private insurance industry is desperately trying to kill. According to CNN, Pelosi and Senate Majority Leader Harry Reid “said they would support any provision that increases competition and accessibility for health insurance – whether or not it is the public option favored by most Democrats.”
This announcement came just hours before Steve Elmendorf, a registered UnitedHealth lobbyist and the head of UnitedHealth’s lobbying firm Elmendorf Strategies, blasted this email invitation throughout Washington, D.C. I just happened to get my hands on a copy of the invitation from a source – check it out:
From: Steve Elmendorf [mailto:steve@elmendorfstrategies.com]
Sent: Friday, September 11, 2009 8:31 AM
Subject: event with Speaker Pelosi at my home
You are cordially invited to a reception with
Speaker of the House
Nancy Pelosi
Thursday, September 24, 2009
6:30pm ~ 8:00pm
At the home of
Steve Elmendorf
2301 Connecticut Avenue, NW
Apt. 7B
Washington, D.C.
$5,000 PAC
$2,400 Individual
Again, Elmendorf is a registered lobbyist for UnitedHealth, and his firm’s website brags about its work for UnitedHealth on its website.
The sequencing here is important: Pelosi makes her announcement and then just hours later, the fundraising invitation goes out. Coincidental? I’m guessing no – these things rarely ever are.
I wrote a book a few years ago called Hostile Takeover whose premise was that corruption and legalized bribery has become so widespread that nobody in Washington even tries to hide it. This is about as good an example of that truism as I’ve ever seen.
Whatever President Obama proposes to accomplish in terms of financial reform will surely be met with a similar fate. Worse yet, his appointment of “Turbo” Tim Geithner as Treasury Secretary and his nomination of Ben Bernanke to a second term as Federal Reserve chairman are the best signals of the President’s true intention: Preservation of the status quo, regardless of the cost to the taxpayers.
On this first anniversary of the demise of Lehman Brothers and the acknowledgment of the financial crisis, many commentators have noted the keen observations by Simon Johnson, a former chief economist at the International Monetary Fund, published in the May, 2009 issue of The Atlantic. The theme of Johnson’s article, “The Quiet Coup” was that the current economic and financial crisis in the United States is “shockingly reminiscent” of those experienced in emerging markets (i.e. banana republics and proto-capitalist regimes). The devil behind all the details in setting these systems upright after a financial crisis is the age-old concept of moral hazard or more simply: sleaze. In making the comparison of the United States to the emerging market countries he encountered at the IMF, Mr. Johnson began this way:
But there’s a deeper and more disturbing similarity: elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.
Here are a few more passages from “The Quiet Coup” that our political leaders would be well-advised to consider:
Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change. As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” But there’s the rub: the economy can’t recover until the banks are healthy and willing to lend.
* * *
The second problem the U.S. faces—the power of the oligarchy— is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.
Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.
Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly— they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.
Mr. Johnson pointed out the need to overhaul our current antitrust laws – not because any single institution controls so much market share as to influence prices – but because the failure of any one “to big to fail” bank could collapse the entire financial system.
One of my favorite reporters at The New York Times, Gretchen Morgenson, observed the anniversary of the Lehman Brothers failure with an essay that focused, in large part, on a recent paper by Edward Kane, a finance professor at Boston College, who created the expression: “zombie bank” in 1987. This month, the Networks Financial Institute at Indiana State University published a policy brief by Dr. Kane on the subject of financial regulation. In her article: “But Who Is Watching Regulators?”, Ms. Morgenson summed up Professor Kane’s paper in the following way:
This ugly financial episode we’ve all had to live through makes clear, Mr. Kane says, that taxpayers must protect themselves against two things: the corrupting influence of bureaucratic self-interest among regulators and the political clout wielded by the large institutions they are supposed to police. Finally, he argues, taxpayers must demand that the government publicize the costs of efforts taken to save the financial system from itself.
Although you may have seen widely-publicized news reports about an “overwhelming number” of academicians opposing the current efforts to require transparency from the Federal Reserve, Professor Kane provides a strong argument in favor of Fed transparency as well as scrutiny of the Treasury and the other government entities enmeshed the complex system of bailouts created within the past year.
At thirty-eight pages, his paper is quite a deep read. Nevertheless, it’s packed with great criticism of the Federal Reserve and the Treasury. We need more of this and when someone of Professor Kane’s stature provides it, there had better be people in high places taking it very seriously. The following are just a few of the many astute observations made by Dr. Kane:
Agency elitism would be evidenced by the extent to which its leaders use crises to establish interpretations and precedents that cover up its mistakes, inflate its powers, expand its discretion, and extend its jurisdiction. According to this standard, Fed efforts to use the crisis as a platform for self-congratulation and for securing enlarged systemic-risk authority sidetracks rather than promotes effective reform.
* * *
A financial institution’s incentive to disobey, circumvent or lobby against a particular rule increases with the opportunity cost of compliance. This means that, to sort out the welfare consequences of any regulatory program, we must assess not only the costs and benefits of compliance, but include the costs and benefits of circumvention as well.
* * *
Realistically, every government-managed program of disaster relief is a strongly lobbied and nontransparent tax-transfer scheme for redistributing wealth and shifting risk away from the disaster’s immediate victims. A financial crisis externalizes – in margin and other collateral calls, in depositor runs, and in bank and borrower pleas for government assistance – a political and economic struggle over when and how losses accumulated in corporate balance sheets and in the portfolios of insolvent financial institutions are to be unwound and reallocated across society. At the same time, insolvent firms and government rescuers share a common interest in mischaracterizing the size and nature of the redistribution so as to minimize taxpayer unrest.
In principle, lenders and investors that voluntarily assume real and financial risks should reap the gains and bear the losses their risk exposures generate. However, in crises, losers pressure government officials to rescue them and to induce other parties to share their pain.
The advocates of crony capitalism and their tools (our politicians and regulatory bureaucrats) need to know that we are on to them. If the current administration is willing to facilitate more of the same, then it’s time for some new candidates to step forward.
TheCenterLane.com offers opinion, news and commentary on politics, the economy, finance and other random events that either find their way into the news or are ignored by the news reporting business. As the name suggests, our focus will be on what seems to be happening in The Center Lane of American politics and what the view from the Center reveals about the events in the left and right lanes. Your Host, John T. Burke, Jr., earned his Bachelor of Arts degree from Boston College with a double major in Speech Communications and Philosophy. He earned his law degree (Juris Doctor) from the Illinois Institute of Technology / Chicago-Kent College of Law.
Ignoring The Root Cause
June 17, 2010
The predominant criticism of the so-called “financial reform” bill is its failure to address the problems caused by the existence of financial institutions considered “too big to fail”. In an essay entitled, “Creating the Next Crisis” economist Simon Johnson discussed the consequences of this legislative let-down:
One would assume that an important lesson learned from the 2008 financial crisis was the idea that a corporation shouldn’t be permitted to blackmail the country with threats that its own financial collapse would have such a dire impact on society-at-large that the corporation should be bailed out by the taxpayers. The resulting problem is called “moral hazard” because such businesses are encouraged to act irresponsibly by virtue of the certainty that they will be bailed out if their activities prove self-destructive.
Gonzalo Lira wrote a piece for the Naked Capitalism blog, explaining how the moral hazard resulting from the “too big to fail” doctrine is facilitating a state of corporate anarchy:
Good-old British Petroleum – the latest beneficiary of the “too big to fail doctrine” — can rely on its size to avoid any sanctions it considers unacceptable because too many “small people” might lose their jobs if BP can’t stay fat and happy. Gonzalo Lira’s analysis went a step further:
Mr. Lira discussed how a leadership void has been helping corporate anarchy overtake democratic capitalism:
The failure of President Obama to take advantage of the opportunity to address this “root cause” in his Oval Office address concerning the Deepwater Horizon disaster, inspired Robert Reich to make this comment:
One of my favorite commentators, Paul Farrell of MarketWatch, recently warned us about the consequences of allowing corporate anarchy to destroy democratic capitalism:
If we ever reach the point when the watered-down “financial reform” bill finally becomes law, the taxpayers should insist that their government move on to address the “root cause” of corporate anarchy by taking up campaign finance reform. That should be one hell of a fight!