Friday, April 9, 2010

Momentum Builds For Reform

Momentum has clearly swung toward new financial sector regulation. Some are predicting that new reform will be in place as soon as May. Recent news out of Congress suggests that Republicans in Congress may be more amenable to a deal on financial reform than they seemed only a few weeks ago. Some voices on the right are suggesting that the Republicans should now begin attacking the bill as being too friendly to Wall Street. Other reports indicate that Senator Richard Shelby has proposed exchanging a stronger Consumer Financial Protection Agency for less stringent derivative regulation currently proposed. Unlike health care, debated for decades, Congresspersons are notoriously underinformed about matters of Wall Street and the financial markets. As Congress and staff become more educated about the reckless excesses engaged in by Wall Street leadership in the run-up to the financial market crisis, it is likely that the desire for thoughtful and meaningful reform will increase. President Obama remains heavily involved in shepherding the legislation through Congress.

As is expected, new and careful regulation is being resisted mightily by powerful lobbyists on Wall Street who are incredibly motivated to derail reform. J.P. Morgan Chase alone spent $6.2 million lobbying Congress against new financial reform last year. Despite taking $25 bilion in TARP bailout funds, J.P. Morgan Chase is spending millions to defeat any new regulation of its industry.

Too big to fail should be primary on Congress’s concern list. While difficult to conceptualize much upside to propping up too big to fail financial institutions, the downside of an implicit guarantee to rescue too big to fail institutions is clear and dangerous. Secretary Geithner claims that the current Senate bill solves the problem of too big to fail. Others are less certain. What is certain is that Congress must steel its spine to Wall Street lobbyists and thoughtfully consider, learn about and pass practical solutions to the difficult issues that precipitated the collapse of 2008.


  1. I have several comments about this posting. First I am shocked to find that there are senators and representatives who are just now learning the details of the financial meltdown. How is this possible?? I read the article that was linked in the blog about the meeting some congressmen had with the writer of the Big Short. If it is true what he said, then the lack of knowledge about such a key issue borders on negligent. If it is true that Bernake doesn't explain things to Congress in a way someone without a financial background can understand, isn't it their job as a Congressperson to do some research of their own? It makes me angry to read that story. It just shows that the government was asleep at the wheel.
    It also concerns me that Congress will not be as informed as they should to pass effective legislation to prevent this from happening again. I know that there is no way to prevent another economic downturn at some point in the future. Our economy is cyclical and that is just the way it works. However I believe we can minimize the pain of any future downturn through proper regulation. If we don't fix too big to fail though, I am frightened that the next downturn may be even worse. With the governments pocketbook increasingly pinched, what happens if we cannot afford another such bailout in the future? I think most economists agree that without the bailout this time the recession would have been much worse, and it is scary to think what would have happened if there was inaction.

  2. I got a kick reading about Michael Lewis claiming that the some House Republicans were "stunningly uninformed about major elements of the crisis", since Lewis himself had to have the crisis explained to him by a 22-year-old Harvard undergrad named A.K. Barnett-Hart. What an arrogant, partisan hack. Does he think that Democrats, like Maxine Waters, who doesn't know the difference between the discount rate and the federal funds rate even though she sits on the House Financial Services Committee, really understand the structure of a CDO or CDS? Please. And what are the odds that the community organizer-in-chief, who has never held a real private sector job, or managed so much as a corner business, really understands any of this? In Michael Lewis's world, anyone who doesn't understand what others have had to explain to him is just, well, not as smart as Michael Lewis.

    The idea, promoted by Lewis, that the entire mortgage industry ignored the housing bubble and the ugliness of the subprime market, while only a select few noble short sellers saw the light, is laughable. Most people in the credit markets were aware that the real estate market was in a bubble and that subprime was a threat. Every mortgage industry conference at the time discussed it. What no one understood was how some insiders were gaming the structure of these derivatives. Most of the chicanery in these financial products was hidden within their complicated structure.

    Of course, the real question is, if the potential problems were being widely discussed at industry conferences and a 22-year-old undergrad can sort it out, why were the regulators at such a loss? Maybe Harry Markopolos has discovered the real problem with our regulatory agencies:

    They’re overlawyered. They’re poisoned by lawyers ... My experiences with other SEC officials proved to be a systemic disappointment and lead me to conclude that the SEC securities lawyers, if only through their investigative ineptitude and financial illiteracy, colluded to maintain large frauds such as the one to which Madoff later confessed. - Harry Markopolos, a former money manager who sought to convince regulators for nine years that Bernard Madoff was a fraud.

  3. In today's NY Times, Frank Rich artfully details this debacle in his piece "No one is to blame for anything." Rich writes: "[Alan] Greenspan’s claim that “everyone” was ignorant of the potentially catastrophic dangers in the securitization of subprime mortgages." Further, "Greenspan was testifying to the commission trying to pry loose the still incomplete story of how the American economy was driven at full speed into its iceberg. He was eager to portray himself as an innocent bystander to forces beyond his control. In his rewriting of history, his clout in Washington was so slight that he was ineffectual at “influencing the Congress.” The “roots” of the crisis, he lectured, dated back to the fall of the Berlin Wall in 1989."

    "In last Sunday’s Times, one of those who predicted the bubble’s burst — Michael Burry, an investor chronicled in “The Big Short” by Michael Lewis — told in detail of how Greenspan and others in power “either willfully or ignorantly aided and abetted” the reckless boom and the ensuing bust. But Greenspan is nothing if not a representative leader of his time. We live in a culture where accountability and responsibility are forgotten values. When “mistakes are made” they are always made by someone else."

    Mr. Rich's piece is a powerful reminder that responsibility must be taken and fully embraced by regulators and policymakers if our country is to never go through a financial meltdown again.

  4. I agree with Mr. Strauss. I am equally shocked that the people we elect to represent our best interest are asleep at the wheel. There is absolutely no explanation for this type of behavior. It is the job of our elected officials to make the most informed decisions possible. The fact that Bernake does not explain things clearly to congress is irrelevant. Congressmen and senators have a duty to ensure that they are placing this country in the best position possible. They cannot effectively do this if they are basing their decisions on flawed or uninformed thinking. If this is a common practice of congress then no wonder we have so many problems in our country.

  5. Personally, I think all of this information goes over the head of many of our representatives sitting in Washington. Is it even feasible to ask a group of people to attempt to regulate something they know little about? In this respect, the people will always be five steps behind the corporations being regulated. As soon as we have found a way, they would have already developed a loop hole. I am not entirely sure about how to stop the insanity, but refusing to "bail" them out may be a start. Perhaps if the corporations actually lost something by telling half-truths, we could get somewhere. However, this will continue to be a struggle as long as we have unknowledgeable people in positions where they are expected to be well-versed in certain information. It's time to let go of politics, and do what is in the best interest of our country. While we are trying to decide how to keep our own people from deceiving their own country, China is getting ahead of us.

    Maybe the answer does not lie in Washington, but rather in our homes, secondary schools, and colleges, where U.S. Americans learn about values, greed, and pride for our country. Maybe we have a problem, but it's not with the corporations, it's with our social upbringing.

  6. I agree with Ms.Norris, let this be a reminder of the need for accountability. We have the power to demand it and enforce it. We demand it with our voice and we enforce it through our vote. The power is in your hands, now do something with it. I will see you there, in Washington, D.C.

  7. "Is it even feasible to ask a group of people to attempt to regulate something they know little about? I am not entirely sure about how to stop the insanity, but refusing to "bail" them out may be a start."

    Bravo, Crystal G.!! Don't ever let someone tell you that any business is "too big to fail". What's needed are clearly defined rules for the liquidation of assets and the assumption of liabilities in the event of a failure. Once the market understands that businesses will be allowed to fail and that the authorities will respond to that failure in a clear and predictable manner, then both management and investors will assess risk more rationally.

  8. Too big to fail should never be an option in our country. "Financial reform" is impossible to achieve by bailing out firms, banks, and other large market players who routinely make poor choices. Government bailouts of these firms does nothing but reward their poor business decisions and practices. By saving these institutions, the government implicitly condones their actions, proving that (regardless of the costs to taxpayers) these businesses will be able to continue to engage in risky market behavior with little to no risk to the institutions themselves. And with each bailout, the risks taken will be greater and greater. Until the government takes a strong stance against bailouts, and allows some of these "too big" institutions to actually fail, their corrupt and irresponsible market behavior will continue to occur.

  9. I've read a lot of comments on this blog saying something to the effect of "if only we didn't bail out the banks" or "if only we let the banks fail" - here is Paul Krugman on why this isn't sufficient, unlikely to work, and would lead to even worse financial crises.

  10. ... here is Paul Krugman on why this isn't sufficient, unlikely to work, and would lead to even worse financial crises.

    Krugman writes:

    Bank managers and/or owners have an incentive to make risky bets; after all, their downside is limited — at worst ... in the S&L crisis of the 1980s, quite a few people made out like bandits while running their banks into the ground.

    This is argument is just nonsense because it reduces the interest of shareholder's, whose downside is 100%, and bondholder's, whose downside risk to their capital investment is substantial, to zero. The threat of failure would only serve to focus these parties interest on how their investment is managed.

    ... a wave of bank runs that brings down many small banks can do as much damage as the failure of a few big banks ...when a generalized run on the system began ... the results were catastrophic ... What has to be protected in a crisis are bank deposits and things like bank deposits — basically, bank-created money. Money market accounts and “repo” — very short-term loans in which businesses often park their funds.

    This why we have the FDIC, to assure savers that their money is safe regardless of what ultimately happens to their bank. The government can, and has, raised the limit on this insurance during a banking crisis, circumventing the concerns of small businesses that routinely deposit monies in excess of the FDIC insured limits. No one is suggesting ending FDIC insurance, though premiums should be adjusted on a bank by bank basis to reflect the real risks to taxpayers. Adjusting premiums would also provide a financial incentive for banks to remain within defined risk parameters.

    ... in 2008-2009 the shareholders were not cleaned out, and the bondholders left untouched; in part this was a policy decision, but it was also influenced by the lack of “resolution authority”: there was no clean, well-established route for seizing complex financial institutions.

    And that is precisely the problem. The shareholders should have been "cleaned out", the management should have been removed and the bondholders should have had work out clauses written into their prospectuses. Temporary government funds, if needed to sustain lending, should be made available only to stronger banks whose past practices have put them in a position to weather the crisis. The entire process should be open and clear and the governments response predictable, every interested party should know exactly where they stand and how they will be treated.

  11. No one is suggesting ending FDIC insurance, though premiums should be adjusted on a bank by bank basis to reflect the real risks to taxpayers. Adjusting premiums would also provide a financial incentive for banks to remain within defined risk parameters.

    I think perhaps Krugman has set up a bit of a straw man here - maybe conservatives don't want banks to fail completely, but be resolved - so I think we are on the same page, that the government must be able to apply a procedure akin to the FDIC to the nation's largest banks when they are insolvent. This is exactly what Krugman called for when he said that banks should have been nationalized (the government would do this not the FDIC because the banks were too big for the FDIC to handle and too complicated for them to unwind) after the crisis - something Andrew Ross Sorkin has recently unjustly criticized him for.

    I do however think that the distinction that Krugman makes is important - that there is a huge difference between letting banks fall into bankruptcy and fail (something we currently don't allow for small banks because of the FDIC) and resolving them. We can't let banks just fail. Therefore, I agree what we need is clear and transparent rules for resolution authority - something that the current legislation attempts to install.

  12. In a recent AP article in the NY Times the President stated that without reasonable and clear rules to check abuse and protect families, markets don’t function freely. Protecting both American families and the markets is going to be a work in progress and it perplexes me that the same individuals we elected to write our legislation and be the American voice are just now becoming aware of the causes of financial meltdown. How are they going to adequately write legislation to keep the financial markets afloat and protect investments when they are just now learning of the problem that has been impacting the country for the last two years?

    There needs to be an independent agency keeping tabs on these big banks so the country doesn't end up in the same set of circumstances we are currently trying to recover form. There needs to be a check on executive bonuses, a curb to risky investments of banks who base their investment on knowing they can be bailed out if needed, and most of all there needs to be a guarantee to taxpayers that their money won't be used to prop up a failing institution.

  13. Regulation reform is much needed. Transparency is essential. I'm all for the free market, but minimizing the effect of these bank busts is important, and I think an efficient government-run regulatory agency can do that. Also, it is extremely disheartening to think that members of Congress have been ignorant to what has been going on with this financial crisis. However, I find it discouraging that your source for this information is a Huffington Post article, who quotes a Vanity Fair writer's second-hand conversation. For me, these are not credible sources. Huffington Post is extremely left-wing, and Vanity Fair is a fashion magazine. The article in Huffington Post even questions the validity of that story. I don't align myself with any political party, and that is why I cast a critical eye on both parties. Do you think Democrats in Congress are not to blame? I don't. They share the burden along with the Republicans. I'm sick of finger-pointing and "It's the Democrats'/Republicans' fault" mudslinging. It's time to compromise and pull together a bipartisan, INFORMED financial reform before we have to spend a few more billion dollars bailing out the banks.

  14. I also think that it is inexcusable for our elected officials to be uninformed about such important issues. We elect these individuals with the belief that they will represent our best interests. It is their job to remain informed about all issues that are relevant to serving our best interest. How can they possibly be able to effectively represent us if they don't understand what is going on? It is scary that they have the ability to regulate an issue that they do not fully understand. There needs to be a concerted effort to ensure that the individuals who are passing this new legislation are informed about the decisions that they are making and the effects that the proposed legislation may have on the people that they have been elected to represent.

  15. Drew Sietsma -

    Financial reform, while it may be a few years too late for a large number of Americans, is important legislation aimed directly at preventing the risky behavior which embroiled this nation in the current economic downturn. The Financial Reform Bill proposes to create regulations for consumer protection, creating a fund to handle financial crises and controls on the derivatives markets. These proposed regulations will have a positive impact in the financial sector, protecting average shareholders by cutting down institutions “that have grown too-big to fail” while providing a mechanism for ensuring the orderly deconstruction of failed institutions.

    It is disconcerting that some in Washington seem confused about the root causes of the financial meltdown. Any Washington insider who has been living under a rock for the last two years and doesn’t realize the benefits of the proposed regulations should immediately find independent, nonpartisan, advice on the causes of the meltdown and the benefits of effective regulation in the financial system. Those politicians who refuse to become adequately apprised of these issues should be called out for perpetuating the current system which rewards “too big to fail” institutions at the expense of average Americans.

  16. Too big to fail companies are the very companies that have put the nation in this financial crisis. Its a very delicate situation because not allowing the company to not fail will set the image that protections are offered to those who unethically operate their business. However, allowing the business to fail can cause the public to feel further financial struggle. It would be in the best interest of the economy and the public to let the companies fail for long-term benefit. An orderly, supervised and regulated dismantling of companies would allow investors to purchase them at pennies on the dollar and recaptialize with a different corporate foundation