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Sunday, February 27, 2011

On the Strategic Use of Regulation: Financial Reform at the Bequest of Wall Street

According to The New York Times, Wall Street bankers were busy working on how to weaken the regulations or otherwise profit from them before the ink was dry on the financial reform law of 2010 . First, regarding trying to profit from the new regulations, BOA, Wells Fargo and other big banks that were faced with new limits on fees associated with debit cards were imposing fees on checking accounts. Compelled to trade derivatives in the daylight of closely regulated clearinghouses rather than in murky over-the-counter markets, titans like J.P. Morgan Investment Bank and Goldman Sachs were building up their derivatives brokerage operations. Their goal was to make up any lost profits — and perhaps make even more money than before — by becoming matchmakers in the vast market for these instruments. That critics were pointing to them as a principal cause of the financial crisis made no difference to those bankers. Even when it comes to what is perhaps the biggest new rule — barring banks from making bets with their own money — banks found what they thought was a solution: allowing some traders to continue making those wagers as long as they also work with clients.

Lest one conclude from the banks’ stretegic responses that the new law passed in the wake of the financial crisis of 2008 goes strongly against their interests, it is important to remember that the reform is more geared to giving government officials adequate power to mop up a future mess than to enabling them to prevent one in the first place by clamping down on the banks. The devil is in the details. This in itself can be an opportunity for banking lobbyists to work over regulators who depend on information from the industry and can be swayed by legislators who have received campaign contributions and fund-raisers from the bankers. Regulators are tasked under the new law with writing the specific rules of the road governing limits on risk-taking by financial firms and previously unregulated trading. By leaving so much to the discretion of existing regulators, the new law is “a boon to Wall Street lobbyists, who will now be working behind the scenes to influence the regulators,” according to John Taylor, president & CEO of the National Community Reinvestment Coalition. Furthermore, in enforcement, there is evidence that regulators are apt to look the other way. The wave of predatory lending that sank the housing market, for example, could have been largely prevented if the Federal Reserve had enforced existing rules on mortgage lending, according to Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University.

Under the financial reform law of 2010, banks and other financial institutions are overseen by a council of  regulators. That group is charged with identifying the kinds of “systemic” risks that spun out of control in the collapse of Bear Stearns and Lehman Bros. in the financial panic of September 2008. But there’s little to be gained by entrusting that task to the same regulators who failed to spot the causes of the panic the first time, said Isaac, the former FDIC head. “If a bank went to the regulators and said, ‘We’ve got a good idea: we’re going to put our lending officers in charge of risk management,’ that bank would be put out of its misery immediately,” said Isaac. “That’s what the government just did. It put the regulators in charge of assessing their own performance. It’s a very bad system.” While the law creates a separate agency with a single consumer mandate, even it remains beholden to those regulators, who retain the power to veto its regulations and enforcement actions. That setup, said Taylor, could seriously hamper the board’s effectiveness. “That club of regulators is very insular, and usually in agreement,” he said. “They can kill serious reform, and the financial lobby remains much more influential with regulators than consumer advocates.”

The problem can be broadened by considering that President Obama brought to head his economic team people like Larry Summers, who while in the Clinton Administration lobbied against regulating derivatives, and Tim Geithner, who had been appointed as President of the New York Federal Reserve at the urging of Citigroup and its major stockholder. In other words, it is not just a matter of relying on the same regulators; the construction of the law involved the same advisors.  Indeed, that members of Congress listened to the banking lobby at all even as the banks were complicit in the financial crisis of 2008 can be viewed as going back to the same. At a fundamental level, the banking industry may have too much leverage over top government offiicals, whether legislators or regulators.

Sadly, according to Newsweek, “the bill does more to help regulators detect and defuse the next financial crisis than to actually stop it from happening. In that way, it’s like the difference between improving public health and improving medicine: The bill focuses on helping the doctors who figure out when you’re sick and how to get you better rather than on the conditions (sewer systems and air quality and hygiene standards and so on) that contribute to whether you get sick in the first place.” This might be because it is in the big bankers’ interest that the government come in and clean up, but not restrict them in the meantime.  In the 1980s, the financial sector’s share of total corporate profits ranged from about 10 to 20 percent. By 2004, it was about 35 percent. According to Newsweek, “What you get for that money is favors. The last financial crisis fades from memory and the public begins to focus on other things. Then the finance guys begin nudging. They hold some fundraisers for politicians, make some friends, explain how the regulations they’re under are onerous and unfair. And slowly, surely, those regulations come undone.”

In the wake of the financial crisis, the American people had a chance to brake up the banks too big for our republics, but even then the bankers were able to quietly get this option off the airwaves. I contend that the too big to fail systemic risk is actually greater with respect to the viability of the US than to the financial system. That is to say, the ability of Wall Street to dodge the bullet even when it was culpable for a near melt-down of the financial markets may mean that we are living in a plutocracy rather than a democracy—the latter being mere window-dressing. Even when Wall Street is “bad,” it owns Congress, according to Sen. Dick Durbin of Illinois.  This ought to tell us that the game is over, yet with regard to the regulators I suspect the games will go on for some time.

Sources:
http://www.msnbc.msn.com/id/38266914/ns/business-eye_on_the_economy/  http://www.newsweek.com/2010/07/15/five-problems-financial-reform-doesn-t-fix.html  http://www.cnbc.com/id/38272518

See Related:
http://euandus3.wordpress.com/2010/07/09/is-the-us-too-banker-friendly-relative-to-the-eu/
http://euandus3.wordpress.com/2010/06/23/regulating-financial-and-commercial-derivatives/