[R-G] [BillTottenWeblog] The Financial Re-Regulatory Agenda

[Bill Totten]

by Robert Weissman

www.multinationalmonitor.org (September 17 2008)


As the Federal Reserve and Treasury Department careen from one financial
meltdown to another, desperately trying to hold together the financial
system - and with it, the US and global economy - there are few voices
denying that Wall Street has suffered from "excesses" over the past
several years.

The current crisis is the culmination of a quarter century's
deregulation. Even as the Fed and Treasury scramble to contain the
damage, there must be a simultaneous effort to reconstruct a regulatory
system to prevent future disasters.

There is more urgency to such an effort than immediately apparent. If
the Fed and Treasury succeed in controlling the situation and avoiding a
collapse of the global financial system, then it is a near certainty
that Big Finance - albeit a financial sector that will look very
different than it appeared a year ago - will rally itself to oppose new
regulatory standards. And the longer the lag between the end (or tailing
off) of the financial crisis and the imposition of new legislative and
regulatory rules, the harder it will be to impose meaningful rules on
the financial titans.

The hyper-complexity of the existing financial system makes it hard to
get a handle on how to reform the financial sector. (And, by the way,
beware of generic calls for "reform" - for Wall Street itself taken up
this banner over the past couple years. For the financial mavens,
"reform" still means removing the few regulatory and legal requirements
they currently face.) {1}

But the complexity of the system also itself suggests the most important
reform efforts: require better disclosure about what's going on, make it
harder to engage in complicated transactions, prohibit some financial
innovations altogether, and require that financial institutions properly
fulfill their core responsibilities of providing credit to individuals
and communities.

(For more detailed discussion of these issues - all in plain,
easy-to-understand language, see these comments from Damon Silvers {2}
of the AFL-CIO, The American Prospect editor Robert Kuttner {3}, author
of the The Squandering of America and Obama's Challenge, and Richard
Bookstaber {4}, author of A Demon of Our Own Design: Markets, Hedge
Funds, and the Perils of Financial Innovation.)

Here are a dozen steps to restrain and redirect Wall Street and Big Finance:

1. Expand the scope of financial regulation. Investment banks and hedge
funds have been able to escape the minimal regulatory standards imposed
on other financial institutions. Especially with the government safety
net - including access to Federal Reserve funds - extended beyond the
traditional banking sector, this regulatory black hole must be eliminated.

2. Impose much more robust standards for disclosure and transparency.
Hedge funds, investment banks and the off-the-books affiliates of
traditional banks have engaged in complicated and intertwined
transactions, such that no one can track who owes what, to whom. Without
this transparency, it is impossible to understand what is going on, and
where intervention is necessary before things spin out of control.

3. Prohibit off-the-books transactions. What's the purpose of accounting
standards, or banking controls, if you can evade them by simply by
creating off-the-books entities?

4. Impose regulatory standards to limit the use of leverage (borrowed
money) in investments. High flyers like leveraged investments because
they offer the possibility of very high returns. But they also enable
extremely risky investments - since they can vastly exceed an investor's
actual assets - that can threaten not just the investor but, if
replicated sufficiently, the entire financial system.

5. Prohibit entire categories of exotic new financial instruments.
So-called financial "innovation" has vastly outstripped the ability of
regulators or even market participants to track what is going on, let
alone control it. Internal company controls routinely fail to take into
account the possibility of overall system failure - i.e., that other
firms will suffer the same worst case scenario - and thus do not
recognize the extent of the risks inherent in new instruments.

6. Subject commodities trading to much more extensive regulation.
Commodities trading has become progressively deregulated. As speculators
have flooded into the commodities markets, the trading markets have
become increasingly divorced from the movement of actual commodities,
and from their proper role in helping farmers and other commodities
producers hedge against future price fluctuations.

7. Tax rules should be changed so as to remove the benefits to corporate
reliance on debt. "Payments on corporate debt are tax deductible,
whereas payments to equity are not," explains Damon Silvers of the
AFL-CIO. "This means that, once you take the tax effect into account,
any given company can support much more debt than it can equity." This
tax arrangement has fueled the growth of private equity firms that rely
on borrowed money to buy corporations. Many are now going bankrupt.

8. Impose a financial transactions tax. A small financial transactions
tax would curb the turbulence in the markets, and, generally, slow
things down. It would give real-economy businesses more space to operate
without worrying about how today's decisions will affect their stock
price tomorrow, or the next hour. And it would be a steeply progressive
tax that could raise substantial sums for useful public purposes.

9. Impose restraints on executive and top-level compensation. The top
pay for financial impresarios is more than obscene. Executive pay and
bonus schedules tied to short-term performance played an important role
in driving the worst abuses on Wall Street.

10. Revive competition policy. The repeal of the Glass-Steagall Act,
separating traditional banks from investment banks, was the culmination
of a progressive deregulation of the banking sector. In the current
environment, banks are gobbling up the investment banks. But this
arrangement is paving the way for future problems. When the investment
banks return to high-risk activity at scale (and over time they will,
unless prohibited by regulators), they will directly endanger the banks
of which they are a part. Meanwhile, further financial conglomeration
worsens the "too big to fail" problem - with the possible failure of the
largest institutions viewed as too dangerous to the financial system to
be tolerated - that Treasury Secretary Hank Paulson cannot now avoid
despite his best efforts. In this time of crisis, it may not be obvious
how to respect and extend competition principles. But it is a safe bet
that concentration and conglomeration will pose new problems in the future.

11. Adopt a financial consumer protection agenda that cracks down on
abusive lending practices. Macroeconomic conditions made banks
interested in predatory subprime loans, but it was regulatory failures
that permitted them to occur. And it's not just mortgage and home equity
loans. Credit card and student loan companies have engaged in very
similar practices - pushing unsustainable debt on unreasonable terms,
with crushing effect on individuals, and ticking timebomb effects on
lenders.

12. Support governmental, nonprofit, and community institutions to
provide basic financial services. The effective governmental takeover of
Fannie Mae, Freddie Mac and AIG zxsmeans the US government is going to
have a massive, direct stake in the global financial system for some
time to come. What needs to be emphasized as a policy measure, though,
is a back-to-basics approach. There is a role for the government in
helping families get mortgages on reasonable terms, and it should make
sure Fannie and Freddie, and other agencies, serve this function.
Government student loan services offer a much better deal than private
lender alternatives. Credit unions can deliver the basic banking
services that people need, but they need back-up institutional support
to spread and flourish.

What is needed, in short, is to reverse the financial deregulatory wave
of the last quarter century. As Big Finance mutated and escaped from the
modest public controls to which it had been subjected, it demanded that
the economy serve the financial sector. Now it's time to make sure the
equation is reversed.

Links:

{1} http://www.uschamber.com/ccmc/0803capmarkets.htm

{2} http://www.multinationalmonitor.org/mm2007/052007/interview-silvers.html

{3} http://www.multinationalmonitor.org/mm2007/112007/interview-kuttner.html

{4} http://www.multinationalmonitor.org/mm2008/072008/bookstaber.html

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