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Financial Reform in Peril

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Tuesday, October 05, 2010 at 6:00 am

Lawmakers say more work is needed to reform Wall Street. (Flickr: Pamhule)

Soon after Rep. Brad Miller (D-N.C.) came to Washington in 2002, a fellow member of the House Financial Services Committee told him to pick an arcane financial issue — any issue — and to make it his pet topic. Miller chose mortgage finance. He knew little about it. Banking lobbyists peppered him with data, but he had difficulty getting much information from independent sources.

[Economy1] “I was even reduced to reading blogs,” he quipped to a crowd of bankers, community organizers, financial reform experts, hedge fund managers and government aides at the Roosevelt Institute’s conference, “Financial Reform: Will It Work? How Will We Know?” on Monday. But Miller educated himself on the topic and became a leader in pushing for stronger regulation of mortgage products. By 2008, as the financial system collapsed, all of his colleagues in Congress had joined him in reading up on everything from liar loans to naked credit-default swaps.

That period of intense interest is over following the passage of financial regulatory reform legislation this summer, Miller and others said on Monday. But that does not mean that reform is done. In fact, because political attention has flowed from Wall Street to immigration, unemployment and myriad other topics, reform is imperiled. The regulatory law gave guidelines for fixing the financial sector, but the rule-writing process has fallen to dozens of agencies and government bureaucrats currently hammering out the details. That means the real work of reform is just beginning and the country is only incrementally closer to a safer financial system.

“It has become quite clear in recent years that the servant’s servant has become the master’s master,” argued Rob Johnson, a former hedge fund manager and current director at the Roosevelt Institute. Banks, he said, which should help companies merge, access credit and grow, instead ended up leeching off of them, piling on fees and unnecessary products. Ultimately, average Americans suffered. “We do not yet have a balance between society, the real economy and the financial sector.”

A few visiting investors noted that the sector has become more concentrated — due to a number of banks failing, and the others picking up their business — and therefore more dangerous. Each one of the systemically risky banks, like Goldman Sachs, has become more systemically important and therefore more likely to receive government backing if financial troubles re-emerge. (It will take years for Washington to put capital requirements and other safeguards in place.) Moreover, the long process of rule-writing allows banks ample time and opportunity to lobby bureaucrats working on legislation.

And that rule-writing is ongoing among dozens of agencies, including the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission, the Treasury Department and the Federal Reserve. The government is also in the process of organizing and hiring workers for the new $500 million Consumer Financial Protection Bureau. And the massive legislation is drawing major lobbying interest. This campaign cycle, the American Bankers Association has pledged $13.6 million on lobbying and $2.1 million to campaigns, pushing for looser rules on banks. J.P. Morgan Chase alone has contributed nearly a million to campaigns this year.

So how will those interested in reform know if it is working in the meantime? The question posed to the gathering of 40 or so met with many answers. “[Reform] would be working if the banks were making a lot less money,” Miller argued. “The reality is for it to be successful it has to be a win-lose-win,” with markets and consumers winning, and banks losing. The Wall Street Journal reported yesterday that financial-sector corporate profits are near their all-time highs.

Sen. Jeff Merkley (D-Ore.) was more optimistic. He praised the reform process, citing the creation of the Consumer Financial Protection Bureau, derivatives reform and proprietary trading regulations as big wins. (Elizabeth Warren, the White House and Treasury advisor helping to build the new bureau, attended the conference but did not speak.)

Still, Merkley conceded, “There is more to do.” He noted that ratings agencies — which stamped triple-A ratings on hundreds of billions of dollars of worthless mortgage-backed products in the run-up to the recession — remained unfixed. (“They’re almost useless,” sighed Jerome Fons of Kroll Bond Ratings agency.)

Others pointed to problems with the derivatives clearinghouses, which might now be the new “too big to fail” institutions. (If banks post insufficient capital to cover their derivatives trades, and another credit crunch hits Wall Street, with investors pulling cash out, the government might be forced to bail them out to calm the markets.) Some criticized the new Treasury Department Office of Financial Research, tasked with understanding Wall Street’s new innovations. Dozens of such niche issues arose.

“There are the tools there to do this,” Mike Konczal, a Roosevelt fellow, said. “Now it’s an issue of political will. [The financial regulatory law] doesn’t presuppose that [reform] will happen. But it does have the tools to do it.”

He concluded: “Those tools sit there, and there’s going to be a lot of pressure not to use them.”

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Comments

53 Comments

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polifrog
Comment posted October 5, 2010 @ 10:33 am

Brad Miller — “I was even reduced to reading blogs,”

Oh the horror for a man lost on the seas of Keynesian Theory. Miller has cast numerous votes on bills that incentivized the financial industry to push loans on those who could least afford them.

Why?

To put money in their hands so they could spend, spend, spend. Very Keynesian of Miller, but this Keynesian spending spree didn't show up on the Federal Government's books, it ended up on the backs of the private citizens who were suckered by artificially low interest rates, incentives through Fannie/Freddie, and government incentivized predatory lending.

Brad Miller's damage to our financial system is greater than any blog research of his can rectify.


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steve
Comment posted October 5, 2010 @ 1:01 pm

As America sets a new record homes foreclosed upon, it's not only upsetting but down right criminal that people in congress talk about “there's more to do.” This isn't a weight loss program, it's people's lives.
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taxedmore
Comment posted October 5, 2010 @ 1:05 pm

I agree that the banks were the prime culprit but every loan has two sides. The bank and the borrower who lied about their income or took out an adjustable loan hoping the rate would never go up or buying above their means hoping the prices would always go up and they could flip the place and make a profit. We can legislate industry responsibility to a certain extent. We cannot legislate individual responsibility, that is supposed to be taught in the home. Individuals can be just as greedy as banks.


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Comment posted October 9, 2010 @ 2:38 am

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Billkav
Comment posted October 10, 2010 @ 3:19 pm

It's apparent that the commenter doesn't know Rep. Miller and wouldn't know John Maynard Keynes' theories if he tripped over them on his way past the library.

Miller, by all accounts, has been one of the few members of Congress to hold the financial sector's feet to the fire both before and since the meltdown.

Fannie and Freddie didn't start the subprime mortgage lending spree; they were the last to get on board and the most vulnerable. Any responsible review of the issue points this out. The private sector led the party and incentives and commissions, allowed in an almost totally deregulated industry, aligned not with the health of the loan, but in officers making as many of them as possible. The diminished possibility that anyone would ever be accused of fraud in so doing stemmed from law enforcement theories based on the belief that the market was always right. Alan Greenspan saw fraud as self correcting and enforcement as wholly unnecessary; his philosophy permeated the system since the Reagan years.

The unsupervised securitization of loans into derivative products, most unimaginably more complex than the information about them available to their buyers, made bad mortgage loans more toxic in orders of magnitude far greater than as individual mortgages. These products were marketed globally as “safe,” without the sort of oversight and disclosure that would have shown their pedigrees to be less than thoroughbred— in a system in which the rating agencies were paid by the banks to rate their own products, not by the consumer or by a disinterested third party.

It wouldn't be too harsh to call this private system corrupt on an enormous scale, from one end to the other. Finally, the concentration of the financial sector into vast supermarkets that spanned from retail banking to the casino of the bond market made Wall Street so interwoven into the global economy— and so bloated— that it's collapse was considered too ghastly to allow by almost all parties with an interest in preventing global financial chaos.

Unsurprisingly, the bailout that helped prevent total global economic destruction was organized by people like Hank Paulsen, who came out of the financial sector and wished it well. Instead of taking common stock in Wall Street companies and allowing the public to participate in the upside as well as socializing the risk, the Treasury Department left management in place, refused to wipe out stockholders in the banks, and left us to pay for the capital financing their recovery.

That there have been initial efforts since the collapse to regulate the financial sector is heartening, while still too little, and too late. We can only hope that after the deluge of November, when know-nothings may take control of the House of Representatives, that there will remain some critics like Brad Miller to look after the country's real interests. There is much work left to be done.


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