Obama's False Financial Reform Is Nothing But Smooth Talk and Some Fuzzy Plans

The most disturbing thing about Barack Obama's call for financial reform was the way in which the president falsified our predicament. He tried to make it sound as though everyone was implicated in the financial breakdown and therefore no one was really to blame. "A culture of irresponsibility took root from Wall Street to Washington to Main Street," Obama explained. "And a regulatory system basically crafted in the wake of a 20th century economic crisis -- the Great Depression -- was overwhelmed by the speed, scope and sophistication of a 21st century global economy."

That is not what happened, to put it charitably. Unlike some other presidents, Obama is much too intelligent not to know this. The regulatory system was not overwhelmed by historic forces. It was systematically gutted and dismantled by the government in Washington at the behest of the banking interests. If Obama wants details, he can consult his economic advisors -- Summers-Geithner -- who participated directly as accomplices in unwinding the prudential rules and regulations. Cheers were led by the Federal Reserve with heavy lifting by both political parties.

The president's benign version of events reminds me of what compliant politicians and opinion leaders said after the war in Iraq they had endorsed turned disastrous. "Hey, we were all fooled." If Obama were to tell the truth now about what went wrong in the financial system, he would face a far larger political problem trying to clean up the mess. Instead, he has opted for smooth talk and some fuzzy reforms that effectively evade the nasty complexities of our situation. He might get away with this in the short run. Congress doesn't much want to face the music either. But Obama's so-called reform is literally "kicking the can down the road," as he likes to say about other problems. In the long run, it will haunt the country because it fails to confront the true nature of the disorders.

Giving more power to the Federal Reserve to be the uber-regulator of banking and finance is a terrible idea (I examine the dangers in a forthcoming Nation article). Asking the cloistered central bank to resolve all the explosive questions about the over-reaching power of financial institutions is like throwing the problem into a black box and closing the lid, so people will be unable to see what happens next. That is the idea, after all, the reason Wall Street's leading firms first proposed the Fed as super-cop, then sold it to George W. Bush and now Barack Obama. Give the mess to the Wizard of Oz, the guy behind the curtain. He can do miracles with money, but don't watch too closely. This constitutes the high politics of evasion.

Still, I am thrilled to observe a nascent rebellion gathering strength in Congress. Some 230 House members have endorsed a measure to force GAO auditing of the Fed -- a small but vital step toward dismantling the central bank's privileged secrecy and intimidating mystique. Even House Speaker Nancy Pelosi expressed concern (and gave a nice plug for my 1987 book about the Fed). "The fact is that the American people want to know more of the Secrets of the Temple," she said. If they do learn more, I guarantee shock and awe will grow into outrage.

Outrage is good. As someone who has been around this subject for three decades, I came to understand that the power of financial titans and their friends at the Fed depends crucially on public ignorance. Most elected representatives and senators are just as clueless as their constituents. This is not entirely their fault. The system is designed to encourage deference to murky power. In our present crisis, people and politicians are naturally bewildered by the complexities. If they knew more about how the system works, they might be able to see that most of Obama's reforms are insubstantial gestures, not actual remedies.

The president, for instance, proposes to raise the requirements for capital and liquidity held by commercial banks with strict limits on leverage -- their ability to borrow. That is a virtuous proposal, but it begs the question. Why did the legal limits already in place fail to restrain the appetites of bankers? Indeed, several times in the last two decades the Fed and other central banks enacted new and supposedly more effective capital requirements to curb the excesses. The big dogs of banking broke free of the leash again and again while vigilant watchdogs at the Fed and elsewhere looked the other way. Why should we expect different results next time?

One reason why old restraints failed is the so-called "modernization" that shifted the credit functions outside regulated banks and into a variety of unregulated money pots -- the so-called shadow banking system of hedge funds and private-equity firms. These all interact intimately with traditional banks and give the banks profitable ways to evade the old rules or conceal the actual condition of their balance sheets from both regulators and innocent investors. This interactions are dazzlingly complex -- too complex for even the bankers themselves to fully understand -- but this was not an accident of nature. It was the goal of financial deregulation enacted by Bill Clinton, arm-in-arm with the Republican Congress.