5 Major Wall Street Problems the Current Finance Bill Won't Fix
President Barack Obama identified five major problems on Wall Street in his speech at Cooper Union today. Unfortunately, the solutions he has proposed to these problems either will not work, or are not included in the legislation that passed the Senate Banking Committee under the stewardship of Chris Dodd (D-CT). Here they are, one-by-one: Too Big To Fail
Everybody agrees that too-big-to-fail is a major problem. Obama wants to end the era of big bank bailouts by establishing a new "resolution mechanism" that will allow the government to shut down complex megabanks on the verge of collapse. We already have this mechanism for ordinary, boring commercial banks, and the FDIC generally does a good job implementing it. Commercial banks that go through this process are not bailed out, they are put to death in an orderly fashion.
The trouble is, when the giant commercial bank Wachovia found itself on the verge of collapse, it wasn't pushed through this process. Instead, the government orchestrated a merger between Wachovia and Wells Fargo that netted $15 billion for Wachovia shareholders. A few weeks later, Treasury kicked $25 billion in TARP funds to Wells Fargo, which also helped Wachovia shareholders.
So we already know that resolution mechanisms don't work for giant banks. Even when there is an effective law on the books, the government doesn't take advantage of it because of big bank pressure. There is no reason to believe it will do so the next time a complex megabank fails. Consumer Protection
Obama's effort to establish a new Consumer Financial Protection Agency (CFPA) is laudable—in fact, the proposal he sent to Congress in June 2009 was perfect. But the idea was watered down in the House and gutted in the Senate Banking Committee. Under that bill, the existing regulators who failed to protect consumers for the past decade will be given veto authority over any rules the CFPA enacts. The Dodd bill also prohibits the CFPA from enforcing regulations against some of the worst actors in the financial crisis, including mortgage brokers. We need an agency with teeth. The Dodd bill doesn't provide us with one. Derivatives
Obama was right to say that Blanche Lincoln's derivatives bill is fantastic. But Lincoln's bill is much tougher than what Treasury Secretary Timothy Geithner supports, and is far more stringent than the bill that cleared the Senate Banking Committee. Surprisingly, while the Dodd bill passed committee along party lines, the Lincoln bill actually won over Republican Senator Chuck Grassley. At this point in the debate, nobody wants to be seen standing with Wall Street against the economy. A strong bill can get bipartisan support, and the final bill must include Lincoln's derivatives language.
The Volcker Rule
The Volcker Rule is a great idea. It's an effort to stop economically essential commercial banks from gambling in the securities markets. But the Dodd bill doesn't even require the Volcker rule be implemented—it gives regulators the power to establish such a rule, a power that regulators already have.
And what's worse, the distinction Volcker draws between proprietary trading and "client-related" trading will be incredibly difficult to implement in practice. Banks eager to take risks will simply disguise proprietary trading as client-related trading, and regulators will have a very hard time stopping it. We have to ban commercial banks from participating in the securities markets outright.
Everyone can agree that CEO pay is totally out of control on Wall Street. But Obama was wrong to argue that empowering shareholders will fix this problem. So long as banking behemoths remain too big to fail—that is, so long as megabanks remain as large as they currently are—shareholders will actually want their executives to reap big rewards for taking on huge risks. If the risk backfires, the government cushions losses for shareholders. If the risk pays off, shareholders make big bucks. I go into this in more detail in an article I wrote for The Nation in November.
Empowering shareholders will work, however, if we break up the biggest banks.
What Can We Do About It?
Obama knows what's wrong on Wall Street, and he deserves credit for identifying the problems in no uncertain terms. It's up to Congress to help him fix it. Fortunately, Senators have already authored amendments to the Dodd bill that can fix the problems Obama wants solved. Check out those amendments here.