The Wall St. Bill Doesn't Protect Us From Banker Abuse: 5 Essential Reforms Are Still Needed
On Wednesday, President Barack Obama signed into law the first serious effort to regulate Wall Street in decades. The bill has much to be said for it, but the unfortunate truth is that it ducks several of the most critical reforms needed to protect our economy from banker abuse. As regulators work to implement the legislation, reformers must turn up the heat on Congress to adopt further reforms, and recognize political opportunities to further economic progress.
Five policy fights stand out as particularly pressing. Many of these policies can be implemented this year, while others will probably have to wait until the next Congress. All of them are critical to ensuring that our financial sector works to support a healthy economy, instead of a reckless bonus machine.
1. Break Up The Banks
Not long ago, breaking up the banks was viewed as an impossible pipe dream, but when the Senate finally weighed in on the matter in May, a surprisingly high number of Senators supported it, with even a handful of Republicans voting to bust 'em up (five other Republicans abstained, afraid of voter backlash from a vote for Wall Street excess). The plan ultimately failed, of course, so what has changed since May? Fannie Mae and Freddie Mac.
Congress will have to decide the fate of the two mortgage giants sometime in the relatively near future. There are plenty of problems with Fannie and Freddie, but the overriding disaster was caused by the firms' quest for private profits with an implicit government guarantee. For years, investors allowed Fannie and Freddie executives to make reckless bets, expecting that taxpayers would pick up the tab if the firms got into trouble. That situation meant huge profits for Fannie and Freddie until the companies totally blew up, at which point taxpayers did indeed eat the losses (this had nothing to do with affordable housing efforts—Fannie and Freddie were mimicking their Wall Street competitors by purchasing loads of lousy mortgage-backed securities issued by Wall Street banks). That's the exact problem posed by megabanks Goldman Sachs, Citigroup, Morgan Stanley, Bank of America, J.P. Morgan Chase and Wells Fargo. When Congress begins debating the future of Fannie and Freddie, no solution will be complete without dealing with the same too-big-to-fail problem posed by the megabanks.
2. Tax Wall StreetGambling
The financial crash of 2008 was a direct result of wild and unrestrained speculation on Wall Street—raw gambling that creates big risks while doing nothing to boost the broader economy. There's no law of economics that says this kind of activity needs to take place, and taxpayers can make serious money by reining it in. In London, financiers are subject to a tiny tax on their securities and derivatives trades. The tax is small enough that it doesn't discourage serious long-term investment in productive businesses, but significant enough to make traders think twice about buying huge volumes of securities only to dump them a few minutes or hours later.
This tax—known as a financial transactions tax or a tax on Wall Street gambling—is a double-win for economic stability. It limits destructive speculation, while raising revenue for the government. How much? According to the Center for Economic Policy and Research, a tax on trading would reap somewhere between $177 billion and $354 billion a year. If right-wingers want to make a fuss about the budget deficit this year, make them put their money where their mouth is and adopt a financial transactions tax.
A transactions tax is also one of the most effective ways to rein in outrageous Wall Street bonuses. If banks can't score huge profits from gambling, they can't pay out bonuses based on those profits.
3. End The Foreclosure Nightmare
The foreclosure crisis has been deepening unabated since 2006. That is a public policy obscenity: politicians rushed to rescue bankers who pushed predatory garbage loans on the public, while leaving troubled homeowners to fend for themselves.
Foreclosures are being fueled by gimmick accounting schemes that are artificially boosting bank profits—and bonuses. Home prices are down dramatically from their bubble-peak levels, and they aren't coming back—it was a bubble, after all. That means that millions of borrowers owe more on their mortgages than their homes are worth. When they have trouble making payments, they can't sell their house and find a more affordable place—foreclosure is the only option.
But borrowers are only up against the wall because banks are refusing to reduce their debt burdens to reasonable levels. If banks cut the amount that borrowers owed on their mortgages to whatever the house is actually worth, then borrowers could afford to keep their homes, and bank accounting would reflect their actual financial condition. Instead, banks are refusing to negotiate with borrowers and booking bogus accounting profits on loans that are never going to be repaid.
There are several ways to make banks play fair. Right now mortgages cannot be renegotiated in bankruptcy—unlike every other kind of consumer debt. Congress could change that. Lawmakers could also adopt a right-to-rent policy, requiring banks to let foreclosed borrowers rent their homes for several years at a fair market rate. Since banks don't want to be landlords, this policy would give borrowers some negotiating leverage. Other options don't require Congressional action at all—the administration could simply urge bank regulators to exercise more vigilant oversight of mortgage accounting practices. The government could also exercise its powers of imminent domain to buy up mortgages at a discount, requiring banks to take losses, and then cut borrowers a break.
4. Prosecute Fraud
The Big Crash of 2008 was fueled by absolutely staggering levels of fraud at multiple levels of the financial system. The FBI warned of an "epidemic" in mortgage fraud starting in 2004, and bankers ran wild with these disastrous loans in every way they could think of. They invented new devices to hide debt from investors, mislead their investors on exposure to toxic mortgages, and concocted abusive derivatives to screw over their own clients. According to the United Nations, banks went so far as to help launder hundreds of billions of dollars in drug money in order to get their hands on quick cash when markets froze up.
More than 1,100 bankers went to jail in the aftermath of the savings and loan crisis, but we've seen almost no serious action this cycle to ensure that financial fraud does not go unpunished. We need strong action against both individuals who commit fraud and the companies that tolerate it. Without prosecutions and indictments, the outrageous behavior of the past decade will be repeated, and soon.
5. Stop Subsidizing Risky Business
The bill Obama signs today includes two critical measures to rein in big banks—an end to taxpayer subsidies for derivatives dealing, and a ban on risky proprietary trading. The trouble is, both measures were punched through with tremendous loopholes at the last minute, rendering them extremely weak.
Commercial banks perform some of the most critical functions in the economy, accepting consumer deposits and extending loans that keep society moving. Banks receive key taxpayer perks designed to ensure that those activities are safe and productive: cheap loans from the Federal Reserve and deposit insurance from the FDIC. But after Congress ripped away the Glass-Steagall Act in 1999, banks started engaging in all kinds of other businesses that weren't essential to the core financial functions of accepting deposits and making loans. Since these banks still had access to taxpayer perks, citizens were actively subsidizing these riskier businesses. When Congress deregulated the derivatives market in 2000, things got even worse. Five big banks now hold over $300 trillion in derivatives—trillion with a 't'—just waiting for an AIG-style blow-up. When big banks succumb to those risks, those essential loan-and-deposit activities break down, and the result is an economic disaster.
If hedge funds want to speculate, fine (though they should be subjected to a financial transactions tax), but economically essential banks shouldn't be subsidized for injecting enormous risks into the economy. If banks want to hedge risks with derivatives, that's fine too, but they shouldn't be getting subsidies for dealing derivatives to other firms and amplifying speculative activity in the financial system.