Why Every Aspect of Dems' Handling of Wall St. Overhaul Seems Headed for Disaster
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Will the derivatives and multi-layered securitization markets remain largely intact?
Despite ongoing debates about which derivatives will have to trade on regulated exchanges and which won't, so far, Congress has kept the most offensive securities in the realm of the unregulated.
There isn't anything in the bill that strictly limits the amount of fabricated debt that can be packaged into a security with solid collateral. Part of Wall Street's big derivatives con was to slice and dice actual mortgages on an actual home into complex securities. But then clever investment bankers realized they could slice and dice the securities themselves, not just mortgages, into second-order securities called "collateralized debt obligations" (CDOs). Many took the scam even further, slicing and dicing CDOs into "CDOs squared" to the point where traders weren't betting on housing anymore, but pure speculative confidence.
Dodd does nothing to limit this fantasy finance. Today, there is a growing market for "distressed assets" – re-packagings of all the toxic crap bankers lost money on in the fall of 2008 into complex "new" securities. Without real reform, these assets could blow up anew at any time.
Will banks be Glass-Steagallized, or remain unnecessarily big and complex?
A number of senators have spoken out in favor of a solid barrier between banks that deal with the public through taking deposits and making loans, and banks that package and trade securities. These include Senators Bernie Sanders, D-Vt., Maria Cantwell, D-Wash., John McCain, R-Ariz. and most recently adding his voice, Senator Ted Kaufman, D-Delaware.
Congress created Glass-Steagall to protect the entire general economy from banking recklessness in 1933, and Congress killed Glass-Steagall in 1999. Now it's time for Congress to resurrect it. This is not a matter of Depression-era nostalgia (I wasn't around at the time and I'm sure many of you weren't either). It's a matter of simple economic prudence and practicality.
Since the repeal, banks have consolidated, becoming bigger and inherently more systemically dangerous. Bank that had deposits and loans could use them to back more speculative businesses, while enjoying access to the Fed for cheap money if they found themselves in a bind, and the FDIC to back their more solid base of deposits.
Post-repeal, banks found themselves competing to borrow as much money as possible to back the riskiest and most speculative aspects of finance, since those activities scored the most profit in the short-term. The result of these bank wars was a massively risky system that collapsed in late 2008. After the rescue, the big banks are bigger, extracting more money from trading with access to deposits and the Fed, and able to raise money more cheaply based on the presumption of further government bailouts. Even the planned "resolution mechanism" to help unwind failing banking behemoths can't undo those unfair (and unsafe) competitive advantages.
This is unacceptable and economically moronic. Dissecting the landscape and dividing boring banks from wild securities firms will do more to protect the public's money and do more to rein in Wall Street stupidity, greed and entitlement than any other reform measure.
Dodd is leaving the Senate after this year. He could get behind real reform and secure a meaningful place in the history books as an important statesman, or continue to wimp out for Wall Street, pull a Robert Rubin and secure a cushy job in banking come 2011. The next few months will indicate whether Dodd cares more about his legacy than his wallet.