Want to Save Our Economy from Almighty Greed? Here Are 10 Crucial Fights and Key Fighters to Watch
Let's face it, financial regulation is boring and complicated. But if the economic crisis taught us anything, it's that bringing Wall Street under control is one of the most critical domestic policies facing the country right now.
Here's what you need to know, and who you need to watch, as Congress readies its banking overhaul.
1. A New Consumer Financial Protection Agency. Subprime mortgages. Abusive and arbitrary rate hikes on your credit card. Payday loans. If you're wondering who lets banks get away with this crap, there are more people at it than you think. There are no less than four federal regulators responsible for overseeing consumer protection in finance, and all of them are terrible.
Regulators currently are responsible not only for keeping consumers safe from predation but for ensuring the "safety and soundness" of banks -- that is, keeping banks from failing.
Not surprisingly, sometimes what's best for bank balance sheets doesn't exactly jive with the interests of consumers. If banks can fend off failure by gouging you on your credit card, they're going to do it, and regulators aren't going to lift a finger to stop them.
What's worse, regulators actually compete to prove to banks how lax they can be at enforcing consumer protections. Each agency is funded by taxes it levies on banks it regulates, and banks can choose who they want to regulate them. If one agency is too tough, the bank can switch regulators. The result is a race-to-the bottom in regulatory standards where the interests of consumers are ignored.
The obvious solution is to give these consumer-protection responsibilities to a single regulator with no such conflicts and with the power to enforce uniform standards across the entire industry. That's what President Barack Obama proposed in June, and it was by far the most significant reform on his Wall Street agenda.
Unfortunately, the bank lobby has seriously watered down the bill in Congress. One of the chief advocates for the CFPA, Rep. Brad Miller, D-N.C., sponsored an amendment exempting 8,000 of the nation's 8,200 banks from the CFPA's oversight.
And it's getting worse -- the powers of the agency are being diminished with every committee. The latest one subjected the CFPA director to input from other commissioners and regulators from the same agencies that failed to prevent the current crisis.
These destructive amendments can be stripped out on the House floor, but only if Speaker Nancy Pelosi, D-Calif., has the political will to make it happen.
2. Too big to fail. Here's an idea: Let's give a handful of firms on Wall Street so much economic power that if they ever fail, the entire economy will collapse with them. Sound good? Of course not. But sadly, that's what Wall Street looks like today, and the problem has actually gotten worse since the financial crisis began because troubled firms have been eaten up in a flurry of mergers with stronger behemoths to stave off catastrophe.
The solution? Break up the banks to a size where failure does not destroy the economy, and ban banks from participating in the capital markets casino. Similarly, companies that engage in speculative, risky securities trading would be banned from doing the boring, economically essential banking activities such as accepting deposits and making loans.
With the two types of banking separated, we have a useful banking sector to support the economy even if the Wild West finance hits the skids.
Obama and his inner circle of advisers have no interest in breaking up the banks or ending too-big-to-fail. Their plan to deal with "too big to fail" would codify the government's ability to bailout big firms with an unlimited amount of loans, guarantees and asset purchases.
In other words, Obama wants to make the Troubled Asset Relief Program a permanent government policy. If that sounds crazy, it is.
3. Derivatives. When people say "derivatives," they mean the crazy financial weapons of mass destruction that brought down AIG. But they also mean hundreds of trillions of dollars of other crazy shit.
If a Wall Street magician can conjure up any contract or security "derived" from the value of something real -- oil prices, mortgages, corporate debt, or literally anything else -- it's called a derivative.
As a derivative, it doesn't have to be regulated the way other Wall Street securities are. Shockingly, after Congress passed landmark legislation in 2000 banning the regulation of key derivatives, the market absolutely exploded, with 95 percent of it concentrated at five too-big-to-fail banks.
Derivatives are one of the key ways banks make themselves too big to fail. Since derivatives can tie a bank to almost anything, from the financial health of other companies to the value of the dollar, firms that buy and sell derivatives can encapsulate themselves in a massive, interconnected web of risk that regulators have trouble deciphering.
If a major derivatives dealer like JPMorgan Chase or Morgan Stanley were to fail, it's almost impossible to determine what else would go down with them.
The best way to deal with the derivatives mess is to require that they be traded on an exchange, just like ordinary stocks. Exchange trading lets everybody know what everyone else is up to, and it requires a disinterested third party to sign off on the transaction. E.g., if a hedge fund wants to use derivatives to make a crazy bet on subprime mortgages with AIG, and the exchange knows AIG doesn't have the money to cover the bet, the exchange won't let the trade go through.
Unfortunately, Obama didn't push hard for this. Instead, he wants all "standardized" derivatives to trade through a central clearinghouse -- basically an exchange without any public transparency. And any derivative that could be classified as "customized" -- estimated to be about one-fifth of the derivatives market -- would be exempt even from this level of market discipline.
What's worse, Congress has watered down even the weak tea Obama offered. Unless the derivatives bill is seriously overhauled on the House floor, the biggest derivatives players won't even have to clear their "standardized" derivatives trades through any disinterested third party as long as a trade is conducted with a hedge fund or a private-equity firm.
4. Leverage. Ever gambled with somebody else's money? Pretty fun stuff. If your bets pay off, you get to keep the winnings. If your bets don't turn out so hot, you can stick your friend with the bill. That's the basic concept behind leverage, and it's how Wall Street is able to make a killing off minor movements in the values of stocks and other securities.
Say I've got $10, and I want to bet on a stock. Turns out, it's a good bet, and the stock jumps 10 percent. I just made $1. Whoo-hoo. But say I borrowed $500 before I made the same bet, and the stock made the same 10 percent gain. I just made $51. That's a profit of over five times on my initial $10. Now we're talking real money.
But what if my stock loses 10 percent? I'm out $51. The trouble is, I've only got $10 -- everything else I borrowed. I just lost more than five times the money I actually had, and I don't have enough to pay back my $500 loan. If I were a corporation, I would be outrageously bankrupt.
That's what Wall Street just did.
The way to fix this is to require companies to have lots of cold, hard cash on hand to keep them from destroying themselves if their bets don't pay off. This cash is called "stock" or "equity." Obama, Congress and the Federal Reserve have all been tight-lipped about how seriously they want to rein in leverage, but at the height of the crisis, banks like Citigroup were leveraged at more than 50 to 1: for every $50 in borrowed money Citi bet with, it had just $1 of its own money on hand.
Saying what the right leverage ratio is can be tricky, but 10-to-1 is the traditional range of safety.
5. Executive compensation. You're pissed off about the $26 billion Goldman Sachs plans to pay in bonuses this year, and you're right to be. Not only is this an obscene gesture in the face of 10 percent unemployment and an affront to the very taxpayers who saved every single job at Goldman Sachs last year, it actively harms the economy.
Ridiculous paychecks tied to short-term profits strongly encourage executives to behave recklessly: If the risk pays off, they make a lot of money for their shareholders. The average chief financial officer spends three years on the job. If they don't get rich quick, they don't get rich.
If the risk backfires, hey, they already made their millions. Think they're shedding any tears for their poor shareholders from their second houses in the Hamptons?
6. Elizabeth Warren. She's been following predatory lending for decades, and she knows every side of the issue you could think of. She knows what's driving foreclosures, what's causing bank failures and can critique complex accounting rules with the precision of a seasoned financial analyst.
As chairwoman of the TARP Oversight Committee, she has taken Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke to task for keeping bailout decisions secret. Best of all, she's an unapologetic consumer advocate who wants the banking system to work for the entire economy, not just Wall Street executives.
Her media appearances have built her significant political clout, and policymakers listen when she brings up concerns.
7. House Financial Services Committee. This is where most of the financial reform legislation starts, and it's where the most egregious Wall Street sell-outs have already taken place. The Republicans, of course, are shameless shills for the bank lobby, as are many conservative Democrats on the panel, such as Rep. Melissa Bean of Illinois. Even committed progressives like Committee Chairman Rep. Barney Frank of Massachusetts, and Rep. Brad Miller of North Carolina have been willing to sacrifice major reforms when cutting deals with the banking industry.
8. Pelosi. The speaker of the House knows how to get legislation passed. Everything that Bean and Frank screw up can be unscrewed on the House floor if Pelosi is willing to twist arms to do it. She rounded up the Democratic votes to pass the bailout in 2008, and she can get the votes to rein in Wall Street if she wants to.
The good news: She has made it clear that she views at least the CFPA as a top legislative priority.
9. Sen. Chris Dodd, D-Conn. No figure in Congress is more complicated than the senator from Connecticut. He brought you both credit card reform and the AIG bonuses. He is currently going to bat for you on abusive overdraft fees, but routinely shills for predatory payday lenders.
As chairman of the Senate Banking Committee, he has as much sway over financial regulations as anyone on Capitol Hill. He has been stalling for a long time -- Obama dropped his regulatory reform plan in June, and Dodd has yet to hold a single hearing to move a single proposal from the administration.
Dodd was skewered in Michael Moore's recent film, and his approval ratings have been in dangerous territory since the AIG bonus outrage broke in March. He's up for re-election in 2010. Connecticut voters would be wise to make him earn it.
10. Obama. The president ran as an economic progressive, promising a robust Wall Street overhaul, but he has offered a tepid set of reforms that only a banker could love.
He has eschewed investigations of what the FBI believes to be an "epidemic" of fraud in the banking industry and failed to take significant action to avert the foreclosure crisis.
He appears willing to slap a "serious reform" label on whatever drivel Congress can pass. But Obama does have some sane economic instincts: His stimulus package has helped stop the economic bleeding, and his plan to create the CFPA is urgently needed.
A change of tone, or a new set of priorities from the White House, could radically alter the political playing field for the better.