Economy

Obama Is Tinkering with Changes to the Banking System While Big Finance Collapses

The absence of any serious debate over financial regulatory reform at this moment in time is frightening.

A congressional oversight panel appointed to monitor the Wall Street bailout (TARP) outlined a few of the problems so far in its second report (released yesterday) including:

• The shifting rationale for a program that amounts to dumping hundreds of billions of dollars on the companies that got us into the mess, along with a continuously changing approach and no guarantee that it will actually stabilize financial markets or help those most impacted, including "homeowners threatened by foreclosure, people losing their jobs and families unable to pay their credit cards," let alone protect the interests of taxpayers or bring confidence back for shareholders.

• Although Treasury responded to a first round of questions from the panel, "it did not provide complete answers to several of the questions and failed to address a number of the questions at all." For example, the panel "still does not know what the banks are doing with taxpayer money." In other words, the Treasury's handling of the bailout is starting to make Paul Bremer's mismanagement of Iraq's reconstruction project (remember the bricks of $100 bills being thrown around without any accountability?) look like a small corner store stickup. Perhaps the panel could recommend that Congress hire Stuart Bowen to set up shop over at the Treasury. At the same time, Congress could start asking why Treasury's strategy "appears to involve allocating the majority of the $700 billion to 'healthy banks,' banks that have been assessed by their regulators as viable without federal assistance."

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So, we have to ask why President-elect Barack Obama is asking for more money to be disbursed when the first $350 billion has been allocated without accountability, and the Treasury department reportedly isn't in a rush to receive it.

We seem to be headed for a triple-failure response to the crisis:

First: A poorly managed bailout (TARP).

Second: A stimulus package that most economists agree will not be enough to revive the economy and, with a good portion going out in the form of corporate tax breaks instead of shovel-ready projects, may not even be enough to stop the hemorrhaging of jobs.

Third, and perhaps most important: The absence of any serious debate over financial regulatory reform.

Congress is too tied up with the stimulus package to take on this latter responsibility with anything like the seriousness it deserves.

Maybe that will change with the incoming administration. After all, it was Obama who said in his March 27 speech at Cooper Union that, "To renew our economy and to ensure that we are not doomed to repeat a cycle of bubble-and-bust again and again and again, we need to address not only the immediate crisis in the housing market, we also need to create a 21st century regulatory framework."

Let's hope so, but so far there is no evidence for it. All of Obama's speeches have focused on the stimulus package and fiscal (rather than regulatory) policy, with little more than a nod to the idea that some kind of reform needs to occur in the mortgage markets. Not much more than that. The danger is that they will move quickly to pass something simple, especially with a G20 summit coming up in April that puts additional pressure on the new administration to demonstrate new leadership. And so, the drum is beginning to beat in Washington for Congress to quickly reform the current patchwork of regulations by giving the Fedexpanded authority over banking regulations, a move that could be disastrous.

I could be wrong about this, but if I'm not, let's hope Obama is smart enough to resist any such proposal.

For one, if we want strong regulators, we need to house them in public institutions. Just as Treasury Secretary Henry Paulson has suggested that Fannie Mae and Freddie Mac will fail if they have to serve two masters -- shareholders and the public, whose interests often conflict -- so many of the other institutions responsible for getting the economy back on track must be redesigned to more capably represent the public interest.

If we want to get beyond the ideological fixation with deregulation that so many (including Alan Greenspan) have finally acknowledged failed to keep the system from doing itself in, then we need to put our faith and support behind strong public regulatory institutions, instead of the now-discredited self-regulating organizations like the Financial Industry Regulatory Authority and the American Institute of Certified Public Accountants.

Another example of this is the credit-rating agencies, which essentially function as the government's surrogates. To make sure they certify investment-grade securities, they should be made public utilities or nonprofits. (The same thing should have been said about the auditing function, which was left with the accounting firms after Enron. Instead, they were left to form a cartel that is now pushing to insulate itself from any accountability through civil-liability caps.)

We need to recognize up front that the Fed is not, as currently designed, a purely public institution and therefore debate whether the Fed's authority for bank regulation should be expanded (in which case, it probably needs to be reformed to be more publicly accountable) or whether we need to come up with an alternative, like some kind of coordinating body responsible for allocating authority, smoothing interagency collaboration and preventing the kind of regulatory arbitrage witnessed in recent years by the shape-shifting financial institutions.

Either way, simply assuming that turning more power and regulatory authority over to the Fed would be to ignore a number of critical facts:

A) It wouldn't guarantee that the Fed will protect other interests besides the big commercial banks and bank holding companies. The Fed was never intended to protect the interests of consumers, homeowners or even shareholders (the Securities and Exchange Commission's job). As anyone familiar with the ways of Washington knows well, single institutions can have vicious internal policy fights, especially if different divisions represent constituencies whose interests can sometimes conflict. Anyone who believes the Fed should be charged with protecting homeowners might want to review its history of enforcement of the Community Reinvestment Act; anyone who thinks the Fed can clean up Wall Street might be forgetting how it helped block the regulation of derivatives when proposals were brought up in Congress. (To be fair, the SEC under Arthur Levitt and others were aggressively opposed to derivatives regulation, and their view may have held greater weight.)

B) The Fed is even less transparent than the SEC and other regulators (ever try to send a Freedom of Information request to the Fed?). The advantage of the Fed is that it is not publicly funded. But that's the disadvantage, too -- it's easy to imagine that it will claim (as it has in the past) that it is not a public agency, and therefore exempt from public oversight and control.

If you want an example of how opaque the Fed is, check out former House Financial Services staffer Robert Auerbach's, Deception and Abuse at the Fed, in which he describes how Alan Greenspan and other powerful Fed officials blocked Congress from providing oversight by falsely declaring -- for 17 years -- that it had no transcripts of its hearings.

Finally, there's an inherent and obvious conflict of interest at issue here: The fact is that the Fed is too intertwined with the big banks themselves to adequately regulate them. E.g. the majority (6 of 9 directors) of the governing boards of the regional reserve banks are selected by the banks themselves.

If we're going to give the Fed more power, then it's clear that the Fed  needs to made more public. However, unless Congress is willing to undertake a broader examination of the issue, we won't see any other alternatives put on the table and very little resistance to the notion that elevating the Fed's authority is a good idea to begin with.

Bank regulation is a complex and important issue, and at a time when the financial services sector is the most powerful -- constituting some 30 percent of the economy (27.4 percent of all of corporate America's profits in 2007, not including GE Finance, GMAC and other corporate financial divisions); in a time of crisis so much is at stake that we need much more from Congress than a simple rush-to-fix-it proposal.

That's why the first thing Congress should do (and could have done a long time ago) in this area is empanel a commission to examine a variety of important questions, including the elimination (or at minimum, proper regulation) of derivatives; strengthened consumer and taxpayer protections; structural regulation and anti-trust questions (including how to prevent regulatory arbitrage and the dangers of cross-sector integration); and the elimination of offshore tax-haven scams.

What we need is something like a combination of the Pecora Commission that Ron Chernow so wisely reminded usabout, and the Temporary National Economic Committee, which began to examine the structure of various industrial sectors in the late 1930s. (Hopefully we don't have to get that far into a depression before Congress does something like that.)

It's an old truism in Washington that how a crisis is solved is determined by the terms of the debate. It's also true that he who pays the piper plays the tune. Although candidate Obama proclaimed his independence from corporate lobbyists and PACs, we learned in today's Wall Street Journal (which used data compiled by Public Citizen) that "90 percent of donations (to Obama's inauguration) received so far have been raised by well-heeled fund-raisers, including Wall Street executives whose companies have received billions of dollars in federal bailout money." As a group, people affiliated with Wall Street firms donated $5.7 million through financial-services industry bundlers.

It looks like "Government Sachs" has yet to be sacked.

Thus, we should be automatically suspicious of any proposals coming out of Washington, starting with Obama's recent request that Treasury release the second $350 billion. But we should also be wary of any proposal for financial regulatory reform that makes a laughable lunge for simplicity, especially if they don't come after fierce debate.

As economist Robert Kuttner, author of Obama's Challenge (and a new report that explains how we should strive to reform the financial regulatory system) said here last week, "the issue isn't whether to regulate or not, but the character of regulation."

We are often told that Heraclitus once said "character is destiny." Judged by his appointments and the direction and timidity of the proposals coming out of the transition team, so far the character of the regulations being proposed by Obama seem destined to fail.

C'mon, Mr. Obama, step it up! What we need is more than a nudge. We need a strong regulatory push.

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Charlie Cray is director of the Center for Corporate Policy in Washington.