Financial Reform Conference

Wall Street Reform: A Good First Step

Zach Carter — Fri, 25 Jun 2010 13:27:23 -0400

Members of Congress finished ironing out their differences on Wall Street reform last night, and the resulting bill deserves unequivocal support from progressives and conservatives alike. But while the final package is a necessary first step to overhauling the nation's out-of-control financial sector, it will do very little to change the destructive status quo on Wall Street. The bill is a good first step. The public deserves too see stronger reforms from Congress next year.

As a matter of history, sweeping financial change takes several years to secure. It took Franklin Delano Roosevelt seven years to enact all of his New Deal banking regulations, and President Barack Obama appropriately sees the 1930s crisis as the historical analog to today's meltdown-and-reform process. Obama is correct to state that the legislation approved by Congress late last night is the most significant since the Depression—but it is a hollow truth. The U.S. government has been steadily deregulating the banking industry ever since Roosevelt, and the mere act of moving policy in the opposite direction is enough to claim the mantle of dramatic reform. Actually living up to the precedent set by Roosevelt will take several years of serious work, and major legislative action during the next electoral cycle.

As for the current bill, Congressional leaders decided late last night to gut the only two serious structural reforms still on the table. With the political wind at their backs, and the finish line clearly in sight, lawmakers decimated an effort to end outright gambling by the nation's largest banks, and sabotaged a plan to rein in rampant speculation in derivatives—the out-of-control market that brought down AIG and necessitated the bailouts of every major U.S. bank. By adopting the plan from Sen. Blanch Lincoln, D-Ark., to fix derivatives and implement a strong version of the Volcker Rule banning proprietary trading, Congress could have made significant strides toward ending the too-big-to-fail financial oligopoly that held taxpayers hostage in 2008. Instead, Congress chose to reinforce the current destructive banking regime.

But while the resulting legislation will not end too-big-to-fail, prevent future bailouts, or significantly rein in risk-taking on Wall Street, it is nevertheless worth supporting. Three important measures made it through that will make the global economy a fairer and more just marketplace. Those three reforms will not be enough to prevent future financial crises, nor will they be able to ameliorate the fallout from those crises once they occur, but they are nevertheless critical.

First, we will get a thorough audit of the Federal Reserve, an agency which has funneled $4 trillion in bailout funding to the nation's financial system without any oversight or transparency. The public will finally know how it's money is being spent, and credit is due to Rep. Alan Grayson, D-Fla., Rep. Ron Paul, R-Texas, and Sen. Bernie Sanders, I-Vt., who fought hard for the plan in the face of overwhelming Wall Street lobbying. Kudos are also due to activist journalists Mike Elk and Jane Hamsher, who cobbled together a coalition of good government supporters across the political spectrum and made the Fed audit a centerpiece of the legislative debate. The Fed's blunders on the bailout of AIG have created significant momentum for real reforms, and further information about the secretive agency's operations will help build momentum for next year's financial fights.

The legislation also includes a critical overhaul of the nation's consumer protection regime wherever banks are concerned. For the first time, the public will have a regulator dedicated to defending consumers against bank abuses, with no other conflicts. The new Consumer Financial Protection Bureau has been pilloried with unnecessary loopholes, but the resulting agency will nevertheless be able to write and enforce meaningful regulations on the financial sector. This is a major accomplishment, made all the more significant by the fact that the front-runner to head the new agency has already established herself as one of the most important voices on U.S. economic policy.

As Chair of the oversight panel for the Troubled Asset Relief Program, Elizabeth Warren has taken a position with extremely limited statutory power and converted it into the only mouthpiece for the American middle class in Washington, D.C. She has done a far better job than even the most optimistic good government activists had hoped for, and giving her free reign to crack down on consumer abuses will be a major victory for the American economy. She has not been formally nominated for the post yet, but the world will be a better place once she is.

Finally, while Lincoln's derivative overhaul was largely destroyed, she did manage to preserve tough new rules regulating both food and gas derivatives. The resulting legislation will not keep Wall Street from gambling with our future, but it will make it much more difficult for financiers to jack up the prices of basic necessities in their quest for bigger bonuses. Back in the spring and summer of 2008, prices for food went through the roof as a result of heavy speculation in market for agricultural derivatives—raw bets placed on the future price of corn, rice and other farm products. The resulting price increases forced consumers the world over to pay too much for food, and sparked outright starvation in regions that could not afford the increases.

The same thing happened with gasoline. Remember paying over $4.00 a gallon? That had nothing to do with the fundamentals of supply and demand—it was a direct result of wild speculation in the market for energy derivatives. The bill approved last night will end that abuse. As a result of Lincoln's efforts, two excesses that created real, tangible hardship for millions of people will be eliminated.

This bill is unquestionably deserving of support. It will make the global economy a fairer marketplace. But it will not end the too-big-to-fail incentives that encourage Wall Street to take wild risks and stick taxpayers with the tab, nor will it sufficiently overhaul the market that brought down AIG, nor will it end the widespread practice of bigwig bankers gambling with taxpayer money. All of those reforms could have been enacted—explicit, concrete amendments were offered on all three, and Congressional leaders rejected them in an overt effort to rake in campaign contributions from Wall Street. Republicans resort to such political calculations all the time—catering to entrenched corporate interests has been their only economic strategy since the Reagan years. But it is enormously disappointing to see significant swaths of the Democratic Party adopt the same strategy (particularly the New Democrats, who should rename themselves the Wall Street Democrats after this episode) and even more frightening to see the Democratic leadership incapable of corralling these turncoats.

So support the Wall Street reform bill: it's a good first step toward building an economy that works for all citizens, not just bankers. But demand that your elected leaders finish the job next year. Too-big-to-fail lives on, and must be defeated.

Gen. Petraeus Goes to War, Mrs. Petraeus Loses to Car Salesman in Congress

Richard Eskow — Thu, 24 Jun 2010 13:57:44 -0400

This pretty much says it all: General Petraeus is going to Afghanistan at the President's request to lead the war effort there, but his wife Holly's struggle to defend our troops against the predatory lending practices of car dealers has been lost. Holly will become another military spouse who lost a battle with car dealers while a loved one serves overseas. Both Houses of Congress are apparently willing to "support the troops" only when it doesn't get in the way of doing favors for the guys raising money at those rubber-chicken campaign fundraisers back home.

Let's hope the General has better luck against Mullah Omar than his wife had against Tony Federico. Tony's the auto dealer we wrote about the other day - the one who says he always gets the best deals for his customers, but doesn't want anyone checking to see if that's true or not. In this Congress, the score is now Tony 1, Holly 0.

The House/Senate Committee approved a carve-out for auto dealers that exempts them from oversight by the Consumer Financial Protection Bureau. There are no good policy reasons for that. The argument that "car dealers had nothing to do with the economic crisis" doesn't wash. As Jeff Sovern observed in Politico, reform is designed to prevent the next crisis as much as it is to avoid a repeat of the last one. With nearly a trillion dollars a year written in auto loans each year, and with auto dealers having the same perverse incentives as mortgage brokers, it's a tragedy waiting to happen.

And it's a tragedy that is happening - every day, in communities all over the country. Holly Petraeus stepped in because she was one of many military family members who grew tired of seeing soldiers exploited by fast-talking bait and switch artists at a vulnerable and frightening time in their lives. When it push comes to shove, gladhanding contributors was more important to Congress than looking out for the interests of our soldiers ... and other ordinary citizens. The racially discriminatory patterns behind auto lending didn't disturb them, either, nor did the average of $647 added to the cost of each vehicle as a result of dealer markups. (More info here and here.)

Negotiators are working to undo a little of the damage done by this decision. As the AP reported yesterday, auto dealers will still be covered by Federal truth-in-lending laws, although the Fed will have to write a justification every time it tried to write rules that specifically deal with auto loans. And there's a plan to create a "fast track" for the Federal Trade Commission to write rules that address auto loans.

But these are band-aids on the gaping wound created by this sweetheart deal. Every lender but one will have to answer to the Consumer Financial Protection Bureau, leaving a messy and confusing two-tiered oversight system that's ripe for exploitation.

We promoted the CREDO/Campaign for America's Future fax campaign last week, saying " Send a fax. Call your Senator and Representative. If you do, we can have you in a nice financial reform package, complete with consumer protections against auto dealer rip offs." Apparently I was overselling - which may qualify me for a job at an auto dealership - but send the fax and make the call anyway. That will let them know you're unhappy, and that you want the FTC and the Federal Reserve to push for the strongest possible regulations. And let the Senators who voted to encourage Tony's giveaway (my Senator, Barbara Boxer, is one of them) know you want them to push for real oversight of these loans.

General Petraeus specializes in counterinsurgency, which is defined as "armed conflict against an insurgency by forces aligned with the recognized government of the territory in which the conflict takes place." Too bad he didn't share some of his techniques with his wife before she went to plead her case before Congress. In the battle between our troops and Tony Federico, the troops never really had a chance.

Help Ensure House & Senate Managers "Aren't in a Good Mood" About Shady Auto Deals

Richard Eskow — Mon, 21 Jun 2010 14:22:35 -0400

"What do I have to do to get you into this car?"

"How much can you afford to pay every month?"

"My manager's in a good mood."

These are the car salesman cliches everybody knows. Now they're trying to add a couple more to the repertoire:

"When you take out a car loan - probably the second-biggest financial decision of your life - you don't need a watchdog looking out for you."

"Watch out ... this will cost you a lot more if somebody's representing your interests."

And if you believe those last two statements, allow me to show you this brand new baby - it's got whitewalls and mag wheels, tinted windows, I'll throw in the deluxe sports package along with that ... oh, and we strongly recommend undercoating.

Fortunately, there's something you can do: You can go to this site, prepared by CREDO and Campaign for America's Future, where a simple one- or two-click process will send a fax to Barney Frank and Chris Dodd urging them protect American consumers from shady auto loans. It's easy to do, it's important - and, if you act now, it's absolutely free! (Racing stripe and rustproofing not included with fax.)

It's easy to sound flippant, since everybody knows why we all hate car dealers, but the topic is deadly serious: As we've discussed at length, auto dealer lending practices are a disgrace. A massive, multi-year study showed that African Americans are charged more than whites for the same loans. Auto dealers routinely mark up the loans they offer, without disclosing that information to customers - a practice that costs consumers $20 billion per year and adds an estimated $647 to the cost of each vehicle sold. Auto dealers also play games with "gap insurance" that covers the replacement cost of your vehicle for loan purposes if it's totaled.

Another common car dealer trick is to "sell" a car to a customer by claiming they qualify for a no-interest or low-interest loan, letting them drive away in it, then calling them a week or two later to say the loan fell through. Dealers do this because most customers will have gotten used to the car by then, which means that many of them will accept loan terms that wouldn't been unacceptable at the point of sale.

Car lenders have made a particular point of preying on young soldiers, who are living far from home in great distress. That's why Holly Petraeus, wife of Gen. David Petraeus, is strongly in favor of regulating auto loans. The Petraeus family are hardly known for their left-wing views. Mrs. Petraeus speaks movingly of the harm unscrupulous salespeople have inflicted on our troops.

What are the counterarguments? Car dealers and their allies love to say they should be exempted from financial reform because they weren't part of the financial crisis. But think about it: Why should auto loans be regulated when they're provided by banks and credit unions, but not when they're provided by auto dealers? That's anticompetitive. What's more, we've already seen that auto dealers sometimes encourage applicants to lie when applying for a loan. If bank auto loans are regulated but car dealer loans aren't, unscrupulous bankers will simply use car dealers as willing minions to make an end run around consumer protection. With auto lending a nearly $1 trillion market, the last thing we need is a replay of the "no doc" mortgage scandal with car salesmen playing the part of mortgage brokers.

The defend-car-salesmen crowd has a couple more arguments, and a credulous Associated Press commentary by Rachel Beck summarizes them: First Ms. Beck repeats the assertion that lending legislation would affect dentists who allow patients to pay over time (the Senate bill does not and this will undoubtedly be clarified and corrected in conference.) Then, she conflates "family dentists" with auto dealers, as if they were both trusted service providers. (It's true that buying a car is as painful as a root canal, but that's as far as the comparison goes.)

That sleight of hand allows her to come up with this:

Just like the dentists, (auto dealer Tony) Federico says that more regulation will boost his costs. It could mean he does fewer loans, or is less generous in the deals he offers. Consumers then would have to seek out loans elsewhere, which could be less convenient and cost more.

"I am always looking out for my customers' best interests, but I also want to do deals that are worthwhile," Federico says.

So, who are you gonna believe - somebody named "Holly Petraeus," who's concerned about military families, or your trusted family friend Tony Federico? Tony says you'll pay less getting a loan through him, even when he's done taking his market - and when has a car salesman ever lied? Sure, studies show that he's wrong, but who are you gonna trust here - the Center for Responsible Lending .... or your old pal Tony?

I'm sure Rachel Beck is a very nice person, but her piece is embarrassing to read. Why would newspapers run it? Let's not forget that, like politicians, newspapers rely on car dealer revenue for their bread and butter. (Why, the Sun-Times was even willing to cut a deal with the New York Times this week to run luxury car ads in the Chicago market; luxury ads are especially lucrative.) Ad revenue buys a lot of credulity, especially on the editorial pages.

Hey, maybe everybody's wrong but Tony Federico and Rachel Beck. They're not - but let's say for argument's sake they are: : Why not support this provision anyway? It doesn't prevent auto dealers from handling loans, it simply provides oversight when they do. If the Federicos of the world are really providing better loans at reasonable rates, there's no reason why the Consumer Financial Protection organization won't simply give them an "attaboy" or "attagirl" and tell them to keep up the good work. (Attaboy, Tony!)

Or look at it the other way: If they're not doing anything wrong, why are they so concerned about a little oversight?

Auto dealers throw a lot of lucrative fundraisers back home for DC politicians. That's why 62 House Democrats have joined their Republican colleagues in pushing for an auto dealer exemption. That's the money talking. Talk back to it: Send a fax. Call your Senator and Representative. If you do, we can have you in a nice financial reform package, complete with consumer protections against auto dealer rip offs, probably by this time next week.

Now that's what I call a deal.

Will Wall Street Reform Be Gutted By A Technicality?

Zach Carter — Thu, 17 Jun 2010 18:24:20 -0400

The tough derivatives overhaul proposed by Sen. Blanche Lincoln, D-Ark., has emerged as the key fight in Wall Street reform. That status is well-deserved. Despite Lincoln's record as a stooge for corporate executives, she is pushing what is by far the most significant threat to the Wall Street bonus machine currently on the table. But what's not as well-known is that Lincoln's plan hinges on critical technicality elsewhere in the reform package that would thoroughly defang her plan if removed.

So far as the absurdly complex world of derivatives trading is concerned, the Lincoln bill is relatively straightforward: No more taxpayer subsidies for the crazy derivatives casino that brought down AIG and Enron. Taxpayers provide two key subsidies to the commercial banking system, namely cheap loans from the Federal Reserve's discount window, and deposit insurance. Deposit insurance protects the public from losing its money when a bank fails, but that guarantee means banks don't have to pay very much to win depositors' money, making them a very cheap source of funding. Since just a handful of commercial banks deal nearly $300 trillion in derivatives, those subsidies are a very big deal.

By eliminating taxpayer subsidies, Lincoln would force banks to raise more capital against their derivatives deals, which provides a cushion against losses, and prevents banks from overextending themselves on risky activities.

To kill off the subsidies, Lincoln's plan—known as "Section 716" on Capitol Hill—would force banks to move their derivatives dealing operations into an independently capitalized affiliate company. That affiliate would have no access to taxpayer perks, and would not be able to use cheap Fed loans and deposits to book artificially inflated profits—and by extension, bonuses—on inherently risky derivatives deals.

But for this plan to work, the bank—a company with access to taxpayer perks—can't be able to simply bail out its derivatives affiliate when it gets into trouble. Those bailouts would ultimately be financed by taxpayer subsidies, rendering the whole point of the Lincoln plan meaningless. There are already laws on the book that limit transactions between banks and their affiliates (for wonks: Sections 23A and 23B of the Federal Reserve Act), but the laws are weak. Fortunately, Section 608 of the Wall Street overhaul that cleared the Senate significantly strengthens those rules.

Current law only keeps banks from bailing out their affiliates with traditional loans. If they want to use a more complicated transaction, like, say, a derivative, to salvage the affiliate, they can. The Senate bill tightens this language, barring banks from bailing out their affiliates with both securities lending and derivatives operations.

This barrier isn't ironclad, but it is meaningful. Banks can still devote up to 10 percent of their capital to transactions with an affiliate firm, but no more. That number may sound high, but remember—even if banks continuously push out 10 percent of their capital to their new derivatives affiliate, which they would never do for various technical reasons, that's only one-tenth of what they're currently allowed to use. It'd be better if this number were, say, zero, but banks really will have to put up a lot more capital to deal in the derivatives casino if the Senate language survives.

Even more important, Section 608 requires affiliates to post collateral for any transaction they engage in with their bank. That means no free lunch for the derivatives affiliate if it gets into trouble. While banks can still make (limited) arrangements to save the derivatives affiliate, the affiliate has to put up something of equal value in exchange. In other words, the bank can't just bailout the derivatives house with taxpayer subsidies.

So watch Section 608 very closely as the conference committee on Wall Street reform reconvenes next week. With derivatives becoming the hot-button issue for the financial overhaul, very few lawmakers are interested in being caught publicly selling out to megabanks this late in the reform process, particularly with the November elections just a few months away. But they may very well gut a handful of less-well-publicized technical measures in an effort to gut the derivatives reform by proxy.

The Conference Committee Must Strengthen Wall Street Reforms

Zach Carter — Thu, 10 Jun 2010 12:16:19 -0400

Conference Committee negotiations on Wall Street reform begin today, with several key battles still unresolved. Thanks to intense progressive pressure, those negotiations are going to be televised live. You can watch the sessions on the web right here, using a stream provided by the Sunlight Foundation. Stay tuned to see if negotiators tip their hand on any of these key reforms:

Streaming live video by Ustream

1. Derivatives

The Senate's language on derivatives contains a plan from Sen. Blanche Lincoln, D-Ark., that would end taxpayer subsidies for banks who deal derivatives—the toxic contracts that brought down AIG. This is by far the most significant Wall Street reform on the table, and the only serious effort it contains to address too-big-to-fail. But both the House and Senate versions of the bill make it extremely difficult for regulators to actually enforce other key new derivatives rules. Sen. Maria Cantwell, D-Wash., has language to plug this loophole, so watch to see if negotiators are willing to follow her lead.

2. Leverage

Banks amplify their bets in the capital markets casinos with leverage—a trick which basically amounts to borrowing tons of money and hoping for the best. When it works out, banks make out like bandits. When it doesn't, they suffer epic losses. The House bill caps leverage at 15-to-1, meaning banks can borrow $15 for every $1 of their own money. The Senate bill would essentially cap leverage at 25-to-1. Some kind of hard leverage cap is essential, but 25-to-1 is far too high.

3. The Consumer Financial Protection Agency

The House version of this agency is generally stronger than the Senate version, with more independence and broader authority. But the House version also exempts auto dealers from CFPA oversight, which the Senate version does not.

4. The Volcker Rule

The best version of President Obama's signature Wall Street reform was an amendment written by Sens. Jeff Merkley, D-Ore., and Carl Levin, D-Mich. It was never voted on in the Senate, and the House bill contains no version of any ban on risky proprietary trading by commercial banks. Rumor has it that negotiators are trying to offer a strong Volcker Rule in exchange for nixing the Lincoln language on derivatives. That's a lousy deal. The two reforms are complimentary and would work best in tandem, but forcing taxpayer money out of the derivatives business is far more important than a prop trading ban.

5. Rating agencies

Sen. Al Franken pushed through an amendment that substantively changes the corrupt business model at rating agencies. Right now, rating agencies do not get paid by the investors who use their ratings, but by the very banks who are issuing the securities that need to be rated. Franken would end this system, having regulators to select which rating agencies rate which securities, rather than the banks who issue the securities. The House bill largely leaves the rating agency business model unchanged.

6. Swipe fees

When you buy something at a store with a credit or debit card, Visa and Mastercard charge that store a fee. The store, in turn, charges you more for its products, making everything everybody buys more expensive. The Senate bill has language cracking down on debit card fees, but the House bill does not.

Radio Appearance in Santa Barbara: The Current State of Financial Reform (And What We Can Do About It)

Richard Eskow — Mon, 31 May 2010 13:16:36 -0400

Here's an audio clip of my appearance yesterday with Hannah-Beth Jackson on Santa Barbara progressive radio to discuss the current state of financial reform and what can be done next:

Hannah Beth Jackson 0530 edited

I edited out about a minute and a half of lead time, mostly commercials, but our conversation has been preserved intact. The audio may be a little rough in the first minute or so, although what I hear may be a problem with the low connection speed at my house that won't affect you.

"No More Secrecy": Open The Wall Street Negotiations and Empower Voters

Richard Eskow — Wed, 26 May 2010 21:18:53 -0400

The Campaign for America's Future (CAF), CREDO, and MoveOn have launched a petition campaign to ensure that the House/Senate deliberations on financial reform be "fully transparent." The good news? The government has the ability, the resources, and the talent to make this process the breakthrough in "open government" the President has long promised. The bad news? Anything less than "full" transparency will lead to a weaker bill, less public confidence in government, and even more anti-incumbent anger.

The goals must be clear: First, a truly transparent process should reduce the ability of lobbyists and other backroom dealers to influence the proceedings. Second, it must let the American people see which elected officials are defending them and which are carrying water for Wall Street. Third, the process should give the public both the time and the tools to make an informed decision about the final bill - and then express their feelings to their representatives.

Robert Borosage of CAF explained the reasons for the petition to Brian Beutler of TPM: "... (W)e want the legislation put online, the differences put online, the issues they're going to talk about put online." The urgency of those comments is underscored by the fact that conference participants have collectively received nearly $58 million from the finance, insurance, and real estate sectors most affected by this bill.

It is time for the President to weigh in, too. After all, he articulated a vision of open government - and promised to deliver it - during a forceful campaign speech in 2008: "I will make our government open and transparent so that anyone can ensure that our business is the People's business," he said. "I am going to make it impossible for congressmen or lobbyists to slip pork-barrel projects or corporate welfare into laws when no one is looking because, when I'm president, meetings where laws are written will be more open to the public. No more secrecy. That's a commitment I'm going to make to you as President: No more secrecy."

The President outlined a clear vision of open government in that speech:

"When there's a bill that ends up on my desk as President, you, the public, will have five days to look online and find out what's in it before I sign it so that you know what your government is doing. When there are meetings between government lobbyists and a government agency, we will put as many of those meetings as possible on line for every American to watch. When there's a tax bill being debated in Congress, you will know the names of the corporations that would benefit and how much money they would get, and we will put every corporate tax break and every pork-barrel project on line for every American to see. You will know who asked for them, and you can decide whether your representative is actually representing you."

Chairman Barney Frank of the House Financial Services Committee promised televised hearings back in March, saying "nothing will be ratified without a public debate." But he appeared to roll back his pledge somewhat this week. "“The negotiations will go on in private,” Frank said, “but the results of any discussion are going to have to be voted on."

Off-camera negotiation is more business as usual. Up-or-down votes on pre-agreed deals is not full transparency, no matter how much speechmaking is allowed beforehand. Elected officials could still wheel and deal for Wall Street in private and then strike a populist pose in public.

Chairman Frank also said that conference participants won't have much personal power. "I believe that we... will be more the agents of collective decision-making than autonomous deciders," he said. That means the real dealmaking will take place in the caucuses, especially the Dems'. If the parties won't open their caucuses to public scrutiny, then at a minimum both parties should express their "collective" positions well in advance of the conference sessions.

The White House can help ... and it should. First, it should use its voice and its influence to push for full transparency. Then it should provide any technical resources needed, since it has much greater resources than Congress. The public should be able to save and review portions of the televised debate online, with links to the same documents, briefing books, and memos provided to the conferees. Beth Noveck, the Administration's Chief Technology Officer for Open Government, would be an ideal candidate to lead the effort. She's not well known to the general public, but she's one of the most interesting and imaginative thinkers operating in government today. Novick, or someone like her, could marshal the resources needed to deliver on the public's behalf.

Given that the Administration's a major player in the proceedings, their actions should also be visible to the public. If, for example, they're expressing an ambiguously-phrased coolness toward Lincoln's derivatives amendment in public, we should know how they're addressing the issue in negotiations. (White House participation would also help clear the air after criticisms of its level of openness during the health reform process, from Nancy Pelosi and other progressives as well as Republicans).

Some of these suggestions may seem like "blue sky" ideas, although they're easily executed with the technology now available. At the very least, however,"full transparency" must mean 1) holding all the meetings in public, 2) giving the public online access to each and every document and memo provided to the conferees, and 3) giving the public five days to review the final bill before a vote is held.

Please sign this petition to demand that these minimum requirements for public transparency are met. Voters of the future may thank you. Your checkbook probably will, too.

Scaling Back Our Bloated Financial Sector

Zach Carter — Wed, 26 May 2010 16:38:31 -0400

It's been apparent for several weeks that the Wall Street reform bill will not cut down the largest U.S. banking behemoths to a safe and manageable size. But individual oversized banks are not the only problem Big Finance poses to the economy—the overall sector is much too large, and if we do not shrink it, we'll be dealing with difficult economic conditions for years to come.

Right before the banking system crashed, the financial sector accounted for an astonishing 40 percent of corporate profits. That share of the economy plunged as banks sought their bailouts, but by the end of 2009, finance was back, again accounting for almost 36 percent of corporate profits.

When the financial industry takes up that much of the economy, it becomes a big problem for two reasons. First, instead of serving as a catalyst for broader economic growth, finance is simply devouring other sectors of the economy. Like money, finance is not a goal in and of itself—it's just a way to support goods and services that make life better. At 40 percent of profits, finance is not supporting that activity, it's destroying it.

Second, for finance to take up 35 to 40 percent of the total profit pie, it has to be engaging in a lot of raw speculative gambling, rather than economically productive lending. That creates a tower of speculation that can easily topple with a single event—and the resulting mess can be very hard to clean up. As Nomi Prins has detailed, between 2002 and 2008, only about $1.4 trillion in subprime mortgages were issued, while about $14 trillion in securitized bets were derived from these mortgages. When the subprime market cratered, all that speculation made a big problem much bigger.

So in addition to cutting the biggest banks down to size, we also need to scale back the entire financial sector. There are a handful of provisions in Wall Street reform packages approved by the House and Senate that would help accomplish that goal. Unfortunately, the bank lobby, and in some cases, the Obama administration itself, is fighting those provisions. Here they are:

1. Capital and Leverage

Banks amplify their bets in the capital markets by using leverage—borrowing a lot of money. If you buy $10 million worth of stock, and it goes up 10 percent, you make a ten percent return-- $1 million. But if you borrow $490 million, put up $10 million of your own money, and put all of it into the same stock, a 10% gain in the stock price scores you $50 million—a 500% return (it would actually be a little less, as you'd have to pay interest on that $490 million loan, but you get the idea). But if the stock drops just 2 percent, you lose all of your own money, and find yourself $490 million in debt. You are ruined.

Rep. Jackie Speier, D-Calif., managed to squeeze an amendment capping bank leverage at 15-to-1 into the House reform bill, meaning that banks could not borrow more than $15 for ever $1 they put up. That's good-- less leverage means less overall financial activity. Sen. Susan Collins, R-Maine, managed to get a weaker, but related provision into the Senate bill, which would force megabanks to reduce their leverage.

Unfortunately, the Treasury Department and the Federal Reserve are fighting both amendments. Even worse, as Mike Konczal notes, the Treasury is also fighting hard against international agreements to limit bank leverage.

2. Derivatives spin-offs

Five big banks control over 96% of the derivatives market, which totals literally hundreds of trillions of dollars. One of the reasons this market is so big is that banks fund these operations with deposits. Since the government guarantees bank deposits against losses, this funding is cheaper than anything else the bank can get outside of the Federal Reserve, which also lends to all five of those banks. Sen. Blanche Lincoln, D-Ark., pushed a provision through the Senate which would bar any commercial bank that deals derivatives from receiving Fed loans. In practice, this would force the banks to move their derivatives dealing operations into a separately capitalized subsidiary.

The banks, Treasury and the Fed are all fighting this provision tooth-and-nail because it would significantly alter the way the derivatives business is funded. Instead of being able to rely on cheap government money, banks would have to finance their derivatives operations in the more expensive capital markets. When something gets more expensive, people do it less, so the Lincoln plan (authored by Sen. Maria Cantwell, D-Wash.) would trim back the derivatives casino.

3. Consumer Financial Protection Agency

One way banks eat up the broader economy is by simply stealing from consumers. Just about everyone has had a bad experience with a credit card, mortgage or overdraft rip-off. These are, first and foremost, bad for our pocketbooks. But what is bad for our pocketbooks is bad for other businesses—it means we have less to spend on goods and services. So by screwing consumers, banks are really sticking it to the broader economy.

The existing bank regulators at the Federal Reserve and the Office of the Comptroller of the Currency simply have not enforced consumer protection rules over the past decade. Their primary goal is ensuring bank profitability, so if banks profit from consumer abuses, they don't really care. We can end this system of abuse by establishing a strong, independent Consumer Financial Protection Agency (CFPA) tasked only with looking out for consumers. The House language on the CFPA gives the agency more independence and broader authority to both write and enforce regulations than the Senate version, but it also exempts abusive auto dealers from the agency's jurisdiction, which the Senate version does not do.

So what else in the bill will cut back on our oversized finance system? Not much. There is a very weak version of the Volcker Rule, which bans banks from gambling with taxpayer money, but it will take years to implement and can easily be gutted by regulators. That leaves a handful of key provisions that should be focus of the reform fight next year:

1. A financial transactions tax.

Many of our current economic woes are tied to excess speculation in finance. By imposing a tiny tax on trades of stocks, bonds and derivatives, the government can discourage rank speculation while bringing in a lot of revenue for the federal coffers. A tax of just a few tenths of one percent will not seriously effect long-term investors. But for speculators who place big bets on the movement of stocks over the course of an hour, or for flash traders who buy and sell millions of shares in less than a second, this kind of tax actually would matter. Based on trading volumes from 1997, which are vastly lower than today's trading volumes, economist Dean Baker estimates that this tax could bring in $100 million a year in tax revenues, even if the overall trading volume fell by 25 percent.

2. Glass-Steagall

Banks don't just use taxpayer-guaranteed deposits to back their derivatives bets, they also fund all kinds of risky securities businesses with deposits. In the 1930s, Congress passed the Glass-Steagall Act, which barred banks that accept deposits and make loans from operating in the securities markets. By separating taxpayer guarantees from risky activity, the move made that risky activity less profitable, and by extension, less profuse.

3. Regulate Hedge Funds and Private Equity

The current bill doesn't really do anything to rein in these shadowy entities. They'll now have to register with the SEC . . . just like Bernie Madoff.

Progressives Demand: No Back-Room Deals On Wall Street Reform

OurFuture.org Staff — Wed, 26 May 2010 16:11:44 -0400

Wall Street's Victory Lap

OurFuture.org Staff — Wed, 26 May 2010 16:09:42 -0400