It’s a Miracle: Financial Reform

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It’s a Miracle: Financial Reform

Against All Odds
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Mirror, mirror on the wall. Which is the fairest financial reform bill of all?


Well folks, our fairy godmother brought us health care reform (sort of) after decades of wishing on a star. Next batter up? Financial reform and regulation. That is a mouthful. But against all the odds, it just might be possible. Blogger Monika Mitchell takes a look at the current state of financial reform in America.

Wednesday, June 9, 2010 - 4:30pm


Do you believe in miracles? Well, brace yourself. We may have another one coming down the pike. Financial reform bills have been passed by both the House and the Senate. Lawmakers are currently working on the final version. We just might see the most sweeping financial reform since the Great Depression within our lifetime. Considering the aggressive and well-funded lobbying by banks, financial institutions, large corporations, and highly placed politicians, this would truly be a miracle.

Why didn’t we have financial reform before this, you may wonder? Because… “The markets can regulate themselves.” Well, at least that is what we believed back in the Bronze Age (20th century.)

In our post financial crisis world, the big question of “to regulate or not to regulate” has been definitively answered. Former libertarians like myself recognize that the markets don’t (and can’t) regulate themselves. The “markets” include groups of money-lusting individuals completely incapable of controlling those desires. To be sure there are lots of good folks out there in business and finance. But the money-lusters interfere with the freedom of the rest of us. They seem incapable of seeing the bigger picture. These folks focus on how much they can get for themselves at the expense of everyone else. Sort of like Pavlov’s dogs—ring the bell and the dogs are off and running to find food.

Therefore it has become unmistakably clear in the last 21 months since investment banking as we once knew it died, that the markets need genuine supervision.

The new  financial reforms currently debated will affect all of us who live in the U.S.  So it’s worth it to take a look at what we are bargaining for.

The Senate Plan outlines the following:

    1.  Establish a new council of “systemic risk regulators.”

The main goals of this council are to stop companies from getting too-big-to-fail, preventing another collapse, bursting economic bubbles before they get too dangerous, and managing systemic risk. A tall order perhaps and one that sounds almost fantastical. How this agency hopes to achieve this lofty goal is still being hammered out.

    2.  Establish a new consumer protection agency within the Federal Reserve.

Been there, done that. Didn’t work the first time to protect consumers. In fact, the Fed failed pretty miserably. This agency should be independent of the Fed, the Treasury and all the Old Boys who are afraid some smart woman (Warren, Bair) will run away with their pots of gold.

    3.  Give more power to the Federal Reserve to supervise risk activities of the largest financial institutions.


Could Alan Greenspan have had MORE power? He spoke and the whole WORLD listened. The man moved markets by breathing! So let’s remember how that worked out for us.  Memories may be beautiful and then…just too painful to remember the way we were. This provision has to go. We may be dumb, but we are not stupid! Hopefully. 

    4.  Increase government authority “in extreme cases to seize and liquidate a failing financial company in a way that protects taxpayers from future bailouts.”

Isn’t the FDIC already doing this and doing it better than anyone else? Didn’t the other “government” agencies blow their big opportunity with unconditional and unlimited bailouts of AIG, Fannie Mae, Freddie Mac, Goldman Sachs, JPMorgan Chase, Citibank, Bank of America, and Wells Fargo? Seems to me when they gave away the store without securing consumer lending and employee compensation, they failed in this mighty task. Let me ask you a question. If you screw up at work do you expect to be ? a) reprimanded b) fired. c) promoted.

Perhaps we can apply common sense logic to our reform bill. Given their track record of handing billions to buddy banks while letting the rest of the Street and the nation crash and burn, the Federal Reserve and the Treasury should never have the authority to liquidate any firm.

A glaring example of official mismanagement is the U.S. government “ownership” of 27% of the perpetually insolvent Citigroup. The Federal Reserve and Treasury engineered a taxpayer guarantee of $300bn of toxic assets and poured billions upon billions into this banking Titanic. 

Yet has this enormous investment reduced bank exec bonuses, home foreclosures, or credit card interest rates for the public that paid for it?  Has our ownership increased lending for small business in any way, shape or form? Have these billions of taxpayer dollars given American consumers any relief from their own toxic assets? The answers are no, no, and no.

Chief execs are paid in the gazillions. Banks are predatory foreclosure machines. Small businesses are left in the dust as big business accesses easy credit. Anyone unlucky enough to have credit card debt from one of the bailed-out banks has seen their fees and interest rates hit the roof.

The provision for “government” liquidation should be maintained strictly within the FDIC since this is the only organization that has done a fair job at it. When a bank is failing the FDIC does not reward errant execs à la the Federal Reserve and the Treasury; they take the bank over and “sell” it to a proven money manager. FDIC’s Shiela Bair has suggested this rule be expanded to include insurance companies and other large non-bank financial institutions. (This would mean AIG execs who were paid big bonuses for losing billions would be out of luck under the FDIC plan.)

    5.  Transparency and oversight for the derivatives markets through a “third party.”

You might be asking, what the heck are “derivatives” anyway? They are the smoke in smoke and mirrors. If you have a hard time understanding how these ”exotic financial instruments” work, welcome to the club. Even the former Fed Chairman, Poindexter Greenspan didn’t have a clue. Hopefully, the “third party” that the Senate Plan stipulates is a regular trading exchange.

Basically, derivatives are “bets” placed between two parties on how markets and  assets will fluctuate in the short and long term. Their value is derived from the value of an unattached asset. They include confusing words like options, futures, and those stealthy neutron bombs called “swaps.”

It works sort of like this: I bet you that a particular horse is coming in first in the race. You bet me that my horse will come in last. Neither of us owns the horse, yet we have money on the race. You can bet at the track or Off-Track betting parlors or we can make a “side bet.” In the derivative world, there is no track (exchange) or OTB—just side bets. This scenario is the root cause of AIG’s $182bn rescue. A multi-trillion dollar credit default swap market grew from third party traders who simply bet whether an asset-backed security would go up or down; they don’t have to own it.

Financier George Soros believes these “air” bets should be eliminated. Parties should have an “asset interest” in the derivative product. Sounds reasonable, but the market for derivatives has reportedly reached $668 trillion. These contracts would be worthless if the Soros rule was enacted. The challenge would be how to wind these down without  economic catastrophe.

The House bill has a few variations from the Senate bill:

    6.  Exemptions  from a trading exchange would be allowed under the House bill for certain derivatives traders. It doesn’t seem reasonable for any of these fake assets to continue under-the-radar. Not if taxpayers or investors are on the hook. We need to know how many of these WMD’s (Buffett’s term) are out there for the public’s economic safety.

Senator Blanche Lincoln’s (D-Ark) solution is to eliminate derivatives altogether from big bank books. (Warning: Don’t make the gals mad fellas. You never know when they will become your boss.) The view behind this clause is to re-establish a separation between boring banking and high risk gambling. Chances of that happening in this bill are slim however; even Paul Volker is against it.

    7.  Prop trading: Speaking of the former Fed Chairman circa 1980s, the Volker rule to prohibit proprietary trading by banks is also on the table. (Prop trading is trading a firm’s “own capital.” This can create a fundamental conflict of interest with investors and clients.) Perhaps there is a middle ground to “silo” a prop desk from the rest of a firm’s transactions. This way the firm’s capital would not be traded based on insider knowledge of its customers’ movements. In the last ten years, proprietary trading has grown to astronomical proportions. It might be virtually impossible to wind them down without devastating economic results.

    8.  Audit the Fed: The best parts of the House bill lay in its power to audit the Fed in a financial crisis. Phew! Do we need this and fast! No unilateral power without checks and balances should be given to any branch of the government. The Constitution was written specifically to prevent this. Yet here we are—at the mercy of the Federal Reserve and the U.S. Treasury as to how our trillion dollar bailout proceeds.  In effect, this is unconstitutional. No one should have their hand in the cookie jar without fear of being caught. The Congressional Oversight Panel headed by Elizabeth Warren is still asking, “Where’s the beef?”

Lastly, the Consumer Protection Agency should do just that—protect consumers. Independent of any politically motivated federal agency that has a clear self-serving agenda like Treasury or the Federal Reserve. An autonomous consumer oversight arm would finally deliver some of the equal economic representation American citizens were promised at our founding.

Isn’t that what it is all about anyway?

Perhaps surprisingly, enormous opposition to an independent agency exists—hence, the push to keep it in the Fed. (FYI: The Federal Reserve is a quasi-public-private agency, run as much by the government as it is by private banking.)

Judd Gregg (R-NH) summed up the alleged fears of Senate opposition to financial reform when he claimed regulating markets would “undermine” the system and warned, “It will inevitably contract credit.”  Was the Senator asleep for the past two years? How could he not notice that lawlessness in the markets created a severe “credit crisis” that has few signs of abating?  Some of us take more time to learn than others.

For the rest of us, it’s time to wake America up and pay close attention to what our lawmakers are doing on our behalf. Post crisis, we no longer have the luxury of looking the other way. All eyes should be on Congress this month as they hammer out the nitty gritty details of our future banking system.

Anyway you look at it, after nearly thirty years of dangerously deregulating banks, real financial reform of any kind would truly be a miracle.


Monika Mitchell - Executive Director
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Keywords: House financial reform bill | Senate financial reform bill | consumer financial protection agency | derivatives | derivatives trading exchange | financial markets regulation | financial reform | financial regulation