USA Today: Why Financial Reform is Needed
Mainstream USA Today recently published its opinion on the financial reform package currently pending in Congress. Lawmakers should pay attention.
I. WHY THE OBAMA FINANCIAL REFORM PROPOSAL SHOULD PASS
USA Today starts out by observing that “[n]o economic downturn in the past century — not even the Great Depression — can be so directly attributed to pernicious behavior by financiers,” which “exposed a bonus-crazed banking culture that amplified risk on a colossal scale.”
It continued: “Despite it all, the public remains exposed to risks of a future economic collapse, and possible bailouts, brought on by the very same behavior. That's why financial reform is so important, and why the push-back from major financial institutions suggests that the sweeping proposal pending in the Senate is on the right track.”
In general, the financial reform proposal would require institutions to set aside more assets as a cash cushion to cover losses, require that risky derivative trades be done on exchanges “in the open,” provide consumer protections and a more orderly process to wind down failing institutions than bankruptcy. This would require large financial institutions, whose failure would have a systemic impact, to file recommendations with regulators and central bankers on how best to wind them down if they become insolvent. The USA Today Editorial board said it approves of such “funeral plans.”
One thing the measure would not do, according to the article, is fund future taxpayer bailouts. “That charge — by Senate Minority Leader Mitch McConnell— is a kind of Orwellian doublespeak,” said USA Today.
In fact, the Obama proposal would collect fees from banks to fund a $50 billion pool, which would be used to break up and dispose of those that fail. To deflect the disingenuous shouting about no more “taxpayer bailouts,” the Obama administration has signaled that this provision could be dropped. “In any event, all it would do is create a shutdown process much like the one that has been used successfully for decades to close down smaller banks,” said USA Today.
“That is the supposed ‘bailout.’ Never mind that no taxpayer money would be involved, said USA Today with apparent disgust.
USA Today did identify some flaws in the reform proposal. For instance, there are still too many separate agencies that would regulate banking. The legislation does not deal with the problem of bankers' compensation, which rewards excessive risk-taking with other people's money. There is also a danger that the “hundreds” of industry lobbyists will succeed in undercutting the bill.
“[T]he measure does many things needed to limit the chances of another horrific credit crisis and rage-inducing bailout. Members of Congress who think they can just say no to financial reform, the way they did to President Obama's health care overhaul, do so at their own political peril.”
II. HOW DERIVATIVES HAVE BECOME “FINANCIAL WEAPONS OF MASS DESTRUCTION" THAT MUST BE REGULATED
Turning to the brouhaha surrounding the SEC’s enforcement action against Goldman Sachs, USA Today said the real problems are: “Goldman and other investment banks have morphed into betting parlors that traffic in exotic financial instruments. Another is that it was the result of a deplorable lack of transparency.”
The financial reform proposal addresses this problem by putting such derivatives on open exchanges, where they can be seen and regulated. Currently, they are like the dark matter of the financial universe.
“But the legislation might not go far enough,” says USA Today. As Warren Buffett famously stated in a to shareholders, derivatives can end up as "financial weapons of mass destruction."
This is particularly true of credit default swaps, the derivative sold by AIG (and others) that (but for TARP bailout money) would have dragged AIG and the whole economy into the abyss.
To give an idea of how much dark matter there is out there, the market for credit default swaps has grown a hundredfold in six years, and was valued at $62 trillion in late 2007, or 15 times the annual budget of the U.S. government. “Had this growth been more transparent and better understood,” USA Today observed, “officials such as Federal Reserve Chairman Ben Bernanke would not have been so confident that the subprime meltdown could be ‘contained.’"
Congress needs to give regulators the authority to act against the problems that they spot. They need to be able to limit the scale of credit default swaps and ban investments better suited to casinos than to banks, according to USA Today.
The article concludes:
"Five major financial institutions — J.P. Morgan Chase, Citigroup, Goldman Sachs, Wells Fargo and Bank of America—dominate the credit derivatives trade. They make fat fees from arranging deals off exchanges, and they oppose putting them all out in the open.
Too bad. If the side-bet business is so important to the banks, they should move to Atlantic City and apply for casino licenses. The future of the global economy is too important not to shine more light on derivatives trades and rein in the ones that have no commercial benefit."
