[corp-focus] The Financial Re-Regulatory Agenda

[robert weissman]

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The Financial Re-Regulatory Agenda
By Robert Weissman
September 17, 2008

As the Federal Reserve and Treasury Department careen from one financial 
meltdown to another, desperately trying to hold together the financial 
system -- and with it, the U.S. and global economy -- there are few 
voices denying that Wall Street has suffered from "excesses" over the 
past several years.

The current crisis is the culmination of a quarter century's 
deregulation. Even as the Fed and Treasury scramble to contain the 
damage, there must be a simultaneous effort to reconstruct a regulatory 
system to prevent future disasters.

There is more urgency to such an effort than immediately apparent. If 
the Fed and Treasury succeed in controlling the situation and avoiding a 
collapse of the global financial system, then it is a near certainty 
that Big Finance -- albeit a financial sector that will look very 
different than it appeared a year ago -- will rally itself to oppose new 
regulatory standards. And the longer the lag between the end (or tailing 
off) of the financial crisis and the imposition of new legislative and 
regulatory rules, the harder it will be to impose meaningful rules on 
the financial titans.

The hyper-complexity of the existing financial system makes it hard to 
get a handle on how to reform the financial sector. (And, by the way, 
beware of generic calls for "reform" -- for Wall Street itself taken up 
this banner over the past couple years. For the financial mavens, 
"reform" still means removing the few regulatory and legal requirements 
they currently face.)

But the complexity of the system also itself suggests the most important 
reform efforts: require better disclosure about what's going on, make it 
harder to engage in complicated transactions, prohibit some financial 
innovations altogether, and require that financial institutions properly 
fulfill their core responsibilities of providing credit to individuals 
and communities.

(For more detailed discussion of these issues -- all in plain, 
easy-to-understand language, see these comments from Damon Silvers of 
the AFL-CIO 
(<http://www.multinationalmonitor.org/mm2007/052007/interview-silvers.html>), 
The American Prospect editor Robert Kuttner, author of the The 
Squandering of America and Obama's Challenge 
(<http://www.multinationalmonitor.org/mm2007/112007/interview-kuttner.html>), 
and Richard Bookstaber, author of A Demon of Our Own Design: Markets, 
Hedge Funds, and the Perils of Financial Innovation 
(<http://www.multinationalmonitor.org/mm2008/072008/bookstaber.html>).)

Here are a dozen steps to restrain and redirect Wall Street and Big Finance:

1. Expand the scope of financial regulation. Investment banks and hedge 
funds have been able to escape the minimal regulatory standards imposed 
on other financial institutions. Especially with the government safety 
net -- including access to Federal Reserve funds -- extended beyond the 
traditional banking sector, this regulatory black hole must be eliminated.

2. Impose much more robust standards for disclosure and transparency. 
Hedge funds, investment banks and the off-the-books affiliates of 
traditional banks have engaged in complicated and intertwined 
transactions, such that no one can track who owes what, to whom. Without 
this transparency, it is impossible to understand what is going on, and 
where intervention is necessary before things spin out of control.

3. Prohibit off-the-books transactions. What's the purpose of accounting 
standards, or banking controls, if you can evade them by simply by 
creating off-the-books entities?

4. Impose regulatory standards to limit the use of leverage (borrowed 
money) in investments. High flyers like leveraged investments because 
they offer the possibility of very high returns. But they also enable 
extremely risky investments -- since they can vastly exceed an 
investor's actual assets -- that can threaten not just the investor but, 
if replicated sufficiently, the entire financial system.

5. Prohibit entire categories of exotic new financial instruments. 
So-called financial "innovation" has vastly outstripped the ability of 
regulators or even market participants to track what is going on, let 
alone control it. Internal company controls routinely fail to take into 
account the possibility of overall system failure  -- i.e., that other 
firms will suffer the same worst case scenario -- and thus do not 
recognize the extent of the risks inherent in new instruments.

6. Subject commodities trading to much more extensive regulation. 
Commodities trading has become progressively deregulated. As speculators 
have flooded into the commodities markets, the trading markets have 
become increasingly divorced from the movement of actual commodities, 
and from their proper role in helping farmers and other commodities 
producers hedge against future price fluctuations.

7. Tax rules should be changed so as to remove the benefits to corporate 
reliance on debt. "Payments on corporate debt are tax deductible, 
whereas payments to equity are not," explains Damon Silvers of the 
AFL-CIO. "This means that, once you take the tax effect into account, 
any given company can support much more debt than it can equity." This 
tax arrangement has fueled the growth of private equity firms that rely 
on borrowed money to buy corporations. Many are now going bankrupt.

8. Impose a financial transactions tax. A small financial transactions 
tax would curb the turbulence in the markets, and, generally, slow 
things down. It would give real-economy businesses more space to operate 
without worrying about how today's decisions will affect their stock 
price tomorrow, or the next hour. And it would be a steeply progressive 
tax that could raise substantial sums for useful public purposes.

9. Impose restraints on executive and top-level compensation. The top 
pay for financial impresarios is more than obscene. Executive pay and 
bonus schedules tied to short-term performance played an important role 
in driving the worst abuses on Wall Street.

10. Revive competition policy. The repeal of the Glass-Steagall Act, 
separating traditional banks from investment banks, was the culmination 
of a progressive deregulation of the banking sector. In the current 
environment, banks are gobbling up the investment banks. But this 
arrangement is paving the way for future problems. When the investment 
banks return to high-risk activity at scale (and over time they will, 
unless prohibited by regulators), they will directly endanger the banks 
of which they are a part. Meanwhile, further financial conglomeration 
worsens the "too big to fail" problem -- with the possible failure of 
the largest institutions viewed as too dangerous to the financial system 
to be tolerated -- that Treasury Secretary Hank Paulson cannot now avoid 
despite his best efforts. In this time of crisis, it may not be obvious 
how to respect and extend competition principles. But it is a safe bet 
that concentration and conglomeration will pose new problems in the future.

11. Adopt a financial consumer protection agenda that cracks down on 
abusive lending practices. Macroeconomic conditions made banks 
interested in predatory subprime loans, but it was regulatory failures 
that permitted them to occur. And it's not just mortgage and home equity 
loans. Credit card and student loan companies have engaged in very 
similar practices -- pushing unsustainable debt on unreasonable terms, 
with crushing effect on individuals, and ticking timebomb effects on 
lenders.

12. Support governmental, nonprofit, and community institutions to 
provide basic financial services. The effective governmental takeover of 
Fannie Mae, Freddie Mac and AIG means the U.S. government is going to 
have a massive, direct stake in the global financial system for some 
time to come. What needs to be emphasized as a policy measure, though, 
is a back-to-basics approach. There is a role for the government in 
helping families get mortgages on reasonable terms, and it should make 
sure Fannie and Freddie, and other agencies, serve this function. 
Government student loan services offer a much better deal than private 
lender alternatives. Credit unions can deliver the basic banking 
services that people need, but they need back-up institutional support 
to spread and flourish.

What is needed, in short, is to reverse the financial deregulatory wave 
of the last quarter century. As Big Finance mutated and escaped from the 
modest public controls to which it had been subjected, it demanded that 
the economy serve the financial sector. Now it's time to make sure the 
equation is reversed.


Robert Weissman is editor of the Washington, D.C.-based Multinational 
Monitor, <http://www.multinationalmonitor.org> and director of Essential 
Action <http://www.essentialaction.org>.

(c) Robert Weissman

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