Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.

Geithner and Summers launch financial regulatory reform

by Jerome a Paris Mon Jun 15th, 2009 at 08:20:29 AM EST

In an article in this morning's Washington Post, two of the senior regulators most responsible for the current mess explain how, trust them, they'll do a better job this time round.

This Wall Street Journal helpfully provides context for several of the propositions on the table, but let me go through their article and comment on some items that I found interesting.

Over the past two years, we have faced the most severe financial crisis since the Great Depression. The financial system failed to perform its function as a reducer and distributor of risk. Instead, it magnified risks, precipitating an economic contraction that has hurt families and businesses around the world.

We have taken extraordinary measures to help put America on a path to recovery. But it is not enough to simply repair the damage. The economic pain felt by ordinary Americans is a daily reminder that, even as we labor toward recovery, we must begin today to build the foundation for a stronger and safer system.

The only damage that has been repaired, so far, is that done to players in the financial system: they have seen their balance sheets propped up by trillions in fresh liquidity to hide or even replace the toxic assets they had accumulated; they have seen their assets guaranteed by taxpayers, and they have suffered no meaningful penalty for their failures.

Indeed, even as the financial system is specifically designated as the source of the crisis, the primary goal today is still to rebuild the financial system rather than the econonmy. Incredibly, even the argument that ordinary people are suffering from the crisis is used to talk about rebuidling Wall Street rather than, you know, helping ordinary people...

This current financial crisis had many causes. It had its roots in the global imbalance in saving and consumption, in the widespread use of poorly understood financial instruments, in shortsightedness and excessive leverage at financial institutions. But it was also the product of basic failures in financial supervision and regulation.

savings and consumption... - this refers, almost explicity, to the theory made popular by Ben Bernanke of a "savings glut" in Asia and other parts of the world: they saved - and forced us to borrow that money and spend it on consumption. That theory, of course, is supposed to be flattering: "we did a service to the world, absorbing all their surplus savings, it's not our fault" - shifting the blame to others (the stingy Chinese and Japanese and Germans, who lectured us on our supposed irresponsibility and are now suffering from the crisis even more than we are, stupid export-addicted hypocrites that they are) and, more importantly, distracting from the core cause of this crisis: stagnant incomes, which pushed people to used debt (conveniently offered at low rates, thanks to the Fed's soft policies, and the "creativity" of investment banks) to prop up their otherwise declining standards of living.

Half a line about irresponsible, over-leveraged banks and the even more irresponsible regulators - without a mention that our two authors were amongst the people that created the current system (remember what Larry Summers' job was in 1999, when the Gramm-Leach-Bliley Act passed? or Tim Geithner's job over the past several years?) and cheered on as banks increased leverage (the easiest way to increase profits in a high-liquidity environment) and invented new products to almost-unanimous kudos from experts, politicians and central bankers who could not praise these risk-allocation instruments enough, then, and made sure that people who expressed reservations were shunned and treated as unserious, obsolete, bitter pariahs...

Of course, not a word on the fact that ever lower taxes on capital gains and high incomes provided skyrocketing incentives for insiders to game the system, create immediate "profits" that could be booked (and pocketed as bonuses or options gains) while leaving the aftermath for others.

And not a word to the fact that those that made their profits once during the boom were allowed (by regulators led by Tim Geithner) to reap a second serving in the form of $13 trillion of taxpayer money supposedly provided to limit the pain on others. I don't think that the financial world ever thought it could get a second bonanza in the middle of the crisis, but that's called "repair the damage"...

So, after such a flawed start, what do we get?

The proposed plan has 5 planks:

  • a focus on systemic risk rather than individual failures;
  • more attention to the non-banking financial world;
  • more regulation of products destined to consumers;
  • reorganising regulatory authorities to avoid conflicts;
  • international cooperation.
While all of these are reasonable on their face, what will matter is what kind of teeth the regulations will actually have, especially given the successful lobbying track record of the financial industry, and the hand the current crew had in dismantling the regulations that has existed until a few years ago and which had mostly successfully functioned since put in place under Franklin Roosevelt.

Quite frankly, given their caving in on the regulation of OTC derivatives, the joke that the bank "stress tests" were (with the "worst case" unemployment rate lower than what today's number already is) and their unwillingness to consider problems through any other lens than that of the financial markets (ie, their belief that the economy can only be sound if financial markets work and dominate that economy - sorry, efficiently allocate capital to it), the omens are not very good.

Like all financial crises, the current crisis is a crisis of confidence and trust. Reassuring the American people that our financial system will be better controlled is critical to our economic recovery.

No word of the fact that highly disruptive financial booms-and-busts were part of the landscape until the 1930s, but had mostly disappeared until deregulation in the 80s brought them back with a vengeance.

Maybe the financial world will have trust and confidence in its faithful representatives inside the US government. But should the rest of the economy?

And, in the long run, when will financiers understand that they cannot endlessly capture an ever-increasing share of the pie without shrinking it, and that their prosperity ultimately depends on that of the economy?

Not yet, from the looks of it.

by Jerome a Paris (etg@eurotrib.com) on Mon Jun 15th, 2009 at 08:21:48 AM EST

Geithner and Summers launch financial regulatory "reform"


Geithner and Summers launch financial regulatory reformTM

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Jun 15th, 2009 at 08:34:58 AM EST
So glad you are writing about this.  I just read the article, and went looking for discussion.  You bring up so many important points.

But here's what got me:

The administration's proposal will address that problem by raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms. In addition, all large, interconnected firms whose failure could threaten the stability of the system will be subject to consolidated supervision by the Federal Reserve>

Especially this: "the largest and most interconnected firms  . . . will be subject to consolidated supervision."  Why should we be creating a system to enshrine these large interconnected firms that have been a huge source of the problem.  

Their statement seems to assume that "interconnected firms" are a good thing, but it seems to me that this is what a large part of the problem has been, brought about by the securitization and the (unregulated) derivatives markets.  Have they decided that the biggest problem is the lack of regulation without identifying what the fundamental problem of these fancy financial instruments really is?   I guess I'm wondering how "consolidated supervision" and regulation is going to work without a clearer understanding of what the basic problem.  They do identify one problem as the separation of borrower and lender, but they seem to be proposing that the answer is the creation of a new middleman who will stand between the borrower and the lender, presumably watching both.  But to what end?  How does this solve the problem.  I do not see anything in this article that really identifies the problem, which must be done before solutions can be proposed and implemented.

Perhaps, as you say, the biggest problem is that they do not even acknowledge their own role in the creation and sustenance of this system.  Greater regulation may be just what is needed, but it is important to talk about what the problem is, what the solution is, and how regulators can help.

Of course, for me the biggest issue, is the focus on the financial industry and the seeming equation of the health and well-being of wall street with the health and well-being of the economy.

This article seems to prove that these two are incapable of getting outside of that mindset.  They are blinded by their own self-interest and complicity.

I think Geithner and Summers should go on a Hilton and Ritchie style tour of "the simple life" around this country and get a clue.

by jjellin on Mon Jun 15th, 2009 at 09:56:54 AM EST
the largest and most interconnected firms

it's getting ever harder to pretend they're not a club of cronies, united in scurrilous scammery.

the lumpies ain't gonna like it...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Mon Jun 15th, 2009 at 10:12:01 AM EST
[ Parent ]
seeming equation of the health and well-being of wall street with the health and well-being of the economy.

... or the seeming equation (nice, virtual math!) of the health and well being of the economy with the health and well-being of the people.

the health care system should have received the trillions, and left the banks begging, not the other way round!

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Mon Jun 15th, 2009 at 10:15:33 AM EST
[ Parent ]
This is really bugging me.

Regulating large, interconnected firms seems to take the opposite approach to regulating large "trusts" and unfair cooperation among supposed competitors.  

We should not be encouraging large interconnected firms--they should not be allowed to collude together.  Collusion of firms undermines competition.

What kind of capitalism is this that encourages and "regulates" corporate collusion??

by jjellin on Mon Jun 15th, 2009 at 10:02:18 AM EST
this is the heart of it.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Jun 15th, 2009 at 10:17:40 AM EST
[ Parent ]
What kind of capitalism is this that encourages and "regulates" corporate collusion??

the one we got, sorry.

they whistle, we dance.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Mon Jun 15th, 2009 at 10:18:32 AM EST
[ Parent ]
The kind of capitalism described by the elder Galbraith in The New Industrial State.

The brainless should not be in banking. — Willem Buiter
by Migeru (migeru at eurotrib dot com) on Mon Jun 15th, 2009 at 10:24:26 AM EST
[ Parent ]
Thanks for the reference.
by jjellin on Mon Jun 15th, 2009 at 10:29:24 AM EST
[ Parent ]
Also known as Corporate Socialism.

Also known as fascism, with the poor as the target of contempt and abuse, rather than foreigners. (Although foreigners get a hard time too.)

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Jun 15th, 2009 at 10:40:44 AM EST
[ Parent ]
Apparently his last published work (in this decade) was called The Economics of Innocent Fraud. I'm trying to decide if I should get a copy. From what I understand, the "innocent fraud" is the professed economic ideology of our society, which already 40 years ago in The New Industrial State he described as an ideological justification for a system which was not accurately described by the ideology.

The brainless should not be in banking. — Willem Buiter
by Migeru (migeru at eurotrib dot com) on Mon Jun 15th, 2009 at 10:54:37 AM EST
[ Parent ]
Idly thought while reading the article, "this smacks of feudalism based on the ownership of money rather than land."

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Mon Jun 15th, 2009 at 10:49:16 AM EST
lorDAmercy financial capitalism in a nutshell!!

(a new SAW -- think it's got legs?)

Diversity is the key to economic and political evolution.

by Cat on Mon Jun 15th, 2009 at 02:04:17 PM EST
[ Parent ]
I like the general framework very much.

Except for the fact that I would bust all super-mega-connected corporation (not just look into it)... and that i do not see how they are really going to regulate hedge funds..

The shadow banking system is the problem.. or at least Krugman says so.

Other than that.. it seems the spanish or the canadian approach which worked rather well.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Mon Jun 15th, 2009 at 10:55:36 AM EST
is not impressed either

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Jun 15th, 2009 at 12:15:13 PM EST
There is something about the concept of Mssrs. G & S reforming the financial system that makes me think of a background scene that includes feathers flying and chickens squawking, while a small, reddish varmint feasts.
by Mnemosyne on Tue Jun 16th, 2009 at 11:16:13 AM EST

Go to: [ European Tribune Homepage : Top of page : Top of comments ]

Top Diaries