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Richard Drew / AP Photo The U.S. can’t rely on the proposed House bill to protect the economy from another crash. Relying on regulators won’t work, says Jeff Madrick—instead, the government should start by dividing banking activities.
Various financial experts, nearly all of whom failed to forecast the Crash of 2008-09, now claim that the answer to stanching future credit calamities is to rein in the giant financial institutions—somewhat. These advocates cover the waterfront, from the right, left, and center.
The bill now being put together in the House Banking Committee will give the government the ability to unravel financial institutions, even to the point of leaving their shareholders with nothing when they are already in trouble. It also will provide the federal government the money to do so by assessing the banks. The lack of such a so-called resolution authority is what kept it from unwinding Lehman Brothers in the first place.
Commercial banks with access to the Fed discount window should not be allowed to invest depositor money in securities investments other than plain-vanilla government and low-risk corporate debt.
The idea is to prevent the snowballing of a catastrophe into an ever bigger one. But there is no persuasive reason to believe that even if the Treasury or the Fed had such authority, they would have taken the steps back in September 2008. There was enormous pressure then to let the market decide, even if it meant major institutional failures. In his recent book, In Fed We Trust, The Wall Street Journal’s David Wessel argues that the Treasury and Fed together could have figured out some way to save Lehman or straighten it out cautiously if they had really wanted. He is almost surely right.
• Allan Dodds Frank talks to Andrew Ross Sorkin about the real bailout hero • Nomi Prins: Pay Cut Backfire Meanwhile, what has happened to prevent future failures? That was the original intent of the Obama administration white paper of last June. Almost as an afterthought, the House bill will give the government an option to raise capital requirements on any institution deemed too big to fail. The idea, first discussed well more than a year ago under the Bush administration, is to reduce “systemic” risk by giving some regulator—one candidate is the Federal Reserve—the power to single out institutions that, if they fail, would bring the rest of us down. The notion gained adherents as night follows day when the markets froze the day after the collapse of Lehman Brothers.
But, despite widespread acceptance, this too is a pipe dream. First, what are the standards for determining who is too big—or too interconnected—to allow to fail? Is there really a bright line here? Would Bear Stearns have been declared a too-big-to-fail institution, or even Lehman Brothers? Such minor details have been brushed under the rug.
More to the point, it is taken for granted that newly chastised regulators will be both wise and cautious enough to implement the higher capital (and liquidity) requirements on such firms, and stick to them forever after. This is simply a Panglossian idea, policy as wishful thinking. Perhaps they are right now. But who can safely predict that in the future the regulators won’t succumb to the lures and blandishments of the rich and powerful once again?
In other words, when times turn better, which is when regulation is most needed, the concept of regulatory adjustment of the too-big-to-fail institutions just won’t work. The big and powerful will argue successfully that as in the last good times they don’t need the tight capital restrictions. Risk is not what it once was, they will say with a straight face. They may even produce a computer model, supposedly improved over VAR and other misleading mid-2000s calculations, to prove the point and attempt to induce memory loss of recent sad events. Then the big institutions will argue that the higher capital costs are restricting their ability to provide the nation the capital it needs. And, after all, the big institutions—they will make very clear to the Fed chairman and the Treasury secretary in closed-door sessions designed to ensure that democracy works—are also the lowest-cost providers of finance in the world.
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I agree with much of this article that new regulations and regulators may only be a stop-gap fix for the caged monster that financial system has become. I think we should re-institute the Glass-Steagall Act, which was repealed by the Republican Congress in the 1990s. It clearly separated banks from the brokerage business. I think the SEC should also be re-invigorated to do regular and rigorous investigations any time they see a dubious trend in the markets. The Justice Department should also re-inforce anti-trust laws that would prohibit corporations from becoming "too big to fail." And finally, the IRS should be fully funded to go after tax cheats in the financial sector who hide money and profits from legitimate taxation. If all of the above were done, the consumers would be safer and the federal government would probably reap an additional half-trillion $$$ in taxation and fees.
If these banks are to big to fall then divide them into smaller banks . These closed door meetings with the Fed. chairman and treasury should not be behind closed doors, open up the the Fed's books, there is to much secrecy going on with the Fed. I think there should be an investigation into Geitner's cell phone records and Paulson's cell phone records and see the collusion that goes on with the Fed's and Wall Street.
As much as I hate to say it, I have to agree with most of what you say, Winnie. My day is ruined...
I would rather let them crash again, then rebuild the banking system with a stronger public component, including banks owned by the state and federal governments, and a national investment bank. We should not have to rely on the crooks and Monopoly players on Wall Street for the vital investment needs of this country.
The problem, mcmchugh99, is that the financial sector will take down the rest of our economy with them. Do you really want to fix this problem by having Great Depression II?
The meaning of a dollar is becoming more complicated every year. It dollar represent a percentage of gold in a nations treasury. But now when you put a dollar in the bank it is digitized, divided, leveraged, traded at speeds and directions incomprehensible to any person. The dollar is only worth anything as long as people believe in it. Understanding and faith create belief. Under the current financial system the public can longer understand the dollar. Should the public lose faith in the dollar, anarchy will reign supreme. The meaning of the dollar (yen, euro, et al) is incomprehensible. Internationally the markets are interconnected in ways that we have no understanding or control of. The global economy has taken a life of its own. It has sprouted wings and has ghastly blood soaked teeth. Those who understand and manipulate this beast can profit greatly. They can also stab the beast in the heart, should they chose too. A convergence of events natural, beastly and wantonly destructive and the global financial market can fail. This failure will be swift and deadly, as all disaters are. Greed is the foundation of the beast. Greed will make it eat itself.
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