Heather McGhee on FinReg Passage

Jul 15, 2010

Our colleague Heather McGhee at Demos sees FinReg's passage as the first step in rebuilding the American middle class and refashioning the rules of Wall Street, even if it still falls short of Glass-Steagall:

Our colleague Heather McGhee at Demos sees FinReg's passage as the first step in rebuilding the American middle class and refashioning the rules of Wall Street, even if it still falls short of Glass-Steagall:

"The meltdown of 2008 was a costly example of what happens when we dismantle the public structures that are the foundation of America's prosperity. Today we begin to rebuild those structures, and in so doing, start rebuilding the American middle class. With this vote, the Congress has begun writing financial rules of the road that will once again benefit Main Street, not just Wall Street. After the new consumer regulator opens its doors, Americans will open a checking account or apply for a loan with greater security because their lender will be accountable to basic standards of fairness and transparency. Investors will know that their broker-dealers are acting in their interest. Businesses hedging risk will know the real price of the derivatives contracts they buy. And if we have truly independent regulators with the will to stop reckless speculation, those regulators will have the power and tools to do so.

The Wall Street Reform and Consumer Protection Act's consumer reforms, investor protections and new Wall Street rules are necessary for a strong economic recovery. Although the Act falls short of transforming the financial sector in the way that the Glass-Steagall Act did after the last great banking crisis, it represents a victory of the public interest over the status quo in virtually every provision and rule. Demos applauds the tireless efforts of experts and advocates in Washington and across the country who have worked together to create this historic set of reforms."

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FinReg Achilles' Heel: Not Too-Big-To-Fail, But Too-Connected-To-Fail

Jul 14, 2010Henry Liu

money-globe-150Henry Liu demonstrates why FinReg, however well designed, cannot be counted upon to prevent future market failures.

A rule of finance: All trading models buy safety by externalizing risk to the trading system.

money-globe-150Henry Liu demonstrates why FinReg, however well designed, cannot be counted upon to prevent future market failures.

A rule of finance: All trading models buy safety by externalizing risk to the trading system.

There is an invisible, but solidly anchored assumption in all structured finance and derivative trading models -- namely, that a systemic collapse would trigger a government bailout. Since each and every derivative trading model derives protection by externalizing risk to the trading system, systemic risk expands automatically (making systemic meltdown inevitable). Institutions, then, have an incentive to be considered of "systemic significance" in order to secure a fail-safe advantage in interconnected transactions, even though by themselves they are not "too-big-to-fail". These trading models are operative when they are marked-to-model, but inoperative when they are marked-to-market in a downturn. This is the point when these models' fail-safe strategy by government bailout is activated.

Even a government like Hong Kong, which assumes a radical laissez faire posture, has had to intervene directly in the equity market because of the connections between a fixed exchange rate and unregulated financial markets that allow manipulators to attack its equity markets by rigging the automatic effect of exchange rates on interest rates to create deflationary pressure on stock prices.

As you will see, focusing on "too-big-to-fail" alone leave windows of vulnerability for "too-connected-to-fail" hazards.

Hong Kong Monetary Authority Fought Off Hedge Fund Attacks in 1997

In October 1997, three months after China recovered Hong Kong following a century and a half as a British colony, the HK$, which had been pegged to the US$, came under powerful, repeated, speculative and manipulative attacks due to the contagion effects of the Asian financial crisis. The automatic monetary adjustment forced interbank interest rates in Hong Kong to shoot up to unprecedented levels (up to an astronomical 300% at one point), reflecting substantial risk premiums on the HK dollar. This generated severe deflationary consequences for the financial and property markets, as well as the entire economy.

The interventionist role the Hong Kong Monetary Authority (HKMA) played in handling violent market turbulence was controversial by the standard of its own free market ideology. HKMA later admitted that as Hong Kong's link mechanism was on "autopilot" during the attacks, the interest rate adjustments were part and parcel of the working of a currency board regime, and therefore generating an inevitable and painful financial crisis. The fact that such financial and economic pain was avoidable by de-pegging was not officially acknowledged as an option.

Hong Kong was the target of speculative and manipulative attacks four separate and sequential times during the Asian financial crisis of 1997. The first three attacks took the form of garden variety currency dumping, whereas the fourth attack targeted the structural vulnerability of the Hong Kong's currency board regime after speculators were convinced that HKMA would defend the peg at all cost. And speculators were waiting to be the happy recipients of guaranteed profit from HKMA's fixation on the peg.

The first attack took place in October 1997, as a result of contagion from the regional financial turbulence that began in Thailand in July 1997. Currency speculators took large naked short positions against the HK dollar, with the expectation of profiting from the breakdown of the Hong Kong linked exchange rate regime. However, interbank interest rates soared in response, forcing speculators to unwind their naked short position as the high cost of borrowing made leveraged naked short trades unprofitable.

Although the automatic defense mechanism inherent in the currency board regime prevented the breakdown of the currency peg, the penalty took the form of unsustainably high interest rates. For example, the overnight interbank interest rate on October 23, 1997 reached as high as 500%. This local interest rate volatility echoed the external market volatility, created psychological shocks to market participants that forced the market to put a risk premium on Hong Kong dollars. Consequently, local banks increased their precautionary demand for liquidity, resulting in continuing high level of interest rates for the HK market. A liquidity crisis developed, further exacerbating already abnormally high interest rates.

This high interest rate anomaly incurred huge adjustment costs in the Hong Kong economy, particularly in the finance, business and property sectors. Labor costs, even though they accounted for only about one-third of the operating expenses of an average corporation in Hong Kong, as compared to the US average of two-thirds, had to be reduced by management through lay-offs and cuts in real wages and benefits in the early 1998. Asset prices such as land, real property and company shares, together with rental and dividend income, also plummeted sharply and swiftly.

The high cost of defending the currency peg system manifested itself in severe price deflation. It triggered further speculative and manipulative attacks in January and June, 1998, each time draining substantial wealth from Hong Kong companies and residents into offshore hedge fund accounts. The monetary defense mechanism successfully maintained the currency peg in the market at the cost of generating sharp, across-the-board price deflation in the economy.

The Hong Kong dollar continued to trade at the pegged exchange rate to the US dollar, but the same US dollar was buying more assets in Hong Kong than before the crisis. The currency board regime merely deflected currency devaluation toward asset deflation. The exchange value of the HK dollar remained fixed to the US dollar, but Hong Kong asset prices and wages fell. It would be less painful to the local economy if asset prices and wages remained unchanged while the HK dollar was devalued against the US dollar.

The HKMA was able to defend the fixed exchange rate of its currency because it had large foreign reserves, but it did so by allowing wealth to be drained from the Hong Kong economy through asset deflation, weakening its market fundamentals. The net economic outcome was negative on balance. The monetary operation was successful, but the economic patient was left near dead.

In August 1998, the fourth and near-fatal attack took place, targeting at the automatic adjustment mechanism of the Hong Kong currency board regime. This took the form of simultaneous attacks on money and equity markets, known in hedge fund tactics as a "double play".

In a double play, before launching attacks, manipulative traders would pre-fund their attacks with highly leveraged positions with HK dollars in the debt market, engaging in big swaps to access large sums in HK dollars that multilateral entities had raised through their bond issuance. Speculative and manipulative traders then spread rumors about imminent Chinese yuan devaluation and a pending collapse of the Hong Kong equity and property markets. At the same time, they made large naked short positions in the stock futures index market. Then, they induced an interest rate hike by dumping their pre-funded HK dollars in the spot and forward market to force the HKMA to buy HK dollar with US dollars from its reserves. All these actions induced the Hang Seng index to plummet sharply and abruptly, from 16802 in June 1997 to 6708 in August 1998. Within three days beginning October 20, 1997, the Hang Seng index dropped 23%.

As the Hong Kong stock market started to plunge, other speculators saw opportunities for profit through massive naked shorting. The Hong Kong financial markets fell into chaos, as further naked short selling created panic selling of shares in free fall.

The Damage by Naked-Short Attacks

The current ban against naked short selling by Germany during the 2010 EU sovereign debt crisis is driven by more than mere phantom fears. The German defensive measure has the 1992 experience of the British pound and the 1998 experience of Hong Kong dollar with naked short selling as cautionary guides.

During the Asian financial crisis of 1997, speculators and manipulators exploited the automatic interest rate adjustment mechanism of the currency board regime, turning speculation into manipulation for certain profit. Hedge funds took naked short positions simultaneously in the Hong Kong stock and futures markets. Simultaneously, they sold yet-to-be-borrowed Hong Kong dollars against the US dollar. Under the currency board regime, the HKMA must stand ready to buy back HK dollars released into the market to maintain the peg.

This was the structural dilemma inherent with the currency board regime. On the one hand, continuing buybacks of HK dollars by the HKMA automatically shrank the Hong Kong monetary base and drove HK dollar short-term interest rate up sharply. On the other hand, the overnight interest rate having risen sharply to 500% at one point in October 1997, triggered precipitous drops in stock and stock futures prices and produced hefty profits for short-sellers. After every attack, market confidence plummeted further by the hour, creating an imbalance of sellers over buyers to push share prices further down.

The HKMA feared Hong Kong's economy could very well bleed to death if the downward vicious cycle was permitted to continue. If the economy should die from hemorrhage of wealth, no further purpose would be served by preserving the currency board. And if the downward asset price spiral was allowed to continue, the currency board would eventually also collapse after the large foreign reserves was exhausted, because wealth was draining from Hong Kong with no stop loss limits.

It soon became clear that the option was not even to choose between letting the economy collapse and letting the currency board regime collapse. The two are linked so that as one sinks, the other would be dragged down with it. The economy must be saved along with the fixed exchange rate. Yet few acceptable options were available to reverse the trend of depleting foreign currency reserves while bleeding the equity market dry. Among all the unpalatable options available, only two stood out with some uncertain promise: 1) outright capital control and 2) direct market intervention. Both were not cost-free silver bullets.

Malaysia's Capital Control Not Operative for Hong Kong

While earlier in the 1997 Asian financial crisis, Malaysia had adopted capital control with positive results, Hong Kong would not benefit from similar measures because, unlike Malaysia, the Hong Kong economy was primarily an outward-oriented trading economy with no sizable domestic market of its own. Hong Kong therefore chose direct market intervention with its huge foreign reserves. When manipulative and speculative attacks intensified again in August 1998, the HKMA intervened with its reserves of US dollars simultaneously in the money, stock and futures markets, in addition to buying back Hong Kong dollars in the foreign exchange market.

During the last two weeks of August, 1998, the HKMA imposed temporary penalty charges on targeted lenders that served as settlement banks for the manipulators and speculators to make speculative funds more expensive while HKMA itself bought US$15 billion worth of Hang Seng Index constituent stocks (8% of the index's capitalization). In addition, it took naked long positions that pushed the stock futures 20% higher to squeeze the naked short sellers. After the massive market intervention by the HKMA, the exchange rate of the HK dollar quickly stabilized, and currency futures and short-term interest rates returned to sustainable levels. Manipulator and speculators were left licking their wounds but not until substantial damage had been done to the Hong Kong economy. To soften anticipated neo-liberal criticism, the HKMA labeled its market intervention as "market incursion".

Still, for this unprecedented "market incursion", the HKMA received harsh criticism for deviating from its long-standing "positive nonintervention" policy. In defense, the HKMA argued that the "incursion" was justified by Hong Kong's strong economic fundamentals as well as the severity of the regional financial turmoil. The HKMA contended that without forceful incursion to foil market manipulation, not only would the currency board have collapsed but there would also have been serious regional and global ripple effects. It was a "too-big-to-fail" argument that was summarily dismissed by US neo-liberals who quietly did the same on a much larger scale in 2008.

The 1998 market incursion was a deviation from Hong Kong's economic policy of "Positive Non-Interventionism" adopted under British imperialism after WWII to appease US free market ideology. The policy was first officially implemented in 1971 by John James Cowperthwaite, a Scottish civil servant in the British Colonial Office who worked to remove all colonial government interventionist preference toward trade with Britain in order to facilitate more trade with the US, the world's biggest market with seemingly inexhaustible purchasing power.

Friedman Condemned Hong Kong for Market Intervention

Milton Friedman's opinion in the October 6, 2006 Wall Street Journal, less than a year before the global credit crisis that imploded in New York in July 2007, criticizing Hong Kong for abandoning Positive Non-Interventionism, praising instead Cowpertheaits as having been "so famously "laissez-faire" [in ideology] that he refused to collect economic statistics for fear this would only give government officials an excuse for more meddling." This is an amazing praise from Friedman who was known for his 1953 propositions for a "positivist" methodology in economics which stresses the important of economic data.

Hong Kong's Sin Repeated by the US

Notwithstanding their stern criticism of the HKMA in 1998, the Federal Reserve and the US Treasury also engaged in direct market intervention in US markets a decade later in 2008. This was done under the rationalization of saving "systemically significant" private institutions that were deemed "too big to fail". At least the HKMA bought all the listed shares in the Hang Seng index, rather than toxic assets from only selected distressed firms as the Fed and Treasury did, which was decidedly less evenhanded or market neutral.

Click here to read the full article.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Tom Ferguson on FinReg Bill: "Not Worth the Hype"

Jul 13, 2010

In a recent interview with the Real News Network, Roosevelt Institute Senior Fellow Tom Ferguson told host Paul Jay that the finreg bill is a disappointment when compared to major reforms like Glass-Steagall. "This thing is not worth the hype. It makes some marginal changes, but it does not attack any of the fundamental problems that got us into this sort of disastrous financial crisis back in 2008."

In a recent interview with the Real News Network, Roosevelt Institute Senior Fellow Tom Ferguson told host Paul Jay that the finreg bill is a disappointment when compared to major reforms like Glass-Steagall. "This thing is not worth the hype. It makes some marginal changes, but it does not attack any of the fundamental problems that got us into this sort of disastrous financial crisis back in 2008."


Tom says that the bill does almost nothing to address the problem of too-big-to-fail and invests more power in the same regulators who failed to prevent the last crisis. Despite some changes to derivatives, "in the end they let the big banks keep about, probably, 80 percent of the derivatives business they've got." Because of this, Tom predicts that "you are very likely sometime—maybe in the not too distant future if things don't go well in Europe—to see yet another big bank brought down by some stupid business deal."

Tom counts the one-time audit of the Federal Reserve and the creation of the Consumer Financial Protection Bureau as two of the bill's modest victories. However, he believes it is a mistake to house the consumer agency in the Federal Reserve, which already has the power to create and enforce consumer regulations and has instead "sat back for years and let banks rip everybody off."

As for whether the bill is worth passing in its current form, Tom says that "you'd probably better take this one, because you'll probably get a worse bill next time," but he's sympathetic to those who want to start over. Ultimately, he views the bill as a victory for Wall Street lobbyists and a prime example of how corporate money can undermine and corrupt the legislative process. He says the banks "know they just dodged a silver bullet" and will wind up paying and changing far less than they should have. "In the end, we have a tale full of sound and fury, signifying nothing."

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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ND20 Interview: Elizabeth Warren Says Big Banks Must Stop Blocking Reform

Jul 13, 2010Lynn Parramore

elizabeth-warren-150Senate Dems are making the final push on financial reform this week, but will big banks really change the way they do business?

elizabeth-warren-150Senate Dems are making the final push on financial reform this week, but will big banks really change the way they do business? Or will we still be pawns in a game rigged in their favor?  I caught up with Elizabeth Warren to talk about the need to reform Wall Street culture, the pernicious influence of bank lobbies, and the debt-fueled threat to America's middle class. **Warren will discuss these issues and more at this weekend's Hamptons Institute symposium, sponsored by Guild Hall in collaboration with the Roosevelt Institute (details below).

LP: Has the financial crisis changed the culture of Wall Street?

EW: I would have expected the financial crisis to sweep through Wall Street like a hundred-year flood -- wiping out old business practices and changing the ecology profoundly. So far, the financial services industry has seemed to treat the crisis like a little rainfall -- inconvenient, but no significant changes needed. The real question moving forward is how the industry will respond to Wall Street reform and growing public anger. Will it react to all the new cops on the beat just by hiring more lobbyists? Will it continue to spend $1.4 million a day to beat back anything that could mean more accountability and oversight? Or will the financial services industry finally begin to rethink its business models, lobbying approach, and attitude toward the public?

LP: Have unregulated financial products slowed our economic recovery?

Let me put it differently: meaningful rules in the consumer credit market can accelerate economic recovery, I really believe that. Rules would increase consumer confidence and, more importantly, weed out all the tricks and traps that sap families of billions of dollars annually. Today, the big banks churn out page after page of incomprehensible fine print to obscure the cost and risks of checking accounts, credit cards, mortgages and other financial products. The result is that consumers can't make direct product comparisons, markets aren't competitive, and costs are higher. If the playing field is leveled and the broken market fixed, a lot more money will stay in the pockets of millions of hard-working families. That's real stimulus -- money to families, without increasing our national debt.

LP: Why is marketplace safety so much harder for people to accept than safety in other realms?

EW: Think about it: cars, toys, aspirin, meat, toasters, water -- nearly every product sold today has passed basic safety regulations well in advance of being marketed and sold. But consumer credit is a kind of buyer-beware, wild west. That is partly the result of history. Usury laws that existed since Biblical times, through the colonial period and into the 1980s, provided basic consumer protection. Once those laws were quietly undercut, the industry moved to a tricks-and-traps business model. The big banks would promise something for free, like credit cards or checking accounts, or for very low cost, like teaser-rate mortgages, then make their money on the back-end with fees and interest rate escalation. Most people don't know they have been fooled until it is too late. Last year, for example, families paid a total of $24 billion on overdraft -- mostly on "free" checking accounts. People can see exploding toasters, and the newspapers run plenty of headlines about lead in children's toys. But smaller hits, day after day hitting millions of people, don't catch the same kind of attention -- even though fixing those hits will help make people much more secure over time.

LP: What are the consequences of distrust in the marketplace? How does it affect our social fabric?

EW: For three decades, the once-solid, once-secure middle class has been pulled at, hacked at, and chipped at until its very foundations have started to tremble. Families have done their best to adjust -- sending both mom and dad into the workplace, cutting back flexible spending on food, clothing and appliances, and spending down their savings. When they learn that they have been tricked -- a $39 fee that they shouldn't have to pay or an escalating mortgage that will cost them their home -- they start to wonder who wrote the rules that allow that to happen. Distrust spreads everywhere -- to industry, to politics, to the institutions that were supposed to make us a stronger country. The costs imposed by a banking industry that makes its money tricking people go far beyond dollars.

LP: Have lenders and creditors preyed on our human weaknesses? Do they drive us to be profligate and irresponsible?

EW: Personal responsibility matters. There are no excuses for those who spend money on things they cannot afford. But it's a whole lot harder to act responsibly when consumer credit contracts are designed to be incomprehensible, when prices are obscure and risks are hidden. I would like to see a world where families can read their credit terms and easily shop for better deals. When we get to that world, it will be a lot fairer for families to be held to every last clause they agree to.

LP: How can consumer trust be restored?

EW: First, big banks can stop pouring so many resources into blocking meaningful reform. Families have made it clear that they are sick and tired of all the lobbying and that they think enough is enough. From the beginning, I think the Wall Street banks underestimated the furor they would provoke by acting like nothing changed and continuing to lobby just like they did before the bailouts. I also think they underestimated the good faith and trust they could have built by cutting back. Second, we need two-page credit card, mortgage, and overdraft contracts. Until the deals are clear up front, until the fine print is gone and the banks price products so people can see the true costs and risks, consumers won't trust any lender claims. And I don't blame them.

LP: What is the most important thing ordinary people can do to protect themselves from abusive financial practices?

EW: Get out of debt. In a world of stagnant incomes and rising core expenses like mortgage and health care costs, that's a lot easier said than done. The middle class is under enormous pressure. But families can stop the bleeding by reducing their reliance on debt wherever they can. They can also start fighting back by taking a hard look at whom they do business with and rethinking whether they want tricks-and-traps banks to hold their money. They can also demand that public officials take the side of families over the side of banks.

ND20 ALERT: Join Elizabeth Warren in NY July 16-18 at a special event sponsored by Guild Hall, in collaboration with the Roosevelt Institute. Thought leaders in the arts, the economy, and the media will gather in East Hampton for a can’t-miss symposium featuring Warren, George Soros, Van Jones, plus ND20 contributors Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

Harvard Law School Professor Elizabeth Warren is currently chair of the Congressional Oversight Panel created to oversee the banking bailouts and first proposed a new federal agency for consumer financial products in 2007.

Lynn Parramore is Editor of New Deal 2.0, Fellow at the Roosevelt Institute, and author of Reading the Sphinx.

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ND20 Alert: Mike Konczal to speak on New America Panel

Jul 12, 2010

alert-button-150Roosevelt Institute Fellow Mike Konczal will be appearing on a panel at New America tomorrow called Dodd-Frank: How Will Financial Services be Transformed from Main Street to Wall Street.

alert-button-150Roosevelt Institute Fellow Mike Konczal will be appearing on a panel at New America tomorrow called Dodd-Frank: How Will Financial Services be Transformed from Main Street to Wall Street. The panel promises to tackle key questions such as: Will FinReg end “too big to fail”? Will it stifle or stimulate innovation? How will it alter the financial services landscape from Wall Street to Main Street?

The panel is at the New America Foundation in Washington, DC and will take place Tuesday, July 13, 2010 (tomorrow) from 10:00am - 11:30am. Hope to see you there!

Meanwhile, read up on some of Mike's recent ND20 posts:

Getting the Best of Both Bills: A Conference Committee Report

Treasury versus Progressives on the Financial Reform Bill

Underwater Mortgages and the Odd Definition of the Experian Study

The Case for Regulating Interchange and Banking Accounts

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DON'T Let Goldman Be Goldman

Jul 12, 2010Wallace Turbeville

wall-street-150Is it fair to single out Goldman in a sea of financial wrongdoing? Absolutely, says Wallace Turbeville, a former Goldman VP.

wall-street-150Is it fair to single out Goldman in a sea of financial wrongdoing? Absolutely, says Wallace Turbeville, a former Goldman VP.

William D. Cohan's op-ed piece in the July 7th New York Times had the same title as this article, but for the word "Don't."

At first glance, I thought the Times piece might be a report on New Age self actualization for investment banks. But the title suggests something more troubling. The whole point of financial reform is that Goldman (and the others) should no longer be permitted to be Goldman. A return to business as usual is the last thing we need.

Mr. Cohan is a student of Goldman, but he profoundly misreads the firm's role in the Wagnerian drama we know as "The Great Recession." He begins by imploring us all to "fess up" to the fact that financial reform would have been impossible had the Administration and Congress not "demonized" Goldman.

"Demonization" is a popular word in today's political discourse. It suggests unfairness. Mr. Cohan does not dispute the facts asserted by the Administration and Congress. Instead, he points out that underlying ethical flaws were shared throughout Wall Street. They arose from the shift toward a business model that rewards taking imprudent risks with other people's money. Mr. Cohan says that "Goldman Sachs did nothing differently in the years leading up to the crisis than did other firms of its stature."

Anyone who has raised a child is familiar with a common excuse for bad behavior. The proper response to "Everyone else is doing it" is a stern demeanor and the answer: "Maybe, but so what?"

But let's give the article a generous interpretation. While the casual reader might interpret the shared lapse in ethics as an excuse, perhaps it is not intended to be read this way. We will assume that Mr. Cohan intended not to excuse Goldman but to find fault with political leaders who unfairly singled out the firm.

It seems obvious that the example of a single firm is a more effective rhetorical device than calling out generalized bad behavior. Politicians used this device and public opinion was successfully mobilized. The job got done. I believe that the public understood that the bad behavior was widespread, and that Goldman was merely one example.

Was it unfair to make Goldman the example? The article argues that Goldman was just like all the other firms. It was not.

Goldman was actually better at executing a certain investment banking business model than anyone else. It became a leader in the industry, admired by competitors, the media and politicians. The problem was that the business model, so effectively executed by Goldman, turned out to be bad for America. The model inherently risks the survival of critically important institutions. It is also nearly impossible to use the model and, at the same time, maintain business ethics conforming to the shared values of the society.

Goldman historically promoted its commitment to ethics when soliciting clients. I am convinced that Goldman people genuinely believed this commitment to be true. It may even be the case that ethics were taken more seriously at Goldman than at its competitors. But seeking business based on ethics carries with it a responsibility. Pursuit of a business model with inherent ethical challenges has consequences that are unavoidable, especially to a firm which has held itself out to clients as particularly ethical.

Goldman's success was envied up and down Wall Street. The pressure to keep pace with Goldman's earnings drove other firms to emulate its model. At a minimum, managers at other banks were driven to take greater risks hoping for greater rewards as proof to shareholders that they measured up to the Goldman team.

It is ironic that Goldman was first to foresee risks of a deteriorating market and acted to defend itself. Goldman's aggressive preparations, including the extraordinary demands to AIG for collateral, may have actually contributed to the intensity of the panic. Goldman was so prepared that, when the tsunami finally hit, the only real threat to it was a total systemic collapse. Congress and the Fed stepped in with cash to avoid catastrophe and Goldman, now even more powerful compared with competitors, immediately prospered. The real irony is that Goldman was greatly responsible for the problematic business model; yet, because management pulled the plug so effectively, the value of the bailout to Goldman shareholders was disproportionately large.

Mr. Cohan suggests that it was unfair to use Goldman as an example because of its relative ethics and its effective response to the danger. Those points may be relevant if the real issues were incompetence and larcenous intent. Instead, the core concern was and is the dysfunctional business model that generated massive profits for the firms but devastated the society.

Goldman was not just like all of the others. It was the leader. Becoming the leader involves a trade that should be well understood at the highest levels of Wall Street. Investment bankers often engage in businesses with underdeveloped rules of conduct. Pushing the envelope may be risky, but the rewards are more than worth it. If a firm is a leader, its profits and the wealth and power of its managers are virtually limitless. If it turns out that the business has consequences to society that are intolerable, even if the consequences were unforeseen, the leader will be the example held out to the public. Management is held to a high standard, but the pay scale more than reflects the level of difficulty.

Is this an unfair trade? I don't think so.

Finally, Mr. Cohan concludes that we should "lay off the firm and allow Goldman and the rest of Wall Street to return to some semblance of normalcy." Besides unfairly demeaning the entire financial reform effort, this statement suggests that our problems have been solved.

In fact, it would be a monumental error if financial reform ends with the passage of the legislation this month. James K. Galbraith points out in testimony to the Commission on Deficit Reduction that focusing on Medicare and Social Security as a means to reducing deficits is misguided. Economic growth is the only sensible solution. He cites the need to restore the financial sector's role of capital formation for productive purposes, i.e., commercial lending and equity investment. The current legislation focuses on curbing dangerous behaviors and on procedures to deal with financial panics. It does not reconnect Wall Street capital to the engine of economic growth: productive and innovative businesses which employ American workers.

No one wants to drive Wall Street out of business, certainly not politicians whose campaigns rely on it as a source of funds. But the economy will not prosper unless Wall Street reengages with the broader economy. Current bankers will keep their Hamptons estates under the new regulations. But their successors may not be able to afford mansions if 10-20% unemployment is the new American reality. Wall Street's attention must turn away from churning derivatives on existing products and instruments and toward growth of the economy and jobs. If more government intervention is needed to force this turn, so be it. Neither the public nor its political representatives should feel regret if this means Goldman and the other banks must fundamentally change.

Wallace C. Turbeville is the former CEO of VMAC LLC and a former Vice President of Goldman, Sachs & Co.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Mike Konczal Talks FinReg on GRITtv: Taxpayers Still on the Hook for Wall Street's Recklessness

Jul 9, 2010

Roosevelt Institute Fellow Mike Konczal joined Demos's Nomi Prins and GRITtv host Laura Flanders last week to discuss the state of financial reform, whether the current bill does enough to change the culture of risk on Wall Street, and whether taxpayers are going to be stuck holding the bag -- again.

Check out the full interview:

More GRITtv

Roosevelt Institute Fellow Mike Konczal joined Demos's Nomi Prins and GRITtv host Laura Flanders last week to discuss the state of financial reform, whether the current bill does enough to change the culture of risk on Wall Street, and whether taxpayers are going to be stuck holding the bag -- again.

Check out the full interview:

More GRITtv

Mike notes that one of the key questions of reform is "who's going to pay for this, and ideally we want the people who caused the trouble to pay for it, not regular citizens." Instead, he says Republicans like Scott Brown have transferred the cost from banks to the FDIC and the savings accounts of average Americans.

On the subject of possible criminal charges for Goldman Sachs, Mike says that the lack of major arrests compared to previous crises "shows how much people haven't internalized the disaster they've caused. The culture is still very much the same." The problem, he explains, is that firms like AIG "thought they were being very clever when they were actually getting gamed." The fact that we still aren't sure how much of this was illegal "shows how disturbed the regulation is."

Mike pushes back on AIG's attempts to shift the blame for its reckless bets, noting that "when we talk about what AIG was doing, that's millions of Americans who are actually in those bonds, that were given loans that they shouldn't have so that AIG could juke some statistics." Unfortunately, he offers a grim prognosis for AIG's victims: "The foreclosure crisis is ongoing, it will be ongoing next year, and the President's plan there, HAMP, has been a total failure that most credible people have walked away from at this point. We have a quarter of homeowners underwater and they have no relief, and they're paying into a system that is pretty much insolvent."

Finally, responding to deficit hawks' calls for cuts to programs like Social Security, Mike argues that "if they were very concerned about protecting anyone, they would go much harder into financial reform. Because this is really where the deficit's coming from right now, the fact that we have a major financial crisis. There's two things that destroy an economy: financial crisis and war, and Republicans over the past decade have put us through a lot of both with no plans on paying for it."

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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SEC & MMS: A Tale of Two Failures

Jul 8, 2010Eliot SpitzerWilliam K. Black

thumbs-down-150How many disasters will it take to overhaul the regulatory agencies?

thumbs-down-150How many disasters will it take to overhaul the regulatory agencies?

The SEC and the Minerals Management Service's (MMS) share a number of characteristics we can't help but notice in the wake of the worst environmental disaster in U.S. history, which followed the second-worst financial disaster in same. We have endured two cataclysms in which a regulatory agency upon which our nation's economy and environment depended failed to meet even the minimum requirements for doing its job. The ecological disaster was aided and abetted by the systematized incompetence and cronyism of the MMS, just as the financial meltdown was stoked by the laxity and inadequacy of the SEC. Both regulatory agencies were designed to fail. At the time of the critical regulatory lapses, they were run by leaders chosen because of their anti-regulatory stance. Both agencies have been failures for at least a decade.

In both instances, the regulators accepted industry assertions about the reliability of their safety mechanisms while failing to acknowledge -- much less investigate -- the darker, more complex reality. In each crisis, we had the same story of a belief in the reporting done by corporations, and in each case, we had a failure to recognize the enormous potential for fraud and the lack of incentives these corporate entities have in ascertaining and measuring potential risks to the public. The regulators continued to believe the lies fed them by CEOs even when the lies had become absurd. Both times, the agencies charged with regulating ignored the advice of their own experts, neglected to enforce rules, and engaged in an alarmingly cozy relationship with the industry they were supposed to be monitoring.

So far, the Obama administration has failed to fully grapple with the weaknesses and corruption of the regulatory agencies meant to guard the public from harm. Across the entire spectrum of regulatory agencies, there exists a dangerous atrophy of infrastructure which may lead to disasters we cannot yet imagine. Maybe now, as the oil slicks spread across the Gulf, killing wildlife and wrecking lives, our false sense of security is dissolving. We hope so, because if we don't learn from these horrific experiences, we can expect more of them. Where will the next disaster occur? At the Food and Drug Administration? At the National Transportation Safety Board? At the Nuclear Regulatory Commission?

The Government Accountability Office (GAO) is supposed to identify "high risk" governmental activities and require that the agencies address any weaknesses. Unfortunately, the GAO has traditionally excluded key regulatory activities from this high risk designation. It has only treated a regulatory activity as "high risk" if the taxpayers were likely to be the direct victims of the fraud or abuse. So far, the GAO has failed to designate either the SEC or MMS' regulatory activities as "high risk" even after recurrent scandals at both agencies that have led to multi-trillion dollar losses and epic catastrophes. That must change. The Obama administration should not only direct regulatory agencies to thoroughly audit themselves, but it must also instruct the GAO to systematically review the agencies' effectiveness and integrity, identify critical weaknesses, and require their timely correction.

Let's not wait for another catastrophe.

Eliot Spitzer is a former attorney general and governor of New York.

Roosevelt Institute Braintruster William Black is a professor of economics and law at the University of Missouri-Kansas City.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Treasury versus Progressives on the Financial Reform Bill

Jul 8, 2010Mike Konczal

58960658Treasury never stepped up to fight against the status quo on Wall Street.

58960658Treasury never stepped up to fight against the status quo on Wall Street.

Bob Kuttner wrote an essay about disappointment with ObamaJon Cohn and Jonathan Chait responded. On a related note, people have asked me what I think about Senator Feingold deciding not to vote for the financial reform bill.

- For my overall impression of the bill, I want to echo points brought up by Roosevelt Institute Senior Fellow Rob Johnson here:

The financial reform legislation is both disappointing and inspiring. The legislation is the product of a broken government process where dollars overwhelm voters. Lobbying in the gazillions predictably stopped the needed major structural reforms that were revealed by the scope and scale of the financial crisis...

What is heartening is to see how so many people and organizations — who had little knowledge of this arcane subject matter two years ago — have contributed the energy to learn and engage and push relentlessly for reforms against the monied odds...It is also heartening to see people like Michael Greenberger, Elizabeth Warren, Damon Silvers, Dennis Kelleher, Matt Stoller, Jane Hamsher, the AFR team, Bob Kuttner and Senators Cantwell, Dorgan, Levin, Kaufman and Merkeley leading this formidable effort.

This is the first act of a many act play. Finance was too large in proportion to our economy. It is still too large, and our dysfunctional political system that aided and abetted the growth of the financial sector over the last 20 years cannot be expected to turn on a dime and enact profound and needed change. That agenda is still ahead. This first round was not the whole fight. It was the wake-up call and the beginning of the fight. Rest up and get ready. There is so much more to do.

I think that's right. Considering that every financial industry bill going back to the early 1980s has been written hand-in-hand with the financial industry, the first bill to push back on this failed deregulation was going to be a nightmare. But I'm impressed and humbled by the works, education and advocacy network that was put into place in such a short period of time and against such odds.

- Jonathan Bernstein notes that Feingold's opposition gives extra power to the centrist Republicans. I'm not sure how I feel about the debate over how much President Obama could have done or could do, especially in terms of the military or in terms of the health care bill. But I do think Treasury could have moved this bill in a lot of ways. They set the terms under which the debate would unfold. And whenever they got involved with Congress, they pushed for less structural reforms. They pushed for the solution that embraced the status quo with arms wide open.

Treasury against Progressives on FinReg

Examples? Off the top of my head, ones with a paper trail: They fought the Collins amendment for quality of bank capital, fought leverage requirements like a 15-to-1 cap, fought prefunding the resolution mechanism, fought Section 716 spinning out swap desks, removed foreign exchange swaps and introduced end user exemption from derivative language between the Obama white paper and the House Bill, believed they could have gotten the SAFE Banking Amendment to break up the banks but didn't try, pushed against the full Audit the Fed and encouraged the Scott Brown deal.

You can agree or disagree with any number of those items, think they are brilliant or dumb, reasonable or a pipe dream. But what is worth noting is that they always end up leaving their fingerprints on the side of less structural reform and in favor of the status quo on Wall Street. These are some of the many ideas that progressives brought to the table, and there's a documentable trail of each one of them being opposed and fought against by the administration.

This is not to say that the administration is against reform. But it is to say that the problem I see is that they think we had was a crisis where regulators didn't have enough powers, not that the financial sector in 2007 was too dangerous and too risky. They did push hard for the CFPA, and I am thankful for that. But if they had put any effort to move just a few of the items above, even watered down versions, I could feel comfortable criticizing Feingold for not voting.

(I also want to note Ezra Klein here: "If he wants to vote no, he should vote no. But he should vote against the Republican filibuster.")

But I didn't see any effort. Maybe there are probably some examples. What documentable examples do you know of? And at what moment did Geithner and Treasury push for something stronger?

One of Kuttner's problems with financial reform is that how it was going to unfold was obvious from the personal and their choices around PPIP and the stress test. That weaker reform was always pursued instead of stronger reform in the financial sector should come as no surprise given the way Treasury decided to handle this bill.

And it is their bill. If it fails, if resolution doesn't work, if derivatives stay in the dark, if banks are still too big to fail, it won't be because progressives hijacked this bill. It will belong with those who supported the status quo.

Mike Konczal is a Fellow at the Roosevelt Institute.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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How Did Wall Street's Looting Become Public Policy?

Jul 7, 2010Joe Costello

money-and-greed-150The economy can't recover so long as we allow Wall Street to rob us blind.

money-and-greed-150The economy can't recover so long as we allow Wall Street to rob us blind.

Gretchen Morgenson has a good piece based on newly released documents concerning the single greatest crime committed by the looting class in the past two years, the bailout of Wall Street with the taxpayer payout of a hundred cents on the dollar for AIG's worthless derivatives. Morgenson writes:

The documents also indicate that regulators ignored recommendations from their own advisers to force the banks to accept losses on their A.I.G. deals and instead paid the banks in full for the contracts. That decision, say critics of the A.I.G. bailout, has cost taxpayers billions of extra dollars in payments to the banks. It also contrasts with the hard line the White House took in 2008 when it forced Chrysler's lenders to take losses when the government bailed out the auto giant.

But the best part of the piece is not only did Wall Street get the backdoor bailout:

When the government began rescuing it from collapse in the fall of 2008 with what has become a $182 billion lifeline, A.I.G. was required to forfeit its right to sue several banks -- including Goldman, Société Générale, Deutsche Bank and Merrill Lynch -- over any irregularities with most of the mortgage securities it insured in the precrisis years.

Any irregularities, that is more appropriately fraud, which was and remains rampant across the system. Fraud is the main criminal device of the looting class. Yves Smith digs deeper into the crime scene and its perpetrators. It's essential to understand that many in government are not simply colluding with the looting class, but are full fledged members. Chris Whalen at IRA has a good piece on Public Enemy #1, Robert Rubin, writing:

Reasonable people might call Robert Rubin the chief architect of the financial crisis and also of Wall Street's grand strategy to minimize the political damage from the subprime crisis. From his mismanagement of the U.S. Treasury's dollar policy in the mid-1990s to his bailout for Mexico (for Goldman Sachs and other Wall Street dealers), to the rescue of Citigroup and AIG in 2008, Rubin has met or exceeded the most demanding expectations for duplicity from our public servants.

Nearly two decades after first migrating to Washington, he apparently is still calling the shots of U.S. financial and economic policy with the full support of President Barrack Obama. Working through his favorite marionettes, Treasury Secretary Tim Geithner and Economic Policy Czar Larry Summers, most recently Rubin managed the defense of Wall Street following the great crisis.

The fleecing of the public by the looting class has now become a matter of general public policy. The looting class' transference of much of the private losses, that is fraud, onto the public books, now ransoms the entire economy for full payment. In an excellent piece(tx jesse), a Professor Hossein-zadeh at Drake University writes:

Never before has so much debt been imposed on so many people by so few financial operatives--operatives who work from Wall Street, the largest casino in history, and a handful of its junior counterparts around the world, especially Europe.

External sovereign debt, as well as occasional default on such debt, is not unprecedented. What is rather unique in the case of the current global sovereign debt is that it is largely private debt billed as public debt; that is, debt that was accumulated by financial speculators and, then, offloaded onto governments to be paid by taxpayers as national debt. Having thus bailed out the insolvent banksters, many governments have now become insolvent or nearly insolvent themselves, and are asking the public to skimp on their bread and butter in order to service the debt that is not their responsibility.

After transferring trillions of dollars of bad debt or toxic assets from the books of financial speculators to those of governments, global financial moguls, their representatives in the State apparatus and corporate media are now blaming social spending (in effect, the people) as responsible for debt and deficit!

This debt is illegitimate and needs to be repudiated. Pouring more money into an economy that has a criminal financial system is no solution, and it doesn't matter how much you spend, the economy will be moribund. The greatest crimes are those committed in full public view, grandiosity is their cover. People simply cannot conceive of criminal activity on such a scale. Such has been our looting class' quarter-century crime spree, climaxing with the collapse of the global economy and the massive swapping of private loss onto the public books. The looting class is private public partnership headquartered on Wall Street and the Fed, but with affiliations across the banking system and government. They will in the end only be stopped by a concerted effort of the American people to reclaim both their government and control of their economic destiny. The looting class needs to be to brought to justice.

Joe Costello was communications director for Jerry Brown’s 1992 presidential campaign and was a senior adviser for Howard Dean’s effort in 2004.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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