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Sunday, July 25, 2010

Claims of U.S. financial reform presuppose great leap of hope


Special to The Japan Times

LONDON — Champagne cork headlines were popping all over the United States the week before last when the Senate passed financial reform measures variously described as "a sweeping overhaul of the big banks" . . . "the biggest changes for generations" . . . "the greatest cleanup since the Great Depression" . . . "leaving few corners of the financial industry untouched."

Such headlines should make you worry about the critical faculties of the media and their gullibility to spin from Wall Street and the White House. The truth is that this piece of legislation — which President Barack Obama signed into law Wednesday — is nonvintage, with equal parts of vinegar and bubbles.

The legislation fails to address the key question of financial institutions that are "too big to fail." It also puts too much power into the hands of Treasury Secretary Timothy Geithner, who has not kept a proper distance from Wall Street and has put too much faith in the ability of regulators to pre-empt the next crisis.

In addition, stricter global capital requirements for banks, which would further help to check financial gambling, have been postponed until 2013 or later because of international squabbling.

Obama promised that the new laws will "protect consumers and lay the foundation for a stronger and safer financial system, one that is innovative, creative, competitive, and far less prone to panic and collapse."

Sen. Christopher Dodd, who was responsible for getting the measures passed in the Senate, proclaimed that Americans' faith could be restored in the financial system: "More than anything else, my goal was, from the very beginning, to create a structure and an architecture reflective of the 21st century in which we live, but also one that would rebuild trust and confidence."

The Dodd-Frank bill, named after Dodd and Barney Frank, who was responsible for its passage in the House of Representatives, will establish an independent consumer bureau inside the U.S. Federal Reserve to protect customers from abuses in as mortgages, credit cards and other loan products, though notably car dealers will be outside its scrutiny.

Federal regulators will also have powers to seize or close big financial companies that are running into trouble, while a new council of regulators will be set up to try to anticipate threats to the financial system. Companies that are regarded as systemically significant will face stricter capital and liquidity requirements and must draw up a "living will" to show how they would be broken up in case of failure.

Derivatives, the complex multitrillion dollar market that brought many giant financial houses to their knees, will be subject to government supervision and traded in clearinghouses or on exchanges. The prices of trillions of dollars of credit default swaps will have to be disclosed rather than set in secret.

Under the Volcker Rule, named after former U.S. Federal Reserve chairman Paul Volcker, banks will have limits on proprietary trading and ownership of hedge funds for their own account.

But for all the brave words of Dodd, it is hard to see any major changes in the financial architecture. Indeed, the major familiar financial names have simply gotten bigger since the crisis, as they have swallowed failed banks whole or gobbled up their remaining profitable parts. There are now just six major financial companies in the U.S. today with tentacles reaching to all major aspects of the financial business.

There was no root and branch radical revision of the system, no attempt to understand why the system had gone wrong in the first place and no effort to undertake a re-design. This is one reason why the reforms do not approach the Glass-Steagall provisions of the 1930s, which set up strict barriers between commercial banking and stock market- related businesses.

The Glass-Steagall wall was breached in the 1980s as banks got big enough and clever enough to find ways of getting around its provisions and was dismantled in the 1990s under the aegis of President Bill Clinton and his treasury secretaries, Robert Rubin and Larry Summers.

So, commentators who call the measures the boldest for generations are plain wrong. At best, they are an attempt to curb the excesses that the Clinton-Rubin- Summers deregulation promoted, but nothing as radical as a face-lift.

Supporters of the reforms may say it is a measure of their success that they have been attacked by Republicans on the right for creating expensive, onerous and unnecessary regulations and reporting requirements that will stifle growth and kill jobs, and by critics on the left who claim that the new rules do not go far enough.

As for derivatives reform and curbs on banks trading on their own account, there are loopholes and exceptions; for example, separate offshoots can be set up to trade in excess of the 3 percent limit for banks themselves.

The crucial issue is whether the regulators can show the foresight to see troubles ahead of time and will have the guts to take firm measures.

What should still be worrying is the close nexus between Wall Street and Washington. On the side of Wall Street — as in the City of London and other financial centers — there is no sign at all that bankers have any sense of shame that they almost caused a collapse of the global system or that they have lost their sense of entitlement to salaries astronomically larger than those of ordinary mortals.

In Washington, big financial institutions have stepped up their lobbying to protect their interests. Obama is earning something of a reputation for being hostile toward big business, but he seems to have an exceptionally soft spot for the financial industry. This may be because key players of the Clinton era, who dismantled the old regulations and discipline, still set Obama's economic policy.

Geithner has accumulated vast powers to shape the new regulations, to create the consumer protection agency and appoint its members. Yet Geithner was widely leaked to be opposed to the appointment of Harvard law professor Elizabeth Warren to head the consumer protection agency. Geithner apparently wants someone more friendly to Wall Street.

Kevin Rafferty is editor in chief of PlainWords Media, a consortium of journalists interested in issues of economic development.


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