Prospects For Financial Reform

By Simon Johnson

The best opportunity for immediate reform of our financial sector was missed at the start of the Obama administration.  As Larry Summers and Tim Geithner know very well – e.g., from their extensive experience around the world during the 1990s (see Summers’s 2000 Ely lecture) – when a financial system is in deep crisis, you have an opportunity to fix the most egregious problems.  Major financial sector players are always good at blocking reform – except when they are on the ropes.  (Look again at Paul Blustein’s The Chastening for more detail on what Geithner-Summers, with David Lipton and others, got right when they sided with reformers in Korea.)

Congratulations to the Treasury PR people for placing such a warm and fuzzy article about Secretary Geithner in Vogue (not available on-line, but definitely worth finding; nice photos).  But what exactly was the point – unless Mr. Geithner is planning to run for the Senate in Massachusetts?  Mr. Geithner comes through as someone who, against much advice, decided to stick with exactly the financial sector that got us into such deep trouble – despite the fact that this is exactly what he and his colleagues (at Treasury, at the IMF, and at the NY Fed) have always, and with good reason, strongly urged other countries not to do.

Naturally, the Obama administration’s generally weak and unfocused financial reform proposals have morphed into generally weak and unfocused congressional bills.  The overall narrative has been lost – despite moments of clarity from the president (e.g., when he spoke first about the Volcker Rules, but this was spun away within 12 hours by Secretary Geithner and others on the team).

Some limited change may now emerge from the Dodd-Corker compromise.  I expect we’ll see a version of the “resolution authority”, despite the fact this is a complete unicorn – a mythical beast with magical properties, but not actually useful in the real world. 

I’ve recently asked senior executives from both Goldman Sachs and JP Morgan Chase – both proponents of a resolution authority – point blank to explain how a US resolution authority of this kind would help close down their cross-border firms (or Citigroup).  I’m still waiting for an answer.

No doubt there will be some sort of “systemic regulator”, meaning a group chaired most likely by Treasury.  This is a great fuss about essentially nothing.  On top of the obvious points about how hard it would be for such a body to act preemptively – particularly when our next wave of problems will again be cross-border, in terms of exuberant lending into emerging markets – we actually already have the functional equivalent: the President’s Working Group on Financial Markets.

This group, of course, was to used to great effect by Robert Rubin and others in blocking Brooksley Born in 1998 - to them, she was the systemic threat, because she wanted to regulate over-the-counter derivatives.  And the same group was used to no effect whatsoever by Hank Paulson in the run-up to the September 2008 crisis.  In the European Union, creating new committees can make a difference; we’re better on form over structure in the US – but when the big banks are so powerful and out of control, we’re lousy at both.

Sadly, the consumer protection agency is likely to be gutted as the price of bringing Senator Corker on board.  This is of course an affront to everyone who has been – and continues to be – ripped off by the financial sector.  But we are where we are in terms of the blatant mistreatment of customers in this society.  Business people often tell me that we need to “rebuild confidence” in this economy.  I couldn’t agree more, but how does cheating people – and refusing to prevent others from cheating – lead to more confidence?

Despite – or rather because – of all the arrogance and misbehavior among our more prominent financial players, we are making progress on the bigger agenda: Changing the consensus on what is regarded as safe and sound in all kinds of banking.

Yesterday, Jerry Corrigan of Goldman Sachs told the UK parliament that there was “nothing inappropriate” in the way Goldman helped arrange for Greece to hide its debts.  This was helpful – it essentially acknowledges that the much vaunted “reputation effects” of issuing securities with a top tier investment bank are worth less than zero.  Mr. Corrigan affirmed that it is completely acceptable for Goldman and its peers to mislead investors and deceive the markets. 

So you can strike out one more purported reason why we should keep massive global financial institutions.  They do not enhance transparency, they do not bring clarity, they do not keep governments accountable.  Instead, they are paid a great deal of cash to mislead people.  What is the social value of that exactly?

With the broader financial picture unchanged - major banks will make lots of money, while unemployment remains sickeningly high – legitimate concerns about the practices of Big Finance continue to build.  Small and medium-sized banks find themselves increasingly hit by commercial real estate woes.  The alliance that has held back reform begins to crack. 

Very few people now claim that serious reform is only proposed by people carrying pitchforks; that myth is long gone.  The middle of the consensus has started to move, against mega-banks and against dangerous overborrowing by the financial sector.  This will be a long hard slog, but we are finally heading in the right direction.

38 responses to “Prospects For Financial Reform

  1. alas the real reform is to go back to the days of roman law. If you are a money lender and go insolvent you and your family get sold into slaverly. Hence offspring of those are also slaves. all of your wealth is confiscated. In this manner appropriate risk reward ratios are restablished.

    I’d be happy with capital punishmemnt and wealth stripping. And people wonder why a guy flies his plane into a building. It appears fairly clear to me and your articles says it all.

    Your article the quite coup is true.

  2. This is a pretty good status report. There will be no “reform” because the government is irredeemably corrupt.

    “Resolution authority” is a scam – exactly right. The CFPA had already been guted and is now being thrown overboard – right as well, though I’d add that that was always the plan for it. Just like with the scam “public option”, so the CFPA was a bait-and-switch. First the concept was floated, then something far less in substance than the original, but with the same name, was actually proposed, and the administration then stood by and did nothing whiile Congress gutted it. And now it’ll be dumped completely.

    Mr. Geithner comes through as someone who, against much advice, decided to stick with exactly the financial sector that got us into such deep trouble – despite the fact that this is exactly what he and his colleagues (at Treasury, at the IMF, and at the NY Fed) have always, and with good reason, strongly urged other countries not to do.

    There’s actually no inconsistency there, when you look at it from the correct point of view.

    Since the goal is always the plunder of Western banks and multinationals, it makes sense that “austerity” and busting (some) of the local crooks is demanded by the richest countries of all others.

    But the same plunder goal calls for the opposite policy where it’s their own crooks who ought to be “adjusted”.

    Business people often tell me that we need to “rebuild confidence” in this economy. I couldn’t agree more, but how does cheating people – and refusing to prevent others from cheating – lead to more confidence?

    That’s what the Orwellian phrase “build confidence” always means – get people to believe lies while the crimes continue. It’s just like “innovation” at fraud and “talent” at being a con man.

  3. “Some limited change may now emerge from the Dodd-Corker compromise. I expect we’ll see a version of the “resolution authority”, despite the fact this is a complete unicorn – a mythical beast with magical properties, but not actually useful in the real world.”

    That mythical beast can be found in Shangrila

    “They do not enhance transparency, they do not bring clarity, they do not keep governments accountable. Instead, they are paid a great deal of cash to mislead people. What is the social value of that exactly?”

    Banking compensation, excluding stock options and perks was reported (this morning) of having gone up 17% from last year and that the Obama Administration supposedly still cannot obtain from Wall Street, the exact figures on those employee bonuses either (mine says zero).

    “In the European Union, creating new committees can make a difference; we’re better on form over structure in the US – but when the big banks are so powerful and out of control, we’re lousy at both.”

    Better on form over “substance” in the U.S.

    “The middle of the consensus has started to move, against mega-banks and against dangerous overborrowing by the financial sector. This will be a long hard slog, but we are finally heading in the right direction.”

    Recommending additional reading from a book that came out earlier this year by Joyce Abbleby, Rentless Capitalism ; reviewed as: “More comprehensive than Niall Ferguson’s The Ascent of Money, this sound, timely study will surely find a receptive audience with both academics and those concerned with the state of the modern financial world.” Her main argument being that capitalism is just as much of a sociological force as it is of Economics (charts and formulas).

  4. Relentless Capitalism, published 01/2010, 512 pp

  5. The fact Geithner and company speak, and command one way, when it is about other countries, and the opposite, when it’s about themselves, is one more proof that they are only into self advancement. Nothing matters to them, except grabbing ever more, and if reason does not work one way, they will try the opposite, without batting an eyelash.

    Who, or what will stop them? Catastrophe?

    PA

  6. I think Michael Lewis wrote about Goldman Sucks a long time ago. Can’t remember the title but the story was the same. I am amazed that so-called knowledgeable investors would even consider dealing with them.

  7. Kleptocracies don’t have “social values.” Let’s not be naive, here.

  8. The financial crisis highlighted :

    The extreme dependency of the economy on credit
    and the financial sector.
    Over-leveraged assets and financial sector
    turned an otherwise “small problem” into the
    worst financial crisis since the great
    depression.
    Government policies are geared toward
    maintaining the status quo of the financial
    sector-emphasizing subsidies and bailouts.

    The Federal Reserve , by law, is the the enabler
    of financial sector subsidies and bailouts.

    Both political parties use the back door
    financing policies of the Federal Reserve to
    pursue their agenda.

    Obama was elected on a platform of change. My sense is that the populace wanted the economy re engineered toward he middle class. Part of that change was to restructure the financial sector to provide a more balanced and stable economy, eliminate the practice of “privatizing profits and socializing losses”. Reining in the powers of the financial sector and the Federal Reserve is an essential part of the overall solution.

    Obama failed to grasp the moment. Intellectually, he may have understood the need for change, but he failed to capture and embrace the angst of the middle class. Bold policies of change were called for. Instead he hired:

    Summers-exceptional technical economist-but with
    a traditional mindset- to run the economic
    team; he advised against breakin
    the “sanctity” of private contracts in the
    discussion of bonus payments to executives of
    financial institutions bailed out.

    Geithner, who was deeply involved in questionable
    bailouts, to head Treasury.

    Bernanke , chief enabler of bailouts, reappointed
    as Fed Chairman.

    Sure, there was always a rationale for the decisions; Bernanke was tied to the old policies and therefore a good candidate for “fall guy” if policy did not work out. In other words, a decision was made from a position of weakness- what might go wrong, rather than a bold move based on what he truly believed in.

    Part of the problem is that Obama defers to his technical experts – which might work if hired the right people for the right vision.

    What Obama “truly believes in” is an open question. At this point his policies seem more aligned to triangulating the various constituent positions, in the hope that nobody will be offended, and we can all live happily ever after.

    There is one area of policy he does appear to believe in, and that is the European model of more government, subsidies, and less competition.

  9. Did the latest post (now offline?) titled: “The PR War” get folded into this post?

  10. Simon, excellent post as usual. The Feds should have pushed strong financial reform when they gave out the TARP funds and during the beginning of the crisis when they had the leverage and could have forced them to take the medicine. What comes out of the sausage factory now I’m concerned will not be strong enough to protect the system going forward.

    I do read this news brief once every few days, it actually is a decent daily recap of US-related financial reform news and it sometimes links articles from this blog.

    http://www.pewfr.org/page?id=0006

  11. Mr Corrigan’s is a ploy to escape inquiry from the FSA, regulator overseeing GSI, GS’s European headquarters in London, which originated the Titlos
    spv through Titlos plc in early 2009. Will be interesting to see Adair Turner’s move on this fraud..

  12. Enter a bank with a gun and rob it and you’ll get a minimum of 5 years in a Federal prison. Enter a bank through a computer terminal, rob it and you’ll likely get a job as a security consultant. Own a bank and rob everybody and you get a bailout and a bonus.

  13. Good sitrep Simon, but so much more needs to be done. The banks have to be brought to book and real rebalancing of power between global mega banks and the perceived and actual weakness of nation states in tackling them. They are not alone, there are many industries whose global reach is highly questionable in terms of damage capacity, oil and gas, mining and resources. As long as we fail to equip powerful supranational bodies with teeth change will not happen. They have the capacity to shift jobs, capital and resources almost without check. This is not an anti-capitalist rant merely that global industries need far greater degree of global containment than currently possible due to the obsessive, if understandable focus on national self-interest. As banks are the transmission mechanisms this applies a fortiori

  14. http://www.vogue.com/feature/2010_March_Timothy_Geithner/

    ….Timothy Geithner, the seventy-fifth Secretary of the U.S. Treasury, doesn’t seem that angry. A lithe and athletic 48 years old, Geithner, who was named one of the 100 most beautiful people of 2009 by People magazine (it may have helped that his brother works for the publication)….

    If he belongs to that 100 – my goodness, I must be the most beautiful woman in Europe….

  15. Patrice Ayme wrote:

    “The fact Geithner and company speak, and command one way, when it is about other countries, and the opposite, when it’s about themselves, is one more proof that they are only into self advancement.”

    If you accept that there is an economic war taking place between the haves and the have nots, then the words of Greek dramatist Aeschylus can explain a lot.

    “In war, truth is the first casualty.”

    Aeschylus (525 BC – 456 BC)

  16. It’s definitely a clinical psychosis of osme sort. I suggest aversion therapy. Have your keyboard wired in such away that very time you type in Goldman Sachs, you get a therapeutic shock.

    In a few years you’ll be fully recovered.

  17. Sad but true.

  18. IMHO we’re getting all wrapped up in a bunch of mostly meaningless esoteric crap. We’re just nibbling around the edges of our banking problem.

    When all we have is a group of people using OPM, other people’s money (depositors & investors) to take money from other investors & keeping much of it for themselves in the process. CDO’s, CDS’s, etc are simply used to facilitate this process. When all this money they’re taking from investors using other investors money, OIM, should be mediated into the real economy to improve standards of living for all instead of just for the plutocracy.

    So what’s the solution? Take the money away from them.

    http://www.globalresearch.ca/index.php?context=va&aid=17732

    Create 50 state banks. Does ND need or use the Fed?
    Then most importantly GET RID OF THE FED.

    I know it ain’t going to be easy, but neither was getting on the Mayflower & leaving England. It all depends on how tired you are of putting up with the King’s $hit.

    Until we get rid of the Fed & open 50 state banks, we’re pi$$ing in the wind.

  19. Of course they do.

    This is the gigantic bet of the State Bank of North Dakota:

    That farmland will continue to appreciate in value forever.

    Sound familiar?

  20. “we are finally headed in the right direction?”

    The only direction in which we are headed was previewed in today’s market action. More bubbles, more crashes, more academic drivel, more IMF straight jackets, more Geithner, Summers, Bernanke, probably more Rubin and Paulson, and who knows, maybe even more Greenspan and John Snow and Bill O’Reilly running the Fed. Where is John Kennedy Toole (O’Toole?) when we need him?

  21. How can you understand all this and give Obama a pass?

  22. DakotabornKansan

    “…warm and fuzzy article about Secretary Geithner in Vogue (not available on-line, but definitely worth finding; nice photos). But what exactly was the point…? Mr. Geithner comes through as someone who, against much advice, decided to stick with exactly the financial sector that got us into such deep trouble…”

    Shades of Ramsay MacDonald?

    “I remember when I was a child, being taken to the celebrated Barnum’s Circus, which contained an exhibition of freaks and monstrosities, but the exhibit on the program which I most desired to see was the one described as “The Boneless Wonder”. My parents judged that the spectacle would be too demoralizing and revolting for my youthful eye and I have waited fifty years, to see the The Boneless Wonder sitting on the Treasury Bench.” – Winston Churchill, on Ramsay MacDonald

  23. In the 9th graf, this… :

    “Despite – or rather because – of all the arrogance and misbehavior”

    ….should read:

    “Despite – or rather because of – all the arrogance and misbehavior”

    Ah, I feel much better now.

  24. A better question is whether or not the state Bank of ND can get by without the Fed. The answer is yes they can. It was formed in 1919. The fed in 1913. It is currently in much better shape than the Fed or any of the other states without state banks.

    Should we prefer that the Bank of ND bet that farmland will continue to depreciate forever? Or stay the same forever? What has this bet done to them? Are they or the FDIC problem bank list or something?

  25. I don’t; like I said- “Obama failed to grasp the moment.”

  26. Simon holds that “we are finally heading in the right direction” and I wonder what he means with that.

    That we are going in the right directions asking our banks for more capital and less leverage at precisely the moment we most need them to lend? That because we before allowed them to become obese, we now have to turn them anorexic?

    Or is he referring to his old colleagues in the IMF starting to talk about the need to increase the inflation targets?

    While we the regulators keep as their principal working paradigm that those operations with low perceived risks and which are already much favored by the coward capitals should be additionally favored by generating low capital requirements for the banks… a sort of “let us support more what is least prone to fail”… as if being perceived a less prone to fail merits additional support… we are heading in the same wrong direction that caused this crisis.

  27. DakotabornKansan

    “…warm and fuzzy article about Secretary Geithner in Vogue (not available on-line, but definitely worth finding; nice photos).

    Not so warm, not so fuzzy…..

  28. Did you mean
    The Relentless Revolution: A History of Capitalism
    by Joyce Appleby, published 2010

  29. In reading all but the last paragraph, I am left with a very bleak impression that there’s any hope for reform. I really can’t see what would motivate the optimism in the last paragraph.

    As Simon Johnson says, our best chance for reform was during the depths of the crisis. I think the Obama administration blew that opportunity completely. Maybe that was the real intention of diverting everyone’s attention to health-care. After all, Goldman was his largest campaign contributor, and wasn’t it Wall Street that threw it’s support behind Geithner’s nomination to Treasury Secretary? They must have had a reason for wanting him in office so badly.

  30. Keep things simple.

    US law should limit all financial institutions – broadly defined – such that consolidated US GAAP or IFRS assets OR liabilities may not exceed 4% of US GDP.

    Good luck passing anything like this with Chris Dodd and / or Barney Frank in office…

  31. What are the new Blue Dog Democrats members of the Financial Services committee going to support in terms of reform , if they were placed on the committee , so they could solicit contributions from the people who have tons of money and oppose reform?
    Frank has very little power under this scenario and reform is very unlikely.Obama appears to want progressive reform but Emmanuel places Blue Dog moderates on the committee. The moderates and conservatives have the power so it’ll be a right of center solution.

  32. It might be more important to limit government!

  33. Believe the book was “Liars’ Poker”. The money-makers at GS were called, memorably, “big swinging dicks”. “Big swindling dicks” would have been more accurate.

  34. “The middle of the consensus has started to move, against mega-banks and against dangerous overborrowing by the financial sector. This will be a long hard slog, but we are finally heading in the right direction.”

    The financial sector does need to be put in its place. But it’s not just overborrowing by the financial sector. What about overborrowing by the private and government sectors? What about unfunded pension liabilities? The reason banks were allowed to get away with it thus far is becuase government and private sector needed the banks help in acquiring further debt.

  35. The oldest written constitution in the world and still in force today belongs to the Commonwealth of Massachusetts. It was written entirely by John Adams. Some excerpts follow along with the more famous words of Thomas Jefferson from the Declaration of Independence.

    The wealthy elite and our government they’ve purchased are shaping events that may ultimately lead to their loss of power, property and lives.

    ………………………………………………
    MA constitution

    Preamble:
    “The end of the institution, maintenance, and administration of government, is to secure the existence of the body politic, to protect it, and to furnish the individuals who compose it with the power of enjoying in safety and tranquillity their natural rights, and the blessings of life: and whenever these great objects are not obtained, the people have a right to alter the government, and to take measures necessary for their safety, prosperity and happiness.”

    Under Part I,
    Article V:
    “ All power residing originally in the people, and being derived from them, the several magistrates and officers of government, vested with authority, whether legislative, executive, or judicial, are their substitutes and agents, and are at all times accountable to them.”

    Article VII:
    “Government is instituted for the common good; for the protection, safety, prosperity and happiness of the people; and not for the profit, honor, or private interest of any one man, family, or class of men: Therefore the people alone have an incontestable, unalienable, and indefeasible right to institute government; and to reform, alter, or totally change the same, when their protection, safety, prosperity and happiness require it.”
    ………………………………………………

    Declaration of Independence

    “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness. That to secure these rights, governments are instituted among men, deriving their just powers from the consent of the governed. That whenever any form of government becomes destructive to these ends, it is the right of the people to alter or to abolish it, and to institute new government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their safety and happiness. Prudence, indeed, will dictate that governments long established should not be changed for light and transient causes; and accordingly all experience hath shown that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same object evinces a design to reduce them under absolute despotism, it is their right, it is their duty, to throw off such government, and to provide new guards for their future security.”

  36. Class warfare. Logic would suggest the law is not meant to discourage robbing banks but discouraging the man with a gun from shooting the banker in a moment of desperation and clarity thereby breaking up the foursome.

  37. FYI, the book was about Solomon Brothers, which became Solomon Smith Barney, which became Smith Barney (subsidiary of Citigroup).

  38. Simon, I have one gripe about your depiction of the doomsday cycle: just as the rating agencies were omitted, it is entirely reasonable to omit the regulators. Frankly, the most recent bubble happend not because new regulation was “aimed to prevent excess”, but because of an ongoing de-regulation through legislation change and executive and legislative de-funding decisions. The core cycle is really just a three-step of privatization of past (Social Security), present, and future (debt) public tax revenue expoiting the self-reinforcing power of Too Big To Be Shrunk.
    http://www.voxeu.org/index.php?q=node/4659