The Middle Ground On Financial Reform

By Simon Johnson

In Politico this morning, I question whether the president should really be seen as “centrist” or “moderate” with regard to financial reform.  His staff goes to great lengths to make this claim, including both the specific quotes and general tone in the Financial Times on Tuesday (May 18, p.7).

Treasury Secretary Tim Geithner: 

“I would say [the president] is fundamentally at the centre and pro-market.  But he recognizes the market cannot solve all problems.” 

Larry Summers:

“Sometimes the most courageous thing to do is not to take the largest and most sweeping course of action.”

But if this is the correct way to frame the president’s position, how can we explain the fact that it is moderates – not left-wing radicals – who are pushing (against the White House, among others) for stronger reform both within the administration and in Congress?  I suggest another interpretation: On financial reform, the president does not hold the middle ground.

17 thoughts on “The Middle Ground On Financial Reform

  1. The pres is unwilling to stake out a position; has ceded the polictics to surigats; is saying one thing but doing another; is unwilling to endanger his campaign funding; does not really concern himself w/the economic situation of most citizens; is a hypocrite; made a strategic mistake in pursuing healthcare reform (not ‘broken’) vs financial reform (catastrophic failure). He’s fundamentally centrist as much as he’s fundamentally a leader.

  2. Wow simon,

    I read your peace in Poltico, and the two comments by the same fool, and then came here and read joel’s comment above and I have to say, it’s truly depressing the quality of comments on this topic. The healthcare discussions you posited on late last year had far more robust discussions and actual expert input from the commenteriat, you could learn something reading those comment threads. But financial reform, just drags people out of the newsweek woodwork over to places like this where the sun his to harsh for daily intellectual existence.

    Back to the original point, I found the back and forth between what you have written and tyler cowens analysis over at MR, my most recent ahaa! moment, piecing together this jigsaw puzzle. Why, is a president like Obama, with a unique mandate in many ways, stacking out his current position. One with considerable risk to it. He is not niave, or foolish. Why bother threading the needle, as he seeems to be attempting.

    I initially thought he, after recognizing the power of the financial industry, he had opted to accomplish healthcare reform, something he actually cares about, rather than squander political capital battling the financial industry, and i do accept the view that entrenched players like summers and geithner have had some influence. Having known several powerful political figures up close, and watched how they acquire and wield power, I have no delusion that they are controlled by anyone, but are constrained by other powerfull actors. But they will drive where they want to go.

    I would like to see the debate between you and Tyler furthered, as the crux of the two arguments, that the government, is wedded to the industry as a extension of it’s funding function, and that Bank size matters for that function as opposed to “normalacy” as you present it, i.e functional for the economy and sub 100 billion.

    What is truly frightening about the implications of Tylers position is that the two are interlinked, and thus power and money have finally merged symbiotically, in very scary ways. We have always assumed this to be the case, but not institutionally as is the current case. In this scenario, even a guy like Obama, when confronted at the embededdness of the financial system with government funding, realized that every other element of his presidency, from saving the economy, to his reform agenda where all dependent on the funding machinery, as it currently exists.

    And i guess that’s what baffles me, is there seems to be many workarounds of the cancer, to reroute organs to blood supplies. Any way, that’s my two Drachma, I would like to see far sharper minds with much better economics, such as yours, tackle the issue. But looking at the comments left on many of your threads, I think were really doomed.

  3. By MSM/system standards he’s “centrist”, which means really that his positions range from right-of-center to hard right.

    That leaves actual centrists/moderates to stand in as the freaky left, according to system measures.

    Any real left, of course, doesn’t exist within the system.

  4. Geithner is correct: Obama is at the center and pro-market. Many readers here tend to be liberal and so they think the center lies under their feet. The left is socialism and the right is 1800s (at the very latest) capitalism. Obama is certainly pro-market, just a little less than ‘W’. The problem is that Obama is wrong, not that he is in the center. He has been given an FDR moment and he proposed Clintonesque solutions.

    Summers is disingenuously correct. Sometimes it is better to not take the largest and most sweeping course of action; Hitler should have taken this advice. But a radical course of action is often the right thing to do. For example, this country was not in favor of desegregation, but Eisenhower sent in the army to enforce a Supreme Court decision. It is called leadership, something Obama clearly does not understand.

  5. 1) WHY is someone a socialist for wanting the rules that we had in place for the financial system for about 70 years. It didn’t bother many people then, and the “liberal” clinton is the one that gutted. the socialist mantra here doesn’t fit.
    2) Obama’s hypocracy (sp) makes bush like like a puppy. At this point I’ll take Bush back. Yes he is a moron, but I knew where he stood. the current president lied his way into office “yes we can”, and at every turn had stood in the way of rational reform.
    3) I voted for a president who talked about usng evidence to make his decisions. he doesn’t it is all lobby money, healthcare, energy, now finance. ware going to stay in Iraq, Gitmo is still there. I hated bush, Obama is worse. he is slick and can fool people very easily.
    4) I am going to add this from a huff post piece:
    In March, the Real World Economic Review performed a poll — which economists were most responsible for the crisis, “for blowing up the global economy.” Over 7,500 people voted; many of them were economists. Each participant could cast up to three votes. In total, 18,531 votes were cast.
    The vote totals for the first seven “winners” were as follows (the first three won the Dynamite Prize):
    Alan Greenspan – 5,061
    Milton Friedman – 3,349
    Larry Summers – 3,023
    Fischer Black and Myron Scholes – 2,016
    Eugene Fama – 1,668
    Paul Samuelson – 1,291
    Robert Lucas – 912.

    Summers is number three according to economists. he is a policy leader. geithner is a summers clone. How more unbiased does soimething need to be to show he has no business in being in any leadership position.
    Now what kind of person keeps someone like this around. Obama does and this tells you more than anything. I have stated before on this site that you take Obama, ignore what he says, and do a black box analyisis (look at appointments, policies, the practical end points). The conclusion reached is easy. Do it yourself. I knw nobody wants to think bad of the president (Bush got away with it for a long time) we have a natural tendency to give him the benefit of the doubt. payday lenders prey on the poor, so do excessive atm fees. he does nothing about this (he should be in the senate right now talking and pressing the flesh). he isn’t even willing to take on the people who are doing the most harm to poor minorities. that says something about his character. we expect that with a white man from texas. from a minority member it is disgusting. the people being hurt the most from the big banks are the poor minorities (they have only savings and only get interest). I have the stock market, bonds, house. he is hurting the very people who elected and supported him.
    A jew who drove people to the camps is a traitor to his race. Supporting payday lenders, crazy mortgage rules, etc is supporting the people who feed of african americans. federal reserve interest rate policy does the same, as well as sxcessive atm fees (these areas are under served by banks).
    I could go on and on.
    Mr. Johnson, good article. glad someone is starting to tell it like it is from the progressive camp instead of the usual Obama hero worship cult i see all too often.

  6. President Obama? Two years as a United States (no one knows anything about the guy,except “Yes,We Can”, and “Change” ?) Senator. Votes 75% present on any controversial legislation. Prior, as a State Rep. Chicago,Il. votes present on any ,and all controversial bills 75%! Surrounds himself with shady characters, and embraces Rev. Wright too the fullest extent possible…only for political gain amongst the (we all know what happened to the Reverend) black community? Rahm Emanuel,and David Exelrod both “Chicago Hip` Boy’s” are his leutinents from Clinton. Is the picture becoming clearer? The only reason he faught so hard for “Health Care”? Answer,…the illegal immigrants can partake on the retiree’s dime, period! Nothings changed, other than the fact that he’s obviously feathering his nest for 2012. Recently,…Rahm Emanuel has said he will run for “Mayor of Chicago”, which happens to be the hub of “Illinois Political Power (Structure) Machine”! PS. Why do you think the failed governor story has gone away? Here’s a hint…Obama’s boys called “Rod”, and wanted their own pick too replace Obama as senator,and “Rod” said ,….? Obama cares nothing about no-one except his own selfish legacy,period. I’m glad I’m an Independent! “Whatever way the Wind Blows” my kinda guy?

  7. A Sign of the Times?

    Chris Mathews, host of MSNBC’s Harball reported today that corporatist Meg Whitman’s lead in the gubernatorial Republican primary has plunged from 49% to just 9% in two months over challenger Steve Poizner.

    Mathews also claims Whitman has spent $68 million of her fortune on media in California.

    Whitman has been hit by PAC advertising identifying her as a Goldman Sachs board member as well as depositing money into offshore tax haven accounts managed by Goldman Sachs.

    Polls also indicate Jerry Brown would defeat either Whitman or Poizner if the election were held today.

    As Simon and James have said all along, this is a long fight.

    It is heartening to watch participatory democracy in action. It is heartening to see even Republicans turn their backs on corporate communism in waves.

    Keep the faith folks. I don’t hear no fat lady.

  8. Take a look around, folks. None of the last three sitting presidents, no matter what flavor, has looked anywhere but Wall Street for advice and consent. Simon and James have only too clearly made this point in their book (with references). The blinders have been on for at least 20 years, and longer if you look at the history of the collateralized debt obligation.

    Given that the psychological transformation happened a while back, these “advisers” do – as Ted K points out – live in a different world, that’s what a takeover means. They had an alternate universe built for them and they’re quite comfortable with it. It will take a complete paradigm shift to convince them otherwise.

    In one sense, the bailout was entirely too successful. Bernanke did learn his lessons well, he saved the day (at least to now). This is what they expected from their head banker.

    The idea that this might be a prelude to additional seismic shifts, given the over-leveraged, risk-laden, deceptive, and dishonest nature of the trading business the big houses engage in, is alien to them.

    It really is a fight for hearts and minds.

  9. My! I couldn’t have written it better, myself:

    Why the ‘Experts’ Failed to See How Financial Fraud Collapsed the Economy
    By James K. Galbraith
    May 16, 2010

    Editor’s Note: The following is the text of a James K. Galbraith’s written statement to members of the Senate Judiciary Committee delivered this May.

    Chairman Specter, Ranking Member Graham, Members of the Subcommittee, as a former member of the congressional staff it is a pleasure to submit this statement for your record.

    I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including “rational expectations,” “market discipline,” and the “efficient markets hypothesis” led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this – but most did.

    Thus the study of financial fraud received little attention. Practically no research institutes exist; collaboration between economists and criminologists is rare; in the leading departments there are few specialists and very few students. Economists have soft- pedaled the role of fraud in every crisis they examined, including the Savings & Loan debacle, the Russian transition, the Asian meltdown and the bubble. They continue to do so now. At a conference sponsored by the Levy Economics Institute in New York on April 17, the closest a former Under Secretary of the Treasury, Peter Fisher, got to this question was to use the word “naughtiness.” This was on the day that the SEC charged Goldman Sachs with fraud.

    There are exceptions. A famous 1993 article entitled “Looting: Bankruptcy for Profit,” by George Akerlof and Paul Romer, drew exceptionally on the experience of regulators who understood fraud. The criminologist-economist William K. Black of the University of Missouri-Kansas City is our leading systematic analyst of the relationship between financial crime and financial crisis. Black points out that accounting fraud is a sure thing when you can control the institution engaging in it: “the best way to rob a bank is to own one.” The experience of the Savings and Loan crisis was of businesses taken over for the explicit purpose of stripping them, of bleeding them dry. This was established in court: there were over one thousand felony convictions in the wake of that debacle. Other useful chronicles of modern financial fraud include James Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s Conspiracy of Fools, on the Enron scandal. Yet a large gap between this history and formal analysis remains.

    Formal analysis tells us that control frauds follow certain patterns. They grow rapidly, reporting high profitability, certified by top accounting firms. They pay exceedingly well. At the same time, they radically lower standards, building new businesses in markets previously considered too risky for honest business. In the financial sector, this takes the form of relaxed – no, gutted – underwriting, combined with the capacity to pass the bad penny to the greater fool. In California in the 1980s, Charles Keating realized that an S&L charter was a “license to steal.” In the 2000s, sub-prime mortgage origination was much the same thing. Given a license to steal, thieves get busy. And because their performance seems so good, they quickly come to dominate their markets; the bad players driving out the good.

    The complexity of the mortgage finance sector before the crisis highlights another characteristic marker of fraud. In the system that developed, the original mortgage documents lay buried – where they remain – in the records of the loan originators, many of them since defunct or taken over. Those records, if examined, would reveal the extent of missing documentation, of abusive practices, and of fraud. So far, we have only very limited evidence on this, notably a 2007 Fitch Ratings study of a very small sample of highly-rated RMBS, which found “fraud, abuse or missing documentation in virtually every file.” An efforts a year ago by Representative Doggett to persuade Secretary Geithner to examine and report thoroughly on the extent of fraud in the underlying mortgage records received an epic run-around.

    When sub-prime mortgages were bundled and securitized, the ratings agencies failed to examine the underlying loan quality. Instead they substituted statistical models, in order to generate ratings that would make the resulting RMBS acceptable to investors. When one assumes that prices will always rise, it follows that a loan secured by the asset can always be refinanced; therefore the actual condition of the borrower does not matter. That projection is, of course, only as good as the underlying assumption, but in this perversely-designed marketplace those who paid for ratings had no reason to care about the quality of assumptions. Meanwhile, mortgage originators now had a formula for extending loans to the worst borrowers they could find, secure that in this reverse Lake Wobegon no child would be deemed below average even though they all were. Credit quality collapsed because the system was designed for it to collapse.

    A third element in the toxic brew was a simulacrum of “insurance,” provided by the market in credit default swaps. These are doomsday instruments in a precise sense: they generate cash-flow for the issuer until the credit event occurs. If the event is large enough, the issuer then fails, at which point the government faces blackmail: it must either step in or the system will collapse. CDS spread the consequences of a housing-price downturn through the entire financial sector, across the globe. They also provided the means to short the market in residential mortgage-backed securities, so that the largest players could turn tail and bet against the instruments they had previously been selling, just before the house of cards crashed.

    Latter-day financial economics is blind to all of this. It necessarily treats stocks, bonds, options, derivatives and so forth as securities whose properties can be accepted largely at face value, and quantified in terms of return and risk. That quantification permits the calculation of price, using standard formulae. But everything in the formulae depends on the instruments being as they are represented to be. For if they are not, then what formula could possibly apply?

    An older strand of institutional economics understood that a security is a contract in law. It can only be as good as the legal system that stands behind it. Some fraud is inevitable, but in a functioning system it must be rare. It must be considered – and rightly – a minor problem. If fraud – or even the perception of fraud – comes to dominate the system, then there is no foundation for a market in the securities. They become trash. And more deeply, so do the institutions responsible for creating, rating and selling them. Including, so long as it fails to respond with appropriate force, the legal system itself.

    Control frauds always fail in the end. But the failure of the firm does not mean the fraud fails: the perpetrators often walk away rich. At some point, this requires subverting, suborning or defeating the law. This is where crime and politics intersect. At its heart, therefore, the financial crisis was a breakdown in the rule of law in America.

    Ask yourselves: is it possible for mortgage originators, ratings agencies, underwriters, insurers and supervising agencies NOT to have known that the system of housing finance had become infested with fraud? Every statistical indicator of fraudulent practice – growth and profitability – suggests otherwise. Every examination of the record so far suggests otherwise. The very language in use: “liars’ loans,” “ninja loans,” “neutron loans,” and “toxic waste,” tells you that people knew. I have also heard the expression, “IBG,YBG;” the meaning of that bit of code was: “I’ll be gone, you’ll be gone.”

    If doubt remains, investigation into the internal communications of the firms and agencies in question can clear it up. Emails are revealing. The government already possesses critical documentary trails — those of AIG, Fannie Mae and Freddie Mac, the Treasury Department and the Federal Reserve. Those documents should be investigated, in full, by competent authority and also released, as appropriate, to the public. For instance, did AIG knowingly issue CDS against instruments that Goldman had designed on behalf of Mr. John Paulson to fail? If so, why? Or again: Did Fannie Mae and Freddie Mac appreciate the poor quality of the RMBS they were acquiring? Did they do so under pressure from Mr. Henry Paulson? If so, did Secretary Paulson know? And if he did, why did he act as he did? In a recent paper, Thomas Ferguson and Robert Johnson argue that the “Paulson Put” was intended to delay an inevitable crisis past the election. Does the internal record support this view?

    Let us suppose that the investigation that you are about to begin confirms the existence of pervasive fraud, involving millions of mortgages, thousands of appraisers, underwriters, analysts, and the executives of the companies in which they worked, as well as public officials who assisted by turning a Nelson’s Eye. What is the appropriate response?

    Some appear to believe that “confidence in the banks” can be rebuilt by a new round of good economic news, by rising stock prices, by the reassurances of high officials – and by not looking too closely at the underlying evidence of fraud, abuse, deception and deceit. As you pursue your investigations, you will undermine, and I believe you may destroy, that illusion.

    But you have to act. The true alternative is a failure extending over time from the economic to the political system. Just as too few predicted the financial crisis, it may be that too few are today speaking frankly about where a failure to deal with the aftermath may lead.

    In this situation, let me suggest, the country faces an existential threat. Either the legal system must do its work. Or the market system cannot be restored. There must be a thorough, transparent, effective, radical cleaning of the financial sector and also of those public officials who failed the public trust. The financiers must be made to feel, in their bones, the power of the law. And the public, which lives by the law, must see very clearly and unambiguously that this is the case. Thank you.

    James K. Galbraith is the author of The Predator State: How Conservatives Abandoned the Free Market and Why Liberals Should Too, and of a new preface to The Great Crash, 1929, by John Kenneth Galbraith. He teaches at The University of Texas at Austin.

    Yeh. I like the part about the NINJA loans and IBG/YBG. But, nobody knew…

    Now, it looks like That Sweeping Financial “Reform”
    may pass after all. I wish I felt better sleeping at night, but I don’t think it will help. sigh….
    …Lady in Red

  10. Simon,

    You have not had a seat at the table while decisions were being made by Obama and the banksters about how to handle this mess, and you will not have a seat before the world “crosses the Rubicon”.

    We have flat run out of time to handle this with decorum and tact – the financial system warning lights are flashing RED all around the world. It’s time to start yelling LOUDLY, and quit pulling punches about what’s going on and what to do next. You have danced around the fact that Summers, Geithner and Bernanke are largely the same group of people that created this mess, and they have been acting in a manner to continue this same mess for as long as possible. It’s time to quit dancing and start swing and landing hard punches.

    We are all very sorry it’s reached this point, but it’s no longer time for political niceties, it’s time to tell the emperor he’s buck naked. It’s time to tell everybody that we need another FDR, not another Hoover. It’s time.


    John Q. Public

  11. Yes, yes!

    And, the answer is not to pass this almost-worthless, present “reform,” with its myriad goiter amendments…

    …it is to pass real reform. Give me no more than ten pages… the Volcker Rule and nine more pages.
    Period! No lawyers. No lobbyists.

    ….simpler than my MasterCard agreement.

    That’s what I’d like to shoot for. Anything less is an illusion of reform. Might Obama do it? …L in R

  12. I see one positive thing out of all of this: Given that financial reform is turning out to be approximately as farcical as the vaunted health care reform, by the day of the fall elections, the chances of any incumbent winning are growing far slimmer than before, and that applies to both parties. We now have a government leadership that has been proven to have been substantially, if not entirely bought and paid for.

    Today the stock market took another massive hit. It was somewhat based upon the weakness of the euro and the reasons (good ones) for it. It was based on the fact that nearly 20% of mortgages still in place are now either delinquent or in foreclosure. It is based on the fact that there are many more entering the unemployment rolls recently than would indicate an “actual” recovery happening. It is based upon another completely botched in ineffectual governmental handling (either prior to or after) of perhaps the greatest ecological disaster in American history. It is based on the markets’ recognition of the fact that a weakening economy will not support the 1.4 quadrillion in notionally valued derivatives now ready to collapse the world’s economies. It is based on the recognition that the “smart money” just doesn’t look very smart at the moment.

    But then we all know, in this widely manipulated world, that if our ethical standards had always been Machiavellian, perhaps we would never have gone very far beyond the dark ages in terms of human progress. We are all beginning to wonder about the Mayan Calendar, J. Alfred Prufrock, and how guys like Stalin, Hitler, etal, were permitted by their respective societies to be proclaimed as saviors. Maybe we aren’t wondering so much at this moment.




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