Regulation not as capitalism's downfall, but its salvation

[mesaSteeler]

Regulation not as capitalism's downfall, but its salvation
http://money.cnn.com/2010/04/05/news...tune/index.htm
James Kwak, author of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, along with Simon Johnson

by Katie Benner, writer April 5, 2010: 4:53 PM ET
Fortune Magazine

(Fortune) -- Of all the books about the financial crisis, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, is the least sexy. No one dry heaves into a wastepaper basket, there are no expletive-laden tirades, and not one character has a glass eye. But this staid looking text holds an explosive idea: Wall Street has hijacked our government. And without a total overhaul, taxpayers will endlessly foot the bill for its sins.

That's not an easy fact to face, says co-author Simon Johnson, a professor at MIT's Sloan School of Business. Who would admit that the government and the public were fooled into thinking that feeding money and power to a handful of bankers was good for society? Johnson and co-author James Kwak contends the financial industry fooled regulators into believing that allowing banks to take huge risks with little oversight was equivalent to practicing free market capitalism.

"But all the deregulation and consolidation of power did not create a free market," says Johnson. "It created the worst kind of socialism, whereby if all goes well, the banks benefit disproportionately and if all goes wrong then the taxpayers clean up the mess and the banks go on with business as usual."

The "13 Bankers" of the title were at a March 27, 2009 meeting with President Obama. The authors argue that they represent an oligarchy, and have managed to deeply ingrain their needs into the public psyche. As policymakers try to reform the financial services industry in the Administration and on Capitol Hill, it can certainly seem that way. Bank lobbyists have swarmed Washington D.C., arguing that better regulation of their risk and practices is akin to an assault on capitalism. They say they are plenty regulated, pointing to quantity of rules they follow, while declining to address their quality. A sea of talk radio hosts and television pundits take that message to the people, decrying rules that curb profit as rules that destroy free markets.

While politicians debate minutia, Johnson and Kwak say they're not addressing the real problem. Until the banking sector is a much smaller segment of our economy, banks will always have too much power. And as long as basic economic functions like mortgages and car loans depend on subsidizing their risky activities, we'll keep bailing them out.

"This is at heart a question of politics, not of economics or of regulatory technicalities," the authors write. "The challenge we face today is similar to the one faced by President Roosevelt a century ago; the antitrust movement was originally a political movement."

Not surprisingly, their solution is to bust up the trust. They argue the government should make banks small enough so that their risks or failures aren't able to crash our entire financial system. To show this is possible, the writers revisit history, from fights between Thomas Jefferson and Alexander Hamilton over the establishment of a federal bank, to monetary crises in the 1990s. They repeatedly show that America's leaders have always feared concentrated power in any one industry, aware that magnates would derive from that power the political influence to warp the two pillars of free markets: democracy and competition.

For Kwak, a former McKinsey consultant, and Johnson who was Chief Economist for the International Monetary Fund, the choice is binary: Make banks "small enough to fail" or face an endless bailout. The recent bailouts did nothing to curb the actual power of banking industry, they say. Firms are returning to health and profitability, thanks to the implicit guarantee of government and taxpayer funds. They are even more resistant to regulation or control. The system works pretty well, for them.

If politicians fight this battle, it won't be to make friends. The conventional wisdom that a few big banks are central to our economic prosperity and know what's best runs deep. It was formed over three decades of deregulation and risk taking, with the death of major American industries as a backdrop. As Wall Street produced more politicians and regulators, government came to argue all of our interests are aligned with those of the banks. "Greed is good,"wasn't just a fun line to quote from a movie; it became the ethos of Main Street, and the nation.

Questions for James Kwak

Kwak, with Simon Johnson is co-author of 13 Bankers and co-editor of the financial blog, The Baseline Scenario. The site gained a following due to its thoughtful and provocative commentary; Time magazine called the blog "essential reading for crisis buffs."

Have you found resistance to the idea that the financial crisis was the result of a systemic misallocation of power?

People seem to be uncomfortable with the idea that power is what is at fault. Bankers and politicians prefer the idea that the crisis was some kind of unforeseeable "perfect storm." Economists often focus on the specific financial mechanisms that caused the crisis--securitization, rating agencies, principal-agent problems, information asymmetries, and so on.

Also, many ordinary people think that the crisis was brought on by greedy Wall Street bankers who were defrauding the public. [Simon Johnson and I] think that blaming it on "greedy bankers" is insufficient, because bankers will always be greedy, and society and government have to adapt to that.

What went wrong in particular over the past three decades is that our government largely adopted the worldview of those bankers and, as a result, implemented policies that were favored by the bankers. This created the environment in which the boom and bust could occur.

Have you had any feedback from people who work at one of the 13 banks that the title of your book references?

We have had some positive feedback from people at major banks. Unfortunately, most of them are not able to speak publicly [due to gag orders and bans on comments by their employers], because the people who run those banks are dead set against us, for good reason. They don't want to see their empires broken up.

0:00 /2:50Biggest banks still at risk
Conservatives have been quiet on the need to reduce the amount of power that banks have in Washington DC, even though they criticized Fannie Mae and Freddie Mac for being too big and too powerful. Have you gotten much feedback from them?

First, our ideas have a broad appeal [on the left and the right].

The idea that our largest banks are able to manipulate the political process, gain access to taxpayer money through bailouts, and tilt the economic playing field in their favor is deeply offensive to many conservative, free market people. Arnold Kling just wrote an article in the National Review saying essentially what we do--that big banks are bad for free markets, for both economic and political reasons.

The battle is really between a group of centrist technocrats who think that the dangers of big banks can be contained through smarter regulation and a group of people all over the political spectrum who think that those banks cannot be contained, at least not without stronger measures.

One of our endorsements is from Jim Bunning, one of the most conservative members of the Senate. And the member of the Federal Reserve system who has been most outspoken about the dangers of big banks is Thomas Hoenig, president of the Kansas City Fed, who is currently the most conservative member of the Fed's Open Market Committee.

Does it shock you that the public seems to have so wholeheartedly accepted the bankers' version of the free market system?

It doesn't shock us that the bankers were able to seduce the public over the past thirty years. This was a period when all of American society and culture celebrated the private sector and looked down on the government.

It was also a time when the American financial sector got very, very big and very, very rich. We have always looked up to and admired rich people, and all of a sudden most of them turned out to be investment bankers and hedge fund managers. Many people took it as a matter of course that if this group of people was making that much money, they must be worth it.

However, we are concerned about how strong the bankers' hold remains even after the financial crisis, and how quickly they returned to business as usual. But we don't think the public still buys the ideology of finance. The problem is that many people in Washington still believe in that ideology, either because they have been steeped in it for decades, or because they depend on the financial sector for their livelihood. That will take years to change.

[GBMelBlount]

"But all the deregulation and consolidation of power did not create a free market," says Johnson. It created the worst kind of socialism, whereby if all goes well, the banks benefit disproportionately and if all goes wrong then the taxpayers clean up the mess and the banks go on with business as usual."

Until the banking sector is a much smaller segment of our economy, banks will always have too much power.

They argue the government should make banks small enough so that their risks or failures aren't able to crash our entire financial system."

Great read Mesa and thank you for sharing your thoughts.

I have quoted all of the things you put in "bold" as I would imagine they are reflective of your beliefs.

While I do understand the spirit of your general post, as far as this being the worst form of socialism, I am not sure I share your sentiments though.

On the other side of the spectrum, we have government "solutions" that are arguably just as bad...


For instance:

Social Security:

Some of you know this .. but not enough of you . Madoff did to his investors what the government has been doing to us for over 60 years with Social Security. There is no meaningful difference between the two schemes ... except that one was operated by a private individual who is now in jail, and the other is operated by politicians who enjoy perks, privileges and status in spite of their actions.

Do you need a side-by-side comparison here? Well here's a nifty little chart.

Bernie Madoff........Takes money from investors with the promise that the money will be invested and made available to them later
Social Security........Takes money from wage earners with the promise that the money will be invested in a "Trust Fund" and made available later.

Bernie Madoff.......Instead of investing the money, Madoff spends it on nice homes in the Hamptons and yachts.
Social Security..............Instead of depositing money in a Trust Fund the politicians use it for general spending and vote buying.

Bernie Madoff............. When the time comes to pay the investors back Madoff simply uses some of the new funds from newer investors to pay back the older investors.
Social Security.............When benefits for older investors become due the politicians pay them with money taken from younger and newer wage earners to pay the geezers.

Bernie Madoff......... When Madoff's scheme is discovered all hell breaks loose. New investors won't give him any more cash.
Social Security............When Social Security runs out of money they simply force the taxpayers to send them some more.

Bernie Madoff is in jail. Politicians remain in Washington.

http://forums.steelersfever.com/showthread.php?t=49996

Would you not agree that the taxpayers are paying here as well when everything goes wrong?

We can only imagine what will happen as the government becomes more involved in healthcare.....

I have one simple question for you friend...if you apply your bolded sentence above (in red) to the government, is it any less true?..

Again, thanks for posting Mesa.

[SteelerEmpire]

It all boils down to Darwinism... only the strong survive and the weak will fall by the wayside... with or without regulation...

Originally Posted by SteelerEmpire

It all boils down to Darwinism... only the strong survive and the weak will fall by the wayside... with or without regulation...

Although I don't like it. You're right.

[MACH1]

Originally Posted by SteelerEmpire

It all boils down to Darwinism... only the strong survive and the weak will fall by the wayside... with or without regulation...

Not exactly.....Depends on if the government wants to support you with hard earned tax dollars. If your deemed to big to fail or whatever reason....

[tony hipchest]

Originally Posted by GBMelBlount

Great read Mesa and thank you for sharing your thoughts.

I have quoted all of the things you put in "bold" as I would imagine they are reflective of your beliefs.

While I do understand the spirit of your general post, as far as this being the worst form of socialism, I am not sure I share your sentiments though.

On the other side of the spectrum, we have government "solutions" that are arguably just as bad...


For instance:



Would you not agree that the taxpayers are paying here as well when everything goes wrong?

We can only imagine what will happen as the government becomes more involved in healthcare.....

I have one simple question for you friend...if you apply your bolded sentence above (in red) to the government, is it any less true?..

Again, thanks for posting Mesa.

first of all, this thread isnt about healthcare or social security, so this attempted deflection and diversion is really a moot point. whats that popular catch phrase around here everyone uses when they disagree... "apples and oranges"?

second of all the bolded part in red WAS applied to the government and how it "created the worst kind of socialism with all the deregulation and consolidation" amongst the banks. how could you mis that very important point (pretty much the crux of the book)

mesa, you will have to excuse my spunky friend, who is a rare advocate of anarchistic capitalism, where free markets is defined by the ends of earning a profit, justifying the means, and is the essense of "freedom and liberty".

but heres a nice article on "foreclosure phil" gramm i posted a while back which ties in nicely with yours. enjoy! (i wont post the whole thing as it is rather lengthy and the front runner to be mccains treasurer is kind of a taboo subject around here)-

http://motherjones.com/politics/2008...reclosure-phil

Who's to blame for the biggest financial catastrophe of our time? There are plenty of culprits, but one candidate for lead perp is former Sen. Phil Gramm. Eight years ago, as part of a decades-long anti-regulatory crusade, Gramm pulled a sly legislative maneuver that greased the way to the multibillion-dollar subprime meltdown. Yet has Gramm been banished from the corridors of power? Reviled as the villain who bankrupted Middle America? Hardly. Now a well-paid executive at a Swiss bank, Gramm cochairs Sen. John McCain's presidential campaign and advises the Republican candidate on economic matters. He's been mentioned as a possible Treasury secretary should McCain win. That's right: A guy who helped screw up the global financial system could end up in charge of US economic policy. Talk about a market failure.

Gramm's long been a handmaiden to Big Finance. In the 1990s, as chairman of the Senate banking committee, he routinely turned down Securities and Exchange Commission chairman Arthur Levitt's requests for more money to police Wall Street; during this period, the sec's workload shot up 80 percent, but its staff grew only 20 percent. Gramm also opposed an sec rule that would have prohibited accounting firms from getting too close to the companies they audited—at one point, according to Levitt's memoir, he warned the sec chairman that if the commission adopted the rule, its funding would be cut. And in 1999, Gramm pushed through a historic banking deregulation bill that decimated Depression-era firewalls between commercial banks, investment banks, insurance companies, and securities firms—setting off a wave of merger mania.

But Gramm's most cunning coup on behalf of his friends in the financial services industry—friends who gave him millions over his 24-year congressional career—came on December 15, 2000. It was an especially tense time in Washington. Only two days earlier, the Supreme Court had issued its decision on Bush v. Gore. President Bill Clinton and the Republican-controlled Congress were locked in a budget showdown. It was the perfect moment for a wily senator to game the system. As Congress and the White House were hurriedly hammering out a $384-billion omnibus spending bill, Gramm slipped in a 262-page measure called the Commodity Futures Modernization Act. Written with the help of financial industry lobbyists and cosponsored by Senator Richard Lugar (R-Ind.), the chairman of the agriculture committee, the measure had been considered dead—even by Gramm. Few lawmakers had either the opportunity or inclination to read the version of the bill Gramm inserted. "Nobody in either chamber had any knowledge of what was going on or what was in it," says a congressional aide familiar with the bill's history.It's not exactly like Gramm hid his handiwork—far from it. The balding and bespectacled Texan strode onto the Senate floor to hail the act's inclusion into the must-pass budget package. But only an expert, or a lobbyist, could have followed what Gramm was saying. The act, he declared, would ensure that neither the sec nor the Commodity Futures Trading Commission (cftc) got into the business of regulating newfangled financial products called swaps—and would thus "protect financial institutions from overregulation" and "position our financial services industries to be world leaders into the new century."

It didn't quite work out that way. For starters, the legislation contained a provision—lobbied for by Enron, a generous contributor to Gramm—that exempted energy trading from regulatory oversight, allowing Enron to run rampant, wreck the California electricity market, and cost consumers billions before it collapsed. (For Gramm, Enron was a family affair. Eight years earlier, his wife, Wendy Gramm, as cftc chairwoman, had pushed through a rule excluding Enron's energy futures contracts from government oversight. Wendy later joined the Houston-based company's board, and in the following years her Enron salary and stock income brought between $915,000 and $1.8 million into the Gramm household.)

But the Enron loophole was small potatoes compared to the devastation that unregulated swaps would unleash. Credit default swaps are essentially insurance policies covering the losses on securities in the event of a default. Financial institutions buy them to protect themselves if an investment they hold goes south. It's like bookies trading bets, with banks and hedge funds gambling on whether an investment (say, a pile of subprime mortgages bundled into a security) will succeed or fail. Because of the swap-related provisions of Gramm's bill—which were supported by Fed chairman Alan Greenspan and Treasury secretary Larry Summers—a $62 trillion market (nearly four times the size of the entire US stock market) remained utterly unregulated, meaning no one made sure the banks and hedge funds had the assets to cover the losses they guaranteed.

In essence, Wall Street's biggest players (which, thanks to Gramm's earlier banking deregulation efforts, now incorporated everything from your checking account to your pension fund) ran a secret casino. "Tens of trillions of dollars of transactions were done in the dark," says University of San Diego law professor Frank Partnoy, an expert on financial markets and derivatives. "No one had a picture of where the risks were flowing." Betting on the risk of any given transaction became more important—and more lucrative—than the transactions themselves, Partnoy notes: "So there was more betting on the riskiest subprime mortgages than there were actual mortgages." Banks and hedge funds, notes Michael Greenberger, who directed the cftc's division of trading and markets in the late 1990s, "were betting the subprimes would pay off and they would not need the capital to support their bets."

[GBMelBlount]

Originally Posted by SteelerEmpire

It all boils down to Darwinism... only the strong survive and the weak will fall by the wayside... with or without regulation...

Unfortunately, unlike free and competitive markets the government has the strength and force to impose and dominate without being being fittest or even competitive....they are a brutal monopoly in some ways.....look at social security....

[mesaSteeler]

Well I have to agree to with Tony the purpose of this thread was to discuss the concentration of power in a few Wall Street banks and what should be done about it. It's not about the problems with Social Security or health care so I will stay on point rather than deflect into those topics how ever worthy they may be of discussion.

With these "to big to fail" banks we have privatized their gains among the fortunate few who may work for them but every tax payer in the country have had to pay for the mistakes made by these few. At the height of the crisis for every dollar Wall Street took in they leveraged (borrowed) thirty more with their credit default swaps and their CDOs.

This is not investing; it is GAMBLING. I don't care if they want to gamble with their own money I do care if they gamble with tax money which is exactly what they are doing.

Wall Street is also the by far the largest lobbyist in Washington. The amount Wall Street spends dwarfs the amount spent by the next largest lobbying group which is Big Pharma.

I find this concentration of economic and political power to be very frightening to say the least. I have no wish to live in a plutocracy in which there are a very few and very rich who then use their power to perpetuate their control over the rest of a very poor and indentured populace.

This country has been here before in the so called "gilded age" when plutocrat monopolists such as Rockefeller and Carniege among others used their ecomomic power to turn their workers into indentured, impoverished, wage slaves. President Teddy Roosevelt, the Trust Buster, took on Standard Oil and the other Trusts and broke them up. It's one of the things that led to creation of the American middle class.

It's been said the greatest threat to a free market is a very successful capitalist. Once a capitalist has a monopoly they use their use economic power to choke off competition, innovation, and anything else that might threaten their monopoly.

The only entity that is capable of breaking up a monopoly or these money center banks, is the Government. Now of course there are those who argue that government is not necessary. However consider that the logical end of a unregulated free market is a slave market. If you can buy and sell with no regulation it's only a matter of time before someone will get to the point of buying and selling children.

It is absolutely insane to permit the failure of one or two Wall Street banks to bring down the entire economy if they fail. These banks must be broken up and regulated.

Well I'd like to continue this but I have to prep for what will be a difficult meeting. There is a contractor wants to make changes to a civil engineering project which would save him a lot of money in building it. However in my professional opinion as a PE (Professional Engineer) his proposed changes are unsafe and I will not permit them.

As a state licensed PE I bear the responsibility for the design since my seal is on the plans. In this small example you can see the proper role of government. All PEs, just like doctors, are licensed by the state they practice in. I will not permit unsafe changes to made to my civil engineering plans and I don't care if this contractor's profit margin is less than he would like. It will be an interesting meeting.

In like wise the Wall Street Banks must broken up and regulated so they can not bring down the entire economy if they fail. It's a matter of safety for the entire economy.

- mesa

PS. Tony, thank you for the article.