Not So Radical Reform

This week the BusinessWeek cover story is about the attempts – or lack thereof – of reform and regulation of the financial markets. BW starts out by describing the media following Barney Frank in the wake of the 2008 financial crisis, as if the media is paparazzi and Frank is a celebrity. Why Barney Frank? He’s the chairman of the House Financial Services committee, which became a key player in the political process last year.

In the fall of 2008 and the disastrous first few months of 2009, public opinion was calling for the heads of the “fat cat” bankers and other ne’r do wells who toppled our 401ks, jobs and the monetary value of our homes. The time was ripe for reform. Frank’s potential power multiplied overnight. The Federal Government jumped in to help with the TARP , the nationalization of Fannie Mae and Freddie Mac and various other involvement.

BW points out that rescuing the system is not the same as reforming it.  When we had a crisis, there was a real chance for reform, and now the crisis has passed, the enthusiasm for making lasting changes has dissolved. Paul Volcker, former chairman of the Federal Reserve and chair of Obama’s Economic Recovery Advisory Board, says that bankers and regulators around the world “have not come anywhere close to responding with necessary vigor”.  Volcker wants the big banks to be split up into smaller banks, but in fact they have only gotten bigger.

The stock market rose by a tremendous amount in 2009. Good news or bad news? For those of us closely watching our 401k balances, we wonder how the news could be anything but good. But to fuel the regulatory fires, good news has a way of placating people so they no longer see the need to change the system. The modest sign of recovery in the economy have also served to dampen the urge to reform.  And now we have the health care bill, a major distraction.

What is really slowing down possible regulation is the New Democrat Coalition(NDC). What is this? A moderate group within the Democratic party, formed during the Clinton years. The Democrats believed they couldn’t win elections without a “strong moderate platform” The NDC has 68 “68 fiscally conservative, pro-business members” in the House of Representatives. Joseph Crowley of New York is the chair of the NDC and states that most of them come from business backgrounds. Crowley has even been on Air Force One with Obama – I’m sure that’s one flight he didn’t want to end.

The NDC has strong ties to Wall Street, both from Goldman Sachs, and from far less glamorous ( and lower-paying) jobs. Melissa Bean of Illinois, who I have heard speak, received the most donations from the financial industry.

The Obama administration and the House Financial Services committee was itching to implement change last summer, but the NDC “pushed back” and let it be known that they would not let such legislation go through. Derivatives trading – remember that? – is a hot issue. As it stands now, derivatives are unregulated, and often traded in less than transparent markets. JP Morgan Chase, Goldman Sachs and Bank of America earned more than $35 billion in the second quarter of 2009 trading unregulated derivative contracts. That’s a lot of clams, even for those big firms. So guess who wants to be Melissa Bean’s new best friend – you guessed it – the financial industry, to thwart regulation that would impede their sources of revenue.

Now banks have to report derivatives trades to regulators, but the trades themselves not regulated. Companies who use derivatives to hedge risk, such as airlines (fuel) energy companies and hedge funds are considered end-users of derivatives, as opposed to speculators, who use derivatives in search of profits. There will now be an end-user exemption in the new House Financial Services bill. But a representative from Cargill counters by saying that the amount of end-user derivatives will not make a significant impact.

Melissa Bean claims she “isn’t carrying water for Wall Street” as BW says, but it sure looks that way. The proposed Consumer Financial Protection Agency has been watered down as a result of Bean’s provisions. Barney Frank readily admits it is the “New Dems” who have lessened the regulation. Not surprisingly, he is not one of them.

The New Dems may have their fingers all over the House, but the senate seems to be still split. Clearly the Republicans will not want much in the way of regulation. Paul Miller, an analyst with investment bank FBR Capital Markets, says that “Wall Street is probably happy with the slowness of the process…because the slower the process, the more you can drag it out and water it down”.

At this point, it looks like we will get hardly any regulation at all. BW says the “onslaught” from the financial services industry on the legislators shows no signs of letting up. Which makes sense. From the perspective of Wall Street, why not take some of those profits, spend it on lobbyists, to ensure more profits in the future? There is an ad campaign called “no sleep”, about the worries of small business owners. But something about that seems wrong to me. Small businesses are generally not the ones using derivatives and requiring a lot of regulation.

Bonus season is coming up, and that will make a difference. Why? A lot of people are either unemployed, underemployed, or still in a bad economic way due to the great recession, and the lawmakers have a vested interest in appeasing some of the negative public sentiments toward big business. Senators McCain and Cantwell would like to reinstate the Glass-Steagall act. This act was instituted in 1933 to separate the public-utility like function of commercial banking from the casino-like function of investment banking. I read a recent interview with Paul Volcker who is not convinced that bringing back Glass-Steagall will fix our problems now. But don’t forget, Volcker is in favor of using this opportunity for reform.