Letting The Banksters Off The Hook

If you want to get seriously depressed about the state of the economy, take a look at Martin Wolf's article about how the state of the global economy pretty much mirrors the Depression right now, green shoots notwithstanding.

Robust private sector demand will return only once the balance sheets of over-indebted households, overborrowed businesses and undercapitalised financial sectors are repaired or when countries with high savings rates consume or invest more. None of this is likely to be quick. Indeed, it is far more likely to take years, given the extraordinary debt accumulations of the past decade. Over the past two quarters, for example, US households repaid just 3.1 per cent of their debt. Deleveraging is a lengthy process. Meanwhile, the federal government has become the only significant borrower. Similarly, the Chinese government can swiftly expand investment. But it is harder for policy to raise levels of consumption.

The great likelihood is that the world economy will need aggressive monetary and fiscal policies far longer than many believe. That is going to be make policymakers — and investors — nervous.

We have this great unraveling to undertake, in the midst of record unemployment and still-sick banks. The way to get out of this was to really stand up to the banks, to create a system that rewarded risk but also managed it so that nobody got too big to fail and drained the money out of the system. Instead, we seem to be sustaining all-new bubbles:

Witness the "fierce rally" in the collateralized loan obligation market. CLOs are made up of sliced and diced assets (including high-risk and junk loans) -- and are kissing cousins to the collateralized-debt obligations (i.e. crap) at the heart of the financial meltdown. But according to analysts at Morgan Stanley there has recently been a "remarkable change" in investor sentiment towards these securities, including an "exuberance" for the lowest grade junk being sold.

In other words, we are right back to risky business as usual. No harm, no foul. Let's get back to the fun we were having before this whole worldwide economic collapse thing started happening.

It puts a whole other spin on the audacity of hope.

The new financial regulations proposed by the President seem good in some places, weaker in others, and certainly an advance, but not what is necessary to truly break the strangehold that the banks have over the government, the central cause of this mess.

Three quarters of a century ago, President Franklin Roosevelt earned the undying enmity of Wall Street when he used his enormous popularity to push through a series of radical regulatory reforms that completely changed the norms of the financial industry.

Wall Street hated the reforms, of course, but Roosevelt didn’t care. Wall Street and the financial industry had engaged in practices they shouldn’t have, and had helped lead the country into the Great Depression. Those practices had to be stopped. To the president, that’s all that mattered.

On Wednesday, President Obama unveiled what he described as “a sweeping overhaul of the financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.”

In terms of the sheer number of proposals, outlined in an 88-page document the administration released on Tuesday, that is undoubtedly true. But in terms of the scope and breadth of the Obama plan — and more important, in terms of its overall effect on Wall Street’s modus operandi — it’s not even close to what Roosevelt accomplished during the Great Depression.

Rather, the Obama plan is little more than an attempt to stick some new regulatory fingers into a very leaky financial dam rather than rebuild the dam itself. Without question, the latter would be more difficult, more contentious and probably more expensive. But it would also have more lasting value.

We'll still have companies allowed to grow too big to fail under this proposal. Banking will not be made more boring, and thus more safe. In effect, there is very little here to "make bankers mad," as Joe Nocera put it. Simon Johnson concurs, although he thinks the model should be Teddy Roosevelt - more trust-busting to break up these huge integrated companies.

And yet, the banksters have grown so audacious that they are, in fact, mad, over the idea to create a Financial Services Products Agency to protect consumers. They found something to shake their stick at, and they're shaking for all its worth. They keep winning because even when they win, they fight. Chris Dodd absolutely blew his stack at this today.

Dodd, who is chairman of the Senate Banking Committee and who will be the chamber's leader on regulatory reform efforts, said he was "upset" by media reports that financial industry groups are gearing up to oppose the Obama administration's proposal to create an agency to protect consumers from abusive financial products.

"The very people who created the damn mess are the ones" now saying they will oppose sensible changes, Dodd, D-Conn., said. "That's not the place to start."

But of course, even a Consumer Financial Products Agency will remain one small island in an alphabet soup that is still wired for the industry to circumvent. We're propping up big banks and not eliminating the huge leverage that allowed the explosion in the derivative market. In short, we're headed for a lost decade, a time of little to no growth and the inability to get out of the crisis.

And if that next bubble bursts... well, start running for cover.