Veto Threat?

This is a gentle veto option, but if Obama actually carries through with it, I'd have to hand it to him.

The White House on Tuesday suggested that President Obama would consider vetoing regulatory reform legislation if it did not include strong enough protections for consumers of credit cards, mortgages and other financial instruments.

Press Secretary Robert Gibbs told reporters that there were "big" concerns inside the administration over reports that Congress was scaling back a key pillar of the president's approach to reform: the creation of a Consumer Financial Protection Agency (CFPA). And, in a warning shot to the legislative branch, he suggested that proposed legislation to create the CFPA might not pass the president's desk if it becomes too watered down in the process.

"The president would not sign any bill that he thought was too weak," said Gibbs. "I think we have seen what happens whether it is credit card companies, mortgage companies, we now see it more in stories covering the charges for bank overdrafts and the amount of money that costs the American people each year. The American people deserve an advocate on their behalf dealing with these entities. The president believes that strongly and believes that at the end of the day we will have a strong Consumer Finance Protection Agency working on behalf of the American people."

This is the proper use of the bully pulpit. The CFPA has already been gutted to an extent. Obama laying a marker can help assure it won't get gutted any further.

Obama veto threats have been rare to this point. The only other I can remember had to do with eliminating the F-22 fighter plane. This is a very good sign, if he's willing to go up against powerful interests, and his own party in the Congress, and siding with the people.

The banks are still running roughshod over Congress. They've beaten back any serious attempt to rein them in, and even now, after taking hundreds of billions if not trillions from the federal government, they are still taking major risks, still not engaging in consumer lending, still playing with derivatives at the same numbers from before the crisis. Clearly the Congress has shown no ability to stop them, and to this point, neither has the President. I hope this signals a true change.

Bill Clinton And Derivatives

Bill Clinton, whose Administration set the ball rolling on a lot of the structures that ultimately led to ruin in the financial markets, gives a pretty honest take of where he feels he went right and wrong:

Mr. CLINTON: Now, there basically have been three charges, if you will, laid at our doorstep, because everybody recognizes that I vetoed the securities reform bill and that we had a very different economic philosophy. But they — the three charges are one, because I enforced the Community Reinvestment Act for the first time and over 90 percent of all lending done under that law was done when I was president, $300 billion, that part of that was a lot of little banks made loans to people they had no business making loans to to buy houses so they could check the box for the Community Reinvestment Act. That’s the right-wing argument.

Then there’s the argument from the left that I shouldn’t have signed the bill that got rid of the Glass-Steagall law because that enabled banks and investment banks in effect to merge their functions.

And then there’s the argument that I make, which is that I should have raised more hell about derivatives being unregulated. I believe the last one is by far the most valid, although I don’t think that the Congress would have permitted anything to be done because Alan Greenspan was against it [...]

But I do believe on the derivatives they made the argument, the people who were against regulating it, that people like you weren’t buying derivatives. It wasn’t like you were investing your 401(k) in derivatives. You were investing your 401(k) in mutual funds, which were subject at least under normal times to the jurisdiction of the S.E.C., which was supposed to be minding the store. And so because we had a hostile Republican Congress which threatened not to fund — I don’t know if you remember this but we had a huge knock-down fight when they threatened not to fund the S.E.C. because of what Arthur Levitt was doing to try to protect the American economy from meltdowns. They said, “Oh, he’s interfering with a free market” and all that. This is what he’s supposed to do.

They argued that nobody’s going to buy these derivatives, we’ll do it without transparency, they’ll get the information they need. And it turned out to be just wrong; it just wasn’t true. And once you got that massive amount of money invested in derivatives that people thought — it’s like these credit default swaps, where people thought, the Lehman people talk about it, they thought, or the A.I.G. people, they thought it was 100 percent safe investment, they thought there would never be defaults on these mortgage securities. So of course you wanted insurance there because you got the insurance premium, you make the profit and you couldn’t possibly lose money, right? Well, it turned out to be all wrong. That rested on a lot of assumptions, including the fact that the ratings agencies would do a good job, which didn’t happen, in evaluating risk. So I very much wish now that I had demanded that we put derivatives under the jurisdiction of the Securities and Exchange Commission and that transparency rules had been observed and that we had done that. That I think is a legitimate criticism of what we didn’t do.

Clinton doesn't buy the arguments about Glass-Steagall or the Community Reinvestment Act. And much of his argument rests on the fact that the Bush Administration just gutted the regulatory apparatus, particularly the SEC, and so he was operating under a different environment. And David Leonhardt makes another very good point - the Clinton Administration allowed the run-up of the dot-com stock bubble, so thinking they would have charged in and stopped the housing bubble doesn't really hold water. They were lucky to get out of office when they did.

But this is pretty honest, and points to Clinton's instincts on this, which were always more finely attuned than his advisors. The derivatives market took off after Clinton left office, when the stock bubble popped and the relationship between housing and mortgage-backed securities started to realize itself. At the same time, Long-Term Capital Management, which invested heavily in derivatives, failed during Clinton's tenure (he couldn't come up with the name in the interview), and apparently this led Clinton to approach Alan Greenspan on the subject, who predictably said that derivatives were a niche market. In other words, Clinton deferred to Greenspan. So how would he have stopped the bubble from inflating, then? I can't see Clinton having bungled the issue as much as Bush, but while his instincts were solid, the follow-through, not so much.

Meanwhile, we have the benefit of hindsight now, and certainly a desire to regulate derivatives. Which makes the banksters unhappy:

For credit-default swaps, information about intraday trades and prices has long been controlled by a handful of large banks that handle most trades and earn bigger profits from every transaction they facilitate if prices aren't easily accessible.

For example, credit-default swaps tied to bonds of companies such as General Electric Capital and Goldman Sachs typically have a pricing gap of 0.1 percentage point between the bid and offer price. That translates into a $40,000 margin for every $10 million in debt insured for five years. Greater price transparency could narrow that gap, lowering costs for buyers and sellers but reducing fees for banks.

Just so you know who's looking out for you. Now, if the banksters still run the place, as Dick Durbin said, then everyone can be right about the dangers of the financial markets and it wouldn't amoung to a hill of beans.

Brooksley Born And The Financial-Political Complex

I almost missed this one yesterday, but the WaPo had a profile of Brooksley Born, the lawyer who, while the Clinton Administration's Chairman of the Commodity Futures Trading Commission, foresaw the coming crisis in unregulated derivatives, including credit default swaps, and staged an ultimately futile campaign to rein them in. Within this article are some of the most fascinating and unbelievable quotes from the men who led our financial efforts then - and some who continue to do so now.

You expect a house organ like the Wall Street Journal to respond to Born's concern over derivatives by saying, "the nation's top financial regulators wish Brooksley Born would just shut up." But this line just absolutely floored me:

Born's baptism as a new agency head in 1996 came in the form of an invitation. Federal Reserve Chairman Alan Greenspan -- routinely hailed as a "genius," the "maestro," the "Oracle" -- wanted her to come over for lunch.

Greenspan had an unusual take on market fraud, Born recounted: "He explained there wasn't a need for a law against fraud because if a floor broker was committing fraud, the customer would figure it out and stop doing business with him."

This is the Randian mindset of the perfection of the market that has caused so much pain for so many millions of people. Greenspan either was literally so in thrall to the Masters of the Universe and his perfect little system that he found greed written out of the program, or so clever that he used transparently idiotic theories to simply allow legalized theft. Either way, everyone should know that this is the philosophy under which the United States, and really the world, financial system operated for three decades, directly from the mouth of its most powerful practitioner. Andrea Mitchell should resign in shame.

Sadly, however, it doesn't stop there.

That was just the beginning. By early 1998, Born had also tangled with Treasury Secretary Robert Rubin, his deputy, Summers, and Securities and Exchange Commission head Arthur Levitt, not to mention members of Congress, financial industry heavyweights and business columnists. She wanted to release a "concept paper" -- essentially a set of questions -- that explored whether there should be regulation of over-the-counter derivatives. (Derivatives are so-named because they derive their value from something else, such as currency or bond rates.)

They warned that if she did so, the market would implode and predicted tidal waves of lawsuits. On top of that, Rubin told her, she didn't have legal authority to regulate the derivatives anyway [...]

In early 1998, Born's plan to release her concept paper was turning into a showdown. Financial industry executives howled, streaming into her office to try to talk her out of it. Summers, then the deputy Treasury secretary, mounted a campaign against it, CFTC officials recalled.

"Larry Summers expressed himself several times, very strongly, that this was something we should back down from," Waldman recalled.

In one call, Summers said, "I have 13 bankers in my office and they say if you go forward with this you will cause the worst financial crisis since World War II," recounted Greenberger, a University of Maryland law school professor who was Born's director of the Division of Trading and Markets. Summers declined to comment for this article.

The discordant notes crescendoed in April 1998 during a tension-filled meeting of the President's Working Group, a gathering of top financial regulators that periodically met behind closed doors at the Treasury Department. At that meeting, Greenspan and Rubin forcefully opposed Born's plans, Waldman said.

"Greenspan was saying we shouldn't do it," Waldman recalled. "Rubin was saying we couldn't do it."

The rest of it reads like a Hollywood potboiler, with Born trying to outmaneuver her more powerful counterparts, ultimately falling short even after being partially vindicated by the failure of Long Term Capital Management, and finally resigning. We're living with the consequences.

But surely you recognize some of the Democratic named involved in shutting Born down. Now let that color your impressions of this report (subs. req.):

Some banks are prodding the government to let them use public money to help buy troubled assets from the banks themselves.

Banking trade groups are lobbying the Federal Deposit Insurance Corp. for permission to bid on the same assets that the banks would put up for sale as part of the government's Public Private Investment Program.

The lobbying push is aimed at the Legacy Loans Program, which will use about half of the government's overall PPIP infusion to facilitate the sale of whole loans such as residential and commercial mortgages [...]

Some critics see the proposal as an example of banks trying to profit through financial engineering at taxpayer expense, because the government would subsidize the asset purchases.

Surely, Larry Summers would follow the refrain of the Maestro, that there couldn't possibly be any fraud because the customer would figure it out and stop doing the business. Of course, in this case, the "customer" and the vendor are... the same people.

James Kwak has more on this plan, which I pretty much expected (what's to stop the banks from using shell companies to buy up their own assets at the right price, with government guarantees, even if the Feds break precedent and reject this?). Kwak has a good short version of this: "It allows a bank to sell half of its toxic loans to Treasury – at a price set by the bank."

And he wants Tim Geithner and Sheila Bair to reject this. But the experience of Brooksley Born suggests that the problem with the incestuous political-financial complex is one of mindset. They view the goals of the banksters as superior to the goals of the country, or at best relatively aligned. And thus, regulating those complex financial instruments, or blocking clear giveaways of public money, somehow equals hurting the greater economy. Whether through dime-store philosophy or simply looking out for the interests of the wealthy - and themselves - we've become completely subservient to oligarchs who clearly value their success over that of the country. Which is fine for them - but there's nobody advocating for the greater public, warning of the dangers of runaway capitalism, arguing for a return to the core mission of finance, to smoothly flow capital to those who need it, rather than the Wild West show we still see today. In other words, there are no more Brooksley Borns. And even if there were, the system is so rotted that not even someone of her talent and determination can get the message through. Despite the worst financial crisis since the Depression.

But never mind, because we have "green shoots."

Here's the coda to the Born article, by the way:

Born keeps informed, but she has other concerns, bird-watching jaunts and trips to Antarctica to plan, mystery novels to read, four grandchildren to dote on. "I'm very happily retired," she says. "I've really enjoyed getting older. You don't have ambition. You know who you are."

More From Populist Obama

I don't know if it's residual anger over the bondholder revolt or what, but the President does seem to be formulating some legitimate steps to regulate the financial industry. First off, he wants to deal with derivatives:

In its first detailed effort to overhaul financial regulations, the Obama administration on Wednesday sought new authority over the complex financial instruments, known as derivatives, that were a major cause of the financial crisis and have gone largely unregulated for decades.

The administration asked Congress to move quickly on legislation that would allow federal oversight of many kinds of exotic instruments, including credit-default swaps, the insurance contracts that caused the near-collapse of the American International Group.

The Treasury secretary, Timothy F. Geithner, said the measure should require swaps and other types of derivatives to be traded on exchanges or clearinghouses and backed by capital reserves, much like the capital cushions that banks must set aside in case a borrower defaults on a loan. Taken together, the rules would probably make it more expensive for issuers, dealers and buyers alike to participate in the derivatives markets.

As it is now, there are $70 trillion dollars exposed in the derivatives market, more than all the money in the world. Without the need to back up the exchange with capital ratios, these things happen. Traditionally, regulations like this hold for a few years until the Big Money Boyz figure out a way to get around them. But this would essentially stop dead the shadow banking system, a major element of the crisis.

And then we have the Big Kahuna: CEO compensation, and a real effort to limit executive pay:

Obama Administration officials are contemplating a major overhaul of the compensation practices in the financial services industry, moving beyond banks to include more loosely regulated hedge funds and private equity firms.

Federal policymakers have been discussing ways to ensure that pay is more closely linked to performance.

Among the ideas under consideration are incorporating compensation as a “safety and soundness” concern on official bank examinations as well as expanding the existing regulatory powers of the Securities and Exchange Commission and Federal Reserve to obtain more information.

Obviously the issue with regulation is who the regulators are. We had plenty of regulations on the books that could have mitigated the financial crisis, but the regulators looked the other way. I mean, the NY Fed apparently knew about the AIG bonuses when Tim Geithner was at the helm. So while I appreciate the attempt, I have to see some teeth out of the oversight before I believe it will solve the problem.

I Keep Forgetting To Regulate*

As much debate and consternation as there has been over the Geithner plan for toxic assets, we are seeing today a move forward on overhauling financial rules, which to my not-economist ears sounds fairly good. In particular, regulating hedge funds and CDS traders makes a ton of sense.

WASHINGTON — The Obama administration will detail on Thursday a wide-ranging plan to overhaul financial regulation by subjecting hedge funds and traders of exotic financial instruments, now among the biggest and most freewheeling players on Wall Street, to potentially strict new government supervision, officials said.

The plan, which would require Congressional approval, would give the government vast new powers over “systemically important” banks and other financial institutions that are so big that their collapse would jeopardize the economy as a whole.

The government would have the power to peer into the inner workings of companies that currently escape most federal supervision — insurance companies like the American International Group, multibillion-dollar hedge funds like the Citadel Group and private equity firms like the Carlyle Group or Kohlberg, Kravis & Roberts.

If regulators decided that a company had become “too big to fail,” as was the case with A.I.G. in September, they would subject it to much stricter capital requirements than smaller rivals and much closer scrutiny of its borrowing levels and its trading partners, or counterparties.

But the most striking new proposals, and the ones that may provoke the most heated opposition from the industry, would regulate so-called private pools of capital — hedge funds, private equity funds and venture capital funds — and the gigantic market in financial derivatives, including instruments like credit-default swaps, the insurancelike instruments that allow investors to hedge against bond defaults.

Hedge funds and private equity funds manage money for wealthy individuals and institutions like pension funds. They operate almost entirely outside the regulation of either the Securities and Exchange Commission or the Federal Reserve.

Under the administration proposal, hedge fund, private equity and venture capital fund advisers would for the first time have to register with the S.E.C. They would be required to provide the government — on a confidential basis — information on how much they borrow to leverage their investments as well as information about their investors and trading partners.

The S.E.C. would then share those reports with a new “systemic risk regulator.” At least for the moment, Mr. Geithner is ducking the crucial question of who the powerful risk regulator should be, a contentious issue among Democratic lawmakers.

A plan, of course, is one thing - getting it through Congress is quite another. And there's a compelling strain of thought that the laws on the books today could have stopped much of this crisis, and what we actually lack is regulatory will. Perhaps taking this completely out of the realm of politics AND Wall Street - I've no idea how, maybe hiring the Blue Moon Detective Agency - would help, but essentially the regulators have to WANT to regulate to protect the public. And yet, we have the elites we have:

Joe Donnelly asked Tim Geithner whether we ought to eliminate naked default swaps. Geithner said that it's too hard to distinguish hedges from gambling. Donnelly pointed out that we're taking money out of truck drivers' pockets and waitress' pockets to pay off Wall Street's gambling debts. Ultimately, though, Geithner said we don't need to--and that it would be very hard to--do that.

I guess the truck drivers will still be asked to pay off rich men's gambling debts.

Maybe Lord Stern's idea for an independent international body with an endowment and no possibility of recall makes the most sense. Because I don't have a lot of trust in anything resembling independence on this side of the pond.

* - Anyone who knows the provenance of the headline gets a cookie.

Shorter Andrew Sorkin: Leave AIG ALOOOONE

Andrew Sorkin tried to defend the indefensible today and make the case for the AIG bonuses, on the grounds that contracts must be honored.

That may strike many people as a bit of convenient legalese, but maybe there is something to it. If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

As much as we might want to void those A.I.G. pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is. Business agreements of other companies that have taken taxpayer money might fall into question. Even companies that have not turned to Washington might seize the opportunity to break inconvenient contracts.

If government officials were to break the contracts, they would be “breaking a bond,” Ms. Meyer says. “They are raising a whole new question about the trust and commitment organizations have to their employees.” (The auto industry unions are facing a similar issue — but the big difference is that there is a negotiation; no one is unilaterally tearing up contracts.)

That just seems wrong to me. Government did not write this bonus contract. I have no doubt that unscrupulous business types would use this as a pretext to wriggle out of their own contracts, but that doesn't mean it would be successful. And in fact, the parallel to the auto industry is perfectly analogous, because nobody is actually talking about breaking the contract but using taxpayer bailout money as leverage to force the outcome, which is what was done there. If this tax law to claw back AIG bonuses is pushed through, in fact the contract wouldn't be broken at all. So this sanctity of the contract strikes me as bogus. Furthermore, taking a stand now against exorbitant bonuses for bailed-out companies will serve as a deterrent to those who would search for loopholes in executive compensation caps and bonuses in the future.

Then there's Sorkin's second point.

But what about the commitment to taxpayers? Here is the second, perhaps more sobering thought: A.I.G. built this bomb, and it may be the only outfit that really knows how to defuse it.

A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.

So as unpalatable as it seems, taxpayers need to keep some of these brainiacs in their seats, if only to prevent them from turning against the company. In the end, we may actually be better off if they can figure out how to unwind these tricky investments.

Certainly the idea that the only people who can properly unwind these derivatives are the ones who wrote them is hard to swallow. It also doesn't entirely make sense.

That’s nonsensical. It’s clear they made a lot of mistakes and we need to undo what they did. If they really understood what they did in the first place, seriously, they probably wouldn’t have done much of it. Secondly, when you are trying to undo something, it is often not the case that the people who did it are the ones to put in place. People are sometimes committed to not admitting mistakes. … So that argument I think is in fact almost counter, because the argument that you take the people who made the mistake and put them in charge of undoing the mistake goes against the human impulse not to admit a mistake.

Sorkin just seems to be calling for a unilateral protection of elites because of their superior experience and intellect. I agree that it takes smarts to destroy your company AND get a bonus of well over a million dollars - some of which were retention bonuses which the individuals responded to by LEAVING THE COMPANY. But trusting them again to put the national interest ahead of self-interest just seems unwise.

If you truly want to throw up, read that report by Andrew Cuomo on who got the bonuses. This is ugly.