As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Saturday, June 20, 2009

The Inconvenient Truth On Financial Regulations

I cannot say that I am a perfect expert about financial regulation, but I can read critically. And the consensus from those trusted sources appears to be "decent, not great, not a fundamental reshaping of the financial system." Paul Krugman:

Yes, the plan would plug some big holes in regulation. But as described, it wouldn’t end the skewed incentives that made the current crisis inevitable [...]

One thing financial reform must do, then, is bring non-bank banking out of the shadows.

The Obama plan does this by giving the Federal Reserve the power to regulate any large financial institution it deems “systemically important” — that is, able to create havoc if it fails — whether or not that institution is a traditional bank. Such institutions would be required to hold relatively large amounts of capital to cover possible losses, relatively large amounts of cash to cover possible demands from creditors, and so on.

Good stuff. But what about the broader problem of financial excess? [...]

True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly.

But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards?

Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.

Steven Pearlstein:

Does anyone seriously think the United States would be reduced to a second-rate economic power if there weren't any CDOs of CDOs, or if the number of credit default swaps on General Electric bonds were limited to the number of outstanding General Electric bonds, or if reasonable leverage limits were put on hedge funds, private-equity funds or structured investment vehicles?

Is there any reason ratings agencies should continue to be paid by the companies that issue securities rather than the investors who buy and trade them?

And is it too much to ask that, in a globalized economy, banks and insurance companies engaged primarily in interstate commerce be required to get federal charters and have federal officials as their primary regulators?

Robert Reich:

The plan doesn't stop stop bankers from making huge, risky bets with other peoples’ money. It does increase capital requirements and oversight, but it doesn't require bankers to take their pay in long-term stock options or warrants, and it doesn't even hint that banks should go back to being partnerships instead of publicly held corporations.

All this means traders still have very incentive to place big and often wildly risky bets as long as the potential winnings are big enough, and top executives have very little incentive to monitor what traders are up to as long as the traders are collecting large commissions on the bets [...]

In short: It's a mere filigree of reform, a sheer gossamer of government. Wall Street must be toasting its good fortune. Unless Congress shows some spine, the great Wall Street meltdown of 2007 and 2008 -- which led to the biggest taxpayer bailout in history, very likely the largest taxpayer losses on record, and the largest investor losses since 1929 -- will repeat itself within a decade, if not sooner.


Of course, you have to feel for the Administration here. Already, their pre-compromised plan has been assailed by lawmakers, mainly out of concern about the centralization of power in the Federal Reserve. I agree to an extent with those Congressmen, in that the Fed is financed by banks and asleep during the last crisis. But there's not much alternative. And surely, consolidating additional regulators and agencies would produce similar wailing. And the lobbyists are ready to gut whatever meager protections exist in this proposal. It seems like the preferred options, the ones with a chance of working, could easily get stuffed by the people that "own the place." And in addition, the regulatory structure matters, but so does the nature of the regulators and their willingness to crack down on bad practices. To wit:

The question with this package is not if it’s well-suited to a world where regulators want to regulate. It’s if it’s well-suited to a world in which they don’t. A world in which growth is quick and greed looks good. A world in which Wall Street seems to be helping Main Street buy, if not houses, then a surprising number of wind turbines. One of the lessons of the past few years is that regulation has to be impartial and disinterested because regulators, and even Fed chairman, get swept up in the cultural manias behind asset bubbles as surely as traders do.

The other issue here, the great unmentionable, is that we actually know, in a sense, how to deal with the perverse incentives of the banks, more concerned with personal financial aggrandizement than the health of their organizations. You can talk about paying for performance and bringing compensation structures on Wall Street in line with those in Silicon Valley. But in the end, there's a really easy way to deal with this problem, which is a legitimate one that expands income inequality and rewards unsustainable risk. Chris Hayes explains.

Bloated CEO salaries aren't exactly new, but why they persist is harder to explain than you might think. Every dollar paid to an executive above his or her actual worth comes from the pockets of the shareholders. And while workers may be too beaten down to fight back, investors aren't exactly a powerless class in America. Why, then, do they allow clubby compensation committees and consultants to pick their pockets?

Part of the problem is the raw difficulty of figuring out how much value a particular CEO adds to a company. There's also a legal structure that attenuates shareholder power. But there's a deeper issue. CEO pay is to corporate governance what farm subsidies are to the federal government: the benefit accrues to a small group (CEOs or big agricultural concerns like Monsanto) while the cost--whether to shareholders or taxpayers--is shared widely [...]

As needed as many of these reforms are, whatever rules are put in place, CEOs will have massive incentives to skirt them. Which is why, finally, much of the solution must be found in the tax code. In 1980, before Ronald Reagan inaugurated the supply-side counterrevolution in taxation, the top rate for individuals was 70 percent. When taxation took 70 cents of every dollar made above a certain amount, there was far less incentive to game the system for giant payouts. By 1988, though, the rate was 28 percent. It has fluctuated between 30 percent and 35 percent under the past two presidents, while capital gains and other wealth taxes have steadily declined.

During the financial services hearing, as Republican after Republican railed against the specter of government bureaucrats micromanaging pay--down to "secretaries and janitors" in the fevered imagination of Illinois Representative Judy Biggert--part of me wondered if perhaps they had a point. Regulating executive compensation might have the same balloon-squeezing effect as bonus caps. And besides, it's easier for executives to game the compensation committee and shareholders than the IRS. So maybe we should let executives make as much as they can wrangle. We just need to make sure we then tax the hell out of them.

Corporate boards hold the power on executive compensation, and that's become an old boys network. The way the federal government can manage inequality is through the tax code.

That has an odd ring to post-Reagan ears, doesn't it?

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