Wall St reform fails to bring real change

PUBLISHED : Tuesday, 20 July, 2010, 12:00am
UPDATED : Tuesday, 20 July, 2010, 12:00am

Champagne cork headlines were popping all over the mainstream US media last week when the senate finally passed financial reform measures variously described as 'a sweeping overhaul of the big banks ... the biggest changes for generations ... the greatest clean-up since the Great Depression ... leaving few corners of the financial industry untouched'.

Headline comments such as those should leave you worried about the critical faculties of the media as well as their gullibility to spin from Wall Street and the White House. The truth is that this piece of legislation - which President Barack Obama is likely to sign into law this week - contains equal parts of vinegar along with the bubbles.

It fails to address the key question of financial institutions that are 'too big to fail'. It also puts too many powers into the hands of Treasury Secretary Timothy Geithner, who has not shown an ability to keep a proper distance from Wall Street, and too much faith in the ability of regulators to be able to spot the next impending crisis before it erupts.

In addition, a rough football game is still being played over capital requirements for financial institutions, in which Americans, Europeans and developing countries are showing cheating skills and abilities in professional fouls that would cause World Cup footballers to blush. Stricter global capital requirements for banks should already have been in place, but have now been postponed until 2013 or later.

Senator Christopher Dodd, who was responsible for getting the measures passed in the senate, proclaimed that Americans' faith could now be restored in the financial system that was close to collapse only two years ago.

'More than anything else, my goal was, from the very beginning, to create a structure and an architecture reflective of the 21st century in which we live, but also one that would rebuild trust and confidence,' he said.

As to its positive details, the Dodd-Frank bill, named after Dodd and Barney Frank, who was responsible for its passage in the House of Representatives, will establish an independent consumer bureau inside the US Federal Reserve to protect customers from abuses in matters such as mortgages, credit cards and other loan products, though notably car dealers will be outside its scrutiny.

Federal regulators will have new powers to seize or close big financial companies that are running into trouble, while a new council of regulators will be set up to try to anticipate threats to the financial system. Companies that are regarded as systemically significant will face stricter capital and liquidity requirements and have to draw up a 'living will' to show how they would be broken up in case of failure.

Derivatives, the complex multi-trillion dollar market that brought many giant financial houses to their knees, will be subject to government supervision and will be traded in clearing-houses or on exchanges. Prices of trillions of dollars of credit default swaps will have to be disclosed rather than set in secret.

Under the Volcker Rule, named after former US Federal Reserve chairman Paul Volcker, banks will be limited as to the proprietary trading and ownership of hedge funds that they can do on their own account.

Yet it is hard to see any significant changes in the financial architecture. Indeed, the major familiar financial names have simply got bigger since the crisis as they have swallowed up the failed banks whole or gobbled their remaining profitable parts. There are now just six major financial companies in the US today with more tentacles than an octopus reaching to all major aspects of the financial business.

There was no radical revision of the system, no attempt to understand why the system had gone wrong in the first place and no effort to undertake a redesign. This is one reason why the reforms do not approach the Glass-Steagall provisions of the 1930s, which set up strict barriers between commercial banking and stock market businesses.

The Glass-Steagall wall was breached in the 1980s as banks got big enough and clever enough to find ways of getting over or round its provisions and was dismantled in the 1990s under the aegis of president Bill Clinton and his treasury secretaries, Robert Rubin and Larry Summers.

This is why commentators who claim these are the boldest measures for generations are plain wrong. At best, they are an attempt to curb the excesses that the Clinton-Rubin-Summers deregulations encouraged - cosmetic changes maybe, but nothing as radical as a facelift.

In a tongue-in-cheek comment, respected blogger Mike Shedlock, claimed the financial reform bill is a 'stunning success' because it accomplishes nothing, which is an improvement on other pieces of legislation that tend to do more harm than good. He claims: 'There is not a single thing in the bill that can possibly be construed to have prevented the last crisis ... There is not a single thing in the bill that can possibly do anything to prevent the next crisis.'

As to derivatives reform and curbs on banks trading on their own account, there are loopholes and exceptions, for example allowing the setting up of separate offshoots that can trade in excess of the 3 per cent limit for the banks themselves.

The critical issue is whether the regulators can use their new teeth and show hitherto unsuspected foresight actually to see troubles ahead of time and then have the guts to take firm measures.

What should still be worrying is the close nexus between Wall Street and Washington. On the side of Wall Street - as in the City of London and other financial centres - there is no sign at all that bankers have any sense of shame that they almost caused a collapse of the global system or that they have lost their sense of entitlement to salaries astronomically larger than those of ordinary mortals.

In Washington, too many congressmen are funded by big financial institutions. Obama is earning something of a reputation for being hostile towards big business, but he seems to have an exceptionally soft spot for the financial industry. This may be because key players of the Clinton era, who dismantled the old regulations, still set Obama's economic policy.

Geithner has certainly accumulated vast powers to shape the new regulations, to create the consumer protection agency and appoint its members. Yet last week Geithner was widely leaked to be opposing the appointment of Harvard law professor Elizabeth Warren to head the consumer protection agency.

Warren has been the staunchest advocate of such an agency, but Geithner apparently wants someone more friendly to Wall Street - not a good sign for anyone hoping that the new financial measures would be real reforms.

Standing tall

The big companies have simply got bigger since the global crisis

The number of major financial companies in the US today: 6