Letting Wall Street off the hook

July 27, 2010

Petrino DiLeo analyzes the financial reform bill that Barack Obama signed into law.

"SPEAK SOFTLY and carry a big stick." That was a phrase coined by President Theodore Roosevelt to describe the foreign policy of the American empire.

A century later, the Obama administration seems to have adopted Roosevelt's slogan in its dealings with the Wall Street financial system--but with a few changes. The White House strategy toward Wall Street can be summed up as: "Speak loudly, and carry nothing at all."

The Obama administration and Democrats in Congress are hailing financial reform legislation--known as the Dodd-Frank bill, after its sponsors, Sen. Christopher Dodd and Rep. Barney Frank--as the "toughest" measures taken to regulate the big banks and financial markets since the Great Depression.

In order to further underline the administration's "hard line," a few days before Barack Obama signed the bill, the Securities and Exchange Commission (SEC) made a big show of announcing the settlement of a fraud complaint against super-bank Goldman Sachs. The complaint concerned Goldman's scheme, cooked up with hedge fund boss John Paulson, to create an investment that was designed to fail, thereby enriching Paulson and Goldman.

Democrats Barney Frank, Nancy Pelosi and Chris Dodd at a signing ceremony for the financial reform bill
Democrats Barney Frank, Nancy Pelosi and Chris Dodd at a signing ceremony for the financial reform bill

But the $550 million settlement with the SEC, though unprecedented, is chump change for a firm that posted more than $16 billion in revenues in the first six months of 2010 alone--and that paid another $16 billion in employee bonuses in 2009.

Like the Goldman suit, the Wall Street reform law that Obama signed to great fanfare won't cause more than a ripple on Wall Street.

The 2,300-page bill took fairly simple ideas--such as banning trading by banks on their own behalf rather than for customers; regulating the highly complex investments known as derivatives; and breaking up financial institutions that have become "too big to fail"--and added dozens and dozens of loopholes and conditions that completely undermined the final product.

Plus, huge problem areas aren't addressed at all by the law. There's nothing to rein in runaway executive compensation on Wall Street--the issue where public anger is strongest. Little has been done about forcing banks to drop their purposely deceptive accounting practices, or to reform credit agencies like Moody's, which aided and abetted the banksters.

At a time when most of the public holds Wall Street in contempt, the Democratic Congress managed to pass a law that safeguards the interests of the financial world above all else.

As on other issues, Republicans opposed any and all proposals on Wall Street reform--with the hypocritical claim that the first party of American business didn't want a law that would "perpetuate bailouts." Not a single Republican in the House of Representatives voted for the Dodd-Frank bill, and Republican senators held the legislation to ransom with filibuster threats.

But rather than call out the Republicans for their obstructionism, Democrats eagerly chipped away at the already weakened legislation, discarding one provision after another over the past month.

THE DEBATE on how to reform the financial system following the Wall Street collapse--symbolized by the bankruptcies of investment banks Bear Stearns and Lehman Brothers in 2008--centered on three ideas.

One was that banks needed to reduce their "leverage"--meaning they needed more cash relative to debts or liabilities. At the peak of the crisis, some investment banks were leveraged at a 40-1 ratio--meaning they had $40 of liabilities for every $1 of cash on hand. So when the losses began piling up after the housing market went sour, the banks were quickly in trouble.

A second idea was that investment banking and commercial banking needed to be split again, as they were for the bulk of the 20th century, from the passage of the Glass-Steagall Act during the Great Depression to the era of deregulation under Bill Clinton in the 1990s.

The third idea, voiced even in the most conservative business press at the low point of the Wall Street crisis, was that banks couldn't be allowed to grow so big and powerful that their collapse threatened the breakdown of the whole system. The government therefore needed greater powers to break up "too big to fail" banks.

The Dodd-Frank bill failed to deliver on any of these ideas. Instead, it's a hodge-podge of half-measures that will do little to alter Wall Street's business practices, much less prevent another major crisis.

Consider the fate of the much-talked-about Volcker Rule--a proposal by former Federal Reserve Chair Paul Volcker to bar banks from making investments not on behalf of customers and from sponsoring or participating in hedge funds and private equity funds. Volcker saw this proposal as a way to reinstate Glass-Steagall in spirit, if not in letter.

But the Volcker rule didn't survive the final weeks of wheeling and dealing before the legislation passed. John Cassidy wrote in the New Yorker:

As the deliberations on Capitol Hill extended through the night of June 24th, the financial lobby exacted several more concessions, including a change in the definition of the 3 percent limit on investments in hedge funds and private-equity funds. To outsiders, the switch in language from "tangible common equity" to "Tier 1 capital" signified nothing. For the banks, it meant that they could increase by up to 40 percent the amount of money put into risky investment vehicles.

Not only were the restrictions on banks' activities weakened, but Democrats agreed to a 12-year delay--yes, that's 2022--before what's left of the Volker Rule is put in place. The bankers' lobbyists claimed they needed more time to adjust to the new regulations, but Congress' concession gives them more than a decade to pressure Congress for even more loopholes and changes.

When it comes to the complex financial gambles that Wall Street calls derivatives, a strict rule included in the Senate's version of the bill that would have banned deposit-taking banks from being in the derivatives trading business was watered down. In the end, banks will be able to maintain trading operations on particular investments, or as long as they are used to "hedge risk." In other words, the restriction is open to interpretation.

Another item removed from the legislation was a proposed $19 billion fee that would have collected from banks and hedge funds over a five-year period to pay for the cost of the legislation. Republicans threatened to filibuster the bill, saying they couldn't support anything that could perceived as a tax increase--and the Democrats quickly caved.

To put this in perspective, the proposed fee amounts to about 0.1 percent of the $14 trillion that the federal government devoted to the financial industry in the form of bailouts, loans and guarantees since late 2008.

IN THE end, the Dodd-Frank law doesn't make any significant structural changes to the financial system. At most, it increases the power of some regulators to constrain--or not constrain--Wall Street's behavior.

So how Wall Street moves forward will depend more on the political appointees then the letter of the law. And on that point, it's crystal clear already that Barack Obama has no intention of appointing regulators who will challenge financial institutions.

The administration's subservience to Wall Street was clear even in the immediate aftermath of the bill's passage. Financial firms have mounted a campaign to block Elizabeth Warren from heading the newly formed Bureau of Consumer Financial Protection, apparently out of a fear that Warren might actually attempt to fight fraud.

The administration and Treasury Secretary Timothy Geithner first attempted to have a consumer protection agency removed from the bill entirely. Having failed at that, the White House at least succeeded in having the bureau put under the oversight of the Federal Reserve. The Fed answers directly to the banks, so the consumer protection bureau will be hamstrung from the start.

But apparently even that's not enough for Wall Street. They want the board headed up by someone more subservient than Warren, the chair of the Congressional Oversight Panel created to investigate the how funds from the $750 billion Wall Street bailout were distributed, and a loud critic of Wall Street.

The outcome of financial reform legislation shows clearly that Washington and Wall Street remain inextricably linked. As James Kwak, cofounder of the Baseline Scenario blog, wrote:

The underlying problem is that the bill doesn't do anything to change the basic balance of power between Wall Street and Washington, which is partly based on the fact that it's a lot better to be a banker than to be a regulator, and the only reason to be a regulator (if you believe in free-market incentives) is so you can then become a banker.

Sen. Dick Durbin put his finger on the truth last year: "[T]he banks--hard to believe in a time when we're facing a banking crisis that many of the banks created--are still the most powerful lobby on Capitol Hill. And they frankly own the place."

So it's no surprise that Wall Street won't be significantly affected by Wall Street "reform."

The kind of proposals that really need to be taken up--breaking up "too big to fail" banks immediately, nationalizing the financial system entirely and running it as a public utility, redirecting money from financial speculation and Wall Street bonuses toward job creation and public services--will need to be put forward by a mass movement from below.

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