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What Does Real Reform Look Like

Well, it looks like we are getting another sorry, weak-ass legislation called “reform”.  First health care or health insurance and now financial regulatory reform.  The House of Representatives passed its weak version of financial regulatory reform last December and now the Senate is working on passing an even weaker version.  But, what would real reform look like?

Please excuse the slight digression.  The Obama Administration lost me as a supporter early on when then President-elect Obama picked Clinton retreads Larry Summers and Tim Geithner to be part of his administration.  In my opinion, the Obama Administration has become part of the problem not the solution whether its the mortgage crisis or financial regulatory reform. 

The Obama Administration, much like it handling of health insurance “reform” is either telling us what we want to hear and acting the opposite or its refuses to fight for a set of principles.  His supporters will argue he is being pragmatic or realistic based on how screwed up Congress is. 

Last year as the house was starting debate of its financial regulatory “reform”, the President gave a speech in support of strong financial regulatory reform particularly in a Consumer Financial Protection Agency and he specifcally mentioned the importance of a “plain vanilla” financial products requirement but someone failed to mention to the President that days or a week before speech Congressman Barney Frank had already eliminated the requirement of the House’s legislative version.  That was the last we heard of the requirement. 

Remember when the President used the phrase of “Wall Street Fat Cats”.  Wow, sounds like he was ready to take Wall Street on - nay.  Days later he softened his words toward Wall Street.  Then comes the “Volcker Rule”.  In January, to much fanfare, the Obama Administration was proposing legislation that would restrict banks from speculative trading that did not benefit its customers.  Sounded good at the time but the devil is in the details particularly when it comes to Senate’s version of “reform”:

[Senator Chris] Dodd’s bill stops short of implementing the Volcker Rule. Instead, it requires that the government “shall issue final regulations implementing” the ban.

The best way to avoid or weaken a potentially strong rule is to leave it to the discretion of regulators.  And what is the White House saying about all this weakening - nothing or worse.  As Simon Johnson pointed out this past week the rhetoric from the Administration and what is actually in the Senate’s legislation don’t jive.  This past Sunday, Larry Summers was singing the praises of the Senate’s version of “reform” on ABC’s This Week but Professor Johnson points out inconsistencies with Summer’s spin:

Larry Summers is incorrect on three important dimensions of the Dodd legislation: it doesn’t “insist institutions have much more” capital requirements, it doesn’t “restrict proprietary trading activities” in any meaningful fashion, and it doesn’t “eliminate the prospect” of a bailout.

Bottomline: From Professor Johnson:

Passing a bill that contains mostly mush is not a good idea – it would only further the perception (and the reality) that this administration is far too close to certain “savvy businessmen” on Wall Street.

So, where are we with the financial regulatory “reform”?  The House passed its weak version last December and Senate is about to amend and vote on its even weaker version very soon.  For a good summary of what is on the table there are the following articles:

Breaking the Bank
Updates on the battle for financial reform
Comparing the House and Senate Financial Reform Bills

What does REAL reform look like?

1)  Consumer Financial Protection Agency - an independent agency with rule making and enforcement authority with very few exempts from oversight and lifting of any federal pre-emption of state consumer laws. 

2)  Derivative Regulatory Reform -  ‘Over the Counter’ (OTC) trading in credit default swap derivatives, or C.D.S.’s, brought down the House of Cards that was the global financial industry and how we deal with derivatives going forward will determine whether we will experience another global financial crisis or not.  Real derivatives reform at the very least should mean the repeal of the Commodities Futures Modernization Act of 2000.
3)  Too Big to Fail - it doesn’t sound like there is the political courage to break up the financial conglomerates so let me put on my pragmatist hat (LOL).  The objective should be to impose a cost on financial conglomerates that are Too Big to Fail and possibly force them to become smaller.  One way to do this is through specific capital and liquidity requirements placed on the asset side of banks balance sheet:

Capital requirements place a limit on the leverage ratios that banks can run with and thus attempt to limit risk-taking. They also constrain the size of the banks because capital is costly. Finally, they reduce the public-private partnership ratio inherent in any banking system where governments will bail out the depositors in event of failure. The higher the capital held against its assets the more the shareholders are exposed to bank failure.

These capital and liquidity requirements must be specific and not left to the discretion of regulators - somewhat similar to Congresswoman Jackie Speier’s amendment.

The other reform would be a hard rule - meaning a specific law (no discretion left to regulators) that bans any speculative trading that is contrary or in conflict with clients - banks cannot advise clients to invest in certain holdings and then take an opposite investment position - essentially betting against the client’s position. 

4)  Rating Agencies - make it illegal for rating agencies to obtain a fee for ratings from issuers of securities.  Many investors rely too heavily on the ratings issued by Moody’s, S&P and Fitch.  These rating agencies receive a fee for their rating services from the issuers whose securities they are analyzing and rating - huge potential conflict of interest.  This was a very lucrative business for rating agencies and it’s not surprising that because of this payment practice we heard stories like this: How Moody’s sold its ratings - and sold out investors

It’s time to draw that proverbial line in the sand.  Anything short of this is NOT real reform.  How’s that for Change to believe in?