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What did you do last night? I stayed up until the wee hours of the morning reading yet another thousand page bill, this one the Financial Regulation Bill. I don’t know why all this recent legislation is a thousand pages long; maybe that is what happens when you get too many lawyers in the Senate and on committee staffs.
Bill Length
This issue of the length of bills is becoming very serious. No citizen in their right mind (I was fighting off another flare-up of my disease last night and hoped reading the bill would put me to sleep–it didn’t it made me mad) is going to have time to read over a thousand pages of legislation. To ask them to do so is absurd and an insult to their family and job commitments.
If citizens cannot read the legislation then we become a democracy once removed. You’ve been hearing a lot about the Tea Party lately, well when the British Parliament passed Tea Act which inspired the original Boston Tea Party those opposed to the act helped to drum up opposition by posting the text in prominent public places and circulating it among the people. Americans were able to read what the British had done to them and it helped to inspire the grassroots opposition of which the Tea Party was the most famous example.
Can you imagine posting 1200 pages somewhere today? Can you imagine even standing long enough to read 1200 pages? If people themselves cannot read the legislation Congress passes then they have to rely on the word of others as to what is in it, which is part of the reason for the Era of Bad Feelings.
By now you have heard what is in the bill from your usual news source. If you are a liberal that means Keith Olbermann or some one like him. If you are a conservative that means Bill O’Reilly or Glen Beck. Now I doubt any of them read it either, so what they are telling you is probably coming from the poor staff person who got assigned to pour over those thousand plus pages, or more likely from news releases coming from the major parties.
As a child you probably played the game called telephone where you sat in a circle and someone passed a story to the person next to them and so on. The fun would come when the first person and the last person compared stories. Usually there was a lot of laughing as people and events got all mixed up by the time they got around the circle.
Well, government playing the circle game is no joke. Whose word do we take for what is in the bill? It is not too far-fetched to say next November’s election hinges on it. People will do what they always do when they don’t have the full story–they will get information from sources they trust. But when Republicans and Democrats, Olbermann and Beck disagree about the meaning of the bill there is no referee. You cannot take time to read the bill to see who is right.
For several years now surveys have shown an increasing distrust of government, no matter what your ideology. If we are going to continue to pass legislation no one can read that distrust is only going to get worse.
It’s About Time
I headlined this essay “It’s about time” because I have been saying for over a year the first thing the Obama Administration needed to do was to take care of the financial mess. Now we are finally seeing that after the health care struggle.
I suppose it is easy to Monday morning quarterback this strategy when you aren’t in the White House, but there is an old truism about leadership and that is, you deal with the important problems that you can get solved first. A new President has only so much good will after the election and after this election in particular people wanted to see action particularly on the economy.
Now we can debate whether health care is more important than financial reform–frankly without financial reform it does not matter what happens to health care–but no one would argue that health care reform was going to be the more difficult of the two issues to pass. The Democrats knew going in there was a serious split in their own party about the central issue of health care reform–a single payer system. Getting agreement was going to be tough.
My guess is the White House decided to use the so-called honeymoon period to try to get health care passed. The end result has been a precipitous drop in the President’s popularity, that of his party and of Congress. They got health care passed but only at a huge cost.
Now they go into the financial issue bruised and tired. Meanwhile the American people are wondering whether this President and this Congress can govern. Had they gone after financial reform first it would have been more difficult for the Republicans to have pulled their stalling tactics because the Democrats and the country are much more united around this issue than they were around health care.
My sense is that when historians examine this administration they will see the decision to go for health care first severely crippled this administration. Had they gone into health care with a victory on financial reform, plus the added point of being able to paint the GOP as obstructionist and friendly to Big Business it would have reframed the health care debate.
Sixty Votes
The Republicans are coming dangerously close to pushing the envelope on the sixty vote issue. It appears they are determined to stall every significant piece of legislation by insisting that the Democrats have sixty votes. It may pay some dividends in the short run, but in the long run the losers are the American people.
If, as they seem determined to do, they force the Democrats to finally evoke what has been called the nuclear option, it will have altered our system forever for it leaves America with two equally distasteful options: first, it means either party will need sixty votes to govern. Suppose, for example, by some miracle at the mid-term elections everything switched so the GOP had as many votes as the Democrats do now, do you suppose the Democrats will not play the same game? The second option is that you kill the filibuster forever so all votes become simply majority votes which is equally dangerous.
Yet can we blame the GOP for holding ranks? Here we come to the very heart of our republic where there are no easy answers. Our form of government has always been based on an uneasy balance between principle and compromise. At times both have gotten out of hand–pick your examples.
This is where we come in, the American people. It is easy for Democrats and liberals to accuse the Republicans of being obstructive, of being in the pockets of Wall Street, but a democracy is not both political parties it is all of us and we need to decide absent the rhetoric from both sides whether the Republican objections are valid or not.
The War of Words
A little over a week ago Senate Republican Leader Mitch McConnell stated:
The fact is, this bill wouldn’t solve the problems that led to the financial crisis. It would make them worse.
McConnell and the GOP’s objections revolve around two issues: first, the regulatory mechanism to reign in rogue firms and second, over what should happen to “too big to fail” firms who do fail.
Democrats, on the other hand, believe the Republicans are trying to water down the bill. The situation is shaping up as one of the most bizarre in political history. The Republicans, who usually favor open markets and less regulation and traditionally are seen as friends of Wall Street are accusing the Democrats of selling out, of putting the government on thehook to bail out the big banks. The Democrats say this is all rhetoric; the Republicans really have not changed.
Senator Judd Gregg of New Hampshire, who never has been one of the intellects of the Senate apparently did not get the message because he is still using the old script which says the Democrats are overregulating:
We shouldn’t put in place a regulatory regime that overly reacts and, as a result, significantly dampens our capacity to have the most vibrant capital and credit markets in the world.
If by now your head is spinning you are not alone. The New York Times tries to get to the heart of the dispute, but offers us little help in sorting it out;
Does the legislation still contain loopholes that could allow future taxpayer-financed bailouts of failed financial institutions?
This is where the thousand page bill causes real problems for those of us trying to sort it out. Because it is impossible to read it, who is right? McConnell ironically voiced the frustrations of the American people:
The days of taking the Democrats’ word for it are over.
If you are a Democrat just change the party and if you are an independent or skeptical of both parties just insert Washington. So whose word do we take? That–and a lot of pain–are what has kept me up reading the bill.
What Isn’t in the Bill
The easiest place to start is with what is not in the bill. Let me put my cards on the table and say this is not the bill I would have liked. In short it does not bring back Glass-Steagall or anything like it. For those of you who have not been following this blog, the Glass-Steagall Act was passed during the Great Depression because it was felt that one of the causes of the meltdown was that banks were investing in the stock market.
In his economic history of the Great Depression, John Kenneth Galbraith pointed out one of the causes was:
The large-scale corporate thimblerigging that was going on. This took a variety of forms, of which by far the most common was the organization of corporations to hold stock in yet other corporations, which in turn held stock in yet other corporations.
Galbraith would note:
During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts—Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing.
That was going on. This took a variety of forms, of which by far the most common was the organization of corporations to hold stock in yet other corporations, which in turn held stock in yet other corporations.
Galbraith cited one example that resonates today:
During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts—Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing.
Little could Galbraith have imagined that a half century after he wrote this that Goldman Sachs would again be in the headlines accused of wrongdoing that has an eerie–and scary–resemblance to what Galbraith wrote about.
Glass-Steagall was intended to prevent this “thimblerigging” but keeping banks out of the stock market. Unfortunately in 1999 in a bipartisan move Congress repealed Glass-Steagall and Bill Clinton signed the bill. Since then many have argued that we need to reinstate Glass-Steagall or something like it.
This bill does not do that. Nothing in it forbids banks from engaging in the kinds of practices that caused the crisis. Yes, there is regulation over derivatives (more on that in a second) but it does not FORBID banks from being involved in derivatives trading.
The second thing missing from the bill is an acknowledgment of the Riegle-Neal Act which forbids any bank from controlling more than 10% of the market. Right now at least three banks are in violation of this, but the bill does nothing to stop it nor does it provide penalties for these violations.
This is ironic in that both parties are viewing the centerpiece of the bill as preventing the “too big to fail” problems that plagued the financial crisis. Maybe I am just stupid but the way you prevent too big to fail is by enforcing the law that makes it a crime to be too big to fail.
The omission of both Glass-Steagall and Riegle-Neal from this bill show that for all the huffing and puffing coming from both parties about who really has the interests of the American people at heart, both of them apparently agree that banks should continue to be allowed to play the stock market and that law-breaking by banks is OK.
What is in the Bill
Ever since Carter Glass and Woodrow Wilson worked to create the Federal Reserve System there has been an argument over how banks should be regulated and who should regulate them. At the time of the debate over the Federal Reserve there were really three plans: first regulation by an elected body of citizens, second regulation by an appointed body of citizens and third, regulation by financial professionals.
Like the health care bill, the Financial Regulation Bill has a healthy appetite for creating new agencies and commissions. (More on this in a minute.) It creates an Office of Financial Research, a Financial Stability Oversight Council, a Data Center, an Analysis Center, an Orderly Liquidation Panel, an Office of National Insurance, an Investor Advisory Committee, an Office of Investor Advocate, a Bureau of Consumer Financial Protection, and a Consumer Advisory Board.
Who will serve on all these boards and commissions and what powers will they have? It would take an encyclopedia-size essay to run through all these but let’s look at the important ones. One of the problems with the recent crisis is not having good, unbiased data about the behavior of financial firms, so the Office of Financial Research is in theory a good idea, but does this bill get it right?
Much has been written about–and testified to–the financial crisis as the result of a crippling groupthink that has gripped economics. So you would think the research office would seek to prevent that. The director is appointed to a six year term by the President with the advice and consent of the Senate (p. 60). The Director then appoints the staff. All of this would suggest that rather than encouraging diverse views the research office will discourage them.
The second and perhaps most important body created in the bill is the Bureau of Consumer Financial Protection. Among the most important sections outlining its duties is Section 1025 : Supervision of very large banks, savings associations, and credit unions. This is the “too big to fail” legislation.
You have to read a thousand pages before you get to Section 1025. I don’t know if it is symbolic or not but 1025 begins on page 1066–the date of the famous Battle of Hastings when the Normans conquered England. What I find fascinating about this section is the language which begins:
This section shall apply to any covered person.
This is sad language to read for it lends the weight of Congress to the absurd notion that corporations are people, something the pro-business Supreme Court first broached in the famous Santa Clara Railroad decision (1886). While the Supreme Court has never overruled the case, in an influential article Justice Douglas wrote:
Corporations were now armed with constitutional prerogatives. And so armed, they proceeded to the development and exploitation of a continent in a manner never equaled before or since. Some think these decisions helped give corporations what Parrington has called “the freedom of buccaneers.” (Columbia Law Review, Vol. 49, No. 6, p. 738)
Once Congress has acceded that corporations are people, it spells out the makeup of the Board on page 1029:
The Director shall seek to assemble experts in consumer protection, financial services, community development, fair lending, and consumer financial products or services and seek representation of the interests of covered persons and consumers, without regard to party affiliation. Not fewer than members
shall be appointed upon the recommendation of the regional Federal Reserve Bank Presidents, on a rotating basis.
This sounds pretty broad, but if you really parse the list you see it is the usual Washington cast of characters. This is what I would call a grab bag of special interest groups rather than a board composed of different constituencies. As a few examples there are no farmers, no small business people, no people of color, and no nonprofits.
The covered “persons” are financial institution with over ten billion in assets. So what happens if the “too big to fail” institution fails? Frankly it would take a team of lawyers to decipher this one. Here is what I think is the key provision:
The process provided in this paragraph shall not apply to a determination by a prudential regulator to appoint a conservator or receiver for an insured depository institution or a liquidating agent for an insured credit union. (p. 1075)
In short that receiver could be the federal government. You have to jump about three hundred pages forward to find the bailout provision in Section 1151.
Such policies and procedures shall be designed to ensure that any emergency lending program or facility is for the purpose of providing liquidity to the financial system, and not to aid a failing financial company, and that the collateral for emergency loans is of sufficient quality to protect taxpayers from losses. (p. 1304)
I’m no lawyer bit it seems to me that this section does authorize bailouts if they are for “providing liquidity to the financial system,” a judgment to be made by the Board in consultation with the Secretary of the Treasury. The Board in this case refers to the Federal Reserve Board.
I can find nothing in this bill that would prevent the kind of bailouts that earned so much consumer wrath or any limits on the amounts. There is language about ability to pay, but this is a judgment call on the part of the Board and Treasury Secretary.
Derivatives
You probably don’t want to hear about derivatives and I am not sure I want to write about them. An economist once told me that derivatives are like the theories of relativity: a lot of people purport to understand them but only a handful really them really do. Which is precisely the problem. As an old lawyer friend once said, if it is too complicated to understand it, stay away from it.
The recent revelations about Goldman Sachs reinforce this. Some of the world’s leading financial institutions were bilked by agreements over derivatives. If they can’t keep from being hoodwinked how can we? In short, derivatives trading is one thing Glass-Steagall was designed to separate from regular banking.
The derivatives part of the bill has been somewhat of a moving target–just do a search and you will see what I mean. Supposedly leading the charge against derivatives is Blanche Lincoln, the Missouri Democrat whose vote on the health care bill was problematical until the last minute. Like New Hampshire’s Gregg, Lincoln is another one who would have problems with Do You Know More Than a 5th Grader.
Supposedly against Lincoln is another one of the less-then-brilliant minds of Congress, Ben Nelson of Nebraska. Seems Nelson is carrying water for none other than Warren Buffett, of Omaha and other places, who after once condemning derivatives trading is the work of the devil has no decided it’s not such a bad idea.
The idea of Blanche Lincoln writing an amendment against derivatives stretches my imagination. My guess is that with Lincoln’s reelection up in the air, in part because of the health care bill, she has been given the honor of slaying derivatives to help her reelection campaign. Meanwhile this image has been enhanced by press leaks about other Democrats having doubts about the amendment.
It is only early this morning that i was able to get a copy of the Lincoln amendment as worked out with the chief author of the regulation bill, Chis Dodd (quick note, check Dodd’s campaign contributions at Open Secrets--lots from the securities and investment industry) thanks to the Finance Blog which is one of the few blogs that publishes primary sources.
Unfortunately this “amendment” is another 300 pages. The key provisions are a clause prohibiting foreign banks from trading in derivatives (swaps is the financial language), an anti-bailout provision (“no Federal assistance may be provided to any swaps entity”–quick aside this language prohibiting federal bailouts appears nowhere else in the bill), prohibits “commingling” of swaps money, stringent reporting requirements, registration of swap traders, and restitution remedies.
You have to get to page 258 then plow through another thirty pages of definitions to really see the meat of the amendment which details new regulations for derivatives traders. The first closes the derivatives loophole in the Gramm-Leach-Bliley repeal of Glass-Steagall. A second establishes position limits (how much money investors may risk). A third sets minimum capital and margin requirements–these rules are different for banks.
The key change in this new language hot off the press is that the section prohibiting banks from entering into derivatives trading has been eliminated. This is a huge blow. Although it has many pages of regulations, nothing in this amendment prevents banks from dabbling in derivatives.
The Big Picture
Having given you some details it is now time to step back and ask, what does this bill accomplish? First it does not restore anything from Glass-Steagall nor does it penalize banks who are currently breaking the law. Had the law merely affirmed Riegle-Neal that would have been a step in the right direction.
On the positive side the law establishes a research office and a host of monitoring functions. Those are much-needed improvements to the existing system, although its structure is a bit top-down with everything flowing through the director. It also creates a new Bureau of Consumer Financial Protection which will have broad powers that even rival those of the Federal Reserve.
It does reign in some of the major abuses of derivatives trading, requiring stricter disclosure provisions and margin protection. This will help to lend some order to the “anything goes in Dodge City” atmosphere that had characterized some derivatives activity.
The law does not prevent bailouts like we have had nor does not remedy “too big to fail” by taking the obvious route of enforcing the existing law on size and requiring firms that violate that law to divest themselves of assets. It does prevent bailouts of derivatives traders. Given the current entanglements of the financial industry how this will actually play out is problematical.
Most of all, by not passing some semblance of Glass-Steagall the law does not have any sense of the future. By that I mean, derivatives trading was not even on most people’s radar screens when Glass-Steagall was repealed. But that repeal opened the floodgates. While this bill finally regulates derivatives trading, it is a safe bet Wall Street will come up with future instruments like derivatives we have never heard of.
By keeping banking separate from speculation, Glass-Steagall had a built-in firewall against this kind of activity. This bill contains no firewalls. To revive an old Midwestern saying it is like closing the barn door after the cows have escaped. It is a law written for abuses that took place in the past and have largely been reined in because of public outcry. Without firewalls, this bill does not go far enough.
But there is something else going on here that parallels the health care bill and debate, but is more apparent in this bill. What this bill does is to create an entirely new regulatory system that in essence runs parallel with the old. I would ask do we really need all these new agencies or to fix the ones we have?
It is this tendency to deal with issues by creating agencies and commissions that is rapidly becoming the signature of the Obama Administration. It is what has the far right all stirred up about the growth of government and the creation what they refer to as “socialism.”
But the Obama approach does not so much remind me of socialism as it does of Max Weber’s discussion of bureaucracy. Weber wrote at the dawn of the twentieth century when the creation of large organizations by industrialization was threatening to get out of control. Being a German I can say this, but some people have seen Weber as the classic German Colonel Klink, obsessed with organization and rules. He saw rational, hierarchical organizations based on principles like good record keeping and well-defined responsibilities as a way of dealing with the complexities of the twentieth century.
This seems to be the Obama approach–create councils and commissions to deal with specific problems. Yet Weber saw bureaucracies in evolutionary terms, believing that after time they could become rigid and less tolerant of people. In saw increasing “by the book” decisions as leaving less room for the circumstances of individual cases. You all know the line–if I do it for you then I have to do it for everyone else.
Weber would write that as the system became more “rational”:
The performance of each individual worker is mathematically measured, each man becomes a little cog in the machine and, aware of this, his one preoccupation is whether he can become a bigger cog.
We will have to watch the Obama Administration over the coming months to see if this tendency to create commissions and agencies becomes even more of a pattern.
As for the financial bill, it is, like the health care bill, the best we can get given the realities of a Congress dominated by the rich or at least those beholden to them for campaign contributions.
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