"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done." John Maynard Keynes
The Obama Administration has put together a wide-ranging set of reforms that attempts to re-regulate the financial sector. It calls for a new consumer protection agency to protect us from mortgage mischief. For the first time, it regulates some (but not all) derivatives. It calls for new controls on "too-big-to-fail" institutions. It attempts to control out-of-control leveraging. It brings private equity firms and hedge funds under stricter supervision, and it develops new ways to monitor and (hopefully) control systemic risk.
But these measures are unlikely to prevent the next meltdown because they do not address the root causes.
1. The financial sector is bloated and will remain so. It's still more profitable to produce a fantasy finance derivative than it is to produce a car or any other tangible product in the real economy. In fact, our economy is totally misshapen. At the time of the crash, the financial sector accounted for about one quarter of our GDP and over 27 percent of all corporate profits. In 1950 there were about eight manufacturing jobs for every job in the financial sector. Now its about 1.5 to one. And its only getting worse. Even during this enormous financial crash, the financial sector still is at or near full employment: The unemployment rate was 4.9 percent in financial services; 7.5 percent in real estate; 12.6 percent in manufacturing; 17.4 percent in administrative and support services; and 19.2 percent in construction.
To reshape the economy would require two policies that the Administration wants to avoid: wage caps on executives throughout the sector and taxes on all financial transactions (see number 5 below).
2. Financial institutions that are Too Big To Fail will still be Too Big To Fail. While the Obama proposals will more carefully monitor and control the largest and most systemically entwined financial behemoths, it refused to break them up, or take the over, or turn them into public utilities. In fact, there is every reason to think that large financial institutions will grow larger as they feast on smaller ones that are struggling. These institutions are far too big to run efficiently. It's impossible for the top executives to keep up with hundreds of thousands of employees and trillions in investments. But bigger always means bigger bucks for the executives. They will again make the money, and still we will have to bail them out when they fail.
3. The derivative casino is still open for business. While the regulations set up new controls on plain vanilla derivatives, it exempts custom made derivative products. This means that our brilliant financial engineers can continue to design impossibly complex and risky products for its clients. I suspect the new regulations would still permit the creation of the synthetic CDOs that fleeced $200 million from five Wisconsin school districts (see the first chapter of The Looting of America at http://bit.ly/F5lh1).
Even if the first generation of regulators will take a firmer stand on derivatives that straddle the custom-made divide, what happens when the political tides change and new, more "market-friendly" regulators take the reigns? Obama will have given them all the loopholes they'll need to exempt anything their revolving-door Wall Street comrades desire. And I don't think having the issuer hold on to five percent of what they've created will make a bit of difference. As far as I can tell, they will be permitted to hedge that bet in a myriad of ways. (That piece of regulation might as well be called "The Financial Engineers Full Employment Act.")
Clearly the Obama Administration refused to follow the advice of George Soros who suggested that all derivatives should be approved before they are unleashed on the economy (just like prescription drugs), and if they are too complicated for a regulator to understand, they should be banned.
4. The wealthy have too much and therefore the demand for fantasy finance gambling will continue. You can regulate the Wall Street casinos all you want but if there is too much surplus capital around, new casino games and asset bubbles will be created. Demand will create Supply. (Hasn't Obama learned anything from the failure of the "Drug War"?) The casinos were created because we encouraged an enormous amount of wealth to accumulate in the hands of the few.
During the orgy of tax cuts, deregulation, and union busting of the Reagan years, the top one half of one percent of all families saw their wealth increase by $1.45 trillion while the bottom 40 percent saw their wealth decline by $256 billion. In 1970 the top one percent garnered 8 percent of our nation's income. By 2006, they took away 23 percent. In 1970 the top 100 CEOs took home 45 dollars in compensation for every dollar earned by the average worker. By 2006 it was $1,723 to one. Meanwhile the real average wage (in 2007 dollars) of non-supervisory production workers--about 94 million of them--declined from $746 per week in 1973 to $612 in 2007.
The money didn't trickle down. When the wealthiest few ran out of easy investments in the real economy, they turned to Wall Street's fantasy finance casinos. The new proposals do nothing to address the wage/income disparities that feed the demand for bubble assets.
5. The proposed regulations don't pay us back. While the proposed regulations include fees on financial institutions, this is chump change. The Obama Administration missed an enormous opportunity to support efforts like HR 1068, the "Let Wall Street Pay for Wall Street's Bailout Act of 2009" introduced by Rep. Peter Defazio (D-OR). While not ideal that bill wisely would place a one quarter of one percent tax on most financial transactions to pay the public back for TARP funds. This would have set up the most efficient way to move funds from the bloated financial sector into infrastructure investments for the real economy.
I hope that history will prove me wrong. I don't want to see more suffering and I would like the Obama administration to succeed. But history is a very cruel teacher, especially when we don't listen And right now it is screaming at us to dramatically reduce the size and influence of the financial sector, and to fundamentally address the obscene and systemically dangerous concentration of wealth in too few hands.
Les Leopold is the author of The Looting of America: How Wall Street's Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What we can do about it. http://bit.ly/rltb4(Chelsea Green Publishing, June 2009)