Simplify Banks and Bank Regulation

Let's face it: There will never be enough regulations and regulators to police all of the gray areas in a system this complicated. The best remedy is drastic simplification.
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In January 2010, after Scott Brown's upset victory in the special Massachusetts Senate election, a panicky President Obama managed to sound like a populist for a couple of days. He called for a tax on banking profits and drafted Paul Volcker to appear at a quickie press conference so that the administration could call for something dubbed "The Volcker Rule."

Volcker, an impeccably conservative former Fed Chair skeptical about the abuses of financial de-regulation, was one of the few elder statesmen in 2010 with any credibility. Though Volcker was an early supporter of Obama and adviser to the campaign, Treasury Secretary Tim Geithner and economic adviser Larry Summers managed to marginalize Volcker because the old man turned out to be leery of their schemes to prop up the big banks without cleaning them out. Even worse, Volcker was nostalgic about the 1933 Glass-Steagall Act, which had staved off big trouble for more than half a century by requiring that federally insured commercial banks stay out of the inherently speculative investment banking business.

Financial lobbies had finally succeeded in getting Glass-Steagall repealed in 1999, with Summers and Geithner cheering. Now the president, in big political trouble, was sending for Volcker the way one breaks glass in an emergency. But the so-called Volcker Rule, a phrase the White House made up, turned out to be Glass-Steagall lite. Unlike the 1933 statute, Obama's so-called Volcker rule did not separate commercial banks from investment banks -- a nice clear bright line that was easy to police and hard to evade.

Rather, the administration's proposed Volcker Rule limited how much "proprietary trading" big consolidated banks could do. Trading, however, is only one of the many kinds of mischief bankers get into when the mix commercial banking and investment banking. The version of the rule that was included in the Dodd-Frank Act left details to the regulators.

Now the regulators have produced a 298-page set of proposed rules, and nobody is happy. The regulators have invited comment on no fewer than 350 questions. Bankers say the whole thing is too bureaucratic and will cut into their profitable lines of business. Consumer groups warn that the thing has too many loopholes. Wiseguys on Wall Street say it is child's play to disguise a proprietary trade for the bank's own account as a customer trade.

All, of course, are correct. It would have been far better policy to return to the simple bright line of the Glass-Steagall Act.

If you want to be a commercial bank, with federal deposit insurance, access to Federal Reserve advances, and a Good Housekeeping seal from regulators, great. You will have to follow closely policed rules. Alternatively, if you want to trade and speculate with your own money, go to it. But don't grow so big that you can bring down the whole system, stay out of the commercial lending business, and don't expect the government to bail out your bad bets.

That system worked very nicely. It was almost impossible to evade, and it didn't require 298-page regulations, with legions of regulators to police the creative evasions and gray areas.

The entire banking system has become far too complex -- too complex for economic efficiency and too complex to regulate. Over at the Commodity Futures Trading Commission, they are having a hard time deciding how to carry out the Dodd Frank Act's provisions on derivatives. And the Federal Deposit Insurance Corporation has just issued the first draft of government regulations on how to proceed when a "systemically significant" large bank gets into trouble. This is also full of gray areas.

But most of the complex financial instruments invented in the last two decades do not add to economic efficiency. They only add to risk, and to the outsized profits of insiders.
Investors and borrowers did just fine before credit default swaps (CDS) were invented in the 1990s. CDS mainly added to the system's leverage, opportunities for reckless gambling, and potential for collapse.

Let's face it: There will never be enough regulations and regulators to police all of the gray areas in a system this complicated. The best remedy is drastic simplification. We need a simpler banking system, and clearer and more straightforward laws like the Glass-Steagall Act. The Obama administration proposed an ambiguous "Volcker Rule" rather than a clean return to Glass-Steagall because the so called rule would be easy to evade and would not interfere in any fundamental way with Wall Street's current business model.

It was Henry David Thoreau who observed, "Our life is frittered away by detail... simplify, simplify." He could have been speaking of the financial collapse and the hapless, half-baked remedies. So forget the Volcker Rule. When it comes to banking, we need a Thoreau Rule.

Robert Kuttner is co-editor of The American Prospect and a Senior Fellow at Demos. His latest book is A Presidency in Peril.

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