At the Global Leaders Summit last week, an octogenarian economics professor from a Southern German university asked, "But will it be enough?" He was referring to the financial reform agreement reached in Congress and passed by the House this week that President Obama calls "historic."
There have been quite a few references to history lately by self-congratulating politicians. Is the exemption stuffed financial reform bill of 2010 really a history-making event comparable to Great Depression reforms? As the seasoned professor asked, will it be enough to rein in an out-of-control financial industry? Or in the words of one NPR broadcaster, is it inevitable that no matter what kind of reforms are enacted, "Wall Street will find a way to blow itself up?"
A simple look at "history" reveals there was a time when Wall Street was not able to detonate. Economist and financial historian Glyn Davies (A History of Money) writes that following the banking reforms of 1932-1935, "significant bank failures, of the kind that inevitably plagued the unit banking system of the U.S. for 150 years, had been ruled out by the reforms." Davies points out that from 1920-1930, nearly 5,000 U.S. banks failed. In 1930-1933, 8,812 banks failed. Yet after the banking reforms, the annual average of bank failures fell to 45. In the boom years of 1943-1960, bank failures never exceeded 9 annually--a truly amazing feat after a century and a half of panics and crashes.
It was not until Ronald Reagan and the repeal of Depression Era banking safeguards that the tide began to turn. Under the "Gipper," the formerly highly regulated Savings and Loan industry became a free market piggy bank for Wall Street masters of the universe. The safe and secure regional banking system was robbed so thoroughly that it ceased to exist. It took taxpayer billions and deep government deficits over the next decade to restart its engines. Sound familiar?
The deregulation continued through the 80s and 90s to reach its crescendo under Bill Clinton with the repeal of the 65 year separation of banking and trading (1999) and the legalization of under-the-radar weapons of financial mass destruction (2000).
A quick history lesson:
Steve Kroft of 60 Minutes reported in October 2008, that the global credit crisis "was magnified worldwide by the sale of complicated investments that Warren Buffett once labeled financial weapons of mass destruction...credit derivatives or credit default swaps."
These derivatives are "a form of legalized gambling that allow you to wager on financial outcomes without ever having to actually buy the stocks and bonds and mortgages. It would have been illegal during most of the 20th century under the gaming laws, but in 2000, Congress gave Wall Street an exemption and it has turned out to be a very bad idea."
So it seems that Wall Street was not able to blow itself up when strapped down with heavy bindings called banking reforms. For fifty years, from 1932 until 1980 and the first of the banking deregulatory acts by Congress, Wall Street was not legally allowed to plunder the nation's coffers. Yet despite those restrictions, Americans enjoyed steadily increasing prosperity for three post war decades.
What happened in the 70s? The first big oil embargo and the nation lined up at the pump and watched inflation fluctuate with gas prices. To combat inflation, Federal Reserve Chairman Paul Volker (1979-1987) manipulated prime interest rates to the obscene level of 21.5% in 1980. In the 1970s and 80s, it was not uncommon for the average home mortgage to cost 10-12%. No wonder the move to deregulation gained momentum.
Well, the old economist is at again and still going strong. This time his ban on proprietary trading (trading one's own capital) for the big banks dubbed the "Volker Rule" made it into the final version of the bill. Banks no longer have the ability to invest more than 3% of their capital in private equity and hedge funds. (Actually 3% is pretty big when talking about banks capitalized at $10bn plus. Deutsche Bank analysts alerted investors that the final regulation was substantially "watered down.")
The belief by Volker is that the self-interest of proprietary trading interferes with customer interest. An investment firm might be more concerned about its own money than say...a client's.
Okay, good thinking Paul and what an accomplishment that this provision made it into the final bill. Hmmm. There is one teeny weeny issue. Banks have until 2022 to wind down their prop trades. Let's see" it is now 2010, so that is 12 years, 3 presidential elections, two Senate terms, and six House of Representative elections.
Lobbyists, on your marks, get set, go! You have 12 years to turn the clock back before the Volker Rule is set in stone. Mr. Volker will be 94. Were they trying to see who would be left standing the banks or the Old Fed Chairman?
Where is Scott Talbott, lobbyist extraordinaire of the so-called Financial Services Roundtable (think Knight) when you need him? Don't let Scott's peely-wally fade-in-the-woodwork demeanor fool you. This guy only fades in the woodwork after dark. The rest of the time he is slivering through the halls of Washington's world of money. Talbott's official response to the Dodd-Frank Act is that banks will earn "less profits." That is lobby lingo for "Slap me five! "
Even with such "historic" reform, banks that were too-big-to fail before are now more cocky and confident than ever. The U.S. economy continues to be controlled by the six big swinging banks. And for some inexplicable and rather remarkable reason, Goldman Sachs and Morgan Stanley are still bank holding companies capable of borrowing from the Fed at zero percent. Say, does anyone know if Goldman offers free checking?