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Saturday, May 22, 2010

Here We Go Again!!

Sometime ago, this blog pointed out that the financial reform bill to come out of Congress would the the most important piece of legislation for the next fifty years. Well, it is now here and the outlook is not good at all. Here are the highlights.

Consumer Protection: There will be a new consumer protection agency created. First thing, it will not cover payday lenders with their outrageous interest rates. There are two important questions to be resolved. 1) Will it be independent or part of the Federal Reserve Bank. Given how diligent the Fed was in protecting us from the gamblers on Wall Street, putting the agency there is not a good idea. 2) Will automobile dealers be covered by the agency. Beginning by excluding special interests, e.g., payday lenders, is not a good idea. On the other hand, there doesn't seem to be any evidence that auto dealers are gouging customers. Since every member of Congress has car dealers in their constituency, maybe this is a good "trade-able" item.

Derivatives: Most of these instruments would be required to be traded on public exchanges. In addition, anyone using them would have to put up collateral to cover their bets. The problem here is that the term derivatives cover everything from Conagra buying soybean futures to Southwest Airlines buying jet fuel futures to the absurd Wall Street "innovations" like synthetic bonds. The questions unresolved here are 1)How widely would public trading be required, and 2)Who could sell derivatives? The appropriate answers are that coverage should be spread as widely as possible and nobody who sells them should be insured by the U.S. government.

To Big To Fail: This is the crucial heart of all financial reform, and results here are not clear. The bill seems to give the government the power to seize and dismantle large firms on the brink of bankruptcy. The FTC has been doing that job very effectively for over fifty years, but the Gramm et al, bill allowed investment banks to become commercial banks, which were covered by the FTC, but FTC action didn't happen. Instead, Hank Paulson put up a huge amount of your money to save Goldman Sachs. The only reasonable conclusion here is that Congress has completely ducked the Too Big To Fail problem, and that is NOT a good thing.

Financial Industry Oversight: This would create yet another government agency that is supposed to monitor the financial industry for levels of risk. This sounds like another government agency with no powers and no clearly defined agenda. Bad news here.

Executive Compensation: Stockholders would now have a non-binding say on executive compensation. Note "Non Binding" which translates into "useless". This is just junk law. If Congress simply reduced the ability of Wall Street banks to take huge gambles with your money so they can get huge bonuses, this would become a non-issue. Sorry to say, that is not happening here.

Now for the two HUGE problems the Congress refused to address. 1)Nothing deals with the rating agencies that rated garbage mortgages as AAA bonds. That was the problem that Hank Paulson encountered immediately when he tried to spend the TARP money. So the basic problem is that as long as the score keeper in this game can still be bribed or threatened, the game will always be crooked. 2)Paul Volker, the only wise man in Obama's economic advisors, wants to prohibit Wall Street banks from betting their own money, as opposed to their customer's money. Such betting is the primary source of those enormous profits, and bonuses, discussed above. Take away the game board and the bonus problem resolves itself.

It is a hackneyed example, but it fits perfectly here. What Congress has done is to re-arrange the deck chairs on a sinking ship. And the ship will sink sooner or later because all of the fundamental problems are still in place.

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