Re-Regulating the Financial Markets

The New York Times notes that there is a tug of war going on between the Bush Administration and Democrats over the type and extent of new regulations.

While I think that some centralization of the "regulatory alphabet soup" is a good idea, one of the things you are hearing, particularly from the Bushies, is that there is a, "tangled web of federal and state regulators".

I think that this is Bush speak for cutting the states out of it, so actions like those of Elliot Spitzer^* will be impossible.

On the other end of Pennsylania Avenue, you have Barney Frank, who I like, but truth be told, I think does not go far enough.

We have large organizations operating under the idea that they are too big to fail, and remember that Bear Stearns is a smallish player in this market, so this assesment is correct.

If the taxpayers are at risk, and they are, then the taxpayers must be allowed to regulate to minimize that risk.

Krugman makes this very point:

America came out of the Great Depression with a pretty effective financial safety net, based on a fundamental quid pro quo: the government stood ready to rescue banks if they got in trouble, but only on the condition that those banks accept regulation of the risks they were allowed to take.

Over time, however, many of the roles traditionally filled by regulated banks were taken over by unregulated institutions — the “shadow banking system,” which relied on complex financial arrangements to bypass those safety regulations.

Now, the shadow banking system is facing the 21st-century equivalent of the wave of bank runs that swept America in the early 1930s. And the government is rushing in to help, with hundreds of billions from the Federal Reserve, and hundreds of billions more from government-sponsored institutions like Fannie Mae, Freddie Mac and the Federal Home Loan Banks.

As does Noriel Roubini who believes that the actions taken to this point are band aids, and not solutions, furthermore, he notes that, "Only a few of such securities firms are systemically important and deserve the liquidity support of the Fed in case of a run on their liabilities", which is a large portion of this crisis.

Many of these institutions have, through years of lax antitrust enforcement become "too big to fail".

So, my first suggestion is that the continuing concentration of market among fewer and fewer firms in the financial arena needs to be reversed.

These firms need to be broken up into small pieces.

On CNN Money, of all places, Paul R. La Monica suggestion that investment banks need to be treated like children. It's eye catching, but wrong, particularly when he suggests that the repeal of Glass-Steagall was still a good thing..

The behavior of the banks, or more accurately the individual people working in those banks, was quite mature, if amoral.

From top to bottom, the employees of these firms behaved in a manner consistent with those employees own personal best interests, as opposed to those of the firm or the market.

The name for such a system, where individual players arbitrage for their own personal best outcome is called Capitalism, by the way.

What we need to do is to ensure that taxpayers are not left on the hook down the road for decisions made for personal benefit now.

Among other things, this means that we need real regulations of wages and benefits in the financial services industries, with real consequences including asset forfeiture and jail.

People will continue to do stupid things for good results this quarter so long as their bonuses and promotions are a result of their performance in this quarter.

I would note that I have not yet come up with any specifics on how to limit excessive compensation for short term results beyond taxing all excessive taxes. I'll put my thinking cap on.

The push for quarterly results is what leads to excessive leverage, which is what has led to many of the problems.

In 1929, you needed about 20¢ to buy $1.00 stock on margin. Following the Roosevelt regulations it was 75¢ to buy that same stock on margin, though this was lowered to 50¢ in the late 1970s.

Bear Stearns was leveraged on the order of 50 to one, or about 2¢.

Leverage is essential to a modern financial system working, but excessive leverage causes a collapse.

We need to put government auditors in the major financial firms today, with the power to review all records and investments, and to demand changes.

Also, there should be a change in taxes. If the rich have to be bailed out, and this appears to be the case, then they should make the down payments on that bail out.

I would also suggest that a surcharge be added to income tax to which no credits or deductions apply, starting at the salary of the President (currently $400K) with a 1% surcharge, and increasing by 1% for each multiple above that (so $400k-$800K would be 1%, $800K-$1.2M would be 2%, etc), to a maximum marginal rate of 75% at around $180 million a year, which would apply to all forms of compensation (H/T to Dean Baker, see below, for noting the total compensation thing).

It would serve to put a brake on executive compensation, and generated some much needed revenue for the treasury.

Dean Baker, co-director of the Center for Economic and Policy Research in Washington, DC, suggest instead that we legislate a cap on total compensation in the financial industry of $1 million.

It appeals to my vengeful side, but I think that my suggestion is better. It applies to overpaid athletes, drugged out pop stars, and worthless hotel heiresses too^†, and provides resources to create a better and more just society.

^*No, I mean his legal actions against Wall Street, when the FTC, SEC, etc., led by Bush and His Evil Minions^™ were letting the foxes run the henhouse.
^†Let's be clear, I am keeping my promise not to mention They Who Must Not Be Named. I don't see no names, do you?