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New Rules Aren't Enough
The Obama administration's financial reforms won't prevent future economic crises if regulators remain asleep on the job
The Obama administration's proposal for reforming financial regulation has many useful features. In particular, the proposed consumer financial protection agency likely would have prevented many of the worst abuses in the subprime market over the last decade, as well as in other areas of consumer lending.
Other measures, like requiring that standardised derivatives be traded as clearing houses and that hedge funds register their interests with the Securities and Exchange Commission are positive steps towards modernising regulation, although they do not go far enough.
The US Treasury should be trying to standardise all derivatives and have them exchange traded to maximise transparency. There also should be increased public disclosure of hedge fund dealings. But, these are not the biggest flaw in the administration's regulatory proposals. The biggest flaw is that they help to support the view that the main problem was inadequate regulations, rather than failed regulators.
The basic story of this crisis was not that the regulatory authorities lacked the ability to rein in this disaster before it was too late. Rather, the regulators – most importantly the Fed – opted not to use their power to rein in the housing bubble.
The Fed had ample tools at its disposal to burst the housing bubble before it expanded to such a dangerous size. To start, the Fed could have tried just providing information. First, Alan Greenspan could have devoted his congressional testimonies and other public appearances to warning about the housing bubble.
These warnings would include both a careful description of the evidence for the bubble (with tables and charts) and a detailed account of the damage that would be caused to both the economy and the financial sector from its collapse. The Fed could have also committed its staff of thousands of economists to detailing the case for a housing bubble and drawing out the implications for various regions and sectors of its collapse.
If Greenspan had followed this route, rather than insisting that there was no bubble, it is likely that it would have been sufficient by itself to burst the bubble. No major financial institution can simply ignore the Fed, and there was no plausible response to the argument showing the existence of a housing bubble.
If talk proved insufficient, the Fed should have used its regulatory authority to clamp down on many of the bad loans that were feeding the bubble. It eventually did issue guidelines that would have precluded many of these loans, but not until the middle of 2008.
Finally, if necessary, the Fed should have raised interest rates until the bubble burst. This would have been undesirable, since it would slow growth and raise unemployment, but it still would have been better than letting the bubble grow and create the basis for even more pain later. And the story of the crisis is the story of a collapsed housing bubble.
The discussion of financial issues has largely worked to hide the centrality of the housing bubble to the crisis. If there had been no credit default swaps, collateralised debt obligations or subprime and Alt-A mortgages but the housing bubble had still grown to $8tn, we would be in pretty much the same economic situation that we are in today.
Residential construction would have collapsed due to a huge glut in the housing market, and consumption would have plunged as a result of the loss of $8tn in household wealth. The financial problems created by failed regulation do complicate the picture, but the fundamental picture is a very simple one of a collapsed bubble causing demand to plummet.
Politicians and regulators have a direct interest in portraying the crisis as being the result of an inadequate regulatory apparatus rather than failed regulators, because failed regulators should get fired. However, by not holding failed regulators accountable, this reform proposal is setting the grounds for the next crisis.
Even a perfect regulatory structure will not work if the regulators do not do their job. They will not have an incentive to do their job if there are no consequences for failure.
In this case, we have seen the most disastrous possible regulatory failure. This is like a drunken school bus driver who gets all his passengers killed driving into oncoming traffic, and no one is held accountable. The message to future regulators is, therefore, to simply go along with the powers that be (ie the financial industry), and you will never suffer any negative consequences.
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Show All"Even a perfect regulatory structure will not work if the regulators do not do their job. They will not have an incentive to do their job if there are no consequences for failure."
Capitalism cannot be regulated. It is like putting lipstick on a pig. The system itself is designed for failure. Failure comes about on a regular basis with capitalism. Sometimes the failure is a "mild recession" and other times a more dramatic "depression". Karl Marx pointed this out in his analysis of capitalism and the problem of capitalism was discovered and exposed by Marx. Its essential contradiction is one of overproduction brought about because of the class nature of the system.
Marx's labour theory of value explains why this happens. The capitalists make their profits by employing unpaid labor. The resulting prices of the commodities they sell includes both the cost of labor to produce them, along with the profits (surplus value) the capitalists need to make. This results in an untenable situation where the working class that produce the products cannot afford to purchase all the products it produces and this working class is the main consumers within capitalist society. The result is one of overproduction, ie. periods of failure until such time as this overproduction is either eventually used up or destroyed.
While this is going on, the capitalist class is also engaged in class struggle, always pushing to reduce the wages of workers (their purchasing power). This imbalance results in the main failure of capitalism.
Professor Wolff shows us just what is taking place in the current capitalist crisis and why regulation IS NOT the answer nor the solution to this problem of capitalist overproduction:
http://tinyurl.com/aca7o3
Any upturn in the world capitalist economy can only be of a temporary nature, as the system will surely fall back into crisis again, as it has done in the past. Each time this occurs the crises get deeper and deeper as they are never truly resolved. Resolution to capitalist crises will only occur when capitalism itself is destroyed and replaced by a more sane economic system that does away with the exploitation of labor for the creation of capitalist profits.
Struggle June 23rd, 2009 9:52 am............ Not only are the crisis never resolved, but each time these fabricated catastrophes occur, trillions are stolen from the masses as their descendants are placed further and further in debt.
It's obvious with this new shill of a president, nothing will ever be resolved without a general uprising and, let's face it, Americans are not South Americans or even Iranians (as naive as the Persians are to succumb to the covert interference from the Empire...at least they showed courage). So, things look bleak..bleaker than when the shrub was president. In those eight years, we knew what we had. With the current mass hypnosis, we are in deeper crap than ever before...with no sign of justice and ever increasing wars.
"So, things look bleak..bleaker than when the shrub was president. In those eight years, we knew what we had. With the current mass hypnosis, we are in deeper crap than ever before...with no sign of justice and ever increasing wars."
I completely agree. I was never as enamored with Obama as many of my friends were. Currently, when I bring up the issues -- the escalation of the war in Afghanistan, unemployment, the economic crisis, state secrets, civil rights, torture, health care, etc. -- they fail to reply. They see what they want to see, and they hear what they want to hear.
A bit of a paraphrase on a Chinese proverb.....:"You cannot awaken a people who are pretending to be asleep!"
"Currently, when I bring up the issues -- the escalation of the war in Afghanistan, unemployment, the economic crisis, state secrets, civil rights, torture, health care, etc. -- they fail to reply. They see what they want to see, and they hear what they want to hear."
I'd bring up the issues myself and from the Obama hardliners with my coworkers, friends, and even my own family members only to get very hostile responses, some even calling me a "racist". I'd call them Obamabots but some of them have sort of mellowed down. I don't even bother with them much anymore on the issues since I don't want them raising my blood pressure. For some of them, it's possible that reality will force them to see and think beyond the party. I always vote on the issues and never on the party or personality of the candidate which is why I almost always end up voting Independent and rarely a Democrat or Republican even on local elections. I can see why people easily fall for blindly voting party over principle, Republican or Democrat. I've never met a 3rd party voter who voted solely on party. I think our task is to get people to vote on the issues and even connect the issues together so that they will be more motivated to vote on the issues over party.
"The message to future regulators is, therefore, to simply go along with the powers that be (ie the financial industry), and you will never suffer any negative consequences." This is not entirely true. Greenspan had a very good reputation for many years, now he's thought of as an ideological bumbling fool. Maybe he laughs all the way to the bank, but I think not.
Bring America Back !!!!.......Here are some new Rules for ya'
GET OUT OF IRAQ ! GET OUT OF AFGHAN ! STAY OUT OF IRAN !
****Then watch the financial sectors make the most amazing
recoveries and start flying straight.
NO MORE BAILOUTS !
Stop playing world cop. Get our own country in order.
any individual holding any power may be directed...
one can be 'carroted'...money, sex, drugs, fine foods, houses, cars, powerful positions, tropical playlands...
one can be 'sticked'...threatened with the loss of any of the above, or with exposure of secrets, or with physical assault or murder...either of one's self or one loved...
obviously, one playing this dangerous game could find oneself unable to quit without the stick falling...as Don Corleone wheezed: there are offers you can't refuse...in fact, this is a big concern for society, in general, given the nature of modern surveillance and weaponry...
How to combat? Remove power structures, and return to individual rights and responsibilities...thank God I don't need a Senator to pick a blackberry...
"The message to future regulators is, therefore, to simply go along with the powers that be (ie the financial industry), and you will never suffer any negative consequences."
This is in fact the message of American history in general.
I am confounded by this lack of accountability. I mean, in China, they execute people for this sort of thing. In the US they give them golden parachutes. Just in case anyone is wondering who rules America.
When the people fear their government there is tyranny,
when the government fears the people there is liberty.
~ Thomas Jefferson
I agree with Baker that holding the regulators accountable for past inaction and past policies is important (I particularly like his concept that blaming the regulations rather than the regulators is mostly a self-serving diversion), but I see blaming the domestic and global financial meltdown of 2008-2009 purely on the housing bubble as making a similar mistake once more.
Baker writes "If there had been no credit default swaps, collateralised debt obligations, and subprime and alt-A mortgages but the housing bubble had still grown to $8 trillion, we would be in pretty much the same economic situation that we are in today." The problem here is causality.
Without credit default swaps (and AIG insurance thereon), without exotic collateralised debt obligations, and without shoddy to criminal local real estate lending practices, the housing bubble would have burst of its own accord long, long before it got to $8 trillion. Those practices Baker indirectly absolves of guilt (along with investment ratings hanky panky, corporate front accounting gimmickery, and good old fashioned fraud) were what grew the housing bubble that big in the first place, and then internationalized the traumatic consequences of the bubble breaking. If "the housing bubble had still grown to $8 trillion" in an America without the Masters of the Universe grandiosely siphoning off their paper profits, when the day of reckoning finally came at least every homeless man and trailer park mom would have probably had a modest bungalow roof over their head to help weather out the storm.
It's as fallacious to shift blame to an inanimate bubble as it is to pin the fault all upon inadequate regulatory standards. Yes, the government regulators who were asleep or who actively enabled the crisis to develop should be taken to task. But so too should those private sector players who profited so immensely from our collective misfortune, transaction by transaction.
Bill from Saginaw
The NFL just announced tough, new rules regulating player conduct on the field during a game.
They also announced that referees will no longer be permitted to call penalties, but they will be able to submit reports about alleged wrong doing to the Commission.
Any player or team found guilty of violating any new and/or old regulations will receive a really harsh tongue lashing from the NFL Commissioner himself!
In a statement, the Commissioner said he feels the system is solid, as no team or player would ever do anything that wasn't in their own self interest and in the best interests of the NFL generally.
Couldn't agree more with Bill. It was the crazy financial derivatives that drove demand for mortgages which, in turn, inflated the bubble. I really like Baker, and agree with most of this article, but I continue to be amazed that even smart economists like like him seem to miss this obvious connection.