Wall Street Reform, Financial Fraud, and Foreclosures

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Wall Street Reform, Financial Fraud, and Foreclosures

Zach Carter

Last week, Senate Democrats broke the Republican filibuster on Wall Street reform. This week, Senators are introducing key amendments to strengthen the bill. While the current legislation is not strong enough to seriously curtail Wall Street abuses, all hope is not lost: A mere handful of amendments could make reform a reality. Unwinding the excesses of the Bush-era economy will require tough new rules on the nation’s largest banks. It will also require aggressive prosecution of fraud, and a serious new plan for helping homeowners in distress.

Ending too-big-to-fail

As Sen. Bernie Sanders (I-VT) emphasizes in an interview with GRITtv’s Laura Flanders , the four largest U.S. financial institutions have more than $7 trillion in assets—that’s over half the size of the entire U.S. economy. With that kind of political and economic muscle, banks can influence just about any financial reform that makes it through Congress simply by intimidating the regulators who try to implement them.

If we want to fix the banking system, we have to break up the banks into smaller firms that can fail without wreaking havoc on the economy. The current bill would not break up the banks, but Sens. Sherrod Brown (D-OH) and Ted Kaufman (D-DE) have introduced an excellent amendment that would do just that.



Keep it simple

Writing for The American Prospect, economist Robert Johnson proposes a few other critical changes. In principle, banking is not a terribly complicated business—you borrow money at low interest rates, lend it out at higher interest rates, and keep the difference as profit. But Wall Street has grown very powerful by injecting needless complexity into the business, everywhere from consumer credit cards to derivatives and securities.

Complexity makes it easier for banks to overcharge their customers—it’s no accident that the fine print on your credit card agreements are next to impossible to decipher. It also makes it harder for regulators to identify and crack down on abuses, or recognize risks to the economy.

Congress can counter this willful deception by imposing straightforward, loophole-free consumer protections, like a cap on interest rates, and by standardizing financial contracts between banks and requiring them to be traded openly on transparent exchanges. Yes, bank profitability will take a hit, but our economy will be safer.

Close derivatives loopholes

Over-the-counter derivatives are a prime example of unnecessary complications. This market is enormously abusive—the alleged Goldman Sachs fraud occurred here—and nearly all of it is unregulated. As I emphasize for AlterNet, Sen. Blanche Lincoln (D-AR) authored a great bill reining in the sector, but a few key elements of her proposal were thrown out last week when her bill was combined with a weaker bill from Sen. Chris Dodd (D-CT).

Lincoln’s bill gave both courts and regulators expansive powers to enforce new rules reining in the derivatives market. But the new Dodd-Lincoln mash-up jettisons much of that language, blocking regulators from bringing legal actions against banks that violate the rules, and explicitly declaring that even illegal trades are still valid. Even though the trades are illegal, banks can still collect on them as if they were perfectly acceptable. These provisions take a lot of wind out of the reforms—if the new regulations cannot be effectively enforced, there’s no point in having them at all.

In a piece for The Washington Independent, Annie Lowry highlights a clever deception from the bank lobby on derivatives reform. 90 per cent of the derivatives market consists of financial firms placing bets with other financial firms. About 10 percent of the market consists of non-financial companies hedging against legitimate risk—airlines protecting themselves against an increase in the price of fuel, for instance. But the U.S. Chamber of Commerce and the bank lobby have been deploying some of these legitimate “end users” to fight reform, arguing that it will increase their cost of doing business.

As Lowry notes, there is no reason for end-users to be worried. They’re exempted from the reforms. What’s more, if they are not exempted from the regulations, these end users they might actually benefit from lower prices established by increased transparency.

Fighting Fraud

Christopher Hayes notes for The Nation, financial reform isn’t the only battle to be waged for a fair economy. Much of the banking system is built on outright fraud:

The earliest chronicles of the meltdown tended to portray it as a tale of groupthink and mania, of hubris and shortsightedness: all these smart people got it wrong! And while that’s certainly true for many, it grows clearer by the day that a lot of people on Wall Street realized early on that the entire enterprise was headed for a crash and responded by smashing and grabbing all they could carry.

Holding Wall Street accountable doesn’t just mean implementing better, safer rules of the road. It also means prosecuting those who violated even the lax rules during the heyday of the housing bubble.

Lest we forget, our economy is still struggling to recover from Wall Street’s mess. In a piece for In These Times, David Moberg chronicles the horrific toll of unaffordable mortgages. The problem is no longer limited to subprime loans—as home prices continue to slip and unemployment remains near triple-digits, more and more borrowers find themselves on the brink.

There are several good options for averting foreclosures, as Moberg notes. Congress could create a new agency that buys up mortgages at their current market rate and modifies them for borrowers. Since plunging home values have reduced the value of the mortgage, this plan would force banks to take a loss, and then remove them from the negotiation process to prevent them from further abusing borrowers.

Second, Congress can also change the bankruptcy laws to allow judges to modify mortgages for borrowers. Unlike every other form of credit, mortgage debt is currently excluded from bankruptcy, meaning that even if borrowers file for it, they cannot get relief on their mortgages. Third, Congress can require banks to allow troubled borrowers to rent their homes at a market rate for at least five years. Banks don’t want to be landlords, so this plan would give borrowers greater leverage over banks that are reluctant to modify their loans.

Any of these policies would work. But Congress has been reluctant to act, even in the face of millions of foreclosures, and the Obama administration has not pressed them on it. There is a remarkable disparity between the plight of borrowers and big banks. Banks and borrowers alike were hit hard by the housing downturn, but when big banks needed help, it came fast and furious. Borrowers are still waiting.

As Moberg emphasizes, the government did not ignore troubled homeowners in prior crises. During the Great Depression, we bought up millions of loans through the Home Owners Loan Corp., and ultimately turned a profit on the effort.

Wall Street reform is critical and necessary. Nothing about it will make the financial elite happy—they’ve prospered on the outrages embedded in the current system, and they are not going to give them up without a fight. If Congress is going to help homeowners, it’s going to take strong leadership from Obama and a willingness to go after the bank lobby head-on. Let’s hope they’ve got the will to do it. The future of American prosperity is at stake.

Zach Carter is a blogger for the Media Consortium

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