A Good Start

Jeff Madrick on Financial Reform

BARACK OBAMA’s main presidential mission should always have been clear. He should have been determined to prove to Americans that, in domestic matters, strong government can work. (In foreign matters, it probably should have been just the opposite.) Instead, the mission was confused. His conciliatory and moderate streak kept him wanting to split the difference between government skeptics and government believers. And the result was a contemporary version of a 1990s New Democrat, who was still wed to the slogan that the age of big government was over.

The conciliatory Obama waited too long to make his case for health care with the American people. Fortunately, he turned that around and won a historic if not ideal victory. But the same ambivalence infected his call for regulatory reform. A Treasury Department paper in June 2008 had no intellectual rigor, and the Obama economic team of Clinton-era technocrats had no passion. It was a laundry list of conventional wisdom with one exception: a financial products safety commission. Obama never went to the people to generate support, carefully avoiding placing too much blame on those good bankers with whom his advisers were friends.

But finally when the people had had enough, Obama woke up to the need for passionately serious reform. When Wall Street fought back vigorously with lobbying millions, Obama was awakened to what economic self-interest really means—you mean they are not interested in the public good first?—and he began to talk tough. Yesterday, Obama almost came to Wall Street—Cooper Union, where I teach, is not really near Wall Street—but he also tempered his anger. He scolded Wall Street for the “battalions” of lobbyists that they sent to Washington, but he also urged them to join the battle for a better Wall Street. Only those who bilk investors will be harmed, he said.

The ideal of financial re-regulation is to make markets work better and to prohibit market rigging, conflicts of interest, and collusive deals. This will, indeed, make markets work better. But we should be clear. True and needed regulation will cut into the profits of Wall Street as well as cut into the absurd bonuses. These excesses served no true economic function. To make Wall Street transparent and efficient is to make it less profitable than it has been.

It is not clear to me that Obama’s visit was helpful. This is a battle, and he has had a hard time fully recognizing that. Did he look weak or strong to Wall Street? Did he win favor with the rest of America? But the fact is that the Senate will probably issue a stronger bill than was likely only two weeks ago. The all-important derivatives market—including the infamous insurance contracts sold by AIG—will, under this bill, be traded openly and with supervision. Remarkably, the Agriculture Committee took the lead, under its suddenly bold chair who is up for re-election. Treasury Secretary Geithner had backed off of such a strong bill months ago. Now it is back. Democracy may be working.

BUT THE Obama administration is still resisting some admirable proposals. Many critics correctly want to prohibit banks that take FDIC-insured deposits to also buy and sell insurance—credit default swaps—on mortgage bonds and other products. They want any such business housed in a separate affiliate that does not have access to savers’ deposits. This will be costly to banks, and the Obama administration is siding with them.

The administration is supporting the Volcker rule, which would prohibit other trading activities. But this also is a fuzzy, and perhaps even meager, proposal as it now stands, and the details are to be decided in the future. A critical issue is how high to set new capital requirements for all financial institutions. They are not in the bill, but there are proposals to put the details in concrete. These probably won’t make it, and the tough work of making hard decisions about the issue is being delayed.

The all-important consumer financial protection agency will probably be housed in the Federal Reserve, if anywhere at all. Independence may always have been a delusion, but now it is baked into the law. Efforts to control compensation are meager in the new bill, but there is a start. The SEC may be given more power as may the FDIC. As for taming the culpable credit ratings agencies, again there is little as yet in the reform package and much to do, and other Senate committees may have to make some waves in this.

It has been eighteen months since the fall of Lehman and the rise of TARP, and there is still no regulatory package. Wall Street made a fortune in 2009—not because its bankers and brokers are brilliant, but because markets, which fell to near zero figuratively speaking, bounced back some. Any bounce back from near zero means a huge gain. In short, Wall Street did not provide business and consumers more capital in order to make a profit; its banks and brokerage firms essentially traded securities among themselves. And they are taking home even bigger bonuses than in the past.

In many respects, we are lucky to have Obama. There is little doubt he fully understands these issues—and better probably than almost anyone else in power in DC. He is learning that the world is filled, if not with “evil” people, than people whose own interests supersede their interests in the community. But he has yet to learn he is the defender of the community. If he gets that clear in his mind, he will do far better. He has at last made a start in financial re-regulation, and the bill that will pass will make a difference. It just won’t be nearly enough. But it may help him build political capital. Political capital is not a finite thing as the old New Democrats seem to think it is. If Obama shows America government is good, they may support more ambitious endeavors.

Jeff Madrick is editor of Challenge Magazine and director of policy research at the Schwartz Center for Economic Policy Analysis, The New School. He is the author of Taking America, The End of Affluence, and most recently The Case for Big Government. Photo: Obama in March (Pete Souza / White House).