Getting to the Core of the Financial Crisis

A LOT OF PEOPLE KNOW IT, but no one with the proper podium wants to say it: the causes of the lingering recession are not being adequately addressed.

Granted, it is a huge jigsaw puzzle that even “all of the king’s horses and all of the king’s men cannot put back together again.” But there is enough evidence now to see the underlying problem: big banks have too much influence over the economy.

It is also evident that this problem is not being adequately addressed because of a secondary problem: that their position gives the big banks too much power over Congress.

I am not an economist, a banker, or a political party advocate. I stand far from the shore of where those events unfold, yet their gargantuan ripple has painfully affected me and those around me. Even I can see the obvious.

The obvious is that the underlying problem of too-big-to-fail has shifted financial and political power hugely in favor of the financial industry, to the disadvantage of taxpayers.

As John Simon and James Kwak write in their illuminating book, Thirteen Bankers, “If the conditions that led to this crisis are left in place, it would be folly to expect that another and worse crisis will not happen in the future.” Sadly, the recent Dodd-Frank legislation does essentially that: leaves conditions in place for possible future crises to occur.

In case you don’t know it, the Dodd-Frank bill is about policies, not procedures. It states what will be done, but authorizes other parties to devise the details of how to do it (such as how to regulate). In effect, the bill allows Congress to acknowledge that there are problems, then hand off the real fixing to someone else—with that someone else being regulators who tend to come from the Wall-Street-insider halls of government. In short, Congress is faking one way, but going the other.

The truth is that if this bill was really effective, it would be simple, clear, and a lot shorter. As it is (all 2,300 pages), it is too broad, complex, and open to interpretation. It leaves ample opportunity for loopholes, arbitrage, and future financial maladies; and it contains many provisions unrelated to financial reform (a common problem with legislation these days: throwing in a bunch of other stuff for other reasons).

Here’s my short version of what Congress should address:

If in crises you’re obliged to bail out large banks—commercial as well as investments banks, and customer deposits as well as the banks’ own (proprietary) betting on hedge funds—then you’re obliged to rigorously regulate them. On the other hand, if you’re not going to regulate them, don’t bail them out. In that case, make it law that you must let them fail. If you still believe what Ronald Reagan said—that “government is the problem”—then don’t let government be the solution to a failure of the financial system. And while you’re at it, return to a division between commercial and investment banks. And make hedge funds transparent.

As Simon and Kwak state in their book, the size of financial institutions—in particular the 6 largest (remaining) banks—should be limited to a point where their possible failure cannot cripple the rest of the system. The authors add that: “Saying that we cannot break up our largest banks is saying that our economic futures depend on these six companies (some of which are in various states of ill health). That should frighten us into action.”

It is indeed frightening a lot of people, but that does not deter banks or politicians who stand to lose considerable profit and power if regulations become law. Their worries about this (and the power of their political reach) are reflected in the probable non-appointment of Elizabeth Warren as head of the new Consumer Financial Protection Bureau (CFPB) which would oversee consumer regulations.

Watch the full episode. See more Need To Know.

In a recent New York Times editorial endorsing Ms. Warren, the authors put it aptly: “The banks don’t oppose Ms. Warren because she doesn’t get it. They oppose her because she does.” As a result, it won’t be a surprise to see Ms. Warren become, not the head of CFPB, but the next Brooksley Born, former director of the Commodity Futures Trading Commission (CFTC) who wanted to start regulating over-the-counter derivatives in 1998. Ms. Born was summarily shut up by the administration and Congress, only to have her prognostications start proving true a few years later, then become convincingly true in 2008.

For a revealing look at Ms. Born’s story, watch the Frontline piece at top about how events unfolded. You can learn more about Elizabeth Warren and how she envisions the role of the CFPB in the PBS video interview above. Both of these videos are worth the time spent to watch them, especially if you want a good overview of where we are.

Back to what needs to be done now, there is another simple, pivotal question: What will it take for the President and Congress to find their conscience, rediscover their original grand purpose as public servants, and agree that the big banks hold too much sway over the economy and the government—a situation that puts our economic and political systems and entire social fabric at extreme risk?

So far, their wisdom and humanity are not prevailing over their special interests and politics. Which means that the only other answer to these questions is time—and the bitter taste of more experience which they, and we, must endure.

Better buckle up. As Creedence Clearwater Revival says: “Looks like we’re in for [more] nasty weather. There’s a bad moon rising.”