| Financial Reform: Averting or Allowing Another Meltdown? |
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| Tuesday, 15 June 2010 01:09 | |
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Exactly how the Congressional debates over Wall Street Reform will shake out is anybody's guess. But one thing is for sure; there are going to be winners and losers. If you've been following the news, you know that both sides of the debate are still duking it out over the details. In one corner you've got the aggressive Rocky, the Bank Lobby fighting to protect Wall Street's bottom line. In the other corner is Team Transparency, trying to push derivatives trading out of the shadows so everyone can see what's really going on. OK, maybe that's an oversimplification. The issues also include placing caps on the amount banks can charge retailers for credit card purchases—the swipe fee. Another is about forcing banks to separate their derivatives trading from normal banking operations. For a refresher course in derivatives, see our earlier posting,Bubbles and Regulation. No matter how many definitions for a derivative you sift through, you'll find that they are basically a bet on a bet on a bet. No matter how you slice it or rationalize it, most derivative trading is pure gambling. And since banks have access to cheap money from the Federal Reserve, why should they be allowed to gamble with it? True banking is based on evaluating the credit worthiness of borrowers and the value of their collateral. Speculation, on the other hand, is all about betting on the how the markets are moving—and betting that the value of an underlying asset will drop. Essentially, while banks were betting on failure and collapse, (a collapse they could foresee because of reckless sub-prime lending), they were generating massive profits while the rest of the economy unraveled. We think it makes perfect sense to separate regular banking activities from pure speculation and gambling. If you read our bookThe Big Gamble: Are You Investing or Speculating? you'll get a real sense about the difference. The proposed reform also includes some pre-emptive methods for spotting risk and for pulling the plug on troubled financial institutions—before taxpayers end up having to foot the bill for more bailouts. There are also calls for stricter oversight of credit-rating agencies and some form of national consumer protection agency. But even if the proposed reform does pass, it's not likely to be a major game-changer in terms of averting a future crisis. There will still be plenty of risk left in the system as a lot will be left to the regulators' discretion, and we all know how astute regulators can be . . .think the SEC and the repeatedly ignored warnings about Bernie Madoff! In our opinion, we can't expect real order and balance in the financial system until derivatives are traded on transparent exchanges. Then if a bank violates those requirements, they should get slapped with hefty penalties. Banks should also be required to protect taxpayers from future TARP scenarios by setting up a kind of escrow account to cover costs associated with the dismantling of failing institutions—much like BP has been forced to do for the clean-up mess in the Gulf of Mexico. The bottom line is this: if some version of this Financial Reform Bill is to be effective, it will require Wall Street to put investors’ interests first and to play by the rules that prevent more financial disasters. Anything less is not real reform and leaves the doors wide open for the next meltdown. |
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