Wall Street Regulation



The Banking Act of 1933, commonly known as Glass-Steagall, was established to tame the harmful speculative behavior of an industry run amok in the early part of the 20th century; behavior many observers at the time credited for the market crash that precipitated the Great Depression. For some, the repeal of Glass-Steagall, by the Gramm-Leach-Bliley Act of 1999, was the deathblow to financial prudence on Wall Street.

 In reality it was simply the formal recognition of careless financial practices that were largely in place already. Since the near-collapse of the banking industry in 2008, Glass-Steagall has made somewhat of a comeback with help from the Occupy movement and rising political stars like Elizabeth Warren, the former federal consumer protection advocate now running for Senate in Massachusetts. The only two political insiders you won’t catch talking about reinstating Glass-Steagall both happen to be running for president.

Wall Street reform is as important as it was in 2008 but both President Obama and Gov. Mitt Romney have taken great pains to avoid talking about it too much. For his part, President Obama seems content to rest on the laurels of the Dodd-Frank Act, Congress’s attempt to rein in Wall Street excess, which had enough support to pass but not enough to be properly funded or enforced. According to Romney’s platform, he would “Repeal Dodd-Frank and replace with streamlined, modern regulatory framework.” That’s the extent of his vision for the future of Wall Street according his platform. Ten words.

So while the rest of the country is suddenly talking about a law enacted almost 80 years ago, these guys aren’t going anywhere near it. The truth is, Wall Street reform and, more specifically Glass-Steagall, is more complicated, making it easy for Obama and Romney to be evasive.

So let’s answer two questions. What would actual Wall Street reform look like and what exactly was Glass-Steagall?

The purpose of the original act was to establish a barrier between traditional banks and the risk-taking investment firms, denying investment banks access to consumer deposits and secure, interest-bearing loans. The unwritten effect of Glass-Steagall, however, was to establish a culture of prudency in the consumer and business banking realm, leaving sophisticated professional investments to more savvy financiers who had the ability to calculate the inherent risk of a financial instrument. For decades to follow, the merits of Glass-Steagall would continue to be debated, but it nevertheless drew a marked distinction between the function of a consumer bank and an investment bank.

Today reinstating Glass-Steagall is a common rallying cry among those who decry the bad behavior of Wall Street. Its repeal has become the fulcrum of nearly every debate surrounding deregulation. Actually accomplishing this, of course, is easier said than done.

The best way to reconcile the debate over whether to reinstate Glass-Steagall is to appreciate that the culture of Glass-Steagall was more important than the act itself. Over time the restrictions placed on bankers under the act were chipped away, but the culture that governed the banking industry endured beyond its measures. Eventually, savvy bankers and politicians found ways to loosen its screws and interpret the act to their own benefit.

Don’t Just Blame Republicans

In 1978, President Jimmy Carter oversaw the passage of the International Banking Act, a bill that should probably receive as much, if not more attention than Gramm-Leach-Bliley. Essentially, the act allowed foreign banks or entities that engaged in “banking-like activities” to participate in domestic financial markets. For the first time, foreign investment firms were able to make competitive loans so long as they didn’t compete for consumer deposits; initially individual states could determine whether their regulatory structure could support this new activity. The government would go on to loosen restrictions governing the competition for consumer deposits and allowing bank holding companies to treat money markets like checking accounts.

In his book “End This Depression Now,” economist Paul Krugman argues that perhaps the most influential step with respect to the banking sector came with Carter’s passage of the “Monetary Control Act of 1980, which ended regulations that had prevented banks from paying interest on many kinds of deposits. Unfortunately, banking is not like trucking, and the effect of deregulation was not so much to encourage efficiency as to encourage risk taking.”

 By 1987 the bank holding companies, including foreign companies allowed to operate within the U.S. banking system, were granted access to mortgages to create a package of investments called mortgage-backed securities; the threshold for the amount of investing activity in instruments such as these was also increased, paving the way for the growth of investments backed by the strength (or weakness) of the consumer market.

During that same year, members of the Federal Reserve began calling for the repeal of Glass-Steagall as then-chairman Paul Volcker was providing the tie-breaking resistance. But this was a mere formality because by this time, Glass-Steagall was effectively over.

Yet even though most of the threads of regulation had been pulled from the overcoat that protected consumers from risky banking practices, the culture of prudent banking still existed to an extent; maintaining the Glass-Steagall Act on the books was an indication of this sentiment. Throughout the decades when regulations were steadily eroding, powerful national figures such as Paul Volcker under Carter and Reagan, and Treasury Secretary Nicholas Brady under George H.W. Bush managed to temper the enthusiasm of the movement.

That George Bush Senior heeded their admonitions was an admission that the public’s appetite for deregulation was actually beginning to wane in the post-Reagan hangover. Richard Berke’s New York Times article of Dec. 11, 1988, on the eve of the Bush presidency, encapsulated this feeling. Berke wrote, “Lawmakers and analysts say the pressure is fed by a heightened public uneasiness about deregulatory shortcomings that touch the daily lives of millions of Americans: from delays at airports and strains on the air traffic control system to the presence of hazardous chemicals in the workplace to worries about the safety of money deposited in savings institutions.” Alas, these four years would prove to be a momentary hiccup in the deregulation movement.

During the Clinton years, the nation’s leadership was largely comprised of proponents of deregulation. In fact, by his second term, Clinton was almost entirely surrounded by rabid free market enthusiasts. A former chairman at Goldman Sachs, Robert Rubin, was Secretary of the Treasury, Alan Greenspan was still at the helm of the Federal Reserve and Phil Gramm was the head of the powerful Senate Banking Committee. All of these men had close ties to Wall Street and made no secret of their intention to release bankers from the burdensome shackles of regulation and oversight.

Reforming Reform

In 2008, economist Joseph Stiglitz warned of the enduring negative consequences of deregulation. At a hearing held in front of the House Committee on Financial Services, Stiglitz invoked Adam Smith saying, “Even he recognized that unregulated markets will try to restrict competition, and without strong competition markets will not be efficient.” One of Stiglitz’s solutions was to restore transparency to investments and the markets themselves by restricting “banks’ dealing with criminals, unregulated and non-transparent hedge funds, and off-shore banks that do not conform to regulatory and accounting standards of our highly regulated financial entities.”

For emphasis he noted, “We have shown that we can do this when we want, when terrorism is the issue.”

Still, the nagging question remains as to what reform might look like. After all, not all deregulation is irresponsible. Most of the discussion in the media surrounding deregulation revolves around the concept that our banking institutions are “too big to fail.” Thus the rallying cry for reinstating Glass-Steagall and separating banks from investment banks. I’m in tepid agreement with the underlying principle, but the reality of the situation is far more complicated. The fact is banking has gone global and the deregulation genie is out of the bottle.

As I said earlier, Glass-Steagall was as much about instilling a culture of prudency to the banking world as it was about erecting a barrier between commercial banks and investment banks. Advocates like Elizabeth Warren like to say that prior to 1999 and the repeal of Glass-Steagall, the economy functioned through periods of both prosperity and recession since 1934 without the banking sector once collapsing. It’s a fair, but oversimplified assertion that overlooks the fact that Glass-Steagall was on a ventilator in 1978 and dead by 1980. A 30-year run of prosperity from 1978 to 2008, with a few brief recessions in between, is nothing to sneeze at.

Restoring balance to the banking sector does not necessarily require separating the banks. Not yet at least. It begins with transparency and reestablishing the culture of prudency that has been conspicuously absent over the past decade. After all, you cannot value what you cannot see; nor can you mitigate risk unless you first manage reward.

What this really boils down to is accountability, which is ultimately a behavioral issue. Allowing investors to actually see how a bank behaves by viewing the size and scope of their transactions would theoretically assuage their appetite for risk. Given these conclusions, it’s easier to make the case that our current president would provide more accountability and inspire behavioral changes on Wall Street, particularly given Romney’s intransigence when it comes to considering financial reform. But tough talk against Wall Street has all but disappeared from Obama’s rhetoric leaving little hope that a second term will elicit any further positive change. So this week, while neither man seems serious about financial reform, the status quo is better than further deregulation and letting bankers rule the roost.

Tie goes to the incumbent.

That 70’s Show

There is no shortage  of theories as to why Americans are finding themselves staring  helplessly at rising gas prices, but few of them are real. In fact, much  of the prevailing wisdom offered by television pundits is false.

He was a relative unknown when he campaigned for president of an America  that was worn down from foreign intervention, a sick economy and  Republican rule. His outsider status brought with him a new brand of  hope that the media devoured allowing his star to rise quickly and shine  brightly. Upon taking the presidency, however, the beleaguered economy  stubbornly refused to show signs of life, energy prices rose to  troubling levels and the Middle East began to spin wildly out of  control. Things were so bad he even had to step in and bail out an American car company with government funds.

After only three years, it was all over but for the counting. His star  faded quickly as the once-media darling became anathema to an  increasingly conservative American public that spent the last year of  his term looking for a new “Mr. Right” in every sense.

Such was the fate of Jimmy Carter, who never had a shot at re-election;  and a good argument can be made that Barack Obama will suffer the same  fate under nearly identical circumstances.

There is so much involved in the making and unmaking of a president that  it’s unfair to boil a career down to only a few factors. But in Jimmy  Carter’s case I believe it is fair to say that three primary issues were  the undoing of his presidency: the hostage crisis in Iran, stagflation  and fuel prices at the pump.

Iran wasn’t a military crisis as much as it was an embarrassment to the United States, though talk of a nuclear Iran was percolating even then.  Prior meddling in the Middle East came back to haunt us in a situation  we couldn’t control, with Carter ill-equipped to handle the predicament  of Americans held hostage in Tehran. Rising oil prices—the result of the  Iranian revolution in 1979 and the panic that ensued in the trading  markets—brought about a second shortage within a decade and with it  hysteria and inflation. This upward pressure from fuel prices in an  already inflationary environment spurred the Federal Reserve to begin  chasing inflation with high interest rates.

In his book Currency Wars, James Rickards addresses the impact of  American monetary policy on the global economy and cites the “50 percent  decline in the purchasing power of the dollar from 1977 to 1981.” He  goes on to depict “a world gone mad,” noting that, “A new term,  ’stagflation,’ was used to describe the unprecedented combination of  high inflation and stagnation happening in the United States.”  Most people recall the moment when interest rates reached as high as 20  percent during this period and point to it as the height of insanity  during the Carter years. In actuality then-Fed Chairman Paul Volcker  under Ronald Reagan did this as a one-time shock to the system.  It was  done in conjunction with vigorous tax cuts to spark consumer spending, a  tightening of the monetary policy to strengthen the dollar and the  latent effect of increased oil production, both domestic and abroad.  With the exception of the tax cuts, these policies and factors would  likely have occurred anyway as Volcker was a Carter appointee and it was  Carter who loosened the valve on domestic oil production. Furthermore,  Reagan would go on to reverse many of these initial tax cuts in a way  that would make conservatives and Tea Party activists blush today.  Either way, Jimmy Carter was a victim of pitiful economic circumstances  that will forever be his legacy in the White House.

Rickards draws some comparisons between the ’70s and today, most notably  deriding Federal Reserve Chairman Ben Bernanke’s actions of Quantitative  Easing, a fancy name for printing money—the same currency devaluation  scheme employed by Nixon—calling them “runaway fiscal and monetary  policies, which were flooding the world with dollars and causing global  inflation in food and energy prices.”

This is an interesting point to hang on for a bit. There is no shortage  of theories as to why Americans are finding themselves staring  helplessly at rising gas prices, but few of them are real. In fact, much  of the prevailing wisdom offered by television pundits is false. It’s  not Obama’s refusal to “drill baby drill” or increased demand from  China. It’s not Libya or Iran, either. It’s the abundance of liquidity  in the markets matched with the ability of investment banks, hedge funds  and oil companies to trade energy futures on commodities exchanges  without any limits or transparency. And this is the result of 30 years of deregulation beginning with Carter and continuing through Obama.

Before the commodities exchanges were deregulated there were few safe  places to “park” excess capital during volatile periods. Today these  exchanges are the perfect shelters for investors with excess liquidity  because many of them are allowed to stand on all sides of the  transaction. An investor such as an investment bank or an oil company  can be the buyer, seller, broker and manufacturer, and can therefore more easily predict the future behavior of pricing by both forecasting  the future price of a commodity it owns while moving the market with  enormous capital infusions. It’s more than the ultimate hedge. It’s a  scam.

With a crisis brewing in Iran, the markets and pundits are once again in  a tizzy, and consumers are bracing for the worst. This brings us to what  might be the nail in Barack Obama’s coffin: inflation.  When fuel prices rise, even for a brief period, it shows up within  months in our food and other consumables. It’s a necessary evil in the  production of nearly everything we consume on the planet, which is why  it’s so utterly dangerous to leave the process of trading energy futures  unregulated. Oil doesn’t have to reach $200 per barrel to destroy any  hope of economic recovery and, worse, force mass starvation around the  globe.

If the price is sustained at $100-plus per barrel without relief  while we continue to suppress interest rates and flood the market with  the dollar, Bernanke and Co. will have difficulty stemming the natural  tide of inflation as it works its way around the globe in the things we  buy and the food we eat.  Bernanke’s announcement that the Fed will continue to artificially  suppress interest rates through 2014 and the government’s steadfast  refusal to implement any reasonable regulation in the markets is a  self-fulfilling prophecy as investors continue to seek safe harbor for  their funds in the only market they have any ability to control. This  will prevent any crash in oil prices that would naturally occur, as we  witnessed in 2008 when oil hit $147 per barrel then plummeted shortly  thereafter.

Further fracture in relations with Iran and high oil prices  will also crush any hopes the European Union has of recovery. And with  the determined stance that austerity is the EU’s chosen path to  prosperity, the United States faces the additional problem of having its  No. 1 consumer of U.S. exports absolutely cash-strapped and constricting  even further.  Barack Obama’s re-election hopes are really a matter of timing more than  anything because the conclusions above are simply common sense and  arithmetic.

Any chance he had to calm this gathering storm has already  passed, leaving him at the mercy of the global markets, which are  teetering on a gigantic bubble. His oratory and confidence are outgunned  by a conservative media machine pouring on the pressure by falsely  blaming his energy policy for high oil prices and stoking the fire with  Iran, thus creating all the necessary traps for his demise. Even if he  were able to truly force real change in the oversight of the financial  markets, it would spook Wall Street and could incite panic. And any  attempt to quiet the saber-rattling between Washington and Tehran would  make him appear weak compared to a bloodthirsty slate of GOP opponents.

Obama’s only option is to pray the storm doesn’t touch down between now  and Nov. 6. If it does, instead of occupying the White House in January,  he’ll be building houses with Jimmy Carter, while Mitt Romney tries to  figure out where to park all of Anne’s Cadillacs.