CTOBER 7, 2010, 8:40 PM
Make Wall Street Risk It All By WILLIAM D. COHAN
William D. Cohan on Wall Street and Main Street.
Tags:
incentives, investment bank, Wall Street
Two years after the near collapse of capitalism, we certainly have our fill of financial reforms. The 2,200-page Dodd-Frank Act, which President Obama signed this summer, creates an Orwellian alphabet soup of new agencies, oversight boards and offices intended to protect us from ourselves.
The problem is that since the incentives on Wall Street have not been changed one iota by the new laws — nor are they likely to be changed by any of the soon-to-be-written regulations of federal agencies — we’re no better protected from bankers’ potentially reckless behavior than we were before the latest round of reforms.
It’s not that Dodd-Frank ignored Wall Street’s past excesses. The law will ensure that some, but not all, derivatives will have to be traded on exchanges and that some, but not all, of the banks’ proprietary trading will be curbed and that some, but not all, of their private-equity and hedge funds will be shuttered or spun off. Dodd-Frank is also supposed to curtail Wall Street’s penchant for creating conflicts of interest, although how the law is going to do that is far from clear.
“In the end, our financial system only works — our market is only free — when there are clear rules and basic safeguards that prevent abuse, that check excess, that ensure that it is more profitable to play by the rules than to game the system,” President Obama said when he signed the bill into law. That rhetoric is fine, but unfortunately Dodd-Frank will do nothing to change the rules on Wall Street.
Nor, frankly, will the expected coming into force, in a couple of years, of the new Basel III capital rules, which will likely require banks to have common equity equal to 7 percent of the value of their assets.
Bankers and traders still have the same irresponsible, accountability-free incentives they have had for the past 40 years to generate as much revenue as they possibly can each year, regardless of the consequences. The change occurred when Wall Street firms stopped being partnerships, in which every partner put his full wealth on the line every day, and became corporations, which put the risks on their shareholders and creditors.
Dodd-Frank and Basel III both missed plum opportunities to change Wall Street’s incentive structure. Which is a shame, since it would not have been difficult. Human behavior is pretty simple actually. We do what we are rewarded to do. On Wall Street, people are hugely overcompensated for generating revenue, which they do by selling products (stocks, bonds, advice on mergers or investing) and by using their vast balance sheets to facilitate trades for clients and to take the risks others don’t want to take.
What’s made all this possible is the vast amounts of capital that Wall Street firms have amassed. Fifty years ago, Goldman Sachs had around $10 million of capital, which came from its partners; today Goldman has upward of $74 billion of capital, derived mostly from the generosity of its shareholders and the creditors who have bought Goldman’s public and private securities.
Over the past generation, this business model has worked well for one group in particular: the bankers, traders and honchos who work on Wall Street. These days on Wall Street, around 50 percent of every dollar of revenue generated is paid out to its employees in the form of compensation. What other business on earth does this? None.
And how would Dodd-Frank change this dynamic? It would give shareholders a nonbinding “say on pay” regarding the compensation of executives of public corporations. And even if a majority of shareholders expressed their displeasure, the companies would be free to ignore them. Yawn.
Regulators at the Securities and Exchange Commission will also have the mandate to explore whether a Wall Street firm’s compensation practices are contributing to excessive risk-taking and, if so, to try to do something about that, like making it easier for shareholders to oust directors. But that directive is an afterthought, too.
We already have definitive proof that Wall Street’s compensation practices lead to excessive risk-taking: witness the way Wall Street’s armies kept selling mortgage-backed securities filled with defaulting home mortgages long after the securities made any sense as an investment. Wall Street did the same thing in the 1980s with junk bonds, the same thing in the 1990s with Internet initial public offerings, and the same thing in the early 2000s with the debt of emerging telecommunications companies.
This sort of thing will happen again soon enough unless Wall Street’s senior executives have the clear economic incentive to closely monitor the risks their firms are taking and make it their business to ensure that the risks are prudent.
IN June 1987, Deputy Secretary of State John Whitehead, who had previously been Goldman’s co-senior partner, reflected on the insider trading scandals that were roiling one Wall Street firm after another.
“Anybody who alleges that Wall Street is rotten I just don’t think understands Wall Street,” Mr. Whitehead told Institutional Investor magazine. “I think it’s a remarkable system that still works effectively at the heart of our free-enterprise system. But if we are going to avoid sweeping government controls and regulations, then it is incumbent on the system to clean up its act.”
Of course, Wall Street did not follow his advice about cleaning up its own act. Rather, Wall Street went to the other extreme, pushing its friends in Washington for less and less regulation all through the 1990s and early 2000s. Let the market regulate Wall Street, we were told repeatedly. Now we face the “sweeping government controls and regulations” that Mr. Whitehead feared.
This did not have to happen. For example, Goldman Sachs seems to understand the power of creating internal incentives to monitor and to regulate the risks the firm is taking. When Goldman went public in 1999, unlike other firms it decided that a group of its 400 or so top executives would get paid not out of the firm’s revenues, but instead from the firm’s pretax profits. If the firm has no pretax profits in any given year, these executives get (only) their six-figure salaries, not the tens of millions in bonuses they count on.
As a result, the senior brass at Goldman is hyperfocused on making sure the firm is always profitable, and it always has been. This may very well be the precise reason that Goldman alone saw the brewing mortgage meltdown and did something about it.
When other firms were losing billions of dollars in 2007 as the mortgage market exploded, Goldman made $17.6 billion in pretax profits, one of its most profitable years ever, and its top three executives split around $200 million. You would think the rest of Wall Street would emulate Goldman’s approach to compensating its top executives. But it hasn’t.
SINCE neither Goldman’s example nor Dodd-Frank and Basel III will change Wall Street’s behavior, we have to find a new mechanism. To my mind, its central feature should be that each of the top 100 executives at Wall Street’s remaining “systemically important” firms be personally liable for the risks they take. Not just their unexercised stock options or restricted stock, but every asset they have in their possession: from their cars to their fancy homes to their bulging bank accounts.
The days of privatizing the profits for Wall Street and socializing the risks must end. As radical as this sounds, in truth it would be no different from when — before 1970 — Wall Street was a series of private partnerships.
We can’t turn back the clock: Wall Street’s big firms will never again be private partnerships. Instead, I propose that each large Wall Street firm create a new security that represents — and is secured by — the entire net worth of its 100 top executives. This security would be subordinated to all other creditors as well as to all preferred and common shareholders; in other words, if a firm goes bankrupt, this security is the first to be wiped out.
Had such a security existed at the time of the collapse of Lehman Brothers, the net worth of the top 100 Lehman executives — no doubt totaling several billion dollars — would have been collected after liquidating everything they owned and paid to Lehman creditors, who under the current system will be lucky if they get back 10 cents on the dollar.
Wall Street’s first reaction to this idea — aside from profanities — will be that it cannot possibly be done. Or that it would somehow threaten the sanctity of our capital markets.
But, in fact, it can and should be done. Indeed, Wall Street has all the intellectual capital it needs in its own archives to construct such a security: in the old partnership days every partner signed an agreement requiring him (and rarely her) to put his net worth on the line every day. Surely, clever Wall Street lawyers can draft a 21st-century version of the old partnership agreement.
What’s more, Wall Street should take the initiative to do this unprompted. As John Whitehead warned, the banks’ failure to show responsibility will only invite more government intervention.
If, however, the firms balk, the S.E.C. should require this sort of accountability from the senior managements as part of its new regulations governing Wall Street compensation. Or Congress should take advantage of the still-brewing outrage against Wall Street to force the creation of such a security.
Pretty harsh, right? Maybe, but Wall Street deserves no sympathy. Had this security, or something like it, been in place at every Wall Street firm five years ago, there would have been no mortgage bubble, no financial crisis, no deep and unsettling economic recession with nearly 10 percent unemployment, no need for the Troubled Asset Relief Program, and no need for Dodd-Frank or Basel III.
Why? Because human beings do what they are rewarded to do — especially on Wall Street — and if they are rewarded for taking prudent and sensible risks, that’s exactly what they will do.
This column appeared in print on October 8, 2010.
Showing posts with label Regulation. Show all posts
Showing posts with label Regulation. Show all posts
Friday, October 08, 2010
Tuesday, April 27, 2010
April 27, 2010 A Bank Tax as Insurance for Us All By DAVID LEONHARDT Washington The financial regulation bill before the Senate has the potential to
April 27, 2010
A Bank Tax as Insurance for Us All By DAVID LEONHARDT
Washington
The financial regulation bill before the Senate has the potential to do a lot of good. But it also has at least one major flaw: it would not do enough to prevent taxpayers from paying the bill for a future crisis.
What would? A tax on banks. The International Monetary Fund has started pushing for a bank tax, and a tax has also become part of the debate in Britain’s election campaign. In this country, however, the subject has taken a back seat to issues like derivatives regulation and the Goldman Sachs case. Those other issues are important, but they are not as central to minimizing the damage from the next crisis.
To understand why, let’s take a glimpse into the future. Imagine the year is 2020, and a major financial firm is collapsing.
The financial regulation bill that President Obama signed back in 2010 was meant to deal with just such a problem. It gave regulators something called “resolution authority.” They could seize a dying firm, wipe out its shareholders, fire its top executives and keep it operating until its surviving parts could be sold off in an orderly fashion. Now, in 2020, the regulators are preparing to use that authority for the first time.
But as they dig into the details, they realize they are facing a raft of problems. One of the biggest is that the firm has 70 percent of its assets abroad (roughly the share of Citicorp’s business that was overseas in 2009). Washington can’t simply seize assets held in London, Shanghai or Moscow.
So ultimately, the regulators are left with the same choice that arose in 2008: bankruptcy or bailout. Regulators can let the firm fall apart suddenly and risk the kind of collateral damage that the bankruptcy of Lehman Brothers caused. Or they can spend billions of taxpayer dollars propping up the firm, as was the case with A.I.G. It’s a miserable choice.
You also can be pretty sure which of the two options tomorrow’s policy makers will choose: bailout. History — in the form of the Great Depression and, more recently, Lehman — argues against the idea of liquidate, liquidate, liquidate, as Herbert Hoover’s Treasury secretary, Andrew Mellon, advocated. The downside, of course, is that taxpayers end up paying for Wall Street’s sins.
Obama administration officials insist that the reregulation plan will prevent this outcome. They note that both the Senate and House bills will give regulators more authority to monitor financial firms. Banks will also be required to hold more cash in reserve, which will give them a bigger cushion when some investments do go bad. The rules for resolution authority, meanwhile, will be written with international cooperation in mind.
And maybe time will prove the administration correct. But a good number of economists and banking experts are worried. They think the odds of a future bankruptcy-or-bailout dilemma will remain uncomfortably high even if reregulation passes.
For starters, there are the cross-border problems; in the midst of a crisis, governments may have trouble cooperating. Then there is the fact that the regulators have never before tried to shut down anything as complex as a multibillion-dollar financial firm. “It’s really hard — really hard,” says Robert Steel, who worked on the financial crisis in the Bush Treasury Department and later was chief executive of Wachovia. “Anyone who says they know exactly what we should do is overconfident.”
Another former top government official adds, bluntly, “Don’t kid yourself into thinking that if J. P. Morgan were on the rocks, it would disappear.”
Above all, no one knows what the next crisis will look like. So no one can be sure exactly how to prevent it. In all likelihood, Wall Street will eventually figure out ways around technocratic rules — and technocrats — and create trouble that today’s proposals don’t anticipate.
The beauty of a bank tax is that it acknowledges as much. Financial firms play a vital role in a market economy. But they also have a long record of causing crises, be it the South Sea bubble of 1720, the Panic of 1873, the Great Depression or our own Great Recession. A bank tax is akin to an insurance policy that taxpayers would require Wall Street to hold. The premiums on that policy would keep Wall Street from making big profits in good times while foisting its losses on society in bad.
The current Senate bill includes a kind of bank tax, but it has all kinds of problems. It would initially collect only $50 billion from firms and then set the money aside to pay the costs of future bailouts. Other crises have cost far more than $50 billion.
For this reason, the Obama administration prefers a postcrisis tax. The White House has proposed a so-called TARP tax, to raise at least $90 billion over the next decade and cover the costs of the 2008 bailout fund (the Troubled Asset Relief Program). But this idea has its own flaws. It does not leave any money for future busts. It assumes Washington will always be able to recoup those costs later, which doesn’t sound like a great bet.
The I.M.F. prefers a permanent tax, for the good reason that the risk of crises is permanent. “The challenge is to ensure that financial institutions bear the direct financial costs that any future failures or crises will impose — and maybe somewhat more, given all the other costs that bank failure can impose on the economy,” Carlo Cottarelli, the head of the I.M.F.’s fiscal affairs unit, wrote last weekend. The tax wouldn’t go into a dedicated bailout fund. Its purpose instead would be to discourage too much risk-taking and, over the long term, help offset any bailout costs.
Because the tax would be calculated based on a firm’s holdings, a small local bank or a larger bank with billions of dollars in safe consumer deposits might pay nothing. A leveraged investment bank would surely be taxed.
The TARP tax, in its technical design, would be similar. And Timothy Geithner, the Treasury secretary, told me recently that he was open to the idea of the tax’s becoming permanent. “There is a very good argument you should put a fee on finance, like a tax on pollution,” he said.
Yet the administration — nervous about upsetting the fragile support in Congress for financial reregulation — has been afraid of making the tax part of the broader bill. That strikes me as a mistake, given the tax’s importance. Obviously, though, if Congress passes a bank tax in a separate bill later this year, it will work out the same in the end.
There is some reason for optimism, too. Max Baucus, the chairman of the Senate Finance Committee, told Politico this week, “I don’t think there’s much doubt that there will be a bank tax.” Why? The tax is not just about punishing banks.
The federal government, remember, is facing a huge deficit. To pay it off, Washington will need to make spending cuts and raise taxes. Can you think of a better candidate for taxation than an industry that made huge profits during the boom and then helped cause the bust that has sent the deficit soaring?
A Bank Tax as Insurance for Us All By DAVID LEONHARDT
Washington
The financial regulation bill before the Senate has the potential to do a lot of good. But it also has at least one major flaw: it would not do enough to prevent taxpayers from paying the bill for a future crisis.
What would? A tax on banks. The International Monetary Fund has started pushing for a bank tax, and a tax has also become part of the debate in Britain’s election campaign. In this country, however, the subject has taken a back seat to issues like derivatives regulation and the Goldman Sachs case. Those other issues are important, but they are not as central to minimizing the damage from the next crisis.
To understand why, let’s take a glimpse into the future. Imagine the year is 2020, and a major financial firm is collapsing.
The financial regulation bill that President Obama signed back in 2010 was meant to deal with just such a problem. It gave regulators something called “resolution authority.” They could seize a dying firm, wipe out its shareholders, fire its top executives and keep it operating until its surviving parts could be sold off in an orderly fashion. Now, in 2020, the regulators are preparing to use that authority for the first time.
But as they dig into the details, they realize they are facing a raft of problems. One of the biggest is that the firm has 70 percent of its assets abroad (roughly the share of Citicorp’s business that was overseas in 2009). Washington can’t simply seize assets held in London, Shanghai or Moscow.
So ultimately, the regulators are left with the same choice that arose in 2008: bankruptcy or bailout. Regulators can let the firm fall apart suddenly and risk the kind of collateral damage that the bankruptcy of Lehman Brothers caused. Or they can spend billions of taxpayer dollars propping up the firm, as was the case with A.I.G. It’s a miserable choice.
You also can be pretty sure which of the two options tomorrow’s policy makers will choose: bailout. History — in the form of the Great Depression and, more recently, Lehman — argues against the idea of liquidate, liquidate, liquidate, as Herbert Hoover’s Treasury secretary, Andrew Mellon, advocated. The downside, of course, is that taxpayers end up paying for Wall Street’s sins.
Obama administration officials insist that the reregulation plan will prevent this outcome. They note that both the Senate and House bills will give regulators more authority to monitor financial firms. Banks will also be required to hold more cash in reserve, which will give them a bigger cushion when some investments do go bad. The rules for resolution authority, meanwhile, will be written with international cooperation in mind.
And maybe time will prove the administration correct. But a good number of economists and banking experts are worried. They think the odds of a future bankruptcy-or-bailout dilemma will remain uncomfortably high even if reregulation passes.
For starters, there are the cross-border problems; in the midst of a crisis, governments may have trouble cooperating. Then there is the fact that the regulators have never before tried to shut down anything as complex as a multibillion-dollar financial firm. “It’s really hard — really hard,” says Robert Steel, who worked on the financial crisis in the Bush Treasury Department and later was chief executive of Wachovia. “Anyone who says they know exactly what we should do is overconfident.”
Another former top government official adds, bluntly, “Don’t kid yourself into thinking that if J. P. Morgan were on the rocks, it would disappear.”
Above all, no one knows what the next crisis will look like. So no one can be sure exactly how to prevent it. In all likelihood, Wall Street will eventually figure out ways around technocratic rules — and technocrats — and create trouble that today’s proposals don’t anticipate.
The beauty of a bank tax is that it acknowledges as much. Financial firms play a vital role in a market economy. But they also have a long record of causing crises, be it the South Sea bubble of 1720, the Panic of 1873, the Great Depression or our own Great Recession. A bank tax is akin to an insurance policy that taxpayers would require Wall Street to hold. The premiums on that policy would keep Wall Street from making big profits in good times while foisting its losses on society in bad.
The current Senate bill includes a kind of bank tax, but it has all kinds of problems. It would initially collect only $50 billion from firms and then set the money aside to pay the costs of future bailouts. Other crises have cost far more than $50 billion.
For this reason, the Obama administration prefers a postcrisis tax. The White House has proposed a so-called TARP tax, to raise at least $90 billion over the next decade and cover the costs of the 2008 bailout fund (the Troubled Asset Relief Program). But this idea has its own flaws. It does not leave any money for future busts. It assumes Washington will always be able to recoup those costs later, which doesn’t sound like a great bet.
The I.M.F. prefers a permanent tax, for the good reason that the risk of crises is permanent. “The challenge is to ensure that financial institutions bear the direct financial costs that any future failures or crises will impose — and maybe somewhat more, given all the other costs that bank failure can impose on the economy,” Carlo Cottarelli, the head of the I.M.F.’s fiscal affairs unit, wrote last weekend. The tax wouldn’t go into a dedicated bailout fund. Its purpose instead would be to discourage too much risk-taking and, over the long term, help offset any bailout costs.
Because the tax would be calculated based on a firm’s holdings, a small local bank or a larger bank with billions of dollars in safe consumer deposits might pay nothing. A leveraged investment bank would surely be taxed.
The TARP tax, in its technical design, would be similar. And Timothy Geithner, the Treasury secretary, told me recently that he was open to the idea of the tax’s becoming permanent. “There is a very good argument you should put a fee on finance, like a tax on pollution,” he said.
Yet the administration — nervous about upsetting the fragile support in Congress for financial reregulation — has been afraid of making the tax part of the broader bill. That strikes me as a mistake, given the tax’s importance. Obviously, though, if Congress passes a bank tax in a separate bill later this year, it will work out the same in the end.
There is some reason for optimism, too. Max Baucus, the chairman of the Senate Finance Committee, told Politico this week, “I don’t think there’s much doubt that there will be a bank tax.” Why? The tax is not just about punishing banks.
The federal government, remember, is facing a huge deficit. To pay it off, Washington will need to make spending cuts and raise taxes. Can you think of a better candidate for taxation than an industry that made huge profits during the boom and then helped cause the bust that has sent the deficit soaring?
Friday, April 16, 2010
The Fire Next Time By PAUL KRUGMAN
April 16, 2010
Op-Ed Columnist
The Fire Next Time By PAUL KRUGMAN
On Tuesday, Mitch McConnell, the Senate minority leader, called for the abolition of municipal fire departments.
Firefighters, he declared, “won’t solve the problems that led to recent fires. They will make them worse.” The existence of fire departments, he went on, “not only allows for taxpayer-funded bailouts of burning buildings; it institutionalizes them.” He concluded, “The way to solve this problem is to let the people who make the mistakes that lead to fires pay for them. We won’t solve this problem until the biggest buildings are allowed to burn.”
O.K., I fibbed a bit. Mr. McConnell said almost everything I attributed to him, but he was talking about financial reform, not fire reform. In particular, he was objecting not to the existence of fire departments, but to legislation that would give the government the power to seize and restructure failing financial institutions.
But it amounts to the same thing.
Now, Mr. McConnell surely isn’t sincere; while pretending to oppose bank bailouts, he’s actually doing the bankers’ bidding. But before I get to that, let’s talk about why he’s wrong on substance.
In his speech, Mr. McConnell seemed to be saying that in the future, the U.S. government should just let banks fail. We “must put an end to taxpayer funded bailouts for Wall Street banks.” What’s wrong with that?
The answer is that letting banks fail — as opposed to seizing and restructuring them — is a bad idea for the same reason that it’s a bad idea to stand aside while an urban office building burns. In both cases, the damage has a tendency to spread. In 1930, U.S. officials stood aside as banks failed; the result was the Great Depression. In 2008, they stood aside as Lehman Brothers imploded; within days, credit markets had frozen and we were staring into the economic abyss.
So it’s crucial to avoid disorderly bank collapses, just as it’s crucial to avoid out-of-control urban fires.
Since the 1930s, we’ve had a standard procedure for dealing with failing banks: the Federal Deposit Insurance Corporation has the right to seize a bank that’s on the brink, protecting its depositors while cleaning out the stockholders. In the crisis of 2008, however, it became clear that this procedure wasn’t up to dealing with complex modern financial institutions like Lehman or Citigroup.
So proposed reform legislation gives regulators “resolution authority,” which basically means giving them the ability to deal with the likes of Lehman in much the same way that the F.D.I.C. deals with conventional banks. Who could object to that?
Well, Mr. McConnell is trying. His talking points come straight out of a memo Frank Luntz, the Republican political consultant, circulated in January on how to oppose financial reform. “Frankly,” wrote Mr. Luntz, “the single best way to kill any legislation is to link it to the Big Bank Bailout.” And Mr. McConnell is following those stage directions.
It’s a truly shameless performance: Mr. McConnell is pretending to stand up for taxpayers against Wall Street while in fact doing just the opposite. In recent weeks, he and other Republican leaders have held meetings with Wall Street executives and lobbyists, in which the G.O.P. and the financial industry have sought to coordinate their political strategy.
And let me assure you, Wall Street isn’t lobbying to prevent future bank bailouts. If anything, it’s trying to ensure that there will be more bailouts. By depriving regulators of the tools they need to seize failing financial firms, financial lobbyists increase the chances that when the next crisis strikes, taxpayers will end up paying a ransom to stockholders and executives as the price of avoiding collapse.
Even more important, however, the financial industry wants to avoid serious regulation; it wants to be left free to engage in the same behavior that created this crisis. It’s worth remembering that between the 1930s and the 1980s, there weren’t any really big financial bailouts, because strong regulation kept most banks out of trouble. It was only with Reagan-era deregulation that big bank disasters re-emerged. In fact, relative to the size of the economy, the taxpayer costs of the savings and loan disaster, which unfolded in the Reagan years, were much higher than anything likely to happen under President Obama.
To understand what’s really at stake right now, watch the looming fight over derivatives, the complex financial instruments Warren Buffett famously described as “financial weapons of mass destruction.” The Obama administration wants tighter regulation of derivatives, while Republicans are opposed. And that tells you everything you need to know.
So don’t be fooled. When Mitch McConnell denounces big bank bailouts, what he’s really trying to do is give the bankers everything they want.
David Brooks is off today.
Op-Ed Columnist
The Fire Next Time By PAUL KRUGMAN
On Tuesday, Mitch McConnell, the Senate minority leader, called for the abolition of municipal fire departments.
Firefighters, he declared, “won’t solve the problems that led to recent fires. They will make them worse.” The existence of fire departments, he went on, “not only allows for taxpayer-funded bailouts of burning buildings; it institutionalizes them.” He concluded, “The way to solve this problem is to let the people who make the mistakes that lead to fires pay for them. We won’t solve this problem until the biggest buildings are allowed to burn.”
O.K., I fibbed a bit. Mr. McConnell said almost everything I attributed to him, but he was talking about financial reform, not fire reform. In particular, he was objecting not to the existence of fire departments, but to legislation that would give the government the power to seize and restructure failing financial institutions.
But it amounts to the same thing.
Now, Mr. McConnell surely isn’t sincere; while pretending to oppose bank bailouts, he’s actually doing the bankers’ bidding. But before I get to that, let’s talk about why he’s wrong on substance.
In his speech, Mr. McConnell seemed to be saying that in the future, the U.S. government should just let banks fail. We “must put an end to taxpayer funded bailouts for Wall Street banks.” What’s wrong with that?
The answer is that letting banks fail — as opposed to seizing and restructuring them — is a bad idea for the same reason that it’s a bad idea to stand aside while an urban office building burns. In both cases, the damage has a tendency to spread. In 1930, U.S. officials stood aside as banks failed; the result was the Great Depression. In 2008, they stood aside as Lehman Brothers imploded; within days, credit markets had frozen and we were staring into the economic abyss.
So it’s crucial to avoid disorderly bank collapses, just as it’s crucial to avoid out-of-control urban fires.
Since the 1930s, we’ve had a standard procedure for dealing with failing banks: the Federal Deposit Insurance Corporation has the right to seize a bank that’s on the brink, protecting its depositors while cleaning out the stockholders. In the crisis of 2008, however, it became clear that this procedure wasn’t up to dealing with complex modern financial institutions like Lehman or Citigroup.
So proposed reform legislation gives regulators “resolution authority,” which basically means giving them the ability to deal with the likes of Lehman in much the same way that the F.D.I.C. deals with conventional banks. Who could object to that?
Well, Mr. McConnell is trying. His talking points come straight out of a memo Frank Luntz, the Republican political consultant, circulated in January on how to oppose financial reform. “Frankly,” wrote Mr. Luntz, “the single best way to kill any legislation is to link it to the Big Bank Bailout.” And Mr. McConnell is following those stage directions.
It’s a truly shameless performance: Mr. McConnell is pretending to stand up for taxpayers against Wall Street while in fact doing just the opposite. In recent weeks, he and other Republican leaders have held meetings with Wall Street executives and lobbyists, in which the G.O.P. and the financial industry have sought to coordinate their political strategy.
And let me assure you, Wall Street isn’t lobbying to prevent future bank bailouts. If anything, it’s trying to ensure that there will be more bailouts. By depriving regulators of the tools they need to seize failing financial firms, financial lobbyists increase the chances that when the next crisis strikes, taxpayers will end up paying a ransom to stockholders and executives as the price of avoiding collapse.
Even more important, however, the financial industry wants to avoid serious regulation; it wants to be left free to engage in the same behavior that created this crisis. It’s worth remembering that between the 1930s and the 1980s, there weren’t any really big financial bailouts, because strong regulation kept most banks out of trouble. It was only with Reagan-era deregulation that big bank disasters re-emerged. In fact, relative to the size of the economy, the taxpayer costs of the savings and loan disaster, which unfolded in the Reagan years, were much higher than anything likely to happen under President Obama.
To understand what’s really at stake right now, watch the looming fight over derivatives, the complex financial instruments Warren Buffett famously described as “financial weapons of mass destruction.” The Obama administration wants tighter regulation of derivatives, while Republicans are opposed. And that tells you everything you need to know.
So don’t be fooled. When Mitch McConnell denounces big bank bailouts, what he’s really trying to do is give the bankers everything they want.
David Brooks is off today.
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