Protect taxpayers from Wall Street risk

(News Terupdate) - As legislators continue to trade loud barbs over the details of the bill that seeks to overhaul our financial system, we risk losing a crucial aspect of reform in the din.

We now have an important opportunity to fix the regulation of derivatives -- those controversial mechanisms that played a central role in the downfall of insurance giant AIG, and helped spark the Great Recession.

The current finance bill contains reasonable proposals, developed by the Senate agriculture committee, under the leadership of Blanche Lincoln, that would rein in the most egregious abuses of these instruments.

The AIG experience should have made clear that derivatives can create enormous risks -- risks that ended up being borne by taxpayers. In addition, derivatives have played an important role in all kinds of nefarious activities -- from trying to obfuscate Greece's real financial position, to vast tax evasion.

Derivatives are not inherently bad. They can play a positive role in risk management, but they are only likely to do that if there is the right regulatory framework.

Without the appropriate legal and regulatory framework, they will almost surely contribute, on balance, to the creation of risk -- as they did in this crisis, and as they did a decade ago in the infamous Long-Term Capital Management bailout.

The provisions reported out of the agriculture committee are an important step in the right direction. But derivatives have been an enormous profit center for a few big banks (about $20 billion last year), so we should not be surprised that there is resistance to anything that is a real change to the status quo.

Derivatives have been advertised as an "insurance product," insuring bondholders, for instance, against the risk of a loss. But if they were really insurance products, they should have been regulated as insurance, with insurance regulators making sure that there was adequate capital to meet their obligations.

In reality, in many cases derivatives are more accurately described as gambling instruments. But gambling should be subject to gaming laws, and derivatives aren't.

Remarkably, in fact, derivatives have been left totally unregulated -- a mistake that President Clinton, who failed to introduce regulations when he had the chance, now acknowledges. Congress's current proposal is the opportunity to rectify that mistake.

One provision holds particular promise -- and has the banks especially riled up. This is the idea that the government should not be responsible for the "counterparty risk" -- the risk that a derivatives contract not be fulfilled. It was AIG's inability to fulfill its obligations that led the U.S. government to step into the breach, to the tune of some $182 billion.

The modest proposal of the agriculture committee is that the U.S. government (the Federal Deposit Insurance Corporation) stop underwriting these risks. If banks wish to write derivatives, they would have to do so through a separate affiliate within the holding company. And if the bank made bad gambles, the taxpayer wouldn't have to pick up the tab.

This change would help fix the current system, where those who buy this so-called "insurance" enjoy the subsidy of the essential, free government guarantee; and where competition among the few issuers of these risky products is sufficiently weak that they enjoy high profits.

This arrangement is economically inefficient -- firms should pay for the costs of their insurance. If the government guarantee is removed, the banks might have to put more money into their derivatives subsidiaries. This will reduce the banks' profitability, and it might force up prices of this "insurance." But that is as it should be. The government shouldn't be subsidizing "insurance" -- and it certainly shouldn't be in the business of subsidizing gambling.

The Fed and the Treasury seem to object to the agriculture committee's proposals. These objections show once again the extent to which the Fed and the Treasury have been captured by the institutions that they are supposed to regulate, and reemphasize the need for deeper governance reforms of the Fed than those on the table.

To be sure, banks' high profits from derivatives would help with recapitalization, offsetting the losses they incurred from the risky gambles of the past. But that doesn't mean that the policy of allowing banks to issue derivatives -- and laying the risk of failure onto the taxpayer -- is right.

Bank recapitalization should be done in an open and transparent way, consistent with sound economic principles. Abusive credit card practices could also help recapitalize the banks, but fortunately we have curtailed some of these. We should now do the same for derivatives.

We should recognize that the agriculture committee provision is already a compromise. Many worry that if the affiliate within the holding company that writes the derivatives gets into trouble, Uncle Sam will still come to the rescue.

The bill, for instance, includes a "strong presumption" of losses for creditors and shareholders. What should be required is that creditors (other than depositors) and shareholders bear all the losses before the government is asked to pony up any money. But ultimately, in a crisis, worries about the consequences of such strong medicine will almost surely mean a bailout for the bank holding companies as well as the banks -- as happened in this crisis.

In a crisis, the government will not only bail out the banks, but also the bankers, their shareholders, and their bondholders -- if not totally, at least partially.

So if we are to protect American taxpayers, we must also bar any too-big-to-fail institutions from writing derivatives. But right now, the institutions who write the vast majority of these derivatives are too big to fail. Ideally, responsibility for writing derivatives should be spun out to a totally independent entity. The agriculture committee bill does not go this far; rather, it strikes a reasoned compromise between political expediency and economic good sense.

It would be a major mistake to walk away from this compromise by allowing FDIC-insured institutions to continue to write these risky products. To allow them to do so would simply generate more political cynicism: It would show that the big banks have succeeded in their ambition of returning to the world nearly as it was before the crash.

Source : CNN

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Protesters descend on Wall Street, New York City banks

New York (News Terupdate) - Protesters rallied in downtown New York City Thursday to voice their anger over what they perceive as the roles Wall Street and big banks played in America's economic crisis.

Marching from City Hall to Wall Street, the protesters chanted "good jobs for all," and held signs with messages including "Hold banks accountable," "Make Wall Street Pay," and "Reclaim America."

The AFL-CIO organized the rally, and union President Richard Trumka addressed the crowd, saying, "How long will we allow the spirit of greed to continue to drive us into economic holes?"

The National Action Network, a group that was involved in organizing the protest, said in a news release that demonstrators represented unemployed workers, foreclosure victims and community activists.

Protester Gerard Pettine said he just wants Wall Street to be held accountable for its involvement in the economic collapse.

"They need to have some integrity and some honor and do the right thing," Pettine told CNN.

Protester Elizabeth Soto, who came with her brother to the rally, was concerned about the lack of job creation.

"We are here to say Wall Street's got to help Main Street," she said. "We supported the stimulus bill, which bailed out Wall Street, but we expected the jobs to come back to Main Street."

The New York Police Department estimated that 6,000 people participated in the rally.

Earlier Thursday, as part of a larger "day of action" against Wall Street, protesters descended upon the headquarters of two New York City banks -- JP Morgan Chase and Wells Fargo -- leaving letters for the banks' chief executive officers.

The letters, according to the news release from the National Action Network, said that the banks have an opportunity "to step up to the plate and be leaders in rebuilding the American economy."

JP Morgan spokesperson Mike Fusco declined to comment on the letter, but said that there were a "couple dozen" protesters who were in the building for less than a half hour.

Fran Durst of Wells Fargo said that about 100 protesters flooded their building's lobby and tried to deliver their letter to the bank's CEO. Durst said the event didn't cause a major disruption to the bank.

Other protests were scheduled in San Francisco, California; Kansas City, Missouri; and Charlotte, North Carolina, according to the National Action Network's press release.

Source : CNN

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Obama pushes for Wall Street reform on Main Street tour

(News Terupdate) - Continuing to hit on environmental and economic topics, President Obama will wrap up his "White House to Main Street Tour" Wednesday with stops in Illinois and Missouri.

Obama will tour a biorefining plant in Macon, Missouri, on Wednesday afternoon and talk with workers about economic issues, according to the White House. He was expected to discuss Wall Street reform during an appearance in Quincy, Illinois.

On Tuesday, Obama told a crowd in Ottumwa, Iowa, that it is "not right" for Republicans to prevent a Wall Street reform proposal from coming up for debate in the Senate.

Senate Republicans blocked a motion Tuesday to begin debate on a bill that would overhaul financial regulations. The GOP senators say the proposal is too broad and needs to be tightened in closed-door talks with Democrats before coming to the Senate floor for debate.

In his Ottumwa appearance, Obama challenged Republicans to allow a public debate on Wall Street reforms.

"The American people deserve an honest debate this bill." Obama told the crowd. "You should not have to have to wait one more day."

The proposed reforms are intended to prevent another Wall Street meltdown like the one that led to the U.S. recession, Obama said.

"We can't let another crisis like this happen again," he said. "We can't have such a short memory that we let them convince us that we don't need to change the status quo."

Senate Democrats have accused their Republican counterparts of stalling momentum on the bill in an attempt to water it down.

Republican leaders have identified their main concern as a Democratic plan to set up a consumer watchdog agency to protect against lending abuses such as unfair credit card charges and mortgage practices.

The votes Monday and Tuesday on opening debate were intended to generate public pressure on the Republicans by raising awareness of their opposition to moving forward on the popular issue. A third vote on launching debate on the measure is scheduled for Wednesday afternoon.

One moderate Republican, Sen. George Voinovich of Ohio, indicated Tuesday he would switch his vote from 'no' to 'yes' if negotiations on the bill between Sen. Christopher Dodd, D-Connecticut, and Sen. Richard Shelby, R-Alabama, fail to reach agreement soon.

The American people "want us to get something done," Voinovich said in explaining why he would eventually join Democrats in insisting the bill be debated on the floor.

Voinovich wouldn't say how long he would wait before switching his vote, but added, "I have an idea of how much time it takes to cut a deal." According to Voinovich, "a whole bunch" of other Republicans are likely to make the same decision.

Dodd and Shelby have repeatedly said they were close to a deal, with agreement on most of the issues. However, Sen. Bob Corker, R-Tennessee, who also has taken part in negotiations, said Tuesday he was "far less optimistic" that a deal would come anytime soon.

Obama's remarks in Illinois on Wednesday will continue to focus on Wall Street reform legislation, the White House said.

In addition to the visit to a biorefining plant, Obama's time in Missouri earlier in the day will include a visit to a farm near the town of Palmyra, according to the president's schedule.

Obama kicked off the White House to Main Street tour in December with a visit to the Lehigh Valley area of Pennsylvania. Since then, the president has made stops in Lorain County, Ohio, and Savannah, Georgia.

The tour is explained on the White House Web site as an effort to "spend some time outside of Washington and talk to American families about what they are experiencing during these tough economic times."

In segments of the tour, "the President will regularly visit communities across the country and meet with members of the community and share ideas for rebuilding our economy for the long term," the Web site says.

Source : CNN

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Obama to Republicans: Let Senate debate Wall Street reform

Ottumwa, Iowa (News Terupdate) - President Obama challenged Republicans to allow a debate on Wall Street reforms, telling an Iowa crowd Tuesday it's not right for the GOP to prevent a proposal from coming up in the Senate.

For the second straight day, Senate Republicans blocked a motion to begin debate on a bill that would overhaul financial regulations. The GOP senators say the proposal is too broad and needs to be tightened in closed-door talks with Democrats before coming to the Senate floor for debate.

"The American people deserve an honest debate on this bill," Obama told the crowd. "You should not have to have to wait one more day."

Obama said Senate Republicans "unanimously blocked efforts to even being debating reform."

"They won't let it [the bill] get on the floor to be debated," Obama said. "It's one thing to oppose reform, but to oppose just even talking about reform in front of the American people and having a legitimate debate? That's not right."

The proposed reforms are intended to prevent another Wall Street meltdown like the one that significantly worsened the U.S. recession, Obama said.

"We can't let another crisis like this happen again," he said. "We can't have such a short memory that we let them convince us that we don't need to change the status quo."

Senate Democrats accuse their Republican counterparts of stalling momentum on the bill in an attempt to water it down. The votes Monday and Tuesday on opening debate were intended to generate public pressure on the Republicans by raising awareness of their opposition to moving forward on the popular issue.

A third vote on launching debate on the measure was scheduled for Wednesday afternoon.

One moderate Republican, Sen. George Voinovich of Ohio, indicated Tuesday he would switch his vote from no to yes if negotiations on the bill between Sen. Christopher Dodd, D-Connecticut, and Sen. Richard Shelby, R-Alabama, fail to reach agreement soon.

The American people "want us to get something done," Voinovich said in explaining why he would eventually join Democrats in insisting the bill be debated on the floor.

Voinovich wouldn't say how long he would wait before switching his vote, but added, "I have an idea of how much time it takes to cut a deal." According to Voinovich, "a whole bunch" of other Republicans are likely to make the same decision.

Dodd and Shelby have repeatedly said they were close to a deal, with agreement on most of the issues. However, Sen. Bob Corker, R-Tennessee, who also has taken part in negotiations, said Tuesday he was far less optimistic that a deal would come anytime soon.

"I just know where they are, policywise, and I just don't see it," Corker said."I don't think anytime in the near future there's going to be a bipartisan agreement."

Republican leaders have identified their main concern as a Democratic plan to set up a consumer watchdog agency to protect against lending abuses such as unfair credit card charges and mortgage practices.

Senate Minority Leader Mitch McConnell, R-Kentucky, contended earlier Tuesday that the consumer agency would extend far beyond Wall Street to infiltrate daily transactions of all Americans.

Shelby headed to another negotiating session with Dodd after Tuesday's vote against starting debate on the bill. Asked whether Dodd is offering any flexibility on the consumer protection provision, Shelby said no.

"They've been pretty steadfast in their view of the consumer agency," Shelby said. "We think we have some constructive recommendations."

Dodd questioned the Republicans' sincerity, saying: "They don't want a consumer protection agency at all. Let's be honest about it."

Source : CNN

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Wall Street didn't cause crash of '08

Washington (News Terupdate) - Financial reform? Not exactly. The bill before Congress does nothing to address the fundamental background causes of the crash of 2008.

Wall Street may have been the instrument of the crash. But the crash was made elsewhere: in Washington's failed policies for middle-class families -- and in China's distorted rush for economic growth.

The story is not a simple one. But I hope you will pay attention to the details. If you don't, you may find that the pocket that has been picked is your own.

As you've heard, the crash begins with the huge excess load of debt built up in the last two decades by American households. Why did Americans borrow so much? Some like to tell a story of irresponsibility: We borrowed too much because we were self-involved yuppies who just could not deny ourselves the latest flat-screen doodad for our McMansions.

Maybe that describes some people. But many millions of middle-class families plunged into debt for a very practical reason. Their incomes were not keeping pace with the cost of crucial items of the middle-class lifestyle: housing, medical care, college tuition. At the same time as housing, medical care and tuition were jumping in cost, the cost of borrowing was dropping to historic lows.

Adjusted for inflation, the typical American family earned less in 2007 than that family had earned in 2000. Meanwhile, everyday necessities such as energy were becoming more expensive: By 2007, the typical American family paid more for energy than it did for clothes and entertainment combined.

As everyday bills piled up, families borrowed to pay extraordinary bills. Mom needs nursing care? Junior got admitted to Chapel Hill? The roof needs refixing? No worries -- just cash out with a cheap refinance deal.

In the 1950s, the total debt of all American households amounted to less than one-third the nation's gross domestic product. In 1980, household debt amounted to less than one-half. As recently as 1990, it was still under 60 percent. In 2000, it was under 70 percent. On the eve of the 2008 crash, total household debt had bulged to 96 percent of gross domestic product.

All this borrowing might look like the road to ruin. And in fact it was the road to ruin. But that's not how it looked at the time. At the time, it looked like a bargain. Between 1980 and 2008, the household debt load doubled as a share of the economy. Yet the interest cost to carry that debt rose much more modestly. In 1980, the average American family devoted about 13 percent of its disposable income to debt service; by 2008, the average family was spending about 17 percent of its disposable income to service debt.

Why was debt so cheap?

This takes us to another fundamental cause of the crisis: the growth of China.

Maybe you've heard that we bought a lot of goods from China and now we are deeply in debt to China. That's true obviously -- but the cause and effect are upside down.

China lent us a lot of money so that we would keep buying Chinese goods.

Export booms do not usually last very long. The exporting country accumulates more and more of the importing country's currency. Eventually the exporting country decides it wants to use some of that currency. It exchanges the importing country's currency for its domestic currency -- and that has the effect of making its exports more expensive. The boom bumps up against its own natural limits.

That did not happen with China. Desperately eager to create more and more jobs to employ the tens of millions of peasants flowing into China's huge cities, China not only accumulated dollars by the hundreds of billions -- it held them. Then it went into the foreign currency market to buy still more billions of dollars, sometimes $1 billion a day.

All that dollar buying prevented China's currency from going up in value, which would have increased the price of China's exports -- and that kept China's factories turning.

What do you "buy" when you buy "dollars"? There are only so many Benjamins in the world, nowhere near enough. Buying "dollars" means buying dollar-denominated debt, and far and away the biggest source of U.S. dollar debt is U.S. mortgage debt.

With China so eager to buy, U.S. bankers went to work to create mortgage paper to sell. It didn't have to be good-quality paper -- the Chinese didn't really care about that. Did you get a great deal on your refi in 2005? Thank the Central Bank of China.

American homeowners borrowed because they could not earn enough. China loaned to keep its factories turning. Money flowed in a frenzied torrent across the Pacific. And somebody had to make it all happen: Wall Street. It created the debt instruments China wanted to buy and packaged the mortgages that Main Street felt pressured to sell. With trillions of dollars changing hands, even a small percentage fee could pay a lot of people a lot of billions in fees.

No doubt some of those fee-takers did abusive things. But the whole dynamic was abusive and dangerous. And so-called financial reform is a petty distraction from that larger, more important, and more urgent dynamic: raising American incomes so Americans borrow less, and redirecting Chinese trade to the home market so that the Chinese lend less. Until we achieve those two things, any recovery will only invite the next disaster.

Source : CNN

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Washington has always helped set rules for Wall Street

Princeton, New Jersey (News Terupdate) - On Sunday, Sens. Chris Dodd and Richard Shelby said that they were close to a bipartisan compromise on financial regulation, which could be reached as early as this week.

Yet many Republicans are attacking the regulations by painting them as yet another example of big government taking over private markets. Even if the bill will likely pass, GOP leaders are planning to use this floor debate to raise philosophical concerns about the role of government in economic life.

As with health care, these Republicans said, the legislation would allow the federal government to control financial decisions in the private sector on Wall Street and squelch private initiative. In The Washington Post, former House Speaker Newt Gingrich has called the Obama-Reid-Pelosi team a "secular-socialist machine."

In response, President Obama traveled to New York to deliver a very different kind of message. Rather than castigating the bankers or threatening a government takeover, he called on Wall Street to "join" the administration in this reform, claiming that the new rules were in the "best interest of our financial sector."

Obama's argument picks up on a long-standing tradition in American liberalism, namely that the federal government has always been needed to protect and strengthen private markets. Historians have shown how the federal government has been essential to the development of our market-based economy. Government and markets have gone hand in hand.

During the 19th century, as University of Virginia historian Brian Balogh showed in his recent book, "A Government Out of Sight," federal and state policy helped create the foundation for the American economic system. Rather than a laissez-faire period, it was a time when the federal government protected property rights, funded public infrastructure projects -- as roads and canals -- and protected international and domestic trade routes.

In the early 20th century, federal policy remained integral to the vitality of the corporate economy. At a time when radical political movements challenged America's political and economic status quo, progressive-era legislation attempted to curb the worst behavior of the new economic titans so that the nation would not move leftward. As President Theodore Roosevelt explained, he wanted to distinguish "good" trusts from "bad" trusts so that Americans would have faith in the former and not embrace socialism or anarchism.

During the heyday of economic regulation, the New Deal, the story was very much the same. The sweeping financial reforms that were put into place by Democrats were a far cry from the type of socialist ideas sweeping through parts of Europe, though many of President Franklin D. Roosevelt's opponents charged him with being on the far left. But in fact FDR wanted to save capitalism by restoring confidence in market institutions.

The government ensured the savings of Americans in their banks through the Federal Deposit Insurance Corp. and imposed numerous regulations on Wall Street so that financiers could not engage in the kinds of destructive practices that led to the market crash in 1929.

The federal government separated investment and commercial banks, created financial disclosure rules, supervised the issue of new securities and more. FDR's message was as much about trusting markets as government. As he told voters in one fireside chat, "it is safer to keep your money in a reopened bank than under the mattress."

As with sports, competition must take place within a certain set of rules, the president understood. When institutions won't impose those rules themselves, the government must help do so.

In 2008, the federal government was once again called upon to save our capitalist system. This time, relief came from a Republican, President George W. Bush, who responded to the terrifying market crash by infusing the system with capital through the Troubled Asset Relief Program to avoid a total meltdown.

When he signed TARP into law, Bush argued, "The legislation is a critical step toward stabilizing our financial markets and ensuring an uninterrupted flow of credit to households and businesses."

Now, Obama is finishing the job that Bush began. The president is pushing for permanent regulations to curb the speculative and fraudulent behavior that robbed America of huge sums of their savings, made wealth vanish and crippled many of our important civic institutions.

The president is calling for Congress to pass legislation that constrains the kinds of risks that banks are allowed to undertake, creates new consumer protection rules and requires more transparency. By restoring the faith of Main Street in Wall Street, the government can make our markets strong once again.

The legislative debate over the proposed financial regulations must address whether the bill contains the best possible set of reforms to improve the stability of Wall Street. The bill is far from perfect.

In a letter to Sens. Harry Reid and Mitch McConnell, a group of policy experts -- ranging from the liberal economist Dean Baker to Lynn Turner, former chief accountant of the Securities Exchange Commission -- have pointed out fixes that must be made, such as requiring balance sheet reporting on all liabilities.

But on the fundamental question, as to whether the government has a right to intervene in these issues and whether these reforms somehow break with the traditions of American history, that is a much easier question to resolve. While there has been tension between markets and government, it is equally important to remember that a close partnership has always existed in this country. The ties between government and markets are as American as apple pie. In other words, government can help markets prosper.

Source : CNN

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