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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

March 26, 2009 at 9:55 AM

We can prevent another financial meltdown — the administration gets it half right

Top of the News: The Obama administration wants to let the sun into the shadow banking system. That appears to be the message from Treasury Secretary Tim Geithner in seeking broad new powers to regulate non-bank financial firms and derivatives. This, rather than in traditional banks, is where the financial crisis was born and metastasized. The shadow banking system is “the banker to the banks” — so problems at WaMu or Wachovia were indistinguishable from the complex products and contracts being done in the shadow world beyond the reach of admittedly lax regulators.

The seeds of the current unpleasantness were sown back in the 1990s, when financial services firms spent $3.4 billion on lobbying, and another $1.7 billion in campaign contributions, to get Congress to deregulate the industry. The rules and boundaries set up in the Great Depression to prevent another catastrophe sprung from speculation were cast aside. At the same time, the shadow banking system and derivatives slipped the leash, thanks to then-Sen. Phil Gramm’s demand that they not be subject to regulation. This was the sector that grew behind the scenes and, among other things, drove the swindles of subprime mortgages and credit-default swaps. In many ways, it became more powerful than the banks.

Geithner is trying to create a 21st century regulatory system. Better late than never. Yet he also seems wedded to the “bigger is better” philosophy. AIG’s predations could have been stopped with regulatory oversight. But AIG never would have had a gun to taxpayers’ heads is it hadn’t been “too big to fail.” Meanwhile, investment banks have been allowed to merge with commercial banks, bringing the risk of speculation further inside the umbrella of federal deposit protection. Will the administration and Congress have the guts to say: After the crisis is stabilized, we must break up these huge financial institutions?

The Back Story: The collapse in exports from Asia is bad news for Washington ports. The World Trade Organization reports that trade volumes worldwide will fall 9 percent this year, the worst contraction since World War II.

Yet the Council on Foreign Relations’ Brad Setser makes this essential point: “Much of the expansion of global trade over the last decade — like much of the expansion in cross-border financial flows — rested on a weak foundation. It required an unsustainably high level of consumption in the U.S. — and, at the tail end of the boom, a bit of a consumption bubble in the U.K., Spain and a host of new European economies as well. And rather than adjusting gradually, the adjustment is coming far too quickly.”

Today’s Econ Haiku:

Enjoy the oil glut

It’s only temporary

Am I being crude?

Comments | More in Banking, Trade

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