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Jon Talton

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

July 15, 2010 at 10:10 AM

The financial reform bill that couldn’t

Neither the talking points of critics of the financial reform bill nor those of its backers get at the heart of the matter. Will it make credit harder to get? Unlikely, considering the banks are already doing that on their own, both because some are hoarding cheap money to gamble through their trading desks while community banks are drowning in bad commercial real-estate loans. A “sweeping” reform that will prevent a replay of 2008? Hardly.

The bill is extremely complicated, adding to the risky complexity of the financial system. Much of it must be written as rules by the Federal Reserve and policed by this same independent, bank-owned, opaque entity. Too Big to Fail Banks remain in place, as do most of their risky practices, including the ability to gamble (“trade”) with taxpayer money. The shadow banking system, another big contributor to the meltdown, is barely touched. Incentives to trade with taxpayer money or derivative swindles remain, as do those for obscene bonuses.

By contrast, the reforms of the Great Depression were simple. Risky investment banks couldn’t engage in commercial banking and vice versa. Period. Average depositors were given a federal guarantee for a portion of their money, providing stability for the system. Regulators kept banking simple, honest, sound. Prosecutors and the Pecora Commission exposed the criminal speculation of the banksters in the 1920s and put an end to it for decades.

Now, the practices that led to the collapse largely remain, and another banking crisis is inevitable. And it will be global in scope as the big American banks now move overseas in search of new speculative havens. Over-leverage and toxic “assets” remain a daunting drag. This is the real deal beyond the political calculus of both Democrats (“victory) and Republicans (“socialism!”), both of whom have been lavishly compensated by “financial services” contributions.

I remember in the 1990s talking to the bank CEOs who were assembling the behemoths thanks to steady deregulation that culminated in the repeal of Glass-Seagall. Their argument was that giant universal banks that combined investment and commercial banking were safer because of their size, that many lines of business would offset trouble in any one area. They were also hiring the smartest wizards from top business schools, who created ever more exotic derivatives, ever further removed from the actual thing of value from which they derived.

This was followed by the rise of the shadow banking system. And for awhile it seemed to “work,” even as the years ahead of the crash saw the broader productive economy stagnate beyond the housing bubble. Capital markets increasingly gambling instead of providing funds for real businesses and job creation. No wonder the ’00s had the worst job creation in decades, even before the Great Recession.

About the kindest thing that can be said of these banking titans is, as a good ole boy might put it, “They’re darned smart, but they don’t have a lick of sense.”

Today’s Econ Haiku:

Slower Chinese growth

Goodbye U.S. export push

Another excuse

Comments | More in Bailout, Banking

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