Is This the Wrong Time for Obama to Reform Wall Street?

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President Obama wants to prevent Wall Street from ever imploding again as badly as it did in 2008, so he's pushing for a reform of the financial system. But the same tactical difficulties that have impeded the passage of health care reform, combined with the aftershocks of the Democratic defeat in the race to succeed the late Ted Kennedy in Massachusetts, will hamper efforts to achieve those reforms.Before getting into why that might be, let's take a look at what President Obama wants to accomplish with financial reform. According to The New York Times, the proposed financial reform plan will put limits on the sizes of banks and prohibit commercial banks from trading for their own accounts -- an approach Paul Volcker, the chairman of the administration's Economic Recovery Advisory Board, has been advocating for quite some time. It was the mammoth losses in that type of trading that led to the credit crisis in 2008.

This shift toward reform could put significant financial pressure on Wall Street. For example, if the proposed rule to ban trading for a bank's own accounts goes through, it could wipe out a large fraction of Goldman Sachs Group (GS) revenues. For example, as I wrote about in a previous article, Goldman took in nearly $24 billion in trading revenues over the first nine months of 2009, some significant portion of which likely came from trading on its own account. But since Goldman became a bank holding company in 2008 in order to get access to cheap capital -- in the form of deposits -- it would be subject to Volcker's proposed limitation.

That leads us to the dual reasons financial reform is at risk:
  • First, it's focused on the wrong issue from voters' perspective. Financial reform -- while it does tap into public anger at the banks -- doesn't deal with the problems that most directly impact the general public. As I have written previously, the right issue for the administration to concentrate on now is job creation, and even the best financial reform plan in the world won't do much to help with that.
  • Second, it kills a golden goose for politicians and lobbyists. Wall Street spends $500 million annually on political contributions and lobbying; it will be difficult for politicians to stand against such deep-pocketed donors.
The effort to shift attention to financial reform comes in response to the results of the Massachusetts special election. As I wrote Wednesday, I believe that 60% of the blame for the outcome (from the Democratic perspective) can be attributed to the White House's failure to put job creation at the top of its priority list. According to The Washington Post, the administration believes that it now understands that message.

According to the Post, the White House plans to respond to the loss by driving down the middle of the road. It will maintain its list of priorities: "health-care reform, energy and bank regulation." Now, however, the White House will spend more time talking directly to the American people about how this agenda will help create jobs. The question is: Will such a communications strategy will be effective? I suspect not.

That's because I don't think it's possible to frame financial reform as a job-creation engine. (That's not to say I don't think financial reform is needed: As I've written previously, I do.) However, such reform will not create jobs. What it is likely to do is cause Wall Street firms to change their legal structures to get around the intent of the reforms so that they can keep doing what they have been doing.

In order to get new jobs, what is needed is an equity-financed technology innovation wave -- like the Internet boom of the 1990s -- that drives businesses to invest so they can become more efficient and effective. I am not sure what the technologies will be, but financial reform will not help us find them.

I know it's not easy -- but the simple reality is that there's a time for talk, and a time for results. And the results the nation needs now are hundreds of thousands of new jobs a month.
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