Obama's Financial Reform Plans: Small Steps in the Right Direction

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The financial crisis has created political and economic problems that remain unsolved. Perhaps mistakenly, President Obama decided to surround himself with advisers who came from Wall Street and whose policy views reflect the corrupting power of the money that the financial industry has provided them or potentially could provide them in the future. These advisers have helped create the perception that Obama is doing more to protect Wall Street than he is to safeguard the interests of its victims and saviors: the American taxpayers.Besides the political problem this creates, Obama faces a more fundamental economic conundrum: What can the government do to spur job creation while blocking Wall Street from repeating the excesses that created the financial crisis? To spur job creation, Obama pushed into law a $787 billion stimulus package.

And to stop Wall Street from killing again, he's trying to introduce a $90 billion TARP tax, he has pushed for the creation of a consumer financial protection agency, and last week, he announced his intention to ask Congress to pass the Volcker Rule, which will keep banks that take deposits from trading securities for themselves. As I wrote in a previous article, I don't think there is anything wrong with these ideas. For example, that TARP tax is a mere 6% of Wall Street's likely bonuses over the next decade. And it is a partial repayment of what the big banks owe taxpayers.

Unfortunately, there are three problems with what Obama has introduced so far. First, none of his actions appear to be creating enough jobs to make a serious dent in the unemployment rate. Although the administration claims its efforts have saved or created 2 million jobs, the public doesn't seem to be buying it.

Secondly, the financial reforms don't go far enough to prevent a repeat of the events that caused the financial crisis. To do that, Obama would need to implement regulations and have Congress pass laws that achieved eight goals:
  1. Put a stop to securitization.
  2. Limit the amount that banks can borrow to trade.
  3. Force all derivatives trading onto public exchanges, which will set and enforce reporting and capital requirements.
  4. End conflicts of interest such as those between ratings agencies and equity analysts and the sellers of the securities they analyze.
  5. Create an independent agency to produce financial statements for all public companies, including banks and investment managers.
  6. Require bankers to keep their pay in an escrow account that would be used to compensate investors for any losses that their deals create.
  7. Break up the biggest banks so none are ever too big to fail.
  8. Require banks to set aside enough capital to cover the cost of bailing themselves out in the future.
Finally, history does not repeat itself -- with one big exception. One major contributing factor that led to the financial crisis was the repeal of the Glass-Steagall Act, which took place in 1999, when Larry Summers, now the director of the White House's National Economic Council, was Treasury Secretary. That allowed financial firms to combine commercial and investment banking in ways similar to those that helped cause the Great Depression, and this time around, gave us the Great Recession.

But while commercial and investment banking should be re-separated, there's a danger that the efforts to prevent a repeat of the last financial crisis may end up providing the basis for the next one. That's because whatever measures are put in place to enforce the new regulatory regime, they will primarily serve one purpose: to inspire the creativity of Wall Street's lawyers, who will create legal ways around that regime's intent.

To combat that risk, Washington's regulators will need to be even more creative and proactive to stay head of whatever Wall Street dreams up next.

Obama's financial reform efforts are headed in the right direction, but they don't go far enough. To solve his financial crisis-related political problems, Obama may need to do more than give a speech in which Paul Volcker is standing closer to Obama than Treasury Secretary Tim Geithner and former Treasury Secretary Summers.
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