Everybody's A Regulator

http://online.wsj.com/article_email/SB10001424052748703876404575200302170446656-lMyQjAxMTAwMDIwMzEyNDMyWj.html

http://www.nytimes.com/2010/04/23/opinion/23krugman.html?emc=eta1

Now that it appears something will become "law" on the regulation of financial institutions, we have two well known news agencies weighing in on the same day - today - over what's about to happen.

We'll give the WSJ the floor first since their editorial board leads into the subject beautifully: "President Obama is a gifted man, but until yesterday we hadn't known that his achievements include having predicted the financial panic of 2008. It was a 'failure of responsibility that I spoke about when I came to New York more than two years ago - before the worst of the crisis had unfolded,' Mr. Obama said yesterday in a speech on financial reform at Cooper Union in New York City. 'I take no satisfaction in noting that my comments have largely been borne out by the events that followed."

The WSJ editors note with interest that they "missed" that prediction but they do remember that it was Senator Obama that was opposing the reform of Fannie Mae and Freddie Mac.

Regardless, the WSJ editors warn that the bill the President is stumping for "shifts" more control over credit allocation and the financial industry to the federal government. There was "regulation" before (however inept) but this will be like turning the banks into the equivalent of "utilities."

So what. Maybe that's what's needed. But the WSJ makes the point that many things which used to be settled by "statute" will now be settled by regulatory discretion after the law passes. This, in turn, will make for even more efforts to "influence" on the part of the banks: "LOBBYING." We thought it was bad before ...

"Consider derivatives, most of which appear headed for daily settlement on exchanges and a clearinghouse if the bill passes. But not all derivatives. The new master of this universe would be Gary Gensler, a Goldman Sachs alumnus who now chairs the Commodity Futures Trading Commission. Under the bill moving thru the Senate, he would decide which derivative transactions must be "cleared" and traded via electronic exchanges, and which can continue to be traded over-the-counter." What will his "criteria" be?

Weighing in from the left on all of this is the continually outraged Paul Krugman who heard the same Obama speech and feels that reform should hurt the bankers, that Obama was too reasonable with Wall Street and should not have "asked" them to join him in this new re-regulation: "... but what's bad for Wall Street would be good for America ..." accurately quotes Krugman's position.

He goes on to ask what's the matter with finance and answers his own question by starting with the fact that the modern financial industry generates huge profits and paychecks, yet delivers few tangible benefits: "In the years leading up to the 2008 crisis, the financial industry accounted for a third of total domestic profits - about twice its share two decades earlier."

We have seen that statistic before and, while we would defer to Krugman, or the Behavioral Economists at Chicago, we feel that the 15% "premium" (30% of the economy's profits vs 15% twenty years ago) actually defines the "amount too much" that finance takes up now in an economy that is choking on "non-productive" profits.

So, why are bankers raking it in? "... it was mainly about gambling with other people's money. The financial industry took big, risky bets with borrowed funds ..." Krugman goes on, "... and here's the thing: after taking a big hit in the immediate aftermath of the crisis, financial industry profits are soaring again." So, it's vital to get this legislation thru.

Getting back to the share of the economy that "finance" represents, Krugman likes, and we agree, a new proposal that is about to be unveiled by the International Monetary Fund: "In a leaked paper prepared for a meeting this weekend, the fund calls for a Financial Activity Tax - yes FAT - levied on financial industry profits and remuneration. Such a tax ... could mitigate excessive risk taking ... and would tend to reduce the size of the financial sector ..."

Krugman: "But the fact is that we've been devoting far too large a share of our wealth, far too much of the nation's talent, to the business of devising and peddling complex financial schemes -- schemes that have a tendency to blow up the economy. Ending this state of affairs will hurt the financial industry. So?" That is beautifully put.

Bottom line: a bill will be passed. Regulators will be more involved and there will be more effort to control what happens with finance and that will be a good thing. There is no formula for where we are. But, there is a good intention.

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Parenthetically, we might add here that there have seen articles recently that chronicle a populist minority that feels there should be something in the new legislation that reduces the size of banks (Sewell Chan, 4/20/10, "Financial Debate Renews Scrutiny on Banks' Size", NY Times). That won't be in the legislation for several reasons surrounding the fact that other safeguards make it unnecessary. However; we wonder what kind of "reduction in size" is intended with these noises since Vikram Pandit at Citi is reporting to Elizabeth Warren in Washington once a month on the progress of his plan to sell bad bank assets (representing a 40% reduction of the bank's "size"). How much smaller is Citi supposed to get?