Who’s Minding The Store? – 3rd Quarter 2009

The Obama Administration has proposed regulatory changes to the domestic financial system. Last year’s events have revealed serious deficiencies in our financial system, not the least of which is the utter lack of oversight. With this lack of supervision comes significant risk, moral risk or the so called “too big to fail” mentality, as well as heightened investment risk tolerance that comes from unregulated speculation with other peoples money.

They have put forth the most sweeping reform of financial regulation since the Glass- Steagall Act of 1933, following the NY Federal Reserve-driven debacle in 1934. This, history reminds us, was when the same Robber Barons who brought us the Panic, found themselves the beneficiaries to a set of regulations that would eventually come to formalize their control over the U.S. and in fact, the World’s monetary system. These entities grew into interlocking, highly leveraged, international banking giants that no rational government would ever allow to fail. The rest as they say is history.

The current administration which monetarily offers no change from previous administrations, believes that the Federal Reserve system should be allowed to regulate these firms. But since the ownership of the Federal Reserve Banks has fallen into the hands of these same corporate behemoths, how could asking them to effectively regulate themselves make any sense? No reasonable measures to strengthen the financial market infrastructure will be complete without taking a fresh and frank observation of the Federal Reserve System. Allowing them to exclusively regulate financial firms would present a gigantic conflict of interests. Another component of the proposed plan would also require derivatives to be traded over the counter on an exchange. Utilizing this facility will promote some transparency while eliminating counter-party risk between financial firms.

The damage in this arena is unfortunately already done and this portion of the reform is akin to simply closing the barn door after the animals have escaped. Taken together, these reforms do nothing to curb the continued risk of failure of any financial institutions. In fact I would suggest that a fresh look at firms such as Goldman Sachs will reveal that their current behavior is every bit as dangerous and egregious as before the collapse. In fact with a tacit government backstop why shouldn’t they increase their risk burden? They have in fact a duty to their shareholders to maximize returns and if there is one shiny spot in these proposed reforms it is that they allow the government to impose losses on shareholders and creditors without the benefit of due process.

For a closer look at a recent example of how this would work, consider the GM debacle. Workers lost their retirement health benefits and their life savings while insiders like JPMorgan and Citibank were repaid 100% of what they were owed from the company’s pension funds. Imagine forcing workers to pay GM’s debt to JPMorgan and Citi out of their pension funds. President Obama recently said, "Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall." Oh yes, Mr. President, that is exactly what they can expect.

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