The most disturbing thing about Barack Obama’s call for financial reform was the way the president falsified our predicament. He tried to make it sound as though everyone was implicated in the breakdown and therefore no one was really to blame. “A culture of irresponsibility took root, from Wall Street to Washington to Main Street,” Obama asserted. “And a regulatory regime basically crafted in the wake of a twentieth-century economic crisis–the Great Depression–was overwhelmed by the speed, scope and sophistication of a twenty-first-century global economy.”
That is not what happened, to put it charitably. The regulatory system was not overwhelmed by historic forces; it was systematically gutted and dismantled by the government at the behest of banking interests. If Obama wants details, he can consult his economic advisers–including Larry Summers and Tim Geithner–who participated directly in unwinding prudential rules and regulations. Cheers were led by the Federal Reserve, with heavy lifting by both political parties.
If Obama were to tell the truth now about what went wrong, he would face a far larger problem trying to clean up the mess. Instead, he has opted for smooth talk and fuzzy reforms that in effect evade the nasty complexities of our situation. He might get away with this in the short run–Congress doesn’t much want to face the music either. But Obama’s so-called reform is “kicking the can down the road,” as he likes to say about other problems. In the long run, it will haunt the country, because it fails to confront the true nature of the disorders.
Giving more power to the Federal Reserve to be the über-regulator of banking and finance is a terrible idea. Asking the cloistered central bank to resolve all the explosive questions about the overreaching power of financial institutions is like throwing the problem into a black box and closing the lid. That’s the reason Wall Street’s leading firms first proposed the Fed as super-cop, then sold it to George W. Bush and now Obama. Give the mess to the Wizard of Oz, the guy behind the curtain. This constitutes the high politics of evasion.
Still, a nascent rebellion is gathering strength in Congress. Some 240 House members have endorsed a measure to force auditing of the Fed by the Government Accountability Office–a small but vital step toward dismantling the central bank’s privileged secrecy and intimidating mystique.
As someone who has been around this subject for three decades, I have come to understand that the power of financial titans and their friends at the Fed depends crucially on public ignorance. Most legislators are just as clueless as their constituents. If they knew more about how the system works, they would see that most of Obama’s reforms are insubstantial gestures, not actual remedies. The president, for instance, proposes to raise the requirements for capital and liquidity held by commercial banks with strict limits on leverage. That is a virtuous proposal, but it leaves unanswered the question, Why did the legal limits already in place fail to restrain bankers’ appetites? Indeed, several times in the past two decades the Fed and other central banks enacted new and supposedly more effective capital requirements. The big dogs of banking broke free of the leash again and again, while vigilant watchdogs at the Fed and elsewhere looked the other way. Why should we expect different results next time?
One reason the old restraints failed is the “modernization” that shifted credit functions outside regulated banks and into a variety of unregulated money pots–the so-called shadow banking system of hedge funds and private-equity firms. These interact intimately with traditional banks and give them profitable ways to evade rules or conceal the condition of balance sheets from regulators and investors. These interactions are dazzlingly complex, but this was not an accident. It was the goal of financial deregulation enacted by Bill Clinton, arm in arm with the GOP Congress.