Sunday, October 12, 2008

Thinking about regulation



TMFW is off doing the work of the Lord, so I'm pinch hitting.

You've heard all the bad news about the global Wall Street so I won't reiterate. We now need to think about what happens next. While scrambling out of this crisis, we need as a nation to think about how to avoid the next one. We will not all agree. Our presidential candidates took a while to start talking about the problems, but in the last few days they've taken a few short, tentative steps toward telling us what they propose, but the solutions will have to be much bigger than anything either candidate has suggested thus far.

Here's the thing: starting with the Reagan administration our government has operated on the assumption that deregulation is universally good. Financial markets, airlines, drug companies, importers and exporters, owners of nesting sites for endangered species--everybody was clamoring to be deregulated. The unseen hand of the marketplace was a far better regulator than the government, so we should let the markets sort everything out. And as a nation, we gave everybody what they wanted. The pace of deregulation slowed a little during the Clinton administration, but it never stopped. One of the exceedingly specific results of all this was that the credit default swaps at the heart of the global financial crisis, understood by very few even on Wall Street, dodged any regulation at all. They didn't even have to be registered with the S.E.C. Nobody who dealt with them had to have special training or a special license, the way you do to sell stocks and bonds or real estate or be a barber. Do you know how a tranche works? Neither does anyone in government.

The events of the last three weeks indicate a need for more regulation of the financial markets, and it is important that we start thinking about what we expect from the leaders and followers that we will elect on November 4. None of them--whether running for president, congress, senate, governor, school board, dog catcher--are talking about a new regulatory framework, but regulations are clearly on their way. Everything will be different in 2010, and it's your job as a citizen to think about what that framework will look like.

Today I suggest three guiding regulatory principles and fifteen specific proposals. I am perfectly willing to admit I don't know what I'm talking about and that all of the particulars of this piece are nonsense. But as a nation, we need to look beyond the current crisis and into what we want to do next. This is your job as a citizen and a voter: think about what the government should do.

Guiding principles: (1) Investing is better than speculating. (2) Saving is better than spending. (3) Nobody needs to be that rich.

Here are some inflammatory specific suggestions.

1. Smaller is better. It is part and parcel of American law that when a company gets so big that it becomes a monopoly, we break it up. We should have a choice when we buy petroleum products, so Standard Oil had to go. For similar public policy reasons, no business entity should become so large that its failure endangers the entire country. As we have antitrust laws preventing monopolies, so should we have laws preventing any organization from becoming too big to fail. We shouldn't have any financial institutions big enough to bring down the whole country, much less the world. Ironically, the moves of the last few weeks have made Bank of America way too big to fail. The next administration should thank it for its service and break it up.

2. Regulate all financial instruments. The unseen hand that's supposed to regulate markets has changed into an unseen fist that's punching random strangers. The Securities Act of 1938 was enacted because of the last crash. The idea was that those who placed securities on the market had to meet certain minimum standards about reporting so that investors could make informed decisions. The credit default swaps at the heart of the current problem are completely unregulated. There are no requirements for capitalization, or debt to equity ratios, of insurable interest. At the race track there's a jockey club. In the credit default swap market, there's nothing. Nada. Zip. Because this was completely unregulated, nobody can tell from the outside how bad somebody else's book are, and because there's no transparency in the default swap market, one bank can't tell how much of this mess another bank has on its books. They were neither insurance (governed by states) nor securities (governed by the feds). Trillions of dollars was gushing around, and nobody understood what was happening. Just as GM has to register with the SEC when it issues new shares of stock, Morgan Stanley ought to have to register with some government agency when it invests billions of dollars in tranches nobody understan ds. In most states, you can't sell insurance policies without getting approval from the state insurance commissioner. Nobody with any sense looked at this credit default swap deal. That's just stupid.

3. Make banks act like banks. In the 1980's federally insured banks and savings and loans were required to have documentation, like evidence of employment and ability to repay a loan. The deregulation model that's been with us since the 1980's posits this as over-regulation. Leave the banks alone, and the good ones will survive. Don't interfere with the unseen hand. Well I, for one, favor the old plan. There was no regulation whatsoever of mortgage-backed securities or even of the mortgages that backed them and they have brought the global financial system down. Stupidity.

4. Encourage investment, discourage speculation. This has lots of vectors. Warren Buffet and Bill Gates invest. Goldman Sachs speculates. Note that Goldman Sachs and its former employees, speculators all, are now in charge of the American economy. Paulson is an academic with no real-world experience outside of the Fed, but Kashkari and the others that are now running the economy were all trained as speculators and they're all still at it, only using the U.S Treasury to do it. This is stupid. Speculation is the problem, and investment (looking for and encouraging long-term results) is the answer. Raise taxes on short-term capital gains, and eliminate taxes on long-term (over two or three years) capital gains, and put investors in charge.

5. Eliminate all taxes on personal savings accounts. Really, what's the down side? We lose a little tax revenue, but every other developed nation in the world saves more than we do.

6. Triple the annual deduction for contributions to IRAs and 401(k)s and everything else that amounts to saving for retirement. I there any reason to discourage saving for later?

7. Dramatically increase taxes on people who make more than $500,000 a year. Or a million. Pick some number, and tax it. Here I'm going to draw a distinction between those who make things and those who don't. Bill Gates is a rapacious bastard and I hate him, but Microsoft makes lots of stuff I use every day. Richard Fuld made hundreds of millions for tanking Lehman Brothers by investing in markets he didn't understand. Since greed seems to blind even smart people, let's make greed less lucrative.

8. Repeal the designated hitter rule. Well, since I'm reorganizing the world, I might as well bring it up.

9. Renstitute Glass-Steagall. The Glass-Steagall Act of 1933 created the FDIC, limited the activities in which banks and bank holding companies could engage, and required investment banks to remain separate from retail banks. It worked. All but the FDIC part was dismantled in 1999 by a bill written by John McCain's economic adviser, former senator Phil Gramm and loudly supported by McCain. The mess you see today is the direct result.

10. Break up the financial markets. Separate stockbrokers from insurance salesmen and separate all of them from bond traders and bankers. Put firewalls between them so that an infection in one segment doesn't spread to the entire country.

11. Impose a tax on executives of cratered financial institutions equal to 100% of their bonuses and 50% of their salaries for the last five years. If they can't think in terms of a long view voluntarily, let's punish them for failing to do so.

12. Shut down the markets if they slide more than two percent in any given day. If we're going to have a crash, let's do it in slow motion.

13. De-nationalize banks and savings and loans. When I was a kid it was rare for a savings and loan to operate outside of a single community. When the loan officers considered a home mortgage, they knew the neighborhood, and they reported to a chief executive who was a part of the same community. That kind of location-driven understanding, that kind of permanence of place and relative smallness is inherently well-informed about its business and inherently well-organized. Washington Mutual's executives couldn't even keep track of where their branches were. Down the road from me there are two Wachovia branches across the street from each other. That may be growth, but it's patently stupid. There have been at least three managers of my B of A branch in the last two years. None of them can remember what I do for a living or how much money I have. Banking isn't just another retail business, and it shouldn't be managed like one. It did not benefit you or me in any way that Washington Mutual had branches coast to coast or that they were managed like fast food franchises.

14. Eliminate short trading. What good does it do? It's the ugliest sort of speculation--betting that someone else will fail. Short traders will complain about being put out of work, but the criminal code puts lots of muggers out of work, too.

15. Require that investment banks be privately held. The shares of Lehman Brothers and Bear Stearns were traded in public markets, and as their value fell, it exacerbated the panic on Wall Street. Small investors are easily spooked, big investors are extremely easily spooked. Let's give them one less thing to be spooked about.

No one on earth is going to agree with everything on this list, but we really need to ask that our elected officials and those seeking to become our elected officials start thinking about what happens next. This means we need to decide what we want them to do. You took ninth grade civics, and you know you have duties as a citizen and voter. Start thinking.

2 comments:

tmfw said...

Excellent job. All that I would add is that it is the height of hypocrisy for those on Wall Street to bitch about the prospect of increased regulation while at the same time expecting the government to socialize the consequences of their risk-taking.

Also, the terms "credit swaps" and "tranches" were cooked up by the geniuses that brought us this mess as a way of not calling them what they really were: insurance contracts. As Polycarp correctly points out, this allowed untold zillions to run through the economy "secured" by "assets" that had never experienced the merciless glare of the auditor.

I predict that any future regulation of these transactions will look to the substance of what these products actually do rather than end the inquiry with what they are called.

Polycarp said...

Precissiment.