The Banks Are Winning the War

06/18/2009 1:20 pm EST

Focus: MARKETS

Howard Gold

Founder & President, GoldenEgg Investing

On Wednesday, with great fanfare, President Obama announced his administration’s long-awaited, much-hyped overhaul of financial regulation.

Yet the stock market barely budged—it even rallied Thursday—and the response was muted in bank board rooms and on Wall Street trading floors. Why? Because the bankers knew they had dodged a bullet—big time.

Billed as the biggest reform of the financial system since the New Deal, the plan eliminates one regulator, creates another, gives more powers to the Federal Reserve to oversee financial institutions, and creates a council of top regulators to monitor systemic risk.

But it fell short of earlier proposals that would have overhauled a regulatory system that failed as completely as the financial markets did over the last couple of years. By declining to consolidate the banks’ many regulators into a simpler, more effective core, the administration may have missed a once-in-a-generation opportunity to fix what was so obviously broken.

That’s good news for the congressional barons who get to protect their turf—a key consideration in drafting this plan. But it’s even better news for the financial industry and its powerful lobbying arm.

As Edward Luce wrote in Thursday’s Financial Times: “Certainly, most of the financial sector lobby community is happy with what has emerged. ‘The Treasury department consulted very widely and has produced a careful and balanced proposal,’ says Scott Talbot, vice-president of the Financial Services Forum, a Wall Street lobby group.”

Translation: We won.

The transformation has been astonishing. A few short months ago, bankers were being excoriated in front of congressional committees. The public’s outrage over Wall Street compensation was boiling over. In response to the bonus scandal at AIG, Congress passed a ludicrous bill to tax up to 90% of employee bonuses in companies getting taxpayer help. Former Masters of the Universe were now whining about being misunderstood.

But now bankers have quietly won a series of victories on Capitol Hill and in Washington’s corridors of power, where they’ve always done best.

  • A $28.6-million-dollar lobbying campaign and campaign contributions of $286,000 to key legislators helped roll back mark-to-market accounting, which would have forced banks to write down the value of certain assets and thus raise even more capital. 
  • Ten institutions that had taken government money last fall under the Troubled Asset Relief Program (TARP) “passed” the Treasury Department’s stress tests, which encompassed a bad recession, but not the very worst one.
  • Following some successful equity offerings, these ten institutions will pay back some $68 billion in TARP bailout funds, even though some of them may face big losses on credit cards, commercial real estate, and other shoes that have yet to drop.
  • “Green shoots” in the markets and the economy and the spread between rising long-term interest rates and the practically free money the banks had borrowed (with government backing) helped several major financial institutions post surprisingly good first-quarter earnings.

That set the stage for the Obama administration’s retreat on regulatory reform. The administration acknowledges it consulted widely with Congress, consumer groups, and, of course, the banks.

“The decision is partly practical and partly political,” The Wall Street Journal reported.

“Officials worry that trying to start from scratch could ignite messy turf battles that might slow or even derail the entire process.”

The key obstacle: congressional committee chairmen, who get a lot of power from overseeing various agencies. An eminently sensible merger of the Securities and Exchange Commission and the Commodities Futures Trading Commission, for instance, would have prompted a huge turf war in Congress, and we can’t have that, can we?

And while we’re on the subject, will someone please tell me when the Obama Administration is going to take on Congress over anything? Is the President hoarding all his political capital for health care reform?

Unfortunately, this “compromise” preserves far too many elements of the status quo.

“The fractured nature of regulation,” wrote The New York Times, “makes it easier for financial institutions to shop for the friendliest regulator or pit agencies against one another, lawmakers say.”

One lawmaker, Senator Richard Shelby (R-Ala.), former Senate Banking Committee chairman, told the Financial Times: “There are powerful forces at work that want to preserve the existing system. They want to do everything they can to keep things the way they are.”

Those “powerful forces” are so entrenched that Simon Johnson, former chief economist of the International Monetary Fund and now a professor at MIT’s Sloan School of Management, has compared the US financial system to an emerging market oligarchy—say, South Korea before the Asian financial crisis of the 1990s.
In a widely read article in The Atlantic, he wrote: “The great wealth that the financial sector created and concentrated gave bankers enormous political weight. Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here.”

“Big banks, it seems, have only gained political strength since the crisis began,” he concluded.

Charles R. Morris, a lawyer and former banker and author of The Two-Trillion-Dollar Meltdown and a recent book, The Sages, on Warren Buffett, George Soros, and Paul Volcker, agrees that “the banks really [screwed] the world up and the regulators let them do it.”

“Are we being tough enough on the banks? No, we aren’t,” he told me. “Are they getting away with murder? Yes they are.”

But he added that the banks are facing a much more difficult environment. Securitization remains dead in the water, investment banking is still weak, consumers are tapped out, and hundreds of billions of dollars of hedge fund assets have vaporized. That means banks and securities firms will have to get smaller, which will lead to more layoffs.

Also, other parts of the administration’s plan would  include restrictions on leverage, higher capital requirements, greater federal oversight of insurance and rating agencies, and—my favorite—finally giving stockbrokers the same kind of “fiduciary duty” money managers have. All in all, the package should mean lower risk and less profitability for the big banks and Wall Street firms.

 “The fundamental forces will keep them in a box for a long time,” said Morris.

So, ultimately, the banks’ recent victories may turn out to be hollow. But for the rest of us, they’re no victory at all.

Howard R. Gold is executive editor of MoneyShow.com. The views expressed here are his own.

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