Derivatives

Getting Serious about Our Financial Mess

Stockholm -- The best way to clear your head of the political chatter that passes for policy debate in Washington is to get out of town. I’m writing today from Stockholm, a grand old city on a picturesque harbor and archipelago, where it’s harder to care much about Larry Summers’ squabbles with White House colleagues, the cynical fulminations from Newt Gingrich or Rush Limbaugh, or even the heated discussions inside Obamaland over its legislative strategy for health care reform. With a little distance, it’s easier to focus on developments which may actually matter for the rest of us, such as the prospects of Iran electing a democratic reformer as president this week or how the unfolding, deep slump in global trade may imperil economic recovery by China, Japan and Germany.

 It’s also easier to concentrate on our own economic conundrums. Let’s start with the crying need for new financial regulation that can prevent a system whose dysfunctions have just wiped out 20 percent of America’s wealth from doing it all over again sometime soon. The current TARP program, now officially a tangled mess, isn’t much of a model. This week the Treasury announced that 10 large institutions will be permitted to repay their TARP loans, including Goldman Sachs and Morgan, while nine others, including Wells Fargo, Bank of America and Citicorp, have to stay in the system. It sounds reasonable, since the lucky 10 can afford to repay while most of the rest cannot. But the TARP system ties regulation to outstanding loans, so now we’re left with a two-caste financial market where the weaker ones operate at a market disadvantage and others who used the taxpayers to fund their comebacks are no longer constrained to operate in the interests of a public which rescued them less than nine months ago.

We also learned this week that the Treasury’s clever plan to use taxpayer guarantees to create a private market for the toxic assets of all these institutions is a flop: Even with all that largesse, nobody wants to buy much of the toxic paper. So if the economy dips again, the 10 institutions now exiting the TARP regulations will be back for more, and there won’t be enough money in the Treasury or the Fed to save Citicorp and Bank of America again.

Then there’s the matter of how to regulate the derivatives that knocked the pins out from under the vaunted U.S. financial markets last year. The Administration’s current economic mandarins, along with the most elevated mandarin of all, Alan Greenspan, all have confessed publicly to their errors in dismissing the need for such regulation in the late-1990s. With the catastrophic collapse of the multi-trillion dollar markets for mortgage-backed securities and their credit default swap derivatives, strict regulation of these transactions to protect the rest of us -- which basically means transparency and reasonable limits on the leverage used to create or buy these instruments -- should be a no-brainer.

So what’s the logic behind the Administration's decision to keep trading in large, “private” deals in derivatives outside regulated markets? Those are precisely the deals that pose a danger for the rest of us, since they’re the large ones and inevitably the deals carried out by the institutions now acknowledged to be too large to fail. That’s Washington-speak for companies important enough to demand help from the taxpayers whenever they need it. The justification is the same as in the 1990s -- it will reduce their profits. That’s correct, in order to protect the rest of us from the now well-known consequences of a mindless drive for higher and higher profits regardless of the risks.

The next time you feel yourself drawn to the insider accounts of the greasy pole inside the White House or the breakup of the Republican coalition, take a deep breath and remind yourself that these are the players actually responsible for serious matters that ultimately may determine whether you ever have the income and assets required to send your kids to college or retire before you’re 80 years old.

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