Obama's bank regulation: Doomed to fail?

Administration lax on cleaning up AIG, Bear Stearns, and Lehman Brothers

Recently, Paul Volcker, the former Fed head and current Obama adviser, indicated that the White House remains committed to the concept of "too big to fail," meaning that the megabanks will continue to have a safety net and may ask for more bailouts. Presently, 19 financial institutions are on the protected list. Their business model hasn't changed materially since the crisis. They're still bloated and addicted to gambling.

WASHINGTON MAY VERY WELL FOIST ONE unified regulator on the industry, a consolidation that, at first glance, could seem like a good idea. The Big Four banks—Citi, B of A, Wells Fargo, and JP Morgan Chase—now control about 53 percent of all bank assets; the biggest 20 banks control 80 percent. There's no denying the appeal of a Transformers-type battle between a heroic Autobot regulator and the financial world's Decepticons. But that's make-believe.

The cyclops theory of bank regulation that would fuse all four bank regulators into one "superagency" is the heart of a bill by Sen. Chris Dodd. Other proposals have been floated by the administration and Barney Frank, chair of the House Financial Services Committee.

Chris Whetzel

Fine is concerned about such a monolithic regulator, saying the big boys would be able to influence it more easily than they can the current mélange of the Fed, FDIC, Office of the Comptroller of the Currency, and Office of Thrift Supervision. But the structure of such a new beast is far from set.

For instance, Dodd wants the Fed to lose its regulatory hold over banking and consumers (especially credit cards). Conversely, the Obama administration strives to make the Fed the über-regulator of banks and "shadow banks"—non-depository units like Countrywide and GE Capital.

But the idea of Super Fed as top financial cop as well as the nation's central bank is colossal and colossally bad. The Fed chair is, by law, independent and doesn't answer to the president or Congress. A lax chief—and there's every reason to expect him or her to be lax considering the cheek-by-jowl closeness of the Fed to banking and finance magnates, and the baleful history of Fed enforcement—could not be simply removed. Fed Chairman Bernanke, for example, is an academic economist with no enforcement or justice chops.

The Fed's obsession with secrecy is another major problem. Take Congressman Ron Paul's popular bill to subject the central bank to audits like every other federal financial agency. The Fed pushed back hard against that proposal. Even when Geithner—himself a former New York Fed chief—asked for a public review of the Fed's murky governance and structure, the secretive agency declined.

In August, a federal judge granted a Freedom of Information Act request by Bloomberg News to reveal the identities of banks that borrowed from 10 Federal Reserve programs during the peak of the financial crisis last fall. The Fed claimed the material was confidential and would hurt the banks' "competitive position." Is this the agency we want protecting the public?

ALL HOPE IS NOT LOST. THE ADMINISTRATION and congressional Democrats do support a promising reform called the Consumer Financial Regulatory Agency (CFRA). Obama's 80-plus-page proposal contains yawning gaps that Congress may fill and the financial industry will fight: Insurance isn't covered, nor are 401(k) retirement plans, and the majority of financial consultants and planners (including all the mini-Madoffs out there) evade scrutiny and standards. But the CFRA would wrest consumer-protection powers away from the Fed, which has them now and has failed consumers utterly.

Critically, a CFRA could allow scammed consumers to go to court against the securities industry. This is major. And, of course, it is a bridge too far for the financial industry. Its lobby has won every major legislative battle in the past 20 years. Wall Street's lobbyists and their congressional allies can be expected to call in all their markers to ensure that securities-fraud and other financial-crimes cases won't be heard in front of hometown juries.

There's something more encouraging: The CFRA, at least as now envisioned, would be a model of financial federalism, allowing states to pass even more stringent protections. The money lobby will have more trouble beating down this reform because of the Supreme Court's Cuomo v. Clearing House Association decision. Though it carries the name of the current New York attorney general, the 5-4 opinion last summer amounts to a last big regulatory gift to consumers from former New York AG Eliot Spitzer, who tried to probe the big national banks about whether their credit interest rates for racial minorities were ratcheted up. The Bush administration sued to block New York from enforcing its laws on national banks, a posture strangely continued by Obama's lawyers. But the high court's four liberals, plus usually arch-conservative business ally Antonin Scalia, collaborated on the decision, which could give the go-ahead to states to pursue big-time financial criminals even if the federal government won't.

Too big to contain, probably, are the derivatives, especially the synthetic (also known as naked) CDS that crashed us last fall. Warren Buffett, among others, thinks this financial plutonium can't be controlled and should be outlawed, as it was until 2000. But a new ban may already be off the table. Barney Frank, usually the most avid reformer on derivatives, pointedly left out a ban on naked CDS deals in the proposal he submitted in early October. The Obama team wants default swaps cleared by a "central counterparty"—in other words, on a public exchange. That way, we're told, if the slaughter starts, we'll see it and stop trading before it's too late.

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