“US Is on Right Path to Banking Reform”

By James K. Galbraith [via The Sphere]

President Barack Obama took an important step in the right direction Thursday. How can one tell? Bank stocks fell. And on Bloomberg just afterward, the industry’s top lobbyist stated that the big bankers want “a civil, adult conversation” about reform. Great. They must be worried.

Oh, and there’s a third reason. Paul Volcker was there. He’s not corrupt. He’s not ambitious. He’s been around the political track a few times. If Volcker shows up to back the president on this one, that’s got to be a good sign.

The president’s speech established some important principles. First, size matters. We should not allow banks — or any other type of financial firm — to become “too big to fail.” A bank that big is too big to regulate, and too big for its own leadership to manage safely and effectively even if they want to. It is a “systemically dangerous institution.” It should not be allowed to grow, because as it becomes bigger, it becomes more dangerous still.

Second, proprietary trading is dangerous. Leveraged proprietary trading is a highly profitable, but exceptionally risky, form of gambling. It should not be done by institutions whose downside risk is publicly insured — either directly or indirectly — because they can blackmail the country when they go down. Get rid of it. John Reed, the former CEO of Citibank, agrees: In the 1980s and 1990s they didn’t do it, and they don’t need to do it now.

Third, the financial sector must be restructured. We have many viable small and medium-sized banks that didn’t get burned by the sub-prime debacle. They should grow and help rebuild America. The big banks right now are, largely, zombies. They are serving no public purpose, yet they remain dangerous. The “Volcker Rule” can help protect us, restoring something like the protections that helped keep us safe for a half century under Glass-Steagall.

The plan doesn’t do enough. But now that the president has set a direction, he can do more. To begin, he should use regulatory powers he already has. Last year’s stress tests were a farce, a public relations exercise to convey a simple message: that the government was going to back the banks, no matter what. That strategy didn’t work. And that’s no longer the message the government should want to send.

So let’s do those stress tests again. This time let the real regulators — the FDIC and not the Fed or Treasury — take the lead. Let’s have clean audits of the toxic assets at their market values, public exposure of the AIG e-mails — which are public property — and a serious review of the documents underlying all those bad mortgages and mortgage-backed-securities. The big banks should be made to shrink, under FDIC supervision. Outright bans and high taxes are the right deterrent for unsafe practices. And prosecution is the remedy for fraud.

Somehow I doubt that our big bankers want to go through this. Maybe they’ll simply retire, removing at a stroke the biggest eyesore on the American political scene — and a big obstacle to both financial reform and an effective economic recovery program.

Another good sign emerged today. According to The Washington Post, Treasury Secretary Timothy Geithner opposed Volcker’s approach, and he got beaten. This sentence is telling: “Industry officials … said they were startled and disheartened that Geithner was overruled, in part because they supported the more moderate approach Geithner proposed last year.”

“Startled” and “disheartened” are good signs. Even better, we have headlines this morning that the secretary is fighting back behind the scenes. ABC News reports: “Treasury Secretary Tim Geithner has reservations about President Obama’s new proposal to limit the size and scope of the nation’s banks, sources tell ABC News. Specifically, the sources say, Geithner is worried that the proposed limits could damage the competitiveness of U.S. firms with their global competitors.”

Competitiveness? That bit of malarkey is a big-bank lobby talking point, nothing more. Its use here reveals precisely the problem that has faced Team Obama from the beginning: They gave the Treasury to a close ally of the biggest banks.

With today’s news, Geithner’s loyalties are completely clear. The next step, in that matter, is up to the president.

So now the ball is rolling, at last, toward real financial reform. Keep it rolling, Mr. President; you’re on the right road now.

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