Tuesday, February 16, 2010

Professor Blinder with his blinders on.

Wall Street Journal OPINION FEBRUARY 15, 2010, 6:48 P.M. ET It's Time for Financial Reform Plan C

Can't everyone at least agree on a resolution authority that would prevent another Lehman or AIG?


About a month ago on this page ("When Greed Is Not Good," Jan. 11), I worried that the financial reform boat was taking on water and in danger of sinking. Since then, legislative prospects have grown progressively worse.

First came the election of Sen. Scott Brown (R., Mass.), otherwise known as "41" to signal the impossibility of breaking a filibuster on a party-line vote. Then came the Supreme Court's outrageous campaign-finance decision, which will strengthen the hands of industry lobbyists who were doing quite well already. That same day, President Barack Obama shuffled the deck by embracing what he called the "Volcker rule" on proprietary trading by banks and the permissible size of financial institutions—two ideas his own Treasury Department had previously rejected.

Finally, in case you thought you still detected a pulse, Republican senators slammed the door on any bipartisan reform bill, embracing yet again the "just say no" strategy.

Doing nothing to safeguard the financial system after what we've been through would be a disgrace. So what can be salvaged from the wreckage?

Let me start with the two most pressing issues: systemic risk and resolution authority.

I don't think any sentient person denies the need for an agency responsible for overseeing system-wide risks, no matter where they emerge. The disagreements come over to whom to give this authority. I have long thought it should be lodged in the Federal Reserve. So, not surprisingly, does Fed Chairman Ben Bernanke. And so, more or less, do the Treasury and the House. But Sen. Christopher Dodd (D., Conn.) objects to giving the Fed additional powers. He wants to clip its wings instead.

There is good news here. If Congress fails to act, the Fed will, by default, continue to be the tacit systemic risk monitor and regulator. Given the searing recent experiences, our central bank will neither ignore this responsibility nor assume that someone else is doing the job. Of course, memories will fade. So it would be far better to give the Fed this responsibility explicitly—in law. But if congressional paralysis continues, we'll get the right solution anyway.

Not so with resolution authority. Nearly everyone agrees there should never be another Lehman or another AIG. In the first case, the government practiced tough non-love, let the firm file for bankruptcy, and then watched in horror as the financial system started imploding. In the second case, the government saved the company (and the system) by putting taxpayers on the hook to the tune of $180 billion. Though diametrically opposed, those two policy decisions were both horrifying. However, should a financial giant start failing today, congressional inaction leaves regulators with those same two options.

Here we do need a legislative fix—one that gives regulators a third way, between bankruptcy and bailout, that would either euthanize these institutions peacefully or resuscitate them under new management. That's what "resolution authority" is all about.

Rumor has it that Republicans and Democrats on the Senate Banking Committee are—or is it were?—close to agreement on this thorny-but-essential issue. Ladies and gentlemen, could you possibly stop bickering long enough to give us a tightly-focused bill that accomplishes this one objective? Mr. Obama, could you please shame Congress into doing so?

Next on my reform list would be the proposed Consumer Financial Protection Agency (CFPA). It is clear that one major contributor to the subprime mess was that unwary consumers were duped into mortgage products they should never have touched. And it can happen again. So I think the CFPA is an essential addition to the regulatory tool kit. But hardly any Republicans agree. My advice on this one to Democrats? Demagogue the issue unmercifully. Portray Republicans as defenders of those who would cheat consumers and permit another subprime debacle. My advice to Republicans? Cave in rather than let Democrats paint you into such a corner. (Don't worry. Neither party ever follows my advice.)

That brings me to the Volcker rule on proprietary trading which, I guess, is: Don't let depository institutions do it. Let me start with a confession: My admiration for Paul Volcker is boundless; he is truly a great man. When Mr. Volcker talks, people should listen. And I could not agree more with his underlying goal: to stop traders from gambling with taxpayers' money.

That said, I am waiting to see if what is really the Volcker "idea" can be translated into a workable Volcker rule. It is devilishly difficult to draw bright lines between proprietary trading and trading, hedging, and market-making on behalf of clients. Mr. Volcker himself said that "you know it when you see it," suggesting an analogy with pornography. The problem is, often you don't.

Furthermore, the firms that take the biggest proprietary trading risks are not banks at all—or at least not real banks, with depositors and all that. (I am not naming names.) Yet some of these firms are too big to fail, whether we like it or not. If they gamble and lose big, we taxpayers may find ourselves on the hook again, which is why we need resolution authority. So I'm waiting for the details of a fleshed-out Volcker rule. After that, we'll see if anyone can convince 60 senators of its wisdom.

But what to do until that glorious day arrives? Bank regulators have the power to judge certain instruments and trading practices riskier than others. They do not need congressional approval. They should use this authority to impose higher regulatory capital charges and closer supervision on trading in riskier exotic assets, especially those not traded on organized exchanges. While that would fall short of the Volcker rule, it would help—especially if capital charges are substantial and eyebrows are sternly arched.

There are many other financial reform issues, but my space and your attention are limited. The overriding message is this. Plan A died long ago, and Plan B is gasping for breath. It's time to prepare Plan C.

Mr. Blinder, a professor of economics and public affairs at Princeton University and vice chairman of the Promontory Interfinancial Network, is a former vice chairman of the Federal Reserve Board.

My Letter to the Editor Response:

Mr. Blinder continues to have his blinders on. The cause of the "subprime meltdown" which led to the near-collapse of the world financial system, according to Mr. Blinder and his left-wing cronies is the stupidity of the citizenry of the United States of America. ("…unwary consumers were duped into mortgage products they should never have touched.") Well first, I disagree that consumers are all so ignorant they were able to be duped. Mr. Blinder and most Democrats do, indeed, consider that American consumers are so stupid, they need handholding by a big government. Only government is honest, businessmen are not. But let's give Mr. Blinder that. Now, sir, do you believe voters were equally as stupid as to be duped by Barack Obama, who arguably misled them? Or, sir, are consumers stupid but voters intelligent? why don't Democrats -- President Obama included -- just announce to the citizenry/consumer/voter -- because they are all one in the same -- that they are stupid and forget all this "equality" stuff? The only intelligent thing, Professor Blinder, you wrote is "(Don't worry. Neither party ever follows my advice.)"  And for good reason!

Theodore M. Wight

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