‘Set the Controls for the Heart of the Sun’

A new working paper from Yeva Nersisyan & L. Randall Wray of the Levy Economics Institute at Bard College titled The Global Financial Crisis and the Shift to Shadow Banking has really got me fired up.  This paper gets to the heart of the kind of financial reform necessitated by the current crisis. Specifically, the authors discuss the need to fundamentally alter our financial system with a clear focus on reigning in what is known as “shadow banking” i.e. the collection of bank and non-bank financial institutions that make bets using your money (among other things). The authors argue that without fundamentally altering the structure of our current financial system the same perverse incentives, inconceivable loopholes, and corrupt practices will continue (if not get worse).

To give you an example, the authors propose that the Obama administration take the oft-discussed “Volcker Rule” a step further:

“Any institution that has access to the Fed and to the FDIC should be prohibited from making any kind of trades. They should return to their traditional roles of making loans, purchasing securities, and then holding them through maturity. Any bank that is unhappy with these new conditions can hand back its bank charter and become an unprotected financial institution. Those that retain their charters will be treated as public-private partnerships, which is what banks are. They put up $5 of their own money, then gamble with $95 of government (guaranteed) money. The only public purpose they serve is underwriting, and that only works if they hold all the risks.”

Basically, banks shouldn’t be able to do this. Doesn’t that make sense? Why even discuss nitpicky “regulation” (which, to many of the people shaping the reform, still tends to mean “self-regulation,” a concept that should have blown up faster than AIG Financial products ZING!) when we can just bar these “too big to fail”  institutions (“too big to save” according to the authors of the paper) from engaging in behaviors that have proven to be so dangerous? We don’t allow convicted felons to buy/carry guns, why allow the people who swindled the world economy to continue using financial weapons of mass destruction?

Unfortunately, the Obama administration is dropping the ball on what could be the Vince Carter over Frederic Weis of policy slam dunks by letting the cronies in congress dance around the edges of a financial reform bill co-authored by the same people it’s supposed to regulate. The banking industry and its lobbyists may loom large (like the aforementioned French center) but it’s up to US to posterize the crony capitalists who got rich gambling away OUR money by demanding fundamental financial reform.

Please, don’t take my word for it. Go and read this paper. There are no complex models or useless data to sift through; just some telling figures with straightforward discussion of both the current state of affairs and what we can do/expect going forward. Actually, for a 30 page paper, it reads pretty fast. Just do it!

Update: Just finished watching the Michael Lewis’  60 Minutes interview and was struck by his statement that the story of this crisis is more about “mass delusion” than criminality. I think that Lewis is 100% right on this and I wanted to clear up what one might read into what I’ve written above. To be sure, I don’t believe that this is all some criminal cabal secretly manipulating the world economy for their own benefit. No, this is surely a much more complicated story than your average James Bond flick. I use the word ‘criminal’ to emphasize how little people have been held accountable for their performance/actions, not to accuse everyone on Wall Street of being a thief. Unfortunately, for simplicity’s sake, stupidity isn’t frequently premeditated. Surely, if people had seen this coming (as some did, Lewis estimates maybe 20 investors worldwide) they would have done differently (and made a fortune in the process). The story, as Lewis explains it, is interesting because of the fact that more smart people didn’t see this coming. It’s this basic observation that, to me, supports the argument that the only thing that could possibly create some form of equity/justice/stability in our society is a fundamental restructuring of the financial system along the lines discussed in the Nersisyan/Wray paper.

See also:

The Global Financial Crisis and the Shift to Shadow Banking — Yeva Nersisyan & L. Randall Wray @ the Levy Economics Institute

Margaritaville — Season 13 @ South Park Studios

60 Minutes: Michael Lewis’ The Big Short — 60 Minutes via TBP

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Filed under Business, Economics, Finance, Politics

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