Given the Republicans’ success in painting the Democrats as the party of Wall Street, it was inevitable that the Obama Administration would announce some measures aimed at bringing the banking sector under more effective control. But the smart money would have been on a symbolic gesture, such as an ineffectual limit on bankers pay.
The announcement today that banks are to be banned from undertaking proprietary trading operations may have proved the smart money wrong. Certainly the sharp drop on Wall Street suggests that the announcement delivers more than expected for the public, and correspondingly less for the shareholders of big financial institutions.
If it is delivered as described, it would force the reversal of the 2008 move by Goldman Sachs and Morgan Stanley to become bank holding companies, with direct access to support from the Federal Reserve and Federal Deposit Insurance Corporation. More generally, it would be a significant move in the direction of narrow banking, preventing publicly guaranteed banks from engaging in the kind of high risk trading that produced the current financial crisis. As Chris Joye points out, narrow banking has surprisingly broad support among economists.
But will it be carried through? The first problem is the dysfunctional US political process, which prevents just about anything from happening. Obama might be able to wedge the Republicans on this issue, but they will probably find an excuse for voting en bloc against any measure he proposes. Under the current Senate supermajority rules that would be enough to stop any reform.
So, it will probably be necessary to scrap the filibuster and pass legislation with a simple majority. And that’s assuming that Obama can command the support of the numerous Democrats who are beholden to Wall Street, just as the Republicans (hypocritically, given their own position) allege.
Leaving aside the political obstacles to getting legislation passed, there’s the problem of making it effective. Even if banks aren’t allowed to own speculative investment enterprises, they can make big money lending to such operations. Then when things go bad, the failure of one or more big speculators can imperil the system as a whole. That’s what happened in 1998 with LTCM.
What matters here is the political dynamic. If the aim is to get back to business as usual as fast as possible, any reform will be short-lived and ineffectual. On the other hand, if there is a permanent shift in public and political sentiment against an economy dominated by the finance sector, things will work out very differently. Instead of eroding control, the discovery of loopholes will lead to tighter and more systematic regulation ending in a full-scale separation of banking and speculative finance.
One sign for optimism is the progress being made on the related issue of tax havens. Until very recently, moves to control the activities of tax havens were almost entirely ineffectual, at most prompting wealthy tax dodgers (and the banks who hid the money for them) to shift accounts from one jurisdiction to another. But as governments have run short of money and tolerance, the picture has changed. A combination of economic/diplomatic pressure on tax havens and a willingness to make use of whistleblowers within banks has rendered international tax evasion far less viable.
Perhaps this time Wall Street really will be cut down to size. If Obama’s Administration is to recover from its current malaise, he needs to win on this one.
I wrote this for Crikey. It should be appearing there soon, I expect
John Quiggin 
john,
you know as well as i do that the banks own obama and have done from well before anyone had heard of him, just what did he do after all at that CIA front company for those years that gets less than a sentence in his book,
when he is completely discredited he will be dropped like the marionette he is
financial reform is a shimmering carrot in the air for one-eyed lefties and morons
private supra-national banks in league with the biggest defence contractors run the show on planet Earth in 2010
in the same way as people referred to the City and the Admiralty as the true powers of Britain two hundred years ago
Perfect timing for the Supreme Court to come in with the decision that restrictions on corporate political donations are unconstitutional. It’s looking like Obama will be America’s Gorbachev.
My feeling is that this is part of a long term strategy by the Obama administration. I think the objective has been to pass the unpopular (though very good) health care bill early on so that it is a dead issue by the time the mid terms come around. The six months leading up to November can then be used for populist (though again very good) anti Wall St politics against a background of economic recovery.
So basically it seems that the US is permanently stuck, and nothing will happen legislatively that is the vaguest bit controversial until they all (or at least a majority of them) recover their sanity.
Could you post a description of what an economy not dominated by the finance sector might look like? I for one don’t know how that might look. There would still have to be an equity market, but to prevent domination would the total value of a finance market have to return to being less than the GNP of its home state? I think Paul Krugman said that that stopped being the case in the US in the 1930s. And would we look for productivity less in [finance] services and more in actually making things again?
Democrats are craven cowards. They are in power because the Repubs thoroughly f*cked the country. They always seen to be trying to appease their enemies while p*ssing off their supporters. Obama is a bit like Rudd. A few sorrys and not much else.
Brown for President. In four years he will be more experienced than Obama was when he ran.
They could stop feeding the financial sector everyone’s mandated super savings which is at the core of why Wall st is so bloated, obscene and recalcitrant. Golsman and their ilk have a guaranteed drip line with super nutritious supplement flowing in intaveniously so that they get fat and few starve except the people and countries they bankrupt.
Its the obvious way to keep the bubble in Wall St from blowing us all up. Its so esy to gamble with other people’s money. Take super away and give people a pay rise which is really what super is. I dont need the government to force me to save.
Note today – there has been a quite substantial (but by no means large enough) decline in the Goldman Sachs “bonus pool”. Down to 16.2 billion – a bit of a cut from last year, it represents 35.8% of their revenues (down from 47% I think from a previous post).
All well and good – bonus pool on the decline. What is hard to stomach though is that the 16.2 billion bonus pool happens to still be larger than their yearly profit of 13.4 billion.
As a simple accounting graduate Im having a few problems with the annual bonus pool being larger than the annual profit.
You bet its not large enough. The market decreed that we ought to be meeting all these worthless clowns down at the centrelink right about now. Morgans are actually hiring people. When this vampire side of the economy ought to have been in retrenchment. The hiring of new staff into the finance sector in America could not be a clearer case of malinvestment.
This reduction in the bonus pool, when they ought not even be getting their base salary, is a bunch of thieves trying to stop a movement for criminal prosecution. There is no doubt that if all the relevant laws were applied, dozens of these people could wind up in jail. For this crowd “Prime Brokerage” really meant naked short selling. A brutal attack on the ability of small companies to raise capital .
Notice that these pretend businessmen came out of this mess with huge underwriting revenues??
Supposing you were able to make huge underwriting revenues? Does that mean you are so skint that you require a loan from the taxpayer? The whole thing is a disgrace. Turning our ally into a banana republic. We ought never forgive this crowd. They ought all be excluded access to this country on account of being of insufficiently worthy character.
Alice, you obviously aren’t aware that America has no equivalent of Australia’s compulsory super contributions. In the US payroll contributions are compulsorily dragooned into propping up the government pension system, not invested in Wall Street.
Unless there is a parallel universe somewhere in which Social Security privatisation was implemented in the US some time ago, I am not sure what you would be referring to.
@Monkey’s Uncle
Many countries have mandatory super MU. There are thousands of super funds in Australia alone and as the GFC showed…its a global market, which the Wall street financial sector plays in, not just the US. Seeing Wall street investments and speculation as US centric is not appropriate at all.
@Monkey’s Uncle
Link for you MU – perhaps we should have taken note of a certain Professor in 2003 – compulsory super since the 1980s/1990s doesnt appear to have increased private sector saving but rather may have been a contributing factor in the fal in private sector saving..
http://www.henrythornton.com/article.asp?article_id=5639
Let banks fail, says Nobel economist Joseph Stiglitz
The Government should allow every distressed bank to go bankrupt and set up a fresh banking system under temporary state control rather than cripple the country by propping up a corrupt edifice, according to Joseph Stiglitz, the Nobel Prize-winning economist.
@gerard
One man they should listen to…but they wont. They didnt when he was head of the world bank and was fired by them for expressing his distate with their policies …which were basically neoliberal one model fits all economies..impose budget surpluses and privatisations on developing nations in trouble…as if that would work (not).
But it was in the user manual..if it was good enough for advanced developing nations it was a template for banana republics as well (who needs to really analyse different situations and different economies ?)
– Doh wrong! They had some brains working there at the world bank and the idiots must have prevailed. Shame.
I think this highlights an economic problem that has become so large it is now damaging democracy as well as capitalism. Banks are not only “too big to fail”, they are “too big to regulate”. Nore are the main beneficiaries bank shareholders. The worst offenders, the big four Wall Street trading banks, were paying half their profits in bonuses to executives and staff, not shareholders. This is simply the exploitation of positional power. Both sides are guilty – the original intention to limit executive payouts was removed frmo TARP by Connecticut Democrat Senator Chris Dodd.
As Alice has said, the laws channeling retirement savings into investment funds have created a fundamental distortion of our markets. But where I think the economics is flawed is that we assume that the distortion benefits that group of shareholders (only). It does, but only partly. It mainly confers enormous power to the executives of those institutions. These do not face the same governance regime that corporations do in Australia or the United States. They can then use those funds to buy political influence, thus ensuring that the situation is perpetuated.
In hindsight, I think executive powers and rewards is one of the weakest areas of economic theory. We understand via Public Choice Theory that corporations can corrupt/buy influence with governments to benefit the corporation at the expense of economic efficiency. We understand via Agency theory that executives can use the power of their corporations to benefit themselves at the expense of shareholders. Yet we fail to put the two together to see that executives can use their corporate power with governments to ensure that regulations benefit executives not shareholders. This is the bit that damages democracy.
Corporate executives have become the new robber barrons. Their next mansions will probably feature moats; a few have already bought private islands. It will never stop until we at least make investment funds fully answerable to their (compulsory) investors, and corporate executives fully answerable to their shareholders. Binding votes on executive compensation would be just a start of the reforms needed.