Financial Regulation Shell Game

Nothing demonstrates the sad state of Washington politics more than the financial regulation going on in Washington at the moment. Over the last couple of elections, the American people, both left and right, have said “enough” to special interest influence and government handouts. But like addicts, Washington can’t stop itself.

Everyone agrees that America’s financial regulations are a mess. There are dozens of different, overlapping regulatory schemes, many created during the Great Depression and supplemented ad hoc as problems arose. These piecemeal regulations overlap and conflict, but also, strangely, leave glaring gaps. This has allowed savvy financial institutions to slip between cracks by cherry picking the regulators they wanted and then sliding through those gaps. This was a disaster waiting to happen, and the financial meltdown was that disaster.

The problem, however, with fixing this is fully on display at the moment. Rather than approaching these regulations rationally, as the public demands, or vindictively, as the left demands, Washington has turned this into an orgy of interest group politics. Money is pouring into both parties in record numbers. Obama took in $40 million dollars from the financial sector during the 2008 presidential campaign -- McCain took in $29 million. This year, the DNC has taken in $9.9 million from the sector. The RNC has taken in $5.2 million. Individual Senators and Representatives have taken in even more.

And, of course, you get what you pay for. Republicans and Democrats both have bent over backwards to hand out favors. The Republican Congress and Bill Clinton removed Depression-era safeguards that kept commercial banking and investment banking separate -- this allowed the creation of these mega financial institutions (“too big to fail”). The Democrats, particularly Barney Frank, kept expanding the scope of Fannie Mae and Freddie Mac, the cause of the financial meltdown. Moreover, in 2003, the Democrats, led by Frank and his many connections at Fannie and Freddie, resisted Bush administration efforts to strengthen the regulation of those institutions. And in 2008, Bush and the Democrats passed the biggest bailout in human history.

So now they try again. But once again, the interest groups are running the show. The Democrats talk big about punishing Wall Street to placate their followers, but they have managed to produce regulations that are truly staggering in how interest group friendly they are. When the Democrats introduced the original bill it contained dozens of new provisions that were intended to clean up these regulations. Many of these regulations were quite good. Some were horrible.

Slowly but surely, the good regulations were snuffed out after the “Wall Street bashing” Democrats met secretly with the likes of Lloyd Blankfein of Goldman Sachs and their friends at JP Morgan. Soon, all that was left in the bill were massive bailouts and some “restrictions” that favored large industry players. It should thus come as no surprise that Goldman Sachs lobbied in favor of these regulations. . . at least until the SEC came after them recently. JP Morgan still lobbies in favor of these regulations, except for the part that would hurt them.

Right now, the regulations create a massive pool of taxpayer money and taxpayer guarantees that are ostensibly intended to allow the government to wind down “too big to fail” institutions that fail. What this really means is that (1) there will be no attempt to break up or limit these huge institutions, i.e. too big to fail can continue, and (2) the government is guaranteeing that taxpayers will pick up the tab if one of these institutions fails. In other words, investors and business partners of these institutions don’t need to worry about getting hurt if they take risky bets that don’t pay off, because the taxpayers will protect them -- all in the name of “protecting the system from the failure of an institution that is too big to fail.”

These regulations also will force small players to sell their derivatives through an exchange, the same kind of exchange that sells favors to the big boys. And they will create a “consumer protection” agency, which will be run by industry friendly regulators that are dominated by the big players. This will effectively put the big banks in a position of controlling regulators who have the power to tell smaller banks what they can and can’t do. Must be nice.

Interestingly, the one group that escapes regulation is Fannie Mae and Freddie Mac, both of whom give heavily to Democrats. Moreover, Fannie and Freddie have become a dumping ground for former Democratic lawmakers and their friends who want to earn large amounts of money. Fannie and Freddie, by the way, were at fault for the financial meltdown. . . the rest of Wall Street just profited like mad off of it.

What makes this so disturbing is that this financial regulation is a clear indication that Washington doesn’t get it. The Democrats were elected on a platform of putting the boot to Wall Street in favor of the “little guy” -- a standard socialist trope. But once they were in power, they did nothing more than open the government vaults and let their Wall Street friends plunder away. The Republicans, for their part, mindlessly defend every indefensible practice Wall Street can come up with.

What they should be doing is what the public wants: the public wants an end to influence peddling. They want Washington to do the right things, not the things the people with the biggest checkbooks want. They want rational regulations that allow the free market to work, but protect people from predatory practices. They don’t want the government propping up institutions, guaranteeing their risk taking, or letting these hazard grow to the point that an institutional failure can wipe out our country.

It’s time for someone to take a stand. The Democrats won’t do it, maybe the Republicans should.


Update: The Republicans have blocked the first round of this "reform," after they were joined by Ben Nelson (D-Nebraska).