Going Home Again

“You can’t go home again.”  At least that’s what the novelist Thomas Wolfe wrote, and it’s acquired the sort of reverence usually reserved for ancient texts.  That also seems the attitude the regulators are exhibiting as they search ever more lengthily for ways of implementing the Dodd-Frank legislation without actually changing anything financial institutions are doing now.  They are engaged in what appear to be metaphysical discussions about the nature of derivatives, when corporations are persons, when is a bank trading on its own account, etc.  It reminds me of how on dismal days at the office many years ago I would go to our legal precedents files and pull out a certain voluminous folder.  It contained a lengthy analysis from the early days of the Social Security Act on the nature of the earthworm. It seems an earthworm farmer had filed a claim for benefits and the lawyers had to decide whether the earthworm was a domesticated creature, whose raising was covered employment, or not.  Their musings always gave me a chuckle, though the metaphysics of Dodd-Frank is much harder to laugh about.

The regulators seem to have forgotten that Dodd-Frank is mostly a reenactment of Glass-Stegall, which was accepted law until the 1990s.  There are issues to be resolved; the Supreme Court has reaffirmed corporations as persons (a self-inflicted wound), subject to criminal liability under American law, while in international criminal law there are only nations and people – the G20 regulators are in a snit about that; deciding just what is a regulated derivative and what is not, or how to tell when a bank is investing on its own account, can indeed be complex, unless of course you take the position that consumer accounts and investment accounts should be managed by separate  institutions as was done under Glass-Stegall – then the problems simplify.  But the regulators continue to muse, and Goldman-Sachs and the other great predators of the financial deep continue to swim lazily about, chewing on hapless customers.

It would not be fair to blame the regulators entirely; they are blown about by the political winds and at the mercy of the politicians.  In fact, the tone of G20 reports written by the finance ministers shows an increasing dislike on their part at being the victims of predatory corporate practices.  Progress of sorts is occurring.  The newly released Communiqués from the G20 meetings in July and last week show at least noble intent to reform, though implementation is not forecast before 2019, still a long way off.  It reminds me of FDR’s description of action at the State Department as like the mating of elephants, a whole lot of trumpeting at high levels and a two year wait for results.  The Communiqués show regulators’ understanding of several important issues.  Mandatory clearing of derivatives through intermediary clearing houses is closer to happening, though regulators threaten more delays.  That is bound to provide some improvement in transparency of financial transactions, though I’m sure corporations are seeking ways to minimize that.  “Shadow Banking”, the practice of bundling and wholesaling risky transactions through non-banking intermediaries, ala Fannie Mae, is targeted for regulation.  International standards for margin requirements and risk analysis of derivatives are proposed.  Regulators are also seeking coordinated ways for nations to cut down on the tax avoidance of corporations, who eliminate their tax liabilities by shipping them elsewhere.  The G20 regulators may actually leap out substantially ahead of American regulators.

There are two basic issues.  The first is that you cannot maintain the current financial environment of combined consumer and investment banking without major risk to the consumer.  In America, the purpose of Dodd-Frank is to change that environment, and financial corporations are fighting it every step of the way.  Part of the problem is that they meet their reserve requirements for derivatives trading through their combined accounts with consumer deposits.  Some of their risk management strategy involves passing risk associated with derivatives trading onto consumers who are not even aware that derivatives are being traded, at sometimes substantial risk to the consumer.  For example, in America a substantial collapse of the derivatives market could conceivably wipe out FDIC depositor insurance funds to create a bank run much worse than the savings and loans crisis.  Annulment of Glass-Stegall gave the predators essentially free meal tickets to munch.  Another part of the problem is the inherent non-transparency of the world of derivatives trading, which makes customer awareness of the true risks difficult to the extreme. That’s what precipitated the Greek financial crisis; Greece took on derivatives consequences they did not understand.   Avoiding repeats is what regulation of clearing houses and risk models is about.  The regulators are right that transparent public exchange of derivatives with standards for risk assessment would be a giant step forward.

But will that step be attainable? For the second basic issue is the relative strengths of national governments versus growing corporate power.  Already multi-national corporations can overwhelm smaller governments with their sheer financial strength and defy larger governments by hopping elsewhere.  Lobbyists are twisting arms everywhere.  A unified vision among the nation states can still overcome the corporate resistance.  Perhaps the G20 can do something no one nation can do alone, and perhaps in the process Dodd-Frank can be seriously implemented.  Perhaps we may even go back home to the good old days when consumer banking and investment banking were separate universes.  I’m not holding my breath, but I still believe it possible.  A lot of our future rides on it.