By Ian Kumekawa
In the wake of a financial crisis that has often been compared to the Great Depression, it is fitting to compare the measures for financial reform currently under debate to the banking reforms of the New Deal. The comparison is more than a little discouraging.
The lasting importance of Roosevelt’s reforms was twofold. First, the system of financial regulation administered by institutions like the Securities and Exchange Commission (SEC) and Federal Deposit Insurance Commission (FDIC) provided enough oversight of large banks to ensure that the speculative behavior that gave rise to the Great Depression would be detected and quashed in the future. That is, it took steps to prevent a repeat catastrophe. Second, in doing so, it reassured a nervous public and provided the public with certain guarantees for the lasting financial health of the nation. That is, it did much to eliminate the pervasive uncertainty which plagued the financial system.
Though history may prove otherwise, the current plan seems to be much more of a temporary sociological reaction against the excesses of big banking: a weighty, bureaucratic slap on the wrist that ultimately amounts to very little. Despite the free-flowing, anti-big-bank rhetoric that has proliferated since 2007, the financial reform legislation currently under debate in the Senate does not effectively limit the power of existing financial behemoths. Indeed, in some senses, it would only magnify their influence: while the bill would limit the size and further growth of financial institutions, it would not break up any of the banks currently considered ‘too big to fail,’ thereby giving the existing large banks significant advantages over their smaller, limited competitors.
It is true that parts of the bill make positive steps towards substantial reform. Commercial banks funded with public money would be prohibited from operating hedge funds or from engaging in proprietary trading of financial securities, (that is, when banks trade in markets with their own money for their own profit, rather than on behalf of their clients). These changes represent a policy that former Fed Chairman and Obama advisor Paul Volcker has been supporting for over ten year. This is a step in the right direction. But when compared to the New Deal’s Glass-Steagall Act of 1933 (repealed in 1999), which completely prohibited commercial banks from functioning as investment banks, the current bill seems comparatively mild. Additionally, the current legislation seems to ignore a great number of institutions that were key players in bringing about the financial crisis. Companies like Bear Stearns (an investment house) and AIG (an insurance company), which received enormous public bailouts, were not commercial banks taking public deposit and thus would be largely unscathed by the proposed bill.
The most important economist of the depression era, John Maynard Keynes, asserted that above all else, it is the elimination of uncertainty that prevented an economy from stagnation and wrought fitful progress. It fell to the government to provide the assurances, the certainty, that would assuage the fears of individual actors and gently encourage their continued participation in the market. What certainty does the currently proposed bill create? Yes, private savers will know that banks are not using their deposits to run hedge funds, but ultimately the risk of massive financial market failure is not fully negated. Without systematic regulation of hedge funds and securitization processes, the market could not only fail again, but fail in a way remarkably similar to how the market collapsed in 2007.
It is deeply unsettling that despite an enormous financial crisis and an outpouring of public outrage over the happy-go-lucky behavior of the financial industry, Obama’s administration is not pursuing more comprehensive measures to regulate volatile financial instruments. Perhaps more disturbing is that even today, more than two years after the initial collapse of the housing bubble, Congress has still not passed even a patchy, watered-down financial reform package.
Earlier in February, after two months of backroom Senate discussion, the Chairman of the Senate Banking Committee, Christopher Dodd (D-CT), declared that negotiations with the ranking Republican on the committee, Richard Shelby (R-AL) had reached “an impasse.” On Feb. 11, Doddannounced a partnership with junior Republican Bob Corker of Tennessee in order to craft a viable bill for the Senate. Though Dodd noted that he was more optimistic than he had been in several weeks, it is impossible to predict what further muzzling will be imposed on the bill in the coming weeks.
Since the 1970s, America has been operating within a Neo-Classical, laissez-faire paradigm of economics. The silver lining, if there is one, of major financial shocks like that of 2007 is that they encourage the reexamination of existing, dominant modes of thought. Whether or not the recent crisis completely topples the current paradigm remains to be seen. Yet for the immediate future, it is absolutely certain that America, and specifically the Obama administration, has a responsibility to quickly ensure that the same sort of financial crisis does not strike again.