Saul Friedman: Why financial regulation is needed

Saul Friedman | Gray Matters

April 19, 2008

Here is one difference between the generations:

The older generation was skeptical of big business and trusted government more to provide protection from the cold blasts of laissez faire. The younger, Dow generation is cynical of government and almost everything else, except the baseless belief that stocks and property values will always go up.

Remember 1999 predictions that the Dow Jones industrial average was headed toward 36,000? If you believed, you also bought houses you couldn't afford with no money down in order to refinance, sell and make a bundle because values would rise ad infinitum. The older generation bought houses to live in, not as an investment.

Along these lines, economist Dean Baker, blogging in The American Prospect, asks, "Suppose we had invested Social Security in the stock market." Thanks to the older generations and their skepticism toward the market, that did not happen. And now as recession deepens, and comparisons are made to 1929, it's dawning on younger Americans watching their retirement savings vanish that there may be a need for government action.

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For the first time since the gay 1990s, when the fad of "deregulation" swept aside some of the strongest deterrents to the financial shenanigans of today, frightened administration officials as well as Democrats are talking about reregulation. Well, sort of.

Treasury Secretary and former Goldman Sachs chief Henry Paulson Jr., who still supports privatizing Social Security but missed the subprime and housing meltdown, has proposed better supervision of investment banks, which taxpayers are being asked to save. But, as The New York Times reported, Paulson's plan "carefully avoids a call for stronger regulation" and may loosen regulation.

In Congress, Democrats are drafting stronger legislation to create new regulations to permit the Federal Reserve to oversee commercial banks, Wall Street firms, hedge funds and nonbank financial institutions that have been buying and selling billions in paper assets, without anyone looking over their shoulders or even understanding what they are doing.

Rep. Barney Frank (D.-Mass.), chairman of the House Financial Services Committee, noted that government has failed to keep up with the explosion of new, exotic financial instruments. "You need regulation," he said, "that is adequate to the scope of innovation."

Among the presidential campaigners, Sen. Barack Obama, speaking at New York's Cooper Union late last month, blamed corporate lobbyists for carrying deregulation too far and he pledged regulatory reform, but nothing more specific than the creation of a financial oversight commission.

Republican Sen. John McCain, staked out a classic conservative position and opposed government intervention in the market. Government, he said, should not reward "irresponsible" behavior by businesses or borrowers. That was not his position in the 1980s when he was one of five senators who met with banking regulators in an effort to help fellow Arizonan Charles Keating, who was convicted of fraud and racketeering after the collapse of his Lincoln Savings & Loan. Keating had given McCain $112,000 in campaign contributions. An ethics probe into the "Keating Five," found McCain did the least for Keating.

Sen. Hillary Rodham Clinton, like Obama, suggested in her economic speech the creation of a regulatory reform commission, and she called for something like the New Deal's Home Owners Loan Corp. to help people hang onto their homes with mortgage refinancing. But she failed to mention her husband's role in 1999, when he cooperated with Republicans and businesses in repealing one of the most important federal protections for the ordinary (and mostly older) saver and investor - the Glass-Steagall Act.

I have reported complaints of older readers who have been accosted in banks by employees trying to sell them annuities that may or may not have been right for them. The salesman was looking for a commission, violating the bank's responsibility to the depositor.

That could not have happened under the Glass-Steagall Act, passed in 1933 following failures of one in five American banks, in large part because they used depositors' funds to speculate in stocks and other investments. Proposed by Sen. Carter Glass (D.-Va.) and Rep. Henry Steagall (D.-Ala.), the law prohibited commercial banks from trading in stocks and bonds in order to limit conflicts of interest.

The act also established the Federal Deposit Insurance Corp. (FDIC) to protect depositors from catastrophic bank losses. The FDIC recently announced it was beefing up its staff to prepare for more bank failures. Together with the Securities and Exchange Commission, these agencies were to protect investors and depositors with regulation.

But deregulation has taken most of the teeth out of regulations for air travel, energy, occupational safety, food and drug safety. More than 20 years ago big banks and brokerages, led by former JP Morgan executive Alan Greenspan, began a campaign for banking deregulation, and an end to Glass-Steagall. In 1999, with help from Greenspan, President Bill Clinton, Wall Street titans and congressional Republicans, Glass-Steagall was repealed. The walls between banks and investment houses came tumbling down.

History doesn't repeat, but it does echo. And now as banks, brokerages and investors lose billions, and Americans lose their savings and their homes, Thomas Kostigan of MarketWatch wrote that the proposals to deal with the credit crisis are "Band-Aids" and another Glass-Steagall "should be considered again."

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