Wall Street Regulation

Glass-Steagall has made somewhat of a comeback with help from the Occupy movement and rising political stars like Elizabeth Warren… The only two political insiders you won’t catch talking about reinstating Glass-Steagall both happen to be running for president.

Part 4 of the Special “Off The Reservation” Election Series in the Long Island Press.

The Banking Act of 1933, commonly known as Glass-Steagall, was established to tame the harmful speculative behavior of an industry run amok in the early part of the 20th century; behavior many observers at the time credited for the market crash that precipitated the Great Depression. For some, the repeal of Glass-Steagall, by the Gramm-Leach-Bliley Act of 1999, was the deathblow to financial prudence on Wall Street.

 In reality it was simply the formal recognition of careless financial practices that were largely in place already. Since the near-collapse of the banking industry in 2008, Glass-Steagall has made somewhat of a comeback with help from the Occupy movement and rising political stars like Elizabeth Warren, the former federal consumer protection advocate now running for Senate in Massachusetts. The only two political insiders you won’t catch talking about reinstating Glass-Steagall both happen to be running for president.

Wall Street reform is as important as it was in 2008 but both President Obama and Gov. Mitt Romney have taken great pains to avoid talking about it too much. For his part, President Obama seems content to rest on the laurels of the Dodd-Frank Act, Congress’s attempt to rein in Wall Street excess, which had enough support to pass but not enough to be properly funded or enforced. According to Romney’s platform, he would “Repeal Dodd-Frank and replace with streamlined, modern regulatory framework.” That’s the extent of his vision for the future of Wall Street according his platform. Ten words.

So while the rest of the country is suddenly talking about a law enacted almost 80 years ago, these guys aren’t going anywhere near it. The truth is, Wall Street reform and, more specifically Glass-Steagall, is more complicated, making it easy for Obama and Romney to be evasive.

So let’s answer two questions. What would actual Wall Street reform look like and what exactly was Glass-Steagall?

The purpose of the original act was to establish a barrier between traditional banks and the risk-taking investment firms, denying investment banks access to consumer deposits and secure, interest-bearing loans. The unwritten effect of Glass-Steagall, however, was to establish a culture of prudency in the consumer and business banking realm, leaving sophisticated professional investments to more savvy financiers who had the ability to calculate the inherent risk of a financial instrument. For decades to follow, the merits of Glass-Steagall would continue to be debated, but it nevertheless drew a marked distinction between the function of a consumer bank and an investment bank.

Today reinstating Glass-Steagall is a common rallying cry among those who decry the bad behavior of Wall Street. Its repeal has become the fulcrum of nearly every debate surrounding deregulation. Actually accomplishing this, of course, is easier said than done.

The best way to reconcile the debate over whether to reinstate Glass-Steagall is to appreciate that the culture of Glass-Steagall was more important than the act itself. Over time the restrictions placed on bankers under the act were chipped away, but the culture that governed the banking industry endured beyond its measures. Eventually, savvy bankers and politicians found ways to loosen its screws and interpret the act to their own benefit.

Don’t Just Blame Republicans

In 1978, President Jimmy Carter oversaw the passage of the International Banking Act, a bill that should probably receive as much, if not more attention than Gramm-Leach-Bliley. Essentially, the act allowed foreign banks or entities that engaged in “banking-like activities” to participate in domestic financial markets. For the first time, foreign investment firms were able to make competitive loans so long as they didn’t compete for consumer deposits; initially individual states could determine whether their regulatory structure could support this new activity. The government would go on to loosen restrictions governing the competition for consumer deposits and allowing bank holding companies to treat money markets like checking accounts.

In his book “End This Depression Now,” economist Paul Krugman argues that perhaps the most influential step with respect to the banking sector came with Carter’s passage of the “Monetary Control Act of 1980, which ended regulations that had prevented banks from paying interest on many kinds of deposits. Unfortunately, banking is not like trucking, and the effect of deregulation was not so much to encourage efficiency as to encourage risk taking.”

 By 1987 the bank holding companies, including foreign companies allowed to operate within the U.S. banking system, were granted access to mortgages to create a package of investments called mortgage-backed securities; the threshold for the amount of investing activity in instruments such as these was also increased, paving the way for the growth of investments backed by the strength (or weakness) of the consumer market.

During that same year, members of the Federal Reserve began calling for the repeal of Glass-Steagall as then-chairman Paul Volcker was providing the tie-breaking resistance. But this was a mere formality because by this time, Glass-Steagall was effectively over.

Yet even though most of the threads of regulation had been pulled from the overcoat that protected consumers from risky banking practices, the culture of prudent banking still existed to an extent; maintaining the Glass-Steagall Act on the books was an indication of this sentiment. Throughout the decades when regulations were steadily eroding, powerful national figures such as Paul Volcker under Carter and Reagan, and Treasury Secretary Nicholas Brady under George H.W. Bush managed to temper the enthusiasm of the movement.

That George Bush Senior heeded their admonitions was an admission that the public’s appetite for deregulation was actually beginning to wane in the post-Reagan hangover. Richard Berke’s New York Times article of Dec. 11, 1988, on the eve of the Bush presidency, encapsulated this feeling. Berke wrote, “Lawmakers and analysts say the pressure is fed by a heightened public uneasiness about deregulatory shortcomings that touch the daily lives of millions of Americans: from delays at airports and strains on the air traffic control system to the presence of hazardous chemicals in the workplace to worries about the safety of money deposited in savings institutions.” Alas, these four years would prove to be a momentary hiccup in the deregulation movement.

During the Clinton years, the nation’s leadership was largely comprised of proponents of deregulation. In fact, by his second term, Clinton was almost entirely surrounded by rabid free market enthusiasts. A former chairman at Goldman Sachs, Robert Rubin, was Secretary of the Treasury, Alan Greenspan was still at the helm of the Federal Reserve and Phil Gramm was the head of the powerful Senate Banking Committee. All of these men had close ties to Wall Street and made no secret of their intention to release bankers from the burdensome shackles of regulation and oversight.

Reforming Reform

In 2008, economist Joseph Stiglitz warned of the enduring negative consequences of deregulation. At a hearing held in front of the House Committee on Financial Services, Stiglitz invoked Adam Smith saying, “Even he recognized that unregulated markets will try to restrict competition, and without strong competition markets will not be efficient.” One of Stiglitz’s solutions was to restore transparency to investments and the markets themselves by restricting “banks’ dealing with criminals, unregulated and non-transparent hedge funds, and off-shore banks that do not conform to regulatory and accounting standards of our highly regulated financial entities.”

For emphasis he noted, “We have shown that we can do this when we want, when terrorism is the issue.”

Still, the nagging question remains as to what reform might look like. After all, not all deregulation is irresponsible. Most of the discussion in the media surrounding deregulation revolves around the concept that our banking institutions are “too big to fail.” Thus the rallying cry for reinstating Glass-Steagall and separating banks from investment banks. I’m in tepid agreement with the underlying principle, but the reality of the situation is far more complicated. The fact is banking has gone global and the deregulation genie is out of the bottle.

As I said earlier, Glass-Steagall was as much about instilling a culture of prudency to the banking world as it was about erecting a barrier between commercial banks and investment banks. Advocates like Elizabeth Warren like to say that prior to 1999 and the repeal of Glass-Steagall, the economy functioned through periods of both prosperity and recession since 1934 without the banking sector once collapsing. It’s a fair, but oversimplified assertion that overlooks the fact that Glass-Steagall was on a ventilator in 1978 and dead by 1980. A 30-year run of prosperity from 1978 to 2008, with a few brief recessions in between, is nothing to sneeze at.

Restoring balance to the banking sector does not necessarily require separating the banks. Not yet at least. It begins with transparency and reestablishing the culture of prudency that has been conspicuously absent over the past decade. After all, you cannot value what you cannot see; nor can you mitigate risk unless you first manage reward.

What this really boils down to is accountability, which is ultimately a behavioral issue. Allowing investors to actually see how a bank behaves by viewing the size and scope of their transactions would theoretically assuage their appetite for risk. Given these conclusions, it’s easier to make the case that our current president would provide more accountability and inspire behavioral changes on Wall Street, particularly given Romney’s intransigence when it comes to considering financial reform. But tough talk against Wall Street has all but disappeared from Obama’s rhetoric leaving little hope that a second term will elicit any further positive change. So this week, while neither man seems serious about financial reform, the status quo is better than further deregulation and letting bankers rule the roost.

Tie goes to the incumbent.

That 70’s Show

There is no shortage
 of theories as to why Americans are finding themselves staring 
helplessly at rising gas prices, but few of them are real. In fact, much 
of the prevailing wisdom offered by television pundits is false.

He was a relative unknown when he campaigned for president of an America 
that was worn down from foreign intervention, a sick economy and
 Republican rule. His outsider status brought with him a new brand of
 hope that the media devoured allowing his star to rise quickly and shine
 brightly. Upon taking the presidency, however, the beleaguered economy
 stubbornly refused to show signs of life, energy prices rose to 
troubling levels and the Middle East began to spin wildly out of
 control. Things were so bad he even had to step in and bail out an
American car company with government funds.

After only three years, it was all over but for the counting. His star
 faded quickly as the once-media darling became anathema to an
 increasingly conservative American public that spent the last year of 
his term looking for a new “Mr. Right” in every sense.

Such was the fate of Jimmy Carter, who never had a shot at re-election;
 and a good argument can be made that Barack Obama will suffer the same 
fate under nearly identical circumstances.

There is so much involved in the making and unmaking of a president that
 it’s unfair to boil a career down to only a few factors. But in Jimmy
 Carter’s case I believe it is fair to say that three primary issues were
 the undoing of his presidency: the hostage crisis in Iran, stagflation
 and fuel prices at the pump.

Iran wasn’t a military crisis as much as it was an embarrassment to the
United States, though talk of a nuclear Iran was percolating even then.
 Prior meddling in the Middle East came back to haunt us in a situation 
we couldn’t control, with Carter ill-equipped to handle the predicament
 of Americans held hostage in Tehran. Rising oil prices—the result of the 
Iranian revolution in 1979 and the panic that ensued in the trading
 markets—brought about a second shortage within a decade and with it 
hysteria and inflation. This upward pressure from fuel prices in an
 already inflationary environment spurred the Federal Reserve to begin
 chasing inflation with high interest rates.

In his book Currency Wars, James Rickards addresses the impact of 
American monetary policy on the global economy and cites the “50 percent 
decline in the purchasing power of the dollar from 1977 to 1981.” He
 goes on to depict “a world gone mad,” noting that, “A new term, 
’stagflation,’ was used to describe the unprecedented combination of 
high inflation and stagnation happening in the United States.” 
Most people recall the moment when interest rates reached as high as 20 
percent during this period and point to it as the height of insanity
 during the Carter years. In actuality then-Fed Chairman Paul Volcker 
under Ronald Reagan did this as a one-time shock to the system.  It was
 done in conjunction with vigorous tax cuts to spark consumer spending, a 
tightening of the monetary policy to strengthen the dollar and the
 latent effect of increased oil production, both domestic and abroad.
 With the exception of the tax cuts, these policies and factors would 
likely have occurred anyway as Volcker was a Carter appointee and it was
 Carter who loosened the valve on domestic oil production. Furthermore,
 Reagan would go on to reverse many of these initial tax cuts in a way 
that would make conservatives and Tea Party activists blush today.
 Either way, Jimmy Carter was a victim of pitiful economic circumstances 
that will forever be his legacy in the White House.

Rickards draws some comparisons between the ’70s and today, most notably
 deriding Federal Reserve Chairman Ben Bernanke’s actions of Quantitative 
Easing, a fancy name for printing money—the same currency devaluation
 scheme employed by Nixon—calling them “runaway fiscal and monetary 
policies, which were flooding the world with dollars and causing global
 inflation in food and energy prices.”

This is an interesting point to hang on for a bit. There is no shortage
 of theories as to why Americans are finding themselves staring 
helplessly at rising gas prices, but few of them are real. In fact, much 
of the prevailing wisdom offered by television pundits is false. It’s
 not Obama’s refusal to “drill baby drill” or increased demand from 
China. It’s not Libya or Iran, either. It’s the abundance of liquidity 
in the markets matched with the ability of investment banks, hedge funds
 and oil companies to trade energy futures on commodities exchanges
 without any limits or transparency. And this is the result of 30 years
of deregulation beginning with Carter and continuing through Obama.

Before the commodities exchanges were deregulated there were few safe 
places to “park” excess capital during volatile periods. Today these
 exchanges are the perfect shelters for investors with excess liquidity
 because many of them are allowed to stand on all sides of the 
transaction. An investor such as an investment bank or an oil company 
can be the buyer, seller, broker and manufacturer, and can therefore
more easily predict the future behavior of pricing by both forecasting 
the future price of a commodity it owns while moving the market with
 enormous capital infusions. It’s more than the ultimate hedge. It’s a
 scam.

With a crisis brewing in Iran, the markets and pundits are once again in 
a tizzy, and consumers are bracing for the worst. This brings us to what 
might be the nail in Barack Obama’s coffin: inflation.
 When fuel prices rise, even for a brief period, it shows up within
 months in our food and other consumables. It’s a necessary evil in the
 production of nearly everything we consume on the planet, which is why
 it’s so utterly dangerous to leave the process of trading energy futures 
unregulated. Oil doesn’t have to reach $200 per barrel to destroy any
 hope of economic recovery and, worse, force mass starvation around the
 globe.

If the price is sustained at $100-plus per barrel without relief
 while we continue to suppress interest rates and flood the market with
 the dollar, Bernanke and Co. will have difficulty stemming the natural
 tide of inflation as it works its way around the globe in the things we
 buy and the food we eat.
 Bernanke’s announcement that the Fed will continue to artificially 
suppress interest rates through 2014 and the government’s steadfast
 refusal to implement any reasonable regulation in the markets is a 
self-fulfilling prophecy as investors continue to seek safe harbor for
 their funds in the only market they have any ability to control. This
 will prevent any crash in oil prices that would naturally occur, as we
 witnessed in 2008 when oil hit $147 per barrel then plummeted shortly
 thereafter.

Further fracture in relations with Iran and high oil prices 
will also crush any hopes the European Union has of recovery. And with 
the determined stance that austerity is the EU’s chosen path to
 prosperity, the United States faces the additional problem of having its 
No. 1 consumer of U.S. exports absolutely cash-strapped and constricting
 even further.
 Barack Obama’s re-election hopes are really a matter of timing more than 
anything because the conclusions above are simply common sense and
 arithmetic.

Any chance he had to calm this gathering storm has already
 passed, leaving him at the mercy of the global markets, which are
 teetering on a gigantic bubble. His oratory and confidence are outgunned
 by a conservative media machine pouring on the pressure by falsely 
blaming his energy policy for high oil prices and stoking the fire with
 Iran, thus creating all the necessary traps for his demise. Even if he 
were able to truly force real change in the oversight of the financial
 markets, it would spook Wall Street and could incite panic. And any 
attempt to quiet the saber-rattling between Washington and Tehran would
 make him appear weak compared to a bloodthirsty slate of GOP opponents.

Obama’s only option is to pray the storm doesn’t touch down between now
 and Nov. 6. If it does, instead of occupying the White House in January, 
he’ll be building houses with Jimmy Carter, while Mitt Romney tries to 
figure out where to park all of Anne’s Cadillacs.

Ayatollyah So!

Rosy neo-con visions of sugar plum oil fields and Jeffersonian democracy fairies transforming the Middle East have blurred beyond recognition over the past decade. So, it’s a good time to change the subject and refocus

“For lust of knowing what should not be known, We take the Golden Road to Samarkind.” 

                –James Elroy Flecker’s play Hassan

There was a mysterious blast at a manufacturing facility outside Teheran last November.  This past week the Israeli Minister for Strategic Affairs told the annual Herzliya security conference that the Iranians were setting up to produce a missile with a 10,000 kilometer range that could hit the United States. U.S. analysts were quick to point out that known Iranian missiles have but a maximum range of 1,200 miles—enough to reach Israel….  Go to the video tape to watch a “concerned” President Bush in the fall of ’02: “Iraq has a growing fleet (of UAVs) that could be used to disperse chemical or biological weapons across broad areas…for missions targeting the United States.”  

Not for the last time will we be misled by rhetorical mushroom clouds into the fog of war with its Rumsfeldian “known unknowns” and “unknown unknowns.” In the lifted lyrics of John “Beach Boy” McCain, do we “Bomb, bomb, bomb…bomb, bomb Iran”?

In The Partition of Palestine, Kermit Roosevelt (Teddy’s grandson) asked, “Will the creation of a Jewish state in Palestine jeopardize the position of the United States in the Middle East?”  He thought it would in 1948; moreover, it would “ease the path of Soviet infiltration.”  A comparable rationale was offered when, as Our CIA Man in Teheran, Kermit spearheaded TPAJAX, which ousted the country’s elected prime minister after he proposed nationalizing its oil, a sovereign assertion that would’ve placed Iran, in our estimation, “behind the Iron Curtain.” 

Gamal Abdel Nasser, the Bollywood handsome head of Egypt, made a parallel move three years later in 1956, by nationalizing the Suez Canal. Wielding Israel Defense Forces as the tip of their spear, England and France sought to regain the Canal and oust Nasser. While the U.S. applied economic pressure on the Brits and French behind the scenes, it was newly installed Soviet Premier Nikita Khrushchev who got Third World cred for threatening to use nuclear weapons in support of Egypt.  Nuclear brinkmanship didn’t work so well when Khrushchev went eyeball-to-eyeball with the U.S. over Cuba in ’62…and blinked.

Two more clashes with Egypt brought Israel and their most potent Middle East adversary to the Camp David peace accords in ’79. It would usher in more than three decades of peaceful coexistence with Egypt even as the Shah was falling to the cursed Ayatollahs. Twenty-six years of fealty and cut-rate oil out of the Shah’s regime was a darned good return on the paltry five-figure amount Kermit Roosevelt claimed in expenses. For all the scorn heaped on Jimmy Carter, Camp David remains the most sustained contribution to Israel’s security.  

Israeli intelligence didn’t anticipate the Arab Spring spreading to Egypt and, once it did, Prime Minister Netanyahu beseeched the U.S. to stand by Mubarek. Subsequent election of the Muslim Brotherhood on Israel’s passive southern front combines with the five-year old Hamas electoral victory on their western flank to make Likudniks very nervous. Netanyahu’s neo-con alter-ego, Newt Gingrinch, has weighed in: “I think we may, in fact, be having an anti-Christian spring. I think people should take this pretty soberly.”  

Rosy neo-con visions of sugar plum oil fields and Jeffersonian democracy fairies transforming the Middle East have blurred beyond recognition over the past decade. So, it’s a good time to change the subject and refocus. And where better to draw a bead on than that spinning Axle of Evil—Iran? Ever ready to play Mad Mullah to Zealous Zionists, Supreme Ayatollah Khamenei has trash-talked, yet again, about removing the “cancer” that is Israel. “So far,” Khamenei boasted to the “Islamic Awakening and Youth Conference” in Teheran last week, “the Iranian nation has kicked them in the mouth at every stage.”

One bold “Awakening” attendee held up a pesky sign—“Syria?”to remind everyone that growing numbers of Syrians will never awaken again, thanks to the brutal crackdown of Iran’s close ally, Bashar “The Butcher” al-Assad. The fall of Assad would blow a huge strategic hole in Iran’s hegemony. Add to that equation the Persian Spring, which was quickly quelled by Khamenei/Ahmadinejad in a forceful flash-freeze. Deep-seeded discomfort with the Arab Spring is one response Israelis and Iranians share in common.  

Given the rough neighborhood Israelis live in, how far off is Armageddon if the mullahs get the bomb? The specter of nuclear Iran was raised in 1992 by Israel’s then Prime Minister Peres as well as current P.M., Benjamin “Bibi” Netanyahu who predicted back then that Iran was three to five years away from getting the bomb.  Before the Shah was toppled in 1979, one intelligence report had him setting up “a clandestine nuclear weapons development program.” A looming Iranian bomb has been sighted more frequently than the Loch Ness monster and Bigfoot.  

Recently retired Mossad director Meir Dagan, reflecting substantive differences in the Israeli intelligence and defense community, said that an attack on Iran would be “a stupid idea…. The regional challenge that Israel would face would be impossible.” With last year’s exodus of Dagan along with the chief of general staff and the Shin Bet director, “there is no one to stop Bibi and (Defense Minister) Barak.” Lest one dismiss the long-serving Dagan as a weak sister, heed the words of former Prime Minister Ariel Sharon: “Dagan’s specialty is separating an Arab from his head.”

As oil hovers around the $100/bbl mark, traders have currently dismissed the saber rattling as so much bluster. But with 40 percent of world oil transported through Iran’s Strait of Hormuz, conflict would drive the current price up anywhere from 25-75 percent sending a gallon soaring close to $6. Add these sobering facts: Iran has 25 percent more people than Iraq and Afghanistan combined, and land mass nearly four times that of its neighbor, Iraq.  

In the guestimate of the current Israeli chief of staff, the Iranians possess enough fissionable material to package four nukes at some point. The Israeli nuclear arsenal is approximately two orders of magnitude greater, an order of magnitude lower than the usual Israeli eye-for-an-eyelash ratio. The South Koreans have reconciled themselves to a nuclear North whose Martian leadership makes the mullahs look like hippies. Moreover, since Nagasaki, no nuclear nation, no matter how extreme, has been reckless enough to use a bomb. That restraint won’t prevail forever.

Can the Likudniks constrain themselves, resigned to sanctions of the economic and targeted variety?  Mysterious explosions, the Stuxnet virus and elimination of a half-dozen nuclear scientists have markedly crimped Iran’s weaponization. Soon the capacity of the Iranian central bank will be SWIFT-moated, severing their capacity for secure electronic financial exchange. “Iran’s economy has always been sick, but now it seems worse than ever,” said a Teheran bank employee about the prospects of more sanctions. Nonetheless, pre-emptive strikes like the ones Israel executed against Iraq in 1981 and Syria in 2007 remain mighty tempting.

As we mull all this over, return to my formative yesteryears, when mullahs were mere whirling dervishes, and consider the following Sufi tale, the Persian variation of Aesop’s Fables:

Two clever young men sought to puncture the reputed wisdom of the Mullah Nasruddin.

“You will hide a chicken behind your back,” one clever fellow instructed his clever friend, “and we will ask the Mullah whether the chicken is alive or dead.   If he says ‘alive’, you will break its neck. If he says dead, we will produce the living chicken.”

They came upon Mullah Nasruddin and put him to the test.

Nasruddin scratched his head, offered an indulgent smile and responded, “It’s in your hands! It’s in your hands!”

 

Main Photo: Richard Williams illustration from the Mullah Nasruddin series
Photo: M-Star oil tanker damaged in an explosion in the Strait of Hormuz 7-28-10