Congressman on Obama’s “Financial Reform”: “Too Little, Too Late”

Congressman Brad Sherman says about Obama’s finanical reform plan – which will be announced today – “This is too little, too late” and “It’s going to be way less than it should be.”

Is Sherman right?

Well, page 3 of the white paper supporting Obama’s plan says that one of the policies implemented will be “Comprehensive regulation of over-the-counter derivatives”. This sounds good.

But the devil is in the details.

Page 6 of the white paper says:

We also propose to strengthen the prudential regulation of all dealers in the OTC derivative markets and to reduce systemic risk in these markets by requiring all standardized OTC derivative transactions to be executed in regulated and transparent venues and cleared through regulated central counterparties.

This confirms that regulation will only really target standardized OTC contracts. Indeed, this is what the derivatives industry itself requested. And see this.

Despite the high-sounding rhetoric about regulating derivatives, this creates a loophole large enough to drive an AIG-sized fiasco through, and to crash the financial system in the future.

Remember that Nobel prize-winning economist George Akerlof co-wrote a paper in 1993 describing the causes of financial meltdowns. As summarized by the New York Times:

In the paper, they argued that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses. In a word, the investors looted.

The authors of the paper predicted in 1993 that the next form the looting dynamic would take was through credit default swaps – then a very-obscure financial instrument (indeed, one interpretation of why CDS have been so deadly is that they were the simply the favored instrument for the current round of looting).

Given this background, and given that Obama’s plan will not aggressively regulate non-standardized OTC derivatives contracts, it doesn’t take a Nobel prize-winner to predict that unscrupulous financial players will use new, creative forms of non-standardized OTC derivatives contracts to loot the financial system in the future.

Moreover, existing credit default swaps are so deadly that a Nobel prize-winning economist said they should be “blown up or burned”, and we should start fresh.Obama instead leaves most of the existing CDS intact to continue to drag the economy into a black hole of debt.

Taking the Wrong Actions

Moreover, Obama’s plan will do some things which are 180 degrees in the wrong direction. For example:

  • Obama will CUT the number of bank regulators, according to Reuters (I am all for free market competition IF the banks have to compete on their own. But if they are being propped up by trillions in taxpayer dollars, then there should be regulators crawling all over them to make sure they aren’t commiting fraud)
  • The Fed will be given massive NEW powers, even though:
  • The Fed has refused to tell Congress or the American people where the trillions of dollars in bailout money are going (see this, this, this, and this)

As economic blogger Mish wrote more than a year ago:

The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

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