What’s wrong with Wall Street and what should be done about it?
October 9, 2011
I am trying to figure out the top five (or so) most important corrupt and actionable issues related to the financial system. I’m going to compile this list in order to conduct a “teach-in” at the Occupy Wall Street protest next week. The tentative date is Wednesday, October 12, at 5:30pm.
I’d love to hear your thoughts: please tell me if I’m missing something or got something wrong or left something out.
The list I have so far:
- Investment bankers trading their books and taking outrageous risks which lead to government-backed bailouts because they are “too big to fail”. The related action in the U.S. might be the “Volcker rule” (i.e. reinstating something like Glass-Steagall); unfortunately it’s being watered down as you read this.
- Ratings agencies in collusion with their clients. The actions here would be changing the pay structure of the ratings agencies and opening up the methods, as well as having better regulatory oversight. We also need to change the structure of ratings agencies, and either make it easier to form an agency or make the agencies that already exist and have government protection actually accountable for their “opinions”.
- SEC and other regulators in collusion with the industry. The action here would be to nurture and maintain an adversarial relationship between regulators and bankers. We’ve seen too many people skip from the SEC to the banks they were regulating and then back. There should be rules against this (how about a minimum time requirement of 5 years between jobs on the opposite sides?). There should also be much better funding for the SEC and the other regulators, so they can actually meet their expanded mandate.
- Conflict of interest issues from economists and business school professors. If you’ve seen “Inside Job” then you’ll know all about how professors at various universities use their credentials to back up questionable practices. Moreover, they are often not even required to expose their industry connections when they do expert witnessing or write “academic” papers. The action here would be, at the very least, to force full disclosure for all such appearances and all publications. I’ve heard some good news in this direction but there obviously should be a standard.
- Rampant buying of politicians and influence of lobbyists from the financial industry. This is maybe more of a political problem than a financial one so I’m willing to chuck this off the list. Please tell me if you have something else in mind. Someone has suggested the opaque and elevated pension fund management system. Although I consider that pretty corrupt, I’m not sure it’s as important as other issues to the average person. I’m on the fence.
mathbabe 
I really love the enthusiasm you’re showing for Occupy Wall Street and all the constructive things you’ve been saying about it and want to do about it.
Your top five list seems pretty good to me, but I’d suggest that you also talked about some of the things the activists are demanding and you with your inside knowledge think aren’t that great.
I think you could get a lot of constructive feed back that way.
By the way have you seen Stiglitz video on OWS? His initial reaction to the repeat and chant is kind of funny. Not to mention that his comments were also informative.
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I’d like to know how you can distinguish the financial system from the political system these days. If you “chuck” the last item off your list, what then remains in terms of wresting the political system (aka the will of the people) from the hands of the bankers and other corporate elitists? I don’t pretend to be an expert on economic or even political matters, but I do know that the election process, the core of which being the campaign-finance process, is completely rotted out. It cannot possibly result in fair elections with this system, where private persons as well as corporations are allowed to make private contributions to directly to individual parties or candidates. Other countries, e.g Germany, have far more modern election systems, and consider this aspect of our elections criminal. This can and should change. The financial industry leaders should keep their bloody hands OFF, plain and simple!!
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Here’s an interesting suggestion: plan a march to the HQ/trading floor of each of the major banks and ask them to publicly sign a pledge to immediately cease and desist all lobbying activities. Specific, targeted and achievable. Remember all the pressure on US multinationals to cease doing business in aparteid (sp?) South Africa–a lot of companies did in fact change their policies and it had an impact.
FoW
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FogOfWar,
you hippy.
Love,
Caty
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I agree that the last item is essential, but it seems to me that recent Supreme Court decisions put it out of reach except via constitutional amendment. I would be thrilled if someone can tell me why I am wrong.
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I think there are a lot of places in the system were players of various sorts are rewarded for number of transactions when they should be rewarded for making the right transactions.
A good example would be the sub-prime mortgage brokers during the build-up to the 2008 crash, who were paid per mortgage sold.
Stockbrokers who churn their clients’ fund are another example.
Investment banks who advise on takeover bids (especially investment banks who are advising both sides of the same takeover bid).
Not all instances of this are as visible to outsiders nor as blatant as these.
In economic systems there are two optima: the user optimum is when no user can improve their personal situation by making a different choice and the system optimum when no user can improve the efficiency of the system by making a different choice. The system optimum requires some people to be worse off so that, on average, people are better off: it isn’t going to happen. Smith’s invisible hand operates to the benefit of society when the two optima are relatively near: by seeking the user optimum, the system moves towards the system optimum also. Somehow we have allowed the financial system to evolve so that they are far apart.
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How about an introduction to “how to bankers get paid”. I agree this is critical, although not sure what I’d suggest as a solution. Increasing the 5-year restricted stock component of bonuses by 20% more is definitely not going to do the trick!
Also, is this a proper policy point? The only reason the public is involved is because the public has been called in to bail out the failures generated. End TBTF (break up the big institutions) and let financial institutions live and die by their own mistakes IMHO.
FoW
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FoW
What do yo think of the British governments idea of ‘ring fencing’ retail banking from investment banking so that only the retail operations are guaranteed by the state,
The banks here are busy arguing the toss about what is and isn’t ‘retail banking’..
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Yep. We had that for 70 years in the US–it was Glass-Steagall. Any kind of trading, insurance or securities business cannot be commingled with a licensed depository banking institution. Why should deposit guarantees be triggered by derivatives trading losses?
Banks will still go under, and we would still need to prevent banks from becoming too big to fail, but it’s a big step in the right direction.
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a couple of points I would address as well:
* the revolving door between wall street and the US treasury: is there any other country where the treasury secretary comes systematically from the same primary dealer?
* central planning and the federal reserve: is there any evidence to prove that the Fed can accurately forecast future economic activity? If not, why has the Fed been allowed to distort asset markets so badly for so long?
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Regarding #1, I guess I never had any doubt that the Volcker Rule would get watered down. The weight of the lobbying effort is far too one-sided.
Also, I think setting proper risk capital requirements is a big deal. Again, there is little hope of this ever happening because most of the “experts” guiding the regulatory agencies (US, foreign, and international) are either from the banks themselves or academics who have been co-opted by the banks.
Also, do you believe that the fact that most investment banks are now publicly held corporations rather than privately held partnerships is a significant factor? It seems to me that when the management actually owned the bank, they were a lot more careful and conservative about their money than when they are merely employees of the shareholders.
Finally, regarding the SEC, my experience (working with Andy Kalotay) is that the SEC is staffed almost entirely by lawyers who have little understanding of finance and therefore are easily steered down fallacious paths and distracted by less important aspects of regulation. Recently, they have started to hire people (from Wall Street) who are more knowledgeable and potentially could be more effective.
Finally, any views on Gary Gensler, chair of the CFTC?
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Difference between Glass Steagall & Volker would be great–there are a number of signs there now about Glass Steagall.
Bank capital is a good one! Don’t think we’ll have time to get into the adoption of BASEL II/III…
IPO vs. private partnership is a really deep point, and it is really important, but not sure what the policy point is. Are we going to prevent I-banks from IPOs? Plus, keep in mind that that DIck Fuld had a huge percentage of his net worth in stock & his institution still took insane risks. Not sure those “agency alignment” theories actually hold water on the ground.
We should talk about Christopher Cox and the deliberate neutering of the SEC enforcement division. He’s up there as one of the top 10 “villains” of the financial crisis.
FoW
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I support much of what I hear coming out of #ows but when protesters cannot distinguish between corrupt bank institutions that trick people out of their money using math and a successful entrepreneur that built his company by innovating and adding value to his products to generate increased demand rather than just respond to falling demand by cutting costs to the bone or sacrificing quality or creating complicated “call for pricing” structures laden with incoherent fees and contracts and penalties, that’s where they start to lose my support.
Do they just hate the criminally rich or all rich/successful people?
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There is a large element of that at the protest, but there’s also a strong current of reasonably informed protesters who want malfeasance removed from the system. They’re also very polite–I recommend you swing by and engage participants in conversation; see for yourself.
FoW
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Check out this article. I think it could to your list.
http://www.zerohedge.com/article/guest-post-extend-and-pretend-where-are-we-after-one-year-suspension-fasb-rules
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Actually this http://www.zerohedge.com/article/guest-post-extend-and-pretend-where-are-we-after-one-year-suspension-fasb-rules is what sets up #1
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Love this post, and yes it’s a huge deal. Right along the lines of Richard Koo’s thesis of Japan’s lost decade not really being lost but being the 15 years where banks recapitalized quietly while the government paid for everything. I’ll blog about that soon.
It does seem disgraceful that not only were the mark-to-market rules suspended, but that there’s no reason to think they will come back.
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Hi Cathy,
What about the marketing/selling of financial products to people can’t afford them and aren’t aware they can’t afford them? I thought that one of the main reasons why people are angry at the financial services industry, and why so many people have been losing their homes is because many investment banks sold mortgage products to people who didn’t understand the risks involved.
People were unaware that adjustable rate mortgages (ARMs), or even worse, option ARMs, might eventually lead to large mortgage payments that they would have no chance of being able to pay back in the future.
The banks gave out loans to people with poor credit histories, and were happy as long as they sold off the loan to someone else and made a profit.
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Very Elizabeth Warren–I agree!
Part of this is: who is responsible for determining what bank products can be offered? What is a “bank permissible activity” and who dropped the ball in allowing these types of products to be offered. How do other countries handle this question?
FoW
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The question of how other countries handle this is a good one. And it is certainly not obvious that you want a government regulatory agency deciding what products are good and what are bad. The fact is that most people who took out non-fixed-rate mortgages knew what they were getting into but were overly optimistic about their future income as well as future movements of interest rates.
I definitely want better regulation of Wall Street, but I don’t believe it is going to be easy. I also believe that part of the solution *has* to be providing consumers better guidance on how to make financial decisions *, making sure they understand that the government cannot protect them against bad decisions, *and* that banks, investment advisors, and mortgage brokers are not to be trusted any more than a used car salesman. The problem is that even supposedly sophisticated clients of Wall Street, such as corporate treasurers, don’t seem to understand this.
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Another issue to consider is the misuse of “financial instruments”. Derivative trading, credit default swaps etc etc all have a role to play in a financial market. However, once they are invented, they are used for totally different usage, mostly to leverage risk to unimaginable proportions.
High frequency trading is another example of misuse of a the system. Financial markets are useful tool to raise capital where people buy/sell parts of companies. A computer that is trading in msec based on trading patterns is not helping with the original goal of the market.
What is needed is more regulation of the market that enforces the “spirit of the law” and makes sure that these financial tools are used for what they were invented for.
The way to influence the market is not by fining companies that break the rules rather add regulation that constantly enforces the spirit of the law. For example, 0.001% tax on all trades will eliminate at one all the high frequency trading while still preserving the usefulness of the market in raising capital etc.
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I agree completely, but we might have to start with baby steps, like “what is a derivative, what are the different kinds of derivative, how are some derivatives useful & others seem to be really not socially useful.”
HFT would be great, but that might need to wait for the “advanced class”.
FoW
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Been thinking about this & I’m a bit overwhelmed by the task.
Here’s a slightly different tack: from the bottom up. Here are some issues that I hear discussed a lot at the protest. How can we help/inform on these:
1. Student debt. As of 6 months ago, there is more student debt outstanding in the US than credit card debt (revolving debt). It’s also nondischargeable in bankruptcy. Not a ton of finance here, more policy, but what can we say about it?
2. Campaign finance reform. We’re not really qualified to speak on this. I’m going to go to the National Lawyer’s Guild table and suggest they pull an expert on existing and proposed legislative campaign finance reform and have a separate teach in on that subject.
I’d also like to add the following:
3. Credit Unions. What are they, how are they different from banks. My informal polls indicate 80%+ of the protesters have their accounts at major banks–the first and most direct thing supporters can do is put their money where their mouth is.
FoW
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I’d be very interested to hear about credit unions myself. I’ve been meaning to switch banks away from Bank of America for a while now but I don’t know if I should pick a local bank or a credit union or what exactly the difference is or anything.
So if you could do a (simple) blog post about credit unions and local banks I would be very grateful!
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We should lead with “what’s the difference between a bank and a credit union?”!
Here’s a quick and essential difference: Banks are owned by their shareholders and their job is to maximize profits for their (outside) owners. Credit Unions are owned by their depositors (one person one vote) and all “profits” are ultimately returned to the depositors in the form of interest on accounts (that’s why CUs call them “share accounts” instead of “bank accounts” or “checking accounts”).
FoW
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Dear Mathbabe,
I think you’ve nailed the main “actionable” causes — actionable, in the sense of “short-term” or “proximate” causes where individual actors could be identified and either prosecuted or replaced.
There are also long-term structural causes:
1. Huge holdings of US debt overseas, causing a flood of capital to Wall Street, where the Masters therefore needed to invent new instruments to get the money out the door to generate returns. So, they securatized everything in itself, most notably sub-prime mortgages.
2. Hence they put tremendous pressure on local mortgage brokers to feed lousy mortgages into the system, ultimately ejecting any and all mortgagee qualifications.
3. As someone says above, the compensation model for the Masters was a driving force. They got paid by pumping up short-term revenues and bonuses, regardless of the ultimate implosion of their own firms and the world economy. (They keep their yachts and homes in the French countryside, while taxpayers pick up the expense.) This resulted from the fact that the investment firms had converted from partnerhips, in which the Masters would suffer from an implosion, to publicly held entites, in which the Masters could take their money (as salaries and bonuses) and run, without taking the full equity hit.
4. As you mention, deregulation of banks and exotic assets: Specifically, failure to ensure adequate capitalization, and failure to ensure transparency in the asset-back securities and credit default swaps. There was a single brave voice on the SEC against this deregulation: Harvery Goldschmidt, my Columbia colleague.
5. But coming back to the structural causes: WHY did China etc hold so much debt, and WHY did US consumers go into so much debt? Short answer: China deliberately suppressed domestic consumption (so the country saves but doesn’t consume). How? By putting the screws to export workers and peasants, deliberately keeping down their earning power. But why do Americans go into so much debt? For surprisingly analogous reasons: Household incomes of most Americans (bottom 80 percent) have stagnated for 30 years. Why? In part because….the rights and bargaining power of workers have been suppressed in this country, analogous to the suppression of worker rights in China. If this seems like a crude explanation: Recall that after the crisis, the cry immediately went out for China to increase its domestic consumption, as a way to re-equilibrate the global economy, and US inequality and income stagnation suddently became a public policy issue.
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I would include the general theme of the banking industry’s complete disregard for its (supposed) customers. A number of comments on this thread (high churn, inappropriate and opaque mortgages, etc.) touch on this. There are many other examples. I always hated many banks’ practice of selling complex derivative products (from structured notes to CDO’s, back in the day) at unfair prices to individual investors, in part to make a quick profit, but mostly to get them off their books. The customers are viewed as marks, not customers. This is partly because of information asymmetry (the knowledge gap between banks and their customers gets bigger as finance gets more complex), but also because of culture: it’s considered OK to treat the customers that way, if it means you get to keep printing money.
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Oh yes….
6. As Mathbabe and others say: The long-term corporatization of US politics. We’re now a plutocracy, owing to the success since the 1950s, but especially since the late 1970s, of corporations and the very rich in creating an effective conservative movement (with its own organizations, ideology, and high-powered electoral and lobbying infrastructure).
7. The Republicans, of course, are completely in the pockets of corporations and the very rich.
8. But the Democracts, who used to be the party of labor (and therefore reliable liberalism), are now an uncomfortable marriage of corporations and labor, with corporations the dominant partner by far. Labor is “trapped” in the Democratic Party — it has nowhere to go — so the Dems need not be responsive to their interests. Corporate money can leave and go to the Republicans, so the Dems have to be more responsive to big money.
9. For the importance of Labor, just look at OWS: Labor unions, and only labor unions, have the money and infrastructure and know-how to amplify a protest to enormous dimensions.
10. When labor unions were stronger, in 1982, I attended a labor-backed protest for “Jobs and Justice” against Reaganism: The biggest Demo in US history — more than a million — at least if you exclude Obama’s inaugural, which was more celebration than protest. Why? Because Labor has busses, money, and people. And don’t forget: Martin Luther King’s I Have a Dream speech at the 1963 March on Washington was also a march for jobs and justice, mostly funded and co-led by labor unions. It was the fulfillment of a dream of A. Phillip Randolph, the great African-American leader of the Pullman Porters labor union. But the big support came from the AFL-CIO and especially Walter Reuther of the Auto Workers, who marched alongside MLK.
11. In short, the long-term decline of labor unions, and the decline in their centrality within the Democratic Party, is key to the current abject state of US politics.
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http://www.youtube.com/watch?v=M6Na9xHN_SQ
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Cathy,
I think all the suggestions, your own and others’, are either too complicated for the average person to understand and don’t make for a good chant-able slogan (e.g. separate investment from commercial banking), or else are misguided at best and completely wrong and backwards and counterproductive at worst (e.g., ban short-selling).
Unfortunately, what I have to suggest is no exception (it falls in the first category). I believe much of the mischief on Wall St, particularly on the banking side, started when the major firms shifted from partnerships to corporations. Partnerships are naturally and inherently less willing to take on extreme risks (and are generally better stewards of capital), because ultimately it is the partners’ capital which is at stake. What I am saying, in effect, is that the Volcker rule does not go far enough. The Volcker rule may force a break-up of JPM, BofA, and Citi, but it would not touch GS and MS, and would not have affected Lehman Bros, so it would not have prevented the GFC of 2008. What is needed is for the pure-play investment banking houses to be forced back into being partnerships. Some will say that they have grown too large for the partnership structure to work. I see that as a feature, not a bug, as it would hopefully force the investment banks to break up further, thus increasing competition.
In terms of converting this into a solid chant-able slogan, that is not my forte, but I would suggest something along the lines of “make bankers responsible” or “no more privatized gains and socialized losses.” These are perhaps too vague and could easily be applied to other proposals, as well, though.
Good luck at the teach-in.
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I’m teaching bright middle schoolers in Huntsville, and I can’t just ditch them, or I’d be up in NYC protesting with the rest of them. But I hope you get to do your teach-in, and I hope to see you when I’m up there during my break around November 5th or so!
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