The Best Policy

Two Disgraceful Failures

How Congress and the Financial Crisis Inquiry Commission are botching their only chance to reform Wall Street.

Robert Rubin

Before it’s too late, we need to try to salvage the investigations of the financial meltdown and overhaul the proposed financial reform bills.

The Financial Crisis Inquiry Commission has so far been a waste. Some momentary theater has been provided by the witnesses who have tried to excuse, explain, or occasionally admit their role in the cataclysm of the past two years. While this has ginned up some additional public outrage, it hasn’t deepened our knowledge about what critical players knew or did. There is a simple reason for this: The commission has not issued a single subpoena. Any investigator will tell you that you must get the documentary evidence before you examine the witnesses. The evidence is waiting to be seized from the Fed, AIG, Goldman Sachs, and on down the line. Yet not one subpoena.

Rather than accept Robert Rubin’s simple disclaimers about Citigroup, why hasn’t the FCIC combed through the actual communications among the board, the executive committee, the audit committee, and the risk-management committee? Why hasn’t the FCIC collected AIG’s e-mails with the Fed and Goldman Sachs? Unless the subpoenas are issued, we will lose the chance to make the record.

Because the FCIC report is going to be issued too late to directly affect the financial reform legislation now being debated, its primary utility will be to set out the historical record in excruciating detail. If the commissioners don’t do this, they fail. If Republican stonewalling on the commission is preventing issuance of subpoenas, then FCIC Chairman Phil Angelides should either get Congress to alter the process whereby subpoenas are issued or threaten to resign rather than preside over a sham. Maybe this would shock the other members of the commission into doing what needs to be done. There are still too many secrets being hidden inside the e-mails, permitting guilty parties to lie and cover up their misdeeds.

Take, for example, the missing information about AIG. The real reasons the AIG counterparties were paid 100 cents on the dollar have never been revealed. Taxpayers invested $180 billion in AIG to stabilize the financial markets, not to honor every contract AIG had entered. Everybody and everything should have been subject to negotiation. Indeed, virtually everything other than the counterparty payments to investment banks was re-negotiated. But Goldman and others walked away with billions, unbothered. Yet the Treasury and the Fed have failed to reveal more about why those payments were made in full. This is not just a footnote. It goes to the core of the relationship among Wall Street, the secretary of the treasury, and the Fed.

The situation in Congress is no better. The reform proposals under consideration are classic rearranging of deck chairs on the Titanic. They will modestly rejigger how Wall Street is monitored but do nothing to fix the real problems.

There is strong evidence that banks are still playing shell games to mask their levels of debt. And banks are not honestly accounting for the value of their enormous commercial real estate holdings. Even if the proposed congressional reforms pass, we will still have a “too big to fail” structure, now with explicit, not implicit, federal guarantees behind these institutions. We still have executive compensation that is based on a heads-we-win, tails-you-lose structure, creating the same risk asymmetry that caused the crisis.

The banks are making the creation of a consumer protection agency the litmus test for reform’s success or failure. While a consumer protection agency would be a step forward, it isn’t the critical measure of reform’s success. The creation of the agency matters less than who is in charge at the OCC, OTS, FDIC, the Fed, or the new consumer agency. By and large, the government already has the regulatory powers that exist at the new agency: What we need are government officials who have the courage to act on those powers and challenge Wall Street.

During the pallid congressional debate over reform, Washington has utterly abandoned the structural reform that we actually need. There is an international consensus that banks are too big and the concentration within the banking sector is increasing, not decreasing. Fundamental reform will not come from having a few regulators “oversee” the sector. Reform will come from breaking apart the overly concentrated banks and separating them. The banks need to be broken up as AT&T and Standard Oil were busted, in order to stimulate competition and creativity.

Perhaps it’s not too late for Congress to consider adding these three simple rules to its reform bill:

-Banks receiving taxpayer guarantees cannot engage in any nonbanking activity. Institutions must choose: Either you can have public guarantees or you assume risk through investment banking and proprietary trading, but you can’t have both.

-Increase capital requirements to no less than 15 percent, and require on-balance-sheet disclosure of all material information pertaining to liabilities of the entity.

-require that banks pay penalties, dilute equity, eliminate management options, and repay executive bonuses before receiving any taxpayer bailout.

Americans have been betrayed by Washington over financial reform. Our leaders have failed to get the evidence, failed to push back when clearly inadequate explanations were provided, and failed to explore the structural reforms that will work. Pretend tears will drip from bankers’ eyes after the consumer protection agency is created. Then their wolfish teeth will slowly break into a grin, the pure delight that Washington has failed to do anything meaningful to restructure the banking sector.

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