regulation

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Lame (Really Lame) Reform Part 2

It doesn’t improve overnight. Having vented my frustration at the extraordinarily limp regulatory response to the financial crisis yesterday I thought I would take a deep breath and come back today refreshed. My hope was that I would discover something I overlooked before which would then redeem the proposal.

No such luck.

“So the solution to bad risk management is to be wrong more quickly?”

A second reading merely confirmed my opinion: this proposal, which will most likely get watered down in Congress is lame stuff. I am not alone: the folks at The Baseline Scenario agree, as does Joe Nocera in today’s New York Times.

I won’t repeat my rant from yesterday, but I will provide you with more color.

Even the tone of the preamble is dull. It is almost entirely couched in a bureaucratically passive voice. No blame is apportioned. No fingers are pointed. There is no ire. This is despite the devastation that the failure of the financial system wrought. Instead what we get is a dry, detached, and deliberately evasive intonement of the things that need to be corrected. Some of the things that is. The big stuff? Not so much.

Nobody did anything wrong apparently. These were all jolly good chaps who just happened to be in the middle of a storm – that they had nothing to do with. What rotten luck!

Oh my.

Where, oh where, is the spine?

Some parts even read like a banker wrote them. The banks that are ‘to-big-to-fail’ mustn’t be ‘over regulated’ just in case that stifles our economic growth … or their profits? So instead of making sure that they can’t ruin our economy again, we will try to nudge them towards better behavior. After all we mustn’t hurt their feelings must we?

At another point we are told that banks should do their risk analysis more speedily. As if getting those models of theirs to run more quickly would help. How about getting the models right? We are going to rely on the old, and quite obviously wrong, models. So the solution to bad risk management is to be wrong more quickly?

Ugh.

I suppose I have to give up. Clearly there is no real intent on fixing the system. There are pages and pages of detailed proposals: exactly what you’d expect from a major bureaucratic effort. Lots of it seems very sensible. But none of it attacks with gusto the essential point: as long as there are banks big enough to ruin our economy we cannot run an effective economic policy. They will always have the potential to destroy our wealth. So what are we going to do with them?

Paul Volcker tells us that if they are too big to fail they should be severely limited in what they do. For instance they should be banned from trading derivatives on their own account. That eliminates the gambling part of banking and turns them into utilities churning out gobs of credit card, auto, and business loans. That sounds sensible. It won’t stop the from losing money in a future recession, but it would probably stop them from causing it. You know: like they caused this one with their gambling. I realize that such severe limits on activity takes all the fun out of banking and may even drive all that ‘top talent’ out. But after this crisis I have a yen for making sure the big banks are emasculated. Neutered. Like my big old cat: they can lumber around dull and staid and not do any harm. Heck they even become lovable.

Overall the entire proposals document oozes with smooth bureaucratic pablum. It seems designed not to upset the sensibilities of the bankers who caused our crisis and whose recklessness has cost millions of people their livelihoods. On the contrary, while banker lobbyists will not doubt claim that the proposals stifle the industry and cramp its innovative abilities, I see nothing in it that will stop a repeat asset bubble inflation and therefore economic crash: the document bends over backwards to avoid recrimination.

It’s as if we taxpayers simply love forking over cash to banks so that they can continue gambling and profiteering safe in the knowledge we will clean up after them.

We do don’t we?

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Lame Bank Reform

Allow me to rant:

We deserve better than this. We really do.

We have now reached that part of the Obama administration’s agenda where we can start to assess the reality of the intent to introduce change. The core of the next few months, and perhaps the entire first term, rests squarely upon the nature of the reforms being introduced for health care and banking. Is Obama shooting for FDR status and enduring legacy, or is he content with a more modest agenda.

It’s too early to tell with respect to health care, which is a subject that Obama must have been wrestling with for a long time. But as for banking reform: he is no FDR. The announcement today outlines a bureaucratic rather than robust response to the central cause of our crisis: the systemic failure of finance.

This is very disappointing.

“Most of the true innovations in finance occurred before this explosion: ATM’s, and debit and credit cards are obvious examples. They are actually useful. That other stuff? Junk. No use except to generate fees and bonuses. What Minsky would call Ponzi finance. Therefore not just rubbish, but dangerous rubbish.”

Let’s start by recalling what went wrong:

  • We walked away from the safety and soundness doctrines introduced after the Great Depression.
  • We substituted market forces for regulatory constraints.
  • We relied on ‘self-regulation’ and ‘personal ethical standards’.
  • We became lax in enforcing what rules were left.
  • We encouraged innovation in finance, but never monitored its value.
  • We ignored the concentration of power and influence in the major banks.
  • We allowed Wall Street to push aside the main street banks in core financial services.
  • We extended the government safety net into Wall Street activities.
  • We ignored asset price inflation.
  • We ignored the steady ratcheting up of risk and leverage caused by competition and lax oversight.
  • We ignored the absence of objectivity of the rating agencies.
  • We ignored the effects of a disconnect between performance and reward in Wall Street compensation.
  • We forgot all the lessons of the Great Depression.
  • We relied on false economic theories.
  • We forgot that extending a safety net to huge banks without constraining them produces moral hazard.

We became fat, happy, complacent and far too reliant on short term memory: we ignored history. Which as we all know condemned us to repeat it.

In short, we screwed up royally.

We had a self induced systemic melt down of historic proportions.

The upshot is that we tore apart the firewall FDR built around the financial system and replaced it with an odd combination of big government subsidies and safety nets to banks, reduced oversight, deregulation, and quiescent or benign attitudes towards obvious excesses. This was Big Government and NeoCon thinking all rolled into one. It is a sure sign of the extent to which financiers captured control of the legislative and oversight systems that no one noticed the contradictions. The wool was pulled firmly over our eyes, while to corrupting power of big money ‘free speech’ did the rest.

Ah! But the market is always beneficent. It is efficient. Rational. And so so special that we had better never get in its magical ability to innovate.

Like credit default swaps on treasury bonds. Or reverse convertible stocks. Or all that jumble of derivatives. Or sub-prime mortgages. Innovations one and all.

Most of the true innovations in finance occurred before this explosion: ATM’s, and debit and credit cards are obvious examples. They are actually useful. That other stuff? Junk. No use except to generate fees and bonuses. What Minsky would call Ponzi finance. Therefore not just rubbish, but dangerous rubbish.

That’s the unfettered financial market at work.

Ugh.

The plain fact is that financial systems simply do not conform to the economics text book model of equilibrium seeking. In fact they have an ugly tendency to veer off course and spin violently into unstable and destructive mayhem.

Bankers need to be kept firmly in a box. We should never, ever, let them play with the matches of financial innovation without firm parental controls in place.

This observation is not new. Keynes, Minsky, and others like Mandelbrot and Roubini have talked about the inherent instability of finance before. We forgot or ignored their work. We had to learn or rather re-learn their insights for ourselves.

Which we just did.

Given the epic destruction of wealth that the financial system just wrought I would have thought that draconian efforts would be made to re-erect a wall around it so it cannot repeat itself any time soon, if ever. This is especially so given the sterling work of analysts who have studied the outcomes of financially induced recessions: all studies point to the massive devastation such recessions cause. Financially created recessions are far more severe, last longer, cut deeper, and destroy more wealth than other recessions. This should cause us to re-double our efforts to take the toys away from the superannuated children who prowl around Wall Street.

So. Is this what we got?

No.

Instead we have a financial regulatory reform proposal that plays lip service to some of the key things we need to eliminate.

But let me be fair. The paper has some merit. It attempts to throw a rope around ‘systemically’ dangerous companies. These are the ‘too-big-to-fail’ businesses that threaten to wreck the economy every time they sneeze. The good news is that the administration wants to place such dangerous firms under stricter control, with tougher capital standards and central supervision. It even wants, if I read the text correctly, to extend regulation to all financial firms, not just banks, who could wreck our economy. Don’t forget that it was in this ‘shadow banking’ part of the system that the really big problems cropped up.

Great. But if these businesses can really destroy us, which they just proved is the case, why let them exist at all? Why isn’t ‘too-big-to-fail’ simply ‘to-big-to-exist’? Why is it that we tolerate the cuckoo in our nest? Have we no say in this? Or have we lost control?

At least the proposal sets up a method for government seizure of these dangerous behemoths. It was because there was no law allowing such seizure that AIG was dealt with in the ad hoc way is was. Such a new power would be very useful: Citigroup needs to be seized. But the issue is not getting the power, it is having the will to use it. The tone of this proposal suggests we may have to wait a while for that will to pop up somewhere.

Next up. I like the idea of coordinated oversight. It’s about time. But why walk away from regulatory consolidation? Are we scared of our own bureaucracy? Make the oversight agency big enough and tough enough to stare down the big shots at the big banks we have admitted we can’t downsize. Put the entire thing under one roof and do away with the unseemly regulatory turf fights and public spats that have bedeviled recent efforts to get a coordinated approach.

As for derivatives. When folks like George Soros and Warren Buffet say that derivatives need to be either eliminated or severely reduced I take notice. So why just set up an exchange? Why just forbid trades by ‘unqualified people’? Given the performance of the geniuses who invented the mess I doubt whether any of them are ‘qualified’. Tell me: were the people who built the AIG book of credit default swaps qualified or not? These are the very clowns who destroyed our economy and we are restricting the derivatives business to them? That makes me feel a lot safer.

Don’t get me wrong: I am all for ‘transparency’. Which is essentially what’s being proposed as the cure for the mischief wrought by derivatives traders. But there’s transparency and then there’s transparently stupid. Much of the so-called innovation that Obama wants so dearly to protect falls squarely into the latter category. Market forces didn’t root them out in the past, what makes us sure that they will in future?

As for the Consumer Safety pieces of the proposal: good idea. But we need to extend product oversight beyond consumer protection. It was the professionals who sank the ship. They had no clue what they were buying either. We should keep the gunpowder from them too. I understand that consumers need better protection against all those terrible mortgage products that implode at the slightest interest rate hike, but what about credit default swaps? Will we see better standards there too? I suspect the administration thinks its new derivatives exchange will accomplish that. That market magic once again.

And I like the notion of making sure asset generators keep some ‘skin in the game’ when they package up and securitize those assets. But 5% is anemic. They should be forced to keep 10% or even more. One of the great mistakes the market made was to think that securitization spread risk. It didn’t it concentrated it. Plus it separated the ultimate asset owner from the debtor. Hence the problems in the mortgage market and trying to induce mortgage owners to renegotiate the loans rather than simply foreclose on them: they have no idea who the borrower is and they don’t have any expertise in mortgage lending. They merely own paper. This is another ‘innovation’ we could do well without.

Another good part of the proposal is that it shoots at the silly notion being promulgated by right wingers that somehow the Community Reinvestment Act [‘CRA’] created the sub-prime mortgage debacle. This is scurrilous nonsense. The sub-prime market was built mainly by businesses not covered by the CRA. More to the point the CRA had been around for almost three decades prior to the invention of sub-prime mortgages. It is an absurdity to try to pin the disaster on CRA. At least the proposal acknowledges that.

Finally: why no word about compensation? I suppose that’s become taboo already. The plain fact is that the incentive structure in finance drove anti-social behavior. Short term gains were paramount. Long term losses were left to the taxpayers. By offering unlimited guarantees to the entire industry we let them gamble with our money. They set up their compensation to benefit, while shareholders and ultimately taxpayers were assumed to carry the losses. There are very few impoverished bond traders, even today, but there are tons of regular folks paying a huge price because the boys had no limits set on them. At a minimum bonuses should be limited to stock payments and spread over very long terms. No trader should ever collect an annual cash bonus again. Incidentally I have argued this one before: the whole thing unravelled even faster once the old time partnerships converted into public companies. They kept their partner style pay methods but no longer had any significant personal risk. They pretended to be partners still, but they were actually bureaucrats. Entrepreneurs and equity partners can gamble all they like: it’s their money. Bureaucrats should never gamble the way the managers of Bear Stearns, Lehmann Brothers, Goldman Sachs, Morgan Stanley did. So compensation is a big deal. Getting the incentives aligned should be a major legislative priority. This proposal fails on that count.

Obama was careful in his introduction of the proposal to pay homage to market forces. That’s all we need to know. The administration’s heart simply isn’t in this one. The bankers still have too much influence , and the administration is littered with market apologists.

The proposal is being presented as a major effort. But it seems more window dressing than profound course change. It certainly pales in comparison to the sea change that emerged form the New Deal era.

Perhaps this is all politics: the hope is that the regulations will emerge tougher once Congress gets involved. Perhaps Obama fears that he cannot get tougher laws passed. He may be right: already even some Democrats are taking pot shots at the proposal. But that merely makes my case: bankers can pour tons of money into politics. They have legislative muscle. They have captured the system to prevent a loss of power. Which is why stronger reform is needed.

My prediction:

If this is all we get, then there will be a new bubble. All we are doing is putting the boys on a short term probation. We are not stopping the game.

We deserve better than this.

So ends my rant!

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Banks To Repay TARP Money

The Treasury Department has approved the plans of ten banks to repay the TARP money they received as part of last year’s bailout of the banking system. The total cash going back is $68 billion, which can either be lent out again if the need arises or simply be used to reduce the government’s need to borrow from somewhere else.

In one way this is a good sign. Obviously the administration has more confidence in the banks than it did even a month or so ago. The names of the banks has not been released officially but reports suggest that JP Morgan Chase, Goldman Sachs, American Express, and Morgan Stanley are among them. Citigroup, Wells Fargo and Bank of America are not.

The banks have wanted to repay the government since they all passed the stress tests performed a month or so ago. Continued use of TARP money meant that they were subject to restrictions on the way they conducted themselves. All the banks chaffed at the notion of government scrutiny of their activities, and in particular, at the limits placed on pay scales. Bankers like to pay themselves big bonuses, and while they were on the government dole political pressure and legal straight jackets stopped them from making significant payments to ‘key’ people.

“The cost in cash and human misery that the bankers created is epic. They should pay for it.”

The government was adamant that the banks demonstrate an ability to raise capital from private sources before it would allow repayment, hence the frenzy of debt and equity issuance by the healthier banks over the past month. Now that most have managed to restore their access to the capital markets the regulators are satisfied that this first group can be weaned off taxpayer assistance.

But is this a good thing?

I am not so sure.

The banks who are now allowed to repay TARP cash all passed the stress tests. As you know I thought the stress tests were none too stressful. In fact I thought them to be easy. Not only that, but the banks all indulged in a period of negotiation subsequent to the tests, so the image created was not one of severe oversight but of indulgent cooperation. The regulators simply didn’t have the stomach to impose strong standards, and so the banks were required to rebuild themselves only up to fairly lenient levels of capital. And the ‘worst case scenario’ they all supposedly passed looks a lot like the most likely outcome for this year’s economy rather than a severe further downturn.

Given this, I don’t think that we truly know just how healthy these supposedly healthy banks are. They are all still sitting on substantial portfolios of toxic assets of doubtful worth. They will no doubt need to keep raising capital just to offset future losses on those portfolios. Which means that the amount of capital available to be deployed as loans is still limited.

So the flow of credit into the economy is by no mean assured even though we now have a slew of ‘healthy’ banks.

Meanwhile we now have two types of banks: those who have repaid their TARP money, and those who are still tethered to the Treasury Department. Clearly the latter are now at a significant competitive disadvantage. The credit markets will differentiate even more strongly between the ‘strong’ banks and the ‘weak’ banks which implies higher interest rate costs for the weaker ones and possibly even more difficulty in their capital raising efforts. Private investors will take the repayment green light as a government ‘seal of approval’ and thus channel their investment into the strong banks and away from the weak ones. This will make it harder for the likes of Citi to rebuild itself to the point that it, too, can be allowed to repay TARP.

The market has, of course, been drawing its own conclusions as to relative bank strengths, so all of this may not change the environment for capital raising very much. But it cannot be welcome news for shareholders of Citi, Wells, B. of A. etc that their organizations are still considered too weak to come off life support.

In broader terms there are very clear signs that the credit markets have settled down from their crisis levels of last September and October. Risk spreads are much lower, funds are flowing, and investors are willing to lend to banks gain. So there is a semblance of normality slowly returning. The recent spate of better news in the ‘real’, i.e. non-financial, economy has helped lift the mood of investors too.

But we should take great care not to declare the crisis over. The banking system remains very fragile and large losses on commercial real estate and credit card portfolios loom in the near future. Plus the banks are as opaque as ever in their activities. Nothing substantial has changed in the system except for the reduction in competitors and the new two tier system of good and weak banks that results from this TARP repayment. The biggest of our banks remain ‘too big to fail’ and can thus indulge in extravagant risk taking for the benefit of their bonus payouts knowing full well that the taxpayers will pick up the pieces.

This privatization of profit and socialization of loss is an anathema to the long term health of the economy. It has to stop. Bankers have to be made accountable for the losses that their excessive risk taking produces. It was failed bank management, and, in particular, a cavalier approach to risk, that brought the nation’s economy to its knees. The cost in cash and human misery that the bankers created is epic. They should pay for it.

This means radical and structural reform of the banking system.

There are proposals already floating around as to how this should be done. So far none are adequate, although some regulators are agitating for strong action. The latest salvo to be fired came from Federal Reserve Board Governor Dan Tarullo just this week who focused especially hard on the banks considered to be ‘systemic risks’. He advocates a fairly hard line to restrict the damage that rotten bank management and failed bank business models can do to us in the future. As of now though the debate is only warming up, and time is slipping by.

But for now the big banks will remain ‘too big to fail’ and thus we can expect them to retain control over public policy. This is the most important point we must confront. The banks have ‘captured’ the legislative process and thus can ensure that legislation is always modified in their favor. Even in these times of evident failure they have been able to push back against bankruptcy law changes that would have allowed easier mortgage payment modifications for borrowers. I am thus not expecting the administration to introduce the kind of stringent re-regulation I see as needed to prevent further banking mischief.

The banks, even in their currently impoverished state, still flood the electoral system with cash and other forms of largesse. In any other nation on earth this flood would be called corruption. Here we call it free speech. It is the sort of free speech advocated by the Mafia. I doubt whether our doughty legislators will be able to resist the suggestions of their local bankers, let alone those of the big Wall Street banks and the various trade associations that inhabit the shadows of Washington.

So while we applaud the repayment of TARP money, we may regret the continued power of the banks. They are not fixed yet. And the odds of getting them fixed, as in becoming socially acceptable and reliable institutions, is waning. As the immediacy of the crisis fades and the attention span of Congress shifts its focus somewhere else our window of opportunity for reform diminishes.

I wonder whether we have lost the chance to restore balance to the economy even though the debate is only now beginning. I hope not.

Addendum:

Clearly the Congressional Oversight Panel [‘COP’], led by Elizabeth Warren of Harvard University, agrees with me about those stress tests. The panel’s June report contains a critique of the tests written by two Berkeley professors. They conclude that the tests are too lenient given where unemployment already is [the tests worst case assumed an unemployment rate of 8.9% as an average for 2009]; that they don’t extend far enough into the future, while much of the commercial loan losses will occur in 2011 and beyond; and that they have been deliberately obscured so that understanding how they were carried out is very difficult. The COP concludes that the stress tests should be run again to adjust for these problems.

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Financial [Re]Regulation

It is a sad commentary on the state of the economy that I return after a few days of idle bliss only to discover that the main topic of discussion is precisely the same as it was last week. And the week before that. And … well the banks need fixing. Not a lot of surprise there I imagine for anyone who had inhabited planet earth during the last two years.

At least the exact topic has shifted. Sort of.

Now we are being treated to a wave of speculation about the shape and timing of the big new regulatory effort that will wind its way through the halls of Congress later this year. For instance the Financial Times speculates that reform of the regulatory system is being slowed down so as to allow other items on the administration’s agenda to have some space or focus while the details of the regulatory legislation is hammered out behind closed doors.

The centerpiece of the new system, whenever we see it, is likely to be an authority roaming over the whole of what is called ‘systemic risk’.

“Our failure to take dynamic and strong action to recapitalize the big banks is having all sorts of ‘knock-on’ effects.”

If there is one thing we learned through this crisis it is that the risk management activities of the financial industry are inept at managing risk. Truly inept. So poor are the banks at risk management that, in their zeal to hedge, offload, mitigate and otherwise purge themselves of it, they magnified, concentrated and loaded up on it to a disastrous degree. They simply fooled themselves. They moved risk off balance sheet as if that shed it entirely. They bought contracts to protect themselves against default only to find that their counter-parties could not honor the contracts and therefore represented a risk themselves. They hedged positions using models that only work in utopia. And their ‘innovation’ of risk management products produced a veritable menagerie of Frankenstein like contraptions that ran amok trampling the balance sheets of those unfortunate enough to have fallen prey to what we have to call the ‘risk-avoidance-but-is-really-risk-concentration’ disease that infected Wall Street and all who came into contact with it.

Swine flu has nothing on this one.

Somewhere Mrs Shelley is smiling at the inventiveness of the lunatics who dreamt all this stuff up.

It takes a particularly fertile imagination to conceive that some of these wonderfully innovative products represent any value to anyone other than the people peddling them. They certainly turned out not to manage risk.

My view is that the entire derivatives trade ended up being a massive con game, the whole purpose of which was to allow a few folks to generate vast wealth for themselves. The con artists lived in an incestuous fraternity skipping from one employer to another, oblivious to the goals and needs of their current employer, and supporting one another through the execution of thoroughly useless trades.

Why else would someone take out an insurance policy against the risk of default of the US Government? In the realm of senseless transactions that one shines most brightly.

Its purpose?

None.

None, that is, economically.

Its motive?

Bonus. Someone had to make a trade to meet a bonus target.

So I suppose that some risk was being mitigated: the risk of traders not hitting their bonus targets was assuredly eliminated. That and the monthly profit targets of the legions of lawyers, accountants and hangers-on necessary to transact these insanely arcane pieces trash.

Thus we need ‘systemic’ regulation.

The entire system can be brought down by the tortuous nonsense these folks created. So we need to protect ourselves against the consequences of their snake oil.

The old regulatory system focused on single banks. It had a vertical quality to it. The theory was to manage to banks, each in isolation, by controlling their activities one at a time. So regulatory efforts took the form of audits and examinations testing the risk management methods of the banks. This left unattended the linkages between banks. The labyrinthine entanglement created by the booming trade in derivatives went uncontrolled because it cut across the system. Its risk characteristics are every different when viewed horizontally between banks rather than vertically within a single bank. The collapse of AIG and the threat it became to other banks is an example of this.

So systemic is in.

But that means big changes to our current regulatory set up so political infighting will inevitably slow down enactment of anything meaningful. All our regulators stand to lose jurisdictional territory. Obviously someone will win, but in the meantime the knives are out.

Simultaneously with this systemic risk management effort is the other big component of re-regulation: the establishment of the authority to take over and wind down large banks.

One of the reasons the administration has failed to fix the capital problems of the big banks is that is has been hesitant to seize them and force them through a government run reorganization. It perceives it does not have the legal authority to dissolve a bank holding company in the way current law allows it to seize smaller banks. This perception was one major cause driving the Treasury Department to step around bank capital issues rather than tackle them head on. The new resolution authority will need to be funded in the way that the FDIC is and that raises political problems: small banks are objecting to having to contribute to a fund that has no impact on them. I assume this will be resolved quickly, but it demonstrates the tip-toeing necessary to get new regulation in place. At the same time the big banks, who will have to ante up to pay for the new authority, don’t want to contribute right now either: they need to retain every penny of their profits so they can earn their way back to health.

Which brings me back to my ongoing thesis with respect to the banks:

Our failure to take dynamic and strong action to recapitalize the big banks is having all sorts of ‘knock-on’ effects. In this case it is slowing to a crawl our ability to set up a new regulatory structure. We need the banks to earn their way free of the crisis. This will take time. There is no certainty they will succeed – the rising tide of credit card and commercial real estate defaults could swamp their efforts to retain profits. Meanwhile we remain exposed to the lunacy of the old structure.

It is tiresome to have to keep repeating this: we have not fixed our banks. The stress tests were a sham. The capital targets too low. The entire banking system remains undercapitalized even after all the frenzy of post stress test share and bond sales.

The best we can say is that the banks are now able to limp slowly. They no longer are crawling on all fours.

So the result of hundreds of billions of taxpayer dollars and many months of dodging and weaving by two administrations is that we have a ‘merely’ crippled system rather than a ‘near dead’ one.

Progress of sorts.

But not enough.

Plus ca change.

Addendum:

I neglected to refer to the administration’s announced efforts to impose regulation on derivatives. Remember that derivatives were specifically exempt from regulatory oversight or control during the Clinton administration: the thinking was that leaving the derivatives market unregulated would allow innovation to flourish. This innovation was thought to lead, inevitably, to market driven solutions to risk management.

This blind faith in market driven problem solving works well in the nirvana that is neo-classical economic theory. It tends to flop in the real world where the vanities and idiosyncrasies of less than rational people muddy the waters a bit.

So the effort to put boundaries around the derivatives market and to make it open to scrutiny is a welcome step forward.

I would have preferred that all derivatives be traded in the open. But as seems to be the case with much of what this administration does, caution has prevailed and we get only partly open trading. Too many of the administration’s experts are beholden to the market-is-best world view. So the fallacy lingers on near the center of policy making and manifests itself in the half steps taken instead of the whole steps that were available.

Sigh.

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Goldman Sachs: Connections Run Amok?

Here’s is a little reported story worth keeping an eye on: some people are concerned about the extent of Goldman Sachs reach into our regulatory and legislative process. I know that’s not real news. Anyone who followed the AIG debacle closely would have seen the apparent preferential treatment Goldman received from the Paulsen Treasury.

With all the sensitivities about proper behavior you’d have thought the bank would try to keep a low profile. At least by their normal headline grabbing standards.

Nope.

Now a juicy story emerges from last September.

Back then it was the New York Fed in the lead on banking issues. Among its actions was the fast track approval of Goldman Sachs as a bank holding company, along with the provision of $10 billion in capital. This is not to mention the hasty approval of the use of AIG bailout money to pay off it counter-parties, amongst whom Goldman Sachs was very prominent.

Now I am not going to cry foul on any of this because everything may well be above board.

But.

During that time the New York Fed’s Chairman, Stephen Friedman, sat on Goldman’s board. Which raises all sorts of red flags of potential impropriety especially since it would be the Fed that regulates a bank holding company.

Worse: in December Friedman bought a sizable number of Goldmans shares, which have since gone up $1.7 million in value.

This could all be proper. It could all be very well covered by all the necessary paper work. And it could also be that Mr. Friedman and Goldman are as honest as the day is long.

But, surely this situation is outrageous. It smells of a kind of preferential treatment that we need to rid ourselves of as quickly as possible. Much of the weakness in our economy right now stems from the actions of our large banks. Especially those deemed to ‘big to fail’. Goldman is one of those banks.

So why on earth is one of our top regulators sitting on its board? More to the point why is he buying more stock in one of the companies he oversees as a regulator?

It is situations like this that raise the specter of a potentially unhealthy relationship between our large banks and the government. The amount of personnel that swap jobs back and forth alone is dangerous because of its erosion of objectivity. But to have the most senior regulator sit on the board of a regulated bank under his jurisdiction is plainly absurd.

This is why I am skeptical of the administration’s ability either to understand or to resolve the banking crisis. Too many of its senior players are inextricably connected with Wall Street.

Add this story to the unseemly amount of coziness surrounding the stress tests and it is no wonder that some of us suspect the fix is in before the game starts.

Bankers like those at Goldman are out for themselves. Good for them. But they should be kept at a distance from the levers of regulation and legislation. In fact the bias should be against them.

Remember who brought the economy down and who has the most at stake. And who could profit the most from tilting the playing field.

That’s what makes this story about Friedman so terribly upsetting. The regulators constantly harp on about the risks of banks being too ‘interconnected’. I has always assumed they meant interconnected in a financial sense.

Maybe we should be more concerned about interconnectedness of the influence peddling kind.

Who’s running the show?

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