CAMPAIGN 08: Reforming the regulatory system for America’s financial markets

Regulation vs. deregulation

John (“I am a deregulator“) McCain can’t completely turn his back on the bedrock of his faith (“I believe in deregulation”) so instead of denouncing deregulation, he’s opting to blame the regulators — hence his silver bullet for dealing with the financial crisis would be to fire Bush-appointee Christopher Cox from his position as SEC chairman.

The financial crisis has forced the economy into the center of the presidential campaign. But as the candidates currently joust through the simplistic and emotive language of TV ads, there’s no better way of contrasting where McCain and Obama actually stand than to look back to March this year and see how they responded to the collapse of Bear Stearns.

This is what McCain had to say on the issue of regulating the financial markets:

Our financial market approach should include encouraging increased capital in financial institutions by removing regulatory, accounting and tax impediments to raising capital.

That comes from a speech McCain gave on March 25 addressing the housing crisis. In that speech he made no other reference to regulation or deregulation.

Two days later at Cooper Union in New York, Obama spoke on “Renewing the American economy.” Much of the speech was on reforming the regulatory system, but the following is a key passage:

…the American experiment has worked in large part because we guided the market’s invisible hand with a higher principle. A free market was never meant to be a free license to take whatever you can get, however you can get it. That’s why we’ve put in place rules of the road: to make competition fair and open, and honest. We’ve done this not to stifle but rather to advance prosperity and liberty. As I said at Nasdaq last September, the core of our economic success is the fundamental truth that each American does better when all Americans do better; that the well-being of American business, its capital markets and its American people are aligned. I think that all of us here today would acknowledge that we’ve lost some of that sense of shared prosperity. Now, this loss has not happened by accident. It’s because of decisions made in board rooms, on trading floors and in Washington. Under Republican and Democratic administrations, we’ve failed to guard against practices that all too often rewarded financial manipulation instead of productivity and sound business practice. We let the special interests put their thumbs on the economic scales. The result has been a distorted market that creates bubbles instead of steady, sustainable growth; a market that favors Wall Street over Main Street, but ends up hurting both. Nor is this trend new. The concentrations of economic power and the failures of our political system to protect the American economy and American consumers from its worst excesses have been a staple of our past: most famously in the 1920s, when such excesses ultimately plunged the country into the Great Depression. That is when government stepped in to create a series of regulatory structures, from FDIC to the Glass-Steagall Act, to serve as a corrective, to protect the American people and American business.

Ironically, it was in reaction to the high taxes and some of the outmoded structures of the New Deal that both individuals and institutions in the ’80s and ’90s began pushing for changes to this regulatory structure. But instead of sensible reform that rewarded success and freed the creative forces of the market, too often we’ve excused and even embraced an ethic of greed, corner cutting, insider dealing, things that have always threatened the long-term stability of our economic system. Too often we’ve lost that common stake in each other’s prosperity. Now, let me be clear. The American economy does not stand still and neither should the rules that govern it. The evolution of industries often warrants regulatory reform to foster competition, lower prices or replace outdated oversight structures. Old institutions cannot adequately oversee new practices. Old rules may not fit the roads where our economy is leading. So there were good arguments for changing the rules of the road in the 1990s. Our economy was undergoing a fundamental shift, carried along by the swift currents of technological change and globalization. For the sake of our common prosperity, we needed to adapt to keep markets competitive and fair. Unfortunately, instead of establishing a 21st century regulatory framework, we simply dismantled the old one, aided by a legal but corrupt bargain in which campaign money all too often shaped policy and watered down oversight. In doing so we encouraged a winner take all, anything goes environment that helped foster devastating dislocations in our economy. Deregulation of the telecommunications sector, for example, fostered competition, but also contributed to massive over-investment.

Partial deregulation of the electricity sector enabled (inaudible). Companies like Enron and WorldCom took advantage of the new regulatory environment to push the envelope, pump up earnings, disguise losses and otherwise engage in accounting fraud to make their profits look better, a practice that led investors to question the balance sheets of all companies and severely damaged public trust in capital markets. This was not the invisible hand at work. Instead, it was the hand of industry lobbyists tilting the playing field in Washington as well as an accounting industry that had developed powerful conflicts of interest and a financial sector that had fueled over-investment. A decade later we have deregulated the financial sector and we face another crisis. A regulatory structure set up for banks in the 1930s needed to change, because the nature of business had changed. But by the time the Glass-Steagall Act was repealed in 1999, the $300 million lobbying effort that drove deregulation was more about facilitating mergers than creating an efficient regulatory framework. And since then we’ve overseen 21st century innovation, including the aggressive introduction of new and complex financial instruments like hedge funds and non-bank financial companies, with outdated 20th century regulatory tools. New conflicts of interest recalled the worst excesses of the past, like the outrageous news that we learned just yesterday of KPMG allowing a lender to report profits instead of losses so that both parties could make a quick buck. Not surprisingly, the regulatory environment failed to keep pace. When subprime mortgage lending took a reckless and unsustainable turn, a patchwork of regulators were unable or unwilling to protect the American people. Now, the policies of the Bush administration threw the economy further out of balance. Tax cuts without end for the wealthiest Americans. A trillion dollar war in Iraq that didn’t need to be fought, paid for with deficit spending and borrowing from foreign creditors like China. A complete…

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A complete disdain for pay-as-you-go budgeting, coupled with a generally scornful attitude toward oversight and enforcement, allowed far too many to put short-term gain ahead of long-term consequences. The American economy was bound to suffer a painful correction, and policy-makers found themselves with fewer resources to deal with the consequences. Today those consequences are clear. I see them in every corner of our great country as families face foreclosure and rising costs. I see them in towns across America, where a credit crisis threatens the ability of students to get loans and states can’t finance infrastructure projects. I see them here in Manhattan, where one of our biggest investment banks had to be bailed out and the Fed opened its discount window to a host of new institutions with unprecedented implications that we have yet to appreciate. When all is said and done, losses will be in the many hundreds of billions. What was bad for Main Street turned out to be bad for Wall Street. Pain trickled up. And that…

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… and that’s why — that’s why the principle that I spoke about at NASDAQ last September is even more urgently true today. In our 21st century economy, there is no dividing line between Main Street and Wall Street.

The decisions made in New York’s high rises have consequences for Americans across the country. And whether those Americans can make their house payments, whether they keep their jobs or spend confidentially without falling into debt, that has consequences for the entire market. The future cannot be shaped by the best-connected lobbyists with the best record of raising money for campaigns. This…

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This thinking is wrong for the financial sector and it’s wrong for our country. I do not believe the government should stand in the way of innovation or turn back the clock on an older era of regulation. But I do believe that government has a role to play in advancing our common prosperity, by providing stable macroeconomic and financial conditions for sustained growth, by demanding transparency and by ensuring fair competition in the marketplace. Our history should give us confidence that we don’t have to choose between an oppressive government-run economy and a chaotic, unforgiving capitalism. It tells us we can emerge from great economic upheavals stronger, not weaker. But we can only do so if we restore confidence in our markets, only if we rebuild trust between investors and lenders, and only if we renew that common interest between Wall Street and Main street that is the key to our long-term success. Now, as most experts agree, our economy is in a recession. To renew our economy and to ensure that we are not doomed to repeat a cycle of bubble and bust again and again and again, we need to address not only the immediate crisis in the housing market, we also need to create a 21st-century regulatory framework and we need to pursue a bold opportunity agenda for the American people.

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Comments

  1. Excellent and timely post, Paul. Great reminder that despite all the wailing over Obama’s lack of experience, he does indeed have a track record of on-the-record statements on so many vital issues. And even if people can’t agree with all of his proposals (and I number among those some of what he said before the AIPAC conference a few months ago), I think it’s pretty obvious that when he takes a position, it’s been thoroughly and soberly considered, as opposed to McCain’s knee-jerking, chest-thumping responses like firing the head of the SEC or proclaiming that “we are all Georgians.”

  2. Carol Elkins says

    I am confused about whether this whole episode will turn out to be a step towards socialism or a huge opportunity for capitalists to buy really really cheap stocks and get exponentially richer. Maybe we have the first socialist government which serves capitalism? A whole new category for the political scientists to figure? Where does it fit into their outline?