Hirsh: Wall St. Reform Doesn't Go Far Enough

Not long ago, a group of skeptical Democratic senators met at the White House with President Obama, his chief economic adviser, Larry Summers, and Treasury Secretary Tim Geithner. The six senators—most of them centrists, joined by one left-leaning independent, Vermont's Bernie Sanders—said that while they supported Obama, they were worried. The financial reform policies the president was pursuing were not going far enough, they told him, and the people Obama was choosing as his regulators were not going to change things fundamentally enough. His appointed officials and nominees were products of the very system that brought us all this economic grief; they would tinker with the system but in the end leave Wall Street, and its practices, mostly intact, the senators suggested politely. In addition to Sanders, the senators at the meeting were Maria Cantwell, Byron Dorgan, Dianne Feinstein, Carl Levin and Jim Webb.

That March 23 gathering, the details of which have gone largely unreported until now, was just a minor flare-up in a larger battle for the future—one that may already be lost. With the financial markets seeming to stabilize in recent weeks, major Wall Street players are digging in against fundamental changes. And while it clearly wants to install serious supervision, the Obama administration—along with other key authorities like the New York Fed—appears willing to stand back while Wall Street resurrects much of the ultracomplex global trading system that helped lead to the worst financial collapse since the Depression.

At issue is whether trading in credit default swaps and other derivatives—and the giant, too-big-to-fail firms that traded them—will be allowed to dominate the financial landscape again once the crisis passes. As things look now, that is likely to happen. And the firms may soon be recapitalized and have a lot more sway in Washington—all of it courtesy of their supporters in the Obama administration. With its Public-Private Investment Program set to bid up and buy toxic assets, the administration is handing these companies another giant federal subsidy. But this time the money will come through the back door, bypassing Congress, mainly via FDIC loans. No one is quite sure how the program will work yet, but it's very likely going to make a lot of the same Wall Street houses much richer at taxpayer expense. Meanwhile, the big banks that still need help will almost certainly get another large infusion once the stress tests are completed by the end of the month.

The financial industry isn't leaving anything to chance, however. One sign of a newly assertive Wall Street emerged recently when a bevy of bailed-out firms, including Citigroup, JPMorgan and Goldman Sachs, formed a new lobby calling itself the Coalition for Business Finance Reform. Its goal: to stand against heavy regulation of "over-the-counter" derivatives, in other words customized contracts that are traded off an exchange. Companies like these kinds of contracts, which are agreed to privately between firms, because they allow them to tailor a hedge perfectly against a firm-specific risk for a certain time period. But in order to preserve its right to negotiate these cheaper private contracts, Wall Street is apparently willing to argue for the same lack of public transparency and to permit the systemic risk that led to the crash.

Geithner's financial regulation plan, announced April 2, does address some of these concerns. The Treasury chief wants all standardized over-the-counter trading of derivatives to go through an industry clearinghouse, which will give the government more oversight. Geithner said he wants to require "systemically important" firms to reserve more capital. He also wants to rein in "customized" derivatives contracts—those agreed to privately between firms. Whereas once these trades went totally unregulated, Geithner would require that they be "reported to trade repositories and be subject to robust standards" for documenting and collateralizing, among other new rules.

But it's unlikely this will do much to change Wall Street. Geithner's new rules would allow the over-the-counter market to boom again, orchestrated by global giants that will continue to be "too big to fail" (they may have to be rescued again someday, in other words). And most of it will still occur largely out of sight of regulated exchanges. The response favored by the administration, the Federal Reserve and even many in Congress is to create a new all-knowing "systemic risk regulator" with as-yet-undetermined powers. Is such a person sitting at 30,000 feet really going to be able to keep up with all this onrushing complexity, especially as over-the-counter trading resumes in quiet places around the world? It is a triumph of hope over experience to think so.

Meanwhile, up in Manhattan, the New York Fed has been conducting meetings on future regulation with a group of major Street insiders and their traditional regulators. At the most recent meeting, on April 1, they agreed on creating central clearinghouses for trading and "trade-information warehouses" that will track market data far better than before. But they have resisted anything more dramatic, like requiring all trading to occur on publicly recognized exchanges. Geithner has also put his stock in clearinghouses; he says he only wants to "encourage greater use of exchange-traded instruments." That has placed Geithner at odds with another Democratic senator, Tom Harkin of Iowa, chair of the agriculture committee, who wants all futures contracts traded on exchange. "The senator feels that what he's offering in his bill does include more integrity and transparency than the current Geithner plan," a Harkin spokesman told me.

Officials at the firms who took part in the New York Fed meeting and at the Fed maintain that there is little difference between clearinghouses and formal exchanges; both are regulated and both are industry-run, they say. But that misses a major point, says Michael Greenberger, a former top official at the Commodity Futures Trading Commission who has been a critic of the administration's reform efforts. Exchange trading gives the government authority over fraud and manipulation and emergency powers to stop trading, he says, and it creates the kind of public transparency that isn't possible in a privately run clearinghouse.

The White House and Treasury Department did not immediately respond to my requests for comment on these issues or on the March 23 meeting (beyond confirming that it took place). But it's noteworthy that more than a month and a half passed before Obama agreed to the meeting, which was prompted by a letter that Dorgan sent in early February. The senators were invited after one of the group, Sanders, put a hold on the nomination of Gary Gensler, Obama's nominee to be head of the Commodity Futures Trading Commission. In an interview, Sanders said he opposes the nomination because Gensler has spent much of his career in Washington working for Wall Street's interests. Gensler, in testimony, has said he has learned from his past mistakes. "At this moment in our history, we need an independent leader who will help create a new culture in the financial marketplace," Sanders said.

Instead, the old culture is reasserting itself with a vengeance. All of which runs up against the advice now being dispensed by many of the experts who were most prescient about the crash and its causes—the outsiders, in other words, as opposed to the insiders who are still running the show. Among the outsiders is Nassim Nicholas Taleb, the trader and professor who wrote "The Black Swan: The Impact of the Highly Improbable." Taleb wrote in the Financial Times this week that a fundamental new approach is needed. Not only should firms be prevented from growing too big to fail, "complex derivatives need to be banned because nobody understands them and few are rational enough to know it," he said. Yet even as we are still picking up the debris, we seem to be ready to embrace that world once again.