Wall Street Banks Need A Financial Super Regulator

One year after the global economic collapse, the United States has yet to adopt any legislation to change the way it oversees or regulates financial industries. Banks that received bail-out money still don't have any restrictions placed on the way they spend the government's cash, and although President Obama wants Congress to create a new consumer financial protection agency to act as a watch dog against unfair lending practices and confusing credit card contracts, the idea has met massive resistance from Washington's well-funded business lobbyists.

But there are ways to regulate businesses and financial transactions without spending piles of money or passing new laws, says William Black, a former federal regulator during the Savings & Loan crisis and a professor of economics and law at the University of Missouri-Kansas City. Black appears in Michael Moore's new documentary "Capitalism: A Love Story," in which he acts as Moore's narrative Sherpa, guiding viewers through the history of federal financial reform. Black spoke with NEWSWEEK's Nancy Cook about the possibility of a new federal financial agency; the problem with current regulators like Timothy Geithner, Secretary of the Treasury; and the search for every industry's Achilles Heel. Excerpts:

NEWSWEEK: A few weeks ago marked the one-year anniversary of the bankruptcy of Lehman Brothers. Since the financial collapse, there have been no indictments. The Dow is ready to hit 10,000 again. Where is the outrage?
Black: During the Saving & Loans crisis, we had over 1,000 convictions that involved insiders and gigantic borrowers. Now we have zero. The FBI did not even begin to investigate the large subprime lenders until March 2007. People would be upset if they had the facts, or if you asked them how many criminal referrals there were for mortgage fraud. (There were 65,000 last year.) Meanwhile, the administration is saying there is no problem and that the financial crisis is over. That's the exact opposite of what you want to say and do if you want dramatic resources to change things.

In dissecting the financial collapse, what do you think went wrong?
Eighty percent of the toxic mortgages that were done were unregulated, but that still leaves 20 percent of a huge market. Had the examiners looked, the incident of the fraud was so great that they couldn't have missed it. The FBI warned about toxic mortgages years ago, but in response to the 9/11 attacks, the FBI transferred 500 white collar specialists to national security. The Bush administration refused to replace the FBI agents it transferred--even though Enron collapsed within about two months.

Now, you have to think in terms of lags. The Enron case was going to trial. There are over 100 FBI agencies assigned to Enron alone. With the lag, who was left to investigate white collar crimes? It's nice to have warned about toxic mortgages. It would have been nicer to stay on top of the warning, but there was nobody left in terms of the numbers. As late as 2006, there were only 180 FBI agents working on mortgage fraud. At its peak, we had 1,000 FBI agents working on the Savings & Loans fraud. Regulators can't bring criminal cases, but the regulators are the ones who have to create the road map for successful regulations for fraud. When you screw up the regulatory process, you have, de facto, decriminalized these elite complex frauds.

Do you think the team Obama has put in place can overhaul the regulatory agencies?The administration's officials have all been failures as regulators. [Chairman of the Securities Exchange Commission] Mary Shapiro's big thing was self-regulation. That worked real well: the self-regulation of the investment banks. Ben Bernanke [Chairman of the Federal Reserve] I'm also very critical of, but I do give him credit for being willing to drop a lot of his anti-regulatory ideology in the face of the crisis. He literally wrote the book on the Great Depression, but he was not going to go down in history as the person who caused the second Great Depression. Some of the things Bernanke did were very bad, but he is in sharp contrast to Geithner who has been wrong about everything in his career. When Geithner was once answering a question in response to Ron Paul, he said, 'I've never been a regulator.' He was then the President of the New York Federal Reserve, and he purports that he was never a regulator? That is a demonstration of what is wrong with the Federal Reserve banks if the head of the unit doesn't think he's a regulator. He's a disaster.

What about the criticism that regulators are not paid enough, or well enough to attract talent and keep it?
The pay can be very bad, but it's not simply that the pay is low. The agency regulating the Savings & Loans was not permitted to pay as much as the U.S. Office of Personnel Management pays. So, in terms of the initial selection, the better people will go to the other agencies. At the SEC, leading up to WorldCom and Enron, the turnover also became obscene. The average lawyer at the SEC stayed barely over two years, and your first year, you're kind of useless. The far biggest thing is leadership. As long as the leader is some kind-of clown, the agency will fail.

What needs to happen now?
It's been two-and-half years since the secondary markets collapsed, and there is zero meaningful regulatory reform adopted by legislation. But you don't need laws to do things in the regulatory ranks. You'll never have enough regulators or top-of-the scale regulators, so you always look for the Achilles heel. In the Savings & Loans case, that was growth. In 1990 to 1991, there was going to be a subprime crisis. Lenders were starting to do the same practices, and we told them, 'No.' There was no crisis.

The SEC, for example, has never effectively regulated the credit rating agencies, but the rating agencies are the Achilles heel. There are only three rating agencies. If you send your 20 best people from the SEC into any of the rating agencies, they can evaluate credit risk. They can find out on day one that the rating agencies never check loan files. On day two, they can say that the rating agencies can't give out more ratings without checking loan files. On day three, the secondary market collapses and the bubble bursts early.

Regulators have to be creative and have to be aggressive. They have to know how to succeed not having the resources, but there is nearly always is an Achilles Heel.

Does the Obama Administration have the political will to bring about financial reform?
No and no--although I'm not even sure that the central problem is will. The administration seems not to believe that you need fundamental change. I know they've given speeches recently. The rhetoric is starting to come around, but the proposals are still designed to create the status quo before the crisis. It's analytically bankrupt. Nothing they're trying for would have prevented the current crisis had it been in place, and it's very unlikely that it will prevent crisis in the future.

In particular, the administration want to create the secondary market that caused trillions of dollars of losses. They still want a massively, too-large financial structure -- so large that it clearly harms the economy. They still want to compete and be the place where finance will reside. That's like saying, "We want to be there when it blows up."