Paulson’s Fixit Plan for the Financial Markets: Less Regulation, More Power to the Fed

It is being billed as a “massive shakeup of US financial market regulation,” but don’t be deceived. Treasury Secretary Henry Paulson’s proposals for broad market reform are neither “timely” nor “thoughtful”. (Reuters) In fact, it’s all just more of the same free market “we can police ourselves” mumbo jumbo that got us into this mess in the first place. The real objective of Paulson’s so-called reforms is to decapitate the SEC and increase the powers of the Federal Reserve. Same wine, different bottle. Paulson’s real motive is to preempt the regulatory sledgehammer that is set to descend on the financial industry following the 2008 election. There’s growing fear that President Obama will take his firehose down to Wall Street and flush out some of the cobwebs that have collected in the market’s dark corners.

If Paulson’s plan is approved in its present form, Congress will have even less control over the financial system than it does now, and the same group of self-serving banking mandarins who created the biggest equity bubble in history will be able to administer the markets however they choose, without the annoyance of government supervision. That’s exactly what Treasury Secretary and his pals at the Fed want: unlimited power with no accountability.

Paulson is expected to lay out guidelines and principles that are intended to help regulators supervise the financial markets. According to AFP:

“The President’s Working Group on Financial Markets said the current regulatory structure is working well despite calls by some US lawmakers.”

In other words, the failing banking system, the housing meltdown, and the frozen corporate bond market are all signs of a robust financial system? This may be the most ludicrous statement since “Mission accomplished.” The system is imploding and real people are being hurt by the fallout. Thirty years of industry-led lobbying has dismantled the regulatory regime which made US financial markets the envy of the world. The credibility and transparency are gone along with the Depression era legislation like Glass-Steagall and government oversight of over-the-counter derivatives instruments. Now the system is prey to all types of dodgy debt instruments, suspicious “dark pool” trading and off-balance sheets operations that reinforce the belief that cautious investment is no better than casino gambling.

“The regulatory line of sight today is by the counterparties,” the official said, adding that the guidelines should be “beneficial to industry.” (AFP)

How is that different than saying, “Caveat emptor”? That’s not a motto that inspires confidence. Many people still naively believe that planning their retirement should not have to be a Darwinian tussle with a crafty junk bond salesman.

Under Paulson’s plan, the Federal Reserve will be granted new regulatory powers, but whatever for? The Fed doesn’t use the powers it has now. No one stopped the Fed from intervening in the mortgage lending fiasco, or the ratings agency abuses or the off-balance sheets shenanigans. They had the authority and they should have used it. The Fed knew everything that was going on — including the mushrooming sales of derivatives contracts which soared from under $1 trillion in 2000 to over $500 trillion in 2006 — but they decided to cheerlead from the sidelines rather than do their jobs. The fact is, they were worried that if they got involved they might upset the gravy train of obscene profits that was enriching their bankster friends.

Former Fed chief Greenspan used to croon like a smitten teenager every time he was asked about subprime loans or adjustable rate mortgages. And, as New York Times columnist Floyd Norris points out, Greenspan “praised the growth in the derivatives market as a boon for market stability, and resisted calls to use the Fed’s power to increase regulation.” Of course, he did. It was all part of Maestro’s “New Economy”: trickle-down Elysium, where the endless flow of low interest credit merged with financial innovation to create a Reaganesque El Dorado. There are no regulations in Eden; anything goes and to heck with the public, they can fend for themselves.

Now it’s Paulson’s job to keep the neoliberal flame lit long enough to make sure that government busybodies and bureaucratic do-gooders don’t upset the applecart. That means concocting a wacky public relations campaign to convince the public that Wall Street is not just a pirate’s cove of land sharks and bunko artists, but a trusted ally in maintaining a strong economy through vital and efficient markets.

The Times‘ Norris summed up Paulson’s sham reforms like this:

The plan has its genesis in a yearlong effort to limiting Washington’s role in the market. And that DNA is unmistakably evident in the fine print. Although the proposal would impose the first regulation of hedge funds and private equity funds, that oversight would have a light touch, enabling the government to do little beyond collecting information — except in times of crisis. The regulatory umbrella created in the 1930s would grow wider, with power concentrated in fewer agencies. But that authority would be limited, doing virtually nothing to regulate the many new financial products whose unwise use has been a culprit in the current financial crisis.“In Treasury Plan, a Reluctant Eye over Wall Street”, Floyd Norris, New York Times.

What nonsense. The house is on fire and hyperventilating Hank is still wasting our time with this rubbish. The real problem is that Paulson and his buddies at the Federal Reserve think of the financial system as their personal fiefdom so they refuse to loosen their hoary grip even though the economy is listing starboard and the water is flooding into the lower decks.

Once again, the New York Times:

All the checks and balances in the plan reflect the mindset of its architect, Treasury Secretary Henry Paulson, who came to Washington after a long career on Wall Street. He has worried that any effort to substantially tighten regulation could hamper the ability of American markets to compete with foreign rivals.

No one elected Paulson to do anything. He has no mandate. He is an industry rep who has worked exclusively for a small group of wealthy investors who have put the entire country at risk with their toxic mortgage-backed bonds, their reckless Ponzi-type speculation, and their off-book chicanery. Paulson should be removed immediately and returned to his wolf’s lair at G-Sax. If Bush is serious about straightening out Wall Street, then bring in Eliot Spitzer. He’s available. And he’ll do what it takes to clean house, that is, put a truncheon-wielding robo-cop in every trading-pit at the NYSE, and dispatch government accountants to every office of every CFO making sure they have a Big Red Pen in one hand and a taser in the other. That’s the only way to get the attention of the bandit class.

“I do not believe it is fair or accurate to blame our regulatory structure for the current turmoil,” says Paulson.

Paulson is wrong. The current turmoil is all about the lack of regulation and he’d better prepare himself for some big changes. The pendulum is already in motion and tighter regulations will soon follow. There needs to be an accounting process for all transactions and capital requirements for every financial institution that creates credit. No exceptions. All of these businesses pose a real danger to the overall system and, therefore, must conform to clearly articulated and strictly enforced rules; no off-balance sheets operations, no dark pool trading, no unregulated derivatives contracts, no level-3 assets, no “mark to model” garbage bonds where CFOs unilaterally decide what they are worth by picking a number out of a hat.

It’s time to restore order to the markets so retirees and working class families can feel safe investing in their futures. They are the ones who are most hurt by Wall Street’s trickery.

Paulson’s plan is a non starter. The era of sandbagging, supply-side banditry is over. Good riddance.

Mike Whitney lives in Washington state. He can be reached at: Read other articles by Mike.

8 comments on this article so far ...

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  1. Don Hawkins said on April 2nd, 2008 at 6:02am #
    You have to read this it will make you feel better.

  2. Michael Kenny said on April 2nd, 2008 at 8:29am #

    Interesting item on the Swiss TV news last night. The boss of UBS, the flagship bank, has suddenly bailed out and replaced at the top by the company’s legal counsel. The cumulative write-offs at UBS now amount to 39 billion Swiss Francs and its most recent figures show a loss of 12 billion. Moreover, UBS is to increase its share capital (by 15 billion, I think). Now the interesting part. That increase is to come from American banks, I recall the names of J.P. Morgan, Morgan Stanley and Goldman Sachs.

    The US elite is recycling its investments out of the dollar by buying, for example, shares in Swiss banks at knockdown prices. Similar deals are probably being made elsewhere. Once they have saved their own wealth, they’ll let the “little guy” take the fall. Let them eat cheese!

  3. Bruce said on April 2nd, 2008 at 9:31am #

    Any one else think all this “year long planning” undertaken well before this financial mess became public, and now passed off as a comprehensive over-haul of the banking and financial system, is part nothing more then what Naomi Klein would call Shock Doctrine policy. It is a ruse for a greater takeover by the shadow financial system and the Deep state. When we feel the full pinch of their maneuver it will be too late to hold them back and we will be left with two bad choices. . .grin-and-bear it or revolt.

  4. Don Hawkins said on April 2nd, 2008 at 11:13am #
    Again I must say James Hansen I can tell is tired of nonsence.

  5. William Kidder said on April 2nd, 2008 at 11:22am #

    This is my plan to fix to the financial sector quickly. I have been in the ‘interest-rate’ business since 1966 and managed a recognized government bond dealer in the 1970’s. Many recognize me as the father of the matched book industry, now the biggest profit center at most banks and dealers. I understand how the system jumped the rails and what’s wrong now.

    The Good Citizen Fund: Proposal For Private Regulation Of The Financial Sector
    These four ‘instant reforms’ could be implemented tomorrow morning by regulators of banks, GSE’s, exchanges, and broker/dealers. At first, compliance with the reforms would be voluntary, but they will be made legal and binding as quickly as possible.

    1) No credit extensions to entities which do not agree to reforms
    2) Stricter minimum margin rules for credit extensions (sliding scale from 2%)
    3) No new off-balance sheet items unless exchange-traded or very collateralized
    4) No more netting of trades unless settlement date is within 30 calendar days.

    How To Enforce The Reforms
    Banks, GSE’s, exchanges and broker/dealers that agree to comply voluntarily with the four reforms will be listed immediately on the Fed’s public website as ‘Voluntary Members of the Financial Sector Reform Movement’ (Reformers). After April 30, Reformers agree not to enter into any transactions with ‘Non-Reformers’ that choose not to comply.

    If a firm does not agree to comply with the voluntary reforms by April 30, the Fed will consider it a ‘bad faith’ market participant and may deny it access to repo, the discount window and other financial support. Even if a firm decides after the April 30 deadline to become a Reformer, it will not be added to list before June 1 (and on monthly dates thereafter).

    The Federal Reserve will post this warning statement on its website:

    The following is a list are ‘Voluntary Members of the Financial Sector Reform Movement’ (Reformers).


    These entities have assets in excess of $10 billion and have elected not to be a member of the financial sector reform movement.

    The Federal Reserve will also post the following statement on its website:

    Good Citizen Awards: Employees are asked to help enforce the Reform Movement. If your employer is a Reformer and you know of any violation which occurred after April 30, you should inform your immediate supervisor about your concerns. If the violation continues after another week after notifying your supervisor, please report the violation to the Federal Reserve Bank at 800-000-000. Your privacy will be protected.

    If inspectors find the reported violation exists — or even that you had good reason to suspect one — you will receive a $10,000 (or more) Good Citizen reward. If the inspectors find the suspected violation did not occur, no action will be taken against you or your firm. But always act in good faith.

    If a firm incurs a second violation, it may pay a $1 million penalty in order to remain on the ‘Reformers list’ or it may choose to delist and not pay the penalty. Subsequent violations will carry a penalty of $5 million each.

    All violations, penalties paid, and voluntary delistings will be noted at the site.

    End of Federal Reserve Message.

    The Federal Reserve can implement the plan immediately as follows
    (1) a telephone number and recorder to take reports of suspected violations
    (2) appoint approriate staff to handle the phones and coodinate inspectors
    (3) open a ‘special purpose’ account for Good Citizen income, awards and expenses

    Note that the Federal Reserve will not be in charge of the voluntary reform movement. Its role is to coordinating activities until the private system outlined next is set up and to otherwise carry out its mandated duties.

    Private Regulation Of The Financial Sector
    The proposed new regulatory company will be a private company (‘Good Citizen’) authorized by Congress to oversee compliance of existing regulatory framework of the financial sector, propose new regulations and changes, and to provide ‘bailout’ insurance.

    Good Citizen will be organized along the lines of a insurance company and funded by tax-deductible premiums based on total employee compensation. The company will have a small staff to gather reports of possible infractions and coordinate remedies with existing regulators.

    Participants in the financial sector must purchase an insurance policy and agree to comply with its conditions. Transactions with uninsured parties in the financial sector are not permitted. The financial sector includes entities which conduct business in securities (securities will be very broadly defined) including banks, broker/dealers, exchanges, inter-dealer brokers, leveraged hedge funds and private entities, insurance companies offering credit enhancements for securities and counterparties. Affiliated companies or closely-tied entities which are at least 20% owned (actual, constructive or contingent) must also be insured. This includes all ‘off-shore’ and international subsidiaries and affliates.

    Total compensation, the basis for annual premium payments, means any money or perks that are paid to employees. This amount must certified by an outside auditor. The insurance premiums may be as much as 25% of annual total employee expense — a huge number that should be sufficent to enlist the financial sector itself as watch dog. It is obvious that market participants can identify rogue firms and shady practices far more quickly than government agencies.

    Claims, awards and operating expenses are expected to small; therefore, the insurance company will begin paying taxable dividends after two years. If the financial sector acts prudently in its self-interest, it should receive back most of the premiums paid in the form of taxable dividends. In effect, premium payment should operate like a deferred compensation plan. Note that there is no tax subsidy involved.

    There will a very generous award system for Good Citizens, including payments for ‘good-faith’ false alarms. Good Citizens will be anonyomous and their privacy protected. There may also be incentives and dividends for faithful compliance and cooperation. There will also monetary penalties for infractions including the ‘death penalty’ cancellation of the policy.

    Non-US Companies and Entities
    Central banks and regulatory authorities outside the US will be asked to cooperate with the spirit of the Good Citizen program and not permit ‘loophole’ competition that disadvantages members of the reform movement. Indeed, off-shore companies may join the Reform movement.

    Reformers will be encouraged to report any foreign abuse to the Good Citizen company so the company will follow through with Congress and other US regulators.

  6. AaronG said on April 2nd, 2008 at 6:30pm #

    I have an observation (humourous, cheeky, call it what you want!) to make about the DV bios given at the bottom of the articles. Like judging someone immediately from what they wear, these bios are a good indication of the writer’s backgrounds and possible prejudices that we can take into account when reading their articles.

    Personally, I’m not too fussed over whether someone has a PhD in astrophysics. If I like the article, it’s well-written and researched, has good arguments and spelling looks alrite, then that’s enough for me. I have to laugh every time I read Mike’s bio given above as simply “Mike Whitney lives in Washington state”. I’m economically illiterate, so his articles are good for me so I can (partially) try to understand what’s going on.

    Keep up the good articles, Mike.

  7. hp said on April 2nd, 2008 at 9:20pm #

    “I try to not let my education get in the way of my learning.”
    Mark Twain

  8. Sunil Sharma said on April 2nd, 2008 at 10:37pm #

    Mike is a thoughtful and exceedingly modest guy. I too learn quite a lot from Mike’s writings on economic issues, and I’m honored to feature his work on DV.