Obama Eclipses Merkel

Financial Crisis

The Chancellor is getting bogged down in the financial crisis. The U.S. president is acting far more decisively in the crisis. His financial reform is moving through the Senate.

At first glance, Angela Merkel has plenty to offer her counterpart Barack Obama. Once she commits herself, she will then get her way.

It hasn’t even been two weeks since the European Union passed the unprecedented €750 billion bailout package. As early as Friday, the German Parliament will vote on Germany’s bailout contribution. The Chancellor doesn’t have to worry about any surprises.

It’s entirely different for Barack Obama. It has been a year since the president presented the main points of his financial reform plans. Just this past Thursday evening, the U.S. Senate managed to come to a preliminary decision whereby the hopelessly divided members agreed to end the debate and finally vote on the financial overhaul bill in its current form.

While this sounds like an inconsequential formality, it is the long awaited breakthrough. Just the day before, the Obama administration was facing a tough defeat on this issue. It’s no wonder Obama rushed to face the cameras in the White House Rose Garden only minutes after the Senate voted to end debate on this bill. Obama was happy to say that the efforts of Wall Street lobbyists to end any chance of reform had failed, “The American people will never again be asked to foot the bill for Wall Street’s mistakes.”

Later that night, just before 3:00 a.m. in Germany, the Senate finally voted on the bill. Now, the Senate and House of Representatives still have to agree on a final draft of the reform legislation that Obama can finally sign.

The president was not alone in celebrating the second victory of his domestic agenda, following his health care reform. The world sees what currently distinguishes Washington from Berlin and Brussels. While Germany and Europe are putting out fires in Greece and with the euro and are fully occupied with presumably angry financiers, the United States is addressing the root causes of the financial crisis with fundamental and radical changes.

There will be more oversight and regulation. Obama, for example, is mandating more transparency in dealings with financial derivatives. In the future, these complex financial instruments will only be traded in central clearinghouses.

Until now, financial firms could make bets on derivatives amongst themselves. But the risk to the general public is considerable. The market for over-the-counter (OTC) derivatives is estimated to be more than $600 trillion.

Furthermore, banks will no longer be allowed to use their customers’ deposits, which are insured by the Federal Deposit Insurance Corporation (FDIC), for their own trading. It is possible that commercial banks will have to spin off their most risky and specialized business divisions. In addition, finance firms will have to set aside considerably higher reserve funds, depending on the level of risk they assume, to make them less susceptible to financial hardships.

Moreover, in the future, a new government agency with sweeping authority will look after consumers and give people a voice when there are complicated credit card policies and dubious student loan practices. Obama said, “We’ll soon have in place the strongest consumer protections in history.”

Most Republicans see this as an excessive overreach by the federal government. But some still voted with the Democrats on this reform legislation. The midterm congressional elections will finally come around in November, and polls show that large majorities of people are still angry with Wall Street.

Many experts believe that Europe and the United States must act together to get the international financial markets to come to terms with the reform measures. Robert Brusca, Chief Economist for Fact and Opinion Economics, said: “If they don’t agree, any regulation will not work. Finance firms are able to get around just about any rule.”*

Because many banks operate in different markets, anything else could lead to chaos. Brusca went on to say, “I don’t have much hope. It appears that every country has its own ideas and priorities.”* There are many examples of this. When the government leaders get together in June at the G-20 summit in Toronto, they will have an opportunity to discuss the most important issues.

An overview of the points of agreement and contention with regard to financial reform:

Banks: President Obama wants to limit the size of financial institutions. To remove all doubt that the taxpayer will have to step in to cover for struggling institutions, there will be no longer be any bank so large that it is “too big to fail.” Splitting up the banks is under discussion. In Germany thus far, there has been no sign of similar plans for the banks. The regional state banks would be primarily involved in such plans, since they could not elude the regulations and possibly lose billions of euros.

Financial Transaction Tax: At the last summit in London, the United States opposed the idea of levying a type of mini-valued added tax on all international transfers of money. Because implementation of such a tax at the international level appears to be hopeless, the Chancellor was not making a serious effort to have it work earlier. But now it is different. The German government is in favor of this tax as are others in Europe. The issue is suddenly becoming a very important agenda item at the coming G-20 summit.

Derivatives: Until now, Europe and the United States have treated financial derivatives differently. While America is making a real effort to address this issue and wants to place derivative trading under supervision, Europe is waiting for suggestions from the European Union Commission. In June, the Commission will explain how it wants to limit the risk involved in derivatives trading. Individual market players should not be able to build up portfolios so big that they can manipulate the market.

Special Tax: The United States wants banks to assist retroactively with their bailout costs, by collecting $50 billion over the course of 10 years. Germany also wants to get money from these financial institutions by setting up a bailout fund for struggling banks.

Hedge Funds: Europe and America want to improve the oversight of hedge fund activities, something they have been doing independently. To do this, among other things, a mandatory registration will be introduced so that supervision will become easier.

But even without a formal cooperation agreement, the Americans are displaying their influence in Europe. As Angela Merkel was procrastinating for so long with the Greek bailout, Obama was urging his European counterparts to move more quickly.

The night before the decisive meeting in Brussels, Obama spoke by phone with Merkel and President Nicolas Sarkozy of France. His message was that keeping still will not solve the problem, but rather make it worse. This will be more satisfying when the Europeans get around to making up their minds and start getting down to work.

So to get going on these points, the German Parliament started dealing with speculators. The official prohibition of indulging in the naked short selling of certain bonds and other holdings is definitely unleashing horror on Wall Street.

Certainly, this alarm on Wall Street is not because of the ban, per se. Naked short-selling and selling securities which speculators do not own or have borrowed have been illegal in the United States for a long time now. But the way Merkel and her Federal Minister of Finance Wolfgang Schäuble had gotten the markets ready for the news was shocking. There was no preparation. In reference to the Chancellor, financial columnist Gregory White asked, “Does this woman have any idea what she’s doing?” Germany resents the political solo effort without consideration of the European neighbors more than it does the surprise approach.

At the same time, from the American perspective, there are already enough problems on the eastern side of the Atlantic Ocean without the need to implement spontaneous measures. The farther the euro falls, the better it certainly is for the redevelopment of European national budgets — but all the much worse for U.S. exports.

American products will simply become more expensive, which is not an ideal starting position to have when exporting products and trying to reduce the budget deficit. Economics Professor Melvyn Krauss of New York University says, “The question is how low Washington will allow the euro to fall before the currency markets intervene.”*

The U.S. government will certainly look to international cash flows should there still be more concerns about exports. On Thursday, a member of the board of the Federal Reserve warned that, “If [this is] the worst case, the financial markets will freeze up because of the euro debt crisis.”*

That is why Obama’s top adviser, Paul Volcker, a former Chairman of the Federal Reserve, sees a crucial test lying ahead for Europe. The continent is facing a long rocky path. Volcker warns: “This process will take years.”*

Germany’s Package of Financial Regulations

Bank Fee

The German Federal Government has already agreed to a bank fee. Accordingly, all institutions shall make an annual payment into a fund, from which banks will be able to obtain funds to cover any future imbalances.

Annual receipts of approximately €1.2 billion are targeted. All institutions shall pay the fee.

The amount of the contribution shall be determined by the amount of risk the bank takes. However, this means that savings banks and credit unions will pay less than private banks. Nevertheless, these institutions are still not in favor of the bank fee. They are pleading for the financial transaction tax instead.

Financial Transaction Tax

A financial transaction tax (abbr. FTT) works in principle like a value added tax on banking transactions. The government levies a minimal tax on business dealings involving almost all financial products.

Tax rates of 0.01 to 0.5 percent are planned. The tax would generate between 12 and 36 billion euros for the German government depending on the tax rate and the assessment. In addition, this tax should slow and prevent events in financial markets from forming huge financial bubbles.

This tax has long been considered to be a “utopian tax” because it only has its biggest effect when all countries participate. However, this idea has had little past international support. But now, there appears to be an increasing number of proponents in Europe supporting this tax. In Germany, the Greens, the SPD, and the Left political parties are calling for the introduction of the transaction tax. Even the Chancellor has now come out in favor of this tax.

Financial Activity Tax

The most recent idea in the German discussion is the financial activity tax (FAT). It would be introduced by the International Monetary Fund (IMF) in Washington and would work in principle like a value added tax on the finance industry.

In practice, this tax would not be levied on businesses, but rather be a value calculated from bank profits and employee salaries.

Depending on how high the tax rate is set, it should prevent the accumulation of excessive profits. This tax should also compensate for the advantage the finance industry has had, unlike other industries, in being exempt from the value added tax.

However, it is uncertain whether the tax being introduced in Germany is constitutional because it is specifically directed at only one industry.

*Editor’s note: These quotations, accurately translated, could not be verified.