The American Turning Point

“Yes” to an consumer protection agency to remedy derivative trading on the stock market. “No” to fund protection for big banks.

America is preparing the most important reform of the financial system since the ‘30s. In 1933, ground was prepared by a committee of inquiry, led by young Italian-American attorney Ferdinand Pecora. Even if the accusations made by Pecora of manipulation of stock prices were for the most part unfounded (or at least, never proven), these hearings had an enormous political effect.

Transmitted by radio, the [1933 hearings] fomented anger against the financial sector, which, according to popular view, was responsible for [the 1929] stock collapse and depression that followed it. In the background of this political context, the Securities Act (one of the legislative hinges of the American stock market) was approved in only a few months.

More than a year was needed to approve the second pillar (the Securities and Exchange Act). To approve the third pillar, (the Investment Companies Act) it took another six years. This progressive slowdown was not due to the complexity of the issues, but to a weakening of popular support for the reforms. This was accompanied by the increasing power to intercede in the affairs of the financial industry that, after the crisis, was slowly moving forward.

Phil Angelides, chairman of the Financial Crisis Inquiry Commission, doesn’t have the same verve as Pecora. Yet, popular support for reform remains high, although the financial and economic crisis seems to be behind us.

Allegations of deceptive communications raised by the Securities and Exchange Commission against Goldman Sachs contributed to reigniting spirits. In these conditions, it is difficult for the representatives and senators who have to face voters in October to explain why they haven’t approved any reform. For this reason President Obama is pushing, realizing that he has before him this unique opportunity; if the reform does not pass by October, it risks never passing. Even Republicans, who up until now have opposed it at all costs, find themselves in difficulty. If they decide to filibuster, they risk finding themselves against public opinion.

A reform, therefore, is almost inevitable, but will it be good reform? For the most part, yes. The big step ahead contained in the proposal of the Senate is the obligation to trade the majority of the derivatives on the stock exchange, with settlement carried out by a third party. This increases the transparency of the system and improves stability. As is happening today for futures and options, the stock exchange where derivatives are exchanged will require sufficient margins to guarantee the solvency of these counterparts to avoid finding themselves in the situation of the group AIG, which required intervention from the American government in the amount of $180 billion.

Even establishment of an agency to protect the consumer is a good idea. The crisis was in part due to many families who took out mortgages under conditions that they did not understand. Just as the SEC was created to protect unsophisticated investors, it is right that there is an agency to protect unsophisticated debtors.

The other two parts of the reform are more controversial. The so-called Volcker rule, which prevents banks from engaging in trading activities, is the wrong response to a legitimate demand; that is, to limit the risk assumed by the banks. This crisis is not born out of the trading activities of the banks, but by the excessive exposure to subprime mortgages. The Volcker rule would not have avoided the crisis and risks aggravating costs to the banks.

But the most controversial aspect is that of the protection fund for big banks. This fund was created by imposing a tax on banks considered too big to fail. Even here, the proposal is made out of a more than legitimate need: to avoid future necessities for taxpayers to be called again to pay to save the banks. Imposing a tax that is independent of the assumed risk, however, just encourages risk-taking. The tax will make clear what the guaranteed institutions are. And these institutions will have every incentive to risk; if they are lucky they earn on their own, if they fail they pay the fund of protection. The opposition of the Republicans on this point is sacrosanct. Let’s hope that for once the bipartisan spirit will prevail, creating a better compromise. Everyone would be grateful. And not only in the United States.