10.03.2007

Speaking Truth to Power

Robert Kuttner's testimony yesterday to the House Committee on Financial Services:
The Senate Banking Committee, in the celebrated Pecora Hearings of 1933 and 1934, laid the groundwork for the modern edifice of financial regulation. I suspect that they would be appalled at the parallels between the systemic risks of the 1920s and many of the modern practices that have been permitted to seep back in to our financial markets.

Although the particulars are different, my reading of financial history suggests that the abuses and risks are all too similar and enduring. When you strip them down to their essence, they are variations on a few hardy perennials – excessive leveraging, misrepresentation, insider conflicts of interest, non-transparency, and the triumph of engineered euphoria over evidence.

The most basic and alarming parallel is the creation of asset bubbles, in which the purveyors of securities use very high leverage; the securities are sold to the public or to specialized funds with underlying collateral of uncertain value; and financial middlemen extract exorbitant returns at the expense of the real economy. This was the essence of the abuse of public utilities stock pyramids in the 1920s, where multi-layered holding companies allowed securities to be watered down, to the point where the real collateral was worth just a few cents on the dollar, and returns were diverted from operating companies and ratepayers. This only became exposed when the bubble burst. As Warren Buffett famously put it, you never know who is swimming naked until the tide goes out.


Not that those idiots in Congress will understand it, much less act on it against the interests of their Wall Street campaign contributors.

I'm all for unregulated, free-market capitalism, but that's not what we have. What we have is no regulation, and an implicit government promise that the Fed/ GSEs /Bush /Congress will bail out the speculators any time they get in trouble. If the taxpayer is always going to be on the hook to bail out speculators, we need to regulate the risks we are signing up for.

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