Thursday, December 31, 2009

Wall Street Is Next

by Richard Crews
The picture we hold of the economic aspects of community life has propelled civilization to new heights. What new heights? Communication, transportation, and trade have become worldwide and facile. Science and technology have enormously expanded our understanding and manipulation of the natural world. Human rights have become enhanced, and their abuses more subject to scrutiny and outrage. Civilization has indeed advanced to new heights in recent years, and its advance continues.

What are the modern economic aspects of community life on which the advance of civilization depends?

Many people who labor--who till their fields, or build or transport or otherwise expend their life energies for the shared benefit of others--largely consume their rewards: they and their families eat, live in, wear, or otherwise dispose of the benefits that accrue from their life activities.

But as communities have become larger and more complex, they have developed communication and protection mechanisms that enable people to labor in increasingly varied and specialized ways, thereby multiplying their productivity or "reward ratios," that is, increasing the amount of value they reap for the efforts they expend. Thus many people have become wealthier.

As people become wealthier, what lies beyond survival and maintenance? Savings (and increased safety, for example protection against a poor harvest or ill health), comfort (and luxury), and expanded influence (that is, power); beyond these also lie expanded identification with aesthetic and humanitarian values (manifested economically as patronage and philanthropy).

Some institutions of society function explicitly to leverage wealth. For example, people put money in banks so it can be pooled and loaned out to others. Similarly, when people buy stocks, they essentially lend their money to entrepreneurs so those entrepreneurs can expand the scope and cleverness of their activities on society's and investors' behalf.

The custodians and administrators of institutions that leverage wealth must earn our trust. But, just like us, they are human beings, so they are subject to greed (and other distortions of their activities from self-interest) and complacency (boredom, and short-cutting for convenience). Therefore, their activities on our behalf must be transparent, that is, these individuals must keep clear track of what they do (by using standardized accounting procedures) and be responsible (or "accountable") to empowered regulatory authorities who are independent (in other words, who do not have the same conflicts of interests as the people and institutions they oversee).

Leading up to the financial debacle of late 2008, several of these basic principles were ignored or violated. Accounting (for example, of credit default swaps and of derivatives of derivatives) was not clear and available for regulatory scrutiny. Regulatory (including rating) agencies had conflicts of interests--in some cases they were supervised by the very people and organizations they oversaw; in some cases their fees depended on the decisions they made. Moreover, they were under-staffed and under-empowered, and in pursuing their responsibilities, they were under-aggressive; people wanted to believe that markets self-regulate (for the convenience of complacency); optimism and denial reigned.

In July 2009 the Obama administration proposed a series of corrective regulations--increased transparency of accounting; increased staffing, empowerment, and autonomy of rating and regulatory agencies; requirements for increased capitalization and decreased leverage; etc. However, over the ensuing five months there were two significant developments--Congress became preoccupied with health-care legislation (which Obama at first insisted they complete before leaving for their August break), and the financial sector recovered--even boomed--following federal bailouts and hand-holding.

As a result no substantial financial regulatory legislation was passed, and now that return to the problem is imminent, banks and other financial institutions are in a reawakened, restrengthened position to resist any significant reform. Moreover, now that the 2010 elections are on the horizon, Congress is increasingly susceptible to campaign-finance arm-twisting.

This problem--that is, passing legislation to provide expanded financial regulations--will present an interesting and severe next challenge for the Obama administration.