BEWARE Do NOT Trust Paulson's Plan to "Protect" and "Regulate"

To the details—Remember where we are: we’ve had years of misguided confidence that investment banks could be left to their own devices, that the wonders of the originate-and-distribute model meant Things Were Different This Time. Specifically, the powers that be believed that risks were so widely spread and diversified that the financial system was now much more resistant to systemic shocks. We’ve seen what a crock that idea was.”

It is just possible that Bush’s successor—Obama or Clinton—will see through this charade, although Hillary has already proposed a Blue Ribbon type commission with former Fed Chairman Alan Greenspan and others whose policies led to the crisis. (Her campaign manager Maggie Williams has now been linked to a defunct mortgage company making subprime loans.)

John McCain has not only admitted he knows nothing about economics, but has advisors whose free market theology seems to be to the right of Paulson and the Fed’s Ben Bernanke who some conservatives fear are already meddling too much in the economy. His key advisor, former Texas Senator Phil Gramm, a Democrat Turned Republican shilled for predatory lenders for years, even denouncing a housing activist as a “terrorist.”

Obama also has a sub-prime link through his Finance Chairman Penny Pritzger who ran a Chicago bank that imploded and owes the government and depositors hundreds of millions. Nevertheless, economics writer Robert Kuttner feels Obama’s ideas, spelled out in a speech last week, are evolving in a progressive direction:

“The speech also showed real understanding and subtlety in grasping how financial ‘innovation’ had outrun regulation, as well as a historical sense of the abuses of the 1920s repeating themselves. Obama is one of the few mainstream leaders — Barney Frank is another — calling for capital requirements to be extended to every category of financial institution that creates credit. This is exactly what’s needed to prevent the next meltdown, but if it were put to a vote now, it would be rejected by legislators from both parties because they are still in thrall to market fundamentalism and Wall Street. That’s where presidential leadership comes in.”

The only candidate challenging the Fed directly has been Congressman Ron Paul, who has been more of a maverick than McCain who loves that title.

We know that those who fail to remember history are doomed to repeat it. The Times article reports:

During the Great Depression, Congress forced the separation of the investment banking and commercial banking industries and set up different regulatory systems for each, which seemed appropriate since the government guaranteed deposits in commercial banks but provided no similar benefit for investment banks.

The wall between the two businesses eroded and was eventually taken down by Congress in the 1990s, and the Bear Stearns case indicates that, at least for some investment banks, the risk of a default is too great to allow.

But the Paulson proposal would not give regulators new powers over other investment banks. The proposed prudential regulator would not have authority, since there is no explicit guarantee of its liabilities, and the Fed would be expected to step in to limit risk taking only if the stability of the financial system were threatened.

The proposal also calls for an early merger of the S.E.C. and the Commodities Futures Trading Commission, reflecting the reality that the markets and products they regulate often overlap or compete with one another. The Treasury wants to assure a combined agency would adopt the gentler regulatory approach of the C.F.T.C., which has exempted from regulation many derivatives products that are traded over the counter. The plan also would eliminate the Office of Thrift Supervision, which now oversees savings institutions.

I don't trust this merger. I am certain that the result will lead to LESS regulation, less accountability.

Barney Frank should be VERY careful about this business. He runs a powerful committee and he better keep a very close eye on this. Trillions are riding on his ability to remain independent and tough. This is so big that I sure hope there are independent watchdog organizations looking over Franks shoulders. The temptation to give these huge financial operations with their many tentacles of lobbyist and other influence will be great. Frank could be a hero here or the next Duke Cunningham. I have not reason to suggest that he has currently done anything wrong, but I worry that he's already gone on the record with some positive feedback to Paulson, saying, “It’s a recognition, maybe a reluctant one, that you have to enhance regulation." Sorry congressman Frank, but it is merely the appearance of regulation.

Finally, it will be interesting to see if any of the mainstream media do anything more than stenographically report Paulson's plan. There should be plenty of questions.

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