Obama and Financial Regulation

5 Jul

Over at Naked Capitalism, Yves Smith reposts an argument that, early in Obama’s administration, there was a “crucial window of opportunity” to seize on popular discontent and regulate the financial industry in a way that could have reduced the systemic risks that brought the economy to its knees. Instead, “Obama failed to act” and, even more problematically, turned to what appears rather disturbingly to be a propaganda campaign to promote his non-reform. The propaganda pivots on what Smith deems the “Theory of Positive Thinking,” or the theory that, so long as everyone’s expectations are optimistic, the market will continue to grow. The real economy doesn’t work that way, but Obama chose this path.

Smith’s indictment is powerful, but it under-estimates the magnitude of the problem involved in re-regulation. We are the last to let Obama off the hook, and he has received too many passes from supporters who think that, deep down, there is some kind of lefty who is simply stymied by the limits of American politics. In that argument, the wish is father to the thought. However, in the case of financial regulation, it is worth recalling some of the reasons why the issue can’t be reduced to the political will of a president willing to seize on the very amorphous and contingent discontent of the public.

First, it’s worth recalling that loosening the reins on finance and promoting the expansion of credit (especially mortgages), through low interest rates, Clinton’s decision to allow Fannie Mae/Freddie Mac to finance sub-prime mortgages (1995), de-regulations like the Gramm-Leach-Bliley Act (1999), Commodity Futures Modernisation Act (2000), and the 2004 SEC decision to raise debt-to-capital ratios, were all part of a particular kind of social compact. Various observers have noted that financialization of the American economy begins to pick up just as real wages begin to stagnate in the mid-1970s. Here is a graphic on stagnating wages:

Compare with various figures showing starting in the late 1970s. The Economist, for instance, observes that consumer debt went from 100% of household income in 1980 to 173% in 2009. Basically, the post-1970s downturn social model was to keep consumption levels high through the expansion of credit, rather than by maintaining the ability of workers to compete for their share of the actual social product. (It’s no accident that unionization and strikes – key methods for keeping wages and benefits high – have declined). For this kind of expansion of credit, especially in key areas like home loans and credit cards, de-regulation was required, not to mention lax oversight and a general social willingness to allow bankers to play.

To be clear, this is not a point about fairness, social justice or any other kind of moral judgement about whether this was a good way of dealing with the crises of the 1960s and 70s. It’s just a point about the way the actually existing accord appears to have worked. The upshot is that re-regulation implies a kind of transformation of American society not just the economy. It would require making a decision to go for a different kind of accord between the various interests in society, and that is not something that Obama can manage single-handedly. It’s evident he doesn’t have the stomach for even the first baby steps. The Employee Free Choice Act is tabled, Obama wants to talk about stock markets not job markets, and nobody wants to talk about real wages.

On top of everything, even if someone decided to tackle the problem of coming up with a different kind of social model, there are the global imbalances that would also have to be managed. An excellent paper by Anush Kapadia and Arjun Jayadev reminds us that the difficulty in dealing with the financial meltdown comes from the overlapping layers of financialization and risk. Over the past decade, what has made possible low interest rates, cheap consumer goods, and thus debt-financed consumption are ‘global imbalances,’ or the way the Chinese have suppressed their own financial markets, instead cycling their profits into US T-bills. This keeps the dollar strong relative to the renminbi, and allows the US to run trade deficits (alongside Chinese trade surpluses). Here again, balancing out this dynamic would involve some development of Chinese financial markets, alongside higher domestic consumption in China, and meanwhile higher American savings and investment, but lower consumption. It’s hard to imagine a move like that, especially a globally coordinated one, especially given the implications that would have for the already struggling majority of Americans.

So, in sum, Smith is certainly right to point to the abject failure of leadership by Obama and the Democrats, especially in the early post-election days when there was indeed some kind of critical juncture, or at least minimal opportunity. Even in the small window available to them, the Democrats took conservative options. And the major strategy seems simply to be to kick the can down the road. But it’s also important to note the magnitude of the social and political problem, because it means the fight to craft a new order will involve some major major losers and winners. In that battle, it’s going to take more than amorphous public opinion to overcome well-organized interests.

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