It's the Deregulation, Stupid

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Despite Bill Clinton's announcement that "the era of big government is over," it took the better part of his administration for him to push these initiatives through Congress. In 1999, Treasury Secretary Robert Rubin, always a good friend to Wall Street, finally brokered a deal between the administration and Congress that allowed banking deregulation to move forward. Shortly after the compromise was reached, Rubin took a top position at Citigroup, which went on to embark upon mergers that would have been rendered illegal under Glass-Steagall. As the New York Times put it, Rubin would be leading "what has become the first true American financial conglomerate since the Depression"—a conglomerate that could exist only because of legislation he had just shepherded through Congress.

Passage of the Financial Services Modernization Act of 1999 was celebrated in a Wall Street Journal editorial as an end to "unfair" restrictions imposed on banks during the Great Depression, under the headline "Finally, 1929 Begins to Fade." But Russell Mokhiber and Robert Weissman, writing in Mother Jones, warned that the legislation, which amounted to the "finance industry's deregulatory wish list," would "pave the way for a new round of record-shattering financial industry mergers, dangerously concentrating political and economic power." Mokhiber and Weissman also predicted that such mergers would eventually "create too-big-to-fail institutions that are someday likely to drain the public treasury as taxpayers bail out imperiled financial giants to protect the stability of the nation's banking system."

Enter Bear Stearns. In addition, the merging of commercial and investment banking helped enable high-risk mortgage lending to make its way into the mutual funds and 401Ks of millions of Americans in the form of mortgage-backed securities. "Diversifying bad debt just spreads the poison," as Frank said in his Boston speech. It also makes a falling housing market reverberate throughout the economy far more than it did even during the S&L collapse. Enter the subprime crisis. And welcome back, 1929.

As these new financial giants go into freefall, a little regulation once again sounds like a good idea, just as it did in 1933. But increased regulation will never come willingly from the Federal Reserve, an "independent entity" that is answerable to no one, and has always operated largely in the interests of the big banks that make up its membership and provide its funding. Under two decades of leadership by the notorious anti-regulator Alan Greenspan, the Fed took a hands-off approach, preferring to set "guidelines" for the financial industry rather than enforce rules. In December 2007, the New York Times compiled a rundown of the multiple warnings and pleas made to Greenspan, over a period of at least seven years, to address the dangers posed by subprime lending—all of them, of course, rebuffed by the man who still claims he couldn't have predicted that the housing bubble would someday burst. The Fed's approach is unlikely to change much now—at least, not without a fight.

The Federal Reserve is set up in such a way that Congress cannot force its hand. But it can apply pressure, by way of threatening to pass legislation to accomplish what the Fed refuses to do. That's what Barney Frank did last summer, when he thought Fed chair Ben Bernanke wasn't doing enough about predatory lending practices. "The Fed has the authority to spell out rules about what is unfair and deceptive," Frank said in an interview with Bloomberg News. "If by default the Fed is not in the process of doing it, we, I think, should pass a law giving the authority" to other government agencies.

Now, in addition to outlining a plan to deal with the epidemic of foreclosures, Democrats on the Financial Services Committee are looking at legislation that could force financial firms to sing for their supper—a few bars, at least. The Financial Services Risk Regulator proposed by Frank last week would have the power to demand "timely market information from market players, inspect institutions, report to Congress on the health of the entire financial sector, and act when necessary to limit risky practices or protect the integrity of the financial system." In return, he said, financial institutions would have "potential access to the discount window for nondepository institutions."

Frank was referring to the lending program for brokers started by the Fed on March 17, which extends the same lending rules previously employed by commercial banks to securities firms. Two days after it opened, Financial Week reported, under the headline "Investment bank CFOs Not Proud," that Morgan Stanley and Goldman Sachs had already overcome concerns that borrowing from the Fed might "make them appear financially weak," and had taken advantage of the discount window, at the new rock-bottom interest rate of 2.5 percent. So Barney Frank's modest proposal simply says that if the government is going to back loans to billionaire investment firms at rates that middle-class credit card holders can only dream about, the companies are going to have to submit to a little oversight in return.

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