Testimony of Robert Kuttner Before the Committee on Financial Services U.S. Ho... - The Diigo Meta page

• 14 Oct 07
  

  Bill H

  post sub-prime

  • My name is Robert Kuttner. I am an economics and

     

    financial journalist, author of several books about the economy, a magazine editor, and

     

    former investigator for the Senate Banking Committee.
  • I devoted a lot of effort to reviewing the abuses of the 1920s, the

     

    effort in the 1930s to create a financial system that would prevent repetition of those

     

    abuses, and the steady dismantling of the safeguards over the last three decades in the

     

    name of free markets and financial innovation
  • The Senate Banking Committee, in the celebrated Pecora Hearings of 1933 and 1934,

     

    laid the groundwork for the modern edifice of financial regulation.
  • 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.
  • A second parallel is what today we would call securitization of credit. Some people think

     

    this is a recent innovation, but in fact it was the core technique that made possible the

     

    dangerous practices of the 1920. Banks would originate and repackage highly speculative

     

    loans, market them as securities through their retail networks, using the prestigious brand

     

    name of the bank – e.g. Morgan or Chase -- as a proxy for the soundness of the security.
  • It was this practice, and the ensuing collapse when so much of the paper went bad, that

     

    led Congress to enact the Glass-Steagall Act, requiring bankers to decide either to be

     

    commercial banks—part of the monetary system, closely supervised and subject to

     

    reserve requirements, given deposit insurance, and access to the Fed’s discount window;

     

    or investment banks that were not government guaranteed, but that were soon subjected

     

    to an extensive disclosure regime under the SEC.
  • repeal of Glass Steagall in 1999
  • A third parallel is the excessive use of leverage.
  • If you thought the

     

    market was just going up forever, you could borrow most of the cost of your investment,

     

    via loans conveniently provided by your stockbroker. It worked well on the upside. When

     

    it didn’t work so well on the downside, Congress subsequently imposed margin limits
  • The fourth parallel is the corruption of the gatekeepers
  • Yet another parallel is the failure of regulation to keep up with financial innovation that is

     

    either far too risky to justify the benefit to the real economy, or just plain corrupt, or both
  • A last parallel is ideological -- the nearly universal conviction, 80 years ago and today,

     

    that markets are so perfectly self-regulating that government’s main job is to protect

     

    property rights, and otherwise just get out of the way.

    • And may be this is the key point. Achieving an optimal stae cannot be realized without some sort of feedback on past performance. if the past performance is not aligned with accountability then there in lies the problem.
    Add Sticky Note
  • Financial regulation was pro-efficiency.
  • Fed races to the rescue
  • it bails out the

     

    speculative system, so that the next round of excess can proceed.
  • So when things are booming, the financial engineers can advise government not to spoil

     

    the party. But when things go bust, they can count on the Fed to rescue them with

     

    emergency infusions of cash and cheaper interest rates.
  • So the point is not that the Fed should let the whole economy collapse in order to teach

     

    speculators a lesson. The point is that the Fed needs to remember its other role – as

     

    regulator.
  • So we need a careful examination of better ways of holding managers accountable
  • “The economic fundamentals are

     

    sound.” Those same words were used by President Hoover and the captains of finance, in

     

    the deepening chill of the winter of 1929-1930.

  17 more annotations...

Public Stiky Notes

• 
  Bill H on 2007-12-19
  And may be this is the key point. Achieving an optimal stae cannot be realized without some sort of feedback on past performance. if the past performance is not aligned with accountability then there in lies the problem.

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