The War Against the NEW DEAL Has Won an Astounding Victory

Submitted by SadInAmerica on Wed, 04/02/2008 - 2:22pm.

Is there anything the Republican Party loathes more than FDR and the New Deal?


How many times have people like Newt Gingrich and Grover Norquist vowed to dismantle the regulations, entitlement programs, and safety nets created by the New Deal? Time and again we've seen assaults on all aspects of FDR's legacy, including a Social Security "reform" effort in 2005 that might have succeeded if George Bush hadn't been hobbled by the Iraq War.

Last month the Republicans had a great victory in their effort to undo the New Deal, by eliminating completely any distinction between commercial banks and investment banks, while at the same time giving investment banks unfettered access to the public treasury with none of the responsibilities or burdens placed on commercial banks. All of this was accomplished in the same way as 9/11 allowed the administration to claim unheralded executive powers - by using an "emergency" to justify a power grab perpetrated with no reference to you the taxpayer, or your representatives in Congress.

To understand the magnitude of what the Republicans have done, we must look back at the 1930's reforms enacted in response to the Depression. The stock market crash and subsequent collapse of hundreds of banks in the U.S. resulted in a series of legislative and regulatory reforms. Investment banks were restricted to bringing bond and stock issues to the capital markets. They were not allowed to have checking or savings accounts for individuals, and they were regulated by the Securities and Exchange Commission. This new regulatory agency has concentrated throughout its existence on protecting the rights of investors, and has not exercised a heavy hand over the investment banks unless they are found to defraud or violate investor's interests.

Commercial banks were put under the strict supervision of the Federal Reserve and the Comptroller of the Currency. Regulation in this case involved extensive and intrusive inspection of banks to ensure their safety and soundness. These two regulators were joined by the Federal Deposit Insurance Corp., which took over failing banks and paid out depositors up to $100,000. The FDIC insurance for depositors helped prevent bank runs, and the close supervision of the regulators ensured that banks were not exposed to undue credit, market or other risks. The Fed had the authority to lend money to banks in the event they got into trouble, and this "lender of last resort" power has also been a significant comfort to the public when any question arises as to a bank's survivability.

The investment banks have never had this lender of last resort protection, which involves access to the Fed's discount window for loans at the cheapest rate in the market. If investments banks have gotten into trouble, they have had to turn to commercial banks for lines of credit, without which the investment bank could fail. This is what happened to Drexel Burnham and other over-extended investment banks - they failed because commercial banks no longer supported them with credit, and because they could not turn directly to the Fed. This second class citizenship has always rankled the investment banks.

On the other hand, the investment banks never had to face up to rigorous Federal Reserve examinations, with examiners poring over every loan and transaction, demanding improvements, and even requiring management changes if necessary (such is the price of maintaining lender of last resort access). Commercial banks have been restricted by Fed regulation to maintaining a 10:1 ratio of assets to capital. Investments banks have no such restrictions. They have routinely carried leverage ratios of 30:1, meaning they can generate vastly more profits than commercial banks, and pay out much higher bonuses.

Investment banks have tried mightily to invade commercial banking business, dating back 30 years ago when Merrill Lynch first introduced the money market account, which acted just like a checking account but with no FDIC insurance. To assuage public fears about default risk, investment banks set up their own insurance fund that mimics FDIC insurance. This however, still did not give them access to the discount window or lender of last resort privileges.

All that changed last month. The most significant thing that happened during the Bear Stearns crisis was not the collapse and rescue of Bear Stearns by the Fed - it was the extension of discount window and lender of last resort privileges to the investment banks. The holy grail long desired by the investment banks has now been achieved, thanks in no small part to the initiatives of one of their own - Henry Paulson - Secretary of the Treasury and former Goldman Sachs executive.

Notice that the Fed and the Treasury deliberately withheld from the management of Bear Stearns any clue that the discount window privileges were about to be extended to investment banks. Had Bear Stearns management known this, they most certainly would have demanded such privileges and been much more hesitant to agree to the Fed rescue orchestrated with JP Morgan Chase. It is clear that the Treasury wanted to force Bear Stearns out of business, even if the collapse in value of the firm shocked the market, just as the Treasury wanted to open the discount window to Morgan Stanley, Goldman Sachs, Lehman Bros., and Merrill Lynch. Don't believe what you read about this measure being "temporary" - this is obviously a permanent boon granted to the very firms that are otherwise bankrupt by mortgage securities losses which have wiped out their capital.

We have learned two other surprising bits of information this week. The Fed has guaranteed $29 billion in losses that may be incurred by JP Morgan Chase in their purchase of Bear Stearns' assets, but the Treasury has issued very quietly a side letter to the Fed notifying them that they will be reimbursed by the Treasury for any such losses. Did anyone ask you - the taxpayer - for permission to use your tax dollars for this purpose? Of course not. All of these revolutionary changes are being done without your consent or that of Congress.

The second thing we have learned comes from Henry Paulson's proposal this week regarding reform of the regulatory system for financial firms. This "reform package" is dressed up to look like it is going to give the Fed much more power to regulate the investment banks, now that they have all the protections of commercial banks. But this is far from the truth. Paulson proposes to expand the Fed's franchise as to which financial firms it can look at, but at the same time - and this is very crucial - the Fed is to be stripped of its power to exercise day to day oversight. No more extensive examiner audits or regulatory directives for commercial banks or anyone else. Fed supervision will be like SEC supervision - regulatory light practices of the type that allowed the investment banks to balloon their balance sheets, ignore fundamental risks, reap obscene profits, and then raid the public treasury when things went wrong.

A lot of the New Deal regulations governing investment and commercial banks were dismantled when the 1999 Gramm-Leach-Bliley Act was approved by Congress and signed by President Clinton. This allowed each side to undertake the business of the other, but the fundamental distinction regarding lender of last resort privileges was maintained. Now it is gone in a breathtaking act of executive power that was disguised as a response to the desperate situation at Bear Stearns. We might say instead that Bear Stearns was sacrificed to provide the remaining investment banks with something they always desired - parity with commercial banks with none of the burdens or responsibilities.

While the press likes to portray the Bear Stearns rescue as a triumph for the Fed and enhancement of its powers, quite the opposite has happened. Paulson has attacked the Fed outright with his threat to reduce its supervisory authority, and by extending the franchise to buccaneer investment banks that have virtually no controls imposed on them, he has forced every commercial bank to ask why they should put up with any more Fed examinations. The Fed has been seriously undermined in front of its own banking constituency, never mind the public disgust with a bail out of billionaire investment bankers.

It has been a very good month for the ideologues in the Republican Party who have despised all attempts to protect the public interest at the expense of the prerogatives of the wealthy or of the corporations they manage. In turn, it has been a dismal month for American citizens, and we can only look with foreboding on the long term and terrible consequences consumers will face because of these actions.


Numerian - April 1, 2008 - posted at

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Submitted by SadInAmerica on Wed, 04/02/2008 - 2:22pm.