Corporate Governance

Shock and Awe: From Massachusetts to the Obama ?Volcker Rule? (Part 2 of 10)

By Jennifer S. Taub

The Need for Financial Regulatory Reform
Boom and bust cycles are not necessary attributes of a healthy, stable economy. After the New Deal legislation was enacted following the Great Crash of 1929, the United States managed to exist for nearly 50 years without a major panic or crash. By the 1980s, the regulatory structure needed some updating. Cracks in the foundation appeared with the S&L Crisis of the 1980s and then later in the accounting fraud (Enron) meltdowns of the late 1990s and 2000s and the 1998 crash of giant hedge fund Long Term Capital Management. Each of these events should have served as warning signs that we needed to strengthen our regulatory supports so the whole edifice did not collapse. Instead, zealous advocates of unbridled free markets and unchecked managerial control (at the expense of good corporate governance, shareholder rights and systemic stability) influenced policy decisions and instead of repairing the vulnerable points, we weakened the supports. Don't just take my word for it. Read Alan Greenspan's testimony on this – he certainly had a turn-around after the 2008 meltdown. In addition, another good source on this is the Congressional Oversight Panel special report on regulatory reform or a draft paper of mine on this topic.

Additionally, after the massive up front and back door bailouts of the banking system (see Nomi Prins chart detailing the bailouts and subsidies), there is now what's known as an 'implicit guarantee' of giant banks. Because there is an expectation that the government will bailout these giant banks in the future due to their interconnectedness, their sheer size and the bad consequences of letting Lehman fail, these big banks can borrow money from private counterparties more cheaply than they should. This fuels growth and makes them even bigger. Thus one goal of the legislative reform is that 'too big to fail' should mean 'too big to exist.'  And, those who want to restore financial stability have also targeted the role of compensation systems in creating perverse incentives for short term, debt-fueled speculation and illusory short-term gains at the expensive of both long-term shareholder value and the stability of the entire financial system. This is but a very general overview, not a comprehensive list.

Full post as published by The Race to the Bottom on January 27, 2010 (boomark / email).