the truth is big business loves obama

"I'm generally supportive [of the financial reform bill]. To be sure, there are details of it that I think I'm less sure of, but I think, on the whole, financial reform is, absolutely is essential and I will say that last week, in New York, I listened to a speech by Barack Obama at Wall Street, and one of the points he made resonated with me because I’d said it myself. He said that the biggest beneficiaries of reform will be Wall Street itself.” 

- Lloyd Blankfein, CEO Goldman Sachs (Homeland Security & Government Affairs, Permanent Subcommittee On Investigations, U.S. Senate, Hearing, 4/27/10)

"We continue to believe that comprehensive health care reform will benefit patients and the future of America. That’s why we have been involved in this important public policy debate for more than a year and why we support action by the House to approve the Senate-passed bill along with the amendments found in the reconciliation legislation."

- Official Statement of the Pharmaceutical Researchers and Manufacturers of America (PhRMA), is the largest single-industry lobbying group in America on 3/21/10 regarding Obamacare.

"Climate legislation is one of the critical issues that will be considered this year on Capitol Hill.  The House passed the Waxman-Markey legislation, a comprehensive, economy-wide bill [that] represents a moderate approach that was supported by a wide range of major American companies who make up the US Climate Action Partnership – including companies with a strong Indiana presence such as AES, Duke Energy, Alcoa, Dow, DuPont, GM, Ford, and Chrysler . . . Exelon has been preparing for a low-carbon future for the last decade. [We have] [s]old or closed most of our inefficient fossil fuel plants, [i]nvested billions in our fleet of 17 zero-emission nuclear reactors. In summer 2008 [we] released Exelon 2020, our plan to reduce, offset, or displace 15 million metric tons of greenhouse gas emissions per year, equal to our 2001 carbon footprint, by 2020. We are one-third of the way to our goal, and have a plan to accomplish the rest."

- John Rowe, CEO Exelon Energy (Indiana Council on World AffairsMarten House Hotel, Indianapolis 1/20/2010)

So if you listen to any cable news network or read most any paper all you here is how Obama is "anti-business" and that it is for this reason that the economy is slowly recovering.  Well that is only a half truth in my opinion.  I don't think Mr. Obama is anti-business per se, although I do believe that he is anti-market, which is actually profoundly worse than being anti-business.  The three quotes listed above are all attributable to big business heavyweights: Blankfein is for financial reform, the PhARMA lobby was all for Obamacare and Exelon, one of the largest power producers in the midwest and mid-atlantic (the coal region), wants nothing more than a full cap and trade system.  Does any of this make sense?  Why would a financial giant like Goldman Sachs want more financial regulation?  Why would a power company that produces a majority of its power on fossil fuels want to have the price of those fuels increased dramatically?  The answer is easy of course: they see a future with less competition.

Take financial reform for instance.  Now I understand and agree that any sound financial system must have rules of the road.  However, I firmly believe that the rules should be clear and must be debated before they are enacted.  This is the opposite of what occurred in the Dodd-Frank Bill. There are no new clear cut leverage requirements, there are no new clear prohibitions on proprietary trading.  There are just directives.  These directives either require or authorize incompetent agencies like the SEC to issue rules it thinks are appropriate.  In total the U.S. Chamber of Commerce estimates that Dodd-Frank authorizes a total of 533 rules to be written over the next few years.  Are some of these rules probably necessary?  Of course, but instead of being written by the Congress in the full purview of the electorate they are going to be written in closed door meetings were you need to pay to play.  I bet Mr. Blankfein knows this and is happy about it.  Few firms have the regulatory, compliance and lobbying staff to compete with Goldman Sachs when the task becomes influencing the inept government agents writing these rules.  They will invariably benefit the biggest and most connected of the banks at the expense of their smaller competitors, hence their support for financial reform.  

The same can be said about Exelon's desire for cap and trade.  As Mr. Rowe mentions in his speech, Exelon has been moving away from carbon based energy for years now.  Exelon is a Illinois based power producer and was a major contributor to Barack Obama.  Now they want their reward.  Instead of having to compete on a level playing field where consumer demand requires energy companies to be as efficient and cost-effective as possible, Exelon wants the Obama administration to price its competition out of the market.  It's whole business model over the past few years is that it is trying to get into a position of strength by lowering its carbon footprint ahead of the U.S. legislation so that it could put its boot on its competitors once their costs were artificially higher because of diktats from Washington.  Now that cap and trade seems dead that are literally shitting their pants and demanding even more intervention from Washington on their behalf.  Notice how the other companies named in Mr. Rowe's comment are all major corporations with huge lobbying arms.  Their support is predicated on the belief that they will be able to influence who gets "free credits" and what parts of industry will be "exempt."  That sure is one way to compete effectively.

What these examples show is that government intervention in the economy always produces winners and losers.  For the most part the interventions most favored by Mr. Obama undoubtedly favor the largest and most connected businesses in the industries affected.  Be it the hundreds of new rules in Dodd-Frank that have yet to be written or the onerous requirement that all business entities must now file a 1099 for every supplier with whom they purchase over $600 per year in goods (courtesy one of the many unread provisions in Obamacare), red tape and government regulation most favors the largest firms with large legal departments and the funds to spend on lobbying.  Small businesses, the real economic and job growth engines in our society, have neither of those advantages.  They are forced to play by the rules negotiated by their larger competitors.  Usually this is to their disadvantage.  These same small businesses are not hiring for this exact reason.  

There are three costs that almost all small businesses face regardless of their type of business: the must pay for energy, they must pay for credit, and they pay for health care for many of their workers.  Under Mr. Obama's polices the price for all three is going up.  Throw in the fact that tens, if not hundreds, of thousands of these small business owners, who are often organized into partnerships, limited liability companies or Subchapter S Corporations, are about to see their taxes increased at the end of the year, it is completely logical that they are not hiring or expanding.  The best thing Mr. Obama could do to help the businesses is to be "anti-business" and instead be "pro-market."  Let them compete effectively with their larger competitors and stop disadvantaging them by enacting "reforms" that put these competitors in a position to write the rules of the game.  These businesses don't want handouts and special privileges, just the opportunity to compete fairly and let the market decide who has the best product.

why the current financial reform proposals are fundamentally flawed

Last night GOP senators blocked an attempt by the Democratic majority to bring Chris Dodd's (D-CT) financial reform bill the the floor of the Senate so that it could be debated and voted upon.   Majority Leader Harry Reid has already said that he would bring the bill back to the floor for another cloture vote this afternoon.  Democrats are attempting to characterize this GOP opposition as purely political: according to their storyline the Republicare in the bed with the likes of Goldman Sachs and are only attempting to block reform so that they can increase their campaign contributions.  This blatant partisan attack does little more that distract from the substance of the bill, and I have no doubt that the Democratic attacks are designed to do just that.  Anyone who has followed the housing and financial markets over the past decade understands that one of the major causes of the financial crisis were some of the policies enacted by Dodd's Banking Committee and his counterpart in the House, Barney Frank (D-MA).  Obviously neither man admits any of this, and their financial reform bill does nothing to stop many of the practices that led to the housing bubble.  So, in the interest of having a informed debate, rather than one of rhetoric, I will lay out may objections to the current financial reform proposal and explain how I would address the problem instead.

From what I can tell, Dodd's bill has three major sections: 1) The creation of a Consumer Financial Protection Agency that will regulate the so called "predatory lending practices" that dooped so many people into buying homes they couldn't afford and spending to much money on their credit cards; 2) Ends the over-the-counter treatment of most derivative investment contracts (CDOs, MBSs, etc.) by forcing them to be traded on an exchange; and 3) Creating a "Resolution Authority" within The FDIC that would be capable of dissolving banks, bank holding companies and other financial institutions deemed to be a systematic risk if they fail.  Man that is some exciting stuff.  Now you can see why it is so easy for the Democrats to claim that this is major reform because 98% of Americans have no idea what any of these things mean.

Starting with number one, my basic beef with the Consumer Financial Protection Agency is that it even if one was in place prior to the recession, it probably would have done very little to help stop the financial crisis.  We all now agree that many people were taking on more loans that in retrospect they could not afford.  This was based on the faulty presumption that the housing market would continue to climb in value, and that even if borrowers were paying very high interest rates after the teaser rate of a sub-prime or Alt-A loan expired, this imbalance would more than be made up for by the increase in equity owned by the homeowner based on the home's increased value.  Presumably he could use this increased equity to refinance if payments could not be met.  Well guess what?  The market fell out, and now many homeowners owe more than the total equity value of their house.  This makes defaulting a rational decision in many cases. 

So according to the Democratic pundits the Consumer Protection Agency would have stopped these bad loans from happening and all would be well.  BULLSHIT.  If there is one thing that is true about all governmental regulators it is that they are backward looking.  All regulators were created because of some event in the past that caused a large amount of financial hardship.  The regulators attempt to stop that specific type of situation from happening again.  The sub-prime crisis was a novel problem in the financial markets.  The very large majority of people, including many sophisticated investors who are much smarter and more savvy than any potential regulators, did not see it coming and lost A LOT of money.  When people lose that much money, then it is a sign that the downturn was very hard to foresee.  It is easy in hindsight to try and stop things that have happened in the past, but in reality it is impossible to predict the problems that will arise in the future.  The next "crisis" will probably have nothing to do with the mortgage market, and even if it did the CFPA would probably fail to stop it anyway.  This really is about a government power grab, so that the government can set all the applicable rates and provisions of almost any financial deal.  They will outlaw certain kinds of loans, favor others, and basically attempt to micromanage decisions that should be made of individual, case-by-case basis.  As is always the case, lobbyists will have a field day because their clients will want to get tight with the regulators so that their offerings will get preferred treatment over that of a competitor.  This will inevitably lead to crony capitalism at its worst.

Secondly, I really think that derivative contracts have gotten a bad name from all of this.  Yes, I ONE HUNDRED PERCENT AGREE that the proliferation of mortgage backed securities and credit default swaps (which were instruments that were intended to spread risk) led to a situation were counter parties were dependent on each others' solvency.  However, why, fundamentally, is this a bad thing?  Because it leads to "too big to fail" says Paulson/Bernacke/Geithner/Summers.  No it does not.  Period.  No one, and I mean no one, is too big to fail.  Let's look at what happened to Lehman Brothers.  They failed.  They went bankrupt.  Did it have an extremely negative impact of financial markets?  Of course.  Credit was extremely hard to find, people started calling debts and most firms had short term liquidity issues.  Did it lead to the end of the world?  No.  That is because we have a bankruptcy system in this country for a reason.  Just because Lehman was forced to take huge losses and dissolve does NOT mean that the good assets of the company went away.  Lehman provided many profitable services and products even up to and after its bankruptcy.  These sectors were sold off during their bankruptcy to help pay off creditors and finance losses in other business areas.  To this day I am not convinced that AIG/Goldman Sachs/CitiBank bankruptcies would have led to the end of the world.  Are you?  Would things have been bad for a while?  Yes, but they are also very bad right now.  But what happens when you allow of a market correction rather than a bailout is that you get the bad assets out of the system immediately.  Instead, we prolonged the problem and helped pass it on to our kids through ridiculous amounts of debt.  In a non-bailout world, the smart firms who could afford to buy up Goldman's bad assets in  bankruptcy would be the ones with market share today, and the moral hazard of bailouts would be eliminated.  Nothing sends a better signal to market actors to rethink their positions than the knowledge that they bare both the risk of failure and are entitled to the benefits of success.  Instead, we rewarded failed firms that that in retrospect misused many derivatives to the detriment of firms that did not.  No amount of regulation of derivatives would do more to temper there use than allowing firms that use them in ultimately unprofitable ways to fail, just like any other multiparty contracts. 

Additionally, derivatives serve many important roles in the financial system such as providing a hedge to risk.  A lot has been made about Goldman's supposed "fraud."  That type of "fraud" (selling a security to two sides: one side with a long position, one side with a short position) helps drive markets to their true value by increasing total information built into the product prices.  Even if people were using derivatives to bet against the housing market, that is a good thing.  It shows that people believe prices are overvalued, helping to deflate the bubble earlier than it would have been absent the derivative trades.  Rather than forcing all derivatives to be traded on exchanges, counter-party solvency and fear of default would provide enough incentive for firms to contract accordingly.  That is only true, however, if firm failure is an option.

Lastly, and in my mind most importantly, is the resolution authority granted to the FDIC.  First, you just read my take on too big to fail, but that doesn't mean that we currently have a perfect mechanism for dissolving failing financial firms.  We don't.  But the best place to do that is in a bankruptcy court, which can provide at least a little bit of insulation from political interests interfering with the process.  But anyway if all the bill did was to create this resolution authority for the purposes of liquidating of a firm entering resolution, that wouldn't be too bad.  However, the Dodd bill gives the FDIC clear authority to engage in loan guarantees during a crisis for any company deemed to be systemically important to the financial system.  This is a bailout authority for creditors in addition to the resolution authority!!!!!  The FDIC can accept any collateral it chooses to borrow up to 90% of the assets value to provide guarantees for for these companies creditors.  And nowhere in the bill does it say that these guaruntees must be made equally and fairly for all creditors.  WE ARE JUST ASKING FOR THE SAME KIND OF FAVORITISM SHOWN TO CREDITORS IN THE CHRYSLER/GM BAILOUTS.  This is simply unacceptable.  Obviously it makes legislators' jobs very easy to simply leave it to the FDIC to determine how and when to exercise this authority, but this puts the the U.S. taxpayer on the hook for the mistakes of political favorites.  For example, take CitiBank.  If the FDIC had used this authority to bailout Citi's creditors it could have borrowed up to $1 trillion. 

Finally, it is absolutely ridiculous that the role of Fannie Mae and Freddie Mac played in the financial crisis is completely ignored in the bill.  Together the two firms have already borrowed $125 billion from the feds and the Congressional Budget Office predicts they ultimately will drain $380 billion.  This is far more than any of the TARP expenses for all the financial firms and auto makers combined.  And we probably have no chance of ever being repaid.  Almost of these losses were realized because of a misplaced government mandate that Fannie and Freddie provide loan guarantees to spur home ownership among low income individuals.  These companies were a moral hazard in the housing market.  They were implicitly backed by the government and were more than willing to back some of the riskiest loans in the housing market.  But alas, they are ignored in the legislation..  Hopefully, the CFPA will crack down on Fannie and Freddie's predatory lending practices.