OP-ED: Time To Seize The Moment And Re-Regulate The Banks
By Sam Pizzigati
Editor, Too Much
Special to PAI
WASHINGTON (PAI)--The former chief economist at the European Bank for Reconstruction and Development is urging lawmakers worldwide to “seize the moment” and re-regulate global banking “before the defenders of the financial status quo are able to collect themselves and launch a massive PR campaign to close the door on radical reform.” And it looks like the Obama administration is thinking big -- and along the same lines as the noted economist.
Among the radical reforms Willem Buiter proposed in a Financial Times paper: Shareholder “say on pay” with real teeth. In the U.S., many reformers, led by union pension funds, want to give shareholders the right to take “advisory” votes on executive pay. Buiter says shareholder votes, to be effective, need to be binding.
In other words, if shareholders vote to throw the bums out, throw the bums out.
And Buiter has an even better idea: If shareholders vote down an executive's pay package, the “default remuneration package” that goes to that executive must not “exceed that of the head of government.”
In one stroke, that would slash execs’ big pay and perk packages -- running into millions of dollars -- down to a manageable size, like the $400,000 yearly Obama earns.
Buiter’s same “head of state” pay standard, says veteran Rep. Elijah Cummings, D-Md., ought to apply to the next CEO at AIG, the insurance giant taxpayers rescued last fall from the great global financial abyss. The U.S. now owns an 80% share of AIG.
Cummings wants the new AIG chief, whomever it will be, to take home no more than what the president makes. Two top business publications last week added to the growing consensus that excessive executive rewards have contributed mightily to the high-finance meltdown that drove the world into recession.
These are all ideas on compensation the Obama administration may be adopting.
Pay excess, The Economist magazine noted, gives financial executives “little reason to dwell on the risks associated with the deals that they were signing.” Those deals collapsed and took the economy with them.
And in The Wall Street Journal, former Federal Reserve Board vice-chair Alan Blinder zeroed in on what he called the meltdown’s defining “source”: “Give smart people go-for-broke incentives and they will go for broke.” And they broke us doing so.
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Can a book on derivatives be delightful? Les Leopold shows how, in The Looting of America: How Wall Street’s Game of Fantasy Finance Destroyed Our Jobs, Pensions, and Prosperity.
Like other great teachers, Leopold, founder of the Labor Institute in New York, loves metaphors to help latch on to realities. Leopold has been using metaphors for decades to help workers understand how our economy really works.
But two years ago, amid the gathering Wall Street storms, Leopold suddenly realized that, as a teacher, he really didn’t understand the high-finance “innovations” just then beginning to crash into the headlines: The CDOs and the swaps, the tranches and the quants. So Leopold set about to educate himself on Wall Street’s innards, and now he’s sharing what he has learned.
The book’s core, perhaps not surprisingly, revolves around a delightfully insightful metaphor. If you really want to comprehend how Wall Street melted down our economy, Leopold suggests, give a look at fantasy baseball.
In fantasy baseball, groups of baseball fans create their own “teams” and stock them with players they pick from lists of real-life baseball players. If the players you pick for your fantasy team do well on the real-life baseball diamond — if they hit lots of homers, for instance — your fantasy team will do well.
Your fantasy team, in effect, “derives” value from real baseball. But you have no actual relationship to this real baseball. Nevertheless, you can still make money, playing fantasy baseball, if the real-life players you pick for your fantasy team put up better numbers than the players your fantasy league competitors pick.
“In effect,” explains Leopold, “you are speculating on the stats derived from real major league players, but those players don’t know they’re playing on your team.”
This same sort of speculation, over recent years, has been driving Wall Street. We have “fantasy finance.” Bankers and traders created a sticky global web of “derivatives” — collateralized debt obligations, credit default swaps, and more — that bear the same relationship to the “real” economy as fantasy baseball bears to real balls and strikes. In other words, none.
In the “old” days, bankers and traders bought and sold claims to real things.
Owning a stock entitled you to a stake in a real enterprise. Holding a mortgage gave you a claim to an actual home.
In fantasy finance, bankers and traders don’t have to hold a claim on anything real. They buy and sell financial products that only “derive” their value from real economic activity. Bankers, for instance, can sell you a “derivative” that will rise in value if the price of oil goes up. They don’t have to own any oil to sell you this derivative. They can create derivatives based on anything, including derivatives of derivatives.
But the fantasy baseball metaphor, Leopold notes, only takes us so far. Fantasy baseball players don’t claim they’re “improving” baseball. And they can’t cause any great damage either. If baseball players go out on strike, fantasy baseball leagues simply grind to a halt. No big deal.
Fantasy finance, by contrast, involves trillions of dollars. And players of fantasy finance spent decades insisting the trillions help our economy by “spreading economic risk.” In fact, their derivatives ended up concentrating risk — and wrecked the economy.
At the root of all this fantasy: The concentration of America’s income and wealth that began in the 1970s. With so much money in so few pockets, our real economy couldn’t offer enough lucrative opportunities for the investor class. Wealthy investors would find those opportunities in fantasy finance.
The Looting of America traces how all this unfolded with clarity, wit, and patience. And hope. The bank bailouts and partial federal takeovers we’ve so far seen, Leopold points out, do help clarify the “fateful choices” we now face.
“We can hold onto and supervise the semi-socialized financial sector,” he notes, “or we can return the entire banking system to private investors. We can enact policies that allow workers’ real wages to rise. Or we can keep the wealth flowing upward to the super rich. We can put limits on financial engineering, or we can wait and see what the next orgy of fantasy finance does to our economy.”
Crucial choices. Thanks to Les Leopold, many more of us will understand them.

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