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The New York Times


What Will Wall Street Look Like Next Year?

May 21, 2010

By Nicole Gelinas

A year from now, we’ll find Wall Street completing its transformation into a conduit not of markets but of politics. As financiers at companies like Citigroup and Goldman Sachs listen to what Washington wants, they will remain unable to respond to what the economy needs.

Over the past two years, Washington has veered inconsistently from financial bailout to financial sacrifice and back again. The government, under two administrations, has had no predictable way through which failed Wall Street firms could go bankrupt without endangering the entire economy.

Specifically, Washington has long allowed Wall Street to take on too much debt through “safe” derivatives and structured-finance transactions, usually related to homeowner or consumer borrowing. When it turned out those investments weren’t so safe, financial firms had taken on so much debt that they couldn’t go bankrupt without taking the rest of the economy with them.

That Washington had allowed this weakness to endanger the nation’s growth would be forgivable if Washington had since moved to fix it. But the financial-regulation bill that the Senate passed yesterday would do no such thing.

Nowhere does the bill call for consistent limits on borrowing — rules that would require financial firms to hold a certain amount of nonborrowed capital behind all debt or derivatives instruments. Such consistent rules would give the economy a necessary cushion against unexpected losses, preventing future bailouts.

Instead, the bill would leave these rules up to a new “financial services oversight council,” inevitably fallible regulators who would decide what is risky and what is not.

Wall Street will be able to game this new regulator easily. Financiers know that Washington has every motive to determine, for example, that home mortgages and consumer lending instruments are not risky, thus allowing Wall Street to create even more exotic financial instruments related to this type of lending. Such political-financial engineering comes at the expense of investments in longer-term projects that would create manufacturing and high-tech jobs.

The bill would also leave future financial-firm failures not in the hands of an impartial bankruptcy judge but up to yet more regulators, who would decide which investors to save and which to sacrifice based not on an orderly process set out beforehand but on snap government judgments.

The bill, then, institutionalizes the terrible precedents set in 2008: that capricious government power, not the steady rule of law, directly rules the financial industry, and indirectly rules the other businesses that depend on the financial industry for funding.

In the long term, investments based on political rather than on economic considerations weaken the economy and weaken the government’s very ability to bail out Wall Street, too. This sad fact may not be apparent a year from now, or even two years from now — and in the meantime, job and wealth creation will stay stagnant.

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