As Wall Street Collapses, Will Washington Get a Clue?

By Nomi Prins, AlterNet. Posted September 17, 2008.

The speculative nature of the financial industry is a threat to
national economic security. It requires a serious exit strategy.

As the Dow hemorrhages, Wall Street firms are betting on which one
will bite the dust next, and Federal Reserve Chairman Ben Bernanke
probably wishes he could leave as the next administration sets up
shop, no one is proposing the long-term solution to the banking
crisis: regulating the industry.

The Fed was right to turn Lehman Brothers away from its window during
those final moments of doom on Sunday night. As such, the resulting
$613 billion Chapter 11 filing, the largest bankruptcy in U.S. history
(WorldCom dropped to second with a mere $104 billion in assets) was
secured.

It was wrong to back the $30 billion bailout of Bear Stearns in March,
which facilitated JPM Chase's acquisition of Bear. It should not be
the Fed's responsibility, or the government's, to back investment bank
speculation. Instead, regulators should have been more vigilant as
speculation outpaced available capital, and transparent quantification
of risk went out the window.

However, it should be the government's job to stabilize the financial
system; the question is how. Unfortunately, neither the Federal
Reserve, nor the government, nor the presidential candidates have the
slightest clue. Neither a blame game nor desperate piecemeal fixes
will work. This is not about Republican or Democratic policies, but
systemic bipartisan deregulation. Only a quick bout of sweeping and
decisive regulation can fix what's broken.

In 1932, three years after the 1929 stock market crash, the banking
system last stood at a brink of implosion. Franklin Delano Roosevelt
zoomed past Herbert Hoover into the White House. The country was
struggling through a Great Depression unleashed by the forces of
unregulated economic greed. FDR stood up to the unrestrained power of
Wall Street and contained it. The resultant New Deal included a
stoplight at the heavy intersection of financial capital and
unregulated greed, called the Glass-Steagall Act of 1933.

Decisively, the Glass-Steagall Act forced institutions within the
banking community to pick a side. If you want to deal with the
population at large, take their deposits, give them a safe place for
their savings and make reasonable loans for which you are as
responsible as the borrowers -- terrific. As a commercial bank, you
will have the newly established Federal Deposit Insurance Corporation
(FDIC) backing your depositors. We, the federal government, will
regulate you.

If you want to raise capital through speculative investors at home or
overseas -- fine. But as an investment bank, you don't get our backing
and you don't get to mix it up with citizens' lives or use their
capital to fund your trading activities.

That simple premise, the pristine logic of the Glass-Steagall Act, not
only kept consumer and speculative capital from intertwining within
the same institution; it simplified the ability to understand the
activities of all financial organizations. Transparency was not
perfect, but it was more easily accomplished.

Lehman Brothers got a taste of the intent of Glass-Steagall. Its
demise is ugly, not just because of its 156-year history, the 25,000
employees who are suddenly without jobs, or the long list of
institutions to which Lehman owed money that will be slugging it out
in bankruptcy court.

It is ugly because it underscores the supreme gutlessness of the
executive and congressional branches of government. Bernanke is
desperately trying to figure out how to save the banking industry from
itself. Treasury Secretary Hank Paulson can't wait until the election
saves him from himself. And the presidential candidates are giving
Wall Street, and each other, a barrage of verbal shellacking.

None of this changes the playing field.

The catalyst for this current crisis may be the housing market -- not
because individual borrowers slightly overleveraged, but because the
entire banking industry massively overleveraged. The larger culprit is
the killing of Glass-Steagall, which paved the way for this
recklessness.

Yet, rather than considering the massive risks of merging commercial
and speculative banking interests, given the overwhelming evidence,
federal officials actually pushed for Bank of America's $50 billion
all-stock takeover of Merrill Lynch, rather than questioned it.

I worked on Wall Street, at Lehman and Bear and Goldman Sachs. Take my
word for it: You cannot merge risk management systems more quickly
than this economic crisis can continue to unfold. It is
technologically impossible.

This knee-jerk move follows the same dangerous green-lighting of
mega-mergers that began when Citigroup took over Salomon Brothers
after Congress killed Glass-Steagall in November 1999, and continued
with Chase taking over JPM and recently Bear Stearns.

The Fed wants to avoid another huge failure in Merrill Lynch by
pushing it under the rug of Bank of America. That is bad policy. Bank
of America cannot possibly have a clue about the extent of Merrill's
potential losses. This commercial bank taking over a speculative giant
is much more dangerous than Lehman Brothers tanking. The Fed was
within all of its rights and sanity to say no to Lehman's plea for a
bailout. But it won't be able to do the same thing with Bank of
America, which, unlike Lehman or Bear, is responsible for the accounts
of millions of customers -- real people with real money on the line.

The speculative nature of the industry, in which commercial and
investment banks can borrow beyond their abilities to repay, is a
threat to national economic security. It requires a serious exit
strategy.

There is no easy answer, but there is only one solution -- and it lies
polar opposite to the Bank of America-Merrill Lynch merger logic. The
only real way to stabilize the financial industry is to take it apart,
quantify and separate its risks, and begin again. We can do this. FDR
did it. The market is larger now, and more global. That is not an
excuse for inaction; it belies a screaming need for useful action and
meaningful regulation. Period.

Nomi Prins is a senior fellow at the public policy center Demos and
author of Other People's Money and Jacked: How "Conservatives" Are
Picking Your Pocket (Whether You Voted for Them or Not).