The Firestorm is Coming: Financial Sector Reform, Puschbak, Sausage-making and the Public Interest

The Firestorm is Starting:

Financial Reform, Industry Puschback and Political Sausage-making

By Dave Livingston. Dave is a management consultant with almost 30 years of experience with analyzing complex business problems and developing solutions and new businesses. He blogs on public affairs at his blog Parts, Systems, Structures and Outcomes ( http://llinlithgow.com/PtW/ ) where he attempts to apply that toolkit to current affairs and public policy.

Introduction

The problems with the Finance Industry are fairly well known, in some form or another, because we’ve all sufferedthe consequences. As a result one of the major issues slowly working itself thru the legislative maze are major re-formulations of the regulatory framework. The proposed changes, in whatever final form they take, represent aslarge a structural change as any we’ve seen since the 1930’s and the reactions to the Great Depression.Because the Industry is systemically important, touching as it does, the lives and well being of every person,these reforms are innately, inherently important. One could even say critical. Representing as they do a majorchange in the rules by which the game is played it’s no surprise that all the major players are doing their best toinfluence the outcome. The question is in whose best interests?One can’t expect any industry to act purely for the public good but the level and nature of the pushbackrepresents an attempt to maintain business as usual. And continue the culture that’s brought us three decades ofslow growth, poor job creation, a mountain of debt and stagnant wages and benefit growth. Three decades wherewe’ve increasingly seen the results of what economic growth there has been go to those earning the highestincomes. We’d suggest that the two are not uncorrelated.The Industry’s pushback is based on the argument that the efficient and effective allocation of capital is essentialfor the health of the economy and the prosperity of society. It so happens that, in the long run, that’s true. As NeilFerguson discusses and demonstrates in his most recent book, “The Ascent of Money”. But the case againstreform is based on the notion that capital allocation is in fact efficient, effective and, in a word, sound. Ah, there’sthe rub, indeed.Below we dive deeply into the “business case” for/against reform. We also take a pretty deep look at the politicalsausage-making of reform and the current state of play and the outlook Our findings are that the case for deepand wide-ranging reform are very clear cut. The Industry has pretty well established that self-supervision is notworkable and that adult referees are required to ensure that the game is played well and according to the rules.There are bigger issues at stake here as well. Not just the most systemically Industry and it’s influence on theeconomy and society. Also at stake is the question of how effectively we can reduce the impact of narrowinterests struggling to influence legislation and regulation for their own narrow benefit. In some ways, and not tobe to dramatic, we are in fact debating the nature of Capitalism and what our collective futures will look like.Can we find, develop and implement an effective governance mechanism that works to everyone’s benefit, ornot? We even argue, and we think demonstrate, that it’s in the interests of the Industry to re-engineer theregulatory framework. Sadly though they don’t see it that way and want to continue the Bonus Culture, which hasproven dangerous and ineffective.This is one among many great debates of the time and will tell us a lot about what the future will look like.

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Table of Contents

EssaysThe Chinese Goldsmith, Finance and the Next Big Fight 3Banks Hate Banks, Voters Hate Banks: Hear the People Singing! 6The Beginnings of a Great Debate: People Singing, Politicians Making Sausage 8Ask Not For Whom the Siren Shrieks: Let the Finance Wars Begin 11Pictures for a Prosecution: Wall St. Bonuses vs. the Public Good 14Bonus Fantasies vs Political Realities: the Reform Firestorm This Time 16Firestorm Flaring up: Finance Reform, Compensation Wars & Sausages 18

ReadingsFinancial Industry Performance and Reform 22Background References on Institutions and Economic Development 22

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October 22, 2009

The Chinese Goldsmith, Finance and the Next Big Fight

http://llinlithgow.com/PtW/2009/10/the_chinese_goldsmith_finance.html The last several months have seen partisan fight afterpartisan fight in Washington, often leaving us average citizensas innocent bystanders or even collateral damage, or so itseems to many people. Now we've been focused on theHealthcare Reform fight and the debate on Afghanistan. Onthe first there was some amazingly good news, the lastcommittee passed a proposal out of the Baucus Committee tothe rest of the Senate, though the day before the InsuranceIndustry published a report attacking the proposals that wasso bad even the consultants who wrote it have disavowed it.On Afghanistan we by stand what we've been saying - it's amess but if we walk away again it'll be worse.The big fight you may be missing is the one over FinanceIndustry Reform. It was back-burnered because of theurgency and importance of immediate business, e.g. savingthe country from economic collapse, but is moving centerstage. Like many of the stakeholders in HC Reform those inFinance have been fighting to water down the bill but in this case with less justification, if possible, moresmoldering anger among the public and, with this week's announcements. The Industry argues that the last twoquarters of monumental bonuses are right, proper, the way they do business, indicate a return to health and goodfor the economy and country. The country's mood is probably captured by the cartoon collage but just in casewere wondering how angry people are check out thisvideo clipfrom Dylan Rattigan's Morning Meeting. Thequestion is who's right? (http://www.msnbc.msn.com/id/31510813/#33414533)

Post De-regulation: Finance Industry, Debt and the Economy

There's no question that a properly functioning Finance Industry is necessaryfor a growing economy and contributes to long-run growth and prosperity. NeilFerguson covers millenia of history in addressing that in his PBS Special "TheAscent of Money". We'll rest the strategic case there and focus instead on thenarrower one of is our finance industry functioning properly? In particular hasit contributed to our wealth and prosperity at an acceptable cost to society,that is are we getting a return for our money? :)!The graphic starts to speak directly to that with the top part showing recentchanges in debt among several sectors (NB: all this worry about excessgovernment borrowing is mis-placed, btw; right now it's simply absorbing allthe excess sloshing around as everybody else de-leverages and is likely to doso for years).The bottom part of the chart is the really interesting part. On the left you cansee ordinary businesses continuing a gradual growth of their borrowing whilethe Finance Industry, ex-post mid-80s de-regulation, securitzation andfinancial engineering wizardry, shooting for the money...oops, we mean moon.Similarly consumers got completely carried away as well, again beginning withthe widespread availability of cheap consumer and credit card debt.