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Gerald Epstein: It’s like a world cup game where one team only has a goalie with his hands tied

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. And in Washington, the SEC has made a deal with Goldman Sachs: no criminal charges, a fine, but perhaps more importantly, an indication of where things might go under the new regime of the new financial reform bill. Now joining us to discuss both the deal and the new bill is Gerry Epstein. He’s codirector of the PERI institute. He joins us from the PERI institute in Amherst, Massachusetts. Thanks for joining us, Gerry.


JAY: So tell us a bit about the deal with Goldman and the SEC and what you think of the bill.

EPSTEIN: Well, the deal with Goldman is a really good deal for Goldman and a bad deal for the American people. The SEC had brought charges of fraud, as well as civil charges, against Goldman Sachs for entering into this ABACUS deal, where they developed these securities with the help of [John] Paulson, the hedge fund operator, sold them to their customers while they were betting against them, didn’t tell them that the hedge fund was going to be betting against the securities they were selling. The SEC brought a suit and was going to bring federal charges, fraud charges against SEC. They just settled—$550 billion settlement, which sounds like a lot of money, but it’s at most 14 days of profits of Goldman Sachs. Some people say it’s just what they make overnight trading, somewhere in between there. No criminal charges. So this bodes very poorly for the implementation of a new financial reform bill that just passed Congress and that Obama is going to sign into law next week.

JAY: Now, the reason for that is because so much of the new bill depends on regulation rather than structural changes.

EPSTEIN: That’s right. What this financial reform bill, the Dodd-Frank bill, has done is set up a set of contests, a set of arenas, almost like the World Cup, where you have 10 or 12 different contests that are going to take place. The bankers are going to fill their team, the reformers are going to fill their team in each of these arenas. Unfortunately, the bankers have 11 players on the field, and the reformers at most are going to have a goalie at each place to try to stop the ball from getting in the goal. And if the SEC deal with Goldman Sachs is any sign, the goalies are going to have two hands tied behind their backs.

JAY: Okay. Let’s talk specifically about the legislation. The big issue it was supposed to address was too-big-to-fail, which you’ve put, in other words, is structural blackmail, that the banks are just such an important part of the global economic system that when they gamble and lose, they can go to various governments, starting with the US government, and get bailed out. So we’re hearing from defenders of this bill that we’re not going to see that again.

EPSTEIN: That’s right. Senator Reid and President Obama and Secretary Geithner are all saying that this is going to end the era of taxpayer bailouts and too-big-to-fail, and that is completely wrong. What it does is set up—sets up a council of regulators, the Financial Stability Oversight Council, made up of all the different regulators, of which there are 10 or 11. And their task is going to be to try to look out for problems of excessive risk-taking and potential failure. And they do have a few more tools to try to prevent this, but in fact these tools are very weak. They’re not settled by any means. They’re going to be determined, over the next 1 to 12 years, exactly what they’re supposed to be. So they’re completely inadequate to the task. For example, there were a number of areas where we have very strong potential legislation that could have helped deal with this problem. Let’s take too-big-to-fail, to begin with. Coffman and Brown had a bill to limit the size of banks’ liabilities to 2 percent of GDP. That was taken out of the bill. Paul Volcker, the ex-Federal Reserve chief who now seems like a flaming left-winger, had a bill, the so-called Volcker rule, which was supposed to prevent banks from using taxpayer-guaranteed money to deal with proprietary trading, trading on their own accounts, and very risky investments. That was cut back tremendously, so that banks can still hold these securities on their own accounts. In trading they’re supposed to be trading just for customers, but in fact now they can hold inventories of these securities on their own account while they’re holding them for their customers, and that’s a type of trading. They can continue to do that and still have access to government bailouts. The derivatives legislation: Blanche Lincoln had put in so-called “push out” legislation, which made it almost to the very end, which wouldn’t allow banks to have swap desks where they could sell risky derivatives—again, banks could use taxpayer money to do this, to guarantee this. They made large exclusions in these, so that now banks don’t have to push out their foreign exchange trading or their interest rate swaps, which makes up 85 percent of their derivatives trading.

JAY: So just to be clear on this, so 85 percent of the kind of speculative trading that many people think—well, not “many people think”; I think it’s now rather clear—caused the financial crisis is still in place. That hasn’t changed.

EPSTEIN: It hasn’t changed. The banks can still do it and they can still have access to the discount window. So we could go into more details, but in each of these realms—.

JAY: Let’s just explain that really clearly so everybody gets it. Before the crisis, many of the banks were not allowed to go to the Fed discount—investment banks, because you were supposed to be a traditional bank to get this money out of the Fed. So just explain that and explain what changed and why that matters.

EPSTEIN: Okay. So the traditional investment banks, like Goldman Sachs, Morgan Stanley, didn’t have access to Federal Reserve support in the case of the crisis. So when the crisis hit in 2008, they couldn’t get funding from the Federal Reserve to help bail them out. They transformed themselves into bank holding companies—became banks, essentially—so then they could get support from the Federal Reserve during the crisis. What that allowed them to do then was to use this kind of backup and guarantee to support all their activities, and among these activities are very risky derivatives trading, foreign exchange and elsewhere, as well as proprietary trading in all kinds of toxic securities, like collateralized debt obligations, credit default swaps, and so forth, that everybody now knows were at the root of this crisis. So there were two proposals. The Blanche Lincoln derivatives proposal, which would say these banks have to “push out” these swaps and derivatives trading out of their bank holding companies and let somebody else do this, so that this wouldn’t get backed up by the taxpayer. The second set of rules were the so-called Volcker rules, supported and strengthened by the Jeff Merkley-[Carl] Levin amendments, which would have prevented banks like Goldman Sachs from using their own funds to engage in high-risk trading, which generates a lot of their profits—they would’ve had to push that out of the bank as well. Both of these rules made it through in a very modified form that really doesn’t get to the root of the problem.

JAY: Well, they’re saying that now that these derivatives, the majority of this derivatives trading will now have to be done on exchanges, and that will give a certain transparency to it, and that that’s a big improvement.

EPSTEIN: Well, no, let’s go back to this [inaudible] for a second. We’re talking about the Blanche Lincoln rules, which said these banks would have to push these derivatives trading outside of their bank holding companies. But now they exempted trading in interest rate swaps and foreign currency swaps, which is really 85 percent of the market. So those will be able to stay in Goldman Sachs or in the other banks. So this was totally gutted in the conference bill at the last minute. There is some change in derivatives legislation and regulation, which is a positive thing. Prior to this bill, derivatives had basically no regulation whatsoever, the $650 trillion dollar derivatives market. Now this legislation is going to require these derivatives to see the light of day to some extent: they’ll have to be traded on exchanges and cleared in clearing houses. This will allow for more transparency, more information. But, once again, the rulemaking is going to have to define which securities derivatives have to be traded that way and which derivatives can go back to the old underground system that crashed the system, and these rules are going to be written and defined over the next 5 to 10 years. So, of course, with the bankers having their full set of players on the team and our side having virtually nobody on the field, they’re going to be able to rewrite these rules so that many of these derivatives are going to be able to be sold underground once again.

JAY: Is there anything in the bill that deals with offshore? I mean, what stops Goldman and other banks like this simply pushing a lot of this business to the Cayman Islands?

EPSTEIN: Nothing stops that at all. But the hope by some of the reformers was that these rules would be written internationally. So if you move to the international forums like the Basel Committee, the G-20, the Financial Stability Board, the hope was that there would be international coordination among the major countries—the European Union, the United States, Canada, and so forth—so that the major markets, the major institutions, would all have strong capital requirements, liquidity requirements, Volcker-type rules on proprietary trading, and so forth. But the problem now is, with the financial crisis in Europe deepening, and the banks there being in worse shape, and the lobbying by these bankers internationally at these international forums, it’s clear that these rules are going to be weak, they’re going to be very delayed in being implemented. So there’s going to be almost nothing that’s going to oversee this financial system on a global basis.

JAY: Okay. In the next segment of our interview let’s talk about the politics of financial reform. The defenders of the bill are saying, well, if it’s really so weak, why is Wall Street fighting it with so much vigor? And let’s answer that question in the next segment of our interview with Gerry Epstein on The Real News Network.

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Gerald Epstein is co-director of the Political Economy Research Institute and Professor of Economics at UMass Amherst.