Controlling care

In the US, financial reform is about to begin. It will help if the next crisis is similar to the current one.

In the distant past, Senate Democratic Majority Leader Harry Reid was a boxer. When senators began discussing a new system of financial regulation in late April, the 70-year-old politician showed his fighting spirit. As soon as the Republicans hinted at the intention to postpone the debate, Reid threatened to leave the senators in the hall all night. The opposition surrendered when the cots were brought in. The debate began, and last week it became clear that the reform would be approved. Barack Obama is close to beating Wall Street.

The US president proposed the biggest financial market reform since the Great Depression almost a year ago. The goal is clear: to prevent a new crisis. To do this, it is necessary to strengthen control over banks and investment funds so that they cannot bring down the markets with their risky game. The bill passed the House of Representatives back in December, but on the way to the Senate, it overgrown with two hundred amendments and swelled up to 1,600 pages. “It's like a soap opera, there's no end in sight,” Senator Reid once remarked, commenting on the flow of proposals for the bill.

Naturally, they are arguing about how and to what extent to control financial institutions now. Republicans are for less control. Their logic: we need to trust the market more. They control 41 out of 100 seats in the upper house of Congress. The bill needs at least 60 votes to pass, and if it weren't for the defectors who defected to the Democrats, the Republicans would have a blocking package.

The fact that the Republicans agreed to discuss new rules for Wall Street is a big success for Barack Obama. Wall Street managers have spent more than $1.4 million on lobbying to stop reform, at least according to a report released a week ago by the Democratic-leaning NGO Campaign for America's Future.

But their opponents brought about 7,000 people to a demonstration on Wall Street with posters "Stop financial banditry" and "Break up the big banks." Chico California student Paul Perata also attended one of the demonstrations. “After the crisis, the budget of my university was cut. Now teachers get less, and therefore fewer lessons. And I love to study, and I don’t like it at all,” he explains.

As a result, the Republicans retreated, the Senate ended the debate and approved the reform plan. "Republicans don't want to look like Wall Street henchmen," explains Robert Kuttner, author of The Presidency in Peril, a book about Obama and the financial crisis. Now senators and congressmen have to create a conciliation commission: the two chambers have adopted a law in different editions, and the text needs to be agreed upon. But the main thing has been done - it is no longer possible to block the reform.

Before the vote, Obama clearly indicated the limits of the compromise, threatening to veto the bill if the items on the regulation of the derivatives market, which, in fact, exploded the world economy, disappeared from it. A derivative is a financial obligation of the second order: for example, a bank bought different bonds, “packed” them into a new single paper and sold it. And unlike the stock and bond markets, the first-tier securities that historically have been more or less followed, the derivatives market has evolved on its own. Before the crisis, new papers and instruments grew like mushrooms after the rain - so that at some point it became very difficult to figure out who owed whom how much, and the volume of liabilities themselves grew by tens of trillions of dollars.

The demonstrative flogging of the largest player, Goldman Sachs, reminded of the danger of such complex investment instruments. In April, the US Securities and Exchange Commission (SEC) accused Goldman Sachs of fraud. By issuing in 2007 derivative securities, the so-called CDO, secured by payments on mortgage bonds, the bank allegedly deliberately concealed from buyers how risky this instrument was. The paper called ABACUS 2007-AC1 obviously had to fall in price.

Billionaire John Paulson's Paulson & Co hedge fund helped build the list of mortgage bonds to which Goldman Sachs was pegged. At the same time, Paulson himself played for a fall in ABACUS - he bet that it would fall in price. Naturally, he was interested in the fact that Goldman Sachs paper depended on the most unreliable bonds - roughly speaking, on mortgage loans, which, most likely, would not be returned. When the mortgage crisis hit, Paulson made a lot of money and became the best American private manager of 2007, and those who bought ABACUS papers from Goldman Sachs lost more than $1 billion.

The head of the British division of the bank, Fabrice Turre, was appointed responsible, but the head of GS, Lloyd Blankfein, also had to give unpleasant explanations to the Senate commission. The senators even got their hands on the bank's internal e-mails, from which, for example, one can learn that Turre called the creation of papers like ABACUS "intellectual masturbation."

But Goldman Sachs assures nevertheless that everything was done within the framework of market practice. The details of the case are not clear to the general public. In the SEC itself, there is still no consensus on whether the bank's actions can be considered fraud or not. But in any case, the public understood: big banks profit from deceit, they need to be monitored.

In addition, the New York prosecutor's office began checking the accuracy of information that Goldman Sachs and other large banks, such as Morgan Stanley and Citigroup, provided rating agencies on the eve of the crisis. When the markets crashed, the agencies got hit hard for valuing derivatives according to purely formal criteria, and as a result, papers in which very risky mortgage loans were packaged received the highest rating. Agencies turn the arrows to banks: they say that they created creative financial instruments and “forgot” to report all the pitfalls.

“Those who have invested in investment banks feel fooled,” said Robert Palomo, an employee at an Ohio-based IT company. “Of course, investors were outraged when they learned that the players who promised them guaranteed profits knew from the very beginning how shaky their business was.” Chico's California student Paul Perata lost nothing himself, but learned a lesson for the future: “Grandparents lost everything when Wall Street got into trouble. And no one will return this money to them now. I will only invest in my private projects.”

If all private investors do this, then the already weakened economy will be in trouble. Obama's reform is precisely designed to revive confidence in the financial markets. One of the key provisions was proposed by the former head of the Fed and economic adviser to Obama, Paul Volcker. The Volcker Rule prohibits banks from playing the stock market with their own funds, as well as owning or investing in hedge funds and private equity funds. That is, transactions that promise huge profits, and therefore are very risky and, moreover, create a conflict of interest, when the bank can play against its clients, will be banned - as is the case with GS and ABACUS paper.

In addition, the senators agreed to revive the Glass-Steagall Act, passed in 1933 and repealed in 1999. It prohibits the affiliation of large banks, insurance companies and securities firms and gives the government the green light to fragment the largest financial institutions whose problems could threaten the entire system.

It seems that these measures insure against crises like the last one, although skeptics are sure that speculators will definitely come up with something new and trouble will come again from where they did not expect. In any case, the Democrats are counting on political dividends. In November, a third of the Senate and the entire House of Representatives will be re-elected. Democrats approach the elections weakened. Back in early April, a poll by Gallup and USA Today showed that the ratings of the ruling party had fallen to a record low. Only 41% of Americans favored them in April. The Republican rating is 42%, and they seriously expect to take advantage of the dissatisfaction with the ruling party and win a majority in both chambers.

"Stronger market regulation could help Democrats score points ahead of the election," says Dean Baker of the Center for Economic and Policy Research in Washington, D.C. But Robert Palomo of Ohio doubts: "People are now angry both on Wall Street and at the government, which was supposed to guard the interests of the people, but instead turned its back on the people." He is confident that all congressmen who were in power at the height of the crisis, both Republicans and Democrats, will lose in the upcoming elections.