Simon Johnson: White House Needs Elizabeth Warren, Now More Than Ever

“The Chamber of Commerce and other lobbyists help spend bank profits framing the consumer protection debate as being about “regulation,” but that is not the issue.  We have had plenty of regulation in recent decades and still have lots of regulators.  The issue is capture.  Big banks in particular disproportionately captured the hearts and minds (and maybe more) of federal regulators.”— Johnson

“the right also understands that “too big to fail” is not a market – it’s an implicit government subsidy scheme, it’s a dangerous, unfair, and nontransparent form of taxpayer abuse, and it should stop.” — Johnson

EDITOR’S COMMENT: “My administration is the only thing between you and the pitchforks”. When we heard about this remark from President Obama to the 13 Bankers, some of us, including myself, were lulled into the belief that he understood the anger of the people and that he was assuming management of the problem. I thought that fact alone would engage the bankers in reforms and corrections that would fix the problem even if it hurt — even if it hurt a lot. I was wrong. Wall Street saw “dangerous populists” and the administration seemed to see it the same way. In the ensuing time since March, 2009, a multitude of Constitutional (due process) restrictions, Federal and State Laws, Administrative Rules, Rules of Civil Procedure, Criminal Laws, and basic rules of evidence were thrown to the wind.

I can’t help wondering how long a sentence I would receive from a federal Judge if I went across the country foreclosing and stealing homes through fraudulent credit bids. How long would it take for me to be indicted if I fabricated documents, caused them to be forged, back dated them, and paid notaries to use their stamp when they neither knew nor saw the person signing? How likely would it be that I be ordered to disgorge my ill-gotten gains from the fraudulent foreclosure sales? How much in fines would I be ordered to pay? How long would it take for the news to spread amongst prosecutors and Judges that this scam was being copied all over the country? How intense would be the media scrutiny be if I was a Madoff character who had engineered all of this? I think I know the answer to these questions, don’t you?

Yet because of a myth that the perpetrators of those illegal acts were too big to fail, they seem to have escaped prosecution and the victims are left hanging “to save the financial system.” MEMO TO PRESIDENT: THERE IS NOTHING WRONG WITH OUR FINANCIAL SYSTEM IF, AS ELIZABETH WARREN DEMANDS, WE ENFORCE EXISTING LAWS AND BASIC NOTIONS OF FAIRNESS AND EQUITY. There are no institutions that are too big too fail in our system. We have only 4-5 banks that are pulling the strings here while the 7,000 community banks and credit unions, the electronic funds transfer grid to which every bank is connected are all ignored because the President believed the myth. In the process we have lost our moral high ground, if we ever had it, and we have damaged our financial credibility for decades.

We continue to suffer from what any common person would tell you is a recession notwithstanding the government proclamations of a “recovery.” Unemployment, the biggest problem, is now acknowledged to be keystone of the recession and the cause of the unemployment is now acknowledged to be housing. The cause of the housing problem is the nearly universal bottle-neck caused by an imbalance in current loan-to-value ratios. That was caused by the nearly universal practice of lying about the value of the property when the loans were created. That lie came from the lenders, not the borrowers. The consumers who got lured into these sucker transactions had no idea what the real fair market value was, they had no idea that the values used for the transaction were unsustainable and they had no idea that the loan and the property value were guaranteed to swoon together.

There is only one way out of this mess. It is the rule of law. No special consideration needed, just apply it. The fact that an invalid mortgage is present should not stop a judge from declaring it just because he doesn’t like the benefit it confers on the homeowners. Besides the obligation is still there and the only thing the Judge is doing is giving the homeowner a little leverage in negotiations. The fact that the mortgage bond is worthless and empty should not prevent a Judge from stating it and letting the chips fall where they will. Investors are going to take a “haircut” one way or the other. Besides the obligation from the issuer from whom they bought these fraudulent bonds together with some equitable solutions created to straighten out title and debt to equity ratios will offset far more of the investors loss than what they are now doing.

One way or the other, either now or later, that is the solution that will come about. Better it should come as the result of leadership from the White House so it seems that this nation is back in control of the people of conscience than to have it unravel in  chaos over decades of litigation. There will be no end to unemployment, there will be no recovery until we change the housing paradigm. In this case the change is a return to the rule of law.

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The White House Needs Elizabeth Warren, Now More Than Ever

By Simon Johnson

The White House today is under pressure, with insiders asking: After the strong showing of the Republicans in the midterm elections, should the president move to the right or to the left?

This is entirely the wrong way to think about the problem – the administration needs to get beyond its mental framework of early 2009, which led it sadly astray with regard to the financial sector.  The President needs to find people and themes capable of cutting across the political spectrum; specifically he needs to promote strongly the ideas of Elizabeth Warren – what we need in financial services, above all else, is much more transparency.

The premise – and central mistake – of the Obama administration in 2009-10 can be summed up in what the president said to leading bankers on that fateful day, March 27, 2009: “My administration is the only thing between you and the pitchforks”.

The organizing notion then, provided by Larry Summers and presumably Tim Geithner, was that the “responsible” administration would protect global megabanks from “dangerous” populists, in return for cooperation and better behavior.  This kid gloves strategy turned out to be a very bad bet – not only is it far from best practice with regard to handling failed financial systems (there must be consequences for executives and shareholders, at the very least), but it also allowed banks and their close allies to bounce back to profitability and use that cash (underwritten by the taxpayer) to oppose the administration on financial reform and, according to credible public reports, to funnel large amounts of money into various “populist” anti-administration midterm campaigns.

A lot of pitchforks ended up being paid for by the 13 Bankers, in various forms (e.g., Chamber of Commerce; American Financial Services Association).

The administration, to its credit, did see Elizabeth Warren as an important potential ally early on – hence the emphasis on the new consumer protection agency for financial products.   But the White House also should have played this card more aggressively by stressing at every turn Professor Warren’s central idea, the need to protect families from opaque small print and deceptive practices.

The Chamber of Commerce and other lobbyists help spend bank profits framing the consumer protection debate as being about “regulation,” but that is not the issue.  We have had plenty of regulation in recent decades and still have lots of regulators.  The issue is capture.  Big banks in particular disproportionately captured the hearts and minds (and maybe more) of federal regulators.

The best idea for rolling this back is Elizabeth Warren’s – require more transparency and full disclosure.  In effect, this is applying the best idea from the 1930s reforms (when it was applied to securities and other investments) to mortgages and credit cards.  In the 1920s, there were terrible abuses of consumers around the investments that they were sold (see Michael Perrino’s new book).  In the 2000s, the abuses were concentrated on the liabilities side of the consumers’ balance sheet, i.e., on what they borrowed; again these were egregious abuses.

This is the key point that Ms. Warren communicates effectively time and again – and to very broad audiences (including CEOs, in her effective no-drama style).  The nonfinancial private sector completely gets and understands this point; if you sold boxed cereal in the same way that financial services have been sold (by some people), you would be kicked out of the boxed cereal business – by your industry colleagues.  The financial sector, unfortunately, has lost its moral compass and ability to police itself.  The right approach is to require full disclosure of all material information – just as we do for the securities industry.  It’s not perfect, to be sure, but it has served us well for going on 80 years.

President Obama is worried about his left and needs to think also where the center is heading.  He needs an issue that cuts across left and right.  The left hates the abuse of power at the center of the financial system, but the right also understands that “too big to fail” is not a market – it’s an implicit government subsidy scheme, it’s a dangerous, unfair, and nontransparent form of taxpayer abuse, and it should stop.

If the administration goes onto the defensive on these issues in response to the election, the Chamber of Commerce and its fellow travelers will have a field day.  Fresh from its successes in the midterms and backed by an increasing wave of clandestine and – by the way, foreign – money, the Chamber will attack again and again.

What the president needs is someone who can take the fight to the Chamber – force them publicly to defend business practices that are unacceptable and abhorrent to responsible entrepreneurs and executives.  (If you doubt whether Elizabeth Warren can pull this off, see her recent speech to the Financial Services Roundtable.)

The problem is absolutely not “fat cat bankers” (if you know a term that more effectively unifies potential supporters of the Chamber of Commerce, let me know).  It is that a few people (and their prominent organizations) at the center of our financial system got out of control.  We can fix this problem – there is no reason to subject ourselves to the risks inherent in these individuals having excessive power and an inclination to take advantage of ordinary people.

The nonfinancial sector gets this.  Community bankers get this.  Hedge funds get this.  Even people who work in bigger banks (but not the biggest or worst behaved) get this.  And people who, until recently, worked in the global megabanks also get this.

But we need a champion.  Deputy Treasury Secretary Neal Wolin railed against the Chamber of Commerce earlier this year for its lobbying activities against reform, but he is too low profile to get much traction.  Secretary Geithner may now understand these issues but he is not the greatest communicator to the broader public.  And the rest of the Obama economic team looks, at best, rudderless – what exactly do they stand for or against?

Elizabeth Warren has the vision, the credibility, and the communication skills needed to really bring overdue changes to our financial system – and to lay the groundwork for 2012.  If the White House downplays her role or themes, the next two years will be very difficult.

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