Bringing Wall Street to Heel

James K. Galbraith writes an article for the New Republic which spells out what's wrong with America's financial sector and what the Obama administration has to do to fix and has not yet done:

The financial crisis in America isn't over. It's ongoing, it remains unresolved, and it stands in the way of full economic recovery. The cause, at the deepest level, was a breakdown in the rule of law. And it follows that the first step toward prosperity is to restore the rule of law in the financial sector.

First, there was a stand-down of the financial police. The legal framework for this was laid with the repeal of Glass-Steagall in 1999 and the Commodities Futures Modernization Act of 2000. Meanwhile the Basel II process relaxed international bank supervision, especially permitting the use of proprietary models to value complex assets—an open invitation to biased valuations and accounting frauds.

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Second, the response to desupervision was a criminal takeover of the home mortgage industry. Millions of subprime mortgages were made to borrowers with undocumented incomes and bad or non-existent credit records. Appraisers were selected who were willing to inflate the value of the home being sold. This last element was not incidental: surveys showed that practically all appraisers came under pressure to inflate valuations in order to make deals happen. There is no honest reason why a lender would deliberately seek to make an inflated loan.

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Third, the counterfeit mortgages were laundered so they would look to investors like the real thing. This was the role of the ratings agencies. The core competence of the raters lay in corporate debt, where they evaluate the record and prospects of large business firms. The value of mortgage bonds depended on the behavior of tens of thousands of individual borrowers, whose individual quality the ratings agencies could never check. So the agencies substituted statistical models for actual inquiry, and turned a blind eye to the fact that the loans were destined to go bad.

Fourth, the laundered goods were taken to market. The investment and commercial banks transformed the bad mortgages into bonds, obtained the AAA ratings, and sold the stinking mess to American pension funds, European banks and anyone else who took the phrase "investment grade" at face value. (Later chumps would include the Federal Reserve.)

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Upon taking office, President Obama had a chance to change course and didn't take it. By seizing the largest problem banks, the government could have achieved clean audits, replaced top management, cured destructive compensation practices, shrunk a bloated industry, and cut the banks' lobbying power and therefore their capacity to obstruct financial reform. The way to write-downs of bad mortgage debt and therefore to financial recovery would have been opened.

What I find impossible to understand is why Obama didn't take advantage of the crisis to come in like a whirlwind, clean house, and fix the US economy. His 2008 campaign promised "change you can believe in" but when he took office he became meek as a lamb and sought compromises with the Republicans and took half measures in all the key areas. Bush was worse because he fiddle while Rome burned. But Obama is bad because he is busy "negotiating" impossible to achieve "compromises" with Republicans while Rome burns. It has been a year and a half and the "fast learner" Obama shows no sign that he has caught on that he's been had by the Republicans. They've gutted him and will feast on him in the 2010 elections. Obama has been a fool. He wanted to be the Lincoln that saved the Union, but he has acted like the George B. McClellan of the Army of the Potomac. He dithered for a year having parade marches and no battles, and when he did make a pretense of "going to war" he dithered and complained of "overwhelming odds" against him that just weren't there. Obama has the same cold sweat and fear to engage the political enemy. He is losing the war. The real Lincoln knew enough to toss out McClellan and try out other generals until he found a true "fighting" general. What will the American people do?