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The Financial Crisis Inquiry Commission is meeting today in Washington to hold hearings on the recent financial crisis and economic meltdown. The Commission will ask Wall Street’s top brass—Lloyd Blankfein of Goldman Sachs, Jamie Dimon of JP MorganChase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America—questions about what went wrong. What the Commission really needs to do is ask what is wrong with Wall Street’s entire culture of finance. The populist rage, from both left and right, at Wall Street is not due to specific actions taken by banks and bankers but at the rise of a speculative, short-term, transactional, culture that rewards individuals with enormous bonuses. This trading culture, over the past 15 years, has replaced a different financial culture which was relational, focussed on the long-term, investment, and, most importantly, aimed at economic growth for many stakeholders—corporations, employees, and the nation as a whole.
The goal of the Commission, and of Congress, should be to replace Wall
Street’s short-term, transactional, trading culture of finance with a long-term, relational, investment culture. This isn’t difficult. In fact, the US did just this after the Great Depression, when traditional banking was separated from speculative trading by the Glass Steagall Act of 1932. Under the Clinton Administration, proponents of efficient market theory combined with heavy bank lobbied successfully to repeal
Glass Steagall. Paul Volcket, ex-Federal Reserve Chief, argues that Glass Steagall should be restored. Volcker is right. The social goal of finance (yes, there is a socio-cultural goal for finance) is long-term investment and economic growth.
A second step Congress should take is to end the financial incentives for transactional speculation. Culture is defined, in many ways, by the rewards bestowed on behavior. Change the rewards, the behavior changes. Washington has created a Wall Street reward system based on the principle of "Too Big To Fail." No matter what mistakes bankers make--and they clearly made horrendous mistakes over the past decade--taxpayers will always rescue the biggest banks from the consequences of their actions. This incentive for speculation should end.
Another major step in changing the dominant culture of financial speculation would be to end quarterly profit announcements. This Wall Street practice is a device that reinforces the culture of transaction and rewards trading, not investment. Regulators should require annual profit announcements. It is that simple.
Finally, the Commission should examine ways of changing incentives for financial innovation. Innovation has been given a black eye because of the debacle in finance. Virtually all financial innovation in the past two decades has involved slicing and dicing transparent, long-term investments, especially mortgages, into opaque, short-term trading vehicles to better suit the needs of a speculative financial culture. At the very least all financial vehicles, including CDOs, need to be traded on open markets so they can be properly valued.
But, more importantly, new forms of financial innovation are needed that are directly at people and the economy, not bankers and speculation. For example, Yale professor Robert Shiller has long proposed home equity insurance. Had it been available, much of the housing crash might have been avoided.
The financial innovation of recent years reinforced the culture of financial speculation now dominant on Wall Street. The Financial Crisis Inquiry Commission should focus on reforming this culture and returning Wall Street to a culture of long-term investment and economic growth.
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