First, a memo to John Paulson:
As we go forward, learn English and try not to lie so much. "There hasn’t been one problem at all to global systemic risk in the U.S. or abroad from a hedge fund." No, hedge funds have not been problematic TO global systemic risk, they have CAUSED the risk. LTCM was what, a church fund? It was the collapse of the hedge fund factories at every major financial institution that caused this crisis. AIG was an insurance company with an enormous hedge fund tumor on its head..
Now, of all the reasons why Timothy Geithner and Larry Summers were disastrous choices to lead us out of this crisis, having them in charge of regulatory reform is the most salient. THE PEOPLE WHO HELPED CREATE THE PROBLEM CANNOT BE TRUSTED TO FORMULATE AND IMPLEMENT EFFECTIVE REGULATIONS ON THEIR FORMER FRIENDS AND BUSINESS PARTNERS. It flies in the face of all common sense. It smells of rank corruption. It tells the American people that the administration thinks we are idiots. Summers was a hedge fund manager, for crying out loud. Why not have Bernie Madoff write the regulations? He certainly knows a thing or two about how to avoid them?
Geithner and Summers were two of the loudest voices over the past 10 years AGAINST regulation of hedge funds and derivatives activity. While head of the Federal Reserve Bank of New York, Geithner promoted the use of credit derivatives, praising them in a speech to the Credit Markets Symposium in 2007 for offering "a relaxation of financial constraints," "increased flexibility," helping to "free up funding and capital." He argued that these deceptive instruments would "make markets both more effective and more resilient" and "better able to absorb stress."
According to the Bank for International Settlements, since 1998, the OTC derivatives market has grown 10-fold, to over $600 trillion in notional contracts. Credit derivatives alone grew over 400% from Dec. 2005 to Dec. 2007. The problem is not just one of a lack of transparency, but also of sheer size. It is literally impossible to expect a single systemic risk regulator to oversee such a gargantuan amount of activity. Geithner made the point himself, while arguing against regulation in 2007: "We cannot turn back the clock on innovation or reverse the increase in complexity around risk management. We do not have the capacity to monitor or control concentrations of leverage or risk outside the banking system(hedge funds). We cannot identify the likely sources of future stress to the system." He believes regulation is actually IMPOSSIBLE. In an earlier speech, he called transparency of hedge fund activity "un-achievable," saying "No one with access to that information could make sensible judgements..." Yet THAT, is precisely what Geithner is proposing. They are not going to break up the big, insolvent banks, or reinstate Glass-Steagall, with its systemically protective barriers between speculative gambling and mom and pop banking. No, no, that would be, I don’t know, SMART. No, they will appoint some guy to keep his eye on things. Where will they find him? Wall Street, of course. See, they think we are idiots.
If Brooksley Borne, Frank Partnoy, Satyajit Das, James Galbraith or Joseph Stiglitz were devising the regulations I would feel far more confident. Forgive my cynicism, but when the devil writes the contracts, he makes a home for himself in the details.
Glass-Steagall must be reinstated. Bankruptcy laws must be amended. SECURITIZATION OF CONSUMER AND HOUSEHOLD DEBT MUST BE DISINCENTIVIZED, not subsidized. Hedge funds must be regulated within an inch of their lives. Derivatives instruments must be strictly limited with painful penalties for excessive, exotic and deceptively risky innovations.
The sad irony of this is that unquestionably necessary and strict regulations will hopefully suppress the market for the toxic garbage Paulson and Geithner have bought or guaranteed with taxpayer money, thereby ensuring greater losses for taxpayers. That is precisely why regulatory reform should have been concurrent with or, better yet, PRECEEDED bailouts.