Sunday’s New Yorker (IV)

Rational Irrationality

Two Cheers for Financial Reform

The financial-reform bill that the Senate voted through last night is an improvement on House bill from last fall, and its passage means final legislation is virtually inevitable early this summer. Given the dysfunctional political situation in Washington, and the Obama Administration’s innate aversion to anything smacking of radicalism, the coming overhaul will be surprisingly broad-ranging, and it should be welcomed. However, it still fails to address some of the root causes of the crisis, some of which will, doubtless, reëmerge in the years to come.

First the good news. Both House and Senate bills establish a new agency to protect consumers from predatory financial companies; force the trading of most derivatives onto public exchanges; oblige Wall Street firms banks to “eat their own cooking” by retaining ownership of at least five per cent of the securitized bonds they issue; and create a new systemic-risk council, which will be responsible for spotting dangerous trends, such as the emergence of another housing bubble. The Senate bill bars banks from investing their depositors’ money in hedge funds, private equity, and other speculative deals; removes some of the loopholes that were in the House bill, particularly in the area of derivatives trading; and orders hedge funds to register with the Securities and Exchange Commission, thus dragging them out of the shadows.

All of these things are sensible, and credit is due to the four Republicans who voted for them: Olympia Snowe and Susan Collins, of Maine; Charles Grassley, of Iowa; and Scott Brown, the Massachusetts freshman. (If the Republican leadership in Congress had had its way, virtually nothing would have been done.) The White House is perfectly justified in calling the reform package the most comprehensive since the nineteen-thirties. But that, by itself, is hardly cause for celebration. We have just lived through the worst financial crisis and global recession in seventy years, and this week’s renewed turmoil in the markets suggests it isn’t over yet. The key question is whether the reformed financial system will be safe. Or will its risk-taking practices still present a deadly danger to the economy at large? I’m afraid they will.

Take the issue of “too big to fail.” The new legislation will empower the federal government to seize control of struggling financial institutions, banks or non-banks, and put them through what amounts to a rapid and orderly bankruptcy process. When Lehman Brothers and A.I.G. were on the verge of collapse, the government lacked this power. I am all in favor of resolution authority: the issue is whether, in the case of a really big institution, the government would be willing to use it. Read more in The New Yorker.

The Financial Page

The Age of Political Risk

It seems crazy: the German state of North Rhine-Westphalia holds an election, and Americans’ 401(k)s go haywire. But that’s not a bad shorthand description of what’s happened to the stock market over the past few weeks. What links the two is the Greek debt crisis and the actions of Germany’s Prime Minister, Angela Merkel, the villain of the story. When the scale of Greece’s problems first became clear, she grudgingly agreed to help with a bailout. But in the spring Germans started to ask why they should pay for Greek fecklessness and, as elections loomed, Merkel began taking a harder line in her public comments. The tougher she talked, the more skittish markets got. On April 26th, Merkel gave a speech in which she said, “Germany will help if the appropriate conditions are met,” making it sound as if that help were far from a sure thing. The yield on Greek debt immediately soared, and within days a rout was on. It may well have been the most expensive “if” in history.

The European Union did eventually come through with a rescue package for Greece and other beleaguered members, like Portugal, but the markets didn’t calm down, rallying on Monday only to nosedive again at the end of the week. The fact is, this kind of volatility isn’t going away, because we now live in an environment dominated by what economists call “political risk”—the uncertainty that businesses face as a result of government actions. Of course, government actions always affect the economy, but usually in an undramatic way: an interest-rate cut here, a new regulation there. The economic downturn and the debt crisis have given us instead a world where governments are among the most important players in markets—injecting money into economies on a colossal scale and routinely propping up, or even nationalizing, troubled companies.

As a result, investors have a vast range of new things to worry about, like voter sentiment in Westphalia. They have to try to figure out whether policymakers will do things they shouldn’t, like slash spending during a downturn, and not do what they should, which is to intervene promptly when systemic crises appear. Unfortunately, this sort of thing is inherently harder to predict than, say, how Procter & Gamble is going to do over the next few years. Last week, Mohamed El-Erian, the C.E.O. of the bond giant Pimco, sent a letter to investors saying that “the new normal” is a world in which “the public sector plays a much more influential role.” That’s a more uncertain world and therefore one in which markets will be more volatile. Read more in The New Yorker.

Comment

Activism v. Restraint

Franklin D. Roosevelt, in his first term, went to war with the Supreme Court. Time and again, the Court’s conservative majority declared that measures that the President regarded as vital in order to address the extraordinary perils of the Great Depression were unconstitutional. Emboldened by a landslide reëlection in 1936, he struck back at the “nine old men” by proposing a change in the structure of the Court: henceforth, the President would name an additional Justice for each one over the age of seventy. The justification was that the new appointees would assist their elderly colleagues with their work, but, as everyone knew, the real motive was to put enough F.D.R. appointees on the Court to allow the New Deal to proceed.

History’s judgment of the court-packing plot has generally been harsh, but Jeff Shesol’s new book on the subject, “Supreme Power,” while acknowledging the conventional view that ego and emotion drove Roosevelt to act, notes that the plan “was also the product of reason.” As late as 1937, the Depression still presented a risk of social and industrial collapse, “the very conditions that in other nations had hastened the slide into tyranny,” Shesol writes. Court-mandated inaction, Roosevelt believed, was therefore not an option. He considered a proposal to amend the Constitution and add explicit authority for government intervention in the economy, but he chose the more moderate plan of altering the makeup of the Court because he “was consistent in his belief that the real problem was not one of law per se, but of law being twisted by ideologically driven, outcome-oriented judges.”

The forty-fourth President is now feeling the pain of the thirty-second. Barack Obama, like Franklin Roosevelt, took office at a time of economic crisis, pushed through a progressive legislative response, and now awaits a verdict on that response from a Supreme Court that is dominated by his political adversaries. Last week, he nominated Elena Kagan, the Solicitor General, a woman of impressive qualifications, if somewhat opaque views, as his second appointee to the Court. But Kagan would replace John Paul Stevens, a like-minded member of the liberal minority of four, so her arrival would extend, not change, the status quo.

Chief Justice John G. Roberts, Jr., and his conservative fellow-Justices, like their ideological kinsmen in the nineteen-thirties, are engaging in what’s known as judicial activism. A few weeks ago, on Air Force One, Obama, a former law professor, gave a useful definition of the term, saying that “an activist judge was somebody who ignored the will of Congress, ignored democratic processes, and tried to impose judicial solutions on problems instead of letting the process work itself through politically.” This is, indeed, what the Roberts Court is doing. Local elected officials in Seattle and Louisville created complex and nuanced strategies to achieve racial diversity in their schools; in 2007, in a decision written by Roberts, the Court overturned the plans. The elected city council of the District of Columbia passed a strict gun-control law; in 2008, in a decision by Antonin Scalia, the Court vetoed it. Most notoriously, Congress passed the McCain-Feingold campaign-finance bill, which President Bush signed into law; earlier this year, in a decision by Anthony M. Kennedy, the Court eviscerated that legislation and decreed that corporations have the right to spend unlimited funds to elect the candidates of their choice. In that case, known as Citizens United, the majority also reversed two recent Court decisions. Roberts and his allies, like the conservatives of seventy years ago, profess to believe in judicial restraint (the opposite of activism) and respect for precedent, but their actions belie their supposed values. Read more in The New Yorker.