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The Key Part Of Obama's Economics Speech

I just had a chance to read the economics speech Obama delivered in New York this morning. Overall, I thought it was in the right place substantively and ideologically. All the principles he outlined were prudent and intuitive-sounding, though there weren't a ton of specifics, and nothing that struck me as especially innovative. (Not that that's such a bad thing. Basic intuition gets you a long way here, I think.)

The most interesting passage in the speech was when he took after the Clinton administration's deregulatory efforts in the 1990s, some of which were clearly bad ideas in retrospect. (Or at the time for that matter.) Like when he said, for example:

A regulatory structure set up for banks in the 1930s needed to change because the nature of business has changed. But by the time the Glass-Steagall Act was repealed in 1999, the $300 million lobbying effort that drove deregulation was more about facilitating mergers than creating an efficient regulatory framework.

Agreed. It's tough to finger Glass-Steagall repeal--which allowed investment banks and commercial banks to merge, and therefore gave rise to behemoths like Citigroup*--as a direct culprit of the subprime crisis. But it definitely contributed. In two ways, as far as I can tell. The first is by bringing different stages of the subprime mortgage securitization process under one roof (lending, re-packaging, re-selling of the loans, etc.), which made the whole process somewhat less transparent. (You can get carried away on this point, of course: Even under Glass-Steagall it was possible to perform more than one step at a single firm. And Glass-Steagall didn't abruptly disappear in 1999. We'd been chipping away at it for years.) Second, the consolidation frenzy it made possible created banks so sprawling their collapse would threaten the whole financial system.

To my mind, the more directly-relevant Clinton administration mistake was their refusal to even consider tightening oversight of derivatives when they had the chance. Back in 1998, when the head of the Commodity Futures Trading Commission, which nominally oversees derivatives, wanted to study the possibility of regulation, Robert Rubin (and Alan Greenspan) used some pretty heavy-handed tactics to stop her.

Unfortunately, a lot of the investments that have gone bad lately are derivatives tied to subprime mortgages. (A derivative is basically a bet on the price movements of an underlying asset--like, say, pork bellies. An example of a derivative would be a pork bellies future--in which you agreed to buy several tons of pork bellies, or whatever, for a certain amount of money a year from now...) One problem with derivatives is that they allow speculators to use a ton of leverage, which magnifies their gains but also their losses. It's hard to imagine that serious scrutiny of derivatives wouldn't have resulted in some restrictions on this practice, but Rubin et al weren't even willing to study the problem...

P.S. For what it's worth, Hillary has implicitly criticized the Rubin position herself (though without linking it back to her husband's administration). Here's what she had to say in a speech back in November:

[D]erivatives also create new risks. They can swing wildly in value. It isn't always clear who owns them or how much they are really worth. Owners don't always understand the risks, which is why even the investment banks that created them are losing billions of dollars on these derivatives. And the ripples are being felt from Wall Street to Main Street.

I believe in our markets, but markets work best when there is information flow. And a lot of these new financial products are not transparent. The market doesn't have enough information about them, and certainly buyers don't. Today, we need a sensible middle ground between heavy-handed regulation and a hands-off approach to a risk that can hurt the innocent, as well as the sophisticated buyer.

I'm still trying to track down whether she's said anything about Glass-Steagall.

Update: Here's the transcript of an interview Obama did with CNBC's Maria Bartiromo today. I thought he held up pretty well amid some tough questioning.

Update II: Doesn't look like Hillary's said anything about Glass-Steagall on the campaign trail. But it's worth pointing out that she has some record of supporting banking and financial-market regulation in the Senate. For example, she recently sponsored a bill that would prevent banks from getting into the real estate brokerage business.

*A reader notes that Citibank had already merged with a securities firm before the repeal of Glass-Steagall. The formal repeal was necessary so that Citibank could merge with Travelers Group, an insurance company, a deal that had also been prohibited under the original Glass-Steagall law.

Still, from what I understand (see here, for example), commercial banks that owned securities firms were really able to ramp up their trading and underwriting activities (i.e., the kinds of things investment banks do) after Glass Steagall was repealed.

--Noam Scheiber