A December 12, 2009, article at Big Brass Blog, an online property of Dark Wraith Publishing, detailed a bill passed by the U.S. House of Representatives to overhaul the regulatory structure that oversees the financial services industry. Below I republish in expanded form my responding comments to that article.

While meaningful, penetrating financial reform is desperately needed, and has been needed for over a decade, given my deeply cynical tendencies, I am most decidedly not impressed by the work of the current Congress in this matter. Any attempt at "reform" that does not address the causes of the near-collapse that has led to the recognition of such need is doomed to failure. Far too much emphasis is being placed upon the failures of the private sector financial institutions and their principals, while far too little attention is being given to the public sector institutions and people who had within their power the means and authority to responsibly carry out their duties but did not.

First, members of Congress demonstrate no courage when, instead of first addressing the irresponsible policies of their own chambers, they pose to lead a populist mob against the private sector. This is not to say in any way that those financial institutions and their principals were not, in their own right, deeply flawed in their activities that led to the crisis. They were, and they rightly deserve a much firmer, far less accommodating grip of oversight; but that brings us to a deeper problem that regulatory reform refuses to address, and this is my second point.

To imagine that the benefits of a so-called "free market" are not tied to the power of a fiercely competitive industry structure is sheer folly. We have now and always have had a bias in public policy toward a substantial amount of freedom in enterprise. Regulations of all kinds are actually the primary evidence of this: containing the excesses, negative externalities, and other unfortunate consequences of market activity through legislation enforced by regulatory agencies is a means by which to give license to a free market environment while merely circumscribing its actions, but not prohibiting pursuit of profit gained for risks taken.

At what point the scale of individual companies within an industry becomes significant in terms of so-called "market power" is a matter of enduring debate, but it certainly depends upon the industry. To the extent that the prospect of scale economies encourages growth of individual companies, market concentration would seem to be favorable to cost efficiency in production and, theoretically, therefore to final prices of goods and services. Against this well-embraced argument, however, are the risks associated with big companies dominating an industry and a subtler possibility that those scale economies are gained at the expense of opportunity costs incurred by factor input markets, consumers, and prospective competitors facing prohibitive barriers to entry.

The first and most apparent risk of market concentration is that of failure of one or more of the huge firms. At some scale, a single firm falling apart can have not just microeconomic impact, but also macroeconomic consequences. A casual look at the financial services industry during last autumn's crisis gives evidence of a cascade effect, where the fall of several industry leaders induced destructive consequences upon other financial institutions and, in fact, upon firms beyond the industry. In current news, the potential default on debt of Dubai World, one of the largest holding companies on the planet, would have staggering consequences on countless large and small financial intermediaries and their stakeholders across the globe.

We cannot have a free market that remains in the grip of fiercely competitive firms that can succeed and fail inconsequentially to the macroeconomy while allowing that freedom to cabin scale that most decidedly can be consequential to the macroeconomy.

A second and more pernicious risk of big companies dominating an industry is the political power they can come to exert. When our government in all three of its branches considers the voices, expertise, and opinions of industry leaders to be co-equal with that of citizens — ignorant or informed as they may be — the concept of democracy has taken a gravely radical turn from any sense it might have had among the ancient Greeks to whom we so scrupulous refer when constructing our own ideals of what a democracy is or should be.

The current President, who campaigned on a platform of change, nevertheless draws to his inner counsel men and women from companies of scale and, in some cases, disrepute.

Members of Congress allow their votes to be influenced by lobbyists paid by powerful corporate interests.

The judiciary deems the concept of "personhood" to encompass both people of flesh and blood as well as business entities, recognizing for each group a certain set of rights as well as responsibilities, never resolutely establishing definitive judgment upon the problem of how natural law could possibly inhere to innate, conceptual constructs like corporations, partnerships, and limited liability companies. (See my article, "Plain Language," for an overview of natural law and inherent rights.)

Returning finally to the matter of why the current posture of regulatory reform for the financial services industry is largely worthless in my judgment, I have no reservation in that assessment, again, because the failures of public sector institutions and personnel are being hidden behind the parade of righteous indignation and resolutions aimed at the private sector, altogether deserving of unrelentingly harsh criticism as it is.

From at least 2004 until around the time of the beginning of the noticeable part of the financial crisis last year, the largest monetary aggregate, M3, was spiraling upward at an annual rate that finally reached nearly 20 percent. The Federal Reserve, which has sole responsibility for the money supply, dealt with this by suspending publication of the M3 data. (See, for example, my May 11, 2008, article, "The Gospel of Impending Doom.")

At the same time this was happening, the monetary aggregate called M1 was barely growing.

Now, M1 is money that includes cash and checking account funds. M3 includes M1, but also includes highly illiquid (that is, not immediately usable) money like massive time deposits, Eurodollars, and the like. (Read about monetary aggregates in Part Three of my series, "The Economics of Wreckage.")

The growth rate of M1 was not sufficient to keep up with the real growth rate of the economy, which meant that a slow, choking throttle was being applied to the economy that uses cash and checking account funds. That's the economy of everyday people and businesses.

The rapid growth rate of M3 was flooding the financial system with a kind of money that the institutions comprising that system could not use directly. So, what does a rational economic agent do when it has an enormous amount of value that it cannot use but little in the way of cash that it actually needs? It will do what quite a few rational individuals in that position would do: it will pledge the highly illiquid assets against instruments that produce meager amounts of immediate money.

That's what people do when they have huge value tied up in a home but don't have money for their day-to-day expenditures. They'll use their homes as backing for lines of credit and other instruments. If that's not enough, they'll pledge the hard assets on bets that are sure things at first but become less and less so the farther out on a limb they go. If you have an investment that will pay off in six months, if you've got lots of wealth but little immediate income, you'll go long against your illiquid assets to buy in on the fast money makers. That's not "human nature": it's rational survival behavior, personal and institutional. (And save me the talk about how "responsible" people don't behave that way. Put just about anyone in the right circumstances, and responsibility goes from fiduciary to personal in no time flat.)

Hence, in the financial industry, we saw credit and other derivatives coming on line as financial intermediaries and other financial institutions utilized vast oceans of M3 money to squeeze out small amounts of liquid cash.

In retrospect, that's extraordinarily risky, of course, but retrospective wisdom is always in unlimited supply, and I dare say that a whole lot of liberal I-told-you-so types did not know beans about what was going on at the time, and they certainly weren't in the mood to knock off their Hey-Hey-Ho-Ho-George-Bush-Must-Go chants long enough to read the articles I was writing and publishing about what was going on and where it was going to lead.

Forward-thinking risk analysis is never particularly easy to come by, and that's why we have a regulator like the Federal Reserve. Whereas no one pays me to write about impending doom, the men and women at the Fed get paid very well at least to try a little bit of objective thinking once in a great while, like when the U.S. financial system is on a run-away freight train to a cliff.

The unfortunate part, though, is that the Fed could do nothing about the soaring M3 without the Chairman of the Board of Governors, Ben Bernanke, going to Congress during the Bush Administration and telling those Representatives and Senators, so many of them full of hubris and bereft of any knowledge of financial systems and economics, that the M3 money supply was spiraling upward out of control and all proportion, and the result was a financial system that was living on borrowed time and madly leveraged non-Tier 1 assets.

Were the Representatives and Senators to have asked how this looming M3 apocalyptic flood was happening, Mr. Bernanke — were he to have the guts, which neither he nor his addled, pathetically partisan predecessor, Alan Greenspan, did — would have explained that it was directly and inescapably the fault of the Congress and the Bush Administration because they were all keeping the U.S. economy going by leveraging off wildly huge trade deficits that were filling the coffers of foreign central banks with American dollars that those foreign central banks were then lending back to the United States government to finance its irresponsibly low taxes and irresponsibly high spending. (See, for example, articles I have written including Part 4 of my series, "The Economics of Wreckage," as well my prior articles about U.S. trade deficits, like "Foreign Trade and Debt," "Seven Principles of Macroeconomics," and "Exchange Rate Regimes," among others published over the past five years here at The Dark Wraith Forums.)

And why were those trade deficits so ridiculously high?

Was it greed of corporations moving their operations overseas?

Was it expensive, slothful American union labor?

Was it ignorant American consumers who wouldn't just "Buy American"?

No, unfortunately for the finger-pointers on the Left and on the Right, it was considerably simpler: China, India, and several other countries were pegging their currencies at staggeringly low, out-of-line exchange rates against the dollar. (Nobel-Prize winning liberal economist Paul Krugman thinks this is just fine, which is why Dr. Krugman is on my all-time Lowest-of-the-Low list of liberals, right beside venture capitalist rich boy PowerPointer Al Gore.)

They, especially the Chinese, were bleeding us dry, wiping out tens of millions of American jobs and hundreds of billions of dollars of our industrial base, all while lending us back the money they were getting from us by virtue of selling their products at to us at artificially low prices that made the Blue Light Special at K-Mart pale by comparison.

Hence, the U.S. government (along with the private sector) lived beyond its means, M3 spiraled, M1 was being crushed by the Federal Reserve in a ludicrously inadequate attempt to counter-balance the spiral of the larger monetary aggregate, and the financial system was swelling like a balloon with illiquid money that it used as the backing for derivative swaps off which its member institutions could make what seemed like a fast buck until the leverage became so great that even a small pull on the fulcrum (as happened on about September 15, 2008) sent the whole teeter-totter into a great big flop off that flimsy fulcrum of trust in the system.

Mr. Obama and his Democratic allies spend like there's no tomorrow while they talk about reforming the tax system but do nothing whatsoever that would come even within a trillion dollars a year of closing our federal budget deficits, and they rely for an economic recovery on unemployment staying high so worker productivity will go up to pull us into a growth phase just like Keynesians for the past seven decades have been doing. (Part Three, linked above, of my series, "The Economics of Wreckage," explains the theory, and my recent articles, "Recession to Recovery: The Rough and Narrow Road Ahead" and "Favorable Signs of a Sustainable Economic Recovery," show how this theory is playing out in the real world of the current economic recovery.)

Financial reform does not impress me.

When the government (at all levels) stops spying on its citizens like every one of us is a criminal waiting to be caught, when the Obama Administration starts prosecuting Bush Administration officials from the top down, and when the members of Congress start educating themselves about economics and finance and stop drooling to every pathetic interest from AIPAC to the healthcare industry to the banks to the military and its failed commanders like Petraeus and McChrystal, then I'll be on board the reform efforts.

In other words, I shall remain now and permanently a cynic.

The Dark Wraith has spoken.