A Crisis Is a Terrible Thing to Waste

In 2009 we wasted a perfectly good financial crisis.

With disastrous economic events accumulating in March, President Barack Obama exhorted listeners during a weekly radio talk to "discover great opportunity in the midst of great crisis." It's an appealing conceit: seeking breakthrough achievement in a time of danger.

That's why it's such a shame we didn't take advantage of the Wall Street crisis of 2008 by making 2009 the Year of Real Financial Reform.

Instead, the Obama Administration offered half-measures. The financiers lobbied against even modest reforms, and a Congress drenched in Wall Street campaign cash has peppered proposed regulation with loopholes. At a conference in the U.K. on Dec. 8, Paul A. Volcker, the former chairman of the Federal Reserve and an Obama adviser, addressed an audience of bankers and executives who were insisting that Wall Street and big corporations can police themselves, without more government scrutiny. "Wake up, gentlemen," Volcker said, according to media reports. "Your response is inadequate."

The warning applies to regulators and politicians as well. The crisis of 2008 offered a once-in-a-lifetime opening to overhaul the U.S. financial engine. It's a machine that can do much good by raising and allotting capital and much damage when allowed to run unchecked. Now, as stock markets recover and bank earnings bounce back, mass amnesia has set in. Political momentum has waned. Financial reform legislation is getting weaker by the week. And Goldman Sachs Chief Executive Lloyd C. Blankfein says we should be grateful to investment bankers for "doing God's work."

The most fundamental failure has been the Administration's unwillingness to take seriously the murmurings of that shrewd old giant, Mr. Volcker, who wants to reverse course on bank gigantism. In the 1990s, Wall Street convinced both political parties that combining all manner of financial services into unfathomable Goliaths was necessary in a global economy. Poof went the safeguards instituted in the wake of the Great Depression separating the public-utility-like functions of the financial system—customer deposits, conventional commercial loans, and so on—and the casino of investment banking and high-stakes trading. The consolidation accelerated a race for hugeness that gave us institutions that are "too big to fail": basket cases like Citigroup (C) and risk factories like American International Group and Goldman. Without hundreds of billions of taxpayer rescue dollars flooding the markets, all of these firms, and many more, might have collapsed, bringing on Great Depression—The Sequel.

With popular skepticism toward Wall Street at a peak in early 2009, our political and business leaders did...nowhere near enough. The White House bought the Wall Street line that bigger is better, or at least unavoidable. Now the banks are larger and more intricate than ever. As The Wall Street Journal noted recently, the world's 10 biggest banks account for about 70% of global banking assets, up from 59% three years ago.

Maybe we'll eventually see new requirements for larger capital cushions at individual banks to absorb future losses. Maybe we'll see the establishment of a new bank-subsidized rescue fund to cover the costs of potential failures. We could even get greater regulatory authority to block certain bank mergers. But the too-big-to-fail mammoths are still just that. The implicit taxpayer safety net—now explicit—means that some bankers almost certainly will engage in the kind of risk-taking that brought us the subprime fiasco. Why not? Someone else will clean up the mess.

The tame alternative to real regulation is greater transparency. And, yes, we will have more disclosure of credit-derivatives trading. These are the insurance policies against bond defaults that helped tempt Wall Street to ratchet risk up to unprecedented levels. But with derivatives, as with bank heft, the politicians have bought what Wall Street is selling.

Lawmakers backed away from any serious attempt to slow the invention of novel exotic trades whose side effects few, if any, really understand. My colleagues at Bloomberg News have lately reported that some of the very same geniuses who brought us toxic credit-default swaps are now angling to juice the carbon-trading market with climate-change derivatives. If the pilfered e-mails from squirrelly British scientists weren't enough to cast doubt on the campaign against global warming, greenhouse-gas swaps surely will do the trick.

The list of missed opportunities is too long for one humane sitting. I'll wrap up with lawmakers' mishandling of the credit-rating scandal. Moody's, Standard & Poor's, and Fitch played a major role in the crisis by rubber-stamping their triple-A approval on mountains of mortgage-backed bonds that went bad. These companies enjoy their lucrative oligopoly only because of a publicly sanctioned system requiring mutual funds and money managers to buy securities given high ratings by the Big Three. But there's a rank conflict of interest: The issuers of bonds pay the credit agencies to rate the bonds. Why we take the ratings seriously remains one of the great mysteries of the financial world.

Congress roughed up some rating-agency executives at hearings and may yet require more disclosure here, too. But the basic conflict persists. Genuine reform fizzled. We'll regret it when the next crisis hits.

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