U.S. regulators should clamp down on Wall Street innovation to prevent firms from creating "Frankenstein" financial products with no substantial value to the public at large, former New York attorney general Eliot Spitzer says.
Spitzer, the former New York governor and attorney general once dubbed "the sheriff of Wall Street," said that the financial crisis has shown cracks in the business model of the big Wall Street banks, revealing fewer checks and balances and confusing the role of investment bankers in society.
"The model of financial concentration that we bought into when we created Citibank and the supermarket model of financial services has not worked," Spitzer told the Reuters Global Financial Regulation Summit on Wednesday.
"It has not worked for the economy. It has not worked in terms of stability, and as we have now seen it hasn't produced smart capital flows."
Over the past few years, as the government bailed out firms that took on too much risk like American International Group Inc., the world was shocked by the bankruptcy of Lehman Brothers and Goldman Sachs became the latest investment bank entangled in a scandal over a product it sold, Spitzer said Wall Street has lost its way.
Investment bankers, he said, could take a page from bioethicists, who routinely ask whether the latest research opportunity on stem cells or genomes is ethically appropriate before going ahead with it.
"In science people are used to asking that question, but in finance we have kind of presumed innovation is inevitably good," Spitzer said. "We fell into this notion that every one of these products somehow shifted risk in a way that was good. Maybe we need to step back and say, 'OK, that is Frankenstein. We don't want that product.'"
Spitzer said the current bank model has left the public trapped in "too big to fail" scenarios that force government bailouts, while still letting those in control of the banks have to take home hefty rewards.
"The problem is the business model," Spitzer said. "The banks are playing so many roles with so many people ... that nobody knows to whom they owe a duty of loyalty. Most of what they do has nothing to do with the public purpose that we want investment bankers to play."
Spitzer, who resigned from the governor's office in 2008 after an embarrassing prostitution scandal, has seen the financial crisis validate many of the concerns he had about Wall Street as a New York prosecutor earlier in the decade.
Spitzer said he supports the concept of going back to a model of smaller banks, and that taxpayers should consider whether certain benefits given to large investment banks in the financial crisis — such as increased access to the Federal Reserve's discount window — are actually of public benefit.
"We don't want to restrain the human mind and imagination but it doesn't mean that every product you can conjure is one you want out there in the marketplace," Spitzer said.
"Things are still as opaque as they always have been — off balance sheet transactions are still there and liabilities come back to haunt us," he continued.
However, Spitzer said issues on Wall Street go deeper than just the banks, noting that in many cases banks believed they had appropriate sign-offs from legal and other advisers to go ahead with now-questionable activities.
"Lawyers, accountants ... over the past 20 years became the facilitators," Spitzer said.
"That, to me, is one of the great structural failures that's brought us to where we are. The people who were supposed to be checks, who were supposed to have erected boundaries in terms of both ethics and what compliance statutes really mean, have failed."
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