President Obama called the CEOs of the nation’s twenty largest banks into the White House in early December and directed them to make loans. He also warned them not to resist his plan for financial industry “reform”. Regular readers know that I am a pretty shameless Midwest populist. I have no desire to defend the Wall Street banks, but the President’s rhetoric was breathtaking. The concentration of financial clout in the too big to fail institutions (Toobtofs) has had a devastating effect on our nation. This concentration of risk has been an unintended consequence of the many conflicting goals of existing federal financial policy and regulation. Eliminating the systemic risk created by these institutions should be the main goal of federal financial policy. The President’s dramatic public action will neither solve the current crisis nor reduce the future damage caused by these financial bubble manufacturers. This action only visibly reinforces the public/private partnership necessary for the bubble trade. Obama loves bankers as long as they will serve as props when he needs them and dance to the tune he plays. The bankers will be fine with the tongue lashing as long as the dance tune leaves room for a move only they can bust.
This public spectacle definitively demolishes the American myth that economics and politics exist separately. What our nation needs is a vigorous, decentralized and apolitical banking system. The pressing policy question is whether we are going to enact policies to “discourage and eliminate” systemic risk or whether we are going to develop a “super-regulator” to “manage” systemic risk. Policies designed to eliminate systemic risk will foster decentralization and force bubble manufacturers to raise private capital for their reindeer games. They’ll be small self-funded games if the private players have to fund them. Those who want to “manage” systemic risk will inevitably only further politicize finance. Megabankers and mega regulators will find the “management of systemic risk” model mutually beneficial, to the detriment of the rest of us.
Our nation is in a very serious crisis. My last post explained why bank loans are down. Funding may be cheap, but capital is the operative constraint on lending and it is very expensive now even for good banks. This is why lending is tight. Attacking and threatening bankers only further increases the cost of capital to banks which further discourages lending. I am party to many private conversations with other bankers. None of them are planning for a recovery in the coming year. Real recovery will not come until there is a rational policy basis for it.
I completely understand the public’s frustration with the banking system. There is plenty of blame to go around and it is only natural to want someone to get tough on the perpetrators. The naked truth is that getting tough on the bad guys is not what will happen with more federal regulatory power. I have previously explained how to solve the Toobtof problem efficiently and raise revenue doing so. “Managing” systemic risk won’t solve these problems, but it fits better with Obama’s worldview that the big things need to be managed by really smart guys working in Washington. There are already a lot of smart well-intentioned regulators working in Washington and it is worth asking why this approach hasn’t worked so far. There are quite innocent explanations I could offer, but since the President has so publically politicized banking I will focus on the most important point. Centralized and politicized finance is financially and politically profitable for both politicians and financiers. This is one reason why the Wall Street money heavily favored Obama in 2008. They love Obama and, hot rhetoric not-withstanding, he appears intent on returning their affection. Public tongue-lashings are just part of the ritual dance. Why would such a skilled politician want to actually solve such a useful problem?