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Why Placating the Tea Baggers Protects the Status Quo

Obama still doesn’t get it on how to rein in Wall Street.

Conceptual confusion remains at the heart of President Obama’s economic policy.

The latest example of this is the decision to try recoup for taxpayers as much as $120 billion of the money spent to bail out the financial system, most likely through a tax on large banks, according to the NY Times.

For once, the American Bankers Association has a point when it argues that imposing yet another fee on the industry would obviously decrease its ability to lend. The new fees will effectively function as a tax, raising the banks’ cost of capital, which invariably will mean a demand for a correspondingly higher return on capital from the borrower to facilitate a loan.

It may well be just to have a punitive “polluter pays” principle, but that’s not the rationale provided by the Obama Administration, which seems determined to do everything possible to avoid offending the banks. Rather, the new levy appears to be aimed at addressing rising anger over bonuses.

Yet again, then, we are addressing symptoms, not underlying causes. The American public justifiably finds the bankers’ bonuses to be offensive. But the real problem is the overall structure of banking itself, and it is this which needs to be fixed. However pleasing the political optics, new bank levies won’t achieve the goal of eliminating systemically dangerous banking practices and could well make things worse for borrowers.

For the most part, the proposed new fees proposed by Obama’s economic team work at cross purposes with overall policy. All they do is raise the common cost of funds for banks, which effectively is passed on to the consumer, whilst current Federal Reserve policy has been to lower rates.

Higher borrowing costs are not exactly what the American economy needs right now, particularly in light of the most recent unemployment data from December, which points renewed deterioration in the job market (there were 661,000 people who gave up looking for work; add them back in, and mark them as unemployed, and the unemployment rate goes up to 10.4%).

Additionally, there is more misconceived deficit terrorism. The fees are supposed to help “finance” the budget deficit, but the new levies on the banks do not “fund” anything, Collecting taxes or fees in no way increases the government’s ‘hoard of funds’ available for spending. By the same token, when the Federal Government spends, the funds spent don’t ‘come from’ anywhere, any more than the points on a scoreboard ‘come from’ somewhere at the football stadium or the bowling alley.

And Obama’s policy is reactive: it comes in response to banking activities which have gone horribly wrong (and the concomitant populist anger that the subsequent bailout packages have engendered), rather than addressing the fundamental reason for the bailouts – namely, the reckless actions of the bankers themselves – activities which will not be banned under the newly proposed financial reform packages being legislated by the House and the Senate.

As we’ve said before, banks are public/private partnerships. In reality the only useful thing a bank should do is to facilitate a payments system and provide loans to credit-worthy customers. In the words of “Winterspeak”:

For banking to do the job it is meant to do (i.e. make loans that will be paid back), a bank should be required to keep all loans it makes on its books until maturity. It should be forbidden to participate in any secondary markets, in any way. It should not run a prop trading desk. It should not sell insurance. It should not have a fee-for-service business. It should simply conduct its own credit analysis, make loans, and service them. And in return for providing this public purpose, a bank shall have a reserve account at the Fed.

A simplistic restoration of Glass-Steagall (whereby investment and commercial banking activities are completely separated) neither eliminates the problem of Wall Street firms that are “too big to fail”, nor does it address the underlying practices which created systemic risk in the first place, largely because securitization has blurred the distinction between commercial and investment banking. The demise of Bear Stearns and Lehman Brothers shows that unsustainable bank-funded asset price booms can and do occur even among smaller banks, or even non-bank financial entities such as GMAC.

“Too big to fail” is a nice slogan. However, the proper way to legislate real financial reform is to establish markets that are liquid and deep. This means relying on a large number of smaller institutions carrying on traditional banking activities, rather than having these activities concentrated in the hands of limited number of highly capitalized global institutions. The former creates vibrant competition and a more stable banking system with less systemic risk, whilst the latter is anti-competitive and even more prone to systemic risk, given the large concentration of deposits in the hands of a minimal number of banks today, along with their insistence to perpetuate highly destabilizing activities contrary to public purpose.

“Too much concentration of function to fail” is more of a mouthful, but it gets to the nub of the problem. Far better to prevent the activity which has necessitated the bailouts, instead of conjuring up more faux populist measures which do nothing but attack the symptoms of the problem. Though U.S. authorities often like to pretend that their hands are tied by other regulators, in fact the U.S. holds a trump card in this situation: It can ban the banks of any country that does not seriously regulate its banks along the lines proposed above from doing business here.

Unfortunately, these distinctions are clearly lost on the Obama Administration, whose main concern these days is to placate the angry peasants, rather than curb Wall Street’s anti-social and highly destructive behavior. If adopted, the latest measures will achieve nothing. Perhaps the FCIC hearings will not only serve to educate the public of what went wrong, but also guide the President’s economic team toward a more sustainable banking model. But don’t hold your breath waiting for it.

MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at MAuer1959@aol.com

 

 

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Marshall Auerback is a market analyst and a research associate at the Levy Institute for Economics at Bard College (www.levy.org).  His Twitter hashtag is @Mauerback

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