The performance of the stock market was the one bright spot in the
otherwise dismal year for the economy in 2009. The Dow Jones Industrial
average rose 65 percent from its March low, causing many to hope it was
a harbinger of recovery.
President Barack Obama has fixed that. Last week the Dow fell 552
points in the three trading days since the president announced his plans
to "reform" the financial services industry.
Wall Street took in stride the president's announcement Jan. 15 he
intends to seek a tax on the 50 largest banks, perhaps because Wall
Street insiders expect the tax — which his aides said should raise
between $90 billion and $117 billion over ten years — to be passed
along to consumers.
What tanked the market last week was Mr. Obama's announcement Wednesday
he will seek legislation to limit the size of banks, to limit the
compensation of executives at banks which have received federal
bailouts, and to prohibit proprietary trading (trading for one's own
account) by bank holding companies.
There is something to be said for both proposals. It makes sense to
have banks which are considered "too big to fail," which are recipients
of emergency loans from the Federal Reserve, to pay into a fund from
which those loans might be drawn, as all banks pay for the Federal
Deposit Insurance Corporation (FDIC), which reimburses bank depositors
when banks fail.
And forbidding bank holding companies from proprietary trading is, in
essence, simply a reinstatement of the Depression-era Glass-Steagall
Act, which was in part repealed (for bank holding companies) in 1999.
But the Devil is in the details, and in the timing. What is a good idea
in normal times can be a bad one in particular circumstances. Vigorous
physical exercise is good for most people most of the time, but not for
patients suffering from pneumonia.
Proprietary trading is a major profit center for bank holding companies,
at a time when few other banking activities are profitable. And the
taxes bankers pay are a major source of revenue for the governments of
New York State and New York City, both of which are nearly bankrupt.
Mayor Michael Bloomberg blasted the president's plan at a news
conference Saturday.
Also uneasy about the plan is Treasury Secretary Timothy Geithner, who
fears it will harm the competiveness internationally of U.S. firms.
However, had the proposed new rules been in effect, they'd have done
next to nothing to prevent the financial meltdown. Lawrence White, a
former regulator who now teaches at New York University's business
school, described them as "a solution to the wrong problem."
The firms whose failures triggered the financial collapse — Bear
Stearns, Lehman Brothers, the insurer American International Group —
were not commercial banks or bank holding companies. There is no
evidence proprietary trading contributed to the meltdown.
The root cause, you'll remember, was sub-prime mortgage lending, home
loans to poor credit risks on ridiculously easy terms — often no money
down for mortgages four or five times the (unverified) annual income of
the borrowers. Sub-prime lending was encouraged — some might say
insisted upon — by politicians in Washington.
Fly by night outfits such as Countrywide Mortgage were able to make such
loans again and again because two quasi-government corporations, the
Federal National Mortgage Association (Fannie Mae) and the Federal Home
Loan Mortgage Corporation (Freddie Mac), both run by politically
connected Democrats, bought all the bad paper they could generate.
Fannie and Freddie are both bankrupt, kept alive only by massive federal
subsidies.
Mortgages were bundled together, chopped into pieces, and sold
throughout the financial system with the blessing of regulators, who
assumed the new financial instruments (chiefly collateralized debt
obligations and credit default swaps) would reduce risk. Instead, they
multiplied it.
The housing boom and bust was fueled by an easy money policy by the
Federal Reserve, begun when Alan Greenspan was chairman, but continued
when Ben Bernanke replaced him in 2006.
Absolutely nothing has been done about these root causes of the
meltdown. It would seem wiser to begin financial reform by addressing
them, rather than with "solutions to the wrong problem" that have been
proposed more to solve the president's political woes than our economic
ones.
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