President Barack Obama’s proposal to regulate the size and reach of larger banks will raise lots of heckles from Republicans and conservatives eager to oppose every initiative a regulation and spending happy president pushes forward. Given economic realities, however, the proposal doesn’t deserve out-of-hand dismissal. Although likely to limit financial creativity in some respects, the proposals may actually end up reducing the reach of government in the markets.
Contrary to some reports—and overheated claims from financial institutions—nothing seems to indicate that President Obama wants a full reinstatement of the onerous Glass-Steagall regulations that significantly limited the businesses of every financial institution between the 1930s and late 1990s. Instead, the proposals would simply end most government guarantees — offered through the Federal Deposit Insurance Corporation and a few other entities — for firms that take sizeable investment risks with their own money through the purchase of equities and riskier bonds.
This isn’t a bad thing and may be necessary. In the wake of the 2008 financial meltdown, several large investment banking firms including Goldman Sachs and Morgan Stanley converted themselves from investment banks to commercial banks. As a result, they accepted slightly tighter controls on their own capital but gained much greater explicit government backing. This is clearly a problem: insofar as government-mandated bank insurance makes sense at all, it should exist to protect individuals and small businesses, not multi-millionaires dabbling in exotic hedge funds.
Government guarantees lead many firms to take risks and then expect taxpayer bailouts even when supposedly sturdy “firewalls” exist between consumer deposits and high-risk investments. AIG, the single largest financial institution to fail as a result of the crisis, was an insurance company that, in theory, was supposed to manage its capital even more conservatively than the most conservative banks. A lot of good that did. Without some more separation, it’s likely that some of the new “commercial banks” could eventually end up like AIG.
This doesn’t mean that Obama’s proposal is altogether good. Coupled with generally increased regulation on risk-taking, the laws will likely make it harder to find capital for high-risk, high-reward ventures and make it nearly impossible for larger firms to introduce truly new products. Firms that do innovative may find that the government limits their growth for all sorts of reasons including some pretty bad ones. A sale of many banks’ investment businesses — which the laws would essentially require — might well further hurt already depressed markets.
Finally, the proposal won’t end “too big to fail” firms. Unless the government imposes an absolute limit on financial firm size (a terrible idea that nobody has seriously proposed) some institutions considered “too big to fail” will probably crop up whatever happens.
Still, the President’s proposal deserves serious consideration. In many cases, it will actually reduce the government’s role in the market.
9 responses so far
1 hormelmeatco // Jan 24, 2010 at 12:40 am
“…the laws will likely make it harder to find capital for high-risk, high-reward ventures and make it nearly impossible for larger firms to introduce truly new products.”
David Frum said mostly the same thing a few days ago. Were credit default swaps and CDOs based on CDOs of bad mortgages really that innovative?
Actually, I must admit, they were. So was the first nuclear weapon…
2 oldgal // Jan 24, 2010 at 9:08 am
For an interesting and informative viewpoint: http://epicureandealmaker.blogspot.com/
3 sinz54 // Jan 24, 2010 at 9:09 am
hormelmeatco:
Credit Default Swaps (CDSs) were “innovative” in the sense that nothing like them could have gotten past the SEC in the 20th century. The SEC had imposed capitalization requirements on firms dealing in such derivatives. And that would have made it impossible to enter into highly leveraged (30 to 1) securitized mortgages backed only by these paper CDS promises.
Then in 2000, the Commodity Futures Modernization Act was passed and signed into law by President Clinton. One of the provisions of that bill gutted the SEC’s ability to regulate and oversee derivatives like CDSs. And the rest is history, as they say.
4 balconesfault // Jan 24, 2010 at 4:51 pm
The Commodity Futures Modernization Act was inserted into the budget bill by Phil Gramm just days after the Supreme Court awarded Bush the Presidency – and Clinton had the choice of either shutting down the government by vetoing the Omnibus bill, or trying to allow Bush to take office without a major budgetary crisis on his hands.
So look to Phil Gramm for the act – it wasn’t even really passed, in the sense that there was no debate on it in the Senate. Here’s Phil Gramm’s statement at the time:
today I am proud to add my voice in support of the Commodity Futures Modernization Act of 2000. This legislation represents the end product of work that began in S. 2697, which Senator LUGAR and I introduced on June 8. The Commodity Futures Modernization Act of 2000 completes the work of last year’s financial services modernization law, bringing our financial regulation in line with the rapid pace of developments in the global marketplace. The Commodity Futures Modernization Act of 2000 will now allow new and important financial products — single stock futures — to be sold in America. It protects financial institutions from over-regulation, and provides legal certainty for the $60 trillion market in swaps…
Mr. President, enactment of the Commodity Futures Modernization Act of 2000 will be noted as a major achievement by the 106th Congress. Taken together with the Gramm-Leach-Bliley Act, the work of this Congress will be seen as a watershed, where we turned away from the outmoded, Depression-era approach to financial regulation and adopted a framework that will position our financial services industries to be world leaders into the new century.
And when you read those words, remember – this would likely have been the chief economic advisor
for a John McCain Presidency.
5 blowtorch_bob // Jan 25, 2010 at 12:49 am
All this Credit Default swaps is fine in theory if used responsibly. But you can no more trust Wall Street than you can trust a pedophile in a schoolyard.
6 sinz54 // Jan 25, 2010 at 11:48 am
balconesfault:
As long as we’re quoting Phil Gramm:
Phil Gramm has a lot more to say about that bill:
7 WillyP // Jan 25, 2010 at 1:43 pm
At what point do the commentators here at FrumForum stop looking for the good in Obama proposals, and start telling the truth – that they’re destroying our economy?
We’re pursuing the same agenda as Japan in the 90’s 00’s, and today; the same agenda as FDR; the same agenda as all Keynesian control freaks.
And we’re suffering BIG TIME.
Obama does not need another proposal. He needs to cut government spending, and tell the American people that this mess must clean itself up. Of course, after his past rhetoric, that would be political suicide. But the alternative is national suicide down the debt hole.
Really, could you commentators wake up?
8 balconesfault // Jan 25, 2010 at 4:48 pm
At what point do the commentators here at FrumForum stop looking for the good in Obama proposals, and start telling the truth – that they’re destroying our economy?
Perhaps when there’s evidence that they’re destroying our economy?
He needs to cut government spending, and tell the American people that this mess must clean itself up.
Sure. Everyone wants to be the next Herbert Hoover.
9 WillyP // Jan 25, 2010 at 4:58 pm
balcones, you’re a darn fool.
do you not realize that the market crashed in Sep. 2008? What’s the date? Why hasn’t the bleeding stopped?
Layoffs are once again picking up. Here they come! Watch out! Hope you’re retired or independently wealthy!
Who knows what the White House and this imperial Congress will do next… that’s the point. Nobody, and nobody can make effective long term plans.
Don’t you libs get it? Maybe not?… See: Mass. election from last Tuesday.
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