A banking strategy that pleases no one
Ever since the $25 billion settlement over foreclosure abuses between five of the nationâ€™s biggest banks and the state attorneys-general was announced, thereâ€™s been a steady drumbeat of naysayers who’ve asserted the deal does more for the banks than it does for homeowners. And barring some happy accident in which the settlement somehow inspires banks to behave, theyâ€™re probably right: In comparison with the estimated $700 billion difference between what people owe on their mortgages and what those homes are actually worth, $25 billion is peanuts.
But the problem isnâ€™t that the settlement is part of some grand plan by the government to help out the banks. Rather, the problem is that the government doesnâ€™t seem to have a grand plan for the banks.
For all the current and well-deserved bank bashing, few question that a well-functioning economy is predicated on a well-functioning banking system. And few question that confidence is a critical ingredient. So then the issue becomes: What kind of banking system do you want to have, and how do you inspire confidence in it?
At two major junctures, our government (Congress went along with the Bernanke-Paulson-Geithner triumvirate) made the call that it wanted the banking system we had, not a radically reshaped one. First, the government bailed the big banks out in the fall of 2008. Perhaps more critically, the Obama administration made the call not to break them up or nationalize them in early 2009. In a sense, this new settlement is a continuation of that call. As Yves Smith at Naked Capitalism has pointed out, itâ€™s a bailout for the banks: It will reduce the amount that people owe on their mortgages, thereby helping them afford their home equity lines of credit, roughly $400 billion of which are parked on the balance sheets of the big banks. And Scott Simon, the head of the mortgage business at bond giant Pimco, has argued that investors, not banks, will bear the brunt of the cost of any mortgage modifications.
But most important, the settlement lets the banks off the hook for repeatedly breaking the law in the foreclosure process. One analyst who has studied this tells me that their legal transgressions alone could have been used to rip apart the banking system, had the government desired to do so. Even if itâ€™s true that the banks merely violated technical aspects of the law, and didnâ€™t kick anyone out of a house who deserved to stay, that still flies in the face of everything weâ€™re supposed to believe about the importance of the rule of law. Next time you get a ticket for running a red light, try arguing that you shouldnâ€™t have to pay because you didnâ€™t hit anyone.
But at the very same time, the government is doing a host of other things that look like theyâ€™re designed to undermine confidence in the banking system, if not the system itself. The news of the settlement broke at about the same time President Obama announced a new task force that would delve into the crimes of the bubble era. Itâ€™s not clear how this task force will differ from the one he announced in 2009, but the point — look out below, banks and bank investors! — is consistent with his anti-bank rhetoric. And the settlement is only a small piece of the litigation facing the banks. As Obama said: â€śThis settlement also protects our ability to further investigate the practices that caused this mess â€¦ weâ€™re going to keep at it until we hold those who broke the law fully accountable.â€ť Indeed, multiple other investigations and lawsuits are ongoing; the Wall Street Journal also reported that the SEC might soon bring cases involving the packaging of mortgages.
The litigation isnâ€™t all. Investors express a whole host of other worries, including Dodd-Frankâ€™s so-called resolution authority — which dictates the way big banks in crisis are supposed to be unwound and, some say, basically means that politicians will pick the winners and losers in the next crisis. These concerns also include new capital requirements, President Obamaâ€™s proposed $61 billion bank tax, and the Volcker Rule. Itâ€™s death by a thousand cuts. All those things, plus a much tougher operating environment, help explain the continuing dismal performance of bank stocks. Yes, theyâ€™re up from the lows of last fall, thanks to the general market rally, but bank stocks are still depressed, thanks in part to the political risk they face. And the mere fact that political risk exists is a big problem in and of itself. (One smart investor uses the phrase â€śpolitical financeâ€ť to describe the dangerous intertwining of two spheres that should be separate.)
You might say: So what? Surely the banks deserve to die for the agony theyâ€™ve inflicted on our economy! Which is probably true. But thatâ€™s a reaction, not a policy. Now, the prudent policy might well be to kill the big banks. Plenty of very smart people, like Simon Johnson, the former chief economist of the IMF, Mervyn King, governor of the Bank of England, Paul Volcker, and Thomas Hoenig, the next vice-chairman of the FDIC, have inveighed against the dangers posed by banks that are too big to fail. So then, letâ€™s kill them outright! While weâ€™ve missed our best chance, there would still seem to be some fairly simple ways to do that, like reinstating the Depression-era Glass-Steagall law separating commercial and investment banking or mandating sky-high capital requirements for any firm over a certain size. That would bring its own set of challenges — most notably a drift of activities to the shadow banking system — but Iâ€™m not sure anything could be more challenging than regulating todayâ€™s big banks, given not just their complexity but also their well-oiled political and regulatory influence machine.
Thereâ€™s an argument that articulating a clear policy, let alone executing it, is simply beyond Washingtonâ€™s capabilities. Which is scary, because right now, we have the worst of both worlds: A banking system that the population at large abhors, and one that investors canâ€™t trust.
PHOTO: A man walks past a Wells Fargo Bank branch on a rainy morning in Washington January 17, 2012. REUTERS/Gary Cameron