James Pethokoukis

Politics and policy from inside Washington

Nicole Gelinas on the new Obama plan

January 21, 2010

She emails me on the Obama plan to limit bank activities:

1) I think that they are now panicking and veering from solution to solution. They will roil the markets and just make themselves panic more. Politically, i’m not sure. It will be hard for republicans to be against this, just like it is hard for them to fight the bank tax. Although if markets fall by hundreds of points, it gives the GOP an opening to say that Obama doesn’t know what he’s doing.

2) As for the merits – the problem is, Bear and Lehman didn’t have insured deposits, didn’t have recourse to the Fed, etc., but still posed significant risk. Why? Because by securitizing, derivative-izing and short-term-izing all manner of long-term debt, non-commercial banks made the economy’s store of credit much more vulnerable to market exuberance on the upside and panic on the downside. Mortgage and other credit depended at the margins not on bank balance sheets but on speculative demand.

3) To deal with that, I think we need consistent (and likely higher) margin requirements, capital requirements, clearing rules, etc., no matter who is holding/trading the debt. That would protect the economy more by putting a buffer between the pure, raw market and these debt instruments, just as we did long ago with equity markets.

4) I fear that if we curtail the big banks without doing these other things, the risks will just move, and people will continue to move their savings accounts into money markets to fund these risks. In fact, that is why we got rid of glass-steagall on the first place – to let banks compete fairly with the non-banks that had stolen their business.

5) So, do the margin and capital stuff to recognize the world we live in today … Doing that will make the economy better able to withstand financial failure, anyway, and the market, knowing this, will bring the institutions down to manageable size.

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