How is it possible that post-crisis legislation leaves large financial institutions still in control of our country’s economic destiny? One answer is that they have even greater political influence than they had before the crisis. During the past decade, the four largest financial firms spent tens of millions of dollars on lobbying. A member of Congress from the Midwest reluctantly confirmed for me that any candidate who runs for national office must go to New York City, home of the big banks, to raise money.
What can be done to remedy the situation? After the Great Depression and the passage of Glass-Steagall, the largest banks had to spin off certain risky activities, and this created smaller, safer banks. Taking similar actions today to reduce the scope and size of banks, combined with legislatively mandated debt-to-equity requirements, would restore the integrity of the financial system and enhance equity of access to credit for consumers and businesses. Studies show that most operational efficiencies are captured when financial firms are substantially smaller than the largest ones are today.
These firms reached their present size through the subsidies they received because they were too big to fail. Therefore, diminishing their size and scope, thereby reducing or removing this subsidy and the competitive advantage it provides, would restore competitive balance to our economic system.
To do this will require real political will. Those who control the largest banks will argue that such action would undermine financial firms’ ability to compete globally.
I am not persuaded by this argument. History suggests that financial strength follows economic strength. A competitive, accountable and successful domestic economic system, supported by many innovative financial firms, would restore the United States’ economic strength.
More financial firms — with none too big to fail — would mean less concentrated financial power, less concentrated risk and better access and service for American businesses and the public. Even if they were substantially smaller, the largest firms could continue to meet any global financial demand either directly or through syndication.
Politics and policy from inside Washington
The only people in Manhattan who are probably eager for a Sarah Palin presidential run are the supposed comedy writers at “Saturday Night Live.” Wall Street bankers, on the other hand, not so much. Big Money has been snarkily dismissive of Palin’s recent opining on monetary policy, the dollar and the dangers of inflation. But guess what? A “free-market populist” campaign in 2012 would likely further highlight that Palin’s not too big a fan of them, either. And her economic musings are yet another sign she’s running
In a speech and a pair of Facebook postings this week, Palin unexpectedly warned her followers about the inflationary dangers of the Federal Reserve’s “pump-priming addiction” — a reference to the latest round of bond-buying by the U.S. central bank, known as quantitative easing. That’s hardly a novel or unreasonable critique. Many conservatives, and even some Fed officials, share Palin’s unease.
It’s the politics and timing rather than the substance that is raising eyebrows. Avid Palin-watchers see her move into economic commentary as further evidence of a run for the White House. Indeed, the campaign team for putative Republican frontrunner and former banker Mitt Romney is assuming she will be in the race. And her upcoming, much-hyped reality television show, “Sarah Palin’s Alaska,” will no doubt play like an extended campaign commercial. And polls certainly hint she would be right in the thick of the fight with Romney and Mike Huckabee, if he runs (via CNN):
In Iowa, it appears Mike Huckabee’s still got a base: the former Arkansas governor is tied with Mitt Romney at 21 percent, with Sarah Palin close behind at 18 percent, and Gingrich nabbing single-digit support. In New Hampshire, former Massachusetts governor Romney displays his home court advantage: he draws more support, at 39 percent, than the rest of his top rivals combined. Palin once again nabs 18 percent. And in the key early-voting state of South Carolina – where Sarah Palin and Mitt Romney both endorsed Gov.-elect Nikki Haley in the GOP primary this year – Palin, Huckabee and Romney are again neck-and-neck.
If Palin does get in the game, her views leave her — not for the first time — well positioned to exploit the zeitgeist. Voters right now seem dubious of Big Anything, be it Government, Business or Money. In her 2009 book, “Going Rogue,” Palin offered a remix of 1980s-style Reaganomics — low taxes, less government spending, strong dollar. That’s all perfectly sync with her recent Fed-bashing. But she also attacked “corporatism” in which government and business conspire against entrepreneurs and consumers. This view fuels Palin’s critique of Obama’s financial reform plan, which she portrays as a creation of Wall Street designed to perpetuate bank bailouts. As she wrote on Facebook:
Of course, the big players who can afford lobbyists work the regulations in their favor, while their smaller competitors are left out in the cold. The result here are regulations that institutionalize the “too big to fail” mentality. … The president is trying to convince us that he’s taking on the Wall Street “fat cats,” but firms like Goldman Sachs are happy with federal regulation because, as one of their lobbyists recently stated, “We partner with regulators.” … You’ll find the name Goldman Sachs on many an Obama administration résumé, including Rahm Emanuel’s and Tim Geithner’s chiefs of staff. We need to be on our guard against such crony capitalism.
Palinomics, embryonic as it is, seems to be rooted in “free-market populism,” a version of conservative thinking that is pro-market rather than pro-business. It says the role of government is to help markets function more fairly and efficiently for everyone, encouraging competition and “creative destruction” (which Palin specifically mentioned in her book). Pro-business policies, by contrast, can end up subsidizing favored companies, raising barriers to entry and otherwise entrenching the status quo.
Palin is also familiar with one of the champions of free-market populism, the University of Chicago’s Luigi Zingales, linking to his writings from her Facebook page. It’s easy to imagine her campaigning against corporate tax breaks, say, or in favor of limiting the size of banks under the belief that as long as they are ginormous, government will find a way to bail them out. That agenda might not attract much campaign cash from Manhattan bankers or Washington lobbyists, but it could be a compelling formula in the new Tea Party-infused Republican party. Then again, bankers who care about cutting government spending and keeping taxes low might want to take a second look.
I just did a CNBC spot debating whether robust banks profits should spur new efforts to tax them. Here were my talking points:
1. My Hill sources tell me the bank tax is not going to happen, at least not the Geithner version.
2. That being said, Dems will surely raise it again both as a way of paying for high-end tax cuts and a way of making banks less reliant on short-term funding. The whole idea might also be coupled with a transaction tax.
3. The TARP rationale for the bank tax has collapsed with banks paying back their bailout funds.
4. What banks do need to worry about is a future bank tax that would pay for Fannie and Freddie losses. There are Republicans who would vote for that.
5. Is is a good idea? Given all the uncertainty raised by Dodd-Frank, do we really want to add a punitive bank tax? To begin with, this idea came from David Axelrod, not Tim Geithner or the Obama econ team. And how would it add one decimal point to GDP or create one job?
Here is a bit-o-goodness from my Reuters Breakingviews column on the Obama-CNBC town hall yesterday .
The Sept. 20 exchange between President Barack Obama and Anthony Scaramucci of SkyBridge Capital illustrates the severity of the rupture between the president and the financial community. … Scaramucci is a guy who was in on the ground floor of Hope and Change, Inc. He’s a former Harvard law school classmate of Obama’s who contributed early and often to Obama’s presidential campaign. … But Scaramucci also gave the impression of a hedgie scorned, even though it’s debatable to what extent new financial regulations have “whacked” hedge funds. More funds must register with the Securities and Exchange Commission, they’re subject to greater state supervision and they may have to give more info to the SEC. Then again, limits on bank trading desks should allow hedge funds to compete more effectively.
What may really be bugging Scaramucci and his colleagues is that when Obama speaks about the Wall Street “fat cats” who almost toppled the economy, the condemnation is sweeping. Hedge funds didn’t need a bailout like the big banks, used far less leverage and are almost always small enough to fail. … Wall Street is never going to get Main Street’s sympathy. Better to talk softly and carry a big wallet. And that seems to be just what Scaramucci is doing. Filings show he’s only contributed to Republicans so far this year, including $5,000 to Free and Strong America. That’s the political action committee of potential 2012 Republican presidential candidate — and potential Obama challenger — Mitt Romney.
The always insightful and interesting Ed Yardeni gathers some numbers on elections and market returns:
So what do stocks do just before and just after midterm elections and in the third year of the Presidential Cycle? They usually go up, and by quite a lot. Let’s review:
(1) According to my friend Laszlo Birinyi and former colleague at Deutsche Bank, in the 12 midterm election years going back to 1962, the S&P 500 has on average risen 2.4% in the two months prior to the election and gained 7.5% in the three months following. The only post-election downer was during 2002, when the Republicans under George W. Bush retook the Senate and held on to their slight majority in the House. The biggest gain was 14.6% during 1998 (under Clinton) and the smallest gain was 3.3% during 1994 when the Democrats under Bill Clinton lost both the House and Senate.
(2) According to Deutsche Bank chief U.S. equities strategist Binky Chadha, the S&P 500 has produced gains in 18 out of the last 19 midterm election cycles. The S&P has returned an average of 13% in the six months after midterm elections, and 17% over the next 12 months. The indicator works regardless of which party wins control of Congress, but it’s especially strong when there is a Democratic president and Republican legislature. When that scenario is in place, stocks average 14.6% annual returns, according to Bill Stone, chief investment strategist at PNC Wealth Management. “It’s the best of all iterations,” he says.
(3) The DJIA has risen 24 times and fallen 5 times in the 29 third calendar years of the Presidential Cycle since 1891. The overall, average gain for the 29 third calendar years is 12.31%, with the 16 Republican presidencies averaging gains of 5.12% and the 13 Democratic presidencies averaging gains of 21.14%.
(4) Joe analyzed the four-year Presidential Cycle of the S&P 500 since 1952. He found that this index increased on average by 4.4% during the first year, 4.8% during the second, 18.4% during the third, and 5.7% during the fourth. Excluding second terms of reelected Presidents, he found that the first term of all of them since 1952 averaged 3.2% during the first year, 2.2% during the second year, 21.6% during the third year, and 11.5% during the fourth year. In other words, third years tend to be the best ones, and have been up years during every Presidential Cycle since 1955.
While the historical record suggests that the stock market is likely to do very well over the rest of this year, and even better next year, might it be different this time? I’ll discuss this possibility tomorrow.
Me: This also plays into the “gridlock into good” mantra. And certainly there should be less anti-market legislation in the second half of Obama’s term than the first half. But the U.S. does have real problems that need attending to — budget reform and tax reform, in particular.
Wall Street always knew financial reform was coming. The big banks never really thought there was a chance of killing it, not that they really tried to. In fact, once the effort moved into 2009, they wanted it over sooner rather than later. The longer the process dragged out, the greater the chance of something crazy popping up and the more political and profit damage they took. For instance: The “break up the bank” movement was almost successful. As it is, the Volcker rules and derivatives reform may end up far tougher than their worst-case scenario.
But now things are going pear shaped. House negotiators want big banks to pay for any future wind-down of Fannie and Freddie and are trying to slip in a bank tax to repay TARP funds. And the hits keep on coming. Democrats have concluded that with the unemployment high and Obama’s approval falling, bashing the banks is the best ticket they have in the November midterms. Liberals have always suspected that despite Wall Street grousing about reform, they were actually quite happy that it was not tougher. Maybe, but now the complains are real.
Binyamin Appelbaum of the NYT tries to simply things for me: ”Broadly speaking, there were two ways for the federal government to respond to the financial crisis. The Obama administration chose more regulation.”
And that is bad news because regulators and their political overlords like bailouts with taxpayer money rather than market discipline. But shrinking the banks, while superficially appealing, is no magic bullet — as this Italian study argues: ”A world with only small and domestic banks is no safer. The key benefit of multinational banks – being able to mobilise funds across countries – could still be extremely useful for maintaining stability in times of distress.”
A sigh of relief is due on Wall Street. The procedural finale for the U.S. Senate’s debate on financial reform came just in time for the big banks. The bill just kept getting tougher as the talk dragged on. But it could have been worse. While banks’ future activities and profitability may get pinched, their core business model appears intact. In the end, Wall Street got nicked, not nuked. Some observations:
1) Wall Street should thank the White House. Had President Barack Obama prioritized bank reform over healthcare at the height of the crisis, the biggest players might have been broken up, hard caps placed on balance sheets, and banking and investing operations separated. More recently, the Securities and Exchange Commission’s lawsuit against Goldman Sachs in April helped re-energize advocates for such changes.
2) Nothing radical here. While the Senate and House bills still need to be blended, it’s safe to say the most radical ideas have fallen by the wayside. A “systemic risk council” of federal regulators will recommend new capital and leverage rules to the Federal Reserve, which will be the most influential bank regulator. The Federal Deposit Insurance Corporation will have the power to wind down any failing large, systemically interconnected institution.
In addition, large, complex financial firms will have to submit plans for their rapid and orderly shutdown should they go under. And for the first time the derivatives that are currently traded privately will mostly be forced to go through clearing houses and in some cases trade on exchanges. Bank lobbyists have defended their corner: it’s not the regulatory reign of terror their clients’ most vociferous critics wanted. But it’s hardly a “light touch” regime, either, and it does involve real changes. Caveat: This assumes the Blanche Lincoln provision on derivatives is softened or stripped in the conference committee.
3) Too Big To Fail is still a problem. As long as regulators and politicians have vast amounts of discretion, a financial crisis will make bailouts an irresistible temptation. The way around this is either breaking up the banks or creating hard, market-based triggers for either regulatory action or a resolution process. Neither is in the bill.
4) Wall Street’s has an enduring PR problem. Yes, big banks are unpopular. But it has gotten so bad that they may not be able to so easily counter their image issues with campaign cash. Getting Wall Street money now has a stigma attached to it like oil and tobacco money. Candidates like Meg Whitman in California and John Kasich are getting hammered for their Wall Street ties. The industry’s continued unpopularity will no doubt spawn further attempts to tax, regulate and restrict the sector.
5) Bernanke trimphant. The Federal Reserve has to be pretty satisfied. It did not lose its role as regulator; in fact, it’s been strengthened. And the central banks was also able to fend off attempts to make it more transparent. The downside: The GOP (see Rand Paul) has soured on the Fed in a big way, particularly at the grassroots. Further economic woes will lead to more calls to change its form and function.