Those calling for financial reform aren’t being upfront about its costs, making it impossible to achieve. This was again evident at the Roosevelt Institute’s otherwise very good conference at Time Warner Center yesterday.
First the good. The purpose of the gathering was to galvanize support for deeper reforms than lawmakers have proposed. Roosevelt’s Chief Economist Rob Johnson and his murderer’s row of thinkers — including Simon Johnson, Elizabeth Warren, Frank Partnoy, Rick Carnell, Josh Rosner and others — presented a very good white paper outlining how best to clean up the financial system. Other attendees were George Soros, Brooksley Born, Jim Chanos, Joe Stiglitz. Even Eliot Spitzer showed up.
When it comes to reform, they all argued, nibbling around the edges ain’t gonna cut it.
Banks need more capital, Fannie and Freddie need to be wound down, banks’ risky activities must be corralled, tax incentives that encourage borrowing must be done away with. Most importantly, perhaps, we need to end the cycle by which the financial system lends too much and too easily only to be bailed out by a compliant Fed when things go wrong.
Throughout there was much indignation as to why such sensible reforms haven’t been enacted. Wall Street’s lobby machine got most of the blame, the rest went to “the people” for their perceived lack of outrage. But of course people are mad, and though the lobby machine is strong, it’s not the real obstacle to reform.
We don’t really want it. More to the point, people care more about their jobs than they do about reform.
What the reforms in paragraph 4 all have in common is that they reduce the availability of debt finance. That’s smart because our chief economic problem is that we’ve too much of the stuff.
But said another way, the reforms reduce credit. Like a lot. And that means deep and prolonged recession. Crucially, it means higher unemployment.
Just for instance, try to imagine winding down Fannie and Freddie. Doing so means housing finance — all of it — goes away. The economic implications are so dire no one is even contemplating how to do it, even though all know it must be done.
Yet the most vocal supporters of financial reform, which should properly be called “lending reform,” also whine that banks and the government aren’t lending enough!
We can’t have it both ways.
Real reform means cutting lending, it means more jobs will be lost. And Americans aren’t yet willing to make that trade, no matter how mad they are about bailouts.
Today we got a new report out of CBO, which may kill the highly sensible bank tax proposed by the Obama administration with the following sentence:
The fee would probably lower the total supply of credit in the financial system to a slight degree. It would also probably slightly decrease the availability of credit for small businesses.
Despite the “slight” qualifier and comments elsewhere that the fee would help level the playing field for small banks, the loss of any credit whatsoever for “small businesses” is something Congress hasn’t been able to stomach.
A reason we got substantive financial reform in the mid ’30s is that folks had nothing left to lose. Real output fell 30% peak to trough during the Great Depression.
During last year’s recession, output fell just 3%. If you compare debt levels today with those leading up to the Depression — and consider that de-leveraging is the proximate cause of the decline — we’ve much further to fall.
That’s not to suggest that reform isn’t necessary. It absolutely is. But it will cost jobs and output. The speakers at Roosevelt Institute’s conference did a disservice to their audience by not discussing these costs. Some even suggested the credit engine can magically be made to run at close to full speed even as it’s in the shop for repairs.
Luckily, Roosevelt is led by the very capable Johnson, who has no illusions about the costs of bank reform. He acknowledges that financial fixes will reduce lending and output, but speaks about the need to control the velocity of that decline.
The test of his leadership, and of Roosevelt’s relevance, will be whether they can convince America to put up with any decline at all. The last thing we want is a rerun of the Depression. A great set of banking rules came out of it, but only after the economy collapsed into a smoldering pile of rubble allowing us the freedom to start from scratch.
We want proactive, not reactive reform. But it won’t happen unless voters and Congress are convinced to prioritize it over credit creation and, yes, jobs.