I’d meant to post on this yesterday, but didn’t get the chance. The devil is in the details, as always, but the core idea here is right and important:
With former Federal Reserve Chairman Paul Volcker at his side, Mr. Obama said he wanted to toughen existing limits on the size of financial firms and force them to choose between the protection of the government’s safety net and the often-lucrative business of trading for their own accounts or owning hedge funds or private-equity funds. . . .
“The key issue is that institutions that are getting a backstop from the taxpayer shouldn’t be able to make a profit off their own investing,” said Austan Goolsbee, a White House economist who staffs the presidential advisory board Mr. Volcker chairs. . . .
Under the Obama proposal, banks that take federally insured deposits or have the right to borrow from the Fed would be prohibited from owning, investing in or sponsoring hedge funds or private-equity firms. “You can choose to engage in proprietary trading, or you can own a bank, but you can’t do both,” an administration official said.
The reason for taking this step was articulated well by National Review‘s Jim Manzi:
Finance professionals, like members of all occupational categories, attempt to build barriers that maintain their own income. One of the techniques used is to shroud what are often pretty basic ideas in pseudo-technical jargon. The reason that it is dysfunctional to have an insured banking system that is free to engage in speculative investing is simple and fundamental. We (i.e., the government, which is to say, ultimately, the taxpayers) provide a guarantee to depositors that when they put their savings in a regulated bank, then the money will be there even if the bank fails, because we believe that the chaos and uncertainty of a banking system operating without this guarantee is too unstable to maintain political viability. But if you let the operators of these banks take the deposits and, in effect, put them on a long-shot bet at the horse track, and then pay themselves a billion dollars in bonuses if the horse comes in, but turn to taxpayers to pay off depositors if the horse doesn’t, guess what is going to happen? Exactly what we saw in 2008 happens.
If you want to have a safe, secure banking system for small depositors, but don’t want to make risky investing illegal (which would be very damaging to the economy), the obvious solution is to not allow any one company to both take guaranteed deposits and also make speculative investments. This was the solution developed and implemented in the New Deal. We need a modernized version of this basic construct, and as far as I can see, this is what President Obama has proposed. . . .
Make no mistake, many banking executives right now are benefiting from taxpayer subsidies. Even if they pay back the TARP money, the government has demonstrated that it will intervene to protect large banks. This can’t be paid back. And this implicit, but very real, guarantee represents an enormous transfer of economic value from taxpayers to any bank executives and investors who are willing to take advantage of it. Unsurprisingly, pretty much all of them are.
Now, as Megan McArdle points out, there’s a lot that we don’t know that will bear very heavily on whether this policy ultimately benefits our country—and even assuming it’s the right thing to do, there will be distinct and significant downsides to it. Nevertheless, the government has to reduce its exposure somehow, and this seems to be the most reasonable way to do it.
The government is recognizing that banks “paying back” the funds they were given is essentially meaningless, because they’ve still got a very, very valuable implied government guarantee. One could argue that they’ve had it since 1991 when the Federal Reserve got the power to loan money to investment banks in extremis. But since last fall, it’s the next best thing to explicit. That means the government needs to take steps to mitigate its own risk.
The way you do that is to decouple the key operation the government insures—the funneling of credit from those with money to those who want to borrow it—from making bets on market outcomes that can go badly wrong. And to ensure that no institution has enough liabilities to take down the system if it fails.
It may not work, as she acknowledges, and it won’t be without significant cost; but we can’t unring the bailout bell, so what else are we going to do?
It won't work at all. Speculation is the market. The market is speculation. You can't run a business unless you plan.
Of course we wouldn't be having this discussion if Capitalism was allowed to work.
The government should have let the banks go bankrupt. Fanny and Freddy should have been shut down. All Executives running those institutions and the politicians blocking the regulation of the GSE's and financial institutions should have been prosecuted.
The healthy banks would have picked up the pieces and life would go on and we wouldn't be in the financial crises we are in and have yet to face the full force of what is now inevitable and can't be stopped but only mitigated to some extent.
As long as Government keeps in place the current laws that encourage exploitation of Moral Hazard to enrich themselves and their business and political crony’s, the economy is doomed to collapse under it's own weight because there is no risk as long as the U.S. taxpayer is on the hook and politicians use excuses like “too big to fail” to protect their sugar daddy’s that pump endless streams of money into their reelection coffers, then try to camouflage it by forcing/threatening good banks to take bailout money they don’t need to cover the political asses of themselves and their Wall Street good ol’ boy’s club.
How will Wall Street ever learn any lesson from the bad business model they employ if they can be bailed out? Congress assisted in perpetrating the very business model they are bitching about instead of letting it go bankrupt. This is known in the business world as throwing good money after bad. It is taught in ivy league colleges around the country as Keynesian Economics, and those students are now in charge of the Federal Reserve and CEO’s and Board Members of Financial Institutions that were bailed out.
Nothing has been fixed and taxing all the banks in the world for the mistakes of a few banks that’ve already paid back that money with interest (the ones that didn’t need the money that is) is like spitting into the wind. Won’t make one bit of difference.
As Zhu Mihn, Deputy Director of the Peoples Bank of China said, "There is not enough money in the world to pay for the U.S. debt." (Which is why zero Treasuries were bought during the last auction. China was competing against us by selling off 1 Trillion of U.S. debt they held to any 3rd world country that would buy them. Uh oh.)
Fanny and Freddy are still operating full steam ahead. Zero down loans are still being made to people who can't afford them. Banks are being forced to renegotiate loans in default, and those loans are failing at a 60% rate. Foreclosures are happening at record pace for over a year now, each new month surpassing the previous month.
Nothing has changed and yes there is another housing bubble coming and nothing, I repeat, NOTHING will stop it.
And this is only the tip of the iceberg you can see above the water. There is more, much more, below the surface, but I would need more space then allowed here to elaborate.
Suffice to say, the US Economy is the Titanic. Government Spending, Healthcare Regulations, Government Subsidies, Government Size, 0% Bond interest rates to Financial Institutions, Inflation from printing money and increased Taxes are the iceberg. How fast we hit that iceberg determines the damage and whether or not we will sink.
There will be damage. That is now unavoidable with Rubicon in the rearview mirror.
Now that you know what the iceberg is made of, the cure is self explanatory.
We need another miracle.
dbrletich
Depends what you mean by "work" . . . it will at least significantly reduce the ability of financial companies to take risks on (with?) the public dime.
In general, though, I certainly agree that we're in a bad way. We need to figure out some way to rescind the implicit bailout guarantee, and make it clear that the next time, the banks are on their own hook, not ours; I think shuttering Fannie and Freddie is part of that, but not sufficient.
Depends what you mean by "work" . . . it will at least significantly reduce the ability of financial companies to take risks on (with?) the public dime
How is that possible when current law mandates the banks loan money to people (read minorities) who can’t afford to pay them back and that those that can’t pay them back, get to renegotiate the contract with the bank? You did read the legislation in the last Stimulus package giving the Treasury Secretary full power to negate contracts, right?
You did see that TARP asked congress for 900,000 billion dollars last January and that congress just told Freddie and Fannie that they have a blank check to take as much tax payer money as they need to stay afloat, right?
Obama’s plan is not only bad, it is a guaranteed job killer.
Those banks are not going to incur those Government taxes on their balance sheets. They are beholding to investors who want a return on their money. The banks will simply pass that loss on down the line to the people (you, me, small businesses) who they make loans to by jacking interest rates (you know, like they recently did with all your credit cards?). Small business as well as large businesses will have to cut jobs to make up the slack on the bottom line for those high interest loans. This has always and ever will be the case. It’s how Capitalism and free markets work.
If those banks do not pass on that loss, they will not remain profitable, investors will bail, the stock will tank and the banks will close. Just like the 9 that have closed so far this year and the 140 that went belly up last year.
Obama’s plan is a blatant job killer, interest raiser, and inflation accelerator and will certainly help us smash into that iceberg looming ahead much faster.
I guarantee you Democrats won’t allow this type of legislation to pass let alone GOP. (Barney Frank, Chris Dodd are of course exceptions, but they are economic lunatics just like the Commander in Chief and his economic advisors.)
I will have to re-read that Stimulus bill though to see if Geithner has the power to just implement this plan with the broad sweeping powers given to him in that unconstitutional piece of garbage. He can basically do an end-run around the Constitution on many financial matters involving banks.
Obama made this threat on Wednesday. The Dow has been in freefall since that announcement the past three business days. Financial investors are already bailing.
Punishing success never made any money for anyone and it never will.
TARP, Fanny, Freddie are Moral Hazard insurance for the welfare state on the taxpayer dime. They need to be shut down and dismantled. Those three GSE’s caused the first crash. The Bush Administration and then GOP congress knew this and tried to rein them in. Barney Frank, Chris Dodd, Barak Maxine Waters, Hillary Clinton, Obama and a handful of others blocked that. Did it have anything to do with the fact that they were the biggest beneficiaries of campaign contributions by these entities?
Those in the GOP with a lick of economics education predicted this exact meltdown we are in now. Google it. You can see all the live hearings on youtube with Barney Frank lying right to your face, as well as Maxine Waters, saying Fannie and Freddie were solid when the numbers showed they were hemorrhaging money at cataclysmic pace. The GOP were too spineless to take this to the mat because it would mean the end of government subsidized loans to minorities who couldn’t afford them (That is called Moral Hazard).
You have the gov forcing banks to lend the money so they make bad loans backed by the .gov and with everyone buying houses because nobody could be turned down, prices started rising until people started defaulting.
If the banks didn’t make the loans (not all did and paid the fines imposed on them rather then participate in bad business practice), they are accused of and sued for discrimination. The loans default at record pace so the U.S taxpayer is on the hook to make them good. This whole house of cards collapses and instead of blaming .gov for their reckless loan practices and causing this systemic failure, they accuse the Banks of “predatory lending” to divert the blame. Nice little vicious circle huh?
This process is still intact and running full steam ahead. Democrats love this stuff and past democrats running Fannie and Freddie made millions running this ponzi scheme. They’ve thrown Enron executives in prison for less damage.
The problem isn’t the Banks. It’s government spending, government spending and government spending.
When .gov grows in size and scope that sucks more money out of the private sector. See Obama’s shovel ready jobs, which has now run it’s course but has added hundreds of thousands more workers to the .gov payroll who will vote Democrat in perpetuity and we get to pay for their healthcare and pensions in perpetuity.
Government spending destroys the private sector that pays the taxes.
Raising taxes kills jobs. When taxes are raised, businesses can’t grow and they have to incur that tax increase somewhere else to keep the business profitable or growing in positive direction. When business owners are punished with onerous tax rates, they are not going to change their lifestyle for what they have worked for and risked their own money to finance and they will not let their business suffer losses or go under. The first place they make cuts is employment. It’s the quickest way to increase the bottom line and it works for awhile until the unemployment rates climb and consumers stop buying goods and services because they are saving, getting ready to be laid off themselves.
With less demand for goods and services in the market place businesses start “downsizing” to stay afloat, and that means more job losses.
Pretty soon, the .gov is bigger then the private sector and the private sector can’t sustain the gov. Then Gov starts laying off people and the gov has all this debt with nobody to pay the taxes. What do you do? Why raise taxes on the Wealthy again playing that old tired class envy game that will only end in ruin. Why? Because the wealthy are the Job Creators, and if you tax them more, they move their business offshore to other countries to turn a profit where the business climate isn’t as hostile to success.
You want to stimulate the economy?
• Freeze, shutdown, reduce government spending, even better if you can tie it to the rate of inflation. Government spending is almost 95% of our GDP or entire economy. This can’t be sustained.
• Eliminate Gov size. Eliminate Cadillac government pension plans and healthcare. Make them pay for and save for their own just like the private sector. Honor the existing contracts (I am a Capitalist after all), but every new hire pays their own way. Civil service should be a stepping stone to the private sector. Government can’t exist without the private sector. The private sector does not need government to exist. Government exists by the private sectors leave. This is also known as a REPUBLIC. Democracy’s can burn in hell.
• Drastically lower capital gains taxes on the wealthy and big business. (This stimulates business growth = more jobs = more taxpayers = more tax receipts. Works everytime it has been tried. Everytime.) In fact, do away with the tax code and implement a flat tax or consumer tax or both. Everybody plays, everybody pays. I don’t think it’s fair that 44% of the working class pay zero Federal taxes. Make everyone accountable then they will keep our lawmakers in check rather then voting for their paycheck, aka democrats.
• Remove all law that encourages or mandates Moral Hazard. Start by shutting down TARP, Freddie and Fannie.
• Stop denying the American people the use of their own natural resources. (we are currently the only country on the planet that is doing this.) We have more proven reserves then the Middle East and South America combined. Build a new coal fired power plant in all fifty states. Where do you think all those electric cars get their electricity from? (No windmills! It has failed miserably everywhere it’s been tried and I can prove it and tell you why.)
• Build Nuclear Power plants. Shoot the waste into outer space somewhere or offer a government money prize to anyone who can figure out how to recycle it.
This would be a good start.
We need a miracle.
dbrletich
Oh, I forgot to mention the fact that the POTUS plan will discourage small business growth and small business start ups. Small business is the engine of America and this plan will be the biggest small business destroyer in history…provided he can get legislation passed.
He won't, mainly because it's patently unconstitutional (barring language in the Stimulus package..but that is also unconstitutional and there is no need to challenge it yet)and it will be challenged in court and he will lose. He doesn't want another glaring failure like this on his resume.
This is a POTUS pipe dream. It will never come to pass, so I have nothing to worry about.
Eric Holder already has enough on his plate with the millions of Tax Payer Dollars he is costing us by trying terrorists in civilian courts. The last thing he needs is a Wall Street class action to embarrass him, more then the embarrassment he is causing to himself. His department just sufforered a serious setback with the correct SCOTUS ruling on campain finance reform being struck down. The argument his lead solicitor made was so pathetically inept as to be laughable. Been awhile since we saw SCOTUS judges get angry with blood vessels bulgin on their necks. 🙂
Meanwhile, Rome is burning…
dbrletich
Pretty much encapsulates every thing I spoke of.
This is all about liberty and freedom going forward.
Listening to the radio here at work this morning. The Nat'l Assoc. of Realtors just announced a 17% drop in home sales last month. Biggest single drop in 40 years.
Dang I'm good.
db
One correction: TARP didn't cause the first crash, because it didn't exist before the first crash. In general, I don't disagree with you; I posted at least once on the willful refusal of Frank, Waters et al. to see the crash coming. The thing is, right now, we have a situation which cannot be allowed to continue unchanged: we have major financial institutions which are essentially in a position to play risk-free (to their bottom line) with other people's money. It's bad enough that the government is able to do that–at least we can vote them out if we don't like the way they're doing it; it's worse if the government is enabling large private-sector institutions to do the same. Short of a law making further bailouts felonious (which might actually pass, in the current climate), the only way I can see or think of to change that is the approach the President has proposed.
Yes, you are correct about TARP.
When I used the term GSE's and Entities I just assume people knew what I was rambling about. You obviously understood so thanks for covering my six.
It was late and it made sense in my head.
You will have to excuse my bad grammar and spelling errors.
One of these days I will be able to afford a teleprompter too.
🙂
Hey, maybe we can lobby government for a new subsidy to…
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