Commentary

Obama Stumbled on Wall Street

In his recent speech on Wall Street, President Obama tried to delegitimize any criticism of his proposed financial regulations and taxes. He said, “What’s not legitimate is to suggest that somehow the legislation being proposed is going to encourage future taxpayer bailouts, as some have claimed. That makes for a good sound bite, but it’s not factually accurate. It is not true. In fact… a vote for reform is a vote to put a stop to taxpayer-funded bailouts. That’s the truth. End of story.”

One of Wall Street’s toughest critics, New York Times columnist Gretchen Morgenstern, must have missed the memo. Two days after the president attempted to foreclose debate, Morgenstern explained that the so-called financial reform bills “would encourage smaller companies to grow large and dangerous so that they, too, could have a seat at the bailout buffet… . The message is this: Subject as they will be to a newly codified “resolution authority,” these [large and intertwined] institutions and their investors and lenders can expect to be rescued if they get into trouble. This perception delivers lucrative advantages to these institutions. The main perquisite is lower borrowing costs, a result of lenders’ assumptions that the giants are less risky because they will be in line for government assistance if they become imperiled.”

Morgenstern told the truth. End of story. Why else would the Senate bill need a new $50 billion bailout fund? The TARP slush fund still exits and the FDIC still insures depositors. Who stands to collect that extra $50 billion if not the big foreign and domestic institutions that might make big bad loans to big bad failures?

[T]he president wants the banks to make more small business loans and also to take fewer risks, which is completely contradictory.”

The president’s broadside against derivatives was based on an assertion that investors “weren’t fully aware of the massive bets that were being placed. That’s what led Warren Buffett to describe derivatives that were bought and sold with little oversight as ‘financial weapons of mass destruction.’ And that’s why reform will rein in excess… “

One man’s weapons may be another man’s favorite investments, but in this case it’s the same man. Buffet’s firm has invested $65 billion in derivatives, and Berkshire Hathaway exemplifies what Obama called “the furious effort of industry lobbyists to shape this legislation to their special interests.” Like many businesses that use derivatives to hedge risk, the financial bills would hit Warren Buffet hard, requiring his firm to keep an extra $8 billion in reserve, uninvested, for no sensible reason.

A Global Recession with Unhelpful Bailouts

President Obama says, “One of the most significant contributors to this recession was a financial crisis… that brought down many of the world’s largest financial firms and nearly dragged our economy into a second Great Depression.” But the causality ran both ways. That is, one of the most significant contributors to the financial crisis was an ongoing recession. Failure of very few large financial firms in this country certainly did not cause a recession began that began nine months before the financial crisis was far more severe in other countries. There was never any rational reason for anyone, let alone the president, to have expected the recession of 2008-2009 to be remotely comparable to 1930-33.

As in the 1930s, it was small banks that accounted for nearly all of the recent banks failures. Out of nearly 225 bank failures since 2008, only one (WAMU) was really big. Another eight were mid-sized, with assets of $11-32 billion.

The president relied on expediency as an excuse for the “Troubled Assets Relief Program,” (TARP) although that fraudulent executive branch slush fund never contributed a dime toward relief from troubled assets. Obama claims that “to save the entire economy from an even worse catastrophe, we had to deploy taxpayer dollars. Now, much of that money has now been paid back and my administration has proposed a fee to be paid by large financial firms to recover all the money… because the American people should never have been put in that position in the first place.” Yet several of the big banks were strong-armed into taking TARP money, like it or not, and all but one (Citigroup) paid it all back. The Treasury grabbed windfall profits of $3.5 billion so far by trading related warrants (which are derivatives, ironically).

In reality, the Treasury’s bailout program is at risk of losing tens of billions only because of small banks and large auto companies. Yet the president’s proposed tax would exempt those troublemakers and fall only on the biggest banks. And that would be a permanent levy having nothing to do with the temporary TARP scheme to add government capital (loans) to participating banks while simultaneously diluting and threatening private capital.

The Obama Team Made Big Banks Bigger

For reasons Gretchen Morgenstern explained, the president tried to transform the subject of too-big-to-fail bailouts into an attack on bigness rather than on bailouts. “To that end,” he says, “the bill … does something very simple: It places some limits on the size of banks and the kinds of risks that banking institutions can take.” But this selective crusade against bigness is hypocritical. Treasury Secretary Tim Geithner, FDIC chairman Sheila Baer, and Fed chairman Ben Bernanke have spent the past two years using arm-twisting, sweetheart deals and FDIC guarantees to make sure the biggest banks became much bigger — by taking over failing banks, brokerage house and mortgage lenders. The result, notes The Wall Street Journal’s Peter Eavis, is that “Bank of America now has $2.23 trillion of assets, compared with $1.46 trillion at the end of 2006. J.P. Morgan Chase now has $2.14 trillion in assets, against $1.35 trillion in 2006.” With the Obama team walking them down the aisle, J.P. Morgan Chase was marched into bigamous shotgun weddings with Bear Stearns and Washington Mutual. Bank of America likewise acquired Merrill Lynch; Wells Fargo acquired Wachovia; PNC Financial acquired National City Corp, etc.

Amazingly, the president now feigns surprise that these federally-built megabanks have grown larger after all the federally-engineered mergers and takeovers. So he suggests they need to be cut down to size — while nonetheless making more loans, of course.

In the State of the Union speech, Obama complained that “even though banks on Wall Street are lending again, they are mostly lending to bigger companies. Financing remains difficult for small business… .” In other words, the president wants the banks to make more small business loans and also to take fewer risks, which is completely contradictory.

If the president really expected Wall Street to make small business loans, then he has no idea what Wall Street is or does. “Wall Street” always meant the biggest investment banks in Manhattan, not commercial banks from such cities as Charlotte and San Francisco. Bear Stearns and Lehman, for example, were classic Wall Street firms — poster boys for the antiquated Glass-Stiegel separation between taking deposits and making loans (which Wall Street never did) and making investments and putting together business and security deals (which Wall Street does). Goldman Sachs and Morgan Stanley became bank holding companies in the wake of the crisis, but their dominant investment bank activities remain separated from their subsidiary FDIC-insured depositary institutions.

In short, the presidential rhetoric behind “financial reform” is so muddled as to leave us all confused about what these bills even hope to accomplish. The hasty illogic of it all should also make us prudently leery about the unexpected consequences of granting dangerous discretionary authority to SEC and Federal Reserve regulators simply because they failed so miserably once again (as with Enron).

Do threats of tighter regulations and higher taxes on banks sound like a way to increase lending? President Obama seems to think so.

Alan Reynolds is a senior fellow with the Cato Institute and the author of Income and Wealth (Greenwood Press 2006).