By Clive Crook
Published: January 17 2010 16:52
Whenever you wonder if rage at Wall Street is getting a little out of hand, some titan of the industry speaks up and makes you think, “Let’s go down there and smash some windows.”Top banking executives appeared last week before the Financial Crisis Inquiry Commission, set up by Congress to look into the debacle. Lloyd Blankfein of Goldman Sachs and Jamie Dimon of JPMorgan Chase were far from contrite. Both said how well their companies were doing despite the crisis, which had been a nuisance, to be sure, but more an act of nature than something their industry brought about. “There are a number of things we could have done better,” Mr Dimon conceded graciously.
When you measure that complacency against the harm the slump has inflicted on millions of innocent bystanders, rage seems the only apt response. Revenge is called for. How about a fine, to punish the bandits and show them who’s boss?
Last week the White House said the country’s biggest banks should pay a “financial crisis responsibility fee”. Levied at 0.15 per cent of liabilities (excluding deposits and regulatory capital), it would raise about $90bn (€62bn, £55bn) over 10 years if enacted. The administration wants the fee to remain until fiscal losses under the troubled asset relief programme, estimated at about $120bn (but likely to be less) are recovered. “We want our money back, and we’re going to get it,” said Barack Obama. Tough talk, and good politics. The Democrats need both.
A crucial senatorial election takes place in Massachusetts on Tuesday. It is Ted Kennedy’s old seat, and the state is as liberal as they come. The Democrats ought to walk it, but the polls say otherwise. Losing this seat, denying the Democrats their crucial 60th vote in the Senate, would be a disaster. At the moment, people dislike the banks even more than the administration’s policies. Venting their anger might help.
But anger is a poor basis for policy – especially when combined with a misunderstanding of the issues. The rapacity of the financial class is striking, but the prevailing idea that greed plus deregulation explains this mess is wrong. Punishing the banks and turning back the clock is not the answer.
Of course there was greed, and always will be. But subprime mortgages, loan securitisation, the house-price bubble, and system-wide over-leveraging had little or nothing to do with the Glass-Steagall repeal and the easing of other rules in the decades before 2007. Regulators did retreat, but in ways that did not matter. Their bigger failure was to be outrun by innovation. Easily as important, US policy rewarded financial recklessness, and not just on the part of banks.
The tax code rewarded over-borrowing, especially for house purchases; it still does. Fannie Mae and Freddie Mac expanded the market in securitised subprime mortgages; they are still there. The Federal Housing Administration backs loans to doubtful borrowers, and still does. (“FHA-insured loans require very little cash investment to close a loan,” the agency’s website still boasts. “There is more flexibility in calculating household income and payment ratios.”) Bank regulation promoted securitisation, requiring less capital to be set aside than against ordinary loans. Monetary policy erred as well; interest rates were kept too low as the bubble inflated. And so on.
The idea that you can address this catalogue of failure by rolling back “deregulation” or pretending to punish the banks is ridiculous. And, by the way, the “crisis responsibility fee” really is just pretending: the levy is too small for deficit-reduction purposes, or any other purpose except political posturing. If you aim to punish, current bank shareholders are not the perpetrators and Tarp losses are not the appropriate metric. If you want to change incentives – to discourage banks from growing too big, or from paying their workers too much – you need new rules as part of a wider regulatory reform, not this temporary fix.
The administration is assuming that if banks object to the levy, it must be good. This is only half right. Arousing protests from the banks is a necessary condition of intelligent reform, but not sufficient. Banks would howl about serious proposals for higher, and cyclically adjusted, capital ratios, for example – but that change would actually affect their future behaviour. Banks will oppose efforts to regulate pay. Again, those protests should be faced down: rules are needed to discourage excessive risk-taking. The level of bank pay, as opposed to its structure, causes offence: if you must, infuriate bankers by raising taxes on very high incomes. These are fights worth having.
The banks’ unpopularity would make it easier to win them – unless half-baked ideas like the levy deflect the anger in unproductive directions. The same goes for the anti-market tendency so pronounced in populist thinking. It blinds politicians to the role that market-sensitive methods ought to play in repairing the regulatory system. For example, finance academics have long wanted to require banks to issue subordinated debt (which by law the government would refuse to guarantee). Holders of that debt would have a strong incentive to monitor the issuer’s soundness, and its price could be used to guide other regulatory responses.
This is another idea the banks do not like. Its time has come, or ought to have come: effective market discipline is part of what is needed. But who is going to pitch that? Not the administration, riffing on greed and market excess, intent on stopping the political rot. “We want our money back, and we’re going to get it.” Yes, fine, but it is no substitute for brains.
Copyright The Financial Times Limited 2010
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