In the wake of last week’s Democratic loss in Massachu setts, President Obama launched an all-out war on finance. The assault isn’t targeted at the sources of the 2008 crisis — and the campaign gravely threatens New York’s economy, even more than the collapse of Lehman Bros.
New York and the nation need Washington to regulate finance, not obliterate it. But a panicked president has ordered up carpet-bombing, with Gotham squarely in the line of attack.
Obama’s finally acknowledging the public’s anger, as Wall Street spews out multibillion-dollar bonuses even as it remains pathologically dependent on taxpayers. “Never again,” the president vowed Thursday, “will the American taxpayer be held hostage by a bank that is too big to fail.” And if the banks don’t like it, he swaggered, too bad. “If these folks want a fight, it’s a fight I’m ready to have.”
Ending “too big to fail” is indeed crucial. But Obama’s proposals wouldn’t do that.
They seem removed from reality and seemed to come out of nowhere, which rattled markets. Volatile markets are a fact of life, though, in an environment where the government doles out rescues and punishments, rather than providing predictable, rational rules.
The details: Obama wants Congress to put limits on banks that can borrow from the Federal Reserve and whose small depositors benefit from FDIC insurance. Such banks could no longer make speculative bets with their own funds. Firms shouldn’t take big risks “while benefiting from special financial privileges,” the president said.
Hmm. This rule would have done nothing to prevent the 2008 crisis. AIG, target of the biggest rescue, didn’t collect FDIC-insured deposits. Nor was it allowed to borrow from the Fed. The same holds true for Bear Stearns and Lehman. Goldman Sachs and the rest, which would be governed by the new rule, won Fed-borrowing privileges only after the crisis hit.
Washington didn’t rescue AIG because it had to save FDIC-insured depositors; it did so because AIG, without any uniform limits on speculative borrowing for its derivatives, was able to take so much risk with no money down that its failure threatened the global financial system.
Likewise, commercial banks that gambled with FDIC-insured customers’ money didn’t cause the credit crunch; inadequately regulated investment products did.
Financial firms (certainly not just regulated banks) warehoused hundreds of billions of dollars’ worth of mortgage-backed securities with hardly any cash down — partly because the government said the securities were risk free. This blunder allowed the financial world to create a bubble. But when the securities turned out to be plenty risky, it created a huge panic and a near-depression.
The problem is that markets have transformed long-term debt into something that’s more like stock — but without the consistent borrowing limits that govern stock speculation and protect the economy from bankruptcy.
Prohibiting banks from making some speculative trades won’t fix this. The banks and other financial firms would still have to put their depositors’ money in something. That something — unless the government adequately limits borrowing across the financial industry — will be the next catastrophe.
So Mayor Bloomberg was right to say Thursday that “I don’t know why [Obama’s idea] would really solve the problem.”
In fact, it would make it worse. With old-fashioned commercial banks even more tightly regulated, even more money would flow into the less-regulated corners of the financial world — and so make the economy’s credit supplies even more vulnerable to panic.
That means future bailouts — even if we pretend that a Goldman Sachs (assuming it opts for the “no Fed borrowing but can make high-risk investments” category) won’t be bailed out in the next emergency.
In the meanwhile, as Bloomberg also noted, Obama’s proposals would weaken New York.
The rules would apply to big European institutions that do business here — including HSBC and Deutsche Bank, which didn’t suffer catastrophic losses. They’re not going to put up with this new, nonsensical burden as well as pay the “too big to fail tax” that Obama announced two weeks ago. They also have to wonder what else Obama might decide to impose, if he finds that he needs more Wall Street-bashing to boost Dem candidates.
In short, foreign banks may decide to ship out their trading desks and in-house investments from Gotham to Switzerland or Paris. Goldman and Morgan Stanley, to keep their government-borrowing privileges, could do the same.
No, Obama shouldn’t coddle New York. The across-the-board limits on borrowing that Wall Street needs would shrink the financial industry, too. But under Obama’s plan, we’d get the worst of both worlds: a smaller Wall Street that still poses the same risks to the global economy.
This blow comes when New York could be gaining on the competition. Britain is playing its own bleed-the-banks game, with Prime Minister Gordon Brown’s having announced a 50 percent tax on bank bonuses for this year. Obama need only be a little less punitive and New York would benefit, not lose.
Nicole Gelinas, of the Manhat tan Institute’s City Journal, is author of “After The Fall: Saving Capitalism From Wall Street — and Washington.”