Will Obama Finally Stop the Scourge of the Megabanks?

As I have long argued, the most important question of this election is who will stop the scourge of the megabanks. By any measure more money is at stake here than any other issue in this campaign, as evidenced by non-partisan tallies of the cost and damage of the last financial crisis--ranging from up to $13 trillion (primarily in lost GDP) to nearly $30 trillion (in government outlays).

As discussed in my last two posts Mitt Romney is the candidate of the megabanks, including the foreign megabanks. For Romney to stop the megabanks, he would need to turn on his base. But, he would need their continuing support for reelection. Romney cannot be expected to stop the megabanks. Simply put, Romney is no Jon Huntsman, who was the one major party candidate who got this issue right. Romney gets an "F" on likelihood of stopping the megabanks.

Historically, there is clear reason to be skeptical of President Obama. But, Obama has been cut off from Wall Street support this election cycle. Mr. Wall Street--Timothy Geithner--has already announced his expectation of exiting after the election. The President will be a lame duck, empowered to follow his instincts on the megabanks--and according to Ron Suskind in Confidence Men Obama ordered Geithner to bust up Citigroup. President Obama gets a "B-" and for the first time in years we may have a political  reality conducive to real reform in the financial sector.

Of course, much can change in the next 6 weeks, and the debates in particular will shed light on the position of Romney and Obama on this critical issue. Domestic issues will be the focus of the October 3rd debate.

Government guarantees for the megabanks guarantees failure. The megabanks become too insensitive to risk because their managers know that government will make good any losses. They will gorge on too much credit because creditors know that the government guarantees megabank debt. Thus, banks backed by the government will naturally take on too much leverage and too much risk at the same time, all but insuring their demise. Further their government guarantee makes them attractive derivative counter-parties. So they will naturally be tempted to push the envelope on the extent to which they can generate illusory profits and hide risks in fundamentally dark derivatives markets. For an excellent overview of the economic hazards of Too Big To Fail banks, see this outstanding publication from the Federal Reserve Bank of Dallas.

The stakes here could not be larger. It boils down to this: Is the USA prepared to once again transfer trillions in bank welfare to a handful of megabanks at the expense of all other government services ranging from fire protection to teachers to Pell Grants to Defense? We are one financial crisis away from such bailouts. This is the reality in the Eurozone today. The federal government would become a vassal state of the banks and state and local government would be consigned to an even more dramatic contraction in resources. We are literally talking a huge portion of American economic wealth.

How much money? Since the crisis began in late 2007, the US government debt to GDP ratio increased from under 60 percent of GDP to over 100 percent of GDP, or by about 45 percent of GDP--representing an additional debt burden of about $6.75 trillion. So, if we add the additional debt burden to the $7.6 trillion in forgone GDP, as quoted above, we end up pushing nearly $15 trillion in lost GDP plus additional debt burden. Then, US household net worth took an additional $7.7 trillion hit between its 2007 peak and the beginning of 2011. So the last crisis easily cost Americans $20 trillion.

We as a society simply cannot afford to spend another $20 trillion saving the megabanks.