President Obama, on the other hand, owes the megabanks nothing. Not a single megabank was among his top 15 supporters. Finance spent three to one in favor of Romney. The megabanks also strived mightily to deny the Democrats the senate. They spent millions supporting GOP candidates against Elizabeth Warren and Sherrod Brown. So, one major consequence of this election is that President Obama and the Democrats owe the megabanks nothing.
The megabanks still threaten our economy and still play with excessively risky derivatives as proven by the recent multi-billion dollar derivatives loss suffered at JP Morgan Chase and the failure of MF Global arising from excessively risky bets on Eurozone debt. The essential problem is that because they are perceived to be too big to fail creditors lend them money on cheaper terms and management is thereby enticed to take on more risk. Further, since they gorge on cheap debt they naturally become ever larger and too complex to manage. Only fragmenting the megabanks will cut off their supply of cheap capital.
The megabanks still threaten our economy and still play with excessively risky derivatives as proven by the recent multi-billion dollar derivatives loss suffered at JP Morgan Chase and the failure of MF Global arising from excessively risky bets on Eurozone debt. The essential problem is that because they are perceived to be too big to fail creditors lend them money on cheaper terms and management is thereby enticed to take on more risk. Further, since they gorge on cheap debt they naturally become ever larger and too complex to manage. Only fragmenting the megabanks will cut off their supply of cheap capital.
As NYU economist Nouriel Roubini puts it: "The
only solution to to break up too big to fail banks.There is no other
alternative. We have to go back to Glass-Steagall. I would have thought
after the worst global financial crisis in a generation, the decision
would have been made. Maybe we need another big financial crisis."
MIT economist Simon Johnson states: "There
are large implicit government subsidies available if your financial
institution is perceived as too big to fail. These subsidies -- in the
form of implicit downside protection or guarantees for creditors --
drive up size and exacerbate complexity."
These are two of the finest economists of our time and each boasts huge credibility. Johnson is the former Chief Economist of the IMF and author of the definitive study of the hazards of an excessively large financial sector, Thirteen Bankers. Roubini famously predicted the financial meltdown in great detail as early as 2005.
MIT economist Simon Johnson states: "There
are large implicit government subsidies available if your financial
institution is perceived as too big to fail. These subsidies -- in the
form of implicit downside protection or guarantees for creditors --
drive up size and exacerbate complexity." These are two of the finest economists of our time and each boasts huge credibility. Johnson is the former Chief Economist of the IMF and author of the definitive study of the hazards of an excessively large financial sector, Thirteen Bankers. Roubini famously predicted the financial meltdown in great detail as early as 2005.
Nor
are these two outstanding economists alone in recognizing the threat
posed by the megabanks. University of Maryland economist Peter Morici: "The
real solution in the banks is not all of this excessive regulation, but
to bust up the big banks. The fact is not only are they too big to
fail, but because they're too big to fail, they're too big to
effectively regulate. That's why there's no lending and they continue
trading." Even former Fed Chair Alan Greenspan, who actually presided over much of the growth of the megabanks, now recognizes that they must be allowed to fail. Mainstream economics has achieved rare consensus: too big to fail banks present a clear and present danger to the economy and must be eliminated from the system.
I cannot count the number of posts on this blog protesting the socialization of financial risk in our economy under the guise of too big to fail. I have also written numerous law review articles criticizing the continuation of too big to fail. But, without the right political context all the academic analysis is meaningless.
I
believe that President Obama faces an historic opportunity to address
the scourge of the megabanks. This is a compelling economic issue. He is
a lame duck who owes the big banks nothing. Huge popular support
would back any move to end too big to fail. Here are the most promising
and straightforward mechanisms available to tame the megabanks:
1) Amend section 121 of Dodd-Frank to allow the government to more easily break up the megabanks. Specifically, change the requirement of 2/3 approval of the Fed Board of Governors to a simple majority. Further, allow the Fed to order divestiture of operating divisions of megabanks without having to show that other alternatives would be inadequate. Finally, delete the term "grave" and allow the Fed to break-up any megabank that threatens the financial stability of the US. (They all already pose a grave threat).
2) Amend section 203 of Dodd-Frank to allow the FDIC to take a megabank into orderly liquidation (i.e., receivership) solely based upon a determination by the Treasury Secretary that the firm faces a high risk of default. This would eliminate the need to get a 2/3 vote by the Fed and the FDIC. It would also help to short-circuit any judicial review.
3) Appoint a truly tough minded financial expert as Secretary of Treasury. The best appointment would be Sheila Bair. As a Republican, she would bring immediate bipartisan credibility on a range of important economic issues. As former FDIC Chair, she understands banking and was a consistent voice for tough reforms. She has a new book out that pulls no punches. Her appointment as the first woman to head Treasury would also help the Democrats to continue to earn the support of women politically.
Of course, perhaps the reinstatement of the Glass-Steagall Act would be the most certain means of taming the megabanks.
In any event, President Obama holds a huge opportunity to impose rational policy and achieve a superior political outcome for Democrats, all at once. He must get tough on the megabanks. My next post will further this basic point in the specific context of corporate governance.
steve, the climate has never been more advantageous for president obama to rein in the banks but have you seen any indication that he has the will or desire to do so? any signals?
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