Obama's Plan to Reform the Banking Business: Not Good

Includes: BAC, GS, JPM, KBE, MS, WFC, XLF
by: Tom Brown

How to describe President Obama’s newest proposals to reform the country’s financial system? A string of adjectives comes to mind:

1. Ineffective. The President says his proposals to limit the size of banks and restrict their proprietary trading will prevent a rerun of the crisis that hit the financial markets in 2008. Wrong.

Lehman Brothers, whose demise in September of 2008 kicked the crisis into high gear, didn’t fail because it had gotten too big or was overly involved in risky proprietary bets. It failed because it became over-levered and then loaded up on a narrow subsector of assets that we now know were doomed. Even if Obama’s new rules were fully in place back then, the firm would have gone under anyway.

The president’s new bugaboo about size is particularly misguided. Too-big-to-fail, as Warren Buffett says, is a “genie that can’t be put back into the bottle.” And the bottle seems to be getting bigger, not smaller. During the current economic slowdown, we found out that TBTF doesn’t just apply to big banks anymore, but also to insurance leviathans, automakers, and non-bank mortgage lenders. Next cycle, we might find out that, depending on who’s defining the country’s “national interest,” certain airlines, defense contractors, technology companies, and who knows what else might be deemed too big to fail, as well. In the meantime, insisting that companies not get too large seems a little beside the point. And what all this has to do with proprietary trading is beyond me.

2. Harmful. On the one hand, the president wants to ensure that another financial crisis never happens again, and wants to tax banks to recoup the costs of TARP. But on the other hand, he wants banks to loosen their lending standards and make more loans. The uncertainty this contradiction has produced (not to mention the verbal jihad the president has inflicted on the banking industry) isn’t going to spur bankers to ease their lending standards. It will have the opposite effect. Taxing banks and trashing bankers will simply result in less lending, not more.

3. Unfair. Most people seem to have forgotten, but the TARP program was a thinly veiled attempt by the government to bail out a handful of financial institutions (most notably Citigroup) without highlighting to a panicky public the fact that those institutions were so weak they needed a bailout. So not only did Citi get an infusion, but a bunch of healthy institutions, such as JPMorgan and Wells Fargo, were forced to take preferred stock investments from the government, as well. They didn’t want the cash, nor did they need it. No matter: the banks had to pay 5% of the TARP principal in after-tax dividends to the Treasury annually, and agree to pay back the entire investment within five years. On top of that, they had to issue warrants to the government, as well.

But the banks did as they were told. Now, a year later, they have all repaid their TARP investments, or will do so shortly. And what is their reward? The president wants to tax them some more because the non-banks that wheedled themselves in on the TARP deal (that would be the automakers and AIG) are still flailing, and are nowhere near repayment.

This makes no sense, and is incredibly unfair. Why single out one class of TARP recipients to pay for the errors and missteps of another?

In addition, if you combine the president’s proposed new taxes and restrictions with the “unofficial” new, higher capital standards that U.S. bank regulators are now imposing, U.S. banks figure to soon find themselves at a significant disadvantage in competing with foreign banks.

4. Disingenuous. Most commentators see the president’s latest proposals for what they are: a ploy to divert the public’s attention away from voters’ disenchantment with his big-spending, big-government plans and the backroom tactics he’s engaged in to try to implement them. This sudden war against the big banks is a transparently political attempt to exploit populist anger at the banking industry. How post-partisan.

If you look at the hastiness with which these latest proposals were put together, and the lack of accompanying detail, it’s hard not to come to the conclusion that the White House’s first, last, and only motivation was to get the media to talk about something else than the walloping the Democrats took in Massachusetts last week.

Put all these adjectives together (ineffective, harmful, unfair, and disingenuous) and then try to distill them down into one single word that can adequately describe the president’s policy toward the financial industry, only one word will do: asinine! Hopefully, as Congress looks at the details (whenever they come out), it will reject the president’s latest ideas. The president’s plans won’t prevent another financial meltdown, or encourage prudent lending. They are worse than useless.

In fact, from nearly first to last, the President’s entire remarks on financial reform last Thursday seemed to be shot through with misinformation and faulty judgment. Here are some highlights:

We intend to close loopholes that allowed big financial firms to trade risky financial products like credit default swaps and other derivatives without oversight.

Taken at face value, the premise of the statement is simply false! Every firm that traded CDSs and other derivatives is regulated. The problem wasn’t a lack of regulation; the problem was ineffective regulation!

. . . to identify system-wide risks that could cause a meltdown.

For as long as there has been a financial system, there have been financial panics. By their nature, they can’t be predicted. President Obama may believe he can identify all the possible risks than can lead to a meltdown, but here’s a little secret: he can’t. No one can. No human being is capable of predicting the next Black Swan, unless you simply want to prohibit all financial transactions. (And even those systems tend not to end well.) This cycle, the B.S. arrived in the form of incredibly high default rates and loss severity associated with instruments rated AAA by the rating agencies. (In retrospect, of course, the problems seem obvious. They always do.) It is simply unrealistic for the president to think he can create a “systemic regulator” who would miraculously see the next Black Swan.

. . . to strengthen capital and liquidity requirements to make the system more stable.

The most highly levered financial institutions (investment banks, AIG, Fannie Mae, and Freddie Mac) operated outside of the capital and liquidity guidelines that govern commercial banks. Just because those organizations had bad business models doesn’t mean the government should change the requirements placed on the banks.

The President seems to not realize that large U.S. banks have to compete globally. The major industrial nations have adopted common capital requirements to level the playing field. The administration can temporarily hold U.S. banks to significantly higher capital standards, but if it tries to make those higher standards permanent, U.S. banks would be at a serious disadvantage competing against foreign-regulated institutions.

So if these folks want a fight, it’s a fight I’m ready to have. And my resolve is only strengthened when I see a return to old practices at some of the very firms fighting reforms . . .

Mr. President, you must be kidding! Your regulators already have all the power and authority they need to stop any unsafe, unsound banking practices. If you know of a bank that’s doing something it shouldn’t and is getting away with it, fire the relevant regulator. And if you don’t know of any bad behavior, stop with the false accusations!

And you don’t think banks should publicly object to your nutty proposals? Give me a break. When the unions didn’t like your plan to tax luxury health care plans, you didn’t tell them to shut up. No, you invited them to the White House and gave them a disgusting sweetheart deal!

. . . when I see soaring profits and obscene bonuses at some of the very firms claiming that they can’t lend more to small businesses…

What is it with the President and bonuses for bankers? These companies paid back the TARP investments that had been forced on them, with interest. Determination of the size of bonuses bankers should receive is a decision best left to management, the board of directors, and, ultimately the shareholders. Does the president think that bankers’ bonuses, by virtue of their sheer size, are inherently objectionable? If so, why don’t we hear him railing against other high-wage earners like pro athletes and Hollywood stars?

I’ve never understood the President’s belief that these “fat cat bankers” won’t lend money to small businesses. If bankers are as greedy as Obama seems to think, they’d be lending money hand-over-fist to small businesses, at positive spreads, and would be earning more money for their institutions that would then fund even bigger bonuses! It’s in bankers’ self-interest to make loans with positive spreads to credit-worthy borrowers!

. . . they can’t keep credit-card rates low . . .

Mr. President, you signed a bill last year that limited the ability of credit card lenders to reprice for risk. Don’t tell me now you’re surprised that they raised rates ahead of the new rules.

. . .they can’t pay a fee to refund taxpayers for the bailout without passing on the cost to shareholders or customers . . .

Whoops! Mr. President, first, if banks don’t pass the along the cost of your new large-bank tax to customers, the profitability of the big banks will go down, the banks’ shareholders will be hurt, and the recovery of the financial system will be delayed. If banks do pass along the cost, fees will go up. By passing a new tax, Mr. President, either the banks’ customers or their shareholders (or both) will be hurt! How is it that the president doesn’t understand that someone will actually pay the new taxes he is proposing?

My head hurts! The President has decided to attack the banks with his idiotic proposals and populist, bank-bashing rhetoric in order to (I assume) buck up his sagging poll numbers. If his proposals are passed (which I believe is unlikely) they won’t help the financial services industry. What’s more, I suspect the resulting tighter credit and higher fees won’t win him many votes!

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