Joseph Stiglit has a new article on the banks that everyone--including President Obama and his economic gurus--should read. America's Socialsm for the Rich, Economists' Voice (June 2009).
Stiglits notes that the Big Banks are "pushing back on efforts to regulate them" and "will muster what muscle they have left to ensure that they have ample room to continue as they have in the past." Because the bailout took place in a scramble without any "thought to the kind of post-crisis financial system we want...we will end up with a banking system that is less competitive, with the large banks that were too big to fail even larger."
Of course, the consolidation of Big Banks was pushed by the Bush Administration--from the Bush facilitation of the Bank of America-Merrill Lynch wedding, see Bank of America-Merrill Lynch: A $50 billion Deal from Hell, Deal Journal, WSJ, Jan 22, 2009, to the Bush Administration Treasury's propagation of the notice permitting merged banks to keep losses denied them under the section 382 limitation anti-abuse rules, see A Quiet Windfall for U.S. Banks, Wash. Post, Nov. 10, 2008. And the Obama Administration has not been able to bring itself to do the restructuring needed to downsize the banks rather than letting this continued consolidation go on.
The problem with not doing anything about the "too-big-to-fail" banks while continuing a bank bailout is that they "are also too big to be managed. ... [I]f [government officials] wait too long [to restructure banks], zombie or near zombie banks...are likely to 'gamble on resurrection.' If they take big bets and win, they walk away with the proceeds; if they fail, the government picks up the tab." Whereas in a restructuring the shareholders get wiped out and the bondholders give up their repayment right for an equity stake, "[t]he Obama administration has...introduced a new concept: too big to be financially restructured....[A]ll hell would break loose... Markets would panic. So not only can't we touch the bondholders, we can't even touch the shareholders--even if most of the shares' existing value merely reflects a bet on a government bailout."
As Stiglits recounts here, the Obama administration has taken the hole that the Bush administration left it in and continued digging with an even bigger shovel--the idea that no harm can be done to bank bondholders or shareholders else the system will fall apart. That's the power of the bank lobby speaking, not the wisdom of restoring stability to our financial system. Because the bigger banks get, the more likely there will be problems like those in the current financial catastrophe. It's harder to manage them, and harder to control risky speculation. There's too much money in the system: when investors think the government will back up the "too big to fail" banks, they keep adding money in (knowing the government will make good their losses) and the banks keep making risky bets for the same reason. It's a "pernicious feedback loop" and moral hazard. It's really harder when there are all kinds of institutions--not just banks with "bank" in their title--that are providing banking services, such as the insurers and mortgage originators and hedge funds and private equity funds (the shadow banking system, if you will). See John Boyd and Ravi Jagannathan, Avoiding the Next Crisis, Economists' Voice (June 2009). Their proposal--first, define banks broadly to include those who deal with risky financial asets funded with liquid debt liabilities as well as regular banks, and regulate them all with a single regulator so that there can't be any manipulation games playing one regulator against another; and second, set a size constraint to prevent the 'too big to fail' problem from materializing.
"Rewriting the rules of the market economy--in a way that has benefited those that have caused so much pain to the entire global economy--is worse than financially costly. Most Americans view it as grossly unjust, especially after they saw the banks divert the billions intended to enable them to revive lending to payments of outsized bonuses and dividends. ... But this new form of ersatz capitalism, in which losses are socialized and profits privatized, is doomed to failure. incentives are distorted. There is no market discipline. The too-big-to-be-restructured banksknow that they can gamble with impunity. ... America has expanded its corporate safety net inunprecedented ways. ...In truth, this is not socialism but an extension of corporate welfarism. The rich and powerful turn to the government to help them whenever they can, while needy individuals get little social protection. ... America's too big-to-fail, too-big-to-be-restructured banks...are too politically powerful."
Stiglitz is right, of course. The banks are way too powerful. The banks have so far gotten Congress and the Obama Administration to do their bidding without a glitch. Bear Stearns was last fall, Merrill Lynch in December, and it is now July. No banking regulation has been passed, and only puny reforms have been suggested that aren't enough to do half of what is needed. (Of course, Congress hasn't even been able to pass a bill that would tax hedge fund managers on their compensation at the same rate that ordinary workers pay, instead of letting them continue to claim capital gains preferential rates.) The Big Banks have gotten billions of government funding, and have used it to profit themselves, and Congress couldn't even pass a law permitting home mortgages to be modified in bankruptcy.
It is too bad that the Obama Administration seems unable to see its way out of the hole Bush and the beginning of the TARP administration dug for it. There is still time, though. Obama should kick out Larry Summers, who is too much of a product of Wall Street thinking to be able to think beyond Wall Street, and instate Stiglitz as the new economics czar for the White House. And then he should do the job that should have been done months ago--restructure the banking system, making banks smaller and unifying regulation under one roof, and regulating all derivatives (if they are too exotic to regulate, they are too exotic for banks to be engaged in).