Bank 'reforms' that make no sense

Peter Wallison:

After the Democrats' disaster in Massachusetts last Tuesday, President Obama appears to be flailing. Gone is the cool and measured demeanor that made him look presidential when the financial crisis struck during the 2008 campaign. Instead, the financial reform proposals he advanced later in the week seem to reflect political panic—a desperate attempt to appeal to the populist sentiment against Wall Street. Unfortunately, they also reflect a limited understanding of good financial or banking policy.

First, Mr. Obama has proposed to limit the size of banks or their holding companies, or both. The trouble with limiting the size of these institutions is that no one has the faintest idea what the right size is. What's more, if the purpose of the size limit is to prevent a bank or bank holding company from being or becoming too big to fail, we have to know what size would cause a failed institution to cause a financial train wreck. No one knows that, either. Under these circumstances, it's hard to take such a proposal seriously.

Second, Mr. Obama says that some firms should be prohibited from engaging in "proprietary trading." The White House announcement seems to apply to both banks and bank holding companies, but there is a huge difference between them. A bank is chartered by the government, its deposits are insured, it can participate in the U.S. payment system, and it has access to the Fed's discount window. None of these things is true of a bank holding company—which is an ordinary corporation that controls a bank.

Because banks are government-backed, and privileged in many ways, their activities are limited by law and regulation. They are restricted in how they can use their insured deposits. The Glass-Steagall Act, despite what we constantly hear in the media and from people who should know better, still applies to banks; it forbids them from engaging in underwriting or dealing in securities. This should prohibit them from engaging in proprietary trading to the extent that this is dealing in securities. Bank holding companies, however, because they are not banks and not government-backed, can engage in any financial activity, including securities dealing. Why would we prohibit them from doing so when they are using their own funds?

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The proprietary trading accounts permit institutions to hedge their positions in order to limit market risk, not increase it.

A Washington Times Editorial also points out:

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Mr. Obama wants to tax banks to make them pay for the bailouts. The scheme apparently was hatched to distract Massachusetts voters from thinking about his party's health care fiasco and to give Democrats a populist wedge to use against Republicans. The ploy failed, largely because Americans are wary of increased government intervention into the economy as the recession deepens following last year's blitzkrieg of federal action. It's transparent that the Obama administration is targeting Wall Street because it needs a new scapegoat. Now that the president is entering his sophomore year in the White House, he can no longer get away with blaming his predecessor, George W. Bush, for all the nation's ills.

Banks are not the bad actors Democrats want people to believe. Banks have paid back almost all the money they were lent along with interest. The same cannot be said for government-run Fannie Mae and Freddie Mac, which have irretrievably lost $400 billion and counting - and the Obama administration is offering those losers a blank check for billions more. The same laxity applies to Government Motors and Chrysler, which aren't close to paying off the nearly $100 billion handout they received courtesy of taxpayers. Outside the political motives to demonize bankers, there's no reasonable public policy justification for why banks should be singled out for a new extra tax.

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Since the government was responsible for most of the blame for the bailouts, it does not make sense to beat up on the banks for any reason other than as a distraction. One thing we learned from the Obama campaign they seem to know a distraction when they see one, but not necessarily when they create one.