The GOP Opposes Bank Reform?

Well sort of.

What they oppose is the currently proposed bank reform bill that Senator Dodd has introduced.

If this seems a lot like health care reform … you are correct. So far the GOP had studiously avoided saying what it thinks is good reform. All we know is that the Senate Republicans will say no to whatever is in front of them now.

Wow. That’s constructive.

The key issue is that the GOP argues the Dodd proposal makes future bail-outs more likely. To use Senator Mitch McConnell’s words: ‘it institutionalizes bail-outs’.

And dare I say it? He’s right.

That’s why the Dodd bill needs to be fixed.

The problem is this: as long as the government extends guarantees of various sorts to the big banks, there will be the probability of a future bail-out. Actually, given the evident incompetence of the big banks, this is not a mere probability, but an outright certainty.

Dodd realizes this and tries to mitigate the damage the banks do to society by establishing an up-front fund sufficient to pay for any such future bail-outs. The cash in the fund will come from the banks via a levy on their income.

My problem with this approach is that we have no idea whether the fund, at $50 billion, will be enough. Given the enormous size of the big banks, and their voracious growth, I doubt it.

Of course the GOP is being disingenuous. They know full well that we will always have to bail out the big banks: they are too central to the workings of the economy for us not to. Which is why I am waiting to hear the Republican alternative. Presumably they have one. But, given their approach to health care reform, I doubt we will be treated to it any time soon.

So McConnell is simply being an obstructionist rather than a legislator.

Typical.

Meanwhile: bank reform is getting more, not less, urgent.

I read with great interest a speech given by Andrew Haldane, a UK regulator, who has emerged as one of the leading thinkers on the bank reform problem. His wording is provocative but accurate: banks should be treated in the same way as a polluter.

Basically a polluter is someone, or a business, who has an economic impact borne by society rather than by that person or business itself. GE is a classic example. GE denied for thirty years that it had dumped toxic waste into the Hudson river, despite all the vast evidence amassed that contradicted that statement. Eventually it was forced to pay for a clean up, but not before the shareholders of GE had benefitted from decades of earnings unencumbered by the full cost of the company’s operations. Pollution is a way that private entities try to avoid the cost of what they do by passing a part of the cost on to society at large.

Cars are another such example. The cost of driving a car should, in a proper economic sense, include the cost of the pollution spewed into the atmosphere. Instead the taxpayers, even non-drivers, end up paying for the clean up.

These two examples also give us insight into the two main ways in which society can recoup the cost from the private sector.

It can prohibit certain activities – dumping toxic waste into public rivers. Or it can tax the activity to raise funds to offset the pollution – taxes on gasoline achieve that aim. A slight variation on the taxation method is to force a private entity to incur a cost they would not normally or willingly incur without coercion. In the case of a car such taxation comes in the form of mileage goals that auto manufacturers have to hit. Such goals raise the cost of owning a car, so it acts as if it is a tax.

Haldane uses these arguments to look at banking.

We should both tax, i.e. artificially raise the cost of certain activities; and we should prohibit other activities.

The current discussion about bank reform should focus on what mix of the two strategies we need to deploy to minimize the damage the banks will inevitably try to offload onto society at large.

But before we can get into that phase we need to recognize the fact that banks are, in fact, polluters. They impose huge social costs on us and reap the benefit of all sorts of subsidies. In one calculation Haldane estimates that the value of the subsidy we give the banks exceeds their annual income. In other words, were it not for the taxpayer propping them up, the banks would be losing money consistently for their shareholders.

The biggest subsidy we give the banks is the implied bail-out that McConnell so objects to.

This bail-out subsidy affects the banks by lowering the cost at which investors are willing to lend to them. Because the investor community is aware of the subsidy, they perceive less risk in lending, and therefore charge a lower interest rate. Haldane measures this subsidy by looking at the different bond ratings the rating agencies establish for the banks, with and without the subsidy.

Crucially, for bank reform, the larger the bank, the greater the difference between the subsidized and non-subsidized cost of funding. In other words the bigger the bank the more it costs us to subsidize it. That’s where ‘too-big-to-fail’ becomes an issue for all of us.

Not only are smaller banks easier to regulate and eliminate when they screw up, but they cost us less to prop up.

The challenge then becomes how to get rid of this subsidy and force the banks to earn their own money and not live off of our largesse.That’s an argument the big banks don’t want us to have since they are addicted to the subsidized way of life.

So, perhaps, we can use the GOP obstructionism as a way of opening up a wider discussion. If they want to eliminate the need for future bail-outs, we should discuss exactly what that implies for reform.

Massive capital requirements?

Intense oversight?

Smaller banks?

Highly restricted activities?

New bankruptcy codes so that bank creditors and shareholders are wiped out before public money is available?

I am waiting for answers …

This could be a long wait!