Obama Banking Too Much On Banks

On Monday-one year after the once-mighty Lehman Brothers collapsed
in the nation's biggest bankruptcy-President Obama addressed the state
of the economy and again outlined his proposals for what he calls
reform. The location-Federal Hall at 26 Wall Street, near the New York
Stock Exchange and New York Federal Reserve Bank-was fitting. George
Washington took his presidential oath there, a precursor for how
intertwined Washington and Wall Street would become. And Obama's speech
indicates that he's still making the grave error of mistaking the
health of Wall Street for the health of the American economy.

Obama
chose not to deliver his speech on, say, the streets of Bend, Oregon,
or Fresno, California, which provide different indicators of our
economic predicament. That's because Washington's approach to the
crisis has been to focus on the banking system, throw a few crumbs to
citizens, and hope everything else will magically work itself out.

The problem with concentrating on the banking system is that it
allows the administration to present an overly optimistic assessment of
its actions. "The storms of the past two years are beginning to break,"
Obama pronounced, attributing this to a government that "moved quickly
on all fronts, initializing a financial stability plan to rescue the
system from the crisis and restart lending for all those
affected by the crisis." He continued: "By taking aggressive and
innovative steps in credit markets, we spurred lending not just to
banks, but to folks looking to buy homes or cars, take out student
loans, or finance small businesses. Our home ownership plan has helped
responsible homeowners refinance to stem the tide of lost homes and
lost home values."

Those steps were certainly aggressive. Under both the Bush and Obama
administrations, the government, from the Federal Reserve to the
Treasury Department, has flushed the banking systems and other
components of the financial markets with $17.5 trillion worth of loans,
guarantees, and other forms of support. About another $1 trillion has
been provided to citizens through the recovery package, first-time
homeowner tax benefits, auto purchase credits, and approximately $800
billion to help guarantee the loans of certain lenders-which somewhat
helps borrowers, but helps lenders more.

But these measures have hardly brought the economy back from the
brink. They brought Wall Street back from capital starvation and
prevented the possibility of more big banks going bankrupt-instead of
the slew of smaller and mid-size ones that have since met the same fate
as Lehman Brothers. Taking credit for stabilizing the financial system
after feeding it with massive amounts of federal money is like a
teacher bragging about turning around the academic performance of a
failing student after handing them all the answers to the big tests.

Here's how the economy is really faring (and how Washington is failing to take adequate steps to fix it):

• National unemployment is at 9.7 percent, higher than last year's 5.8 percent, with double digit jobless rates in 139 metropolitan areas this July, compared to 14 last July.
• The number of foreclosures is greater than last year: nearly 2 million new foreclosure filings occurred in the first half of 2009, up 15 percent from the same period in 2008.
• While homes in some areas have begun to slowly sell again, they are
  doing so at deeply depressed prices, in many instances below their
  mortgage value.
• Wall Street bonuses are back to pre-crisis levels. For some firms, such as Goldman Sachs, they are even higher.
• Bank leverage, or excessive borrowing on the back of risky assets-a major cause of the meltdown-is rising again.
• Geithner recently reported that his program to enable private
  financial firms to buy up toxic assets with government help will wind
  up costing less than the $1 trillion he had first envisioned. However,
  he did not mention that there are less toxic assets available to buy
  partly because the Fed has allowed banks to use some toxic assets as
  collateral in return for cheap loans.
• Big banks are bigger
  than they were last year. Since the Fed blessed more mergers last fall,
  the nation's three largest banks-Bank of America, JPMorgan Chase and
  Wells Fargo-hold the maximum percentage of legally permissable US
  deposits or more.
• Mid-size and smaller banks keep closing. This year, the Federal Deposit Insurance Corporation (FDIC) has closed 92 banks and depleted its deposit insurance money in the process.
• We still don't have detailed information on the trillions of
  dollars of loans the Fed handed out to the banking sector or about the
  quality of the collateral banks provided in return.

Obama did acknowledge that the picture isn't entirely rosy. He also
outlined his ideas for avoiding another catastrophe: reshuffle the
decks of regulatory agencies, slap a few trading constraints on some
derivatives, and create a Consumer Financial Protection Agency (CFPA).
But while Obama's rhetoric was stern-"normalcy cannot lead to
complacency," he vowed-the proposals themselves are hardly sweeping.

Obama's plan calls for eliminating the Office of Thrift Supervision
and providing greater oversight by the Fed of "systemically important"
institutions. The Senate is trying to water that down, in part because
some members of both parties in Congress remain skeptical about the
power of the Fed itself. The Senate also wants to consolidate
regulatory authority into fewer entities, but leave oversight to a
council of regulators. Of course, consolidating regulatory oversight
only works if regulators are doing their jobs and the banking system is
transparent enough to allow them to do so.

The last leg of Obama's proposal would be establishing the CFPA,
which would monitor financial products in an effort to protect
consumers from risky instruments such as subprime mortgages.
Legislation to create such an agency is expected to be taken up this
year by the House Financial Services Committee, chaired by Rep. Barney
Frank (D-Mass).

A strong CFPA is a sensible plan. Right now there is no other body
imbued with the power not just to protect consumers but also to foster
the general economic stability that would be achieved by closely
monitoring the integrity of financial products. This proposal has drawn
the most ire from the banking community, so you know it's good. The
Chamber of Commerce launched a $2 million ad campaign
to convince people that a CFPA would mean that local butcher couldn't
extend credit to his customers without government interference.

But Obama's reforms do not strike deeply enough. The banking crisis
has been subdued, not fixed, because of enormous amounts of government
assistance. Ignoring that fact, and failing to overhaul the sector,
leaves us open to another crisis. And the next round will be worse,
because there is now so much more federal money invested in the banks.

Simply funding the banking system without reforming it is an
expensive and dangerous game. Obama is capable of truly fixing
things-by dividing up the Wall Street mega-banks with a new Glass
Steagall Act, thereby enabling the success of more extensive regulatory
reforms. Or, he could introduce a set of cosmetic changes that allow
banks to keep doing what they did before last year's crisis and that
put us on the path for the next one.