Break the Banks, for the Good of the People

With all the talk of "green shoots" of economic recovery, America's
banks are resisting efforts to regulate them. While politicians talk
about their commitment to regulatory reform to prevent a recurrence of
the crisis, this is one area where the devil really is in the details -
and the banks will muster what muscle they have left to ensure that
they have ample room to continue as they have in the past.

The
old system worked well for the banks so why should they embrace change?
Indeed, the efforts to rescue them devoted such little thought to the
kind of post-crisis financial system we want, that we will end up with
a banking system that is less competitive, with the large banks that
were "too big to fail" even larger.

It has long been recognised
that the US banks that are too big to fail are also too big to be
managed. That is one reason the performance of several has been so
dismal. When they fail, the Government engineers a financial
restructuring and provides deposit insurance, gaining a stake in their
future. Officials know that if they wait too long, zombie or
near-zombie banks - which have little or no net worth, but are treated
as if they were viable institutions - 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.

This is
not just theory; it is a lesson learned, at great expense, during the
savings and loan crisis of the 1980s. In a financial restructuring,
shareholders typically get wiped out, and bondholders become the new
shareholders. Sometimes, the government must provide additional funds,
or a new investor must be willing to take over the failed bank.

The
Obama Administration has, however, introduced a new concept: "too big
to be financially restructured". The Administration argues that all
hell would break loose if we tried to play by the usual rules. 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 bail-out.

This judgement is
wrong. The Obama Administration has succumbed to political pressure and
scare-mongering by the big banks and, as a result, has confused bailing
out the bankers and their shareholders with bailing out the banks.

The
Obama strategy's current and future costs are very high - and so far,
it has not achieved its limited objective of restarting lending. The
taxpayer has had to pony up billions, and has provided billions more in
guarantees - bills that are likely to come due in the future.

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.

This ersatz capitalism, where losses are socialised
and profits privatised, is doomed to failure. Incentives are distorted.
There is no market discipline. The too-big-to-be-restructured banks
know that they can gamble with impunity - and, with the Federal Reserve
making funds available at near-zero interest rates, there is ample
money to do so.

Some have called this "socialism with American
characteristics". But socialism is concerned about ordinary
individuals. By contrast, the US has provided little help for the
millions of its people who are losing their homes. Workers who lose
their jobs receive only 39 weeks of limited unemployment benefits, and
are then left on their own. And, when they lose their jobs, most also
lose their health insurance.

America has expanded its corporate
safety net in unprecedented ways, from commercial banks to investment
banks, then to insurance, and now to cars, with no end in sight. In
truth, this is not socialism, but an extension of long-standing
corporate welfarism. The rich and powerful turn to the Government to
help them whenever they can, while needy individuals get little social
protection.

We need to break up the too-big-to-fail banks; there
is no evidence that these behemoths deliver societal benefits that are
commensurate with the costs they have imposed.

This raises
another problem with America's too-big-to-fail,
too-big-to-be-restructured banks: they are too politically powerful.
Their lobbying efforts worked well, first to deregulate, and then to
have taxpayers pay for the clean-up. Their hope is that it will work
again to keep them free to do as they please, regardless of the risks
for taxpayers and the economy. We cannot afford to let that happen.