Political Animal

Blog

May 14, 2013 10:27 AM Don’t Believe the Banks on Dodd-Frank

By Haley Sweetland Edwards

In his latest column, the Washington Post’s Robert Samuelson, who’s generally not big on big government, comes out pretty much in favor of the Dodd-Frank financial reform act, but expresses one major concern. He worries that by limiting the scope of Section 13(3) of the Federal Reserve Act, which is the part of the law allowing the Fed to be the “lender of last resort,” Dodd-Frank strangles banks’ willingness to lend and therefore strangles economic growth.

This is a fairly common criticism of ending “Too Big To Fail.” And it’s kinda, sorta true—but in the most myopic terms possible, and it misses the larger point about how our banking system works.

If you ignore for a moment the fact that the current implementation of Dodd-Frank does not, in fact, significantly tie the Fed’s hands—show me the woman who believes “Too Big To Fail” is a thing of the past—then Samuelson has a point. Banks do need to be able to guarantee to their investors that if something goes wrong, they’ve got an escape hatch. But why—and this is a question that Samuelson never raises—must the role of guarantor fall to the Fed?

The fact that banks need to convince their investors that they won’t go belly-up is the best argument out there for requiring banks to keep more capital reserves. (The Brown-Vitter bill, which was killed in Congress two weeks ago, would have required that banks with more than $500 billion in assets have 15 percent in capital reserves, which is about twice as much as they are required to have now.)

It’s the banks (and stockholders) who are making money from riskier bets; so shouldn’t it be the banks (and stockholders) that take a haircut if those risky bets tank? And that’s not just an argument made on the grounds of some sort of populist justice; that’s an argument based on aligning the incentive structure of the larger economy. If the banks and stockholders are unwilling to make risky bets because it’s their ass on the line, then that’s a pretty good indication that we shouldn’t really be making those bets to begin with, right?

Now, this is where Samuelson is kinda, sorta right again. It’s true that if banks are held responsible for their own bets, then their bets (and their willingness to lend) will get more conservative. And it’s true that if they’re betting and lending more conservatively, our economy may grow less rapidly in the short term. But if banks are making bets and loans that they actually think are safe, then the growth that does occur is much more likely to be stable and enrich more than merely the Wall Street traders, who generally take home the lions’ share of those short-term winnings. And, of course, an economy that grows responsibly is more likely to avoid spectacularly collapsing one afternoon—a situation that definitely contributes to long-term economic growth.

And anyway, I suspect Samuelson may be making kind of a moot point. The language in Dodd-Frank that attempts to declaw Section 13(3) of the Federal Reserve Act is so riddled with loopholes that, even if it were to be implemented as strongly as possible (which is unlikely), the Fed could probably step in and bailout whoever it wanted, whenever it wanted. There’s a reason, after all, that financial reformers are up in arms that “Too Big To Fail” is still the de facto law of the land.) The reformers know this, the banks know this. So pretending that banks aren’t lending because they’re fearful the Fed won’t bail them out if they get in above their heads? I’m not convinced.

Haley Sweetland Edwards is an editor of the Washington Monthly.

Comments

  • c u n d gulag on May 14, 2013 10:41 AM:

    I know our economy dwarfs Iceland's, so I'm sure there would be some significant differences in recovery rates, and schedule - and that's IF it could succeed, but, just to throw the fear of the FSM into our Banksters, let them see how things worked out to that countries, and peoples, advantage, and not to the advantage of the Banksters:

    http://www.moneyweek.com/news-and-charts/economics/europe/the-lesson-from-iceland-let-banks-go-bust-20800

    Here's a brief excerpt:
    "What Iceland did
    Governments around the world bailed out their financial sectors. The US government bought stakes in key banks and lent them money. Britain nationalised RBS, assuming all its debts. Ireland guaranteed all the debts of its six largest banks.

    However, Iceland took a different tack. The government declared that it would only save domestic bank account holders - everyone else would have to fight over the remaining assets.

    It also refused to pay foreign governments for the cost of compensating retail depositors in foreign subsidiaries of Icelandís banks. Although a deal that would have paid the debts, over a longer schedule, was nearly agreed twice, it finally collapse due to public opposition.

    Meanwhile, instead of trying to prop up its currency, Iceland let the value of the krona more than halve. It also imposed capital controls to prevent money leaving the country."

    Now, maybe the EU can't say "F-U!!!" to its Banksters, but, since we have our own currency, we certainly can to ours - AND SHOULD!!!!!!!!!!!!!!!!!!

  • low-tech cyclist on May 14, 2013 11:20 AM:

    With respect to Robert J. Samuelson, I'd say even a stopped clock can be right twice a day.

    But if this is the closest he can come to being right, then the stopped clock doesn't have to worry about the threat of competition from Samuelson.

  • Rick B on May 14, 2013 12:02 PM:

    The largest banks are making money hand over fist by making speculative bets on financial deals. In the meantime the largest American firms are still sitting on over $2 trillion they cannot find places to invest because the consumers (who make up 70% of the economy) do not have the money needed to increase consumption spending.

    Why do the consumers not increase spending? Jobs are not being increased. If you were laid off during the Great Recession for more than six months and are over age 50 you are not finding jobs to move to.

    Are the banks lending to the smaller farms who cause increased hiring? No. The banks are too busy getting taking the large sums of money at super low interest rates and using it to speculate with other large financial institutions. The reserve rates are so low and the interest rates so low that the really large bank-to-bank gambles are where the big money is.

    As long as hiring does not increase the big banks do not fear inflation which would remove the punchbowl from the party they are currently enjoying.

    It's time to increase the reserve rates on large banks, make the financial transactions of large sums they speculate with much more transparent to everyone (organized markets) and start rewarding lending to smaller businesses so that main street begins to grow businesses instead of making the big banks larger.

    Also provide some protectionist legislation for American-made products instead of exporting jobs and prevent the big firms from keeping money overseas free of taxes.

  • paul on May 14, 2013 2:35 PM:

    Why do banks need to convince their investors that they have an escape hatch? If investors want an escape hatch, they can hedge the bank's stock, or just not invest.

    It's not as if other kinds of corporation can guarantee their investors' safety.

  • SpaceSquid on May 15, 2013 7:22 AM:

    Shorter Samuelson: this new legislation might make it more difficult to recover from the disasters this legislation was created to prevent!