The big news of the day is the president's apparent embrace of Paul Volcker's proposal to "restore Glass-Steagall," which is short-hand for confining commercial banks to traditional commercial banking activities, and specifically bar them from trading on their own account. I do not know how serious the proposal is or what support it will garner in Congress; maybe it's just an attempt to change the subject from health care in light of the result of the Massachusetts senatorial election. In my new book I argue that Volcker's proposal deserves serious consideration--which is not to say that it is the solution, but that it may be.
I will return to this issue in future post. For now I want to link Bernanke's self-defense, the subject of my last post, to the Angelides investigation and the proposed bank tax.
By refusing to acknowledge a role for the Fed's monetary policy in the financial crisis, and by acknowledging only in a perfunctory and backhanded manner the regulatory laxity that also played a key role, Bernanke feeds the theory that "greedy reckless" bankers caused the crisis. That theory is also likely to emerge from the investigation being conducted by the Financial Crisis Inquiry Commission, headed by Phil Angelides. Its first public hearing was in the style of congressional investigatory hearings, designed to humiliate designated culprits called as witnesses. The first witnesses were the heads of the major banks--not Bernanke, Geithner, Rubin, Greenspan, and other contributors to the crisis. The order of witnesses suggests a preconceived judgment that the bankers are to blame.
There is a political problem with blaming the banks, however, and that is that the Treasury and Bernanke have invested hundreds of billions of federal dollars in the banks, that the new administration is thoroughly complicit in these policies, and that Bernanke by continuing to keep interest rates very low (albeit with greater justification than in the early 2000s) has enabled some of the banks to reap huge profits. As I mentioned in my last post, borrowing at low interest rates is no fun if you can only lend at those rates. But there are always opportunities for risky loans or other risky investments, and when there is an implicit government guarantee against a company's failing the company can borrow at very low interest rates even though it is making risky investments, because its lenders feel secure by virtue of the government guarantee. So it faces a steep "yield curve" (the upward-sloping curve that relates the maturity of a loan to the interest rate--the longer the maturity, or the greater of some other risk factor, the higher the rate) and can make a lot of money.
The government's policy toward the banks may well be sound in the present economic conditions. The banks took a big hit in 2008 and continue to carry a lot of bad loans. Government policy has enabled them not only to survive but, in many cases, to thrive. It has not, however, stimulated enough lending to power a vigorous economic recovery. The banks are hoarding huge cash reserves, partly because their balance sheets remain impaired, partly because loan demand is down because there is little appetite for private investment. But if the government were not lending a helping hand, the banks would be lending even less and the economic recovery would be even slower.
The government has failed to explain to the public (it would doubtless be difficult to explain) how its largesse toward the banks and the profits that that largesse has enabled have served the public interest. Instead, the government is busy denouncing the bankers as "fat cats." If they are fat cats, why has the government been stuffing them with money?
That is a hard circle to square. The proposed bank tax is an attempt. Absurdly named the Financial Crisis Responsibility Fee in order to underscore its punitive character, it is a small tax on large banks' borrowed capital (other than deposits). It would yield about $10 billion a year and is due to last until the Treasury recovers the $117 billion that it is believed it will lose as a result of the bank bailouts. The fee has no regulatory rationale; it is too small to affect the banks' behavior significantly. It is merely a hostile gesture.
The harder the government comes down on the banks, the more they will be inclined to hunker down, to hoard (which is what firms and individuals alike do when they face a hostile and uncertain economic environment), and to shift attention from running their firms to dealing with their public image and political vulnerabilities.
Photo credit: Timothy A. Clark/AFP-Getty Images