Obama Scolds Bankers, Appeals to Moral Compass: Caroline Baum

Commentary by Caroline Baum

Sept. 16 (Bloomberg) -- It says a lot about the shift in the center of gravity from Wall Street to Pennsylvania Avenue when the main focus of the trading day is what the president of the United States says.

Last week it was health care; health-care stocks went up.

This week it’s financial regulation; financial stocks rose Monday when President Barack Obama took his case for overhauling financial regulation to Wall Street. At times he sounded more like a parent scolding a disobedient child than a president proposing a new regulatory framework.

“We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis,” Obama said in a speech at Federal Hall in New York City. (“You will not stay out until 2 a.m. again.”)

Obama’s regulatory revamp would create a new consumer protection agency to -- what else? -- protect the consumer from himself, as well as from predatory lenders; a “resolution authority” to seize and wind down insolvent non-banks; and an oversight council to share information across markets and plug regulatory gaps “that don’t fit neatly into the organizational chart.”

He said that. Honest. By the time regulators figure out their reporting channels, bankers will have identified and wiggled their way through new loopholes.

“Regulation is static. Markets are dynamic,” said Allan Meltzer, professor of political economy at Carnegie Mellon University in Pittsburgh.

Trees, Not Forest

The president didn’t anoint the Federal Reserve as the new systemic risk regulator, which suggests to Meltzer a move away from the Treasury position, and for good reason.

“The Senate Banking Committee doesn’t want to give the Fed more power,” Meltzer said. “I’ve never seen such unanimity, and I’ve been testifying before the committee since 1962.”

Obama blamed the patchwork system of financial regulation for the current crisis. So many agencies and regulators were responsible for oversight of individual financial firms that no one was minding the store or, as he put it, “protecting the whole system.”

Obama said his reforms are designed to promote “transparency and accountability,” buzzwords of his administration.

Don’t hold your breath. When it comes to the “particulars of a given industry or instrument, they are only transparent ex- post,” said Bob Barbera, chief economist at ITG/Hoenig, a New York brokerage. “You are overstating your skill set if you think you will see through the potential pitfalls.”

Bankers Outfox Regulators

It is fantasy to believe a new, bigger, better regulator will ferret out problems before they grow to system-sinking size. Those being regulated are always one-step ahead of the regulator, finding new cracks or loopholes in the regulatory fabric to exploit. When the Basel II accord imposed higher risk- based capital requirements on international banks, banks moved assets off the balance sheet.

What’s more, regulators tend to identify with those they regulate, a phenomenon known as “regulatory capture,” making it highly unlikely that a new regulator would succeed where previous ones have failed.

The single biggest problem with Obama’s speech on financial regulation was the failure to dent the doctrine of too big to fail. Obama warned “those on Wall Street” against taking “risks without regard for consequences,” expecting the American taxpayer to foot the bill. But his words rang hollow.

Learn by Example

You can wag a finger at bankers and brokers and try to appeal to their moral sense, reminding them of the debt they owe to the American people for bailing them out.

But you can’t, with words alone, alter the perception -- now more entrenched than ever -- that the government won’t allow large institutions to fail.

How do you convince bankers they will pay for their risk- taking when they’ve watched the government prop up banks, investment banks, insurance companies, auto companies and housing finance agencies?

They learn by example. The system of privatized profits and socialized losses has suited them fine until now. It is accepted wisdom that allowing Lehman Brothers Holdings Inc. to fail a year ago was a huge mistake, one that shut down, and almost brought down, the financial system.

Failure as Success

One solution, according to Meltzer, is to insist that bigger must be made better. Regulators could “make sure capital requirements rise more in proportion to asset size,” he said.

Another option is to excise proprietary trading from the banking and brokerage business, according to John Cochrane and Luigi Zingales, professors at the University of Chicago Booth School of Business, as outlined in a Sept. 15 Wall Street Journal op-ed.

In other words, institutions deemed “systemically important,” shouldn’t engage in systemically destabilizing activities.

Then there’s a third unpalatable option. When it comes to the doctrine of too big to fail, nothing succeeds like failure.

The rise and fall of the wealthy

The rich under attack

The Economist

Going for the bankers is tempting for politicians—and dangerous for everybody else

STONES thrown through a banker’s windows in Edinburgh, workers “bossnapping” executives in France, retrospective 90% tax rates proposed in Washington, and now a riot in London as G20 leaders arrived for their summit (see article). A sea change in social attitudes that could have profound effects on politics and the world economy is under way.

The rich are certainly not the only targets in the current populist backlash. Frightened by the downturn, people are furious with politicians, central bankers and immigrants. But a rising wave of anger is directed against the new “malefactors of great wealth”. Today’s villains are a larger and more global bunch than the handful of American robber barons Teddy Roosevelt denounced a century ago; and most of them are bankers and fund managers, rather than owners of trusts and railroads. Yet the themes are similar to those at the end of that previous gilded age: rising inequality—the top 0.1% of Americans earned 20 times the income of the bottom 90% in 1979 and 77 times in 2006—and a sense that the greedy rich have cheated decent working people of their rightful share of the pie.

Some of this cheating has been of an old familiar sort: building Ponzi schemes and bribing politicians to secure favourable deals. There are greyer areas, in which the rich hide their cash in tax havens and get tax law written to their advantage—witness the indefensible treatment of private-equity profits. But what makes the rich’s behaviour so galling for many critics is that their two greatest crimes were committed in broad daylight, as they were part of the system itself.

The two great cheats

The first charge is that the rich created a new form of heads-I-win-tails-you-lose capitalism. Traders and fund managers got huge rewards for speculating with other people’s money, but when they failed the parent company, the client and ultimately the taxpayer had to pay the bill. Monetary policy contributed to this asymmetry of risk: when markets faltered central banks usually rescued them by cutting interest rates.

The second charge is that the bankers and fund managers were not doing anything useful. Unlike the “deserving” rich entrepreneurs who set up Microsoft and Google, the “undeserving” traders and brokers just shuffled money around the system to nobody’s profit but their own. The faster the money went round, the larger the financial sector loomed in the rich countries’ economies. At its peak it contributed 41% of domestic American corporate profits, more than double the rate two decades ago. As finance grew, the banks got ever bigger—too big to fail, eventually, so when they tottered taxpayers had to prop them up. Far from epitomising capitalism, the undeserving rich undermined it: it was socialism for the wealthy.

These two charges run together, but the second has much less justification. Enormous though the cost of bailing out the banks has been, there is nothing inherently undeserving about finance; even in their flawed state, more liquid markets have brought huge benefits to the rest of the economy. The lower cost of capital has made it easier for industry to invest, innovate and protect itself against interest and exchange-rate risk. Trying to single out financiers from entrepreneurs is a fool’s errand: you will end up hurting both.

The heads-I-win charge is not entirely proven, either: some of the people who ran banks did lose when they went bust. Yet even a newspaper as inherently pro-business as this one has to admit that there was something rotten in finance: the basic capitalist bargain, under which genuine risktakers are allowed to garner huge rewards, seems a poor one if taxpayers are landed with a huge bill for it all. Hence the anger.

A time for correction and brown paper bags

Periods of excess, when inequality has grown, tend to be followed by eras of reform: Roosevelt bust the trusts and shortly afterwards Congress moved towards introducing a federal income tax. Part of the genius of capitalism is its ability to adjust to disruption from within and attacks from without.

Indeed, the system is already beginning to correct itself. As our special report this week points out, the rich are not as rich as they were: some $10 trillion, around a quarter of the wealthy’s assets, has been lost. Inequality will decline. Investment banks and hedge funds are shrinking; private-equity groups are struggling to finance takeovers. Having discovered how volatile markets can be, banks will be less keen on trading in the future. There is even a correction going on in conspicuous consumption: Net-a-porter, a pricey website, offers to deliver designer outfits to its customers in brown paper bags.

The market’s self-correction will not be enough, however. Higher taxes will eventually be inevitable, since so many governments have lurched heavily into deficit. But politicians must tread carefully. Tax rises right away would be a rotten idea, since for the moment fiscal stimulus is needed. And even when governments raise the money, they should first get rid of deductions and reverse unmeritocratic measures (such as George Bush’s repeal of America’s death tax) rather than jacking up income-tax rates to punitive levels. Squeeze the rich until the pips squeak, and the juice goes out of the economy.

As for heads-I-win capitalism, the problem of asymmetric risk should shrink, because the rule changes needed to make the financial system safer will also remove unwarranted profits. Contra-cyclical capital requirements, forcing banks to build more reserves during good times, will leave them less cash to splurge on bonuses. Many of the sweetest sources of profit sprang up in the cracks between regulatory systems; governments are now filling in these gaps. If central banks focus on asset markets when they rise as well as when they fall, they will remove much of the froth. Treat a bank that becomes too big to fail like a utility, and it will make less money.

Curbing the excesses of wealth, then, will be a side effect of regulations designed to make capitalism work better. Such measures will not provide the lyrics to revolutionary anthems, but they are going to be better than going after the wealthy. The rich are an easy target. But when you try to bash them, you usually end up punching yourself in the nose.

Day Ahead: Obama Meets with Senior Bankers

BANKERS IN THE HOT SEAT

Bankers in the Lion’s Den

Bankers in the Lion’s Den

"Don't forget, there's a big gladiator show coming up the day after tomorrow. Not the same old fighters either. They've got a fresh shipment in. There's not a slave in that batch. Just wait. There'll be cold steel for the crowd, no quarter and the amphitheatre will end up looking like a slaughterhouse. There's even a girl who fights from a chariot."

Petronius in AD 60
(History Learning Site)

"The wild beast hunts, two a day for five days, are magnificent. There is no denying it. But what pleasure is there in seeing a puny human mangled by a powerful beast or a splendid animal killed with a hunting spear."

Cicero in 50 BC
(History Learning Site)

Do you know how Daniel kept from being eaten when he was thrown into the lions' den?

He told the lions they would be expected to say a few words after dinner.

Fear of public speaking wouldn't have deterred the Congressmen in Wednesday's (February 11) Roman-circus attempts to humiliate large-bank CEOs. In fact, public posturing and ranting for the benefit of constituents was an important part of the charade. The sadistic Congressmen may have nicked the bankers, but they didn't come out looking so good themselves. Why do politicians with enough ability to get themselves elected think that a public display of meanness and uninformed sadism is a cool thing?

On the other hand, the Congressmen may have been onto something since many of the TV commentators expressed disappointment that the hearings were too tame. Looks like the politicians aren't alone in their willingness to pander to the ongoing orgy of populism. They should be careful lest an unleashed populist beast decides that they, too, are overpaid.

Maybe I'm just squeamish. I've never had a desire to watch bull fights, dog fights, rooster fights, or even thugs fighting out behind the gym. Blood and guts don't do it for me. If you are wavering on rooster fights, you probably haven't heard the ballad of Gallo del Cielo.

I recall with revulsion my first tour of the Tower of London, featuring tales of public beheadings and the treks the country folks made into town to enjoy the entertainment of rolling heads. Do you remember "Who's Afraid of Virginia Wolfe" and the games they played: get the guest, humiliate the host, and . . . oh, well? At least no blood was shed.

Public officials and CEOs with public relations staffs are usually advised to go into the lion's den steeled to take anything thrown at them with humility and contrition. If you see a line, get in it to say you are sorry. The safe rule is not to talk back, nor correct your betters. I know because I've had that advice.

I also know the powerful urge to cowboy up and defend your dignity against the onslaught. It rarely happens, but it did happen last week in Texas. A member of the University of Texas Board Of Regents-a good man who has worked tirelessly for the university at zero pay-finally decided there was a limit to the abuse one should have to tolerate in order to serve the public. He did what most of us only fantasize about. In effect, he spoke the words immortalized for all of us by Johnny Paycheck: "Take This Job and Shove It."