Roosevelt Institute

Want To Create Jobs? Break Up The Banks.

Zach Carter — Fri, 08 Oct 2010 11:08:02 -0400

I attended two big economic gatherings this week, one on financial reform organized by finance blogger Mike Konczal for The Roosevelt Institute, another on the economic outlook, presented by the American Enterprise Institute. Each event was depressing in its own right, but combined, they spell out very big trouble for the U.S. economy. Things are about to get much, much worse for just about everybody, even as big banks deploy their lobbying armies to secure the right to make things even more miserable. Despite all of this bad news, I think we might actually be on the verge of some real economic progress. Let me explain.

The general mood at the Roosevelt Institute forum was one of caution bordering on pessimism. Congress passed Wall Street reform legislation that gives regulators a lot of powers to rein in banks that behave badly. Without intense and sustained pressure from reformers, those powers will not be used, especially if Republicans take control of at least one house of Congress next year, and use it to divert regulatory attention with intentionally meaningless inquiries and investigations. The regulatory battle has just begun, and further legislative action is needed to deal with some of the most pressing problems, particularly too-big-to-fail and the foreclosure mess. With a few exceptions, the thirty or so people who attended the Roosevelt Institute event were the individuals most responsible for getting that legislation through Congress—for them to be sounding the alarm is significant (see Annie Lowrey's write-up of the conference for more details).

The AEI panel was packed with a cadre of intellectually boring conservatives, notable for the fact that many were actually advocating strong federal action to right the economic ship. But the discussion was unquestionably dominated by the remarks of Nouriel Roubini and Christopher Whalen, two very smart people who don't work for AEI.

Whalen made the most persuasive case of the group. We haven't fixed the banking system. Banks aren't lending, they aren't trying to lend, and they aren't going to try until they've finished absorbing all the foreclosures embedded in their balance sheets. Left to their own devices, banks will drag that process out as long as possible in order to avoid immediate losses. And the past four years of horrific foreclosure statistics are just the beginning—Whalen thinks we're, at best, about 25 percent of the way through process.

What's worse, the mortgage situation is effectively serving as a blockade against economic policy. Any action the government takes is going to be stymied by the fact that millions of American households are struggling to pay of homes that aren't worth their sticker price.

Fortunately, there's a solution to that problem. Take over the banks, and write-down the amount that troubled borrowers owe so that they can stay in their homes without pissing away their money to banks that don't lend. In Whalen's view, if we want to solve unemployment and get the economy growing again, we have to break up the banks and help troubled homeowners.

That just happens to be my view, as well. Essentially, Whalen—who describes himself as a conservative libertarian—and the progressive braintrusters from the Roosevelt Institute agree about what needs to be done. The critical question is whether there is any political will to do it. And that's where Nouriel Roubini's presentation gets scary.

If we don't fix the banks and don't fix foreclosures and don't get serious about fiscal policy to ease unemployment, we're going to have another financial crisis within a few years. And the next time around, a financial crisis will mean a real fiscal crisis for the U.S.-- not just phony fear-mongering by opportunistic traders.

This isn't the first time Roubini has issued that warning. He said the same basic thing when I interviewed him in May. The trick is, back in May, none of the bank analysts and traders who attended yesterday's AEI event really took him seriously. Now even those elites believe that the economy is in deep trouble and in need of a major shot in the arm from the federal government.

Perversely, all of this bad news gives me some cause for optimism. Wall Street's lobbyists are as powerful as ever, but the intellectual debate over the economic path forward is getting more reasonable as the economy deteriorates and people realize that conservative policies and liberal half-measures are simply not working.

That doesn't mean that securing real reform will be a walk in the park. Both panelists and attendees of the AEI shebang bemoaned the new Basel III capital regime as overly onerous for banks and a barrier to economic recovery—a view which is simply wrong on both points. Given that they're averse to higher capital requirements for the banking industry—the bare minimum move for greater financial stability—convincing them to break up Bank of America and Wells Fargo will be a major task.

But at least those people aren't laughing the reformers out of the room anymore. That's a step in the right direction, and it shows that financial reform isn't really about any kind of ideological divide between the left and right. It's about the basic functioning of the economy, and more broadly speaking, of democratic systems. Coupled with the fact that banks have created a legal nightmare for themselves by cutting corners on their mortgage paperwork, there's quite a bit of room for persuasion.

Of course, if things don't get fixed prior to another crisis, then we not only have prolonged social misery, we have an unimaginable economic disaster. But hell, we might actually fend it off. Get out there and make a fuss.

Why Wall Street Reform Should Hammer Bank Profits

Zach Carter — Tue, 05 Oct 2010 13:11:42 -0400

Of the universal-policy-bloggers who occasionally wade into financial waters, Matt Yglesias is generally one of the best. But sometimes he's just flat wrong, and his post today on financial profits is one of those times. Matt argues that looking to financial profits to measure the effectiveness of Wall Street reform is not a good idea, and he's missing the point. The good news is, Annie Lowrey wrote a great piece explaining the current landscape surrounding Wall Street reform, one in which responsible policymakers understand that lower bank profits are an important sign of economic progress.

Here's the key passage from Matt's blog:

"Much has been made, for example, of financial sector profits as a share of overall corporate profits. The numbers are sufficiently striking as probably constitute cause for alarm, but as a metric this is an odd one. If competition between cell phone carriers becomes more robust, leading to falling prices for consumers that’s a good thing. But since it implies smaller profits for Verizon and AT&T it means banking sector profits will rise as a share of overall profits. But who cares?"

This is silly. When people cite this statistic—and I'm one of the people who like to do so—they're not comparing Citibank's profitability to Verizon's. They're comparing the entire financial sector to the entire corporate economy. The idea that innovations in corporate governance, technology and overall corporate efficiency could be applicable to the entire economy except finance should be extremely suspect. Many of these innovations should apply to corporations generally—whether they're banks or boat-manufacturers. Moreover, there is no reason to believe that literally every sector of the economy except finance has found a way to make itself more efficient over the past few decades, while finance has remained the same old bloated bureaucratic beast.

And if we look at the actual recent history of finance, we see that there have, in fact, been dozens of major financial innovations—but innovations that served to extract rents from other players in the economy. Finance, and banks in particular, figured out great ways of simply gobbling up other peoples' money. This didn't create new, better economic activity—it destroyed economic activity and converted it into bonuses for bankers and traders.

And you can measure this phenomenon by examining financial profits as a share of overall corporate profits. It's one way of analyzing the extent to which finance is cannibalizing the real economy. That problem is very significant, even if you ignore the fact that big banks need to be bailed out and create financial crises that have brutal effects on the broader economy. The crashes and bailouts are bad, but finance is eating jobs and converting them into bonuses without them. That's worse.

Matt also emphasizes the need for international coordination on financial reform. It's true to a point, but essentially meaningless so far as U.S. policy is concerned. Sure, if the U.S. adopts really tough Wall Street regulations, and the rest of the world doesn't, then reckless financial activity will move overseas. And eventually, financial excess elsewhere can create trouble here.

But financial recklessness abroad doesn't create the same kind or degree of economic fallout that financial excess at home does. It's bad for the U.S. if global credit markets freeze up because of a real estate bubble in France. It's much worse for the U.S. if global credit markets freeze up because millions of Americans are in foreclosure. "International cooperation" has become a lame excuse not to regulate finance at home, but we can only expect our friends abroad to be as stringent as we are here. If the U.S. continues to allow its banks to take on huge risks as taxpayers guarantee losses, then we're setting ourselves up for economic trouble—much worse economic trouble than we'd have if Europe alone was allowing financial excess.

Matt is commenting on Annie Lowrey's excellent write-up of the Roosevelt Institute conference organized by finance blogger Mike Konczal. Lowrey's piece is a superb summation of the event, and an excellent snapshot of where financial reform stands at this moment—both its enormous economic potential and its perilous political straits.

I'll have my own write-up on the conference tomorrow, but here's a quick summary: Getting Congress to pass any legislation reining in Wall Street was a major task, and the bill we got gives regulators several useful tools. The trouble is, it doesn't give regulators all of the tools, and the regulators who want to fix problems are about to get badgered to death by a Republican Congress that has already threatened to de-fund key parts of the legislation. We'll know if Wall Street reform works if bank profits decline for the right reasons-- not just because the economy sucks, but because banks aren't devouring other economic activity.