Finding the Good in Obama's New Bank Reg Proposals
President Barack Obama’s proposal to regulate the size and reach of larger banks will raise lots of heckles from Republicans and conservatives eager to oppose every initiative a regulation and spending happy president pushes forward. Given economic realities, however, the proposal doesn’t deserve out-of-hand dismissal. Although likely to limit financial creativity in some respects, the proposals may actually end up reducing the reach of government in the markets.
Contrary to some reports—and overheated claims from financial institutions—nothing seems to indicate that President Obama wants a full reinstatement of the onerous Glass-Steagall regulations that significantly limited the businesses of every financial institution between the 1930s and late 1990s. Instead, the proposals would simply end most government guarantees -- offered through the Federal Deposit Insurance Corporation and a few other entities -- for firms that take sizeable investment risks with their own money through the purchase of equities and riskier bonds.
This isn’t a bad thing and may be necessary. In the wake of the 2008 financial meltdown, several large investment banking firms including Goldman Sachs and Morgan Stanley converted themselves from investment banks to commercial banks. As a result, they accepted slightly tighter controls on their own capital but gained much greater explicit government backing. This is clearly a problem: insofar as government-mandated bank insurance makes sense at all, it should exist to protect individuals and small businesses, not multi-millionaires dabbling in exotic hedge funds.
Government guarantees lead many firms to take risks and then expect taxpayer bailouts even when supposedly sturdy “firewalls” exist between consumer deposits and high-risk investments. AIG, the single largest financial institution to fail as a result of the crisis, was an insurance company that, in theory, was supposed to manage its capital even more conservatively than the most conservative banks. A lot of good that did. Without some more separation, it’s likely that some of the new “commercial banks” could eventually end up like AIG.
This doesn’t mean that Obama’s proposal is altogether good. Coupled with generally increased regulation on risk-taking, the laws will likely make it harder to find capital for high-risk, high-reward ventures and make it nearly impossible for larger firms to introduce truly new products. Firms that do innovative may find that the government limits their growth for all sorts of reasons including some pretty bad ones. A sale of many banks’ investment businesses -- which the laws would essentially require -- might well further hurt already depressed markets.
Finally, the proposal won’t end “too big to fail” firms. Unless the government imposes an absolute limit on financial firm size (a terrible idea that nobody has seriously proposed) some institutions considered “too big to fail” will probably crop up whatever happens.
Still, the President’s proposal deserves serious consideration. In many cases, it will actually reduce the government’s role in the market.