Bashing the bankers is making Obama go blind

It’s the oldest trick in politics: when you’re in trouble, change the subject. And so two days after his administration and party were reeling after losing the special senate election in Massachusetts, President Barack Obama announced a plan that places new restrictions on banks’ activities and overall size.

First, he called for a ban on commercial banks (like high-street banks) from trading using depositors’ money unless directly on behalf of customers (so-called ‘proprietary trading’), and from owning, investing or sponsoring hedge funds or private equity funds. Second, he proposed expanding the current cap on the market share of deposits (set at 10 per cent) to other liabilities.

Obama’s proposals follow on the heels of other bank-bashing moves in recent weeks. In mid-December he blasted ‘fat cat’ bankers during a TV interview. On 14 January he announced a new tax on the larger banks, with the aim of recouping some of the costs of the financial bailout. His scheme last week came with some tough-sounding words for the banks: ‘If these folks want a fight, it’s a fight I’m ready to have.’

It is obvious that, the more that support for Obama and the Democrats drops, the more they scapegoat the banks. The administration claims that the new policies have been in the works for some time. But they have had a year since Obama entered the White House, and until very recently they rejected the latest proposals. The treasury secretary, Timothy Geithner, never (at least publicly) supported separating banking activities until now, and the Wall Street Journal reports that it was only in mid-December that Obama asked Geithner to look at separating banking activities, an idea most closely associated with Paul Volcker, the former Federal Reserve chairman and now an outside adviser to Obama.

Even if the proposals have been brewing for some time, the timing of the announcement is politically motivated. Obama clearly believes that his administration needs to become more ‘populist’ to head off what he sees as the public’s ‘anger’ about favourable treatment of the banks.

Many of the administration’s erstwhile critics indicated support. The Wall Street Journal was ‘encouraged’ by the announcement, which they consider to be Obama’s ‘first serious idea into the debate on reforming the financial system’. Financial journalist Felix Salmon expressed a common reaction: ‘OK, so this is populism. But populism in the service of a good cause is no great sin.’

But this interpretation is far too generous, and it underestimates the problems inherent in Obama’s new approach. For a start, the administration will not even admit this is a policy U-turn, hastily thrown together following the Massachusetts debacle. It exposes the White House as panicked and confused. The administration says it supports global coordination regarding financial reform, but its rushed-in proposal came as news to foreign governments. Even if the proposed reforms are worthy of consideration, this is not a rational way to establish government policy.

Taking the administration’s proposals at face value ignores that they are entirely self-serving in that they shift the blame for the financial crisis away from the political class itself. The proposals are token measures at best, and they will hardly address the serious problems revealed by the crisis.

Obviously the big banks were at the centre of the financial meltdown. About a week-and-a-half ago, the Financial Crisis Inquiry Commission, chaired by California state treasurer Phil Angelides, began hearings by grilling the CEOs of four of the biggest banks. That set-up implied the commission had already determined who was to blame. But the banks were not the only guilty parties, and government officials were not helpless observers. All along the way state institutions were complicit in the crisis.

Reliance on credit expansion was roundly supported by both parties for the past two decades, and, more immediately before the onset of the crisis, Federal Reserve chairman Ben Bernanke pursued a low interest rate policy. Governments of both parties supported the expansion of home ownership and mortgages – the site where credit problems imploded – including through backing the quasi-government lending agencies Fannie Mae and Freddie Mac (which needed to be bailed out, and still owe money). And governments from Reagan through Clinton and to Bush pursued policies to deregulate financial services.

In principle, separating higher-risk activities (like trading) from lower-risk ones (like retail bank processing) is not an unreasonable proposition: it could be a helpful – but far from sufficient – reform. However, a closer look at the Obama proposals finds that they will not lessen the likelihood of another financial collapse. For a start, while the Obama scheme places limits on commercial banks’ activities, it does not regulate the so-called ‘non-bank’ financial institutions. During the 2008 crisis, none of the biggest problem firms – Bear Stearns, Lehman Brothers, Merrill Lynch, AIG – were considered deposit-taking commercial banks. And so, the proposals would not have stalled the financial meltdown, nor would they prevent one in the future.

Many misinterpret the scope of the proposals. In welcoming Obama’s latest moves, Britain’s Observer says: ‘The basic principle is that banks would no longer be able to blur the distinction between their classic retail functions and their capital market speculations… The separation was enforced in the US after the 1933 Glass-Steagall Act, but gradually abandoned in the 1990s. Now, in essence, Mr Obama wants it back.’

Obama may want his proposals to be perceived as a return to the more cautious Glass-Steagall days, but they do nothing of the sort. His plan does not restore a split between retail and capital markets: retail banks can participate in investment banking activities, as long as they are customer-related. And thus most banks will not be significantly affected: for example, it is estimated that JPMorgan Chase’s proprietary trading represents one per cent of its total revenues and about three to five per cent of its investment banking revenues.

Moreover, under the proposals, commercial banks can continue to put their depositors’ funds at risk. Most of the banks’ losses during the crisis were not from trading activities; they were from bad lending decisions (mainly related to mortgages). Once again, the proposed reforms would not prevent this from happening in the future.

In announcing his measures, Obama said ‘Never again will the American taxpayer be held hostage by a bank that is too big to fail’. But his plan does not prohibit bailouts, nor make them less likely. The scheme includes limits on liabilities, but absolute size has not been the main problem: Bear Stearns, for instance, was not that big in relative terms. In announcing his suggested reforms, Obama seemed to imply that the ‘non-banks’ would not be bailed out in the future, but that seems unlikely. Many expect that, if the Obama proposals were enacted, Goldman Sachs would give up its status as a banking holding company so that it can continue with its proprietary trading and other investment activities. But based on recent experience, few believe that a bank as large and interconnected as Goldman would not be propped up by the government if it ran into problems. The ‘too big to fail’ issue remains unresolved.

The financial crisis has exposed the need for better, more targeted regulations. However, at the same time, there needs to be a recognition of the limits of government oversight. Financiers will find ultimately new, creative ways to get around regulations, and so all hopes should not be pinned on them.

What’s overlooked in most discussions of financial reform is the fact that the problems in that sphere are the by-product of a decline in the real economy. It is the demise of industry that explains the relative over-growth of credit and the financial sector. Consequently, rebuilding industry is the best way to address financial problems: if the real economy prospers, finance will be less central, and problematic, to the overall economy. However, the Obama administration has got nothing to say when it comes to backing industrial innovation – it is too busy bashing the bankers.

The adminstration’s approach towards the banks is half-baked – just like its policies in other areas, such as healthcare and Afghanistan. It would be consistent to restrain the bank if simultaneously non-financial endeavour was supported. But it is illogical to attack the banks while still relying on them so much for economic growth. If Obama’s reforms do manage to have an impact, they will most likely restrict lending, which will only hurt growth in the short-term.

Some might argue that Obama’s financial proposals are not the answer for finance’s woes but they will help him politically. Even this is questionable. Sure, the Democrats might put the Republicans, who do not want to be seen as defending the big banks, back on the defensive after success in Massachusetts. But Obama is unconvincing as an angry, working-man populist. And this faux populist ploy is based on a misreading of the public mood. It assumes that people are simply angry about big banks, when the real issue is a broader distrust in elites, especially those in government. But neither the Democrats nor the Republicans offer a clear vision or appear willing to take tough, longer-term decisions (like shifting towards an innovation economy), and thus are unlikely to provide the foundation for renewed trust.

Obama’s transfer of the blame for the financial crisis solely on to the shoulders of the banks is rank political opportunism that avoids real reform and puts off a restructuring of the economy away from financial services. The administration’s proposals are not simply bad politics in the service of a ‘good cause’ – the whole exercise is suspect.

Sean Collins is a writer based in New York.