|With the "sweeping" financial reform bill effectively a done deal, I'm not sure who's supposed to be happy about it—those wanting to address the underpinnings of the financial crisis got next to nothing, some increased transparency, banks got punished (and possibly put at a disadvantage to foreign banks, all of which ultimately hurts average folks who actually do banking), and we got a smattering of new oversight boards. Who got the satisfaction? This turned out to be a feckless bill full of "stuff" that makes it look like the politicians did "something." Which means on balance this bloated bill will create some winners and losers and a general disincentive toward financial activity, but the world will go on.
Part of capitalism's adaptive ability to create prosperity includes scraping out the bad (which can be violent, à la 2008). Now, we're emerging from that destructive phase, and the new financial regulation had nothing to do with that recovery. After such dislocations, debate rages on the balance between markets and government. But the foundation of governmental skepticism—as old as the US—is to realize the dangers of a government with good intentions. The sheer nature of concentrated power corrupts, diverts, and distorts into eviler things. It's quite telling of this bill's plight to read long-standing Democratic economist and public servant Arthur Levitt excoriate the thing with malice in the Wall Street Journal.
Enter Simon Johnson and James Kwak's 13 Bankers. A handful of clients have mentioned this book, noting its emphasis on the interconnectedness of Wall Street to the Beltway. On this topic, Bankers is a blitz of finger-wagging at both politicos and CEOs. But its premises, and the sum of its argument, simply don't hold water.
Bad Banking Attitude
MarketMinder's written extensively that today is an era of anger and pessimism. As such, we get books like Bankers operating from the baseline notion that banks are predatory and aggressive, and left to their own devices will suck the blood from anything they can. Moreover, if not regulated properly, banks will effectively, and consistently, commit suicide (via overleveraging or excessive risk-taking). All this acts as great populist rhetoric, but is untrue.
Maybe we can agree many high financiers aren't cuddly teddy bears, some compensation incentives are perverse, and the potential for systematic problems exists without government oversight. But on balance, private banking has provided one of the greatest social functions in all human history—acting as a vital intermediary directing capital to more productive places. (That is, unless we don't want a mechanism allowing us to fund entrepreneurship or buy cars, houses, college educations, and so on.)
By the last chapter, the fangs really come out. To Johnson and Kwak's minds, banks essentially exist to "ensnare" (their word) fees from the unwitting public. This is more a rhetorical trick than reality. Banking costs for the average person have come down a lot over the years—from brokerage trading costs to checking fees. (Of course, that'll change now that new regulation is coming to pass: "…banks are preparing new fees on basic banking services as they try to replace revenue lost to regulatory rules…" Talk about the Law of Unintended Consequences!)
And anyway, when did it become a crime to charge a fee for services rendered? Maybe we should refer to charges for all goods and services as "fees." How can McDonald's take such a fat (pun intended) fee for providing high calorie food? Why, I'll bet they're skimming 3 to 5% right of the top of each transaction! And what about the fees involved in purchasing the authors' book? I would have thought, out of the kindness of their hearts, Messrs. Johnson and Kwak would at least give us the wholesale price. But I digress. The only way this makes a lick of sense is if you believe (as many of the intelligentsia do) that banks ought to be purely bodies serving the public welfare. In which case, profits are illegal.
Many have used this recession as a platform for rebuking capitalism, calling the last ~30 years (ostensibly starting with Reagan/Thatcher) the "Great Moderation" that led to the big panic—an era highlighted by few crises and high economic growth, allowing for deregulation that allowed predatory banks to kill the system. This is ridiculous. First, go back 30 years or more. What about the 70s was so idyllic that we should return to those years? Why is that viewed as an ideal? The 70s were a perfect example of what you get with government "guiding" markets.
Also, the last 30 years have been the most prosperous on human record globally, but also included much turbulence along the way—the Cold War, two Gulf Wars, 9/11, the S&L crisis, a massive tech bubble, most of South America defaulting, the Russian Ruble crisis, the Asian debt contagion, the market crash of 1987, Japan's decades-long malaise…and much, much more. Also, Superman died for about a year in the early ‘90s (which broke my heart). It was a turbulent time. And today is no different; there was no Great Moderation, just a very prosperous time that I'm not convinced has ended and/or can't accelerate from here.
Yet, the "Era of Deregulation" has now been accepted as gospel, as if it were an official thing. I want to see a study—some real, non-anecdotal evidence that we're less regulated today than 30 years ago. Because for every dissolution of Glass-Steagall, there are 10 Sarbanes-Oxleys. This world is vastly more regulated today than bygone days. I think the confusion lies in a mix up between actual regulation (i.e., rules) and an era of privatization. Indeed, the last 30 years have been a global era of privatization—a tremendous thing, not just for stocks, but for society.
We had a bear market/recession with Financials as the hub, which is more damaging than having it, say, start in Technology because Financials are the epicenter of commerce and the engine oil of capitalism. But that doesn't mean this was the end of finance, or that a bad 2008 for stocks means the 30 years of unprecedented economic stability and wealth were nothing but a "leading up" period. We're going to have more bear markets on the way to higher highs and ever more prosperity.
US-Centric, and Concentrated Power
What Johnson and Kwak's perspective reveals is an over-focus on the US. This is the sin of much investment and economic analysis. If this really was a 30-year period leading up to the worst bear and recession since the Depression, with the US as culprit, then how is it that the US is currently a recovery leader for the developed world and that the supposedly safer—and more regulated—Europe is ailing most now? The narrative simply doesn't hold.
How then can the authors argue that more regulation is the key to a safer system? They start with US forefathers Hamilton and Jefferson. Theirs was a heated debate, seen largely in the Federalist Papers. Hamilton was amenable to banking and financial markets generally, while Jefferson was skeptical and supported tighter restraints. Hamilton saw the vast benefits of free flowing capital, and Jefferson feared consolidated economic power, particularly its influence on politicians. Through the latter part of the 18th and early 19th century, the US was an emerging market. Much of its charge toward global economic leadership during the Industrial Revolution can be traced to market liberalization à la Hamilton, many of its 19th century travails to Jefferson's antagonistic view of banking (I'm talking to you, Jacksonian-era politicians).
This is the strongest part of the book and the authors are quite creative in framing the discussion this way. Big banks are the center of today's heated debate, and the US has a long history of (generally) successful trust-busting. Or, at least without hamstringing the economy fully. (Whether the government needed to break up companies in the early 20th century is debatable. The Titans probably would have declined of their own volition. After all, what killed big rail companies wasn't rail competition, it was competition from newer industries like autos and aircraft. What brought Microsoft back to earth? Google and Apple, not antitrust hawks.)
Either way, now isn't the same as then. To see that, resume thinking globally. It's true the big US banks are highly consolidated (even more now than before the crisis—thanks largely to the government!) and enjoy a great deal of influence on the Beltway. But they aren't the only game in town anymore. An average person can do business with banks across the world. HSBC, Barclays, and others are all over. Heck, my firm uses the brokerage services of a handful of foreign banks too. Thinking US-centric makes it seem like Goldman Sachs rules the world and controls all liquidity. But in fact, especially in places like Europe and Asia, the biggest banks have much more government scrutiny and intervention, yet they fared no better in the crisis.
All this context leads to a near total misinterpretation of how and why 2008 happened. Johnson and Kwak view it as the aforementioned 30-year process, whereas the true causes stemmed from government itself—dreadful regulation and guidelines in the form of Sarbanes Oxley and FAS 157, mixed with inconsistent government response to spark the panic. (Again, MarketMinder has featured much commentary on this, so we'll abstain here.)
But it should give us pause when the authors say the government-conducted banking stress tests turned the tide in the panic. (Huh? The tests were done in April/May ‘09—markets had rallied hard for two months by then.) Johnson and Kwak also claim that each time the government intervened with a new program or policy, panic waned a little, until panic finally ceased. The opposite is true—as Bernanke and Paulson haphazardly hopped from bank to bank, panic heated up in late 2008. And TARP didn't stem jitters a wit.
In the end, much of this rolls up into the fantasy of exerting complete control over a complex system like the global economy. It would be so nice to prevent cyclical downturns, but we can't and shouldn't seek to. Government should play a role in establishing property rights, transparency, and enforceable rules of the game. The goal of regulation isn't to prevent crises (those are a part of capitalism), but to increasingly deal with them effectively as they happen. If you preemptively dampen crises, you dampen potential prosperity—which actually makes us all worse off in the long run.
Few see this now, but my view is the end result of the last +30 years was a Golden Age founded on burgeoning financial innovations that moved into the mainstream, sparking some of the most profound wealth creation of all time. Capitalism's engine always gets a bit overheated and must cycle back. And we're getting through it now. But today's world is a better one than decades ago, and tomorrow's will be better than today's.