Some food for thought from National Review yesterday:

Indelicate Questions . . . [Nicole Gelinas]

President Obama promised today that “never again will the American taxpayer be held hostage by a bank that is ‘too big to fail.’”

To that end, he pledged to work with Congress to prohibit commercial banks, whose smaller depositors benefit from FDIC insurance, from owning, investing, or sponsoring a hedge fund, private equity fund, or proprietary trading operations.

“It is not appropriate” for banks that indirectly benefit from FDIC insurance of their depositors to “turn around and use that cheap money to trade for profit,” the president said.

Obama needs to explain how, exactly, such a prohibition would have prevented or alleviated the financial crisis in any significant way. Consider:

* Bear Stearns did not rely on FDIC-insured deposits. Yet the government had to bail it out in March 2008 (indirectly).

* AIG did not rely on FDIC-insured deposits. Yet the government had to bail it out in September 2008 (directly, and often).

* Lehman Brothers did not rely on FDIC-insured deposits. Yet the government’s failure to bail it out in September 2008 set off a mass-scale panic.

* Non-bank money-market funds (by definition!) do not rely on FDIC-insured deposits. Yet the government had to guarantee them against losses in September 2008 to avert a run.

Obama’s proposal would be brilliant — save for the needling inconvenience that it has nothing to do with reality.

— Nicole Gelinas, contributing editor to the Manhattan Institute’s City Journal, is author of After the Fall: Saving Capitalism from Wall Street — and Washington.

Thanks for sending this on Mrs P. I understand these points, but I’m not sure that they speak to exactly what my problem is. My problem is that commerical banks have been behaving more like investment banks and even like regular corporations. Bank of America and Wells Fargo were destabilized by their exposure to risky investments. Now, they were also able to play a role in stabilzing the finance system by buying other banks (ie Wachovia) or investment firms (ie Merrill Lynch) because they are allowed to behave like investment banks and commerical banks. That is the root cause of my concern. I can’t recall the name of the legislation from the late 1990s that enabled commerical banks to own investment and insurance enterprises, but reviewing how that legislation has work (or not) might be a good thing.

I am also not quibbling with the government bailouts described above. On the balance I think that Paulson (and Geithner and Bernake) did the best they could to avert a major meltdown in the 2008-2009 time period.

Fair points. Some more food for thought. From our mutual buddy, Steve Forbes -some time in the last few days :

”Too Big to Fail” Fails

Playing to populist passions and trying to raise desperately needed cash, the Obama Administration wants to impose a big, new tax on the nation’s largest financial institutions, particularly investment banks such as Goldman Sachs. The levy will supposedly reimburse taxpayers for losses suffered in the financial and auto industry bailouts under the Troubled Assets Relief Program (TARP). But the tax is also an implicit fee on large institutions for being covered under the government’s “too big to fail” policy. That’s why the tax will be based on the size of a financial institution’s assets minus insured deposits and shareholder equity. (Retail deposits are already covered by the Federal Deposit Insurance Corporation.)

Of course, politics intrudes: The auto companies themselves are exempt from this so-called fee, even though their bailouts will cost more than $50 billion. After all, why upset the unions to which the Administration has already awarded these companies? Investment giants Fannie Mae ( FNM - news - people ) and Freddie Mac ( FRE - news - people ), still beloved by big-spending Washington politicians, are also exempt. In fact, on Christmas Eve the Treasury Department quietly removed the ceiling on how much money these twins can get from the government.

Putting aside the fact that it’s foolish to impose any tax on the financial system when the economy remains shaky, and that the levy will fall heaviest on those institutions (most of which didn’t want the money in the first place) that have paid back their TARP injections with interest, this proposal also ignores the difficult question of whether we should even have a “too big to fail” policy. Such a principle is a formula for future disaster if the financial system is explicitly divided between a handful of behemoths, which will not be allowed to go broke, and everyone else. Innovation often comes from small firms, but they will be at a decided disadvantage in such a suffocating environment.

Government backstops are an invitation to recklessness and overleveraging, which is why the Administration wants to impose a new array of regulations and to have a big say in Wall Street pay packages. Washington is firmly convinced that it was compensation formulas–the desire to make big bucks quickly, regardless of the consequences–that brought us to the current sorry pass.

Of course, a gold-based monetary policy; an end to government-sponsored enterprises (Fannie and Freddie should be recapitalized, broken up and privatized); no more government interference in such areas as the housing market (the Federal Housing Administration is still guaranteeing mortgages with down payments of only 3.5%); and no more mark-to-market accounting rules applied to financial institutions’ regulatory capital would, together, prevent future financial panics such as the one we recently experienced. But we must also credibly repudiate the whole notion of “too big to fail.” A number of ideas are floating around on how this might be done, particularly regarding special bankruptcy provisions for large financial entities. A commission should be tasked with studying this issue and coming up with recommendations, which shouldn’t be too difficult. The Lehman Brothers ( LEHMQ - news - people ) failure would probably not have sparked a panic had it not been for mark-to-market accounting rules, which led to devastating bear raids on banks and life insurers. The fears over AIG ( AIG - news - people )’s counterparties to its credit default swaps are now increasingly looking to have been needlessly overblown.

The January report by the Independent Congressional Oversight Panel of TARP made it clear why we must rid ourselves of “too big to fail”: “Belief remains widespread in the marketplace that, if the economy once again approaches the brink of collapse, the federal government will inevitably rush in to rescue financial institutions deemed too big to fail. This belief distorts prices, giving large financial institutions an advantage in raising capital.… These implicit guarantees also encourage major financial institutions to take unreasonable risks.”

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from realclearmarkets - I think this references the bill from the 1990’s you are thinking of:

Shifting The Blame

Posted 01/21/2010 07:30 PM ET

Regulations: Apparently believing the best defense is a good offense, the president wasted no time after his jarring loss on medical overhaul in upping the ante on another of his signature issues — financial change.

Just as Speaker Nancy Pelosi confessed Thursday she lacked the votes to quickly move the Senate’s sweeping health care bill through the House — foreclosing one way to keep hope alive on socialized medicine — President Obama approached the lectern at the Executive Office Building to drop a bombshell of his own. Training his sights back on Wall Street, he called for tougher regulations that would limit the size of banks and their ability to engage in propriety trading.

The president last year proposed a series of measures to tighten the reins on financial institutions, and the House passed a bill last month. His announcement Thursday broadens those measures, particularly by endorsing a proposal by ex-Fed Chairman Paul Volcker to restrict proprietary trading by commercial banks.

Such a limit would separate commercial banks from investment banks, a line that was blurred a decade ago by the repeal of the 1930s Depression-era Glass-Steagall Act. Without such regulations, Obama said, the financial system will continue to operate under the same rules that led to its near collapse.

But Wall Street didn’t cause the collapse — government did . And this call for tougher rules is yet another attempt to escape blame. All Glass-Steagall did was let bank holding companies buy into investment banks. What undermined the financial system was a fanatical application of rules aimed at getting banks to lend as much money as possible to facilitate homeownership among minorities.

It was the government, not Wall Street, that created the subprime market by compelling banks to make bad loans and urging Fannie Mae and Freddie Mac to cash out the banks by putting more and more of the toxic mortgages on their balance sheets.

The administration apparently hasn’t given a thought to limiting, let alone blocking the proposed expansion of, the Community Reinvestment Act that started it all. Or to reining in Fannie Mae and Freddie Mac, the government-created monsters that aided and abetted the meltdown.

No, the Obama administration is back on its quest to take control of as much of the private economy as it can. Polls must be telling the White House that kicking “Wall Street” still plays well in Peoria, even if the nationalization of health care does not. (It sure didn’t play on Wall Street, with the Dow off 335 in two days.)

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As for Geithner, have you heard about his concerns -from The Corner:

Geithner’s Advance Cover [Yuval Levin]

You know an administration is in trouble when prominent officials let it be known to the press that they disagreed with one of the president’s major decisions. It happens to every president, and it’s always a very bad sign. Usually it comes after some policy goes terribly awry, and sends senior advisors running for cover. But sometimes, in the very worst cases, it happens as soon as a decision is made, before the policy in question has even had a chance to be tested—and it reveals more than dissent about one particular decision, but a broader sense that things are not well at the top.

That is why this Reuters story from yesterday was so striking. It describes Treasury Secretary Tim Geithner’s opposition to the bank limits President Obama announced. It seems that on the very day of the announcement, Geithner decided he needed to dispatch people close to him to make it known (anonymously) that he did not agree with the decision, and indeed that he agreed with the two key arguments offered by its staunchest critics. Here’s Reuters:

Geithner is concerned that the proposed limits on big banks’ trading and size could impact U.S. firms’ global competitiveness, the sources said, speaking anonymously because Geithner has not spoken publicly about his reservations.

He also has concerns that the limits do not necessarily get at the root of the problems and excesses that fueled the recent financial meltdown, the sources said.

After the story first appeared, the White House dispatched someone to offer comment to Reuters, so the second version (which is the one now posted at that link) includes an update with those quotes. But clearly they could not get Geithner himself to tell Reuters that their story was wrong about his views. Geithner was out selling the decision here and there yesterday, to be sure, but very tepidly (as in this NewsHour interview, where he looks like a man making the case for his own beheading).

It all suggests serious dissension in the senior ranks—not what the White House would want as they “pivot” to the economy. Just a great week all around for these guys.

01/22 10:50 AM

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Now to toss a total curve ball, did you catch Conrad Black’s - yes I know he’s a convicted felon in Club Fed - column Christmas week? This was a remarkable little tidbit :

Conrad Black from What a dismal Decade:

The flip-side of this controversy is the emerging U.S. economic miracle, which at this point officially promises increased taxes, faster economic growth, 50% to 100% annual increases in money supply without inflation, for a decade of trillion dollar annual federal budget deficits without seriously raising interest rates, or devaluing the dollar. All 18 wheels will come off this impossible contraption, in all directions of the compass. And all numerate people, including, presumably, the unfathomable Timothy Geithner and the fabulist President whom he serves, know it.

I predict that in a decent interval after his confirmation as Federal Reserve chairman next month or February, Ben Bernanke will announce that the central bank will no longer buy the treasury notes that finance this orgy. The United States cannot drink itself sober. China has now passed on the pleasure of continuing to buy low yield instruments of a country that is doing the necessary to convert its currency into wall paper, if not toilet paper. The Federal Reserve is buying the treasury issues that finance the federal government’s deficit-straight additions to the money supply — the most familiar form of currency debasement and rampaging inflation, from the times of Caligula to Juan Peron and Robert Mugabe.

Obama and Geithner will scream like wounded banshees that Bernanke has betrayed them on how to deal with what they will portray as George W.’s messy leavings, while Bernanke devalues the dollar by about 15%, raises interest rates to about 6% and requires federal government spending cuts of about $500-billion annually, largely from a revisitation of entitlements and some sales and transaction taxes that the Congress will have to agree to in conference as an emergency compromise between the parties. The health care charade of buying individual senators with from $100-million (Christopher Dodd,), to $3-billion (Bill Nelson of Florida — not Ben Nelson of Nebraska who folded at $100 million) can’t slice this Gordian Knot. There will be fewer lawyers and investment bankers in the U.S., and more savers and investors, and if the politicians don’t ruin it again, market forces will shape up the U.S. to meet the Chinese challenge. But both job creation and economic growth will be slow in a transitional period.

Read more: http://network.nationalpost.com/np/blogs/fullcomment/archive/2009/12/26/conrad-black-what-a-dismal-decade.aspx#ixzz0dMq1PblP

Here’s some more food for thought from The corner:

More Like a Bogus Journey [Stephen Spruiell]

Jim, I have to disagree with some of what you say in your post. While I agree that it might be a good idea to put new restrictions on the investment banks now that they’ve converted themselves into bank holding companies for the purposes of accessing cheap money from the Fed, I disagree when you list as a major cause of the current crisis commercial banks gambling with insured deposits. Bear Stearns, Fannie, Freddie, Lehman, AIG — none of these firms got in trouble making large bets with insured deposits. They got in trouble making large bets with too much borrowed money and too little capital to back them up.

Of all the approaches to financial regulatory reform that are floating around — bans on exotic derivatives, limits on firm size, stricter capital requirements, smarter compensation structures, the creation of a “resolution authority” for systemically large firms — the “return to Glass-Steagall” approach makes the least sense to me, because the repeal of Glass-Steagall didn’t blow up the financial system, and may have helped contain the fallout. As other commentators have noted, Bank of America would not have been able to acquire Merrill Lynch under the old rules.

Even more irksome is the administration’s continued refusal to acknowledge the role policymakers played in inflating the housing bubble. In the president’s speech today, he placed the blame squarely on the “banks and financial institutions” which “took huge, reckless risks in pursuit of quick profits and massive bonuses.” He even had the gall to praise the leadership of Barney “Roll the Dice” Frank and Chris “Friend of Angelo” Dodd in crafting the new reforms.

By the way, I’d like to take a moment, in the midst of all this bonus talk, to note that the current CEOs of Fannie Mae and Freddie Mac are expected to take home around $6 million apiece for 2009 in all-cash, no-stock compensation packages. These firms will not pay the “Financial Crisis Responsibility Fee,” despite the large role they played in the crisis. And the administration, while calling for new limits on bank debt, is simultaneously dismantling limits on GSE debt, lifting the caps on their government credit lines and slowing the mandatory unwinding of their portfolios.

Like you, I would feel more comfortable taking a position on the administration’s bank-reform plan after seeing more details. But what I’ve seen so far is not very excellent at all.

01/21 05:47 PM

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This is fascinating as it touching closely to some of the points Conrad made:

Exploding Debt Threatens Economic Recovery [Sam Brownback]

The latest U.S. national-debt figures are truly mind-boggling: According to the Treasury Department, for the twelve-month period ending Dec. 31, 2009, the federal government ran a deficit of $1.472 trillion, which is 116 percent greater than the deficit for the twelve-month period that ended December 31, 2008.

Since the first “stimulus” bill passed a year ago, some of us in Congress have been arguing that massive new federal spending as a strategy to spur economic recovery is sheer lunacy — the fiscal equivalent of trying to put out a fire in your house by dousing it with gasoline. Now a new study by economists Carmen Reinhart and Kenneth Rogoff provides confirmation of our worst fears about the economic policies of this administration: The explosion in government debt puts at grave risk any potential economic growth in the U.S. for years to come.

According to “Growth in a Time of Debt,” which was recently presented at the American Economic Association, “the sharp run up in public sector debt will likely prove one of the most enduring legacies of the 2007–2009 financial crisis in the United States and elsewhere.” The wide-ranging study looked at the debt levels of 44 countries and included data from the last 200 years in order to get a comprehensive picture of the effect of debt on economic growth. The conclusion was clear: Very high government debt — classified as 90 percent or more of gross domestic product (GDP) — resulted in average growth rates a full 4 percent below those of countries with lower debt levels. Since annual growth in U.S. GDP has averaged considerably less than 4 percent over the past ten years, carrying a high national debt could mean the difference between a growing economy and a contracting economy.

After the recent binge of federal spending, our nation’s gross debt is scheduled to surpass 90 percent of GDP this year, and to approach 100 percent of GDP by the end of the decade. And this does not even include Democratic plans to establish a massive new health-care entitlement and impose costly new energy mandates on business. If all of these agenda items are accomplished, it is a safe bet that the national debt will surpass 100 percent of GDP within the next decade.

Is this really the path we want to set for ourselves as a nation? As it stands, we are dangerously dependent on China for the financing of our debt. If the Chinese government determines that America is no longer the sound investment that it once was, it will cease to provide this service that we have come to rely on so heavily. Who, then, will support our enormous deficit spending year after year?

The foolish notion of spending our way to prosperity is the polar opposite of the tradition of hard work, thrift, saving, and living within our means that made the United States an economic powerhouse and an example to the rest of the world. Our current economic crisis is hardly the time to enact huge new entitlements and “stimulate” the economy with colossal new federal spending. In fact, the results of the past year have shown just how ineffective such an approach has been, with unemployment above 10 percent and little indication that the massive stimulus bill has affected job creation in the least.

What would stimulate the economy, as the study quoted above clearly indicates, is getting our fiscal house in order. One idea that I have long championed is a Commission on Accountability and Review of Federal Agencies. This proposal looks exclusively at controlling federal spending and debt by providing a path to realign or eliminate federal programs that are wasteful, inefficient, duplicated, failed, and outdated. It is a process that has worked before and can work again.

In the meantime, let us not be deceived by those who tell us that we can dig our way out of this fiscal hole by piling on more debt. The only thing that approach will stimulate is the inexorable growth of government.

— Sam Brownback is a U.S. senator from Kansas and the ranking Republican on the Joint Economic Committee.

“Ach! Zese verdamt ‘bankers,’ vill ve neffer be free uff zem?!”
-Oberfuhrer Baracken Von Obamastein

“… repeal some of the legislation that allowed commerical banks and investment banks to merge and own other types of companies (like brokerages and insurance companies). ”

Seriously, how hard would it be for them to UN-repeal the Glass-Steagall Act? Instead, what I (and apparently Judah Kraushaar) expect we’ll be getting is “Protracted congressional hearings on the bank crisis, piecemeal new regulations, sporadic attacks on bank compensation, and an ad hoc approach to taxing banks…”
Short version: if THIS administration manages to fix this problem, it’ll be an accidental side-effect of their shabby populist demogoguing and scapegoating.

“I can’t recall the name of the legislation from the late 1990s that enabled commerical banks to own investment and insurance enterprises, but reviewing how that legislation has work (or not) might be a good thing.”

The Gramm-Leach-Bliley Financial Services Modernization Act of 1999.
I wrote a case study about it, actually, but I won’t be trying to shoehorn it into this comments thread, despite my frustration at failing to find a publisher for it.
Very short version:
It acted in conjunction with the Community Redevelopment Act of 1977 to create a giant, fatal bubble in the housing market.
See? Short.

Maximum Leader:

I’m all in favor of increasing capital requirements, but the devil is all in the details. This FDIC worksheet is representative of how these things are calculated. It’s esoteric but the various weights for each of these things are huge. For example, last time I really looked into this stuff, OECD debt was considered extremely safe, but given recent deficits it might not be, and everything non-OECD debt is considered not safe. That’s not terrible helpful.

More capital? Yes, but what type is just as important.

Huck Foley:

I’m still waiting for a reasonable explanation why GLB, ie the repeal of Glass-Steagall, caused the problems.

As I see it, GLB allowed BoA to buy Merrill during the crisis, which ameliorated the conditions, not exacerbated them. Lehman and Bear were pure investment banks and the stuff still hit the fan.

The financial system changed since 1933 and the Chinese wall between investment and commercial banks was not only outdated, but unwise. To clarify: I’m all for keeping risky stuff quarantined, but I don’t think either keeping Glass-Steagall or re-instating is the ideal or even an effective way to do so in today’s financial system.

GLB’99 wasn’t the cause, and if I indicated that it was, then I drastically overstated or oversimplified the situation. The long slow fuse on that bomb was lit with CRA’77 (*). The problem had a passive aspect and an active aspect, and CRA was the active part.
(* Ha! And I got THAT wrong too! It’s the Community “Reinvestment” Act, not the “Redevelopment” Act. Has somebody been sneaking decaf into my coffee supply or what?)
Anyway, yes, GLB allowed for some helpful short-term corrective action, AFTER the crisis was in progress, but that’s not much of an argument in favor of enabling the destabilization which made that action necessary. My beef is that the long-term destabilizing of the system was enabled by GLB’s negation of Glass-Steagall.

F&L in G: “Lehman and Bear were pure investment banks and the stuff still hit the fan.”

The competitive environment was changed. Individual actors IN the environment adapted accordingly; some mutated and some stayed the same. The fact that Lehman and Bear were able to continue to exist in the new environment (at least until it blew up) doesn’t negate the fact that the rules of competition had been changed.
Their continued existence doesn’t argue against that, any more than the continued existence of crocodiles and snakes argues against the end of the Cretaceous era.
Oh man, what a tortured analogy, eh? But do I really need to unpack it?
You’re pointing at Lehman and Bear as evidence of the okay-ness of GLB, but there’s nothing about their mere existence that shows me that their environment hadn’t been destabilized.

My point is this:
Glass-Steagall kept commerical and investment banks separate.
Bear and Lehman were investment banks.
When they went the whole system was about to come crashing down.
First, the other investment banks and pseudo-ones like AIG. Inevitably, the commercial banks would follow.

So, to summarize: Even in the counter-factual world where Glass-Steagall were in effect the crisis still would’ve happened. Two pure, allowed under Glass-St. investment banks are what collapsed.

Yet, repealing it allowed commercial banks to pickup some of the pieces.

Also, I think you place too much blame on the CRA. It’s a dumb law, but I find the evidence that it was primarily at fault weak.