The economy has been chugging along at about 2% annual GDP growth ever since the end of the Great Recession in June 2009. Unemployment has been steadily dropping and is now a fairly low 4.4%. Low wage earners are now even beginning to see bigger gains in pay.
Most people would like to speed up economic growth even more. Tax reform will help in this regard but so will sensible deregulation. Barron’s has an excellent article this week about deregulating Wall Street by William D. Cohan.
According to Mr. Cohan:
GDP growth is highly correlated with bank lending.
The Dodd-Frank Act, passed by Congress in 2010, has disproportionately burdened community banks, despite their having no role in the financial crisis.
More than 1700 U.S. banks have disappeared since Dodd-Frank was passed.
Senator John Kennedy (R, LA) has introduced a bill which would exempt community banks and credit unions with assets of less than $10 billion from the Dodd-Frank Act.
As a result of Dodd-Frank, big banks are now required to have more capital and less leverage. Today a bank’s assets would have to fall about 7% before a bank’s capital would be wiped out, as opposed to only 2% in 2008. This makes them safer.
Prior to 1970 the Wall Street partnership structure ensured that bankers had plenty of skin in the game – essentially their full net worth was on the line every day.
Today bankers and traders are rewarded for taking risks with other people’s money. Mr. Cohan recommends that the top 500 traders and executives at every big bank have a significant portion of their net worth on the line.
Conclusion. Mr. Cohan’s program would not only give a big boost to the economy by enabling community banks to lend more freely but would also make our financial system safer by requiring top financiers to have skin in the game.
The major congressional response to the Financial Crisis was the passage of the Dodd-Frank Act in 2010, putting many restrictions on U.S. financial institutions in hopes of ending “too big to fail.” The problem is that the new regulations often apply to the many low risk, traditional, main street banks which did not cause the financial crisis. The new regulations hamper the ability of these smaller banks to lend money to their regular customers, thereby slowing down the economic growth we need for full recovery from the recession. Thomas Hoenig, Vice Chair of the Federal Deposit Insurance Corporation, has recently made some common sense recommendations for alleviating this problem.
He proposes to provide relief for financial institutions which meet the following criteria:
Banks that hold zero trading assets or liabilities.
Banks that hold no derivative positions other than interest rate swaps and foreign exchange derivatives.
Banks whose total value of all derivative exposures is less than $3 billion.
Banks which have a ratio of equity-to-assets of at least 10%. Most community banks meet this criteria and the number is within reach for those which do not.
Of more than 6500 commercial banks, only about 400 do not meet the first three criteria. None of the banks with more than $100 billion in total assets meet these criteria. Banks which qualify could receive relief such as:
Exemptions from Basel capital standards and risk-weighted asset calculations.
Allowing for examiner judgment in eliminating requirements to refer “all possible or apparent fair lending violations to Justice” if judged to be de-minimis or inadvertent.
Exemptions from appraisal and stress test requirements.
Allowing an 18-month examination cycle as opposed to the current 12-month cycle.
Mr. Hoenig’s conclusion: “For the vast majority of commercial banks that stick to traditional banking activities, and conduct their activities in a safe and sound manner with sufficient capital reserves, the regulatory burden would be eased. For the small handful of firms that have elected to expand their activities beyond commercial banking, the additional regulatory burden is theirs to bear.”
“It was a great mistake to push lower-income people into housing they couldn’t afford and couldn’t really handle once they had it. former Congressman Barney Frank, 2010
“Only by understanding the factors that led to and amplified the crisis can we hope to guard against a repetition.” former Federal Reserve Chair, Ben Bernanke, 2010
As I explained in my last post, my views on the financial crisis are most heavily influenced by John Allison, President of the CATO Institute; Sheila Bair, former Chair of the FDIC; and Peter Wallison, a financial policy analyst at the AEI, as follows:
The primary cause of the crisis was the affordable housing policy, created by Congress and administered by HUD, under which higher and higher percentages of mortgages acquired by the GSEs Fannie Mae and Freddie Mac had to be made to low and moderate income borrowers. This policy, aided by the very low interest rates maintained by the FED from 2002-2004, created the housing bubble which burst in 2007 leading to an unprecedented number of delinquencies and defaults.
Subprime lending abuses could have been avoided if the FED had used the authority it had under the Home Ownership Equity Protection Act of 1994 to require appropriate mortgage lending standards. In other words, lax regulation, but not deregulation, was a major contributor to the crisis.
Investment Banks, such as Bear Stearns and Lehman Brothers, magnified the misallocation of credit to the housing market with financial products such as CDOs and derivatives.
Clearly congressional action was needed to address the financial abuses leading up to the crisis. But the Dodd-Frank Act is an overreaction. It requires 398 new regulations which are taking a big toll on the economy as shown by the chart below from the American Action Forum. Dodd-Frank should be scaled back so that its provisions apply only to the very largest financial institutions where the abuses were the greatest. This can be accomplished with capital requirements which increase proportionally with the size of the institution so that smaller banks are better able to compete with the giants.
Faster economic growth is critical for our future. It will not only create more jobs and higher paying jobs but will also alleviate our deficit problem by bringing in more tax revenue. Paring back and streamlining Dodd-Frank would be a big step in the right direction.
“If stupidity got us into this mess, why can’t stupidity get us out?”
Will Rogers, 1879 – 1935
The Financial Crisis of 2008 and the subsequent Great Recession, from which we are still slowly emerging, is the greatest shock to our fiscal and economic health since the Great Depression of the 1930s. There are many explanations available for what happened, the most believable ones being written by the major participants themselves. My favorite reference for these events is the book, “Bull by the Horns,” written by the former Chair of the Federal Deposit Insurance Corporation, Sheila Bair, who held this post from 2006 – 2011. Ms. Bair could see the crisis coming. She interacted with all of the prime players but was too late on the scene, and with too little clout, to have a major effect on the outcome. Another persuasive account is provided by Richard Kovacevich, Chairman Emeritus of Wells Fargo, in a recent speech, “The Financial Crisis: Why the Conventional Wisdom Has It All Wrong.” According to Mr. Kovacevich:
Forcing all large banks to take TARP funds, in October 2008, even if they didn’t want or need the funds, was one of the worst economic decisions in the history of the U.S.
If Bear Stearns had been allowed to go bankrupt in March 2008, Lehman Brothers would have been sold and the subsequent financial crisis greatly reduced. A total of just 20 financial institutions caused the crisis, half investment banks and half savings and loans, yet 6000 commercial banks are being punished by Dodd-Frank.
Dodd-Frank does not address the major causes of the recent crisis and offers few approaches to prevent the next one.
Since regulatory agencies are not capable of using the authority they already have to prevent failures, we need a regulatory system which limits the damage of failures. In case of failure, all creditors, other than insured depositors, should take a “haircut”.
Requiring excessive levels of capital will only cause financial institutions to take on greater risks. If equity and long term debt, at both the bank and bank holding company levels, is required to be maintained at 30% of assets, it is unlikely that the FDIC will ever incur losses.
The quasi-private/public agencies Fannie Mae and Freddie Mac need to be abolished.
The Glass-Steagall Act, passed in 1933 and repealed in 1999, should not be reinstated because investment banking is far less risky than commercial banking, and therefore the two forms of banking need not be separated.
There are three warning signs when a financial institution is approaching the danger zone: concentration of risk, inadequate liquidity and significant exposure to capital markets. Competent regulators, not Dodd-Frank, are needed to address these risks.
Recoveries from past recessions have been much more vigorous than our anemic 2.2% rate of GDP growth for the past five years. Mr. Kovacevich believes that because of the Dodd-Frank legislation, and the current monetary policies of the Federal Reserve, the bottom 25% of Americans on the economic ladder have restricted access to mortgages and personal loans. This is inhibiting economic growth and contributing significantly to the inequality gap.
“Family leave, child care, workplace flexibility, a decent wage – these are not frills – they are basic needs.”
“There is only one developed country in the world that does not offer paid maternity leave. And that is us. And that is not the list you want to be on by your lonesome.”
“We need you to tell Congress, don’t talk about how you support families: actually support families.”
The economic journalist, Robert Samuelson, pointed out in the Washington Post a few days ago, ”The Jobs Mystery”, that even though our unemployment rate has now dropped to 6.3%, there are still 9.8 million officially unemployed people, plus an additional 7 million who would like a job but are not looking. There are also 7.3 million part-time workers who would like longer hours. This gives a really quite shocking total of 24.1 million unemployed or underemployed workers.
Granted we had a bad recession which was not the President’s fault, but it ended in June 2009, a full five years ago. In the meantime his administration has done much to retard economic growth (passing ObamaCare and the Dodd-Frank Act) and little, besides huge deficit spending, to boost it. He and the Democratic Party should be held responsible for this neglect and they probably will be.
One thing which would do a lot to boost economic growth is apparently contrary to liberal ideology and therefore off the discussion table. I am referring to fundamental, broad-based tax reform whereby individual tax rates would be lowered across the board, but in a revenue neutral manner, by closing or greatly shrinking the loopholes and deductions which primarily benefit the wealthy. The two-thirds of Americans who do not itemize their tax deductions would get a big boost in take home pay. Since they are primarily middle and lower income workers whose wages have been stagnant since the recession began, they will tend to spend this extra income, thereby giving the economy a big boost.
If the President were to sincerely ask the House Republican leadership to work with the Democratic Party to boost economic growth, something along this line could be acted upon. This is the way to really aid families. Why doesn’t he do it?