Trouble Ahead: Can the Right Seize the Banking Reform Issue in 2010?

Trouble Ahead: Can the Right Seize the Banking Reform Issue in 2010?

Eliot Spitzer explains how the White House defense of the status quo will give Republicans powerful ammunition in the 2010 elections.

Few things are as potent in politics as calling for change at a moment of fundamental dissatisfaction with the status quo. Nobody should know this better than the current White House. Gauzy words describing the possibilities for change are always more comforting than defending the current dire straits. That is why — in addition to all the substantive arguments — the current White House plan for banking reform is so troubling.

Let us fast forward a couple of months. Momentary GDP pops notwithstanding, the economy next year is likely to be in pretty sad shape. Consumer spending is sagging; foreclosures are still climbing (and may surge as ARMs re-set); unemployment is likely to be hovering in the 9.5-10.0 range; federal deficits and state deficits will be soaring; and Goldman profits will still be setting new records.

Added to this toxic political brew will be a new, and perhaps counter-intuitive, but highly successful political attack from the RIGHT: break up the banks. Imagine this: by next spring, an intellectual consensus will have emerged that the concentration in the banking sector that developed from the 1980s until the crash of ‘08 was misguided. Voices as disparate as Former Fed Chair Paul Volcker, Bank of England Governor Mervyn King, meta- investor George Soros, and the Wall Street Journal editorial page will be in agreement on this point.

A few brave souls on the Right — recognizing that the Republican Party has been bereft of ideas in its attacks on President Obama — will then try to re-define a populist, conservative attack by asserting that the White House has been captured by Wall Street. Real populism and change, they will argue, will come from the Republican, not the Democratic, party.

The power of such an attack from the Right should not be underestimated. There will be a huge first mover advantage that goes to the candidates who grab the real banner of attacking the structure of Wall Street as having been the root of the crash of ‘08. We Democrats are spending way too much time wringing our hands over the new, “reformed” structure of regulation, and not nearly enough focusing on restructuring the banks. Congress continues to mediate the intramural battle among regulators who are defending turf in the next regulatory flow chart. Yet the real debate should be how to take the big banks and make them smaller: how to peel off proprietary trading and other high-risk endeavors that are now being funded and guaranteed by taxpayers.

In addition, there is too much attention being paid to the one recent idea thrown into the mix by the White House: how to place a tax on big financial institutions after the next crash, so that they shoulder the cost of the next bail out. The notion that a levy on surviving big banks when the next crisis hits can pay for the bail out seems wrong in at least three ways:

First, applying a levy at the moment of crisis will merely accentuate a down turn. At a time when we will presumably need more liquidity and lending to revive a stalling economy, the federal government is going to apply a significant tax to healthy institutions capable of lending? Not likely.

Second, having the healthy institutions cover the losses of the sicker institutions takes us right back into the land of moral hazard. Profligate, risk taking entities will be bailed out by those that exercised caution.

Third, any downdraft significant enough to bring “too big to fail” institutions to the brink of the precipice is likely to be broad based enough so that virtually all the other major institutions are troubled, probably leaving them in a no position to cover the cost of the bailout.

So the simple question remains: why aren’t we focusing on the problem that got us here in the first instance — the scope, range, and size of the mega-institutions whose risk taking has so far inflicted only enormous harm on our economy? If the Republicans pick up this issue before we do, the elections of 2010 could be even worse than we are now fearing.

http://www.nakedcapitalism.com/2009/11/trouble-ahead-can-the-right-seize-the-banking-reform-issue-in-2010.html