It is Necessary to Accelerate Banking Industry Reform

It is necessary to accelerate banking industry reform.

In the face of the recent economic downturn, American banks have begun resisting efforts to reform banking regulations.

The former system functioned well for bankers (if not for their shareholders), so why would they want to change it? In fact, the measures taken to come to the aid of the banks granted such little opportunity to reflect on the post-crisis financial system that the U.S. once again risks finding itself with a less competitive banking system and with some powerful banks much larger than before.

For a long time, however, these banks were too large to be managed properly. Unlike other sectors of the economy, the state plays an important role in bank restructuring by securing bank deposits.

The authorities know that if they wait too long to act, the “zombie” banks- ones with some bad assets, but still considered viable institutions- will probably bet “on a resurrection.” If they bet big and win, they pocket the earnings; if they lose, the government will settle the debt.

When an ATM machine displays “insufficient funds”, the government’s hope is that it is your personal account that is inadequately stocked, not the bank itself; the government thus intervenes before the bank’s till is empty. In the case of financial restructuring, stockholders in general write this lack of funds off, and then the holders of responsibility become the new stockholders.

The Obama administration, however, has invented a new category: the banks that are too big to be restructured. In other words, the administration thinks that if the familiar rules were applied to them, it would create a disaster. The markets would panic. Therefore, we find ourselves in a situation where the bondholders and stockholders are untouchable -even though they will take risk actions while gambling on help from the government.

I think the Obama’s plan is a mistake. The Obama administration is reacting to political pressure and the red rags waved by the large banks. Its plan confuses bailing out the bankers and the stockholders with bailing out the banks.

A restructuring offers the opportunity for a new start for banks: the new investors will have confidence in the new banks from the start and other banks will be less hesitant to dole out funds to them. The new banks will also be more inclined to loan. The holders of responsibility have everything to gain from a well thought out restructuring, and if the worth of the assets is clearly more elevated when the markets (and analysts) aren’t so worried about them, they will collect the dividends sooner or later.

What is clear, nevertheless, is that the actual and future costs of the Obama administration’s strategy are very high for a strategy that has not achieved the objective at hand, which was to start reviving the credit markets. The taxpayers have had to advance billions of dollars to the banks, and billions more in the form of guarantees-bills that will have to be settled sooner or later.

To change the rules of the market economy- into a form that has essentially allowed those who caused this global economic crisis to profit- is not simply costly. This crisis is profoundly unjust for the majority of Americans, especially after it was revealed that the banks have used billions of taxpayer dollars intended to restart the flow of credit in order to allocate exorbitant bonuses and dividends. Destroying the social contract is a bitter pill to swallow.

This ersatz version of capitalism- where the losses are collectivized and the gains are privatized- is doomed to failure. The incentives are corrupted. There is no longer any discipline in the market. Banks that are too important to go bankrupt know they can risk all impunity. And with the American Federal Reserve having opened the floodgates of credit with interest rates close to zero, there is plenty of money to gamble with.

Some have described this new economic regime as “socialism with American characteristics.” But socialism concerns itself with individuals, while the United States has hardly helped the millions of Americans who have lost their homes. Employees who lose their jobs have the right to 39 weeks of limited unemployment pay.

America has stretched its protection for businesses to an unprecedented level- from commercial banks to investment banks, then to insurance companies and now to the automobile industry- and it is not over. Truthfully, this is not socialism, but the extension of a welfare state for established businesses. The rich and the powerful turn towards the government in times of difficulty, but individuals in need don’t receive any comparable aid from the state.

We must dismantle the banks too big for bankruptcy. There is no reason to believe that these behemoths offer benefits to society in proportion to the damage they cause. And if we don’t dismantle them, we must seriously limit their activity. It must not be possible for these banks to do what they did before: gamble with other people’s money.

This raises another question: these banks that are too important to go bankrupt or to be restructured have become too politically powerful. The pressure they put on the administration has rendered an unfair result, at first in favor of deregulation, and then to make sure the taxpayers foot the bill. Their hope now is that this strategy will let them once again have free hands to do what they want, whatever the cost to the taxpayer and the economy. We don’t want to give them that free hand.