The Obama Bank Plan

Well, calling the administration's financial reform proposal a "plan" is something of an exaggeration. According to the White House's own release, the administration simply wants to "strengthen the comprehensive financial reform package that is already moving through Congress," though there are real differences between Barney Frank's House bill and Chris Dodd's Senate bill.

How will the Obama plan "strengthen" the "comprehensive financial reform package"? By barring a "bank or financial institution that contains a bank" to "own, invest in or sponsor a hedge fund or a private equity fund, or [engage in] proprietary trading operations unrelated to serving customers for its own profit." And by placing "broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits." That's it. Seems reasonable.

Jim Manzi, for one, likes the president's suggestions:

If you want to have a safe, secure banking system for small depositors, but don’t want to make risky investing illegal (which would be very damaging to the economy), the obvious solution is to not allow any one company to both take guaranteed deposits and also make speculative investments. This was the solution developed and implemented in the New Deal. We need a modernized version of this basic construct, and as far as I can see, this is what President Obama has proposed.

But The Economist's Buttonwood columnist thinks otherwise:

The question is not, as some of the commenters on my last post seem to think, whether banks should be regulated better; the question is whether these reforms tackle the right issues, or even come close.

The banking crisis was caused, as banking crises are almost always caused, by banks lending too much money against dodgy collateral, usually property. So the way to tackle that is to restrict their leverage, insist on lower loan-to-value ratios, or intervene (via monetary policy) to try to curb credit growth.

There is not much evidence that banks were brought low by proprietary trading, nor indeed by their links with hedge funds or private equity. There was a problem with the "shadow banking system" but this was in the form of off-balance sheet vehicles like conduits.

For Buttonwood, the president's sudden focus on bank-bashing smacks of politics: "This is not a serious proposal but a way of regrabbing the political initiative by forcing the Republicans to defend the unpopular banks." Sounds right to me!

On the other hand, it would be politically treacherous for Republicans to oppose outright serious reforms that tackle the problem of over-leveraged financial institutions with Too-Big-To-Fail guarantees. The independent voters who are flocking to the GOP may not like the Democrats all that much, but they do not like the big banks, either. I know I don't. That's why the administration's bank tax could turn into a political trap for GOP candidates this fall--especially when a free-market economist like Greg Mankiw says there may be a case for such a tax.

Now would be a good moment for Republicans to announce a serious proposal to remove implicit and explicit subsidies to financial institutions and kill Too Big To Fail for good, wouldn't it?