Wednesday, March 27, 2013

The oldest story in our Republic.

March was an big month for the big banks. Little by little, the tragedy of Sandy Hook Elementary School is fading into memory, and the NRA and the gun lobby are proving themselves more than capable of staving off legislative reforms that according to public opinion polls enjoy broad public support. With the withering of gun reforms, the power of political money and the ability of special interests strategists to drive wedges between Red America and Blue America is once again proving out.

And why do the banks care? Because slowly but surely, people are coming around to the understanding that there is no solution to the concentration of risk in our financial system that does not begin with reducing the size and market share of our largest institutions. And only the political muscle of the financial industry lobby--manifest in political contributions and lobbying prowess--can continue to thwart this emerging consensus.

Two weeks ago, the President of the Dallas Federal Reserve Bank, Richard Fisher, spoke his mind as he said that the time has come to dramatically reduce the size and market power of our largest banks:

"Here are the facts," Fisher said. "A dozen megabanks today control almost 70 percent of the assets in the U.S. banking industry. The concentration of assets has been ongoing, but it intensified during the 2008–09 financial crisis, when several failing giants were absorbed by larger, presumably healthier ones. The result is a lopsided financial system. Today, these megabanks—a mere 0.2 percent of banks, deemed candidates to be considered “too big to fail”—are treated differently from the other 99.8% and differently from other businesses. Implicit government policy has made the megabank institutions exempt from the normal processes of bankruptcy and creative destruction. Without fear of failure, these banks and their counterparties can take excessive risks." 

Fisher went on to cite the estimated $50 to $100 billion in annual subsidies reaped by these largest institutions, to the detriment of the 5,570 other banks across our economy upon whom our economy relies for the depository services and lending that is so critical to a healthy private sector and economic growth.

Richard Fisher's speech came on the heels of a report issued a week earlier by Democrat Senator Carl Levin and Republican Senator John McCain on the "London Whale" trading losses at J.P. Morgan. The Levin-McCain Permanent Subcommittee on Investigations report suggested the need "to tighten oversight of banks’ derivative trading activities, including through better valuation techniques, more effective hedging documentation, stronger enforcement of risk limits, more accurate risk models, and improved regulatory oversight." The report, however, documented the practical impossibility of implementing the needed reforms as J.P. Morgan traders had proven their ability to hide losses from internal monitoring for months at a time, to breach bank-imposed risk limits, to manipulate risk evaluation models, and to "dodge or stonewall" regulatory oversight.

The imperviousness of large financial institutions to effective risk regulation is not news, and was argued persuasively by Greenlight Capital President David Einhorn in the months before the 2008 meltdown, yet a half a decade has passed and next to nothing has been done to mitigate trading risk and temper the unchecked derivatives exposure that continues to threaten the commercial banking system.

The conflict between the interests of the banks and the public interest is as old as the Republic. Popular distrust of Wall Street runs deep, and historically has been a conviction held across the political spectrum. In his speech, Fisher highlighted bi-partisan concerns over the issue, citing the McCain-Levin partnership as well as such odd Senate bedfellows as Democrat Sharrod Brown and Republican David Vitter finding common cause in asking the Government Accountability Office to quantify the hidden subsidies to our largest financial institutions.

To date, however, the industry has been effective in deflecting concerns over the growing concentration of financial risk and power. After the initial public anger in the wake of the 2008 collapse, the narratives that have survived the financial crisis are strongly partisan. While there continues to be periodic public clamor over how it is that no one went to jail related to the 2008 financial collapse, public debate about bank system risk has now been effectively subsumed into our larger political wars, essentially derailing any significant discussion of financial restructuring as Richard Fisher suggests.

But even as each side has their own narrative assigning blame for the 2008 collapse, no one can seriously argue two basic facts. First, as Richard Fisher points out, the size of our largest banks means that they are--financially and politically--to big to fail. Should J.P. Morgan or Goldman Sachs teeter on the brink, threatening the collapse of the globally interdependent financial system, the governments of the world will demand action, and the central bankers will take all necessary measures to prevent massive bank failure. Second, no regulatory regime can hope to monitor and control bank risk-taking to the extent recommended by the Levin-McCain Report. The only prudent path to mitigating systemic risk is to reduce the size of our largest banks, as Fisher has argued.

For all the power of the financial industry, parallels with the anti-gun lobby may lack salience, as financial reform is a fundamentally different issue from gun control. While there are real differences in public attitudes about gun ownership and government regulation, there are fewer such differences on matters of bank size and derivatives risks among the general public. Few at any point on the political spectrum believe that there is any inherent public benefit in continuing to increase the market share of our largest banks, and fewer still argue the essentiality of the $639 trillion of financial derivatives to our economic recovery. Rather, critics on the right and the left have consistently argued that the concentration of power in a few large banks constitutes a threat to the vibrancy of our commercial banking system, and the growing profitability of the financial sector over the past decade or more has created a very real brain drain from the productive sectors of the economy to a non-productive sector.

The bulwark against bi-partisan action to address the continuing threat of concentration in the financial sector is money, specifically the $1 billion of annual spending by the financial services industry in lobbying and political contributions. The contributions of the financial industry exceed any other industry, and the names of the largest donors come from that same subset of banks that are working hard to protect the deposit insurance, the unregulated derivatives trading, and the scale that combine to produce implied federal protection that reduces their cost of capital, increases their potential leverage, and enhances their profitability and executive compensation.

Distrust of Wall Street has long been an issue of equal passion on the left and on the right, but one that has been obfuscated successfully by the consensus of senators of both parties whose votes have been bought and paid for. While it is popular to decry analysis that blames both parties for the problems we face, this is an issue on which neither party can claim the moral high ground. The Republican Party has historically been the party of Wall Street, but it was Bill Clinton who did the most damage as he promoted financial deregulation at the end of his term.

While a majority of Senate has been bought and paid for, the left and the right, and specifically the Occupy Movement and the Tea Party, have much in common on this issue. Pundits on the left were too quick to ignore the anti-corporatist strain within the original Tea Party movement, which was in its inception anti-banking and anti-corporate power. Charles Koch's 2011 editorial in the Wall Street Journal said as much, but was quickly dismissed because it had the Koch name on it. But Koch's message--that corporate power over federal spending and regulation is damaging to the public interest--could have equally been delivered by an activist on the left as on the right. But instead of finding common ground, each side weakened themselves by ignoring the potential for uniting around common instrests.

Perhaps the greatest success of the bank lobby has been its success in pitting the right and the left against each other to undermine a broader understanding that the status quo is neither in the public interest nor necessary for an effective financial system. Richard Fisher's speech made an argument that is essentially non-partisan and rational. The problem is that the banking industry strategy has been effectively bi-partisan and politically masterful. They have bought the center, and can watch contentedly as pundits of the left and the right scream at each other on MSNBC and Fox even as the concentration of financial power and risk grows largely unabated.