Bank Reform We Can All Agree On

Bank Reform We Can All Agree On
Bruce Bialosky
Monday, March 01, 2010

One thing on which there seems to be universal agreement is the need for redesigning our banking laws to adapt to the realities of the 21st century. We have had only minor changes, some of them harmful, since enactment of the Depression-era laws that still govern a large part of our system. Henry Paulson, Secretary of the Treasury under George W. Bush, was working on a modernization plan when the market cratered at the end of Bush’s second term. Now the question is what should we do?

Paul Volcker, former Chairman of the Federal Reserve, has been appointed as the point man for the Obama Administration. The appointment of Mr. Volcker as Chairman of the Fed may be Jimmy Carter’s single greatest accomplishment, even though his most significant work came during the first term of Ronald Reagan. His success at helping to reverse the economic problems that Reagan inherited has established him as a near-legendary figure.

Mr. Volcker expressed his thoughts about what needs to be done in a lengthy article published January 31st in the New York Times. While he proposed many fine ideas to modernize our policies for today’s financial world, even the brilliant Mr. Volcker unfortunately falls way short in defining the underlying problem and how to resolve it.

The first area of concern is the “too big to fail” issue. Part of the problem that Secretary Paulson faced was whether to allow a company to fail, and/or whether that failure would cause an avalanche crushing the rest of the banking system. Mr. Paulson admits he was flying blind as he had no prior experiences to reference. Yet the fact that he and his successor, Timothy Geithner, made enough correct decisions to place us in a stable situation was part luck and lot based on their lifelong careers.

Unfortunately, as part of this realignment they have consolidated the banking industry even more. Four banks, Bank of America, Wells Fargo, Citibank and Chase, were asked to absorb several failing enterprises and did so to salvage the day. They now have well over 50% of the bank deposits in the country and they are truly too big to fail. In addition, they were asked to absorb failing investment firms like Merrill Lynch and Wachovia.

However Democrats are now saying these operations are too big and they should not be taking investment risks. The government has already forced the resignation of Ken Lewis, former CEO of Bank of America, regarding supposed misdeeds related to the acquisition of Merrill Lynch. He stepped in to save a failing Merrill Lynch at the government’s behest and then gets blamed when the losses of Merrill Lynch turned out to be worse than anyone estimated. Now they don’t want Bank of America to benefit from the some of the assets that Merrill brought to the table.

In another recent Times article, Mr. Paulson states that the proposals by the Obama Administration barring banks from trading activity would not have prevented the collapse of Fannie Mae, Freddie Mac, Lehman Brothers, AIG, Washington Mutual, or Wachovia. In other words: thanks for saving the economy in 2008 but now we need a whipping boy, so bankers – you are it. No wonder few people trust politicians.

Mr. Volcker never mentions reform of governmental entities and laws that were central to the crisis that came to a head in 2008 and still lives with us. There is no suggestion of revamping the Community Reinvestment Act that requires banks to make risky investments, and the words Fannie Mae and Freddie Mac are nowhere to be found in his article. It was as if all problems were created by private industry, with none of it created by naïve and dangerous government policies.

A perfect example of the denial of government responsibility centers on Andrew Cuomo, currently Attorney General of New York and gubernatorial hopeful, who has sued Bank of America. While Secretary of Housing and Urban Development from 1997-2001, in an attempt to encourage more home ownership, he directed Fannie Mae and Freddie Mac to increase the percentage of loans they issued to low and moderate income homeowners over a 10-year period. The targeted numbers were 28.1 million loans valued at $2.4 TRILLION.

This caused Fannie and Freddie to increase their purchase of subprime and poorly-documented loans to meet the direction of their overseers. Yet, Mr. Cuomo still doesn’t accept blame for his actions, and even has the gall to sue Bank of America and ask the people of New York to promote him to Governor. Is it any wonder our banking system still has challenges? Is there any surprise that people question the wisdom of their political leaders?

Mr. Volcker may be the best person to shepherd effective banking reform through Congress. He has immense skills and brain power. But he will never succeed unless he admits that government and Congress are the root causes of the problem. Like a 12-step program, government needs to admit they are at the core of the problem before they can seek redemption.