Weekly Standard: Time To Get Tough With The Banks

Jul 18, 2012

Irwin M. Stelzer is a contributing editor to The Weekly Standard, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).

Where's the outrage? No, not at President Obama's performance, foreign and domestic, or his airbrushing the past three years of his failed economic policies out of the history books. That particular outrage Mitt Romney is taking good care to express as part of his strategy of concentrating on Obama's failures rather than risk proposing policies to return morning to America. But where is the Republican candidate's outrage at some of those who might be considered his own friends and allies?

Just because Obama attacks "fat cat" bankers in one of his egalitarian rants doesn't mean that Romney should refuse to excoriate those bailed-out, over-bonused executives when their behavior warrants it. Ever since the days of Adam Smith, believers in the virtues of free markets have known that "people of the same trade seldom meet together . . . but the conversation ends in a conspiracy against the public." It's bad enough when these conspiracies aim to fix prices on, say, construction projects. But when the conspirators are bankers who label themselves "dudes" and "big boys," and promise each other bottles of Bollinger for manipulating prices, and when the price they fix is the interest rate that the Wall Street Journal estimates governs $800 trillion of loans and derivatives worldwide, including almost one million U.S. home loans indexed to LIBOR carrying an unpaid principal balance of $275 billion, we have an assault on the heart of capitalism, not to mention a potential bonanza for class-action lawyers. The CEO of one multinational bank told the Economist, "This is the banking industry's tobacco moment," referring to that industry's $200 billion claims payout.

That's what the bankers' fixing of the so-called LIBOR (London InterBank Offered Rate) is all about. Don't worry about the details. Know only that the bankers manipulated the global rate to turn a market into what the Bank of England calls a "cesspit" in order to enhance their profits; that Barclays has agreed to settle for a fine of $450 million and demanded the resignation of its American-born president, Bob Diamond; and that the British authorities are all over other banks like a tent.

And where is Mitt Romney, with a golden opportunity to show that he is outraged at this latest effort of the banking community to appropriate to itself a still larger share of the national income, to show that he believes in a market manipulated neither by government bureaucrats nor by private bankers? It's not banker-bashing to criticize bankers when they deserve it. And it's not bad politics when that criticism lets Main Street know that Wall Street does not own this candidate. The Manhattan Institute's Nicole Gelinas said it best: "When a bank egregiously breaks the law, it should run the risk of a criminal conviction." Why not a simple comment from the candidate that bankers' "monkeying with the LIBOR this way for their own financial benefit is outrageous"? Alas, that statement came not from Romney but from Barney Frank, who predictably sees congressional hearings and more regulations as the solution.

Then there is the not-so-small matter of the structure of the financial sector. Romney must know better than anyone that the folks running our big banks, including Obama's favorite banker Jamie Dimon, are hardly paragons of risk assessment. After all, Bain Capital, where Romney made his fortune, existed in part because -worthy businesses often could not borrow on attractive terms from traditional banks. He must know two other things about these banks: They are too big to fail, and too complicated to regulate. So where is he when economists say that the better alternative is not more of the failed policies of the Obama years — regulating the unregulatable, bailing out when all else fails — but breaking up the big banks? Not for vulgar populist reasons, but to improve the functioning of the capital markets. If so inclined, he could toss in a fairness argument to top off the economic efficiency point.

But that might be too much to ask of the candidate of a party that sees the need to bail out banks but is squeamish about supporting measures to keep delinquent mortgagees in their homes. Pity. After all, it took both improvident borrowers and imprudent lenders to build up this stock of dicey paper, so why not share the burden of digging out of the problem more evenly? I know — moral hazard, the fear that failing to punish bad behavior by borrowers will produce imitations of that behavior. A legitimate consideration, but not one that tops all others, including the social cost of evictions, borne not only by the evicted family, but by every family on the block, doomed to see the value of their homes fall as the vacant adjacent house deteriorates under the incompetent maintenance of the foreclosing bank

Besides, the moral hazard argument applies not only to borrowers, but to bankers, many of whom remain in place and well compensated after seriously damaging their institutions and the larger economy, while -others have had soft landings thanks to golden parachutes. The absence of consequences for reckless lenders as severe as those imposed on delinquent borrowers is surely the stuff of which moral hazard is made.

Then there is the matter of consumer protection. Democrats seem to have a monopoly on wanting to save consumers from the big businesses with which they often partner. Why does Romney not agree with the Consumer Financial Protection Bureau (CFPB) that mortgages should be made more understandable to the borrower? After all, good conservatives should favor programs to eliminate "information asymmetry" — a situation in which one party, in this case the lender, knows a lot more about the costs and risks inherent in a transaction than does the other party. He could at the same time take a swipe at the administration's preference for regulation, in this case the CFPB's 1,099-page proposed regulation to mandate a three-page mortgage-disclosure.

Instead of such complicated regulations, a gift to the class-action lawyers who contribute so generously to Democratic campaigns, Romney can propose a simple rule requiring lenders to keep skin in the game so that they have an incentive to lend only to borrowers with a reasonable prospect of repaying their loans. And elimination of the multiple barriers to entry in the real estate, mortgage brokering, and related businesses. Incentives and competition trump regulation in serving the national interest every time.

And a good conservative, which Romney claims to be, certainly should feel comfortable railing against charges and fees that are obscured to the point of invisibility and enacted retro-actively. That's not how well-functioning competitive markets work. Instead of more regulation, Romney can propose eliminating barriers that make it difficult for large retailers to enter the credit card and other banking businesses. The fact that Elizabeth Warren, the creator of the CFPB, is on the warpath against bankers is enough, of course, to make one want to oppose all the bureau's doings. But that is an urge that can be overcome in the interests of championing borrowers in an imperfect market.

Finally, where is Romney every time the Fed cranks up the printing presses, or depresses interest rates first by one means and then another? Surely he knows that the hyperactivity of the Fed is due to the failure of the Obama fiscal policies, threatens future inflation, and cheats savers in order to benefit borrowers. Millions of retired folks are watching their pensions and modest savings shrink in the face of the Fed's low interest rate policy, one that has failed to persuade America's corporations to use their $1.7 trillion cash pile to build factories and hire workers, as Carnegie Mellon University professor Allan Meltzer so clearly pointed out in the Wall Street Journal last week.

There's more, but you get the idea. There is solid conservative ground on which Mitt Romney can stand that would enable him to promise to lance the festering sore that has come to be called crony capitalism — deals between big business and big government to shield big business from competition and help big government get even bigger, all the while distorting capital markets. Indeed, there are instances when good conservative economics just happens — well, not just happens, but inevitably proves — to coincide with politically popular causes.

As University of Chicago professor Luigi Zingales puts it, "Democrats have promoted crony capitalism to foster their liberal agenda. They are pro-business — at least certain businesses — but fundamentally anti-market. This is exactly the opposite of what most Americans want. . . . A pro-market, but not pro-big-business, platform would be a winner for Republicans."

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