"Risk-taking at banks will soon be larger than ever"

A new report has been released by the Roosevelt Institute and has been announced by ABC News:
http://abcnews.go.com/Business/economists-warn-financial-us-economy/story?id=9990828. The chief economist of this institute is the Nobel prize-winning economist Joseph Stiglitz. Also, on the panel that produced the report is Elizabeth Warren of Harvard and head of the congressional group that is overseeing the spending of the TARP funds, Simon Johnson of MIT, Robert Johnson of the United Nations Commission of Experts on Finance and Peter Boone from the Centre for Economic Performance.

A major forecast of the report is that “Risk-taking at banks will soon be larger than ever.”

I am shocked!

Aren’t you?

In my view, risk-taking at commercial banks, big commercial banks, was going strong by the summer of last year. It has grown since.

Why?

Thank you Mr. Bernanke and the Federal Reserve System!

Over the past year or so, we have seen the largest subsidization of the banking system in the history of the world!

No, I don’t mean the bailout money. I mean the money the banks have access to that costs less than 50 basis points!

There is, of course, a reason for the low interest rates. The small- and medium-sized banks in the country are is serious difficulty. See my posts, “The Struggles Continue for Commercial Banks,” http://seekingalpha.com/article/190191-the-struggles-continue-for-commercial-banks, and, “Reading Between the Lines on Bernanke’s Testimony,” http://seekingalpha.com/article/191159-reading-between-the-lines-on-bernanke-s-testimony. The concern here is that if the Fed began to remove reserves from the banking system, the great “undoing”, it would precipitate even more bank failures than are projected now, given the number of banks, 702, that are on the FDIC’s list of problem banks.

The large banks, however, the top twenty-five of which make up almost 60% of the commercial banking assets in the United States, are making out like bandits. And, why not when they can borrow for almost nothing and lend out at spreads of 350 basis points or so…risk free.

And, the dollar-trade continues to prosper internationally.

But, this is not regular bank lending, lending to businesses or consumers. Regular bank lending supports the expansion of the economy and employment of workers. That lending has been declining for months and it appears as if that lending will not pick up for many more months in the future.

The large banks were too big to fail and now the large banks produce huge profits because the Fed believes that the other 40% of the banking system is “too big” to fail.

And, what are these big banks doing?

I’m not sure that there is anyone else that knows the answer to this other than the banks themselves. I have said this over and over again beginning last summer. The big commercial banks are way beyond the regulatory system in terms of what they are doing, perhaps more so now than in normal times.

Regulation is ALWAYS behind the regulated. This is just a law of nature. The issue always is, how far behind the regulated are the regulators?

When I was in the Federal Reserve System, the estimate we used was that the Fed was about six months behind the commercial banks. The banks would try something to avoid regulations and the Fed would then have to find out what the banks were doing. Once the Fed found out they would then have to bring the “regs” up-to-date to close the loop-holes.

Last summer or so, I surmised that the commercial banks, after they had paid back the bailout money, moved ahead rapidly to take advantage of the subsidy they were receiving from the Federal Reserve in terms of exceedingly low interest rates. The subsequent profit explosion at the large banks seemed to justify my suspicions.

By the fall of 2009, I was convinced that these large banks were way ahead of the regulators in terms of what they were doing. For one, the regulators still had a financial crisis on their hands and were diverted from the “new” activity. Second, as is always the case, the politicians decided to fight the last war. Their battle cry: “We have got to stop the commercial banks from doing what they were doing.” Of course, that is why regulation is seldom very effective.

The Roosevelt Institute report calls for more financial reforms: re-regulate. Of course, Joe Stiglitz is one of the leaders in crying for new, more stringent regulation. Elizabeth Warren is there also. But, the picture I have just painted contains with it the conclusion that regulation never really is that effective because it is always behind the curve. However, if the rules and regulations are excessively restrictive then innovation and change may be delayed. (How long did it take to get the Glass-Steagall Act removed?)

In this world, the world of the Information Age, innovation and change is going to take place somewhere because, as I have said before, finance is just about 0s and 1s. (See my post “Financial Regulation is the Information Age,” http://seekingalpha.com/article/184153-financial-regulation-in-the-information-age-part-a.) My feeling is that regulation can delay but it cannot stop the changes the bankers want to make. If regulation delays the ability of commercial banks to innovate and change, the innovation and change will take place elsewhere in the world. And, funds will flow to where the innovation and change is taking place.

If the conclusion of this report is that “Risk-taking at banks will soon be larger than ever,” my question to the authors of this publication is: “Where have you been?”