The "Sound and Fury" of Banking Reform

Well, the Senate finally passed a banking reform bill. It is said that President Obama wants to sign the final bill around July 4.

All I can really say about the bill is that it represents a lot of “sound and fury signifying nothing.”

The bill will be costly. The bill will result in a lot of inconvenience.

But, banking and finance will recover and will continue on their merry old way!

The reason that I say this is that finance is just information and with the accelerating pace of information technology in the United States and the world, finance will continue to expand and prosper. The regulators cannot control how information is used or transformed!

History has shown that information spreads and although the pace of its spread can be slowed down, it has never been stopped. Just ask all the religious medievalists in our world today that are fighting a losing battle and are defensively striking out at everyone else.

I have stated some of the reasons for my position in a series of posts beginning January 25, 2010: see “Financial Regulation in the Information Age”; http://seekingalpha.com/article/184153-financial-regulation-in-the-information-age-part-a.

I have also highlighted the place of information in the practice of modern finance in my review of the book “The Quants”: see http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.

Furthermore, attempts to reform and re-regulate the banking system will ultimately do more damage to banks that are not among the 25 largest banks in the country than it will do to those banks that the administration and Congress are really after. And remember, the largest 25 domestically chartered commercial banks in the United States control about two-thirds of the banking assets in the country.

Another factor that I have tried to stress over the past year is that the largest banks have already moved on. The legislation in front of the Congress is aimed at preventing the last financial crisis from occurring again. In my estimation, the largest banks are beyond this feeble effort and are moving into areas we will learn about in the next round of “popular” books explaining what has happened to our financial system.

An example of this was a recent report in the press about how Congress is trying to alter the status of how hedge funds reward their managements so that more of this income is taxable. The response of the industry was to have already hired scores of lawyers to “get around” any legislation about hedge fund fees.

Can you imagine any other kind of response from the financial industry…or, for that matter, any industry?

Reform and re-regulation face a moving target and, consequently, they are aiming their efforts at the past, not the future.

The financial reform package will change the playing field for a limited amount of time. However, in this age of information you can bet that the lag between what “the Feds” do now and how the financial system reacts to these actions will be shorter than ever before.

NOTE: we now have 775 commercial banks on the list of “problem banks” put out by the FDIC, up from 702 banks at the end of 2009. When this latter list was presented, I argued that the FDIC would close between three and four banks a week for the next 12 to 18 months. We have been averaging 3.8 banks closed every week this year through May 14. Using a rough “rule of thumb” my estimate now is that at least four banks will be closed every week through the end of 2011.

I still have grave concerns about the solvency of the 8,000 “smaller banks” in the United States. I define the “smaller banks” as any bank below the top 25 largest banks in the country. These 8,000 “smaller banks” control only one-third of bank assets in the United States. I derive this concern from the actions of the Federal Reserve who continues to subsidize the banking system with extremely low interest rates, and the FDIC. Although the Fed and the FDIC are not “owning up” to this problem, everything they are doing raises questions about how solvent these smaller 8,000 banks really are. I guess the big issue concerns what would happen to the value of bank assets IF interest rates were to rise. Would this result in a “cascade” of “small” bank failures?

Obama's Push for Bank Reform

“President Obama on Thursday will publicly propose giving bank regulators the power to limit the size of the nation’s largest banks and the scope of their risk-taking activities.” This from the New York Times (http://www.nytimes.com/2010/01/21/business/21volcker.html?hp) and from the Wall Street Journal (http://online.wsj.com/article/SB10001424052748704320104575015910344117800.html?mod=WSJ_hps_LEFTWhatsNews).

After the Tuesday victory of Scott Brown in the Massachusetts Senate race, the Obama administration seems to be going “populist” and taking on Wall Street and the bankers seems to be the way to go!

Simon Johnson, a professor at MIT, published this advice on the New Republic website this morning: “Run hard now, against the big banks. If they oppose the administration, this will make their power more blatant--and just strengthen the case for breaking them up. And if the biggest banks stay quiet, so much the better--go for even more sensible reform to constrain reckless risk-taking in the financial sector.” (See http://www.tnr.com/blog/simon-johnson/trap-their-own-design.)

This, I believe, is the wrong direction for the Obama administration to take. First of all, I believe it is incorrect. See for example my post from yesterday, “Blame the Central Bankers” (http://seekingalpha.com/article/183429-blame-the-central-bankers). Also see my post from Wednesday “Bracing for New Banking Regulations” (http://seekingalpha.com/article/183203-bracing-for-new-banking-regulations).

Secondly, there is strong evidence that you cannot win on a “populist” platform. Arguing from the “populist” approach can vote someone out of office, but it doesn’t seem to be able to elect anyone to office.

I still believe that Al Gore had the 2000 election wrapped up until he took on the “populist” mantel during the election campaign. I can still see him overlooking the Mississippi River in Mark Twain’s childhood home town of Hannibal, Missouri. Then I heard him starting to expound on the world as a “populist” politician would. My comment to others at that time: if Gore keeps heading in this direction he has lost the election!

The same advice also comes from one of the most astute political families in America: the Clinton family. In Robert Rubin’s book “In an Uncertain World: Tough Choices from Wall Street to Washington,” Rubin presents a discussion he had with Hillary Clinton. He wanted to take a public approach to an issue that was couched in “populist” language. Rubin states that Hillary responded strongly to his ideas with the comment that one could not win elections relying on a “populist” message. Rubin, consequently, backed off this approach to presenting the matter.
And, he succeeded in getting what he was after, politically.

I believe that the approach the President is taking toward banking reform should be strongly rejected. Not only do I believe that it will not help him to get re-elected, I believe that it would be a disaster for the American financial system!