Obama’s Top Errors: Too Big Government, Failure to Spur Lending

Posted January 20, 2010 at 3:59pm

President Barack Obama’s collapsed poll ratings, the unpopularity of Democratic health plans, Republican polling gains and now the GOP’s stunning victory in Massachusetts all send the same message — Democrats have misread the country and pushed for too many of the wrong things.

[IMGCAP(1)]Democratic victories in 2008 did not mean that the electorate had shifted left and wanted European-style social democracy — the governing model (conscious or unconscious) of the liberals who dominate Congress.

Rather, 2008 was a rejection of Republican mismanagement. And it was a call for the economic crisis to be dealt with — not taken advantage of to push through a broad, expensive liberal wish list.

As Job One last year, Obama should have tried to find a bipartisan solution to the recession crisis — incorporating GOP tax cuts — instead of pushing through a pork-laden stimulus package that relied almost entirely on government spending.

And as Job Two, instead of pushing for climate change legislation (Speaker Nancy Pelosi’s top agenda item) or a government-heavy health plan (Obama’s) Democrats should have worked with Republicans to reform the financial services industry whose excesses triggered the crisis.

Here it is, a year into the administration, and while a financial regulatory bill has passed the House, it is nowhere near passage in the Senate and the administration is just now starting to push for it.

In the meantime, big banks are making huge profits — some didn’t last year because they were paying back their government bailouts — and paying out obscene bonuses while failing to lend money to businesses that could create jobs and restore growth.

And they are back to their old tricks, inventing risky, impossible-to-understand financial instruments and lobbying hard and lavishly against Congressional attempts to regulate them.

Instead of demanding that Congress get on with regulatory reform, Obama is trying to tap into populist anger by proposing a tax on banks that University of Maryland economist Peter Morici has correctly labeled “demagoguery— and a mere “paper cut— — a $9 billion charge in 2010 against planned bonuses of $150 billion.

Looking backward, according to David Smick, editor of International Economy magazine, the administration should have refused to allow banks to pay back their Troubled Asset Relief Program loans, which they did to escape executive pay restrictions, and insisted the money be lent to small business.

Looking forward, regulatory reform ought to observe one principle above all: No financial institution should be deemed “too big to fail.— The implicit (or explicit) guarantee of government rescue encourages banks to engage in risky behavior dangerous to the economy.

Since last March, two of the brightest first-term Senators, Mark Warner (D-Va.) and Bob Corker (R-Tenn.), have been holding seminars on financial reform — they had their priorities right — and Corker told me “the most important thing to come out of this is that we must purge from the American vocabulary any use of the idea ‘too big to fail.’—

“Central to any legislation — all Republicans share this, and many Democrats — is that if an entity fails, it fails. And it fails out of business. It’s not conserved. It’s not propped up. It doesn’t live to see another day,— Corker said.

The House’s regulatory bill ostensibly calls for closing down failing banks, but critics contend it contains bailout protection for big banks. The administration, Corker said, wants “foam on the runway— for failing banks.

Big banks are making their huge profits not by lending to businesses, Smick said, but by borrowing money from the Federal Reserve at 0.25 percent interest and investing in Treasury bonds yielding 2.5 percent or corporate bonds yielding 5 percent.

Moreover, according to Harvard economist Oliver Hart and the University of Chicago’s Luigi Zingales, the government’s “too big to fail— guarantee allows big banks to borrow at nearly a 1 percent lower rate than smaller banks — a subsidy amounting to $34 billion a year.

One of the best analyses I’ve read on the causes of the 2008 financial meltdown is by Nicole Gelinas of the conservative Manhattan Institute in the winter issue of the new journal National Affairs.

She argues that, beginning in the 1980s, the regulatory system adopted after the Great Depression began to break down. Bailouts of Continental Illinois National Bank in 1984 and Long-Term Capital Management in 1998 created the “too big to fail— mentality, and investment houses invented securities so complicated as to escape the disclosure required of stocks.

She asserts that “the same regulatory philosophy that protected the post-Depression economy, and created the conditions for the prosperity that followed, would have prevented the post-millenial financial meltdown.—

“And, this approach can work again, if policymakers apply it to the financial system that exists today.—

That should have been at the top of Obama’s 2009 agenda — although Gelinas does not call for a return to Glass-Steagall regulations separating commercial banks from investment banks, repealed in 1999.

Obama only Thursday finally picked up on this proposal, long recommended by former Fed chairman Paul Volcker. It remains to be seen if Congress will buy it because it would involve breaking off parts of big, politically powerful entities such as Goldman Sachs, JPMorgan, Wells Fargo, Bank of America and Citigroup.

It ought to be considered. But at this point, according to Smick, another wise chronicler of the meltdown, the top problem for Obama is that “the people who are the job creators can’t get credit. The brain-dead bankers have no problem, but they’re not lending.—

If they don’t lend, Smick thinks, the economy is weak enough that it could fall into a “double-dip— recession or flat-line like Japan’s in the 1990s.

“Obama’s quarterback— — that would be Treasury Secretary Timothy Geithner and/or Federal Reserve Chairman Ben Bernanke — “needs to keep his eye on the ball; getting the banks to lend, and fast. At this point, nothing else matters,— he said.