Sunday, January 24, 2010

Obama's grab for populism

Commentators across much of the political spectrum have lauded President Obama's hardly coincidental announcement that he is going to regulate the US banking sector on a grand scale.

It came less than a day after voters in Massachusetts gave the Democrats, including Obama and indeed government a bloodied nose. This was largely due to the ham-fisted attempts by Obama, but most disturbingly by the indisputably corrupt forces in both the House and the Senate, to reform healthcare. Instead of taking a breath, Obama decided to go on the front foot and wage war against what has been portrayed as public enemy number one by the left - the banking sector.

The message was simple:

- The banking sector caused the recession (untrue);
- The government was forced to bail out the banking sector as a whole because of its own failings (mostly untrue)
- The banking sector is full of people who earned a lot of money doing the wrong things (partly untrue);
- Time to punish them all and stop it happening again.

What he didn't say was:

- The banking sector took risks because of the fiat money of the Federal Reserve effectively encouraging such behaviour;
- The Federal government through Fannie Mae and Freddie Mac funded a boom in housing investment including loaning to those who couldn't sustain the borrowing;
- Hundreds of thousands of Americans borrowed far too much money making foolish investment decisions;
- Bad banks could have been allowed to fail and it is time to have a fundamental review of the entire monetary system.

The crisis came about because loose money, combined with rules requiring a portion of lending to risky borrowers, saw a bubble of lousy investment in property. It was a bubble seen in many countries, and it has only partially burst. Had it fully burst there would have been hundreds of thousands of more mortgagee sales across the US, UK, Europe and elsewhere. It would have hurt those property owners, but it would have opened up enormous opportunities for many others to buy homes and engage in the sector.

No. Obama is completely uninterested in this. He is far more interested in gaining kudos from the popular masses for bashing bankers. He is "doing something" to divert attention from the Massachusetts result, whether it is right simply wont be understood by most in the media (who have little understanding of economics or finance), and 99% of the public.

So is he not justified, will his measures make a difference? Alastair Heath at City AM thinks not:

Was the financial crisis due to the fact that some banks own private equity firms? No.
Would Lehman have been saved by the restriction on size or any other of the proposals? No. Just one firm, Bear Stearns, a pure investment bank which would not therefore be covered by the new rules, was destroyed because of its ownership of a hedge fund which invested in sub-prime mortgages.

Would any of these rules have protected Northern Rock or HBOS? No.

Did the losses racked up by the state-sponsored Fannie Mae and Freddie Mac mortgage giants have anything to do with prop trading or hedge funds? No – and neither did the failure of Wachovia, Washington Mutual, Countrywide or the over 100 US banks and many others around that world that have gone bust.

In truth, banking losses were caused by bad property loans – and the purchase of this sub-prime debt by other banks and funds in the belief that they were safe. Wall Street was crippled because it was so leveraged and didn’t hold enough high quality, truly liquid capital. AIG insured packages of sub-prime debt through credit default swaps but didn’t set capital aside in case things went wrong.

Obama’s pseudo-remedies completely miss the point.

Heath believes banks should have living wills and it should be made abundantly clear to banks and to depositors that governments wont bail them out again. Banks' creditors and debtors would need to learn to pay more attention to what is behind their assets. In other words, a deal needs to be struck whereby the state turns it back.

However, this cannot be while fiat money continues to be manufactured by central banks at interest rates barely above zero. What is happening right now is a new series of asset bubbles because of it, with property picking up again in London, share prices getting an unholy boost because bank deposits offer nothing, and the cycle starting once again.

It is most telling and disturbing that Conservative Shadow Chancellor George Osborne supports Obama's proposals. A man who hasn't a clue about the banking sector seeking to show his solidarity with the "common folk" when to get votes (when in fact he has never had a real job, and lives primarily off of vast inherited wealth). City Am notes that Obama's proposals would hurt RBS, now primarily taxpayer owned, showing Osborne's foolishness in speaking in such a kneejerk manner.

However, what's being cultivated is not solutions to problems that are primarily about how individuals react to incentives, but envy. Bankers are public enemy number one, and the foolishness of some, who were paid very well, is a fertile breeding ground for hatred of the whole sector.

It's a sector that bores most, that is largely not understood, and ignorance breeds suspicion. Be sure that few politicians will point out that both the Obama and the Bush Administrations (and Clinton before) all bear much responsibility for the monetary policy, and the investment regulatory environment that inspired and rewarded irrationality.

Sadly, what all of this shows is how incapable democracy is at handling complicated public policy. Politicians are mostly clueless, the media similarly so, those who do understand are often accused to seeking to protect vested interests, and most media seeks sales based on massaging public anger. Few will dare profile the average people who took out self certified 120% mortgages at the peak of the property boom and ask them why they took such risks, yet they too contributed to it all.

However, Obama dare not ever say that banks shouldn't be forced to lend to people who are a bad risk, nor that the Federal Reserve system be subject to a fundamental review. It's blame banks, whether they received taxpayer largesse or not, were foolish or not.

The main winners from this will be those countries that don't follow in line - I expect Zurich, Geneva, Hong Kong, Singapore and Shanghai will all be looking for opportunities to attract more of the financial sector from the West.

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