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The Consensus on Big Banks Shifts, But Not at Treasury

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Attitudes towards big banks are changing around the world and across the political spectrum. In the UK, the new center-right government is looking for ways to break them up:

"We will take steps to reduce systemic risk in the banking system and will establish an independent commission to investigate the complex issue of separating retail and investment banking in a sustainable way; while recognizing that this will take time to get right, the commission will be given an initial time frame of one year to report."

The European Commission, among others, signals that a bank tax is coming; presumably, as suggested by the IMF, this will have higher rates for bigger banks and for banks with less capital. And other European officials are increasingly worried by the lack of capital in German banks, by the recent reckless lending sprees in Ireland and Spain, and by the dangers posed by banks that are much bigger than their home countries (e.g., Switzerland).

Yet top Obama administration officials refuse to change their opinions in the slightest; they have dug in behind the idea that they represent the moderate center on banking policy. This is a weak position; it is simply a myth with no factual basis - the people who pushed effectively for more reform over the past few months were the center, not the left, of the Democratic party.

In the best profile to date of Tim Geithner, by John Heilemann in New York Magazine, even the Treasury Secretary himself expresses frustration with the biggest banks - calling them "the warlords".

"The irony here was rich, of course, since Geithner's stabilization scheme would turn out be strikingly favorable to Wall Street. From the outset, his aim was never to punish the banks. Quite the contrary, it was to save them--by pouring money into them, restoring confidence in them, treating them with kid gloves. Nor was his goal to restructure the financial system. It was to prevent the existing system from collapsing and then strengthen the rules governing its operation. In all this, Geithner was betraying the extent to which he shared Wall Street's mind-set, even if he wasn't a creature of it. "His office was there and he was deeply enmeshed in that culture and he had those relationships," says one of his best friends. "That part of the critique is fair."

David Brooks argued in the New York Times on Friday - writing about a different industry - that this is unavoidable, and perhaps normal:

"Finally, people in the same field begin to think alike, whether they are in oversight roles or not. The oil industry's capture of the Minerals Management Service is actually misleading because the agency was so appalling and corrupt. Cognitive capture is more common and harder to detect."

More specifically, however, it's not that "people in the same field begin to think alike", but rather that "people who are supposed to regulate" begin to see the world through the eyes of the biggest private sector players. Note, for example - and this is important - most hedge fund managers agree big banks are dangerous and will again mismanage risk in a reckless manner.

And cognitive (or cultural) capture, as we argued last year in The Quiet Coup, runs deep in the financial system. Last year David Brooks rejected our argument; it seems the graphic failures of big oil have further shifted the consensus.

Geithner insists that, above all, he represents the reasonable center of responsible opinion,

"I care about us passing [reform legislation] good and strong," he tells me. "And my feeling is that you have to do this from the center."

But this is simply not a left-right issue (look at the blurbs and reviews for 13 Bankers). This is regulatory capture, as laid out by George Stigler from the University of Chicago (a man of the right) - supersized by the increasing gap since 1980 in incomes between the regulated and the regulators (see Figure 2 in this paper, on p.29, by Thomas Ferguson and Robert Johnson).

Mr. Geithner is no closer to a moderate, centrist view on the financial sector than Robert Rubin and Larry Summers were vis-à-vis derivatives (and financial deregulation more broadly) in the 1990s - as documented at length in 13 Bankers.

The constraints on size, leverage, and activity of our largest banks could have been much stronger in the Senate bill (and presumably in the final legislation). Matt Taibbi has a good account of what was (and what could have been) and this is not denied by the administration (speaking to John Heilemann):

'If enacted, Brown-Kaufman would have broken up the six biggest banks in America,' says the senior Treasury official. 'If we'd been for it, it probably would have happened. But we weren't, so it didn't.'

(In case you missed it, Brown-Kaufman was an amendment to the main financial reform bill in the Senate; more detail here.)

The people in charge of our strategy towards big banks are not fools and they are not corrupt; they are also not doing things just because someone on Wall Street calls them up. Our top policymakers are simply convinced that what is good for the biggest and most dangerous element on Wall Street is good for the American economy.

This is cultural capture in its purest and most extreme form. It increasingly stands out as a problem both in the US context and around the world. Unfortunately, the White House and Treasury may be the last to realize this.

Originally posted at the Baseline Scenario