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You Think The Government Doesn't Want Big Banks? Think Again

Posted: 04/19/10 08:49 AM ET

How much political power do the big banks have? I'd like to air a skeptical note and ask whether they're really running the show.

To most people these days - whether on the left or the right - such a question smacks of insanity or deliberate stupidity. It barely seems worth addressing.

Have we not observed hundreds of billions in bailouts, up to three decades of lax regulation, massive and unjust CEO bonuses, and now the near-immediate return of record bank profitability? Are not many of the Republicans serving up knee-jerk opposition to virtually any kind of meaningful financial reform, perhaps because they receive campaign contributions from banks? On the surface, banks seem to be a nearly invulnerable interest group in American politics.

Yet this last week's SEC civil lawsuit against Goldman Sachs, which caused a thirteen percent decline in the company's stock in one day, should serve a cautionary note. Of all the big banks, Goldman is supposed to be the strongest and most politically connected. It remains to be seen how the charges will proceed, but at the very least it is odd that the Masters of the Universe would have let it come to this at all.

The context for this question is the "public choice" analysis in Simon Johnson's and James Kwak's enlightening new bestseller 13 Bankers. Johnson and Kwak make a major step forward in describing our recent financial crisis as a fundamental problem in political economy, namely by pointing their fingers at an unholy alliance between banks and the U.S. government. Much as I admire their analysis and exposition, I see the problem a bit differently than they do. Whereas they see banks as the puppet master and our government as the fool, I wonder whether it is not more accurate to think of the government as running the show.

Perhaps the strongest piece of evidence for the financial sector dominance of U.S. political economy is the recent bailouts. Yet it's instructive to ask which other groups have received bailouts in the last fifteen years. The list would include Mexico and the numerous countries which have borrowed from the largely U.S.-created International Monetary Fund, such as Indonesia. They are hardly dominant forces of influence in Washington. It was China who made out like a bandit from the bailout of the mortgage agencies, and the validation of their debt issues, but again the Chinese are not in charge.

There's a different way to think about the bailouts, namely that the U.S. government stands at the center of a giant nexus of money raising, most of all to finance the U.S. government budget deficit and keep the whole show up and running. The perception at least is that our country requires the dollar as a reserve currency, requires New York City as a major banking center with major banks, and requires fully credible governmental guarantees behind every Treasury auction and requires liquid financial markets more generally. Furthermore the international trade presence of the United States (supposedly) requires the federal government to strongly ally with major commercial interests, just as our government sides with Hollywood in trade and intellectual property disputes. To abandon banks is to send a broader message that we are in commercial and political decline and disarray, and that is hardly an acceptable way to proceed, at least not according to the standards of the real Washington consensus.

In other words, it's our government deciding to assemble a cooperative ruling coalition - which includes banks -- at the heart of its fiscal core. It's our government deciding who belongs to this coalition and who does not, mostly for reasons of political expediency and also a perception - correct or not -- of what is best for the welfare of American voters. If we don't in this year "get tough" with banking regulation, it's because our government itself doesn't want to, not because of some stubborn recalcitrant Republicans.

Ask yourself the simple question: who has both the guns and the money, including the ability to print new money at zero cost? It's Washington, not the private banks.

If we look back at the broader stretch of American history, banks are by no means a dominant interest group. They arouse massive suspicion in the Jacksonian era, they are left to rot in the 1930s, they are forbid branching rights for many decades, and they end up as a decentralized sector for most of the postwar era. It's not clear why the fundamental equation of power should suddenly have changed so dramatically in recent times and perhaps it hasn't.

This analysis bears on one of the main policy recommendations of Johnson and Kwak, namely to break up the big banks so they cannot soil Washington with such powerful lobbying and privileges. I believe this recommendation will not achieve its stated ends and that Washington would find another way to assemble privileged financial institutions - no matter what their exact form -- within its ruling coalition. Breaking up the large banks would be striking at symptoms rather than at root causes, namely the ongoing growth of political power and the reliance of that power upon an ongoing inflow of capital.

If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take. It would mean that our government no longer needs to worry so much about financing its activities. Of course such an outcome is distant these days, mostly because American voters love both high government spending and relatively low taxes.

I commend Johnson and Kwak for their excellent work, but I also conclude that the problems of banking reform are harder than we usually like to think.

Tyler Cowen is Professor of Economics at George Mason University and he blogs at www.marginalrevolution.com.