We’re now 9 months into the Obama administration and, on a number of fronts, I think our country is more secure. Most of all, Obama has set a new tone in our relations with the world. But I continue to see our greatest source of our insecurity — our economy — as suffering from a failure of governmental leadership.
By now, everyone knows the story that got us into the current economic crisis. Primed by cheap capital and lax regulation, Wall Street took out huge sums of debt and gambled on everything from stocks to subprime mortgages. This bubble economy proved incredibly profitable for Wall Street and its executives took home tens of billions of dollars in bonuses. Then, the bubble burst. But instead of having Wall Street bear the brunt of this cost, a decision was made that its banks were “too big too fail” and so the government bailed them out.
As I wrote back in March of 2008, I’m not necessarily against the original bailout, but it should have been accompanied by a “new contract with Wall Street” where banks were regulated so they could never again be “to big too fail.” My point was that if the government’s thesis was right, that some banks were too big to fail, then we had a terrible set of market incentives. Banks would come to realize that they were immune from bankruptcy because the government would be there to bail them out. This would lead to a dangerous market system where banks got all the profits from gambling and society absorbed all the losses.
I hoped that the Obama administration would clean up this growing moral hazard on Wall Street, but we are unfortunately seeing more of the same. Obama’s central plan has been to make capital incredibly cheap for large banks so that they get credit flowing again. While the credit markets have admittedly improved, this cheap capital has also added to the risk-taking and the bigness of these banks. In other words, we’ve made the moral hazard worse. The recent profits by Goldman show that it has returned to its high-risk business. No one can fault Goldman for taking risk and making money–that’s capitalism. The problem is that they’re taking this risk with the government’s highly subsidized capital and implicit guarantee in the case of failure.
Obama’s economic team appears to believe that what’s good for Goldman, JP Morgan, and Citi is good for America. And recent reports show that our Treasury Secretary is spending much of his time with leaders of these banks. But the problem is that injecting more cheap capital makes these banks bigger and more likely to take catastrophic risks. That’s the formula that created our insecurity in the first place.
Even more importantly, the current approach goes against Obama’s core principles. He sold his candidacy as a way to “fire the whole trickle-down, on-your-own, look-the-other way crowd in Washington who has led us down this disastrous path.” But the current strategy is “trickle-down… look-the-other way” economics. We pump billions of cheap capital into banks and then look the other way as they put it into risky stocks and derivatives trading rather than into small businesses on main street. Stimulus funding that goes directly into main street’s pockets seems like a much smarter investment.
For America to be more secure, Wall Street needs a regulator, not a cheerleader. I still have hope that Obama can be the change that he promised. But it’s going to mean bringing the same determinism to changing Wall Street that he is currently bringing to the health care debate.