Not long ago, in September 2008, a lot of people thought the world was coming to an end. The economic crisis had brought global financial markets to a standstill, dried up lending, curbed international trade, accelerated the recession that began in December 2007, and produced the worst unemployment in decades. Democratic capitalism, the engine of the greatest increase in wealth and well-being in human history, had hit the shoals. There was a rush for the exits. It was every desk trader for himself.
How soon we forget. Today the economy is growing again. The latest job numbers are positive. Consumer spending is up. The president and Congress are preparing for the fall campaigns. The emergency is over.
But the financial system is not fundamentally better off than it was before. No CEO or regulator or politician has been held accountable. No rules have been changed, no regulations imposed to address the perverse misalignment of incentives that led big banks to gamble money they did not have and leave the American taxpayer to pick up the tab.
Sometime soon, the Senate will debate the Banking Committee’s attempt to patch up the holes in the system. The proposed legislation is complex and unwieldy. It delegates too much decisionmaking to unelected bureaucrats. It does nothing to break apart the giant banks whose concentration of economic and political power is unfair and dangerous. It aggrandizes the Federal Reserve. And it could have the unintended consequence of perpetuating the same Too Big To Fail mentality that everyone but bankers wants to outgrow.
But these weaknesses do not mean that financial reform is unnecessary. To the contrary: In order for financial markets to behave properly and connect creditors with debtors efficiently, market participants need to be confident that government will enforce clear and simple rules in an equitable manner. Such confidence is missing. And while the banks may have repaid much of the money Americans spent to bail them out, the moral debt the bankers, regulators, and politicians owe to the people has not been repaid. No wonder we keep hearing it’s angry out in the country. How does America profit when an ordinary citizen who plays by the rules looks up to see the powerful advancing their own interests without considering his?
The economic case for reform is plain. When the investment banks began failing in 2008, government did not know what to do. Some institutions were bailed out indirectly, by government-mandated private-sector takeovers; others, directly; and one, Lehman Brothers, went helplessly into bankruptcy. This hodge-podge approach created uncertainty, and uncertain markets are chaotic markets. It wasn’t until the passage of the TARP bailout that the government could deal with the banks uniformly. TARP restored a measure of confidence and congruity to a system out of whack. But no one would tell you that it’s a model for future crises.
What’s needed is a playbook for the next meltdown. Start by establishing a procedure to unwind large and complex financial institutions on the brink of insolvency. The Dodd bill creates a new resolution authority financed by the banks. But a modernized bankruptcy code could do the same thing better, without creating a two-tier system of “systemically important” and “non-systemically important” institutions. Next, create an open and transparent exchange for derivatives. And what about a properly structured Consumer Financial Protection Agency, along the lines of the SEC and the Consumer Product Safety Commission, that would make sure the fine print in your credit card or mortgage contract isn’t a ripoff?
The public correctly judges that elites have behaved irresponsibly. One way to address this concern is to constrict elite power. Scale back Fannie and Freddie. Withdraw from GM, AIG, and Citi. The bankers took on too much debt or leverage, so increase capital requirements while whittling down leverage ratios. That way the traders will find it harder to play with other people’s money. And because a few big banks exert tremendous influence over the Treasury and Federal Reserve, why not break those banks up? A multiplicity of interests makes it harder for any one faction to dominate. Yes, bank-busting wouldn’t end the threat of panics or bailouts. But it would disperse power, increase competition, and perhaps encourage local banking.
The thing to understand is that not every problem can be solved. Anyone who’s read Kenneth Rogoff and Carmen Reinhart’s This Time Is Different understands that financial crises are endemic to market societies. No planner or regulator or trader knows the future. Our ignorance is vast, and our ability to change behavior and culture is minimal. Financial innovation outpaces regulation. Market incumbents find ways to capture regulatory authorities. It’s hubris to think that new rules won’t produce unintended consequences or that none of those consequences will be negative. No reform will be truly effective if we lack modesty and humility and prudence. We’ve seen what happens when these bourgeois virtues are missing from commerce. And scorning those virtues in politics is no corrective at all.
Matthew Continetti is associate editor of The Weekly Standard.
