Trust No Bankers

The financial industry has always been wrong about the dangers of regulation.

Jamie Dimon

Predictably, Wall Street and the banking industry don’t like President Obama’s plan to tax banks to help pay for the bailout. JPMorgan Chase CEO Jamie Dimon, an Obama supporter, said, “Using tax policy to punish people is a bad idea.” Republicans generally denounced it, with RNC Chairman Michael Steele noting “this money has already been paid back by the banks” and calling it a “punitive tax” that “will hurt Americans’ savings and discourage job creation at the worst of economic times.”

It would be a lot easier to accept this line of reasoning if JPMorgan Chase didn’t have about $40 billion in FDIC-guaranteed debt outstanding, and if the Federal Reserve didn’t have $27 billion of Bear Stearns assets on its balance sheet (which it had assumed to help JPMorgan take over Bear). Big banks might have paid back the money they borrowed under the Troubled Asset Relief Program, but they’re still benefitting hugely from the bailouts and taxpayer supports enacted after the crisis.

But there’s an even better reason to dismiss their concerns. A study of recent—and not so recent—financial reform and regulation yields two rules. Rule No. 1: The banks have no idea what kind of regulation is good for them. Rule No. 2: If you ever think the banks have a point, remember Rule No. 1.

This rule dates almost to the beginning of American history. Many commercial banks in the United States opposed the creation of the first and second national banks of the United States in the late 18th and early 19th century. They saw the proto-central bank as competition, since it was essentially a congressionally chartered private bank that would compete with them. As a result, the United States, in contrast to economic rivals England and France, lacked a central bank in the 19th century—despite periodic banking panics and failures, the severity of which could have been mitigated by a central bank. It was only after the Panic of 1907 that forces were set into motion for the creation of a central bank. Would it surprise you to learn that many bankers and their political allies opposed the creation of the Federal Reserve? Didn’t think so.

The same dynamic returned in the 1930s, after Wall Street and the commercial banking sector had essentially destroyed itself. The banking industry had proved utterly incapable of ensuring the safety of its customers’ deposits. Yet when the Roosevelt administration proposed the establishment of an industry-funded Federal Deposit Insurance Corp., Francis Sisson, then president of the American Banking Association, called deposit insurance “unsound, unscientific, unjust, and dangerous.” After all, “overwhelming opinions of experienced bankers are emphatically opposed to deposit guaranties which compel strong and well managed banks to pay the losses of the weak.”

Sisson’s objections notwithstanding, deposit insurance went into effect in January 1934 and proved remarkably successful in restoring confidence in the banks. “Rarely has so much been accomplished by a single law,” said John Kenneth Galbraith. Of course, deposit insurance doesn’t prevent banks from failing. But at least when they do, they do not wipe out their depositors.

On Wall Street, meanwhile, the industry went nuts when FDR proposed the establishment of the Securities and Exchange Commission, which forced disclosure, the registration of securities, and federal oversight of exchanges. The industry led a vicious campaign against any and all regulation, accusing FDR and his crowd of being nothing more than a bunch of Communists. No regulation was necessary; Richard Whitney, then chairman of the New York Stock Exchange, actually called the NYSE a “perfect institution.” (Whitney would later be busted for grand larceny and serve time in Sing Sing. Among his crimes: stealing from the NYSE’s gratuity fund and—the ultimate in WASP betrayal—embezzling from the New York Yacht Club.)

After the creation of the SEC, the industry went on a short-lived capital strike, which is a little like hookers taking a vow of celibacy. And in the end, the SEC proved to be quite good for Wall Street—in both the short and long term. The capital markets revived and the financial services industry expanded exponentially in the decades after World War II.

As it grew, the financial industry gained more of a voice in Washington and took a bigger role in shaping policy. And as it turns out, it is an almost perfect contrary indicator: Most regulations it has opposed have turned out to be good for the industry, while most regulations it has supported have turned out to be bad for the economy.

The savings and loan industry, for example, fervently backed the regulatory reforms of the early 1980s that freed banks up to go on a lending binge. Largely because of those reforms, the industry fell flat on its face. In the 1990s, Citigroup pushed for the erosion of the Depression-era Glass-Steagall Act, which required the separation of commercial and investment banks. The result: debacle. Wall Street agitated for the Fed and the government agencies not to regulate derivatives, not to regulate credit default swaps, and not to regulate subprime loans. The result: debacle. And perhaps there was no single policy move so damaging as the SEC’s 2004 action, taken at the behest of the CEOs of the large investment banks, to allow the banks to boost their leverage ratios from 12-to-1 to 25-to-1 and above. The CEOs of Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Bros. and Bear Stearns pushed for the change, assuring all concerned that it would be good for them, for the system, and the country. At the time, SEC Commissioner Harvey Goldschmid said, “If anything goes wrong, it’s going to be an awfully big mess.” Four years later, the freedom to take on more leverage proved to be their collective undoing.

Why are bank CEOs so clueless about the impact of regulation? The simple explanation is that these guys don’t know the first thing about their business, regulation, or history. Then again, maybe there are important factors of organizational psychology at work here. Industries, as a rule, don’t like regulations that they didn’t come up with on their own. They like to control their own environment. (You can praise the deliciousness of steak until you’re blue in the face, and your 6-year-old will pronounce it “blech.” Then one day, on his own, he decides to eat it and pronounces it “yummy.”) CEOs have been schooled to believe they know better—better than employees, better than subordinates, better than other CEOs, and certainly better than regulators and legislators—how to run their businesses. They also think they know better what would hurt and harm their businesses. That’s why they get paid so much. In addition, while CEOs have excellent short-term self-preservation instincts, their long-term vision is lacking. Who can blame them? The typical tenure of a CEO of a big bank is five or six years, if he’s lucky. And he is forced to keep an intense focus on the current month, quarter, year. Anything that would detract from activities that produce profits or that would require attention and resources to focus on compliance and adjustments, is therefore a negative.

If Obama’s proposed bank tax passes, the industry will be fine. The tax won’t hamper lending any more than the banks’ self-implosion already has. The same dynamic will play out if Washington enacts other restrictions on Wall Street and banks—a tax on trading, say, or letting the Bush-era tax cuts expire.

One of these decades, bankers may turn out to be right about the impact of a proposed regulation on their business. Probably not this one, though.