Friday, January 22, 2010

A Glimmer of Sanity But Bad Timing

Amidst the vitriol and phony populism from the President yesterday was the seed of a good idea in Obama's proposals on the banking system. The central problem with the financial system is the "too big to fail" policy. Even the public, resentful of the bailouts, has had it with this Bush/Obama policy.

Paul Volcker is the guiding influence behind Obama's proposal, announced yesterday, to limit bank size, separate proprietary trading from banking, and raise capital requirements for "risky" activities. Volcker's concern, rightly, is that the "too big to fail" policy guarantees bad resource allocation and guarantees that banks, indeed, will fail. He's right.

The only problem is that we are in the middle of the worst recession since the 1930s. Apparently, the White House hasn't yet noticed this. Simple back-of-the-envelope estimates suggest that the new rules will reduce lending to the private sector by $ 1 Trillion. That number could rise to $ 2 Trillion depending upon details. In the middle of a recession, it is not likely to be good policy to contract lending by that amount.

This is another example of Obama policy that seems disconnected to the real world situation on the ground. The Volcker proposal should not be dismissed out of hand, as there is some merit to it. But, the time could not be worse for this idea. If enacted now, as a populist measure to attempt to resurrect Obama's declining popularity, this plan will only further exacerbate the deepening recesssion.

The right tack for the President is to propose things that would increase lending not reduce lending. The President needs to encourage hiring not discourage hiring. The President still doesn't get it.