Time to make banking boring again

Yes! Vindication is nigh! Well, that's what Simon Johnson at the Baseline Scenario thinks, anyways. Johnson is convinced that Paul Volcker will be victorious in his quest to re-regulate the banking industry, and dare I say it, make banking boring again through reinstituting the Glass-Steagall reforms. What a concept, right? It's funny to me that when I read classic fiction, the bankers are portrayed as the staid, conservative types, who are well-off, but never considered the captains of industry as they are today (well, except perhaps in The Great Gatsby). And what is humorous to me is that that classic image of the banker is very much divorced from the one we have witnessed over the past decade, when banking became one of the most, if not the most, freewheeling industries in terms of risks taken and sums of money made.

The topic of banking and financial reform has become quite compelling to me of late (as is clear from the substance of my recent posts) as I believe that the problems we are witnessing strike at the heart of the American approaches towards money and morality. "More is always better" is the stereotypical American ethos, and yet there should be consequences for wrong actions (witness America's continuing fascination with the death penalty as a form of crime control, despite widespread statistical studies that show the death penalty does not deter crime). However, the financial titans pursued wealth with a single-minded focus, playing with other peoples' money, and when the house of imaginary wealth they built came crashing down, they suffered few, if any, consequences. There is a basic unfairness to this matter, and a sense that the outrages will not stop, given the current weaknesses in the financial reform plans the House passed last week and that are now before the Senate (and sure to be watered down there even further). Johnson notes the fairness issue in the context of Volcker's proposed reform measures:

This strategy is partly about timing – and in this regard Volcker has chosen his moment well. The economy is starting to recover, but this process is clearly going to take a while and unemployment will stay high for the foreseeable future. At the same time, our biggest banks are making good money – mostly from trading, not much from lending to small business – and they are lining up to pay very big bonuses.

Not only is this contrast – high unemployment vs. bankers’ bonuses – annoying and unfair, it is also not good economics. Bankers are, in effect, being rewarded for taking the risks that created the global crisis and led to massive job losses. And they are being implicitly encouraged to do the same thing again.

And there's the rub; bankers are being incentivized, to use the economics term, to take massive short-term risks again if we keep the basic banking structure the way it has been since the repeal of Glass-Steagall. The bonuses will not stop, and the government will continue to be expected to backup the banks when they fail, because they've done it once, and the banks now have an incentive to ensure that in the future they will once again be "too-big-to-fail" so that the government will be forced to backstop their losses when the next recession hits. The core business of banking, saving and lending money, is being short-changed in what ought to be our country's economic recovery in favor of the massive profits (and risks) of the financial innovations of the past decade. Until Obama and his Administation get a grip on the need for fundamental reform and a return to the basics, the Wall Steeters will continue to put all of our nation's money in harm's way.