Obama and Wall Street: Is There Hope?

Obama and Wall Street: Is There Hope?

by Wade Lee Hudson

The federal government is beginning to clamp down a bit on big banks and President Obama’s new Treasury Secretary Jack Lew has recently declared:

It's unacceptable to be in a place where too-big-to-fail has not been ended. If we get to the end of this year and we cannot, with an honest, straight face, say that we have ended too-big-to-fail, we are going to have to look at other options.

But how far will President Obama go? His weak response thus far is not encouraging.

Understanding why Obama has been so timid is important. The answer is not that he’s a puppet, deeply aligned with Wall Street, or has been afraid of Wall Street's political power. The problem is deeper than that. Meaningful reform requires understanding Wall Street’s power. Only then can we counter its threats.

If Wall Street is unhappy, it can cripple the economy by loaning less money at affordable rates. Obama knows that, and no President wants the economy to tank while in office.

When Francois Mitterand was elected President of France in 1981 with majority support in the legislature, he implemented a number of progressive economic reforms. In particular, he increased the wealth tax and nationalized a number of banks (France already had two nationalized banks). One response from elites was “capital flight.” Many wealthy people simply moved their money to other countries. The French economy worsened and in less that two years Mitterand had almost completely reversed his 1981 reforms.

In the United States, in the early 1990s, President Clinton attempted to boost the economy out of a recession by increasing the federal deficit. Fearing greater inflation, many Wall Street bondholders sold their bonds because those bonds would be less valuable if inflation increased more than expected. This sell-off prompted higher interest rates on new bonds, which threatened the economy.

In response, Clinton decided to shift toward seeking a balanced budget. This dynamic prompted Clinton adviser James Carville to comment, “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

In 1984, according to Wikipedia, the term “bond vigilante” emerged to describe “a bond market investor who protests monetary or fiscal policies they consider inflationary by selling bonds, thus increasing yields.”

The 2008 financial crisis prompted a “credit crunch.” The big banks were reluctant to loan money to each other because they were afraid loans would not be repaid if more banks collapsed. This tightening made it more difficult for banks to make loans to consumers and businesses.

In May 2009, though interest rates on 30-year fixed mortgages were only slightly above 5 percent and inflation was tame, in an article titled, “Bond Vigilantes Confront Obama as Housing Falters,” Bloomberg.com reported:

They’re back.

For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion.

Like Clinton, Obama responded by emphasizing reduced federal spending, though the best way to reduce the deficit is to boost revenue with economic growth.

These instances indicate how Wall Street can “protest,” “challenge,” and “punish” Administrations that adopt policies that threaten to diminish its paper-economy profits.

This threat led Obama to focus on “restoring confidence” on Wall Street. He wanted to enable Wall Street to make enough money so it would loan money to Main Street. Against the advice of many close advisers, he decided not to confront Wall Street and the Tea Party filled the void.

Now Wall Street is raking in enormous profits. JPMorgan, for example, with $4 trillion in assets, reported $21.3 billion in net income in 2012, a third straight year of record profit. With that largesse, there’s no excuse for not pursuing meaningful reforms. And Obama no longer has to worry about getting re-elected. So perhaps more progress is on the horizon.

Still Wall Street claims that any significant reform will limit the credit that is available to consumers. So the question remains: Is trickle-down economics our only option? Must we always allow Wall Street greed to go unchecked? Is there some other way to counter the threats posed by Wall Street?

The bottom line is access to capital. When Wall Street jacks up rates or squeezes credit, it’s much harder to borrow money. Whether they do so for purely economic reasons, or as a political tactic, or some combination of the two is irrelevant. Whatever the case, we need to counter Wall Street’s suppression of the real economy so it can no longer hold the economy hostage.

Since October 2008, the Fed has been paying interest to banks who deposit with the Fed “excess reserves” -- money over and above what they are required to deposit. So banks have increased those reserves to almost $2 trillion rather than loaning that money to consumers and businesses.

In July 2012, Bruce Bartlett, a Republican economist, pointed out that the Fed could charge the banks interest on those reserves rather than giving them interest, as have Sweden and Denmark, which would probably encourage lending. If it did not, as Alan Blinder, a Democratic economist, stated, at least it would generate $8 billion in annual revenue for the federal government.

In light of this situation, in his excellent review of the financialization of our economy, “The “Bankization of America,” Richard Eskow argued for the Federal Reserve to “demand that banks perform their central economic function – responsible lending to consumers and job-creating businesses....” And Senators Elizabeth Warren and Bernie Sanders have echoed this position with their “Four Questions for Fed Chair Candidates,”

in which they ask:

What would you do to divert the $2 trillion in excess reserves that financial institutions have parked at the Fed into more productive purposes, such as helping small- and medium-sized businesses create jobs?

Even stronger measures could develop alternative sources of capital. As did John Fullerton, we need to question “why we give banks, responsible or not, the sole authority to create money for the economy” -- which they do by lending more than they receive in deposits. We need not rely only on banks to inject money into the economy.

Various proposals for alternative sources of money have been presented. Reformers have not coalesced around any clear consensus about the best course. The matter needs more research and deliberation. This lay author certainly has more to learn. But some of the more promising options include the following.

As Pulitzer-Prize winner reporter Jesse Eisinger wrote in “The Problem With the Fed’s Easy Money Policies,” the Fed could could bypass private banks and stimulate the economy by buying  municipal bonds directly from state and local governments to support infrastructure improvements. “If quantitative easing is necessary,” he concluded, “it should support investment, not speculation.”

Along the same line, in “Getting More Bang for the Fed’s Buck,” Stanford professors Joseph A. Grundfest, Mark A. Lemley, and George G. Triantis argued that the Federal Reserve Act should be amended to allow the Fed to buy municipal bonds with a maturity of more than six months.

Every Fed dollar spent in the muni market would absorb a larger percentage of outstanding debt and is likely to have a greater effect on reducing the bonds’ interest rates than the same expenditure in the mortgage market.... Lowering the borrowing costs for states, cities and counties should not only forestall tax increases (which dampen individual spending), but also make it easier for local governments to pay for police officers, firefighters, teachers and infrastructure improvements.

From the New Deal, we know the federal government can directly provide significant debt relief to small borrowers, including both farmers and homeowners. If the government can bail out Wall Street, why can’t it bail out Main Street? Robert Kuttner insists:

If the federal government got serious about this concept, it has plenty of resources through its feeble HAMP program to acquire distressed mortgages, reduce the principal to fair market value, and give the homeowner all of the break.

In addition, Kuttner argues that local governments can use their power of eminent domain to provide homeowners with basic assets:

There was money in the 2009 Recovery Act for local governments and non-profits to acquire abandoned and foreclosed homes.... A Homeowners Loan Corporation using eminent domain could be a full service solution. It could pull distressed mortgages out of securitized pools, provide principal reductions on both performing mortgages and ones where homeowners are behind on their payments. And it could purchase foreclosed homes at deep discount and convey them to nonprofit groups to be returned to the supply of affordable housing.... Even without legislation for a new HOLC, the government could use existing entities to perform this role.

In “The Debt We Shouldn’t Pay,” an incisive review of Debt: The First 5,000 Years by David Graeber, Kuttner concludes:

The original Federal National Mortgage Association (FNMA), nicknamed Fannie Mae, was a public entity. It used government borrowing to purchase mortgages and replenish the working capital of lenders. Public FNMA had no scandals, and when it was working effectively, from its founding in 1938 to its privatization in 1969, the US rate of home ownership rose from about 40 percent to over 64 percent. The trouble began when Wall Street invented complex, exotic, and easily corrupted mortgage bonds, and private Fannie began purchasing high-risk mortgages in order to protect its market share. The remedy is to restore Fannie to a public institution with high lending standards, not to kill it.

Public banks, owned by taxpayers, are another option. According to the wikipedia, the very successful Bank of North Dakota

has taken a role more akin to a central bank, and has many functions, such as check clearing, that might be expected from a branch office of the Federal Reserve. The bank does have an account with the Federal Reserve Bank, but deposits are not insured by the Federal Deposit Insurance Corporation, instead being guaranteed by the general fund of the state of North Dakota itself and the taxpayers of the state.

The Public Banking Institute reports:

The Bank of North Dakota makes low interest loans to students, existing small businesses and start-ups. It partners with private banks to provide a secondary market for mortgages and supports local governments by buying municipal bonds.

With measures such as these, we could reduce our dependency on Wall Street, establish a more diversified financial system, and develop new ways to provide loans to creditworthy consumers and businesses.

With adequate consumer demand, the economy would do well and Wall Street should be happy enough -- without being pampered by the federal government. And if their greed remains out of control and they become unhappy, then, if we don’t rely only on private banks to make loans, that could be their problem, not ours.

NOTE: Thanks to Bob Planthold for his assistance with this essay.