Government-Caused Depression?

During the Vietnam conflict, a common complaint of soldiers was that you could never tell who the enemy really was.

In this current economic recession, too, I am beginning to wonder who the enemy of our recovery really is.

The president, Congress, the Federal Reserve, and the regulators are all telling us why so many others are to blame.  The big banks have done it to us! shouts one group.  Wall Street did it, claims another.  Homebuyers who bought homes they could not afford are the real culprit! claims another.

Perhaps those who have been charged with the responsibility for managing the fiscal and monetary policy of our nation should look inward for their responsibility in this continuing crisis.

For example, the major banking crisis in 2008 -- as seen with the Lehman Brothers disaster, the Bear Stearns crisis, the Wachovia Bank crisis, the National City bankruptcy, the Countrywide fiasco, and the virtual meltdown of Fannie Mae and Freddie Mac -- caused Congress to become concerned about capital adequacy of banks and financial institutions.

Stress-testing banks came into vogue.  The intent was to protect the economy from the "too big the fail" firms so that our economy would no longer be vulnerable to the bankruptcy of one institution.  Stress-testing may have been a laudable objective in concept, but it was perhaps not so laudable in practice.

To implement a too-big-to-fail strategy in the middle of a recession likely made the recession more severe and prolonged.  Investors became concerned about what the government would do next with banks, which in turn made it harder for banks to acquire the very capital that would be needed to eliminate the "too big to fail" concern in the first place.

By the same token, our government is considering BASEL 3 capital adequacy standards.  Such capital standards make sense on the surface; however, in the middle of a recession, with stock prices already depressed for banks, the likelihood is that banks will increase their capital ratios by getting smaller rather than by raising equity.  Reducing capacity to lend in a recession is problematic for our economy.

In reality, the most recently released stress tests have allowed many well-capitalized banks to buy shares of their own stock back because the shares are so "cheap."  In other words, the financial sector is contracting in the middle of a recession!

In a similar vein, in a misguided effort to spur on the economy, the Federal Reserve has enacted Quantitative Easing 1, Quantitative Easing 2, and Operation Twist.  The intent of all of these measures is to reduce long-term interest rates to spur on consumer spending and investment by business.

In reality, what has occurred is that we have set the stage for unrealistically low interest rates, which, when the interest rates reset, will make the investment or spending decision painful in retrospect.

Quantitative Easing is an identical concept to the teaser interest rates that Fannie Mae, Freddie Mac, and the federal government encouraged with banks and investment banks to entice homeowners into buying homes they could not afford.  Have we not learned anything from the housing crisis?

The extremely low interest rates have encouraged investors to withhold funds from the investment markets because they understand that these rates are unrealistically low in light of inflation concerns.

Finally, at the height of the financial crisis in 2009, the FDIC required banks to post three years of prepayments of the FDIC insurance premiums.  The prepayments amounted to $45 billion.  The intent was to restore some solvency to the FDIC insurance fund, which had seen rapid withdrawals in 2008 and 2009.

Unfortunately, the impact of the $45-billion premium was to pull almost $450 billion of lending capacity from the banks at a time when the nation was already in crisis.  The problem expands to $450 billion because of the capital requirements of banks with the Total Risk Based Capital calculation.

The intent of the FDIC was very sound.  Unfortunately, bank stocks were selling at such depressed levels in 2008 and 2009 that most banks decided to get smaller rather than raise equity at depressed prices to meet the regulatory capital requirements.

In defense of the FDIC, they did try to increase the size of the fund during booming economic times, but large banks were able to successfully lobby that the fund was big enough already.  In reality, the fund should have been allowed to continue to grow so that in stressful economic times, the fund would be large enough to weather the storm without special assessments during a crisis.  This is a situation where the large banks, Congress, and the FDIC were all complicit.

For there to be a reasonable solution to the current economic malaise, government must recognize the timing, as well as the intent, of its decisions.

Increasing capital standards in good times would likely be absorbed by the economy and the banking industry with little adverse effect on consumers.

Allowing the FDIC to maintain the insurance fund as an insurance fund without intervention on the limits of the size of the fund would permit insurance to do what it's intended to do: insure.  By reducing FDIC premiums in good times, banks actually reported above-normal earnings.  In severe economic times, banks' earnings have been negatively affected by increasing premiums.  Not the message that should be sent in the middle of a recession.  

The Dodd-Frank Bill was intended to reduce our economy's risk to institutions that were too big to fail.  Since the passage of this bill, the exact opposite is happened.  The larger banks have become bigger and our risk greater.

It is essential that until the economy is more robust, the federal government, Congress, the president, and the regulators stop all efforts at increasing regulatory compliance burdens.  Capital standards should be maintained at prudent levels until after the recession is over.  At that time, it would be appropriate to consider recapitalizing banks with higher regulatory standards.

Once again, the very people tasked with assisting in controlling the economy are meddling, in a political way, in activities of which they have no understanding.

When will Congress understand that you cannot legislate economic principles?  Congress and the president must be aware that the laws of supply and demand were never passed by any government, nor can those laws be repealed.

Interfere excessively with a free market, and be prepared for the unintended consequences.

Col. Frank Ryan, CPA is a retired Marine Reserve colonel.  He taught economics as an adjunct faculty member at the college level, and he specializes in corporate restructuring and lectures on ethics for the state CPA societies.  He has served on numerous boards of publicly traded and non-profit organizations.  He can be reached at and via Twitter @fryan1951.