Government sending mixed messages to banks

The current economic crisis had its own unique economic and financial aspects. The political response did not. Politicians initially reacted by blaming everyone in sight (save members of their own party). The blame-game was then followed by posturing about how legislators would act to prevent any possibility of a future occurrence. Then, cobbled up legislation was drafted that would "solve" the problem.

The political script is timeless. It fits all situations, no matter what the crisis or when. Only the actors on stage change. Dialog does not. The political theater is akin to the old Keystone Kops routine. It would be just as comical if so much weren't at stake.

At this point, it appears little meaningful legislation will occur, primarily because the government has been co-opted by the financial sector. Re imposition of Glass-Stegall type legislation would preclude banks from taking the undue risks that created this crisis. Paul Volcker and many other outsiders have called for such change. Restricting banks in this manner would restrict future financial industry profitability. Therefore it is unlikely, and meaningful change will not be implemented. The same moral hazard that produced the problem will drive behavior in the future.

In lieu of meaningful legislation, politicians resort to bloviation. President Obama, quite adept in this technique, demonstrated his skills the other day with his chastisement of the banks.

Whether such populism works politically is moot. It clearly accomplishes nothing in terms of economics. What made Obama's performance especially egregious was browbeating banks to increase lending. Does he not understand that is how banks make money? Is he so naive to believe that they would not lend to reasonable credit risks? Or is he trying to force banks to return to the risky lending that brought us to this point? Regardless of how one answers, no answer reflects well on Obama's intelligence or leadership.

Another element related to the banks raises competency questions. At the same time that banks are being told to lend more by President Obama, the regulatory apparatus of the government is telling banks to lend less. While no de jure change has occurred, bank regulators are requiring increased margins of safety through higher bank reserves. That can only be achieved via less lending and higher lending standards. From an economic perspective, the regulators are almost surely correct.

The banking industry has no clear message. The leader of the country tells them to behave exactly opposite of what their regulators tell them they must do. Do they listen to the bloviating politician or follow sound economic principles?

In a less imperfect world, the answer would be simple -- sound economics. In our world where politicians have the power to ruin a business, it is less clear.

What to do, what to do?

Monty Pelerin