Hillary Clinton gets everything wrong about banking
In a column published last Friday on Bloomberg, Hillary Clinton is trying to build her credentials for the US presidential election. Sadly, her quite populist tone is let down by the quality of her arguments and the accuracy of her facts.
Let’s deconstruct her piece step by step.
She starts with a comment that could be interpreted as ironic if it were not in fact serious:
Before the crisis hit, as a senator from New York, I was alarmed by this gathering storm, and called for addressing the risks of derivatives, cracking down on abusive subprime mortgages and improving financial oversight. Unfortunately, the Bush administration and Republicans in Congress largely ignored calls for reform.
Interestingly ‘abusive subprime mortgages’ were in fact first pushed by the…..Clinton administration in 1990s (and then continued under Bush), and banks were literally forced to maintain a quota of such mortgages to obtain various regulatory approvals (including merging with other banks, during the consolidation period that followed the end of interstate banking restriction). This whole very political process was clearly outlined and very well documented in Calomiris and Haber’s Fragile by Design (see my review here).
But don’t get my word (or Calomiris and Haber’s) for it. See this 1999 NYT article, a newspaper that hardly qualifies as banking and free market lover (my emphasis):
Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
When politics trumps economics. (and then blames ‘irrational’ economic actors for the catastrophic outcome)
She later attacks high-frequency trading and shadow banking (she wants more ‘oversight’ – how? – and she forgets that regulators still have no idea how to follow a continuously morphing shadow banking sector), apparently without realising that HFT and shadow banking were reactions to government regulations (the so-called Reg NMS in the case of HFT) and not free market creatures.
Clinton wants to ‘rein in the complexity and riskiness’ of financial institutions. Good. Surely this means getting rid of the tens of thousands pages of complex rules that banks have had to accommodate and that fundamentally reshaped their business model? No, she actually means adding another layer of rules, as she seems to consider Dodd-Frank as ineffective (how ironic).
Consequently, she wishes to reinstate the Glass-Steagall act (which was repealed under her husband’s watch) (and strengthen the Volcker rule – how?), even though there is now no real clear boundary between commercial and investment banking (hence why it was repealed: when the small business, to which you just extended credit to purchase inventory from abroad, seeks to hedge its future expenses by entering into an FX derivative contract with you, or simply when you lent in another currency and wish to hedge FX fluctuations, well, you need a trading book and trading counterparties to take the other side of the trades…).
But Glass-Steagall just misses the whole point: the financial crisis wasn’t an investment banking crisis; it was originally a plain vanilla mortgage lending crisis. Many banks that had no real IB activity suffered or collapsed due to the bad loans they are extended or the fall in value of the securitised products based on bad quality mortgages they had purchased. In short, IB wasn’t the root cause of the crisis.
Where it gets really dangerous is when she wants to give regulators even more authority and power than they already have. The opacity and the lack of respect for the rule of law is already a characteristic of our regulatory system. More discretion is not welcome unless we wish to build a world led by all-powerful but flawed economic administrators that need to get ‘pleased’ if one desires to avoid negative consequences. This would be the end of the Law, and the end of economic efficiency. And this is what happens in a number of developing countries that struggle to develop the sort of solid institutional framework and rules that would allow them to finally thrive. And this is what Clinton is suggesting.
As usual with such wishful political thinking, it ignores all public choice issues: give them all powers, and they’ll work for the greater good:
We need to find the best, most independent-minded people for these important regulatory jobs — people who will put consumers and everyday investors ahead of the industries and institutions they’re supposed to oversee.
Regulatory capture? Personal utility maximisation? Human ignorance/lack of omniscience? Unknown concepts. As Milton Friedman adequately remarked: “and where in the world do you find these angels who are going to organise society for us?”
The only thing I agree with is that financial crimes/frauds should be punished, although in order to respect the rule of law, financial services employees should be judged on the same basis as the employees of any other sector.
Granted, she’s a politician in campaign and not a banking/economic expert. But a more moderate tone and a little more fact-checking would help the US economy more in the long-run than vengeful finger-pointing that will only result in more distrust.