Breaking the Banks

Simon Johnson at the New York Times takes Ron Paul seriously:

Mr. Paul  has a clearly articulated view on the American banking system, laid out forcefully in his 2009 book, “End the Fed.” This book and its bottom-line recommendation that the United States should return to the gold standard – and abolish the Federal Reserve System – tend to be dismissed out of hand by many. That’s a mistake, because Mr. Paul makes many sensible and well-informed points.

But there is a curious disconnect between his diagnosis and his proposed cure, and this disconnect tells us a great deal about why this version of populism from the right is unlikely to make much progress in its current form.

There is much that is thoughtful in Mr. Paul’s book, including statements like this (on Page 18):

“Just so that we are clear: the modern system of money and banking is not a free-market system. It is a system that is half socialized – propped up by the government – and one that could never be sustained as it is in a clean market environment.”

Mr. Paul is also broadly correct that the Federal Reserve has become, in part, a key mechanism through which large banks are rescued from their own folly, so that their management gets the upside when things go well and the realization of any downside risks is shoved onto other people.

But Mr. Paul’s book also acknowledges the imbalance of power within the financial system that prevailed at the end of the 19th century. Wall Street financiers, like J.P. Morgan, were among the most powerful Americans of their day. In the crisis of 1907, it was Morgan who essentially decided which financial institutions would be saved and who must go to the wolves.

Would abolishing the Fed really create a paradise for entrepreneurial banking start-ups, enabling them to challenge and overthrow the megabanks?

Or would it just concentrate even more power in the hands of the largest financial players?

Important questions, no doubt — but also something of a contradiction.

Absolute power — who gets bailed out, who gets access to a lender of last resort, who gets access to money at next-to-zero rates, who gets stimulus funds — is today concentrated in the hands of the largest financial players— the US government, and the Federal Reserve system.

And the US government is susceptible (understatement is an art!) to the activities of lobbyists.

Here’s the NYT on that issue:

The financial industry has spent more than $100 million so far this year [2011] to court regulators and lawmakers, who are finalizing new regulations for lending, trading and debit card fees. During the second quarter, Wall Street spent $50.3 million on lobbying, a small dip from the prior period, according to an analysis by the Center for Responsive Politics.

 Big banks are among the most prolific spenders. JPMorgan Chase‘s team of in-house lobbyists spent $3.3 million, a slight uptick over last year. The biggest war chest among organizations focused primarily on Dodd-Frank belongs to the American Bankers Association, which so far spent $4.6 million on lobbying. The organization wrestled the top spending spot from the Financial Services Roundtable, a fellow trade group that represents 100 of the nation’s largest financial firms.

And the Federal Reserve itself is much worse still. Its stock is owned by private banking interests:

The 12 regional Federal Reserve Banks  issue shares of stock to member banks. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.

The banking industry effectively writes much of its own regulation, because it is enmeshed into the governmental-bureaucratic superstructure:

Frankly, I don’t think that power could get any more concentrated.

So surely only the naive would be surprised that the banking industry — through their benefactors at the Fed — bailed themselves out of the last crisis to the tune of $29 trillion.

And that is not just unfair; it’s unhealthy.

As I wrote in November:

Bailing out failed and failing financial institutions creates a zombie economy. Why?

In nature, ideas and schemes that work are rewarded — and ideas and schemes that don’t work are punished. Our ancestors who correctly judged the climate, soil and rainfall and planted crops that flourished were rewarded with a bumper harvest. Those who planted the wrong crops did not get a bailout — they got a lean harvest, and were forced to either learn from their mistakes, or perish.

These bailouts have tried to turn nature on its head — bailed out bankers have not been forced by failure to learn from their mistakes, because governments and regulators protected them from failure.

So it should be no surprise that financial institutions have continued making exactly the same mistakes that created the crisis in 2008.

So while it is all very well debate the various schemes to end the problem of too-big-to-fail, it is important to remember that the problem will ultimately solve itself — a system that rewards failures and creates zombies is fundamentally unsustainable.

Ron Paul does not need to end the Fed. By bailing out a system shot with fragility, leverage junkies and counter-party risk — by attempting to sustain a system that is fundamentally unsustainable — the Fed is quietly abolishing itself, or at very least strongly endangering the status quo.