President Obama rails against Wall Street to score populist political points. But when the smoke clears from all the demagoguery, the financial regulations he is pushing will result in fewer loans, more costly credit and individuals facing more risk.
Contrary to the president’s talking points, the proposed regulations will not prevent “a second Great Depression.” In fact, the problems that created America’s recent financial troubles have been ignored in pending legislation. Nothing is being done to reform government-backed lenders Fannie Mae and Freddie Mac despite their history of fraud and responsibility for taxpayers being saddled with $400 billion in bailouts. Mr. Obama won’t even discuss changing government regulations that forced banks to make risky mortgages.
Given Mr. Obama’s continued bashing of the free market, it’s hardly surprising that the Democrats’ regulations run counter to how markets operate. A good example is the “Volcker rule” to limit the size of banks, which is one of Mr. Obama’s five “key proposals” for new financial regulation. What the president never addresses is why some banks become large. He seems to assume it’s because they are just lucky or have been up to no good.
There are more rational explanations that determine bank size. Companies grow because they offer better services than their competitors. Larger banks can provide services at a lower cost. Big loans frequently necessitate the involvement of multiple banks working together, which requires complicated negotiations; large banks can handle larger loans and sometimes avoid such extra costs. Limiting bank size means these efficiencies will be lost. As a result, there will be fewer loans, and their costs will increase.
There is similar danger in Mr. Obama’s proposal to “bring derivatives and other complicated financial instruments out of the dark” by forcing them to be traded on registered exchanges and approved by regulatory bureaus. This idea ignores why firms and individuals make deals between themselves rather than doing everything through exchanges. Derivatives often provide insurance to investors. Farmers trade in derivatives when they sell crops harvested in the fall before they are planted. By doing so, they know how much to plant and how much they will get paid, thus avoiding price risk. Many firms do the same thing.
Simple deals between companies often make more sense than having to deal on an exchange. If government forces companies to go through a regulatory process for every transaction, they won’t do it as often and they won’t be benefiting from the insurance they otherwise would have gotten.
Mr. Obama is trying to put bureaucrats in the corporate driver’s seat by regulating every aspect of business. Government has neither the expertise nor the incentive to run companies correctly, and government surely can’t keep politics out of its decisions. These general rules apply even more to banks, whose performance can be greatly manipulated through regulatory tinkering. No matter how Democrats spin their power grab in the banking sector, making the financial system less efficient means higher costs for American consumers.