The rapid negotiation of a fiscal compromise between President Obama and Republican leaders indicates that the new Congress will feature horse trading rather than gridlock on many other issues also — including banking.
In order to enact legislation he seeks, Obama will have to modify some of the more radical initiatives prompted by the financial crisis and grope for a middle ground.
If our industry could speak with a unified voice, what should be our top legislative priority for 2011? An even less restrictive treatment of bank securities activities? A bank-friendly approach to housing finance? Or limitations on the scope and funding of the Consumer Financial Protection Bureau? This is the debate that we should now be undertaking.
The Volcker Rule and customized derivatives are of interest primarily to the few large banks whose share of total deposits has grown so dramatically in the past 20 years. No industrywide consensus will develop to go to bat for the permissive treatment of derivatives and proprietary trading.
The more crucial issue, however, is a much broader one: To what extent should securities activities be integrated with banking?
The Glass-Steagall Act cut off commercial banking from the securities industry for 50 years starting in the 1930s. The force of events during the 2007-9 period, including the collapse of three of the largest securities firms, caused an accelerated reintegration of the two industries.
Is it salutary for banks accepting insured deposits to do nearly everything that securities firms do? Banks failed because they took excessive risks. I think banking should focus on less risky assets and activities.
An even larger issue is the role of the government in subsidizing home finance, both through guarantees and by funding immense portfolios. The subsidies, particularly the underpricing of risk, marginally increase homeownership. By making mortgages cheaper, they also let consumers bid up home prices, even to levels that were unsustainably high.
Right now, banks hold record levels of deposits, and cannot find enough good loans to make. It seems perverse to argue that, in this environment, we need the current huge level of government subsidies in order to enable home purchases to be financed. Why not eliminate the subsidies in an orderly way, let rates on new mortgages rise to a market level and encourage banks to acquire and hold them? If total mortgage balances and hence home prices were restrained by the amount of capital available to support the mortgages, then future bubbles would be much less likely.
Would the banking industry be better off if mortgage rates offered us an attractive risk-adjusted return? Yes, and for more than one reason. At an early stage of the bubble, the CEO of one of the largest originators told me: "There is no money to be made in conforming mortgages. I want to do more seconds, more stated-income, more subprime." This behavior was unhealthy and, in fact, disastrous consequence of government mortgage subsidies.
I think we should give strong support to a winding down of mortgage subsidies and an end to political control of mortgage volumes and terms. If social policy seeks to favor homeownership, let it do so in other ways, such as the mortgage interest tax deduction.
This brings us to the CFPB, which heralds potentially the most dramatic change in financial regulation since the 1930s. We are headed now toward a system of banking regulation akin to that of the U.K., where one agency aims to assure banks' soundness and another seeks to advance consumers' interests — which are presumed to conflict with those of the banks. The result: For a long time the U.K. has not been a good place to own or operate a bank. HSBC's experience demonstrates this.
The reasoning behind the CFPB is clear. The less revenue and profit banks get from their business with consumers, the better off the bureau presumes consumers will be. "Apples-to-apples comparisons of financial products," Elizabeth Warren's catchphrase, translates into head-to-head price competition, with no innovation to provide new sources of value to consumers, lower pricing of bank services and lower profits.
The Financial Reform Act tried to assure long-term funding and expansion of the CFPB, in defiance of future Congresses' previously unquestioned right to appropriate (or refuse to appropriate) every dollar of annual government spending. The formula is not foolproof. In fact, I expect it will not stand. I believe banks' top legislative priority for the upcoming Congress should be to cut CFPB funding and narrow its immensely broad scope of authority. We should also be active in seeking to trim federal subsidies that reduce investor returns on mortgages.