Remember the creature Dr. Dolittle discovered that went in two separate directions at the same time? The pushmi-pullyu has stepped out of fiction and taken residence in Washington.
The past few weeks have seen an increase in bank regulator finger-wagging on the topic of acceptable risk. In an attempt to hang on to meaningful trading profits, banks are moving toward executing trades for customers and moving away from house account trading. One end of the pushmi-pullyu says, "It's natural for banks to be in the business of managing risk for their customers." The other end says, "Uh oh, here we go again."
It doesn't help that the conversation is colored by moralism. The press would have you believe that derivatives are evil instruments destined to destroy our country. I have a hard time finding the moral component of a desire to eliminate, or take on, risk. Isn't this the essence of insurance — allowing someone to sleep nights because someone else is willing to take on the risk?
Regulators and Congress are feeding the pushmi-pullyu a lot of populist hay. Let's get this straight: to get the country out of our current economic mess, good banks need to make more loans, but not stupid loans. Lend money in economically disadvantaged areas, but not predatory loans. Charge interest rates commensurate with risk, but don't charge too much. Provide the infrastructure for cash on demand and overdraft protection, but don't get paid for it. Promote the American dream, but discourage overdependence on credit. All this while we protect capital and make a return for shareholders. Clear? Hardly.
So what do we do? There is no arguing that the banking system benefits from regulatory oversight and the scrutiny of Congress and the press. But, there is an equally powerful check and balance that has been effectively dismantled through the FDIC insurance system. Consumers feel no need to question the quality of deposit-taking institutions since they assume the FDIC does that for them as evidenced by deposit insurance. My mother-in-law is no expert in banking, but she sure knows what FDIC insurance is and where to find the highest CD rates. When she tells me that one bank's insured CD is the same as the next, who am I to say, careful, what do you know about that institution? Good banks and bad banks all get thrown into the same pot. We've seen this movie before during the S&L crisis in the 1980s. That movie had a tragic ending.
Take a simple test. Look at the ads for the institutions paying the highest rates in the country. What do you know about their balance sheets? Do you care?
I think we would be better off if millions of depositing consumers had an incentive to understand, and demand information on, the health of their bank. Consumers should know that high relative rates telegraph high risk rather than a good deal.
Our FDIC insurance has turned into a subsidy. It enables bad banks to stay in business. In effect, the FDIC insurance fund is asking us to build in a floodplain. Nutty? The pushmi-pullyu likes it.