When risk is outlawed
Washington,
May 18, 2012 -
Rep. Jeb Hensarling (R-TX)
Washington Times
The news of J.P. Morgan Chase's recent trading loss has raised the cry of "I told you so" from proponents of the almost 2-year-old Dodd-Frank Act. They say the law's Volcker rule would have prevented such a loss and that without more regulation, financial institutions will continue to make poor investment decisions.
As an opponent of Dodd-Frank and one of many who have warned against the politicization of our economy, the threat of future bailouts and attempts by the government to eliminaterisks, I also wish to say, "I told you so."
Within Dodd-Frank's 2,300 pages are provisions allowing the government to designate certain financial firms "systemically important financial institutions" - otherwise known as "too big to fail" (TBTF). The law then empowers the Federal Deposit Insurance Corp. (FDIC) to seize a troubled TBTF firm for the purpose of winding it down. In doing so, the FDIC can borrow up to the book value of the institution from taxpayers, an amount that could be astounding, as Bank of America, Citigroup and J.P. Morgan are all $2 trillion institutions.
Because private financial firms such as J.P. Morgan inevitably will blunder regardless of their size or sophistication, designating any firm TBTF is bad policy and worse economics. It causes erosion of market discipline and risks further bailouts paid in full by hardworking Americans. It also becomes a self-fulfilling prophecy, helping make firms bigger and riskier than they otherwise would be. Look no further than Fannie Mae and Freddie Mac and their taxpayer-funded bailout to the tune of nearly $200 billion.
Unfortunately, Dodd-Frank codifies TBTF into federal law. Since its passage, the big banks have become larger and the small banks have become fewer. As a nation, we would do well to rethink TBTF's fundamental premise before it's too late.
Even if some conclude that certain financial firms are indeed TBTF, it begs the question whether Washington is even competent to manage their risk. A review of the federal government's track record in this area does not inspire confidence. The Federal Housing Administration's poor risk management has left it severely undercapitalized. The Pension Benefit Guaranty Corp. has an unfunded obligation of $26 billion. Even the National Flood Insurance Program is $18 billion underwater (pun intended). Then we have Fannie and Freddie.
In fact, it was the government's misguided affordable-housing mandate, combined with a massive loosening of underwriting standards and dangerously low capital requirements, that eventually led Fannie and Freddie to acquire nearly half of the high-risk mortgages in the market at the height of the housing bubble, ultimately causing their downfall.
If these examples don't sufficiently cast doubt upon Uncle Sam's risk-management abilities, consider how TBTF summons the specter of the very kind of crony capitalism that brought us Solyndra.
When pressed on whether he regretted the taxpayer-sponsored "investment" his administration lost in Solyndra, President Obama responded, "No, I don't ... what we always understood is that not every single business is going to succeed." He went on to say that "hindsight is always 20-20. It went through the regular review process, and people felt like this was a good bet."
Apparently, the president has deemed it acceptable for taxpayers to lose a $500 million "bet" he made on their behalf on Solyndra but downright egregious for a private company to lose its own money on its bet. Furthermore, when it comes to systemic risk, continual trillion-dollar federal deficits pose a far greater threat than a $2 billion trading loss at J.P. Morgan.
Defenders of Dodd-Frank say the law's Volcker rule would have prevented such a loss. The reality, however, is that no one yet knows whether that rule would have stopped the trade that triggered the losses. Even if it would have, many think the rule will make access to credit more expensive and thus hamper economic growth.
Recent testimony on behalf of the Chamber of Commerce noted that the Volcker rule "will make U.S. capital markets less robust ... and ultimately reduce underlying economic activity." With job growth already at a generational low, such ominous new federal involvement in our economy is the last thing we need.
Regrettably, much still needs to be done in the wake of the 2008 financial crisis. But we have to keep our focus on the right questions if we are to achieve the right solutions. Why should the government have to protect Wall Street firms from taking losses? Do we really want a Solyndra-like economy in which risk management is guided more by politics than economics and taxpayers are left holding the bag? And perhaps most fundamentally, is risk even something worth eradicating?
As a society, we should want financial firms to take risks. In the not too distant past, one of the large investment banks took a risk on Apple when it was floundering. Now Apple is the most valuable company in the world and its products have revolutionized our lives and economy. Without financial risk, we risk losing out on innovation. Under TBTF, we also risk encouraging irresponsibility. After all, if financial firms were allowed to fail without the benefit of a taxpayer-funded safety net, perhaps J.P. Morgan would have been more careful.
When we reflect upon J.P. Morgan's loss, we should remember this: Bailouts beget bailouts, and if we lose our ability to fail in America, then we may one day lose our ability to succeed. That is what this debate really should be about.
Rep. Jeb Hensarling, Texas Republican, is vice chairman of the House Committee on Financial Services and Republican Conference chairman.
