Ramblings of a Portfolio Manager 12-14-2009

In this present crisis, government is not the solution to our problem; government is the problem. From time to time we've been tempted to believe that society has become too complex to be managed by self-rule, that government by an elite group is superior to government for, by, and of the people. Well, if no one among us is capable of governing himself, then who among us has the capacity to govern someone else? All of us together, in and out of government, must bear the burden.
-Ronald Regan

Ahh, how we (and, doubtlessly, most similarly-aged capital market participants) miss the Great Communicator. We try to remain politically neutral, as opposed to apolitical, in our Ramblings since the issues of politics and financial markets are inexorably intertwined--unfortunately, more so, these days, than we would like. So we’ve been fairly quiet on much of the rhetoric spewing from the current administration as it has been just that and has called for social engineering with tangible but peripheral predicted effects on the capital markets. Now, however, the populist sentiment on Capitol Hill is being aimed squarely at Wall Street in the form of legislation that, we believe, will result in very negative, unintended consequences for both Wall Street and Main Street.
On Friday the House narrowly passed sweeping “reform” legislation to restrict the operations of large banks and narrow the powers of the Federal Reserve. The bill, which still faces major scrutiny and modification in the Senate, advances a major initiative of the Obama Administration to close what it perceives as loopholes that caused the financial crisis of 2008. It was written in large part by Rep. Barney Frank (D., MA.), who, as House Financial Services Committee Chairman, was “shocked, shocked” to hear that there was “financial gambling” going on at major Wall Street banks. Said Speaker of the House Nancy Pelosi (D., CA.), "We are sending a clear message to Wall Street. The party is over. Never again." The details of the bill are too large to list here but the key, and disturbing, elements, are: 1) Stripping nearly all of the Federal Reserve's powers to write consumer-protection laws and creating an arm of Congress to audit the Fed's monetary policy decisions, once considered a necessarily a politics-free zone. 2) Creating a new Consumer Financial Protection Agency, which would write rules and examine large banks for compliance with (existing and soon-to-be-enacted) consumer protection policies on a host of financial products, from credit cards to mortgages. Small banks, which presumably have no impact on consumer credit or the financial system in general, are exempt from the CFPA’s examination. 3) Granting an advisory vote on executive compensation to shareholders of public financial institutions. The legality of this is one unclear if indeed the power is granted exclusively to the shareholders of banks and other financial companies.
It could have been worse. In one victory for banks, Republicans and more than 70 Democrats defeated an amendment that would have allowed bankruptcy judges to rework the terms of mortgages. Of course all this new legislation and the additional bureaucracies created to over see it aren’t free. It’s unclear exactly how much the annual tally for it’s enactment and supervision will be but the costs are expected to be passed on to the banks in the form of additional fees and taxes. This will be on top of an additional $150 billion in fees that will be collected by the FDIC from the large banks to pay for future failures.
Why are we sounding alarmist here? Is not the government’s attempt to reign in those big banks and “help” the little guy consumer a good thing? One need only like at the financial system of our European friends to answer that question. Decades of stifling regulation on financial institutions has driven out smaller firms, leading to a highly concentrated banking system with high fees and little product innovation—that’s why their banks are all so eager to do business here. Our legislators, who daily rail against the evil, monopolistic empire of “Big Oil” are now posing legislation that will create “Big Buck,” an oligopoly of banks large enough to survive wielding similar market power. Regardless of the theories expounded in business school, oligopolies do keep prices higher than a system of perfect competition with virtually no motivation toward product development Think the few banks remaining wont pass the higher costs of doing business on to business and the consumer? Think consumer and business credit, the current “tightness” of which is being blamed for slowing job growth and economic rebound, will get easier with all the new regulation? What about the scariest proposal, politicalization of Federal Reserve policy, which is all promulgated under the House bill? Think it will ensure the continued autonomy and flexibility of that body to stave of financial disasters and reign in inflation, especially when there is a political agenda in Congress or personal angst, as there was between Rep. Frank and Alan Greenspan?
As we write this House Economic Advisor Larry Summers is saying that President Obama will tell bankers that they have an obligation to restart lending. Uh huh. Bankers, like most business people in a free capitalist society, operate on the basis of profit motive, not moral obligation. Unless, of course, as Ayn Rand warned (maybe foretold), they are legally compelled by government. We hope the Obama administration will take time to read the text of President Regan’s fist inaugural address and that, in the meantime, Atlas keeps his shoulders level.