Let’s hope David Stockman is wrong.

The Dow Jones and Standard & Poor’s 500 indexes reached record highs on Thursday, having completely erased the losses since the stock market’s last peak, in 2007. But instead of cheering, we should be very afraid.

Over the last 13 years, the stock market has twice crashed and touched off a recession: American households lost $5 trillion in the 2000 dot-com bust and more than $7 trillion in the 2007 housing crash. Sooner or later — within a few years, I predict — this latest Wall Street bubble, inflated by an egregious flood of phony money from the Federal Reserve rather than real economic gains, will explode, too.

Since the S.&P. 500 first reached its current level, in March 2000, the mad money printers at the Federal Reserve have expanded their balance sheet sixfold (to $3.2 trillion from $500 billion). Yet during that stretch, economic output has grown by an average of 1.7 percent a year (the slowest since the Civil War); real business investment has crawled forward at only 0.8 percent per year; and the payroll job count has crept up at a negligible 0.1 percent annually. Real median family income growth has dropped 8 percent, and the number of full-time middle class jobs, 6 percent. The real net worth of the “bottom” 90 percent has dropped by one-fourth. The number of food stamp and disability aid recipients has more than doubled, to 59 million, about one in five Americans.

So the Main Street economy is failing while Washington is piling a soaring debt burden on our descendants, unable to rein in either the warfare state or the welfare state or raise the taxes needed to pay the nation’s bills. By default, the Fed has resorted to a radical, uncharted spree of money printing. But the flood of liquidity, instead of spurring banks to lend and corporations to spend, has stayed trapped in the canyons of Wall Street, where it is inflating yet another unsustainable bubble.

When it bursts, there will be no new round of bailouts like the ones the banks got in 2008. Instead, America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.

THIS dyspeptic prospect results from the fact that we are now state-wrecked. With only brief interruptions, we’ve had eight decades of increasingly frenetic fiscal and monetary policy activism intended to counter the cyclical bumps and grinds of the free market and its purported tendency to underproduce jobs and economic output. The toll has been heavy…

First the housing bubble. Now we have two more bubbles to fret about: student loan debt and muni debt.

Walter Russell Mead on the latter:

The next financial market meltdown may already be brewing: not in the housing market, this time, but in municipal bonds. Greedy bankers, opportunistic politicians and hobbled regulators are putting a time bomb in the muni market that could set off another devastating crash.

California is leading the way.

It is starting out innocently enough. Looking to expand a number of aging school facilities but loath to raise the taxes necessary to pay for it, California cities have opted to fund school construction projects with capital appreciation bonds, which allow school districts to borrow money now while putting off payments for decades. It sounds like a great deal, but it has one major drawback: The interest rates involved push the eventual price tag to many times the original amount—sometimes as much as ten times more. The New York Times has the story:

In San Diego, property owners owe $630 million on a $164 million bond. For theFolsom Cordova Unified School District, a $514,000 bond will cost $9.1 million.

And in the most expensive case yet, the Poway Unified School District borrowed $105 million to finish modernizing older school buildings, which local property owners will be paying off until four decades from now at an eventual cost of nearly $1 billion. Because payments on the bond do not start for 20 years, current school board members faced little risk of resistance from property owners. [...]

In 2009, as the housing market crash drove down tax revenues for schools and state education financing was cut, California lifted its requirement that long-term bonds be paid off at approximately the same rate each year, opening the door for bonds that delay payments for 20 years.

This is irresponsibility on steroids, but it represents a dream come true for crony capitalists and Wall Street I-bankers. Fat fees, enormous interest, and the taxpayers won’t even know what hit them when the whopping bills come due.

But everyone involved should be put on notice: While not all of these bond issues are equally bad, as a class these bonds are toxic and likely to bring serious pain to everyone connected to them. Some of the deals already done will likely blow up in the future; bankruptcy will loom when the pension squeeze and the bond bomb both hit at full force.

But the worst danger is not from the relatively small number of deals already done but in the potential for this kind of finance to spread. Like the bad ideas that started off small but grew until they were big enough to blow up the mortgage market, dangerous practices can become more common and widespread in municipal finance.  More politicians will catch on to the magic of long term bonds that bring benefits now but will savage your town a couple of decades on. Other state legislatures will be pressured to follow California’s rash venture into muni (more…)

Obama’s radio address excerpt:

“Here in America, we know the free market is the greatest force for economic progress the world has ever known.  But we also know the free market works best for everyone when we have smart, commonsense rules in place to prevent irresponsible behavior,” Obama began.

This from Mr. “You Didn’t Build It”?

“That’s why we passed tough reforms to protect consumers and our financial system from the kind of abuse that nearly brought our economy to its knees.

You mean the federal government won’t induce/compel lenders to make bad loans again?

And that’s why we’ve taken steps to end taxpayer-funded bailouts, and make sure businesses and individuals who do the right thing aren’t undermined by those who don’t.

Solyndra ring a bell? His list of taxpayer funded flops is long.

And if he means Dodd-Frank, its reforms unwittingly enshrine “too big to fail.”

“But it’s not enough to change the law – we also need cops on the beat to enforce the law.  And that’s why, on Thursday, I nominated Mary Jo White to lead the Securities and Exchange Commission, and Richard Cordray to continue leading the Consumer Financial Protection Bureau.

To date, the Obama administration has not prosecuted one single criminal case against the crooks on Wall Street.

Big talking guy, that Obama.

Lefty columnist Michael Hiltzik fails to name Obama for failure to prosecute.

If you’re concerned about corporate crime, 2012 looked like a pretty successful year for the good guys.

The Thousand Oaks biotech giant Amgen paid $762 million in fines and penalties and pleaded guilty to a federal charge related to illegal marketing of its anemia drug Aranesp. Britain’s GlaxoSmithKlineand Illinois-based Abbott Laboratories paid $3 billion and $1.5 billion in government penalties, respectively, in connection with their off-label promotions of blockbuster drugs. Glaxo’s was the biggest drug company settlement in history.

The global bank HSBC paid a record $1.92 billion to settle federal accusations that it operated a huge money-laundering scheme for Mexican drug dealers and Middle Eastern terrorists. BP agreed to pay $4.5 billion and plead guilty to 11 felony counts in connection with the 2010 Deepwater Horizon oil spill in the Gulf of Mexico. It was the biggest federal criminal penalty ever.

To the companies, however, these big numbers are just chump change. Typically they don’t even represent repayment of ill-gotten gains — more often merely the cost of doing business. And to the public, they’re insults piled atop the injuries caused by the firms’ wrongdoing.

“These fines are a carny act to keep the rubes happy,” according to William K. Black, who was a thrift regulator during the savings and loan crisis of the 1980s. “It’s cynical — the art is to make the amount sound large but make sure that it has no material effect.”

What might really get the attention of the CEOs and other top executives of lawbreaking companies would be some time in the hoosegow. Does that sound quaint? If so, it’s because not a single high-ranking executive of any of the companies mentioned above faced indictment or was even forced to step down.

The absence of criminal cases against perpetrators of the 2008 financial crisis is a continuing scandal. It’s not as though there haven’t been suitable candidates for the docket. Angelo Mozilo, the chairman of Countrywide Financial, was the face of mortgage company excesses in the housing bubble…

It’s a bitch watching Obama get away with blatant lies. He blamed the 2008 mortgage meltdown on Bush and some vague policy. No one ever called him on it. Not the media (natch), nor Romney.

But one simple fact remains: if individuals had not borrowed money they could not repay, there would have been no meltdown. And banks would not have made bad loans if not induced/coerced by the federal government to do so. Both created opportunities for Wall Street to cash in.

Have the Feds learned? No.

LAT

FHA gives those who defaulted on homes another chance

After two foreclosures and two bankruptcies, Hermes Maldonado is as surprised as anyone that he’s getting a third shot at home ownership.

The 61-year-old machine operator at a plastics factory bought a $170,000 house in Moreno Valley this summer that boasts laminate-wood floors and squeaky clean appliances. He got the four-bedroom, two-story house despite a pockmarked credit history.

The last time he owned a home, Maldonado refinanced four times and took on a second mortgage. He put a Cadillac and Mercedes-Benz C300W in the driveway and racked up about $45,000 in credit card bills and other debts. His debt-fueled lifestyle ended only when he was forced into bankruptcy.

His reentry into home ownership three years later came courtesy of the Federal Housing Administration. The agency has become a major source of cash for so-called rebound buyers — a burgeoning crop of homeowners with past defaults who otherwise would be shut out of the market.

“After everything that happened, thank God I was able to buy another house,” Maldonado said in Spanish. “Now, it’s good because the interest rates are low and there are lots of homes.”

The FHA, which backs nearly 8 million loans, is helping rebound buyers recapture the American dream, boosting the housing market in the process. But that’s touched off a fierce debate about the financial and ethical wisdom of bankrolling borrowers who contributed to the last housing bubble — and the potential cost to taxpayers.

The agency has suffered deepening losses in the last three years that have put it under enormous scrutiny.

Created during the Great Depression to revive the devastated housing market, the FHA doesn’t originate loans. It guarantees mortgages made by banks in exchange for insurance premiums. The agency now insures more than $1 trillion worth of homes. This year it has backed roughly 14% of all mortgage originations, according to the trade publication Inside Mortgage Finance…

John Tamny at Forbes writes that the dire prediction of a lending freeze in 2008 was based on stale, and hysterical, reasoning.

…Put plainly, banks in the U.S. have long since been eclipsed by alternative sources of finance when it comes to providing companies with credit. Putting it in numeric terms in the present, in their excellent new book Freedom Manifesto Steve Forbes and Elizabeth Ames write that U.S. companies have $1.2 trillion in bank loans outstanding, whereas their European counterparts have over $6 trillion. Contrary to popular opinion, the failure of one or many banks in 2008 would not have led to a collapse in credit for solvent companies.

To understand why, we must consider what economists refer to as the “substitution effect.” Basically, shortages of anything are often made up for by new market entrants. Banks are no different in this regard.

Back in the summer of 2010, with its small-business clientele suffering from tighter than normal credit, Walmart’s Sam’s Club subsidiary announced its willingness to provide its customers with $25,000 lines of credit. Walmart has for years tried to get into banking, absurd regulations about new entrants arguably kept it from purchasing some of the insolvent banks in ’08, but even without a banking charter, Walmart was able offer up credit at a time when banks weren’t able to.

Much the same is occurring now at Amazon.com. Traditional banks remain careful about lending, but Amazon, flush with cash, is eagerly substituting for the banks. Through its Amazon Capital Services subsidiary, Amazon is helping the sellers on its website to access credit that is in short supply at the moment from banks.

Getting into specifics, the Wall Street Journal recently reported on Lisa Zerr, owner of Yankee Toy Box, and her urgent need to secure credit in order to upgrade her inventory ahead of the holiday shopping season. Yankee Toy Box does a lot of business on Amazon, and she’s since borrowed from Capital Services $38,000 in July, and then $13,000 last month.

It should be stressed that Amazon is one of myriad companies that uses its balance sheet to provide banking services to customers. Not a traditional bank, it acts as a bank, and is a substitute for a limping sector.

Amazon’s story naturally exposes as fraudulent the hysterical assertions made by politicians, Fed Chairman Bernanke, and numerous members of the commentariat who said absent bank bailouts in ’08, the economy would disappear. They were wrong then, and they’re wrong now…

James Freeman

Mr. Obama has had so much success pinning the blame on George W. Bush that he’s even trying to tie the crisis to Mr. Romney. This takes some nerve considering that Mr. Romney was in private life at the time and had no policy-making role before the mortgage meltdown. Yet the president and his aides routinely make the fact-free claim that the GOP candidate intends to “let Wall Street write its own rules again.”

Unlike Mitt Romney, Mr. Obama did have a policy-making role, serving as a U.S. Senator beginning in January 2005. The media custom has been to give Mr. Obama a pass for the 3.5 years he spent as a senior elected official before the crisis hit. It’s ironic that he’s just about the only one of the 100 senators serving at the time who’s never really had to answer for the disaster or explain why he did nothing to prevent it.

To be fair, a list of the 20 Members of Congress most responsible for the crisis would not include Barack Obama. He didn’t create Fannie Mae or Freddie Mac. He simply went along as the Democratic caucus blocked GOP Sen. Richard Shelby’s effort to rein in these mortgage monsters.

Similarly, Mr. Obama didn’t invent the idea that the Securities and Exchange Commission should oversee not just stock brokerages but their parent companies as well. That decision was made at the SEC in 2004 and allowed the Wall Street giants to rely on their own risk models and operate with catastrophic levels of debt. Mr. Obama simply endorsed this policy when he co-sponsored the “Industrial Bank Holding Company Act” in 2007.

Recognizing the SEC as an “appropriate federal supervisory agency,” akin to a prudential bank regulator, was one of the signature policy mistakes of the pre-crisis era. But that policy was already being implemented by the time Mr. Obama signed his name to it.

The financial crisis likely would have occurred with or without Mr. Obama in the Senate. He was generally a non-factor in the business of legislating as he spent much of his time preparing to seek his next job.

But however modest his contribution, he did help create the mess he now blames on others.

…or Black Swan? Reuters

Chinese banks and companies looking to seize steel pledged as collateral by firms that have defaulted on loans are making an uncomfortable discovery: the metal was never in the warehouses in the first place.

China’s demand has faltered with the slowing economy, pushing steel prices to a three-year low and making it tough for mills and traders to keep up with payments on the $400 billion of debt they racked up during years of double-digit growth.

As defaults have risen in the world’s largest steel consumer, lenders have found that warehouse receipts for metal pledged as collateral do not always lead them to stacks of stored metal. Chinese authorities are investigating a number of cases in which steel documented in receipts was either not there, belonged to another company or had been pledged as collateral to multiple lenders, industry sources said.

Ghost inventories are exacerbating the wider ailments of the sector in China, which produces around 45 percent of the world’s steel and has over 200 million metric tons (220.5 million tons) of excess production capacity. Steel is another drag on a financial system struggling with bad loans from the property sector and local governments.

“What we have seen so far is just the tip of the iceberg,” said a trader from a steel firm in Shanghai who declined to be identified as he was not authorized to speak to the media. “The situation will get worse as poor demand, slumping prices and tight credit from banks create a domino effect on the industry.”

And the world economy, probably.

Charles Gasparino

Among the many falsehoods pushed at last week’s Democratic Convention is that this is the party of the people, unafraid to hold Corporate America responsible for its many ills.

Judging by the records of the last two Democratic administrations, just the opposite appears to be true. Certainly, President Obama and, to some extent, Bill Clinton like to talk a good game in terms of class warfare, but under both men, real corporate crime-fighting has been at best a side issue — despite the immense amounts of white-collar fraud their administrations faced.

In fact, neither Obama nor Clinton can hold a candle to the corporate crime-fighting record of George W. Bush, that supposed lapdog for large corporate interests.

Consider: As we near the four-year anniversary of the financial crisis, not a single Wall Street fat cat has been charged with violations of securities laws in connection with the 2008 collapse.

Then we have the outlandish case of MF Global, the brokerage firm run into the ground nearly a year ago by Obama’s pal and campaign-cash bundler, Jon Corzine. It isn’t just that the former Goldman Sachs CEO and New Jersey governor took outsized trading risks that destroyed the firm; his firm appears to have misused and lost $1.6 billion in customer funds in the process.

Under securities laws, those customer funds were supposed to be kept sacrosanct — yet not a single MF Global employee, much less Corzine, has been charged in the matter by the Obama Justice Department or the Securities and Exchange Commission.

For obvious reasons, Clinton’s putrid record on corporate crime went unmentioned as he rewrote history during his speech.

(It wasn’t all that got left out as he tried to make people believe they’re doing just fine after four years of Obamanomics. He also skipped over the fact that the ’90s economy only got strong after he turned right by cutting deals with the Republicans to cut taxes and spending and to reform welfare.)

Simply put: The law-enforcement agencies under Clinton turned a blind eye to one of modern history’s biggest corporate crime waves.

Forget insider trading, where traders are basically ripping off each other. During the Clinton years, big Wall Street firms came up with new and imaginative ways to screw the average investor — who for the first time was turning to the stock market to save for retirement. Yet there wasn’t much of a peep from Bubba’s Justice Department or the corporate watchdogs at his Securities and Exchange Commission.

One such rip-off involved feeding small investors fraudulent research reports so they’d buy overvalued (and overhyped) Internet stocks — but there were many more, most of which came to light after the tech bubble burst in March 2000 and small investors lost countless billions in savings.

Those research scandals were initially uncovered by a Democrat — New York then-Attorney General Eliot Spitzer. But the Bush SEC shared in the enforcement of the cases.

The Bush Justice Department and SEC also started the investigations that have led to Obama’s one arguable area of success on Wall Street crime — insider-trading prosecutions. But the victims of insider trading are mostly other traders, not the average Joe — this isn’t the sort of corporate crime that ruins Main Street.

Anyway, lots else got prosecuted under Bush. The accounting fraud at Enron, a Houston-based energy company with ties to the Republican Party, brought immediate indictments against individuals like Bush friend Ken Lay. One major firm, accounting giant Arthur Andersen, was forced out of business.

The same thing with Worldcom, another accounting fraud prosecuted in the Bush era that landed its CEO in jail.

As it happens, the last major financial firm to be run out of business after being hit with criminal charges (prior to Arthur Andersen) was Drexel Burnham Lambert — and that was accomplished by President Ronald Reagan’s US attorney for Manhattan, a guy named Rudy Giuliani.

Of course, Bush’s record of corporate crime fighting was far from perfect. Much of the risk-taking that led to the 2008 collapse occurred under the nose of his regulators — but these practices started to explode during the Clinton years.

The bigger point here is that, if you’re really keeping a score card on who’s going after corporate America’s bad guys, the Democrats may talk a good game but have very little to show for it.

Keep that in mind the next time President Obama says how much he detests the Wall Street fat cats.

Holman Jenkins

From Bill Clinton to Joe Biden to Michelle Obama, Democrats tried to get mileage from jobs not lost because the economy did not succumb to a total meltdown, thanks to President Obama’s timely rescue of the banking system.

Mr. Obama’s administration does get credit for mopping up, namely the kabuki “stress tests” that pronounced the banking system “saved.” Mr. Obama also played an important role before he took office when he might have been obstructive rather than supportive or noncommittal on the sidelines of a bailout then underway.

But it pays to remember that most of what was done, wise or not, was done before he became president. His task in the presidency was getting the country back on its feet rather than taking credit for arresting a fall that was arrested before he ever set foot in the oval office.

Recall two key dates:

TARP, or the Troubled Asset Relief Program, was enacted by Congress on Oct. 3, 2008.

Then-U.S. Treasury Secretary Henry Paulson, center, and Fed Chairman Ben Bernanke, right, before the House Financial Services Committee in Washington, D.C., in November 2008.

The move to put GM and Chrysler on the federal dole, with details left to the next administration, began with President Bush, who cut a check for $17.4 billion on Dec. 12, 2008.

Mr. Obama has subsequently accused Mr. Bush of giving money to the auto makers with no conditions; this is untrue and also ungenerous. Mr. Bush plainly put money into GM and Chrysler to keep them afloat for Mr. Obama’s benefit, since Mr. Obama would have to clean up the mess if they went into liquidation. And you know the sequel—a questionable, UAW-friendly bankruptcy that is proving one of the few money losers for taxpayers.

The main event, however, was the rescue of the financial system. Here, the heavy lifting was done by the Federal Reserve and FDIC long before Mr. Obama became president. It also involved a far greater effort than the public yet understands.

On March 16, 2008, the Fed intervened to halt the collapse of Bear Stearns and, over the next eight months, performed roughly similar heroics on behalf of Citigroup, AIG, Wachovia, Morgan Stanley, American Express, Goldman Sachs and many others.

On Oct. 3, 2008, the FDIC increased deposit insurance protection to $250,000 from $100,000. On Oct. 14, the FDIC allowed banks to raise new debt with federal guarantees and provided unlimited protection to certain accounts used by businesses.

On Sept. 19, 2008, the U.S. Treasury announced a temporary guarantee of money-market funds. On Oct. 26, the Federal Reserve itself started buying commercial paper issued by big industrial companies. Without these interventions, many large employers (notably GE) might have folded or drastically cut back operations and laid off workers to maintain liquidity.

These are the steps that stopped the descent and stabilized the system.

The rather more cosmetic solutions began with Hank Paulson’s injection of TARP money into the banks, to achieve an effect that could have been achieved less dramatically by waiving for a period the federal (more…)

CBS News

A Democratic committee chairman overrode his own subpoena three years ago in an investigation of former subprime mortgage lender Countrywide Financial Corp. to exclude records showing that he, other House members and congressional aides got VIP discounted loans from the company, documents show.

The procedure to keep the names secret was devised by Rep. Edolphus Towns, D-N.Y. In 2003, the 15-term congressman had two loans processed by Countrywide’s VIP section, which was established to give discounts to favored borrowers.

The effort at secrecy was reversed when Towns’ Republican successor as chairman of the House Oversight and Government Reform Committee, California Rep. Darrell Issa, issued a second subpoena. It yielded Countrywide records identifying four current House members, a former member and five staff aides whose loans went through the VIP unit. Towns was on the list.

Issa, in a statement to The Associated Press on Wednesday, said, “It was a long fight to expose how Countrywide used its VIP program to advance its business and policy goals.”

Most of the names had dribbled out to the media by the time Issa issued the committee’s final report last month on Countrywide’s use of loan discounts to buy influence with government officials. But there was no official confirmation until Issa made his report public.

Towns’ effort to keep the loans secret was at odds with statements by Republicans and Democrats alike that full disclosure of lawmakers’ financial dealings was the best means for keeping the public aware of congressional perks, unethical conduct and fundraising.

Countrywide had been the nation’s largest home loan originator before the housing market collapse. Many of its borrowers were left unable to repay mortgages that, in many cases, required no proof of income or a down payment. The company was purchased in 2008 by Bank of America, which now holds the VIP loan files.

The original Towns subpoena had asked for all files that went through the Countrywide VIP unit and specifically mentioned House members and aides. Bank of America sent a spreadsheet that identified 18,000 files that listed a borrower’s employer, but without names to maintain privacy.

The spreadsheet identified several files listing the House or Congress as the employer. Since the vast majority of the employers in the spreadsheet were of no interest to the committee, committee Republicans – then in the minority – and majority Democrats each drew up a separate list of loan files to be turned over by the bank.

The Republican list totaled 3,000 files and included borrowers listing the House as an employer. Towns narrowed the files to about 300 and excluded references to the House. It was Towns’ truncated list that went to Bank of America.

Bank of America confirmed in a statement to The Associated Press that it produced the files requested in the truncated list.

Karl Rove writes about how the Democrats killed an attempt by Bush to rein in Fannie and Freddie long before the economy went into “the ditch.”

Obama was an author-by-default of the “failed policies” he pins on Bush.

[This was] the same week as the seventh anniversary of the Senate Banking Committee’s approval of S.B. 190, the Bush administration’s reforms of Fannie Mae and Freddie Mac.

Though publicly traded companies, Fannie and Freddie are government-sponsored enterprises—GSEs—chartered by Congress. Because the U.S. government implicitly backed them, they could borrow money more cheaply than competitors such as mortgage companies and banks. And borrow they did. It took from Fannie’s founding in 1938 until 1999 for the companies to acquire or guarantee $2 trillion in mortgage-backed securities. By 2005, they had snapped up another $2 trillion in mortgages, many of them subprime.

The Bush administration supported S.B. 190 to provide more oversight to America’s two largest financial institutions similar to that of the nation’s banks, savings and loans, and credit unions. A new regulator could examine their books, limit their mortgage portfolios, and set capital requirements.

After the Banking Committee passed the bill with 11 Republicans in support and nine Democrats opposed, Senate Democrats warned committee Chairman Richard Shelby (R., Ala.) that all of them—including an Illinois freshman named Barack Obama—would filibuster the bill if it were brought to the floor.

Democrats opposed regulation in large part because the GSEs were an important source of funds for community groups allied with the Democratic Party, and they were run by Democratic power brokers like former Clinton Office of Management and Budget Director Franklin Raines and Walter Mondale’s 1984 campaign chairman, James Johnson. And so the Bush reform died.

For the next three years, the GSEs increased their purchases of mortgages and mortgage-backed securities by $1.2 trillion to a total of $5 trillion, of which about $1.8 trillion was in subprime, “liar loans” or other non-prime mortgages, according to Columbia Business School’s Charles Calomiris.

At the end, Fannie and Freddie were drastically overextended, with a loan-to-capital, or leverage, ratio of 70 to 1 or higher. In the summer of 2008, when housing prices declined, the value of their mortgage portfolios collapsed and the government put them into conservatorship. When the GSEs collapsed, they took down Lehman Brothers and then nearly America’s entire financial sector. Democratic opposition to sensible regulation made this possible…

If you think this is ancient history, read the rest of Rove’s column to learn how Obama has doubled down on Fannie and Freddie — at the public’s risk.

Regulating credit reporting agencies might be a good idea.  But this is not:

The Consumer Financial Protection Bureau said it would begin this fall to supervise the 30 largest credit reporting companies, which account for 94% of the market’s annual receipts.

Among the firms are the big three: Experian Information Solutions Inc.,Equifax Inc.and TransUnion. Combined, they issue more than 3 billion consumer credit reports each year and have files on more than 200 million Americans.

“Credit reporting is at the heart of our lending systems and enables many of us to get credit, afford a home or get an education,” said bureau Director Richard Cordray, who will announce the oversight at a hearing on credit reporting Monday in Detroit.

“Supervising this market will help ensure that it works properly for consumers, lenders and the wider economy,” he said. “There is much at stake in making sure it is both fair and effective.”

The CFPB was created by Dodd-Frank and was set up to be beyond the reach of Congress (it is funded by the Federal Reserve).

Furthermore, President Obama illegally appointed Richard Cordray as a recess appointee when the Senate was not in recess.

So we have a new agency, structured to be unrestrained by our elected representatives and ruled by a man who is serving illegally, deciding to regulate another part of the economy.

Welcome to Obama’s brave new world.

From Obama’s Cleveland speech Thursday:

“Without strong enough regulations, families were enticed and sometimes tricked into buying homes they couldn’t afford. Banks and investors were allowed to package and sell risky mortgages. Huge reckless bets were made with other people’s money on the line. And too many, from Wall Street to Washington, simply looked the other way.”

Seriously, how does anyone get tricked into buying a house? If they’re that dumb, they shouldn’t be getting a mortgage — and would not have if Big Government hadn’t made it happen.

Bill Clinton was touting his record of having four balanced budgets. Let’s remember:

• Clinton inherited a booming economy when he took office
• Clinton lost control of Congress after two years and was held in check by a GOP that actually cared about controlling spending, unlike the GOP under Dubya.
• Much of the boom people remember was the tech/Internet bubble. One, Clinton had nothing to do with creating it. Two, it blew up in 2000 and the nation went into a recession.

He got the ball started on the mortgage meltdown. First, by repealing the Glass-Steagall Act (a GOP initiative) and then using the Community Reinvestment Act to force lenders to make subprime loans to minorities.

Obama’s favorite finger pointing metaphor used to be that the GOP drove the economy into the ditch, then had the  nerve to ask for the cars keys back.

Then he rode into town and cleaned things up with his Democrat Congress via Dodd-Frank. Oops.

Politico

The giant $2 billion trading loss at JPMorgan Chase highlights a central problem in President Barack Obama’s case for a second term: Four years after the financial crisis nearly brought the nation to its knees, very little appears to have changed.

No high-profile bank executives are in jail. Special multi-agency task forces to go after financial fraud and mortgage market abuses appeared in State of the Union addresses, only to issue a few news releases and mostly vanish from public view.

And now one of the largest banks in the United States, headed by a Democrat and operating with government guarantees, has turned in the kind of headline-grabbing, casino-style loss that drives voters crazy and that Obama’s financial reform bill was supposed to stop. It’s led to the immediate retirement of Ina Drew, the bank’s chief investment officer, along with a statement from Dimon that JPMorgan remains “strong.”

His royal highness:

“If we would just convert these investments that we’re making through out government in education, research and healthcare. If we just turn those into tax cuts, especially for the wealthy, then somehow the economy is going to grow stronger. That’s the theory,” President Obama said about the right at a campaign event on the tax code in Boca Raton, Florida today.

Investments like Solyndra? Obama is a failure as a venture capitalist. Alas, unlike real venture capitalists, his loss is our loss.

Besides, it’s a false dichotomy: tax cuts don’t always equate with less revenue. The weathy invest in our economy, just with more intelligence.

“Here is the news. We tried this for eight years before I took office. We tried it. It is not like we did not try it. At the beginning of the last decade, the wealthiest Americans got two huge tax cuts, in 2001 and 2003. Meanwhile, insurance companies, financial institutions, they were all allowed to write their own rules, find their way around the rules. We were told the same thing we’re being told now — this is going to lead to faster job growth, it’s going to lead to greater prosperity for everybody. Guess what? It didn’t,” he said an audience at Florida Atlantic University.

The middle class got an even bigger tax cut — which is precisely why Obama worked to keep it. Under Bush, many of the poorest Americans stopped paying income taxes altogether.

Financial institutions, far from being allowed to write their own rules, were induced and in some cases coerced by the federal government into making sub-prime loans (in the interest of equality, naturally) that set the stage for the mortgage meltdown.

The Obama administration will extend mortgage assistance for the first time to investors who bought multiple homes before the market imploded, helping some speculators who drove up prices and inflated the housing bubble.

Landlords can qualify for up to four federally-subsidized loan workouts starting around May, as long as they rent out each house or have plans to fill them, under the revamped Home Affordable Modification Program, also known as HAMP, according to Timothy Massad, the Treasury’s assistant secretary for financial stability. The program pays banks to reduce monthly payments by cutting interest rates, stretching terms, and forgiving principal.

Here is yet another example of why the federal government should not be steering the economy.

Christina Hoff Sommers:

Richard Epstein on whether Europe or the US is handling the financial crisis more prudently.

A close look at the economic woes at home and abroad raises this unedifying question: who has proved more inept at handling the current economic crisis, the European Union or the United States? To Paul Krugman, this question has an easy answer: The Europeans for their maddening insistence on fiscal austerity when large government expenditures and credit infusions are needed to prop up a sagging economy. With fiendish glee, Krugman denounces the EU’s austerity measures as “pain without gain.”

The spending cuts of the EU nations, Krugman argues, have shrunk their economies, without offering any prospect of generating long-term growth. The Europeans, it seems, have emulated the worst of President Herbert Hoover’s skinflint budgets that helped prolong the Great Depression. The United States, which this time around has been more liberal with the purse, has suffered far less damage than the EU, which shunned Keynesian prescriptions.

Krugman’s cryptic Hoover reference is telling. In addition to worshiping balanced budgets, Hoover got economic policy wrong time and again. On trade, he acquiesced to the 1930 Smoot-Hawley Tariff; on labor, he signed on to the Davis-Bacon Act of 1931, which calls for “prevailing [i.e. union] wages” on government funded projects; on taxation, he championed the Revenue Act of 1932, which raised the top tax bracket to 62 percent; more globally, he stubbornly accepted the general deflation of the time. The combined effect of these various measures did much to deepen and prolong the Great Depression. His policies sadly misfired in so many directions that it is difficult to attribute his disastrous presidency to any one factor.

Krugman would do well to dwell on the multiple mistakes of the Hoover presidency. Yet, in his monochromatic way, he focuses in on only one piece of the larger mosaic: that governments here and abroad are not spending enough. For the United States, Krugman advocates for large transfers of federal revenues to the states to provide a large shot in the arm to local governments, putting them in a position “to rehire the hundreds of thousands of schoolteachers they have laid off and restart the building and maintenance projects they have canceled.”

The federal government’s trillion dollar deficits can wait for another day when interest rates start to rise. His dismissive views on the deficit match those of his colleague at Princeton, economist Alan Blinder, who acknowledges that sometime in the future, it will be necessary to right the deficit ship—but not until at least five years from now. Enjoy the low interest rates while the getting is good.

Seniors who live on interest income don’t find the current interest rates good, something you don’t hear much about.

The WSJ on the fed’s $25 billion shakedown.

…The banks did have sloppy paperwork practices, but they were also dealing with a historic wave of foreclosures created in large part by government-backed Fannie Mae and Freddie Mac. To date there’s no evidence that borrowers current on their mortgage payments were improperly ejected from their homes. Federal regulators have already stepped in, conducted lengthy audits, forced banks to change their internal procedures and yesterday levied $394 million in fines against four of them.

But the politicians know an election-year windfall when they see it. Ally Financial, Bank of America, Citigroup, J.P. Morgan Chase and Wells Fargo promised to devote a mere $1.5 billion of the $25 billion to alleged victims of wrongful foreclosures between January 1, 2008 and December 31, 2011.

The rest of the loot will serve the political agenda of paying off favored home owners—er, voters—with principal reductions, refinancing programs and foreclosure forbearance. The states and feds will also get nice cash payments. Think of this as one more giant political stimulus package—Congressional approval not required.

At least $10 billion will go toward principal reduction for delinquent borrowers or those on the brink of foreclosure with loans issued by private lenders. In other words, Washington is taking money from bank shareholders and investors in mortgage-backed securities, who will see the value of their holdings fall, and giving it to people who aren’t paying their bills. Welcome to the “fairness” era.

Hurrah!

Iowa’s Mr. Miller argued yesterday that principal reduction will salvage loans on the path to delinquency and thus save investors money—the proverbial free lunch. But mandated principal reduction may not save the borrowers if housing prices don’t rise. Meanwhile, 42% of all borrowers with loans in foreclosure haven’t made a mortgage payment in two years, according to Lender Processing Services. They are being rewarded for not paying their bills.

The settlement also has at least $3 billion to refinance homeowners who pay their bills but owe more than their home is worth—in other words, people who bought more home than they could afford. Another $7 billion will go to “other forms of relief,” including loan forbearance for the unemployed, “anti-blight programs,” “transitional assistance” and other political transfer payments.

Incredibly, the settlement doesn’t prevent states or the feds from pursuing more criminal cases, civil-rights or securitization lawsuits, or more claims against the Mortgage Electronic Registration Systems. So even after this round of political extortion, the banks will be asked to pay again and again. They have little ability to say no because Mr. Cordray and regulators now have life-or-death control over nearly every bank product. Ma and Pa Barker should have gone to law school and run for office.

All of this will entrench the government ever-deeper into the housing market, and this may be the real political goal. In January the Administration announced it would take billions of dollars in leftover TARP funds to entice Fan and Fred’s regulator to do principal writedowns. Last week, the White House asked Congress to let the taxpayer-backed Federal Housing Administration—which is already insolvent—underwrite loan refinancing for underwater borrowers with private mortgages.

Once upon a time, Florida land developers saw mangrove swamps as wasteland. They tore up the plants and their habitat, creating new building sites in a process called dredge and fill.

Then fish populations shrank.

It turned out the lowly mangrove leaf plays a key role in the ecosystem as they decompose and provide nutrients to the bottom of the food chain.

We’ve all heard similar stories about ignorant humans blundering along, upsetting the natural order.

Few think about the sophisticated business and financial ecosystem that sustains our modern way of living. This is especially true of Democrats who blunder along passing laws purporting to fix problems, but instead making things worse.

Peter Wallison writes that Dodd-Frank, the sweeping “reform” passed by the Democrats

Dodd-Frank relies on the notion that interconnections among large nonbank firms amplified the crisis—in effect, that Lehman Brothers’ bankruptcy in September 2008 weakened other large financial institutions, imperiling the entire financial system. Thus, under the authority granted to it by Dodd-Frank, the Federal Reserve recently proposed limits on any systemically important nonbank firm’s exposure to a counterparty—25% of regulatory capital as a general limit. This means that if regulatory capital is 10% of assets, exposure to any counterparty could not exceed 2.5% of its assets.

These limits will have a significant effect on the flexibility of these companies and the U.S. economy as a whole. The function of a financial system is to transfer funds from a place where they are not used efficiently to a place where they will be, and this is done in substantial part by interconnections—that is, by borrowing or lending—among financial institutions. If adopted, the Fed’s new rule will impose bureaucratic controls and rigidities that will substitute for a firms’ own risk management, affecting trading as well as lending.

Rules which will impede the capital markets that make our economy work.

…But there’s no evidence that any of the financial institutions that were rescued—AIG, Citigroup, Wachovia, Washington Mutual, Merrill Lynch—were weakened by their exposure to Lehman. Since they weren’t, the whole idea of interconnections—and thus Dodd-Frank’s rationale for designating financial firms as systemically important—is called into question.

As “fish” populations dwindle, and the economic pie gets smaller because of cloddish, ignorant government intervention, Democrats will no doubt point fingers at everyone but themselves.

Holman Jenkins:

If not for hindsight bias, financial pundits would have no shtick at all. Happily, the world is a conveyor belt delivering surprising events that we can criticize others for not foreseeing. Lately our profession has been feasting on newly released Federal Reserve minutes from 2006, which reveal Ben Bernanke’s hair barely smoldering over the end of the housing bubble: “I think it would take a very strong decline in the housing market to substantially derail the strong momentum for growth that we are currently seeing in the economy.”

Tim Geithner, then head of the New York Fed, opined that “financial market data” gave off no sign of trouble. Kevin Warsh, a fellow Fed governor, agreed: “Capital markets are probably more profitable and more robust . . . than they have perhaps ever been.”

What idiots. And yet they were right. Jobs, consumption and stock prices were holding up smartly despite the well-recognized turn in housing markets. Then came the financial panic. Did the housing bubble cause the panic—or was the panic somehow separate, making everything worse, including the housing crunch? Good question.

Gratifying, then, is the attention showered on a recent book by Jeffrey Friedman and Wladimir Kraus, “Engineering the Financial Crisis.” Their work is refreshing for many reasons: It does not assume the housing bubble is the whole story. It allows that honest ignorance (especially about the interaction of complex regulations) might explain the behavior of bankers and regulators. It asks especially interesting questions about the triple-A mortgage derivatives at the heart of the financial meltdown.

Whether these securities ever deserved their triple-A ratings is, of course, a debatable proposition. But what’s certainly true is that these “structured products” were structured to protect investors’ cash flow even in the face of a considerable rise in mortgage defaults. From many accounts, including the Fed’s, which ended up owning a bunch of them, the securities have largely performed as advertised.

Yet when the panic hit, it was the presence of these assets on bank balance sheets that fomented a global loss of trust in banks. Why?

And why did so many banks load up on these assets in the first place? Blaming “greedy, reckless” bankers, the authors say, is a stretch because banks’ housing assets were in fact heavily tilted toward the safest. Citibank was entitled, for capital purposes, to treat higher-yielding triple-A and double-A private mortgage securities the same as Fannie- and Freddie-issued securities. Yet Citi held a lot more Fannie and Freddie than it did the private securities.

The future is unknowable. Capitalists will make mistakes. But why the same mistake? Here the authors blame the homogenizing effect of the Basel banking regulations spawned in 1988, ironically to address the same fears of “moral hazard” and Too Big to Fail on every lip today.

Basel tried to make banks safer by prescribing capital levels, and by steering them toward “safe” assets. Experience had shown that mortgage-backed securities were among the safest, safer than business and consumer loans and even whole mortgages. So the Basel rules strongly favored mortgage-backed securities. Alas, this became an incentive to over-produce these assets until they became very dangerous indeed to the entire financial system (a formula also implicated in Europe’s sovereign debt crisis)…

WSJ

It is a newspaper truism that what is good for journalism is bad for the country, and vice versa. Let’s just say that regarding the pending retirement of Congressman Barney Frank, we’re delighted to make the professional sacrifice.

Few House Members have made a bigger legislative mark, and arguably no one so expensively. Mr. Frank deserves to be forever remembered—and we’ll help everyone remember him—as the nation’s leading protector of Fannie Mae and Freddie Mac before their fall. For years Barney helped block meaningful reform of the mortgage giants while pushing an “affordable housing” agenda that helped to enlarge the subprime mortgage industry.

“I do think I do not want the same kind of focus on safety and soundness that we have in OCC [Office of the Comptroller of the Currency] and OTS [Office of Thrift Supervision],” Mr. Frank said on September 25, 2003, in one of his many legendary rhetorical hits. “I want to roll the dice a little bit more in this situation towards subsidized housing.” The dice came up snake-eyes for the housing market and U.S. economy.

Democracy can be unfair, and for his sins Mr. Frank was rewarded with the chairmanship of the Financial Services Committee in 2009 and an opening to remake the U.S. financial industry. It was like asking Charlie Sheen to teach an anger management class. The result was Dodd-Frank, which didn’t solve the “too big to fail” problem but did make banks even more subject to the wishes of Washington. The crony capitalism exemplified by Fannie and Freddie became more broadly embedded in U.S. financial markets.

Peter Boone and Simon Johnson at Bloomberg

Investors sent Europe’s politicians a painful message last week when Germany had a seriously disappointing government bond auction. It was unable to sell more than a third of the benchmark 10-year bonds it had sought to auction off on Nov. 23, and interest rates on 30-year German debt rose from 2.61 percent to 2.83 percent. The message? Germany is no longer a safe haven.

Since the global financial crisis of 2008, investors have focused on credit risk and rewarded Germany with low interest rates for its perceived frugality. But now markets will focus on currency risk. Inflation will accelerate and the euro may break up in a way that calls into question all euro-denominated obligations. This is the beginning of the end for the euro zone.

Here’s why. Until 2008, investors assumed that all euro- zone sovereign bonds, as well as bank debt, were risk-free and would never default. This made for a wonderfully profitable trade: European banks could buy government debt, finance it at less expensive rates through funding provided by the European Central Bank, and pocket the spread.

Then credit conditions tightened around the world and some flaws became evident. Greece had too much government borrowing; Ireland had experienced a debt fueled real-estate bubble; and even German banks had become highly leveraged. Investors naturally decided some credit-risk premium was needed, so yields started to rise…

Paul Sperry for Investors Business Daily

President Obama says the Occupy Wall Street protests show a “broad-based frustration” among Americans with the financial sector, which continues to kick against regulatory reforms three years after the financial crisis.

“You’re seeing some of the same folks who acted irresponsibly trying to fight efforts to crack down on the abusive practices that got us into this in the first place,” he complained earlier this month.

But what if government encouraged, even invented, those “abusive practices”?

Rewind to 1994. That year, the federal government declared war on an enemy — the racist lender — who officials claimed was to blame for differences in homeownership rate, and launched what would prove the costliest social crusade in U.S. history.

At President Clinton’s direction, no fewer than 10 federal agencies issued a chilling ultimatum to banks and mortgage lenders to ease credit for lower-income minorities or face investigations for lending discrimination and suffer the related adverse publicity. They also were threatened with denial of access to the all-important secondary mortgage market and stiff fines, along with other penalties.

Bubble? Regulators Blew It

The threat was codified in a 20-page “Policy Statement on Discrimination in Lending” and entered into the Federal Register on April 15, 1994, by the Interagency Task Force on Fair Lending. Clinton set up the little-known body to coordinate an unprecedented crackdown on alleged bank redlining.

The edict — completely overlooked by the Financial Crisis Inquiry Commission and the mainstream media — was signed by then-HUD Secretary Henry Cisneros, Attorney General Janet Reno, Comptroller of the Currency Eugene Ludwig and Federal Reserve Chairman Alan Greenspan, along with the heads of six other financial regulatory agencies.

“The agencies will not tolerate lending discrimination in any form,” the document warned financial institutions.

Ludwig at the time stated the ruling would be used by the agen cies as a fair-lending enforcement “tool,” and would apply to “all lenders” — including banks and thrifts, credit unions, mortgage brokers and finance companies.

The unusual full-court press was predicated on a Boston Fed study showing mortgage lenders rejecting blacks and Hispanics in greater proportion than whites. The author of the 1992 study, hired by the Clinton White House, claimed it was racial “discrimination.” But it was simply good underwriting…

Tigerhawk:

There was a big story yesterday, but most of the blogosphere, caught up in shaping the narrative around the Occupy activists, ignored it. Too bad, because it is much more important.

The Census Bureau reported that American mobility — the condition of people moving around this vast and beautiful land of ours in search of new opportunity — has stopped like a car door slamming, and is at its lowest level since World War II. The reason given is that Americans are “locked in place,” confined by houses they cannot sell — or will not sell because they do not want to recognize losses that they have already incurred — and young people are living with their parents.

Any reasonably large employer knows how bad this has become — we are no longer really a national labor market, because so many otherwise excellent recruits cannot afford to relocate because they cannot sell their houses. The new American immobility is not only bad for our restless national spirit, it is terrible for GDP, and it needs to be fixed.

Separately, Mitt Romney drew rare praise from the Wall Street Journal for speaking the truth about housing and foreclosures.

Campaigning last week in Nevada, the epicenter of the housing bust, Mr. Romney was asked by the Las Vegas Review-Journal editorial board what he would do about housing and foreclosures. His reply:

“One is, don’t try and stop the foreclosure process. Let it run its course and hit the bottom. Allow investors to buy homes, put renters in them, fix the homes up. Let it turn around and come back up. The Obama Administration has slow-walked the foreclosure processes that have long existed, and as a result we still have a foreclosure overhang.”

Romney is right — the country will not really recover until housing transactions start to clear at something akin to a natural price. This is easier said than done for many reasons. Many homeowners heard some number for their house’s value back in 2006 and thought of their equity as savings, and now feel they have to hang on until they recover their paper profits. Others bought at those levels and will lose most or all of their down payment when they sell. Still others could sell if they could reduce the outstanding debt, but it is no longer a simple matter to negotiate with one’s mortgagee.

There is, however, a solution that might increase the velocity in the American housing market, restore the geographic mobility that is arguably our greatest cultural patrimony, and appeal to both Democrats and Republicans.

The Official TigerHawk housing proposal is this: Allow housing losses realized between 2011 and 2015 to be deductible against ordinary income with no limits (or some really high limit) in any tax year through 2021. What about sellers who cannot use the tax deduction (perhaps because it overwhelms their income, or they are part of the 47%)? Allow them to sell those losses, for cash, to individuals, to partnerships of individuals (the pooling of purchasers would create a more efficient market for the losses), and any corporation that hires and relocates the seller…

IBD

If Republicans are to take back the White House and Senate, they need to do a better job tying Democrats and Washington to the subprime crisis. It’s not hard, yet even their front-runner struggles to make the case.

On Wednesday night, CNN host Piers Morgan guilted Cain into allowing that banks were, as Morgan put it, “effectively preying on the most vulnerable elements of American society,” and that Wall Street deserves at least partial blame for the crisis and should be held to account. “I wouldn’t defend the banks,” Cain said, “because I happen to think that the banks are part of the problem. Wall Street is.”

Cain belatedly also faulted Fannie and Freddie, and the Democrats in Washington who protected them. Piers then pressed him to come up with a pie chart alloting blame — Washington vs. Wall Street—and Cain assigned neither a majority responsibility for the mess.

But based on the number of toxic loans in the system in 2008, the government was responsible for not just a simple majority, but more than two-thirds. It’s quantifiable — 71% to be exact (see chart). And the remaining 29% of private-label junk was mostly attributable to Countrywide Financial, which was under the heel of HUD and its “fair-lending” edicts.

To be fair, the blame-Wall Street narrative has cemented in the public consciousness, and is hard to crack. That’s because in the wake of the crisis, the Obama White House and Pelosi-Reid Congress engineered a cover-up of Washington’s role in the mess through the Democrat-led Financial Crisis Inquiry Commission. The national media now defer to it as the final authority on what caused the crisis and ensuing recession.

“The FCIC’s report put the majority of the blame squarely where it belonged: on the shoulders of the Wall Street executives,” Bloomberg News opined.

While not blameless, Wall Street is an easy scapegoat. And investment houses that made billions slicing and dicing mortgages into CDOs, derivatives, credit default swaps and other exotic paper are easy to demonize. But the problem wasn’t these financial instruments. Or even the obscene profits they generated. Mortgage-backed securities were nothing new, and we’ve always had speculation in the market.

The problem was the underlying assets: low-quality mortgages. We’ve never had so many junk home-loans poisoning the financial well before. And who poisoned the well? Washington and its affordable-housing policies.

It was Washington that declared prudent home-lending standards racist and gutted traditional underwriting rules in the name of diversity. It was government that created the risk on Main Street. Yes, Wall Street spread it, with the help of Treasury-backed Fannie and Freddie. But who’s at greater fault for harming the village — the person who poisons the well or the one who distributes the water?

While the OWSers bitch about Wall Street bailouts, the incompetent Dodd-Frank law has made “too big to fail” a permanent feature of our financial landscape.

John Huntsman in the WSJ

Is Dodd-Frank an appropriate regulatory response to the 2007 financial crisis? Tragically, no. That legislation ignores the government’s pervasive role in causing the crisis, assures future transfers from taxpayers to bankers by institutionalizing a government backstop for “too big to fail” firms, and imposes massive new regulations and unreasonable compliance costs on smaller banks. As a result, lending to small businesses from small banks suffers.

The government helped bring on the recession by distorting the housing market through Fannie Mae and Freddie Mac, touching off financial bubbles driven by excessive credit creation by the Federal Reserve, granting a privileged position to toothless rating agencies, and allowing the capture of regulatory agencies by the biggest Wall Street players. The largest banks were pushing hard to take more risk at taxpayers’ expense.

Today we can already see the outlines of the next financial crisis and bailouts. Mitt Romney admitted as much at last week’s debate in New Hampshire. While he gave lip service to opposing bailouts, when asked how we would avoid bailouts he offered no solutions other than implying he would participate in a bailout of Greece. The Obama and Romney plan appears to be to cross our fingers and hope no “too big to fail” banks fail on their watch.

More than three years after the crisis and the accompanying bailouts, the six largest American financial institutions are significantly bigger than they were before the crisis, having been encouraged to snap up Bear Stearns and other competitors at bargain prices. These banks now have assets worth over 66% of gross domestic product—at least $9.4 trillion, up from 20% of GDP in the 1990s. There is no evidence that institutions of this size add sufficient value to offset the systemic risk they pose.

The major banks’ too-big-to-fail status gives them a comparative advantage in borrowing over their competitors thanks to the federal bailout backstop. This funding subsidy amounts to roughly 50 basis points, or one-half of a percentage point in today’s market.

The big banks’ advocates claim that eliminating the too-big-to-fail subsidy would disadvantage American banks against global competition. But U.S. banks’ major competitors in the United Kingdom are facing more sweeping regulatory curbs than any yet proposed here, including the possibility that the investment banking businesses of the large banks would indeed be allowed to fail. The big competitors in Switzerland, another large financial center, are being forced to hold significantly more capital to offset their risks to the government.

The U.K. is absolutely right to attempt to take away this implicit bailout subsidy, and it should be supported by the U.S. We need a level playing field, in which all banks on both sides of the Atlantic achieve solid footing without relying on the implicit guarantee of a government bailout. Experts agree that small and medium-size businesses would benefit if their lenders faced lower regulatory burdens and fair competition with the too-big-to-fail firms.

There is more than one fix. The best would be to eliminate Dodd-Frank’s backstop. Congress should explore reforms now being considered by the U.K. to make the unwinding of its biggest banks less risky for the broader economy. It could impose (more…)