The president was right to talk about nuclear power, high-speed rail, offshore drilling, and tax credits for small business, as well as the modest jobs bill. But he would have added to the longer-term business confidence if he had put forth a national infrastructure bank, independent from Congress, focused on large-scale interstate programs or programs paid for over time by tolls. He could have let Congress keep the smaller projects so it would still have some earmarks and pork to pass around, in return for giving up the big-ticket items.
He did focus on the financial system. The grave financial crisis is now behind us, but it was a close call. Today, the president is whaling away at the financial world in an attempt to channel public anger against Wall Street. The populist rhetoric may be politically helpful, but it is economically counterproductive. Attacking the financial world and business just adds to the climate of uncertainty and puts yet another hurdle in the path of creating jobs. Every business owner or would-be business owner already faces the uncertainty of new costs from healthcare programs, new taxes, cap-and-trade, and additional regulation. No wonder the administration's condemnation of the financial world caused a plunge in the Dow of 500-plus points, wiping out billions of dollars of equity. Instead of taking a meat ax to a business sector suffering from fragile confidence, the president should at least wait until there is a reasonable sustainable path back to mass prosperity.
Yes, the banks are not lending as they used to. But many banks' loan books remain impaired even to this day, forcing them to hoard their cash to deal with the losses they may face in the future. Banks still hold toxic assets, including subprime mortgage paper and even prime mortgage-backed securities, which are still being unwound. They are facing unprecedented defaults on credit card lines, automobile loans, student loans, and other loans to small businesses.
So credit is still constrained, especially for small businesses, 82 percent of which use credit card lines as a vital portion of their overall funding. Those credit lines have been cut by at least 25 percent, while lending standards have been tightened dramatically. Similarly, there has been a constriction in home equity loans, another widely used source of funding for small businesses. But given banks' shrinking loan books and the dubious credit of their existing loans, the only way for banks to make money is to ride the yield curve. This means taking billions of dollars in deposits or other funds, mostly from the Federal Reserve and costing them less than 1 percent, and then investing them into medium-term treasuries or high-quality paper at 3 percent or more. The administration's approach of taking proprietary trading away from the banks means that they lose the one area where they could make money over the next few years. This raises the danger that we will have a zombie banking system similar to Japan's in the 1990s, when banks were functioning but incapable of extending credit. If the administration wants to restrain certain activities of banks, it could raise the appropriate capital requirements, especially for proprietary trading, so that shareholders have more at stake and will be the ones to absorb the losses before anyone has to turn to the government.
One step to consider now would be to provide financial institutions with liquidity by having the Fed buy nonliquid, asset-backed paper for realistic discounted market prices so that the speculators and the banks would pay for their bad behavior by realizing their losses. The banks don't want to show these losses, but at least that would help restore additional liquidity to the banks.
The banks alone did not create the meltdown mess. The American public played its role when it turned from saving to borrowing, going on a consumption binge based on credit rather than earnings and then borrowing against its rapidly appreciating housing assets. Many people cheated on their mortgage applications, especially loans that required no verification of the borrowers' income or net worth, which infamously became known as "liar loans." And let's not forget the regulators from the Securities and Exchange Commission on down who failed to police these activities, or the lawmakers who failed to adopt new rules to prevent the side effects of increasingly complex financial innovations. They failed to understand that, cumulatively, this posed a "systemic risk." Congress itself, now busy pointing the finger, was grossly negligent in failing to rein in Fannie Mae and Freddie Mac, which congressional Democrats saw as honey pots for their party colleagues and as sources of campaign contributions.