Another Mis-step in Reactionary Regulation

Michael Sykuta —  16 December 2009

Today’s Wall Street Journal reports that Senators Cantwell and McCain are preparing legislation to reinstate Glass-Steagall-type restrictions to create a “firewall” between commercial and investment banks. Apparently Rep. Hinchey is preparing a similar assault in the House.

The purpose behind the proposal, according to Ms. Cantwell, is so that “banks will stop diverting resources to Wall Street speculation and get back to more business lending to main street.” Mr McCain wants to “ensure that never again we stick the American taxpayer with another $700 billion or even larger tab to bail out the financial industry.”

Perhaps instead they should spend just $0.25 and buy a clue.

Let’s start with Ms. Cantwell’s concern for the ever-elusive “main street.” Affording the benefit of the doubt, I presume Ms. Cantwell is referring to small business in general, that sector of the economy that is traditionally responsible for the majority of job creation in the US. But to whom do most small businesses sell? Answer: larger businesses. And what does all that speculative money on Wall Street do? Reduce the cost of financing–either directly or indirectly–for (sometimes larger) businesses, which makes them more likely to grow their own businesses and purchase more things from smaller businesses. Not to mention that large businesses also hire people and are more likely to provide them health benefits (an added bonus in our political point count). Imposing restrictions that reduce financing options for large businesses may, in Ms. Cantwell’s world, mean more money to lend small businesses, but in effect it means small businesses have fewer opportunities to sell their wares and therefore have less need of financing.

As for Mr. McCain’s concern about ensuring we don’t have another $700+ billion bail out, there is a much easier solution: Just Don’t.  First, “just don’t” spend another $700 billion of tax dollars to bail out the banks (or the auto industry or … well, you get the point).  And as, if not more, importantly, “just don’t” impose financial market distortions (such as federally-subsidized mortgages to sub-prime borrowers) in order to achieve political and social engineering goals.

The media consensus seems to be Congressional leadership has no interest in the Cantwell-McCain proposal. Let’s hope they get this one right and this proposal dies a quiet death.

2 responses to Another Mis-step in Reactionary Regulation

  1. 

    What you describe is pretty much consistent with what I wrote (if I’m following your argument correctly). If large businesses are seeking out funding and banks are less able to supply it, the price rises. While in the long term additional supply may be drawn in to take advantage of profit opportunities, at least in the short run the price is higher. When price goes up, quantity demanded goes down (along with the business activity for which the financing was sought).

    Of course, the same argument is true for “main street”. If banks are redirecting money to Wall Street, it means there is not sufficient demand on Main Street to attract supplies of financing at prices that compare with profit opportunities elsewhere.

    It’s amusing that some folks are complaining about banks that are not selling their products to (main street) businesses that are not willing or able to pay a sufficient price to access the product, but I haven’t heard anyone in Congress suggesting that small businesses should start giving their products and services away to people who can’t afford to buy them otherwise.

  2. 

    While I agree with your points about just saying no to bail outs or risky legislative incentives, I am not convinced by your main argument. Essentially, you are arguing that small businesses will be hurt because there will be a reduced supply of financing options for larger businesses because banks will be restricted from offering such options (I hope that is not a mischaracterization of your statement). But won’t a reduction in supply only be temporary? If large businesses are seeking these financing options, that means there is a demand. If these banks are no longer able to provide the supply, price for these services will rise due to shortage, and firms who do not have to exit the market will reap the profits. These above-equilibrium prices will attract new firms to enter the market, and I would suspect that securities firms would increase in size or new specialized firms would enter the market to eat away at these profits until supply and eventually prices stabilize. Perhaps I’m missing something or boiling this down too far to make sense in the complex financial markets. However, wasn’t one of the arguments in favor of repealing Glass-Steagall that banks had too much competition from less-regulated firms? This would lead me to believe there would not be a shortfall (or at least only a temporary shortfall) in financing options for large businesses, thereby not harming small businesses in the long run.