"Fixing the banking system should always have been the No. 1 priority of the U.S. government," exclaims Harvard economic historian Niall Ferguson, the author of The Ascent of Money: A Financial History of the World. While recent rhetoric suggests the Obama administration is finally waking up to the importance of pursuing such changes, Ferguson sees little evidence that governments, here or abroad, have done enough to alter the status quo.
"The banks have become even bigger and their leverage has barely dropped," observes Ferguson, "and with the economy having seemingly moved away from the brink of meltdown, the urgency for change has been slipping away." Worse, he believes the focus on the symptoms of the financial crisis, rather than the root causes, is leaving the world even more vulnerable than it was a year ago.
The financial crisis was certainly not of President Obama's making, says Ferguson. But he feels that the president lacks a grip on congressional Democrats and thinks every one of Obama's policy initiatives has been wildly distorted in the legislative process.
"If Obama leaves solving the federal debt, budget deficit and banking reform to Congress, you're going to get a dog's breakfast of ideas and special interest measures," Ferguson surmises. "You won't get what we need, which is a clear root and branch reform. To that end, it will take Abraham Lincoln-like presidential skills."
Perhaps what has surprised Ferguson most over the first year of Obama's presidency is that in spite of having assembled some of the brightest economic minds in Larry Summers, Tim Geithner and Christina Romer, there remains an almost laissez-faire attitude toward the "too big to fail" problem. "I find this puzzling because I'm quite sure these people are intelligent enough to know there is something amiss with the system. It seems they are very reluctant, for reasons that aren't entirely clear, to tackle these problems."
He does see the recent proposals conceived by Paul Volcker as somewhat on point. But Ferguson doesn't believe focusing on just the size of banks or their proprietary trading-the targets of Volcker's plan-will address the root causes of the crisis.
He would like to see reforms focus on actual risk-on what the banks can actually lose in given scenarios-not just on the characteristics associated with these risks.
Ferguson would rather see a new international standard for bank leverage and the serious consideration of Boston University professor Larry Kotlikoff's proposal for "limited purpose banking." The proposal would limit the liability of all financial companies by turning them into mutual fund companies that have 100% capital requirements. They would not be permitted to borrow to invest, and therefore would never face a failure due to a bank run.
Ferguson has no problem with hitting the banks with special windfall taxes now that they have recovered their profitability following their bailouts. The government, he thinks, has a right to make back a part of what it has lost due to the crisis, which goes well beyond TARP money. But he sees the current banking proposals as more of an attempt to "punish the big banks for daring to make money and pay big bonuses so soon after they were bailed out." The reforms, aren't addressing the root causes of the crisis, such as the concentration of risk and the failure of the banks to anticipate the worst-case scenarios. Instead, populism is driving much of the dialogue.
Not all is bleak, according to Ferguson. Central bankers did save the system by decisively improving liquidity, easing credit and opening the discount windows to key institutions that previously would not have had access to cheap money. "We sort of avoided Great Depression 2.0," he observes, "but I wouldn't say we are out of danger. We've only addressed the symptoms of the financial crisis, such as bank failures and credit contraction."
What Still Worries
To Ferguson, the structural causes of the crisis that remain in place include excessive bank leverage, bond markets contaminated with AAA-rated toxic assets, the reckless insurance of financial risk, excessive economic incentives to increase home ownership, the huge credit line that China extends to the Unites States and, finally, China's currency policies.