Move Your Money?

What to do about the banks? This is a significant question for 2010. The large banks are considered too big to fail by the Treasury. Localities are complaining about the still frozen lending capacity. Small and medium-sized banks continue to collapse into the arms of the FDIC at record rates. And toxic debt remains a pervasive weight on virtually the entire banking industry. How can all this be turned around?

Arianna Huffington and some of the Huff Post crowd have an idea: convince everyone to pull their deposits out of the big banks and put the cash in community banks. She and a handful of others have started as an attack on the large banks, which they see as a threat to the fiscal stability of the nation. And in theory, there is nothing inherently wrong with more people shifting their cash to community banks.

But it is not going to solve bank problems. When you look at the philosophy behind the Move Your Money movement, there are some very flawed presuppositions mixed in with very accurate criticisms. Unfortunately, the misguided views are representative of a wide number of voices in the pundosphere and on Capitol Hill—and if they continue to drive banking reform, the end result is likely to be reduced competition, retarded innovation, and a missed opportunity to get back on a path to prosperity and economic growth. Here is a look at the founding ideas, as put forth by Huffington and Rob Johnson:

“The big banks on Wall Street, propped up by taxpayer money and government guarantees, have had a record year, making record profits while returning to the highly leveraged activities that brought our economy to the brink of disaster.”

Yes, the banks have been propped up by taxpayer money. And that has allowed them to avoid making tough management decisions while maintaining some of the operating practices that got them in this mess in the first place. This was one of the reasons the bailout was a bad idea in the first place. However, the “profits” this has garnered the banks are largely surface level. The banks certainly aren’t healthy, and those much reviled profits have really benefited the banks in the way that profits are traditionally defined (unless you’re Goldman Sachs, in which case you actually have made money). It is important to realize that the banks aren’t leaving 2009 sitting on a pile of gold from all the money they’ve swindled away this year, and that we should be looking to make them healthy again, not attack them as institutions.

“In a slap in the face to taxpayers, they have also cut back on the money they are lending, even though the need to get credit flowing again was one of the main points used in selling the public the bank bailout. But since April, the Big Four banks — JP Morgan/Chase, Citibank, Bank of America, and Wells Fargo — all of which took billions in taxpayer money, have cut lending to businesses by $100 billion.”

We were sold the bailout on grounds that liquidity was the main problem. But this wasn’t the core issue, as we have come to find out. Cash has been pumped into the system, but without confidence it hasn’t been moving. The banks haven’t slapped America in the face by reducing their lending, they have acknowledged years of loose lending were a bad idea. Why do we want the same lending back in the system as before? Wasn’t that part of the problem? Sure, it is going to be harder to get a loan now, but that is the point of getting back to a more stable, health system. We forced bailout money down the throat of half the Wall Street banks (Paulson actually threatened banks who didn’t want the government shackles), told them we’d break them into pieces if they screwed up again, didn’t force them to deal with the toxic debt… and somehow we expect lending to be back at boom year levels?

“Meanwhile, America’s Main Street community banks — the vast majority of which avoided the banquet of greed and corruption that created the toxic economic swamp we are still fighting to get ourselves out of — are struggling. Many of them have closed down (or been taken over by the FDIC) over the last 12 months.”

Community banks largely didn’t succumb to the same misguided leverage practices because they didn’t have the capacity to. The large, national banks were able to shift their loans off balance sheets through securitization, expanding their ability to lend. This leveraging ability was not open to small banks who simply lent and managed deposits. Nevertheless, there are still plenty of small banks that made the same mistake as the big boys in lowering their lending standards. They issued bad mortgages as well, and that is why many of them are being taken over by the FDIC. While there certainly are plenty of examples of community banks acting wiser than the big boys (and I’d guess it was the majority of them), it would be a mistake to idolize them as perfect institutions.

“The government policy of protecting the Too Big and Politically Connected to Fail is badly hurting the small banks, which are having a much harder time competing in the financial marketplace. As a result, a system which was already dangerously concentrated at the top has only become more so.”

This is absolutely correct. The policy too big to fail has allowed big banks access to cheaper credit, giving them a widening competitive advantage over smaller banks.

“We talked about the outrage of big, bailed-out banks turning around and spending millions of dollars on lobbying to gut or kill financial reform — including ‘too big to fail’ legislation and regulation of the derivatives that played such a huge part in the meltdown.”

Why is this an outrage? Obviously banks are going to try and combat new rules that limit their profitability. The problem is that Washington has a vindictive “us” vs. “the banks” mentality in regulation reform, instead of working with them to find the best possible rules of the game. Obviously the banks don’t want to fail themselves. If they can’t count on a government bailout, then regulations or not, they are going to seek to protect themselves. The banks aren’t trying to kill financial reform—they (and this is a very general term) are trying to prevent this reform. And for good reasons. The CFPA would not only be bad for banks, but for consumers as well. The regulations on executive pay don’t help the industry return to health. The systemic risk oversight proposals would codify the idea of too-big-to-fail.

“…The idea is simple: If enough people who have money in one of the big four banks move it into smaller, more local, more traditional community banks, then collectively we, the people, will have taken a big step toward re-rigging the financial system so it becomes again the productive, stable engine for growth it’s meant to be. It’s neither Left nor Right — it’s populism at its best. Consider it a withdrawal tax on the big banks for the negative service they provide by consistently ignoring the public interest.”

This idea certainly isn’t Left or Right, but it is unclear as to how this will create a productive, stable engine for growth. The whole reason that banks and other mortgage originators grew so rapidly was because they were able to provide a service that local banks couldn’t. In the 1980s, when it became clear that there was about to be an explosion in demand for homes, Wall Street figured out that community banks weren’t going to be able to handle the increased demand. In fact, we never would have experienced the growth we saw in housing in the first place without securitization. Now, it shouldn’t have happened the way it did, but it is important to understand this basic fact when trying to get out minds around what a return to “stable growth” looks like. Shifting all deposits into community banks would not mean going back to what we had before. Some local businesses might have access to loans, but there certainly plenty of entrepreneurs that wouldn’t have access to credit. A stable, productive market includes credit provided by both community banks that bet on more sure risks, by larger banks that can bet on a wide range of risks, and by private equity that can take bigger risks.

“It’s time for Americans to move their money out of these reckless behemoths. And you don’t have to worry, there is zero risk: deposit insurance is just as good at small banks — and unlike the big banks they don’t provide the toxic dividend of derivatives trading in a heads-they-win, tails-we-lose fashion.”

Yes, your money is safe in either location because of FDIC insurance. But derivatives are not a win-lose deal for Americans. Derivative trading, when done property, allows for the expansion of the U.S. economy, advanced standard of living for Americans and the world, and prosperous society. This doesn’t mean derivatives shouldn’t be monitored. This doesn’t mean derivatives weren’t problematic. It just means they shouldn’t be demonized in principle. And it should be clear to any who like the idea of shifting all deposits to community banks that the ability of big banks to leverage their wide asset holdings is beneficial to the economy with prudence and proper risk management.

Read the entire article here.