Hey, Simon Johnson agrees with me!

A little, sort of.

I shared this shower musing about a year ago:

why not index tax rates to GDP growth?  The government has no trouble indexing the yield on TIPS to inflation. Why not set a baseline tax rate that's operative at, say, 3% GDP growth, adjustable down in a set ratio all the way to, say, a 3% contraction, and adjustable up all the way to, say 6% annual growth? Economic velocity will determine our GAIT (Growth Adjusted Income Tax).

Yesterday, contemplating the possible gridlock-induced expiration of all the Bush tax cuts (no way...), Johnson proposed:

The messy evolution of the legislative process, cont.

Bulletin from Pollyannasville:  the health care and financial reform bills disappointed purists of all persuasions.  But both came out stronger than most progressives familiar with the legislative process could have hoped.  In both cases, the widely forecast denuding of key provisions by powerful lobbies was largely forestalled.  In both, the process was more open, more closely tracked by interest and public interest groups and media observers of all stripes, than any prior legislation.

I have more than once referred  to the health care bill  postmortem by Andy Stern, ex of SEIU. His first observation below is tactical. But his second makes an historical argument for what has happened to the legislative process:

First, the longer you wait, the harder it gets and the worse it gets. Time for deliberation is appropriate, but indecision and delay are counterproductive to getting something done. The choices don't get easier over time. They get harder.

Second, people have to decide whether people in the same party will use procedural tricks to trip up their teammates. Or whether parties, particularly the Democratic Party, appreciates that the special deals and earmarks that might traditionally have been part of the process no longer work. Politicians used to bring kickbacks home to their district, but now people think the system is corrupt.

Even Simon Johnson is surprised, if not satisfied, by the FinReg bill

The FinReg bill is good news for the many who have argued that the financial sector is bloated, absorbing too high a share of the nation's profits, attracting a disproportionate share of talent and wielding dangerous influence over public policy. The Wall Street Journal's Randall Smith:

The Senate version of financial regulation hits Wall Street harder than expected, with some analysts estimating it could cut the profits of major financial institutions by roughly 20%...

Goldman analysts recently tried to quantify the impact of the changes likeliest to survive, including already adopted caps on fees for checking accounts and credit cards, as well as restrictions in the Senate bill on proprietary trading with the banks' own money and the House curbs on derivatives. Those elements alone could shave 17% off bank earnings, Goldman said. Less-likely changes could boost the hit to 23%.

Glenn Schorr, an analyst at UBS AG who follows financial stocks, said Wall Street could recoup some of the lost profit through higher volumes or by keeping pay below historical levels. A derivatives-trading spinoff could free up capital for redeployment elsewhere.

The degree to which the legislation curbs current banking practices has stimulated a kind of wonder, even in that most trenchant of regulatory Cassandras, Simon Johnson.

The Senate gets into the swing of bankwhacking

Some months ago, as health care reform languished and the Senate ground nearly to a halt, one read frequent laments that the moment for sweeping financial reform was being wasted -- that by the time the Senate got around to full consideration, memories would have faded, rage against the banks cooled, and lobbyists' hooks sunk ever deeper. 

Reasonable worries, perhaps. But those who despaired of strong reform did not reckon on HCR passage changing the dynamic in Congress; or on the pressure that would be generated by bringing the bill to the floor just as election season heated up; or on the fresh spur to rage afforded by an SEC suit (and criminal investigation) against the nation's most lucrative financial institution.

Just nine days ago, Jonathan Chait was marvelling at the strength of the Dodd ill as it came to the floor. Now, the WSJ reports, a tide of amendments is bidding to restrict financial institutions' activity far more radically:

Sens. Ted Kaufman (D., Del.) and Sherrod Brown (D., Ohio) plan an amendment that would prohibit any bank from ever holding more than 10% of the country's deposits and put strict caps on the debt banks issue.

Sens. Maria Cantwell (D., Wash.) and John McCain (R., Ariz.) have worked on an amendment that would force commercial banks to separate from investment banks—revisiting the Glass-Steagall Act of the 1930s.

Sens. Jeff Merkley (D., Ore.) and Carl Levin (D., Mich.) plan a provision to forbid banks with federally insured deposits from certain trading activities.

Mitch McConnell, bank-shrinker?

Ezra Klein has beat me to it again.  Today Mitch McConnell came out against Dodd's bank reform bill,  claiming that by setting up and funding a resolution authority that enables regulators to liquidate the largest financial institutions in an orderly fashion if they become insolvent, it is enabling and in fact guaranteeing future "bailouts." "“This bill not only allows for taxpayer-funded bailouts of Wall Street banks;  it institutionalizes them,” McConnell pronounced.

Klein points out that McDonnell is equating a liquidation that wipes out shareholders and management with a bailout -- and further notes that McDonnell is following to the letter a political strategy laid out by GOP pollster Frank Luntz in February: to equate any Democratic bank reform bill with the hated bailouts of 2008-09.

Cynical indeed. As Klein suggests, if you don't want to give regulators resolution authority over banks currently considered too big too fail, it would seem you would have to be in favor of not allowing banks to grow, or stay, too big to fail.   I would add that the only intellectually consistent, if insane, alternative to  breaking up, shrinking, or reining in today's behemoths or making provisions for their orderly liquidation is to take the position taken by many of the most ignorant and extremist Republicans in fall 2008: let 'em all fail and let the chips fall where they may. Pull down the whole temple of global finance around our ears.

But McConnell is not that crazy. He acknowledged last October that TARP “succeeded in stabilizing the banking system.” It seems fair to assume that he believes that the Federal government can't simply step back and let too-big-to-fail banks enter bankruptcy. That brings us back to Klein's question:  what steps would McConnell favor to make the behemoths smaller, or otherwise enable them to fail without systemic risk?

A tailor's yard for cutting megabanks to size

Ever wonder how a regulatory regime with a mandate to break up banks that are "too big to fail" would operate?  Every article I recall reading on the subject treats the question structurally -- that is, by addressing what activities a single financial entity should not be allowed to engage in simultaneously. For example, Paul Volcker recently recommended forbidding deposit-taking banks from engaging in proprietary trading. John Gapper has proposed.separating the functions of retail banks, investment banks and asset managers.

But leaving aside function-based restrictions, how would a regulator determine how big is too big -- literally, from the standpoint of creating systemic risk?  Peter Boone and Simon Johnson, posting on The Baseline Scenario, provide a legislative update, an analogy, a guideline, and a recommendation:

The Kanjorski amendment recognizes that the systemic and societal danger posed by banks can be hard to recognize, and it proposes a number of potential objective criteria that could be used by the Financial Services Oversight Council (to be created by legislation in progress) to determine when banks need to be broken up, including the “scope, scale, exposure, leverage, interconnectedness of financial activities, as well as size of the financial company.”

The Kanjorski amendment does not impose a hard size cap on banks, but lawmakers in the House are discussing amendments that would do so.

There is, of course, a strong precedent for capping the size of an individual bank: The United States already has a long-standing rule that no bank can have more than 10 percent of total national retail deposits.