Have Regulations Hurt Bank Profits?

If recent rules have brought Wall Street revenue back down to earth, is that healthy or a sign of heavy-handed regulation?

Sure, new fees and regulations -- some necessary and some not -- will shrink bank profits. But what should shrink bank profits is the free market doing what it is supposed to do: cut a bloated industry down to size.

The financial industry has grown too quickly for more than 25 years. Between the early 1980s and 2007, financial-industry profits more than quadrupled as a share of the nation’s income. Why the financial industry enjoyed this growth is no great mystery. Beginning in the early ’80s, Washington treated the financial industry’s big lenders -- global bondholders -- as a class of investors immune from losses. The phrase “too big to fail” entered the financial press lexicon.

Subsidize corn production, and you get more corn. Subsidize lending to the financial industry, as America has done via its “too big to fail” guarantees, and you get more financial industry -- whether you need more of it or not. In turn, over the past two and a half decades, we got more American indebtedness, as financial firms turned around and lent their own cheaply borrowed money to the American home “owner” and consumer via ever more complex structures.

The best way to shrink Wall Street is to let the markets do it. If the government made it clear that it won’t bail out financial firms’ bondholders and derivatives partners, these bondholders and partners would think twice about putting their money on the line with black-box financial firms.

The only way to stand by a “no bailouts” pledge is to make sure that financial firms can fail without bringing down the entire economy. That means regulating derivatives and consistently limiting borrowing.

America hasn’t accomplished these goals, as this Dealbook article points out. More than three years after TARP, despite new caps on some bank fees, we have no idea what bank profits will look like one year — or five years — from now. Such a projection would depend on predicting not how much banking the nation actually needs — and at what price — but on predicting government whim.

The situation is not good for the economy. It’s not good for the banks, either, in the long run, as people fed up with the lack of market discipline for banks take matters into their own hands.

This piece originally appeared in The New York Times

This piece originally appeared in The New York Times