Even Bigger Banks and the Coming of Finance Socialism

According to David Cho of the Washington Post, big banks like Morgan Stanley, Bank of America, and Wells Fargo have become considerably bigger as a result of last year's financial meltdown.

J.P. Morgan Chase, an amalgam of some of Wass Street's most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue of of every two mortgages and about two of every three credit cards, federal data show.

A year after the near-collapse of the financial system last September, the federal response has redefined how Americans get mortgages, student loans and other kinds of credit and has made a national spectacle of executive pay. But no consequence of the crisis alarms top regulators more than having banks that were already too big to fail grow even larger and more interconnected.

It almost goes without saying that a higher level of concentration in the banking industry means that the next financial meltdown is going to be even worse--much worse. The Obama administration and the Federal Reserve Board were able to get through the last crisis because there was some margin for error. When BearStearns went belly-up, it could be absorbed by Morgan Stanley. The same with Merrill Lynch being absorbed by the Bank of America.

But there not going to be any Plan B for failed big banks next time. Last year, the "big banks" were "too big to fail." Next time, the even bigger big banks will be "too big to save" within the framework of private corporations. Morgan Stanley and Wells Fargo are plenty big, but they're not big enough to absorb teetering monstrosities the size of Citigroup or Bank of America. The only answer to the failure of "bigger big banks" will be to nationalize them.

Whether we like it or not, "finance socialism" has almost arrived.

Are Banks the No. 1 Threat to Capitalism? Fareed Zakaria has an article out for Newsweek entitled "Can Obama Save Capitalism." But I'm beginning to wonder if capitalism can be saved, or at least capitalism as we know it.

This is what got me wondering. Talking Points Memo features a post from someone in the real estate business who claims that banks are not using TARP money to lend for development projects. He quotes one banker as telling him that the banks have decided to use TARP money for buying other banks rather than new lending or renewing old loans.

As a commercial real estate attorney, I'm deeply involved with the current complete freeze-up of the commercial lending markets. I have many clients who have sound business practices in the development of commercial real estate.

Suddenly, and coinciding with the Lehman/Goldman fiasco, the commercial lending markets completely disappeared. Not just a slow down, but a complete and total shut down. Loans for which there were commitments were suddenly pulled. Term loans (most in the development world are for 1-2 years at a time) were suddenly not available for renewal putting borrowers in immediate default, or the lender required severe principal reductions in order to for the borrower to renew - severe to the point of not possible.

I'm not talking about over-speculative developers here asking for a bail-out. I'm talking about fiscally responsible developers, on-time payors with pared down staffs, who wrongly believed that the TARP funds going to the major banks would be put into circulation in the credit markets for new loans and renewals, which are the life-blood of the real estate industry. One bank had the temerity to tell me on a conference call that they were using the TARP funds for acquiring other banks,
not for new loans or renewals. And here lies the problem with the Paulson/Bernacke/ Frank plan...they once again trusted the banks "to do the right thing", (a la Greenspan), without requiring that the TARP funds go right back into the lending stream through the conduit of the banks. I'm not socialist, but I sure would agree for a Bank of US to come out of this mess. This is happening today, and the warnings are clear, and the results will be catastrophic.

If that claim is true, it's very interesting. Perhaps most importantly, it means that banks have decided that their "normal" business is mergers and acquisitions rather than lending.

But why is that the case?

I can't help but believe that bank executives believe that "buying other banks" is more profitable, better for the health of their companies, or more conducive for big bonuses and promotions than lending money to businesses.

Why that's the case is hard to tell. Perhaps the profits from lending are low because of low interest rates? One could argue that commercial ventures don't look very safe right now. But why would acquiring new banks look safer? It must might be that lending money looks boring, stodgy, or extremely limited in comparison to buying and selling other companies.

Whatever the reason, the reluctance to lend poses problems for American capitalism. First, the reluctance to lend undermines the rationale for using TARP funds for financial bailouts. If financial institutions just don't want to lend money to commercial enterprises, they won't use TARP money to restart lending. As a result, there is no reason to give bailout money to large-scale financial institutions. The money would be better devoted to creating an alternative for the commercial loans, consumer loans, and housing loans that business needs to get back on track.

In this context, the logic of the situation is that the government should be willing to take on a lending role for the next few years. Perhaps the TPM poster's "socialist" idea of a Bank of the US is the only way to generate the credit mechanisms needed to keep American business afloat.

The next question is whether private institutions are capable of providing the financial instruments needed for American business to function and grow. Right now, the jury is probably out on that, but it may be that the Obama administration needs to reimpose the Glass-Steagle Act that mandated the separation of commercial banks that primarily engaged in lending from brokerage houses that primarily engaged in investment.

To the extent that banks view themselves primarily as investment institutions, they may not be very useful for the American economy. The Obama administration should be gearing its policies toward re-making commercial banks as lending institutions. Otherwise, the government is going to have to become the primary lending institution in this country.