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Short-Termism Rearing Its Ugly Head - Again

In 2008 the world nearly ended as we know it.  At the root, the global financial system nearly collapsed.  Cutting through all the BS, it was extreme leverage that nearly brought the world to its knees.  In layman’s terms, “leverage” just means too much borrowing.  It all began with the banks who had borrowed way too much, which is another way of saying that they were operating on too little equity, or true net worth, and were thus in a very vulnerable place.  Then they pushed their excessive capital onto the public in the form of very enticing loan funds that proved hard to resist.  Many bought homes they could not afford to buy, which inspired homebuilders to build homes that should not have ever been built.  Companies were inspired to borrow to grow, or to be created, thus creating jobs rooted in speculative activity – many of which probably had little justification for existence and would in time be lost. Financial buyers, including those who bought stocks of companies – in the public or the private market, and real estate investors continued to pay ever-increasing prices, which only served to make all their previous decisions look prescient, thus emboldening them to continue to borrow and buy more.  And consumers, offered unprecedented access to funds through an unending string of offers in the mail for credit cards, credit lines, and home equity loans were ultimately enticed to buy things they could not afford. In 2007 everyone was happy, with so many unaware of the tenuous nature of their joy which would soon come to an abrupt and frightening end.  

Today, thanks to some restrictive policies that were enacted in the wake of that crisis, U.S. banks, businesses, and consumers are in somewhat better shape.  However, there is a significant movement afoot to reverse some of that restrictive regulation – called broadly “The Dodd-Frank Bill.”  You might rightly ask who would benefit from undoing these restrictions that would make our financial system more vulnerable to collapse, and the answer is:  bankers, politicians, and borrowers.  So, in other words, many influential and powerful forces.  Bankers want to lift as many limitations as they can in that this would enable them to manage larger, more far-flung empires that would enhance their wealth and status.  Politicians benefit from loosening the reins on banks because more bank leverage means that more capital would be available to course through our economy and would be available to be borrowed by consumers and businesspeople, which would foster more economic vibrancy, more jobs, more wealth.  Consumers and businesspeople would surely be pleased to have greater access to cheap source of debt capital just as all of us sugar addicts would forsake our diets in a heartbeat for an excuse to indulge on some special sweet treat.  So, in short, many would be pleased and, at least in the short run, very gratified.  The allure for our economy to get a boost from any source, even a temporary sugar high, is very powerful.

The opponents of liberalizing bank legislation thus face a serious uphill battle.  These few and brave people are inevitably portrayed as being either Scrooge-like, because they stand in the way of enhanced economic prosperity and joy, or as being simply ill-informed.  Their argument, that there is a massive price that must ultimately be paid for short-term joy is, sadly, not one that resonates in a world filled with short-term thinkers.

I write this piece today because the new administration, understandably anxious to create any economic vibrancy, seems to be leaning towards undoing some of the Dodd-Frank restrictions, and I am very concerned.  Bankers make the argument that the restrictions impair their ability to compete favorably with other nations’ banks, although I’m not sure what banks they’re worried about competing with given the decrepit situation of most of them (see: Deutsche Bank).  Recently I read Gary Cohn, former president of Goldman Sachs and current White House National Economic Director, defending this position and quoted by the WSJ as saying: "It has to do with being a player in the global market, where we should, could, and would have a dominant position as long as we don't regulate ourselves out of that."

Mr. Cohn, with all due respect, if other nations want to gamble with the health of their financial system and pursue unsound policies that lead their banks to loan at lower rates or too high proceeds than ours, stand down and let them do so. Their stupidity is a subsidy for our economy. In fact, get out of their way and liberalize laws to entice them to lend to American businesses and consumers too cheaply. Our economy will be uplifted by this gift and we should welcome it with open arms, but our banks should not be allowed to follow suit.  If that means that our big banks lose market share for some time, and if their leaders must make due with less compensation and maybe less prestige at gatherings like Davos, so be it.  And, Mr. Cohn, as I'm sure you already know being a career man of the markets, the price that these other nations will pay will ultimately be very steep. By not following them into another round of global financial stupidity we will one day soon be in a very enviable position indeed.  In other words, have a little vision please.

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