Campaign conundrum.

Photographer: Jin Lee/Bloomberg

GOP Says Big Banks Are Bad (But Don't Touch Them)

Paula Dwyer writes editorials on economics, finance and politics for Bloomberg View. She was London bureau chief for Businessweek and Washington economics editor for the New York Times, and is a co-author of “Take on the Street: How to Fight for Your Financial Future.”
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It came through loud and clear in Tuesday's presidential debate: Republicans don't like Wall Street. They don't like its behavior before the 2008 financial meltdown. They don't like the bailouts that followed. And they don't like the financial power the biggest banks still wield. 

Here's the snag: Their contempt for Wall Street is exceeded only by their contempt for regulating Wall Street. That means, with one notable exception, they offer no realistic solutions to the problems they identify, especially the risks of too-big-to-fail institutions. In some cases, the solutions they offer would reverse five years of progress toward the very thing they claim to want, a sturdier financial system. 

The reasons lie in ideology and practical politics. On the ideological side, Republicans are opposed to big government and skeptical of regulation. That makes them hostile to the 2010 Dodd-Frank law, which gave federal agencies more authority to monitor risk within financial companies and reduce the likelihood of future bailouts by, for example, requiring banks to borrow less and hold more equity capital. 

Politically, the candidates are caught between Wall Street donors who finance their campaigns and the many voters who are still angry that their tax dollars bailed out the banks but not distressed homeowners.

So maybe it shouldn't be surprising that the candidates say strange things about what caused the crisis, the measures adopted to prevent another one, and what more needs to be done. 

Jeb Bush, for example, has raised tons of money from Wall Street and once served as an adviser to Lehman Brothers. On Tuesday night he dodged a question about whether he would bail out a failing bank. Instead, he decreed that the U.S. "shouldn't have another financial crisis." Alone among the candidates, he even had a good way to prevent one: raising capital requirements on the biggest banks and easing them for community banks. 

QuickTake Capital Requirements

The other candidates weren't so clear-headed. Marco Rubio said big banks got bigger because the government added thousands of pages of regulations that they, unlike smaller institutions, could manipulate to their advantage with armies of lawyers and compliance officers.

Wrong. The banks are big, and take big risks, because they have trillions of dollars in assets and can finance 90 percent of their activities by borrowing at slightly below-market rates because of the presumption that the government will bail them out if they get into trouble. It's not because they have lots of employees to make sure they don't violate the law. 

Ben Carson said he favors policies "that wouldn’t allow" banks to become too big to fail. Sound like an endorsement of stronger antitrust enforcement?

No. He said he would stop banks from buying back their stock. His theory turned out to be that the Federal Reserve -- after Wall Street banks, the Republicans' favorite target Tuesday --  makes it too easy for companies to buy back their stock and drive the price up artificially. "Those are the kinds of things that led to the problem in the first place," he declared. Hmmm, the suggestion that share buybacks caused the financial crisis is a new one to me.

Senator Ted Cruz went so far as to say that he would let Bank of America fail if it were on the brink. Would he bail out any of the big banks again? "Absolutely not." 

So what would he do to prevent another 2008-like meltdown? Return to the gold standard, an idea most economists have rejected since the gold standard was dumped after the Great Depression. 

In truth, the Fed would be less able to turn on the money spigot in a downturn if the dollar were tied to the availability of gold, a scarce resource. Printing money to buy huge amounts of U.S. treasuries, as the Fed did in several rounds of quantitative easing to lower long-term interest rates, would be impossible.

Then there was the issue of how to protect depositors in failing banks. Governor John Kasich of Ohio said he would protect the funds of "hard-working folks" over those who can afford to lose their money. He didn't mention that those folks are already protected by federal deposit insurance, which covers up to $250,000 per account. 

Even Bush, who alone seemed to understand the role of bank capital, stumbled when he said Dodd-Frank had resulted in higher concentrations of risk in banks, and in capital requirements that are too low -- the opposite of what's actually happened.

He's half right on the biggest banks' risk levels: Three of the six largest banks are smaller now than they were in 2008. But he's dead wrong to say that banks have less capital because of Dodd-Frank. Regulators, following the letter of the law, now require banks with more than $50 billion in assets to have far more capital than they did before the crisis. They require even more from banks that are considered systemically risky. Bush can argue it's not enough, but not that Dodd-Frank didn't result in stricter capital rules. Besides, if more capital is good, wouldn't the law that requires banks to have more capital be good, too?

QuickTake Too Big to Fail

Kasich tried to back up Bush by saying that "what Jeb is talking about with the big banks is to force them to reserve their capital." But the Ohio governor mixed up reserves, which are the funds banks set aside for potential losses on loans, with equity capital, which is the money banks use to fund their business.

Equity capital can be loaned or spent in any manner a bank wishes. It isn't a rainy-day fund; it isn't reserved, or kept in a lock box. It's simply the money that comes in when shareholders buy stock, or when a bank retains earnings instead of paying dividends. 

Bush further blamed financial regulation for the sluggish economy. "My worry is that the real economy has been hurt by the vast overreach of the Obama administration," Bush said.

He told the story of a community bank with $125 million in assets in four branches. Its compliance costs went from $100,000 to $600,000 two years after Dodd-Frank passed. That sounds as if it had one compliance officer covering all four branches before the law, and now has one per branch. To paraphrase something his father, President George H.W. Bush, might have said: That would be prudent. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Paula Dwyer at pdwyer11@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net