It will be interesting to see how the Big Government punditocracy squares its doubling-down defense of President Obama’s comments that “the private sector is doing fine” with today’s long-awaited Senate testimony of JPMorgan Chase CEO Jamie Dimon. After all, if the private sector were really “doing fine,” then there’s no need to worry about the bank’s recently announced $2 billion trading loss, right?!
But, of course, that’s not what those pundits will say. Should they address Obama’s comment at all in this context, they will no doubt say something to the effect of “The private sector is just fine, except when it needs massive regulation for market failures.”
To be sure, the existence of too-big-to-fail institution with explicit or implicit government guarantees is where many on the Left and Right agree that the private sector is not “doing fine.”And the prospect of government bailouts is one of the most compelling cases for regulation, if the regulation would actually reduce the existence of bailouts. The problem is most of the regulations proposed — such as those in Dodd-Frank — wouldn’t fix too big to fail, would add great costs to ordinary consumers and investors, and would actually prevent smaller entrepreneurs from challenging too-big-to-fail.
First, a word about the JPMorgan Chase loss. There is general consensus that this loss won’t pose a risk to JPMorgan Chase itself, much less to the financial system. As I wrote initially and has been subsequently confirmed, much of this loss is “mark-to-market,” or a paper loss to the trading value of securities. The actual losses to the company will depend on how and when the firm unwinds the trades in the securities, and there may even be some gains if they pick up in value. Further, JPMorgan Chase’s losses appear to be others’ gains, as banks from Goldman Sachs to Bank of America are reported to have bet on the other side of the trades.
Nevertheless, the sudden reporting of losses of such a big number that taxpayers could however conceivably be on the hook for brings home the problem of too-big-too-fail. And that’s not a bad thing provided solutions are not destructive, as the Volcker Rule in Dodd-Frank would be. As I have written, the Volcker rule would negatively affect initial public offerings for smaller public companies and other “trading that is necessary for activities that there is widespread agreement benefit the economy as a whole.”
One of the best solutions to the existence of too-big-to fail banks is to free competitors to challenge these banks’ position in the financial system. One place to start is to cut the federal and state red tape that keep the non-bank lenders that bet entirely with their own money from having a broader reach.
Throughout American history, non-bank lenders gone where banks failed to go and provided desperately needed loans to countless entrepreneurs and consumers, even though there is no government deposit insurance to rescue these lenders should the loans go sour. This sector has been the true provider of “microcredit” in America.
“Microfinance” is a hot topic in the academic and policy world. Muhammad Yunus of Bangladesh won a well-deserved Nobel Prize a few years back with his innovative approach to non-bank neighborhood lending in Bangladesh. Yet providers of microcredit in America — payday lenders, pawn shops, etc. — are looked on by many policy elites with scorn. And even when these lenders are subject to legitimate criticism, frequently no one details how to remove barriers to creating an alternative in the lending market.
Not only that, but non-bank lenders are frequently subject — by state government interest rate limits that may be copied by Dodd-Frank’s new federal Consumer Financial Protection Bureau — to different standards than big banks offering similar financial products.
As I detailed in a recent Competitive Enterprise Institute paper, the typical charge that payday lenders charge a 400-percent annual percentage rate, which has served as the basis for several state interest caps enacted in the past few years, is highly misleading. If common “fees” for overdrafts, bounced checks and late payments were counted as interest, they would well exceed the APR for payday loans.
Kelly Edmiston, senior economist at the Federal Reserve Bank of Kansas City, points out in his study published in that Fed branch’s Economic Review, that the “median interest rate” for bounced check fees — if they were measured as interest payments — would be “well in excess of 4,000 percent, or up to 20 times that of payday loans.” In short, annual percentage rate is an inappropriate measure for loans that have a duration of weeks and months.
Fortunately, there is legislation from an ideologically diverse group of members of the U.S. House of Representatives that aims to even the playing field between banks and non-bank lenders. H.R. 1909, the FFSCC Charter Act of 2011, would create an optional charter from the Comptroller of the Currency for non-bank lenders who choose to be designated as “Federal Financial Services and Credit Companies.” It is sponsored by Rep. Joe Baca (D-Calif.), with cosponsors including liberal Democrats such as Reps. Gregory Meeks (D-N.Y.) and Albio Sires (D-N.J.), and conservative Republicans such as Reps. David Schweikert (R-Ariz.) and Ed Royce (R-Calif.).
Under the bill, nonbank lenders would still be operating entirely with their own money and without any form of deposit insurance. But they could choose between federal and state regulators and be able to obtain an optional charter to operate nationally without encumbrance by a particular state’s foolish rules. This is similar to the system of competitive federalism that has existed for more than 150 years for banks, and that CEI has proposed for insurers
The need for quick access to small amounts of credit couldn’t be more pressing in an economy with unemployment more than 8 percent. Unexpected circumstances like a car breaking down or the need for emergency travel can hit responsible individuals who could pay back the loan in a few months, or even a few weeks. Non-bank lenders with broad reach could offer an alternative to limited options such as overdraft fees.
And they would reduce the power of too-big-too-fail bank, by providing credit alternatives that would be there should these banks fail. All of this would be small steps toward make the private sector more “fine.”