Obama's banking proposals will hurt, not help

WASHINGTON — Barack Obama, whose political fortunes are being overturned by a tide of national frustration that began spreading before he took office, has adopted a populist stance against the mighty bankers. But his proposals against the evils of Wall Street will hurt all of us more than the guys in the suspenders.

The president's plans include a tax on banks' liabilities other than deposits; a government agency with the power to break up big banks; and forbidding large financial institutions from engaging in proprietary trading (that is, from investing their own capital as opposed to their customers' money) or owning hedge funds.

The tax punishes banks for borrowing money from sources other than depositors. The problem, however, was not that banks borrowed too much money but exactly the opposite — that they dished out too much credit.

Setting up a pachydermic government agency with the power to break up financial giants sounds a bit like those ancient tablets called palimpsests that the Romans scraped off in order to write on them again — and again and again, until they became illegible. Numerous agencies, including the Federal Reserve, with the power to restrain banks were already in place before and after the bubble. Placing a new one on top of the others is comically redundant.

There is a much simpler way of breaking up banks deemed too big to fail. It's called ... letting them fail. When a bank fails, its assets are absorbed by more efficient institutions eager to expand. After a short period of suffering, the recovery begins. This is what is happening with the hundred-plus local or regional banks that failed last year. The notion that the entire system will come tumbling down if the government lets a mammoth financial institution fail is a superstition that invites recklessness in Wall Street — and postpones the recovery when something goes wrong.

Finally, blaming proprietary trading for the credit bubble is like blaming Tiger Woods' time-consuming appreciation for women on the fact that he uses his spare time to play golf. What the government is in effect saying to banks is: Devote all your energies to taking risks with your clients' money, not your own. The truth is that proprietary trading had little to do with the credit bubble, which mostly involved the customers' money. Banks used those funds to buy or underwrite mortgages and mortgage-backed securities, which was just another way of lending money.

When the bubble exploded, they were left holding what became known as "toxic assets." Unable to resell or earn income from such assets, the banks had trouble paying back interest on short-term loans they had taken.