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What Further Bank Regulations Means For the Economy


Credit is growing more and more sparse.

When my kids were little, my wife and I would tell them: "Trust is like a LEGO tower. It takes a long time to build it up, but only an instant to knock it down."

I was reminded of this today while watching Camden Fine, the head of the Independent Community Bankers Association, on CNBC this morning, waving the book Big Bad Banks.

In his 15 seconds of fame this morning, Fine nailed current public opinion: Big banks are now bad.

Now there are those who will say that these firms are finally getting their due. But before we dog pile the largest banks, let's consider that almost 80% of all US deposits and loans are in the big banks, and almost 100% of all derivatives, mortgages, and credit card loans are originated by those same big banks. Think Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C).

To say that the big banks are bad is to say that the American banking system is bad.

My point isn't to agree or disagree, but rather to suggest the consequences of this thinking.

The banking system must become less bad in the eyes of public opinion.

As Congress is charged with that responsibility, here's how I think they will do that:

First, the big banks will be broken up. How? I don't know, but US economic history suggests that once vilified by the public, "shrink and separate", to borrow Secretary Geithner's phrase, is inevitable.

Second, populist-driven re-regulation will result in lower profitability for the banking industry. And already we've seen a flurry of activity across all aspects of consumer lending and deposit taking. It's a zero sum game. What you take from the banks and give to consumers comes at the expense of shareholders.

Third, industry-wide risk reduction, which I also see as inevitable, will represent an enormous de-revenuing of the banks, which, if it's coupled with higher overall capital levels as I expect, will result in returns on equity well below historic levels.

Finally, and most importantly, the cumulative effect of the prior three points will be an enormous narrowing of credit availability in this country -- and not just to consumers. And we're already seeing this as banks dramatically reduce available lines of credit.

But truly, the greatest consequence will be on overall economic growth. History suggests that achieving any kind of V-shaped recovery amidst the kind of regulatory reform that we're about to experience is just not possible. (See also, Expecting a V-Shaped Recovery? Consider Yourself Warned)

So, like achieving a higher savings rate, getting what we want will come at an economic cost.

But with trust in our banking system now clearly broken, I unfortunately see no other outcome.
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