Obama Administration is Taking Steps to Shrink the Financial Sector

Due to the capital requirements in the Dodd-Frank bill, we've seen some of the bigger financial institutions start to downsize - specifically GE and MetLife. There is some expectation that others will follow. Here is how Fed Chair Janet Yellen described that:

“We’re beginning to see discussions that these capital charges are sufficiently large it’s causing those firms to think seriously about whether or not they should spin off some of their enterprises to reduce their systemic footprint,” Federal Reserve Chairman Janet Yellen told the House Financial Services Committee on Wednesday. “And frankly, that’s exactly what we want to see happen.”

But as Matt Yglesias points out - the Obama administration seems to be working another angle on this. It doesn't have as much to do with shrinking individual financial institutions so much as it does with reducing the overall size of the entire sector. To get a look at the big picture, he points to two new rules recently released by the administration and a third one that is on the way.

First of all is the crackdown on corporate inversions. These are vehicles to avoid corporate income taxes by buying a company that is headquartered in another country. As Yglesias points out, stopping them does more than raise additional revenue for the federal government.

Thomson-Reuters estimates that $1.3 billion in fees have been paid to investment banks for work on tax inversions since 2011, amounting to a bit more than 5 percent of the overall merger and acquisition market. All that is now set to vanish, according to the Wall Street Journal's John Carney, who notes that beyond direct fee collection, major Wall Street banks are also primed to lose because "if inversion deals dry up, fees earned from underwriting bonds and bank loans connected to them will do the same."

Second is the crackdown on investment advisors - who will now be required to offer advice that is in the best interests of their clients rather than line their own pockets with fees. The White House Council of Economic Advisors expect that this will save investors $17 billion a year.

Finally, the administration has been working for several years on a rule that is aimed at preventing American banks from doing business with the kind of shell companies that have been the focus of revelations in the Panama Papers.

What Yglesias noticed in all of these efforts is that they are aimed at "shrinking the financial sector as a whole by cracking down on many of its sources of revenues." But it is even more than that. Beyond reducing the size of the sector, it is the type of activity that is being targeted.

All three new rules shrink the financial sector by cutting down on lucrative activities that have nothing to do with finance's core social purpose of channeling funds to economically useful activities.

In the March/April/May 2015 edition of the Washington Monthly, Daniel Carpenter wrote a prescient article that took issue with Thomas Piketty's singular focus on raising taxes as a way to combat income inequality. He suggested that a real solution must also include stronger financial regulation. When Yglesias suggests that these new rules are focused on "channeling funds to economically useful activities," he is reinforcing that point.

On the campaign trail, Bernie Sanders often says that the business model of Wall Street is fraud. That is a crowd-pleasing slogan in this post-Great Recession era. But it overstates the case. What these regulations from the Obama administration are doing is cutting off activities that might not have been criminally fraudulent, but have grown the sector by engaging in the business of lining their own pockets without any public benefit.

None of this fits nicely on a bumper sticker and doesn't provide Democrats with a slogan to juice up their supporter's anger. But they address very real problems with the benefit of not throwing the baby out with the bathwater in ways that could potentially harm the economy. In other words, they are quintessentially Obama.

When it comes to specifics, the world is complicated and there are choices you have to make. The trajectory of progress comes in fits and starts and where you’re going is balanced by what is and where you’ve been. Progress in a democracy is never instantaneous and it’s always partial.

...It’s like steering an ocean liner and making a 2 degree turn so that 10 years from now we’re suddenly in a very different place. You can’t turn 50 degrees all at once because that’s not how societies - especially democracies - work. As long as we’re turning in the right direction and we’re making progress, government is working like its supposed to.