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Rebuilding The Structure of America’s Economy

Thomas Easton, The Economist | Special to CNBC.com
Monday, 22 Oct 2012 | 1:45 PM ET
Bank Vault
Digital Vision | Getty Images
Bank Vault

In America’s early years financial institutions of any sort were scarce and there was little consensus for adding them until Alexander Hamilton and a handful of other men, mostly immigrants, were able to show that in other countries, their capacity to transform savings into credit, and a related ability to facilitate transactions, was beneficial for economic growth. To the extent financial institutions fail to do these well, they fail in their basic mission. That scenario is now coming to pass in no small part because their efforts are now directed ever more to surviving a legal deluge.

In theory, banks are supposed to be overflowing with tellers, ATMs and loan officers. In reality, they are increasingly focused on servicing legal claims. To cite the case of the large bank with the lowest legal cost, Wells Fargo receives around 300 state, federal and grand-jury subpoenas a week on average (some against the bank itself, many pertaining to the suspected crimes of others). The bank gets so many legal orders-5,000 a week in total-that it has two centres that work full-time on processing them, one on the west coast, one on the east. A specific group works on prioritising the bank’s response to subpoenas.

How much of this is due to crime is uncertain, in part because what constitutes a crime is uncertain. How much is due to the legal environment is clear: lots. America’s financial system is drowning in law. An excellent case could be made that a system that provides public subsidies on hand, while extracting it on the other in either settlements or frictional costs is lost. This is all the more true because the only group unequivocally benefiting from this situation are regulators, both because of the swelling size of their fiefdoms, and because they are in high demand by financial institutions desperate to hire people who might have an inside track on the next round of investigations.

This is the situation to be addressed during the 3:45 panel on October 25th. The nominal title is: Reformed: Has financial regulation saved the system? A better title would be: has the current round of reform undermined America, and can anything be done about it. The answer to the first question is surprisingly easy: the recent financial reforms are unequivocally bad. This is most eloquently stated in the Dodd Frank legislation, a vast document that is physically painful to read and thus is largely unknown. But even worse has been the tens of thousands of pages of rules that the government has put out to apply Dodd Frank’s convoluted provisions. No one who reads this mountain of paper can feel anything but dismay, with the exception of the vast legal and political machinery that profits from its inefficiency.

But if identifying a bad course of action is easy, the harder task is finding a better course. No substantive proposal has gained any visibility. There are reasons for this. The financial system has come to embody an extraordinary number of political goals beyond the basic provision of capital to entities that can use capital efficiently. Financial institutions play a role in national defense, and redistribution of wealth. There is no consensus on the range of activities they should perform, and how they should be compensated for this work, if at all. And there is no consensus on who should carry financial risk, with the result that every failure results in a futile but costly effort to add regulators. Coming up with a better answer is the goal of Thursday’s panel.

There may be little interest for such ideas in the current administration, at least in the near term, but it is clear that for America, and the world, to have a robust economy, there must be a robust financial system and this requires rethinking its structure and if Buttonwood works, it will provide some genuine insights about how this could be done.

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Thomas Easton is American finance editor for The Economist.