PRESIDENT BARACK “RED HERRING” OBAMA

The performance of the stock market was the one bright spot in the otherwise dismal year for the economy in 2009.  The Dow Jones Industrial average rose 65 percent from its March low, causing many to hope it was a harbinger of recovery.

President Barack Obama has fixed that.  Last week the Dow fell 552 points in the three trading days since the president announced his plans to "reform" the financial services industry. 

Wall Street took in stride the president’s announcement Jan. 15 he intends to seek a tax on the 50 largest banks, perhaps because Wall Street insiders expect the tax — which his aides said should raise between $90 billion and $117 billion over ten years — to be passed along to consumers.

What tanked the market last week was Mr. Obama’s announcement Wednesday (1/20) he will seek legislation to limit the size of banks, to limit the compensation of executives at banks which have received federal bailouts, and to prohibit proprietary trading (trading for one’s own account) by bank holding companies.

There is something to be said for both proposals.  It makes sense to have banks which are considered "too big to fail," which are recipients of emergency loans from the Federal Reserve, to pay into a fund from which those loans might be drawn, as all banks pay for the Federal Deposit Insurance Corporation (FDIC), which reimburses bank depositors when banks fail.

And forbidding bank holding companies from proprietary trading is, in essence, simply a reinstatement of the Depression-era Glass-Steagall Act, which was in part repealed (for bank holding companies) in 1999. 

But the Devil is in the details, and in the timing.  What is a good idea in normal times can be a bad one in particular circumstances.  Vigorous physical exercise is good for most people most of the time, but not for patients suffering from pneumonia.

Proprietary trading is a major profit center for bank holding companies, at a time when few other banking activities are profitable.  And the taxes bankers pay are a major source of revenue for the governments of New York State and New York City, both of which are nearly bankrupt.  Mayor Michael Bloomberg blasted the president’s plan at a news conference Saturday (1/23).

Also uneasy about the plan is Treasury Secretary Timothy Geithner, who fears it will harm the competitiveness internationally of U.S. firms.

And here’s a key point:  had the proposed new rules been in effect, they’d have done next to nothing to prevent the financial meltdown.  Lawrence White, a former regulator who now teaches at New York University‘s business school, described them as "a solution to the wrong problem."

The firms whose failures triggered the financial collapse — Bear Stearns, Lehman Brothers, the insurer American International Group — were not commercial banks or bank holding companies.  There is no evidence proprietary trading contributed to the meltdown.

The root cause, you’ll remember, was sub-prime mortgage lending, home loans to poor credit risks on ridiculously easy terms — often no money down for mortgages four or five times the (unverified) annual income of the borrowers.  Sub-prime lending was encouraged — some might say insisted upon — by politicians in Washington. 

Fly by night outfits such as Countrywide Mortgage were able to make such loans again and again because two quasi-government corporations, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), both run by politically connected Democrats, bought all the bad paper they could generate.  Fannie and Freddie are both bankrupt, kept alive only by massive federal subsidies.

Mortgages were bundled together, chopped into pieces, and sold throughout the financial system with the blessing of regulators, who assumed the new financial instruments (chiefly collateralized debt obligations and credit default swaps) would reduce risk.  Instead, they multiplied it.

The housing boom and bust was fueled by an easy money policy by the Federal Reserve, begun when Alan Greenspan was chairman, but continued when Ben Bernanke replaced him in 2006.

Absolutely nothing has been done about these root causes of the meltdown.  It would seem wiser to begin financial reform by addressing them, rather than with "solutions to the wrong problem" that have been proposed more to solve the president’s political woes than our economic ones.

So we must ask:  Is the president proposing to solve the wrong problem because he knows nothing about economics?  Or is Mr. Obama’s purpose to divert attention from the real culprits, who are to be found more in Washington than on Wall Street?

Should we nickname this president "Red Herring" Obama?

Jack Kelly is a former Marine and Green Beret and a former deputy assistant secretary of the Air Force in the Reagan administration. He is national security writer for the Pittsburgh Post-Gazette.