The American Banking System: America's Hope

General Motors,IBM,Google,Microsoft,Apple,Caterpillar and countless other great American companies that at some point (some currently) were the symbol of America's power, envy and prestige.

A Subway franchise, a local hardware store, a gas station with a convenience store, a neighborhood Laundromat, a medical practice, a medium size business etc... together they provide most of the private jobs in America.

This combination of status and economic power is the result of ingenuity, hard work and ability to innovate in a free society with a stable political system and minimal government interference where capital is most efficiently allocated by those willing to take a risk.

There was a time when America did not have to worry much about competition from abroad. Of course that is not to say that foreign companies did not exist. But American technology and know how were sought after the world over. Today a Japanese company can produce the same quality product for less, a Korean manufacturer can out innovate an American company, even Airbus can cast shadow over a great American icon such as Boeing. It seems that America may have lost its technological and manufacturing edge in a world of globalization. This could not be more evident than in the surge of Chinese exports (and others). There is still one area in which the United States,even after all that has happened over the last three years, still holds a big advantage. That is America is still the financial Mecca of the world. However this advantage may not be with us much longer if the current policies of attacking, regulating and blaming the banking industry continues. Let's get one thing straight here. I am not suggesting that American banks are financially sound nor am I defending some of the practices of wall street but I am defending and arguing for the need for wall street to innovate. This can only happen in an open and free environment where business decisions are left to the private sector and regulatory uncertainties are kept to a minimum. Otherwise we risk losing a very defining edge of the American way.

No question some on wall street have committed social injustices if you will. Some may have even committed punishable crimes; but it takes two to tango as they say. Banks could not have lend all that money to buy houses if they didn't have willing clients, and Americans would not have borrowed as much if money was not readily and cheaply available. Greed goes both ways. But here is why I place more blame on the consumer in this case. First, it does not take a genius to figure out that if you make $50,000 a year you probably can't afford an $800,000 house (common sense people please!!!). Second, a doctor, a businessman and perhaps even a banker cannot claim he/she were mislead by an aggressive banker. The point being, if you look at the statistics and the market segments affected you will see that highly educated people are in the same boat as those claiming (some justifiably so) ignorance and having been mislead. The comfort of a safe and stable business environment comes from the dependence on and the knowledge that an agreed upon set of laws apply to a certain situation. In other words people will not invest in an uncertain political or judicial environment. Hence New York is the financial capital of the world, not Shanghai or even Tokyo; not even London (even though we saw some pretty aggressive moves by the administration especially with the auto industry). So let's use the laws on the books now to prosecute those who have broken the law. If the argument is that the laws are outdated than let us update them but let us not make the mistake of applying collective punishment for that achieves nothing but short term political gains at the expense of future viability of the banking system.

For those who know me know that I have argued, contrary to popular belief that our banking system is now healed, that there are more pains for this industry ahead. The most obvious to me are all those toxic assets that suddenly everybody stopped talking about when the regulators did away with the mark-to-market rule. They may have done away with the rule but not the toxic assets which are still sitting on banks' balance sheets. By not having to set aside reserves (or as much reserves) against these toxic assets banks have been showing what I call fake profit. A quick glance at the major banks reports show that most of the money they have made over the past year or so came from trading activities and not from traditional commercial banking transactions (the exception beingtwo or three investment banks). This is unsustainable. The slowdown in world's economic activities will put further pressure on banks' profit. In addition all the talk about increased fees and taxes on banks and banking/investment related activities does not lend itself to a nurturing and predictable environment needed for capital investment. Capital should and will go to where it is less restricted and most needed. Does anyone believe that a bank will lend money out when it is told by the government who to lend to, how much to lend and how much to charge? It is unrealistic to expect anyone with excess capital to turn over the decision of risk management to the government.

It will be a long time before American banks are back in shape for it will take years to work off (charge off) all these toxic assets in a slow economic environment yielding minimum profits at best. Otherwise their only quick and painless solution would be a sudden V-shape recovery of the housing market, something I believe even the most optimistic forecasters don't see happening for many many years to come.

I believe a vibrant and innovative banking system free from government shackles is what will ultimately lift us from this economic malaise for it is the best way to allocate capital where it is most needed based on free market principles. In this day and age a technological edge is not necessarily the sole determinant of a society's dominance. In fact I would argue that a free banking system is a better indicator of a country's future. No matter how great ideas are most would remain just that if not for the ability of a financial system to take on risk of its choosing and allocate private capital where it thinks would be most productive. Apple and Google,to take just two most recent examples, would not be where they are today without the help of our free banking system and specifically investment banking.

With all its past present and future problems or inequities our banking system remains the best engine to power future growth in the US as well as globally. If you are a believer in the China story or the emerging market story or whether you subscribe to Africa as the last investment frontier or space travel as our future then you also have to believe in a strong, free and capitalist banking system capable of innovating without worrying of having rules changed haphazardly and unexpectedly. Yes life is not fair but as to why it is not fair no one on this earth can convincingly say. A banking system of the kind I support may and will have some injustices but it is still a far better system for society as a whole than a centrally planned politically charged allocation system the kind of which we have witnessed disintegrate with the fall of the Soviet Union. Society cannot exist where everybody is a doctor or a banker or a Judge or a cashier etc...society is only sustained by the variety of functions necessary to complete the economic circle of life.

As sick as the banking system is (or perceived to be) it still is the heart that supplies blood (credit) to the body. A feeble heart is not capable of delivering the necessary amount of blood to keep the body going. The patient gets sicker and eventually dies. The creativity of IBM, the innovation of GM (in the past of course), the vision of Apple and Google and the ability of a Subway franchise to create jobs would not have been possible without the ability of our free banking system to take those ideas to the next level of actual execution. So please let's keep those arteries open and unobstructed by any hick ups or regulatory buildup. The way to do this is not by proping up some banks or exempting some from the upcoming regulations (think Fannie Mae), rather you achive this by letting the free market weed out the weak (let them fail). Than and only than would the heart regain its strength and ability to sustain a growing body.

Don't bank on our banks as an investment in the short run but do bank on them to pull us out of this mess eventually and keep America's edge going forward.