Last Friday, JPMorgan Chase chief executive Jamie Dimon blamed Washington for the economy’s failure to thrive. He’s right—mostly. But Washington’s failure to perform this year is more the fault of the Republican Congress than of President Trump, and even now the Congress could make some simple, straightforward fixes to taxes and regulation that would have a positive impact on investment and business expansion. The president, after months of delays on his own tax and regulatory plans, would surely sign them.
Dimon told financial analysts and reporters Friday that “it’s almost an embarrassment” traveling the world these days as an American. Other countries, from Israel to Ireland, he noted, “understand that practical policies that promote business and growth [are] good for the average citizen.” He pointed to America’s failure to fix the tax code, but he mostly focused on onerous financial regulations. “Had banks been free to use their capital and their liquidity five years ago, there would’ve been a lot more lending in the system,” he said. “There’s a false notion that all the stuff didn’t hold back the economy. Yes, it did.”
Dimon is right about the tax code—and there’s nothing holding back House Speaker Paul Ryan and Senate Majority Leader Mitch McConnell from voting on a bill this week that would lower the corporate tax rate from 35 percent to 25 percent, the average in developed nations. Presumably, the Republican majority in Congress doesn’t have any ideological objection to making such a move, which is far simpler than trying to reform health care. Complexities do exist over which corporate-tax loopholes to eliminate in return for the cut, but Congress could defer addressing that problem, along with that of the far more complex individual-income tax code. For now, a one-line bill would show the world that, well, yes we can.
Dimon is on shakier ground when it comes to debt, implying that regulators’ constriction of lending is what’s holding the economy back. True, total household and business debt is nearly 3 percent below what it was in 2007; adjusted for inflation, it now stands at $28.6 trillion. But that’s because household debt is down significantly since the crisis—by 14 percent, to $14.8 billion. That’s a good sign: American household debt had nearly doubled in inflation-adjusted dollars between 2000 and 2007, reaching an unsustainable level.
Business debt has increased at a seemingly healthy pace, up 10 percent, in real terms, to $13.4 trillion, over the past near-decade. It’s true that businesses are taking on debt at just one-sixth the rate that they did during the previous decade, but today’s rate is more in line with the 9 percent increase in business debt between 1987 and 1997. The current problem is with small-business lending, which, as the Treasury Department notes in a recent report, “has been one of the most anemic sectors, barely recovering to [pre-crisis] levels.”
The trouble is not in total levels of debt, then, but in debt misallocation. Because of the government’s regulatory rules, left unfixed by the 2010 Dodd–Frank law, banks lend too much money to some people and institutions and not enough to others. The government puts banks’ assets into four categories, from not risky (0 percent) to very risky (100 percent). The higher the risk category, the more capital—non-borrowed money—the bank must set aside, to account for possible losses.
The government assigns the lowest risk to cash and Treasury bonds. A step higher in risk are mortgage bonds guaranteed by Fannie Mae or Freddie Mac, municipal debt, and any security that rates a AAA rating from a bond-analysis agency, including much credit-card and auto-loan debt. Slightly riskier, but still considered largely safe, are most mortgages without a government guarantee and some home-construction loans. The “standard-risk weight” category—the government’s way of saying that something is not quite as safe—includes commercial and consumer loans. This system of weighing risk means that a bank must set aside 8 percent capital to make a commercial loan to a small business, versus no capital to lend money to the government and only 1.6 percent to lend money, indirectly, to a homeowner buying a house with a Fannie or Freddie mortgage. This extra capital costs banks money.
In addition to this weighting system, the bureaucracy involved in making loans to small businesses has slowed the flow of commercial lending. One risk officer at a medium-size bank said that a computer model will almost instantaneously approve a government-backed mortgage loan, whereas she must send a commercial loan up a chain of three supervisors for approval. When a bank invests its assets in a Fannie or Freddie security, it can let the government do the work; when it lends money to a small business, it must do its own due diligence of assessing the borrower’s revenues, expenses, other debts, and business prospects. It’s therefore not surprising that large banks now hold 24 percent of their assets in cash as well as government and Fannie and Freddie securities, according to the Treasury—five times higher than the figure before 2008.
It may be true, over time, that lending money to credit-card borrowers through a highly rated security is less risky than lending to a cupcake store. But that should be the job of the banks to decide, not the government. Republicans in Congress should strike a blow for free markets and reduce regulators’ reliance on risk-based weightings, instead measuring financial firms’ total assets as compared with their non-borrowed capital.
Congress could accomplish this with another one-page bill. The House Financial Services Committee, as part of its Financial Choice Act, proposes that banks could win themselves an exemption from most of Dodd–Frank if they maintain a simple leverage ratio of 10 percent (the current requirement is 5 percent). The idea is that banks with more capital are less likely to fail, meaning that the government doesn’t need to keep such a close eye on them via Dodd–Frank. The Treasury Department agrees, proposing this off-ramp for banks with a similar leverage ratio in its recent report.
To give banks an even higher buffer, Congress should raise the capital level for the off-ramp to 12 percent. (If banks do well under this provision for five years, then Congress could consider lowering it to 10.) Moreover, Congress should enact this off-ramp provision as a standalone bill, leaving the more complex aspects of fixing financial regulation—just as with a large-scale fix to the tax code—for later.
Banks might lend more with a higher but consistent capital standard; or they might lend less. But at least they’ll be doing it based on their own risk assessments, not on the government’s. If they judge wrong, the government should allow them to fail.
Passing these two simple measures quickly would demonstrate that Congress can do something besides agonize over bills hundreds of pages long that eventually require hundreds of additional pages to improve, worsen, or undo. And the next time Dimon feels “almost” embarrassed to be an American, he won’t be able to blame our clunky corporate-tax code and financial regulations.
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