The Credit Crunch and Bank Reform Jude Wanniski February 6, 1991

A reporter from the American Banker called me yesterday for a comment on Treasury Secretary Nick Brady, who took a major beating in The Wall Street Journal last week. The article, "Is Brady's Treasury Up to Doing Its Job? Many People Doubt It," 1-31, is a clear signal that his days are numbered. Articles like this do not appear in the Journal unless its Washington bureau knows it will be protected by the White House from being cut off from its sources. It has been my belief, from his earliest days at the post in President Reagan's last year, that Brady, who is probably the nicest man in the Bush Cabinet, does not have the perspective or the grit that the job demands at this dicey moment in U.S. economic history. He is not an unintelligent man. But he is a "Commerce Secretary," not a finance minister. Given the awareness of this fact by practically everyone in Washington, possibly including Brady himself, it would not surprise me in the least if he were to retire soon to start work on the '92 campaign — turning the recession, the credit crunch, banking reform, the capital gains tax proposal, Third World debt, and international monetary matters, over to a suitable replacement. If President Bush makes a wise choice, we would move into a major bull market. Indeed, the bullishness under way this past week is directly tied to Brady's defeat on the capital gains issue by White House Chief of Staff John Sununu.

Brady's determination to focus on banking reform instead of capital gains taxation is the clearest sign that his scope is too narrow for Treasury. Banking reform involves rearranging the allocation of a shrinking pool of capital. The nation's finance minister should have been, and now still should be, concentrating on expanding the pool of capital. At the moment, unfortunately, there is not a world-class banker in the United States to point this out to Brady. They are all occupied with hanging on for their lives during the downsizing of America. The bank reform legislation Treasury has concocted will only put the Bush Administration at the center of a crossfire within the financial services industry. At the end of the day I suspect little will have changed, the Vested Interests having fought each other to a standoff.

At the same time we observe Citicorp's John Reed out passing the hat, trying to raise capital outside the United States, oblivious to the fact that he would have all the capital he needed, and then some, if he could help expand the domestic pool of capital. We have not heard one word from the investment banks or commercial banks during the last two years in the struggle for cutting the confiscatory tax on the formation of capital. Only in the last several weeks has the Independent Bankers Association of America, representing 12,000 country banks, passed a resolution advocating a lower capgains rate. Have we heard from John Reed, or from Tom Labrecque of Chase Manhattan, or Lewis Preston of Morgan Guaranty, or Richard Rosenberg of B of A?? I asked the American Banker reporter if his newspaper had done any work on the issue of capital gains taxation, and he answered tartly that the paper does not trifle with issues that do not involve banks!

In Japan, where capital grows like mushrooms, creators of capital do not face a government that threatens to tax away the fruits of their creation. It strikes me that the focus on banking reform in the United States is the equivalent of the poor person who must shop in several department stores looking for the cheapest price before making a single purchase. As the capital pool shrinks, the capital allocators scrap among themselves as to who gets to do the allocating. The fuss is about turf and relatively meager shifts in profit opportunities. At the same time government regulators poke their noses into every point of the allocation process to "protect" the public interests through a reign of terror, adding enormous costs to the allocation process. There is something to be said for a reform of the banking laws to relieve the regulatory burdens. Increasing the efficiency of the allocation process, though, is a minor affair compared to the reform of the capital creation process. Secretary Brady reckons that if his reform goes through as is, the efficiencies will be worth a "mind-boggling" $10 billion and somehow assumes the banks would get to keep this amount. A substantial capgains cut would add at least $1 trillion to the value of the nation's capital stock. Banking reform can't solve a credit crunch that is crunchy primarily because of tax policy and inflation.

Japan is certainly not engaged in domestic turf battles over capital allocation. With a negligible capital gains tax on equity and the hardest currency in the world over the last 20 years, it has the most powerful capital-formation machine on the planet. Loaded with capital that continues to pour from its machine, Japan is like the rich shopper, to whom time is money. It simply goes to the ritziest store and buys whatever strikes its fancy. It has plenty of room for error. The cost of capital is so low that it can license U.S. products, make them in Japan at wage rates that are now higher than in the U.S., and sell the products here cheaper than Americans who hold the patents. Sony borrows $5 billion to buy Columbia Pictures, then issues stock in Tokyo to pay off the loan! All the while, Treasury Secretary Brady is trying to dump capital gains while yelling at the Fed for a softer currency.

The good news is that the Greenspan Commission, contrary to universal reports that it ain't nothin', is really real. The only very important decision that has to be made is not who is to be appointed — which is merely important. The decision has to be made to make the commission proceedings open to the public, including C-Span. The whole point of the commission is to shift the terms of discussion to a non-partisan arena, where the "fairness" argument can quickly be drowned out by arguments on the economic merits. BusinessWeek, which is as hostile to the Greenspan Commission as it has been to capital gains, this week warns Greenspan that he will be sorry he accepted this nasty assignment from the President! But it is hard to see how Greenspan can lose. He has all the right arguments, his heart is in it, he appreciates what is at stake, and he has President Bush and John Sununu rooting for him. This is as good as it gets, Alan.

He also has plenty of silent support he doesn't know about. I'm advised directly by Robert Strauss, Mr. Democrat himself, that he is rooting for capital gains, even to the point of considering Ted Forstmann's idea of a zero rate after a three-year holding period. I'm told indirectly, by one of his closest advisors, that New York Gov. Mario Cuomo knows how extremely important a lower capgains rate is to New York, and how he is hoping Greenspan will find a way to depoliticize the issue. One way would be for Greenspan to invite Super Mario to testify. (He could also invite Reed, Labrecque, Preston and Rosenberg to put their two cents in on whether capital formation has anything to do with banking.) At the end of the exercise, a cut in the Social Security payroll tax, which Cuomo and other Democrats are plugging for, will almost certainly be twinned with capital gains, to smooth things out.

As for the banking crisis and the credit crunch, it will be simply amazing how quickly those terms would be forgotten when the DJIA whizzes past 4000.