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Recklessness Has Its Place

President Obama is moving aggressively to stamp out what he calls “reckless risk” on Wall Street. The place for reckless financial behavior, in the president’s view, is Washington, D.C., where he can direct it.

Smarting from his party’s loss last week in Massachusetts, Obama took another swing at his favorite political punching bag — the nation’s big banks — by declaring that they should be banned from running hedge funds or trading securities with their own capital and for their own profit.

Never mind that proprietary trading by banks had nothing to do with causing last year’s financial crisis, which is the ostensible reason the president says he backs the so-called “Volcker rule,” named for 82-year-old former Federal Reserve chairman Paul Volcker. Volcker was a lonely voice calling for the restrictions until the president seized on the idea.

Never mind that the profits banks made in the past year have helped rebuild their capital, repay the government’s bailout money — of which the president has vowed to collect “every dime” — and stabilize the global financial system, when only months ago banks were afraid to lend money to one another.

Never mind that the largest banks that did buckle during the crisis, banks like Washington Mutual (which merged into Chase) and Wachovia (which merged into Wells Fargo) did so because they were part of the mania in which too many people borrowed too much money to buy too many houses that they could not afford. Those bad loans polluted the global capital pool, bringing down major non-bank investment houses like Bear Stearns and Lehman Brothers, and forcing the government to rescue the insurer American International Group and seize mortgage finance companies Fannie Mae and Freddie Mac.

The president finds it convenient to ignore the fact that his own administration, which has all but nationalized the market for residential mortgages, continues to churn out shaky loans, in the form of unsustainable modifications of existing mortgages and for new purchases, to prevent homeowners and the housing industry from finally facing the music. Homeowners vote. Banks, on the other hand, do not, and prosperous bankers are not exactly a large segment of the electorate.

So the president, believing he has found a strategy that will make voters happy, takes swipes at the bankers every chance he gets. In another of the most recent attacks, the Federal Deposit Insurance Corp. said earlier this month that it may start imposing higher premiums on banks whose compensation policies regulators don’t like.

A staff memo on the proposal explained, “The FDIC seeks to provide incentives for institutions to adopt compensation programs that align employees’ interests with those of the firm’s stakeholders, including the FDIC, and that reward employees for internalizing the focus of risk management.”

But, when the conversation turns to Fannie Mae and Freddie Mac, Washington suddenly seems a lot less interested in managing risks.

Last month the Treasury Department lifted the $400 billion cap on what it is willing to spend to help keep the two mortgage companies afloat, declaring that it is prepared to hand over an unlimited amount to Fannie and Freddie in 2011. Less than a year ago the original limit of $200 billion was doubled, even as officials said that the companies would almost certainly never need so much money.

While the government is encouraging other financial institutions to fix their business models, the more Fannie and Freddie lose, the more they get from the taxpayers.

The wide-open pipeline seems to be primarily aimed at freeing Fannie and Freddie from the constraints of profitability so they can be used as tools for government policy. Edward Pinto, a housing consultant who served as Fannie's chief credit officer in the late 1980s, commented, "They've cleared the decks to use Fannie and Freddie as a vessel for whatever they want.”

In addition to eliminating the credit limit, the new measures also relax restrictions on the size of the companies’ investment portfolios, actually allowing the too-big-to-fail companies to get even bigger. The new mandates from the Treasury require each company to keep its holdings below a set maximum, which will start at $900 billion and decrease 10 percent every year. At the end of October, Fannie Mae had a portfolio of $771.5 billion. Freddie Mac ended November with holdings of $761.8 billion.

As the Federal Reserve begins to wind down its $1.25 trillion program aimed at keeping rates on home loans low, Fannie and Freddie will likely step in, taking up the administration’s torch in the fight to reduce foreclosures. Unfortunately, helping struggling homeowners is not always compatible with prudent risk management. While the government may want other companies to do right by their shareholders, it would prefer for Fannie and Freddie to instead funnel lots of cash to voters...excuse me, homeowners.

I once watched one of my daughters stand, frozen, in the toy aisle at Wal-Mart for an hour while she struggled to decide what she wanted. Let’s just say she did not take kindly to suggestions, or to any hint that she should speed up the process. Of course, she was only 3 years old at the time.

Like the angry voters he wants to court, Obama needs to make up his mind. Does he want financial institutions to make a lot of money or to make a lot of loans? Does he want the industry to hire top talent (which can command top dollar), or to keep only the utility players while the stars go to hedge funds here or to banks overseas?

Most of all, does he want somebody to help the U.S. economy recover from the crash, or just somebody to blame? I cannot fathom how we are going to get a recovery if the financial system shuts down again. The fastest way to get it to shut down is to keep attacking financial institutions and the people who run them.

Voters who want Washington to lash out at Wall Street are going to change their tune in a hurry if the markets seize up and the economy heads south once again. If that happens, the president and his allies in Congress, who are wielding the whip right now, are going to find themselves holding the bag.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book Looking Ahead: Life, Family, Wealth and Business After 55.

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