The political imperative to get elected and then retain power noted in the previous post can in some rare cases be a truer force for good governance than ideology. Obama's unblemished string of policy failures has offended ideologues on all sides - some for too little effort and some for too much. His plunging popularity and influence have prompted some to declare him a lame duck after just one year and predict great change in the 2010 elections. The loss in Massachusetts of a safe Democratic Senate seat seems to have forced a change of direction.

I’ll just note this WSJ article noting that Paul Volker, who long appeared to be sidelined in these discussions, while arguing strenuously for a separation along these lines, appears to have won the conceptual day in what amounts to a policy pivot for the administration. It’s a very interesting article describing how that came about.

The policy’s evolution took months, according to congressional and administration officials. Prompted by the cajoling of former Federal Reserve Chairman Paul Volcker and other respected voices, dissenters in the administration—notably Treasury Secretary Timothy Geithner and White House economics chief Lawrence Summers—gradually dropped their opposition ....

On Thursday, Mr. Obama proposed a plan that would prevent banks that receive a federal backstop from investing their own money in financial markets—what is known as proprietary trading. He also pushed for new limits on the size and concentration of financial institutions. Both moves echo the Glass-Steagall Act, the Depression-era banking curbs that was repealed in 1999.

The proposal marked the return of Mr. Volcker to center stage in the Obama White House. The 82-year-old chairman of the president’s Economic Recovery Advisory Board consulted closely with Democrats in the House and Senate as they drafted their proposals to address “too big to fail” entities, referring to financial behemoths whose collapse might bring down the economy. Mr. Volcker spoke frequently with Mr. Obama as well.

But he faced a philosophical divide with others on the economic team .... In talks with his financial team, Mr. Obama started letting his frustration show, asking why he was on the wrong side of the “too big to fail” debate.

Obama needs to get on the right side of some debate rather than extending his string of policy gaffes. It's pure political desperation. He's doing the right thing even if he's doing it for the wrong reasons. In this case politics is helping rather than hindering good governance. It will not be painless.

It is also quite important to add here McArdle’s observation that many of the relaxations of the line between these activities were justified on the grounds that the regulations made New York less competitive as a banking and money center globally. She correctly says that reimposition of such lines will make New York less globally competitive:

If we do choose this “something”, Americans should probably be clear that this is going to deal a major setback to New York as a world financial capital. Many of the rules that were undone in the last two decades were got rid of because they were making it too hard for American banks to cope with foreign competition. If we do this, America’s financial sector will shrink, and our banks will lose a lot of business to foreign firms. That means, among other things, that we are going to lose big chunks of tax revenue, because bankers are very disproportionate contributors to federal coffers. It also means that New York’s renaissance will probably slack off–and the people who complain about the bankers will discover how many city services those banker salaries paid for.

Competitive pressures on London might turn out to mean accepting more risk and moral hazard for the sake of remaining a competitive industry that sustains much of the rest of the your national economy. The relative size of the financial services sector in Britain arguably suggests this (I don’t have time now to provide links), at least by comparison to the vastly more diversified US economy.

How does that risk express itself, however? Again, arguably, in Taleb distributions — it all goes swimmingly, so to speak, until you drown. How many times, in order to remain globally competitive as a financial center, can the UK public fisc swallow the occasional disastrous meltdown? Meanwhile, a less competitive, but also less competitively pressured, New York financial center gradually acquires a reputation for stability in the much longer term, fewer political uncertainties because the moral hazard does not exist in the first place ... might work. Of course, might not.

This all brings to mind the issues discussed in the earlier post Disgust.

I think many people, even Sarah Palin’s devotees, might concede under pressure that having a President who has a strong baseline knowledge about the world, about American history, about economics, and so on, is a good thing. Not because we necessarily want an executive who is himself or herself a policy wonk, but because it lets that executive make more judicious choices about what policies to approve or reject. Many of the worst policy disasters under Bush the Lesser can demonstrably be traced back to the bedrock fact that he was easy for his courtiers to manipulate because he didn’t have an independent knowledge of his own on many issues, just a kind of personal appraisal of his staff that appeared to mostly revolve around obsequious loyalty.

The issue isn't knowledge or intelligence. The assumption that a willingness to wear the colors and flash the gang sign of self selected "elites" is a reliable signal of either knowledge or intelligence, much less wisdom, is mistaken. In many ways it is the reverse. Modesty and a willingness to consult are signs of greater real world knowledge and intellectual maturity. When we compare the policy disasters of Bush to those of his past and present opponents this becomes ever clearer.

Obama seems to be a weather vane spinning in the wind of his courtiers, as he must be since he's a politician with only the most rudimentary grasp of the issues, primarily the political implications of the issues rather than the operational governance aspects. Much like Bush.

Update: Another view.

To be sure, Obama is going after a real problem: that banks often take too many risks in their investments. Wouldn't it be nice if we could go after that problem while not destroying the benefits of having large banks?

We can. And the best way to do that is to give those closest to banks a strong incentive to make sure the banks aren't taking undue risks.

One way to do that would be to get rid of deposit insurance. Until Dec. 31, 2013, if a bank fails and you have up to $250,000 in that bank, the Federal Deposit Insurance Corp. will make you whole. We depositors, therefore, don't have an incentive to monitor banks: it's called "moral hazard." Moral hazard, as you can see, has little to do with morality, but much to do with incentives. With little monitoring by depositors, banks are freer to take risks with "other people's money."

We could also repeal another restriction that prevents any one entity from holding more than a small percentage of ownership in a bank. Allowing concentrated ownership so that one firm or hedge fund could own, say, 10 or 20 percent of a bank's shares would allow the owners to kick out bank managers who are not doing well for shareholders.

If President Obama wants to avoid "too big to fail," he should focus on giving those closest to banks a stake in preventing failure in the first place.

This may be a more sensible approach to the banking issue, but I doubt that it is politically possible. Repealing deposit insurance seems as improbable as repealing medicare though both have the potential to destroy society in future.

Update: Bank Kabuki

If our banking system absorbs trillions in losses you can be sure the government will step in, regardless of whether we have big banks or small banks. And if our banking system isn’t in crisis, then FDIC is perfectly capable of handling an isolated bankruptcy, even at a large bank. In any case, I can’t imagine a future where the US doesn’t have any large banks, but Europe, China, Japan and Canada have lots of large banks. Can you? Wouldn’t it make more sense to try to prevent the banking system from suffering trillions in losses after a bubble bursts, perhaps by requiring sizable downpayments?

But then I read that the FHA is about to set much tougher standards for FHA mortgages—they plan to require borrowers with a 590 credit score to put down at least 3.5% downpayments. As Tyler Cowen recently argued, you knew Congress wasn’t serious about global warming when they refused to make Americans pay more for gasoline. And I would add that you can be sure that the populists who want to “re-regulate the banking system” aren’t serious when all they can do is talk about 3.5% downpayments for bad credit risks. It is so much more fun to bash big banks.

A plague of posers is upon us.