President Obama has finally taken a more populist tone on the economy by proposing that the TARP money given to the financial institutions in the midst of crisis be repaid by a special tax on large banks. It’s a good start, but only a start. What matters is how this plays out over the next few weeks and whether or not it catches on. Less obvious, however, is that support of this approach is going to be good politics for everyone as we head into an election year, Democrats and Republicans alike.

The proposal at hand is nothing more than a step towards what I proposed in the first place, which is a kind of insurance system for large financial institutions. The basic is idea is that an independent panel of underwriters should periodically evaluate the risk inherent in the whole system and charge a premium to everyone for the costs of our government being “the insurer of last resort”. When they get behind, as they have done lately, the premiums go up across the board for everyone.

That is something like what the FDIC does. Back when smaller banks were the engine of our economy, this form of insurance stopped the panics that were triggering bank failures and became the first step towards recovery in the last Depression. Since our system is a bit bigger and more complicated than it was then, a more comprehensive kind of FDIC is needed to handle the whole job. That’s what has been created in an ad hoc basis for this crisis.

Why is this still a problem? Because we do not, as of yet, have any kind of comprehensive reform in place to prevent these abuses from happening yet again sometime later on. The banks have been fighting it and Congress has been busy trying to figure out the politics of this and health care and a few other things. What has been proposed is an overly complicated bureaucratic system that lacks clear lines of responsibility and, more importantly, good incentives for good behavior. That’s where the Republicans need to step up and do something other than whine about “socialism”.

Regulation is, obviously, needed. What’s less obvious is something that I think that everyone should be able to agree on, which is the need for market-like forces that promote self-regulation in the industry. That’s where insurance comes in. The last bubble was created, in part, by fantastic short-term gains by companies that took on huge risks that they really didn’t understand (or care to). They were able to do this because derivative contracts allowed them to spread the risk out through the whole market in ways that made everything less stable.

This all became a bubble when large (and previously conservative) institutions started to get their butts kicked by high-fliers who could promise very high returns. There was a ton of competitive pressure for everyone to get into the game, and so they did. Insurance premiums that assessed this risk properly would have met that pressure with an incentive for the industry to self-regulate in order to keep the premiums down.

Insurance by itself is not self-regulation, of course, but it’s a piece of the puzzle. The problem is that an oligarchy of banks will always naturally form because competition encourages them to off-load risk on the greater system of banking. Those who can ditch the risk that they won’t be paid back are the ones who get rich. Without incentives for banks to act against the oligarchy and be genuinely competitive, which is to say have an immediate reason to resist taking on everyone else’s risk, they will always go along with the latest trends in banking.

That’s where the Republicans come in. I doubt that they will be able to come up with a system of strong market forces that create a genuinely self-regulating system, but I dare them to try. Whatever they do come up with will be a genuine contribution to the debate and help us to move forward with a regulation system that will be inherently stronger – and probably less costly overall to the banks. Why not give it a try?

The only reason for them to not take up this challenge is that they are too embedded in the system as we know it to understand that change is inevitable. Let’s hope that the dose of populism injected by Obama changes the political game just enough that some kind of regulation – and repayment – becomes a given. There’d be no excuse for cowardice if the Democrats can ratchet it up just that far.

Of course, I’m still waiting for a real WPA and a focus on the cost of creating jobs. Those may seem like a distraction in the twisted politics of Washingtoon, but they are how the economy will be restructured properly. What the Democrats need to understand is that a bit more populism might force some of these other nasty issues, like financial regulation, to move forward much quicker. Here’s hoping.

This argument is building on a lot of old arguments that I’ve made over the last two years. Those are imbedded in the links, which I invite you to follow. Thanks.