There was a saying in Silicon Valley in the 1990s: "The thing that makes America the greatest country on earth is that it is the only place where you can borrow $100 million without owning a suit."



Borrowing even fifty dollars is a lot tougher these days than a decade ago, suit or no suit. But as the U.S. economy struggles to recover, we all have an interest in preserving the innovation, dynamism, flexibility and creativity of the financial sector.



That's an unpopular point of view these days, I know. You can overdo anything, even innovation—and over the past half dozen years, mortgage finance overdid just about everything. Now we are all paying the price.



Yet curiously, the Obama administration's bank reform plan announced last week corrects almost none of the regulatory gaps that enabled the mortgage crisis. What those reforms do instead is clamp a series of restrictions on non-mortgage activity by financial institutions.



Secretary of the Treasury Tim Geithner and senior White House economic aide Larry Summers outlined the plan in an op-ed in the June 15 Washington Post. Highlights include:



* More stringent capital and liquidity requirements for all institutions, especially the largest.

* Tighter Federal Reserve supervision of firms whose failure could threaten the stability of the system.

* Closer regulation of derivatives markets.

* A new consumer protection agency with power to approve or disapprove consumer lending practices.

* A new system for "winding up" failed banks—something between a bailout and bankruptcy—with details to be provided later apparently.

Let's consider some of the implications of these moves.



Bigger banks will be more tightly supervised—but will also get some kind of guarantee that they will never be allowed to be bankrupt. All other things being equal, that guarantee should allow them to borrow more cheaply, creating a competitive advantage. Over time, we'd expect the financial system to tilt in favor of these more subsidized financial institutions. Risk taking would diminish, innovation would ebb.

Consumer lending will be more tightly policed. That will increase the cost and reduce the availability of consumer credit. One of the proposed Obama reforms would require credit card companies to post notice of proposed interest rate increases. Yet the long history of such regulations powerfully suggests that their effect is (1) to encourage competitors to coordinate their rate increases and (2) to discourage price-cutting (because future increases may have to be justified to the regulator, but mere maintenance of existing prices never needs to be).



Some Obama administration supporters yearn for the "boring finance" of the postwar years. But those were also years when the U.S. economy was dominated by giant oligopolistic firms that financed themselves out of retained earnings—a regime tough on newcomers with no earnings to retain.



Nor is it just newcomer firms that are threatened by the administration's quest for stability even at the expense of innovation. The real victims of the Obama approach to the economy will be individual newcomers, especially the young, who risk entering an economy less able to generate new employment, new wealth, and new opportunity than the more dynamic economy of the past three decades. (Click here to hear a broadcast on American Public Media's "Marketplace" in which I further detail the plan's failings.)

And yet while the economic effects of the Obama plan induces despair, politically perhaps it offers conservatives a first glimmer of hope. Maybe the high costs of state control are a lesson that must be relearned in every generation. As the new policies go into effect and do their harm, there will be a great relearning among young voters entering the workforce after 2010. And just as today's college students rallied to Barack Obama's language of change—so perhaps will today's high school students someday rally to a conservative who can re-articulate the free market's exciting offer of hope, growth, and opportunity.