Mitt Romney – a 21^st century Thurston Howell; a Wall Street shill; the man who invented the silver spoon.  This is the narrative that democrats have tried to create concerning the republican presidential nominee.  And yet during the first debate on Wednesday, Romney sounded a populist tone as it relates to Wall Street and big banks.  Was this a moderate version of Mitt Romney, breaking with conservatives?  I think not, and here’s why.

Romney was asked a question about regulations and the free market.  He responded by stating that regulations are important for a marketplace to work smoothly and promote fairness, and then reflected on the financial reforms implemented in Dodd-Frank.  He stated, “Dodd- Frank was passed, and it includes within it a number of provisions that I think have some unintended consequences that are harmful to the economy. One is it designates a number of banks as too big to fail, and they’re effectively guaranteed by the federal government.”

The basic thrust of his argument was that the Wall Street bailout and the financial reform legislation that followed prevented a collapse of the financial sector, but, in doing so, was a boon to big banks and a hindrance to smaller ones.

Republicans have often been aligned, for good reasons and bad, with Wall Street and big business.  They support the free market through investment, capital formation, innovation, and job creation.  But just because they support these principles does not mean that it is necessarily conservative to defend big banks at any cost.

As AEI’s James Pethokoukis pointed out in The Weekly Standard, five mega-banks – JPMorgan  Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs – have combined assets equal to about 60% of national output.  The growth of the financial sector, and particularly these five financial institutions, was only exacerbated by the bank bailout and Dodd-Frank.  As Romney argued on Wednesday, the government has institutionalized “too big to fail.”  Prior to the debate, the only presidential candidate in either party to even mention the inherent dangers of this reality was Jon Huntsman, whose voice was drowned out by criticism of his record and campaign strategy.

The financial crisis of 2008 resulted from the universal (and irrational) assumption among financial institutions that housing prices would continue to rise uninterrupted.  Banks became overleveraged, as the demand for capital exploded, and shifted risk down the securitization chain.  When the housing bubble burst, the damage rippled through the chain leaving no institution untouched (lenders, borrowers, insurers, etc.).  This brought the financial sector, and by extension, the entire US and world economy, to the brink of collapse.

The bank bailout and Dodd-Frank reforms, while bringing us back from the brink, institutionalized this reality, and even expanded it.  The big banks got bigger, to the point where a large-scale collapse by a single bank could have almost the same impact as the bursting of the housing bubble.  This is not capitalism, as Pethokoukis points out, it’s crony capitalism, and the risk now rests on taxpayers.

Pethokoukis recommends, as Thomas Hoenig does, splitting up the big banks to separate the traditional banking functions (commercial banking, underwriting securities, asset management) from investment banking services (creating and trading in securities and derivatives,  sponsoring hedge funds and private equity funds).  A system such as this would reduce risk to taxpayers and the market as a whole without unduly limiting the banks’ profits.

It’s unclear whether this is the type of reform Romney would seek – he gave no specifics in the debate.  But floating the idea makes sense from both a policy perspective and a political perspective.  It would prevent widespread financial panic while protecting the ability of small banks to borrow and lend safely.  Politically, republicans cannot continue to be, or at least seem, beholden to big banks; forcing them to maintain a safe securitization system is not anti-capitalism, it’s smart-capitalism.