Financial reform is the new focus of the Obama White House and Democrats in Congress.  Coming on the heels of a grueling and politically costly fight over health care reform, Democrats can be forgiven for seeking once again to be seen as champions of the apocryphal “little guy” who is the unquestionable saint of American political discourse.  Republicans got to ride that pony for nearly a year now.  It’s the Democrats’ turn.

The problem is that good politics makes for very bad policymaking in this area.  The President has cast his drive in explicitly populist terms,  attacking opponents as nothing more than corrupt lobbyists in the service of the rich.  As populist politics in an age of economic struggles goes, it is fertile ground.  The bailout for large banks was absolutely necessary to stop a slide towards a devastating deflationary depression, but for average Americans struggling with job losses and unable to find a bailout for their mortgages, student loans, and credit card debts it had the appearance of robbing the poor to pay off the rich.  Moreover, the media and political elites did their usual dreadful job of explaining things to the country. Blustering populism is also an easy cover up for the gross ignorance of some reporters.  As a result, there is a lot of resentment towards “the rich” these days and it is all too easy to cast anyone who defends the interests of wealthy capitalists as vampires.  Economic populism provides a desperately needed opportunity for Democrats to restore their battered poll numbers before November rolls around.  And Republicans are already beating a disorderly political retreat.

The trouble is that the President’s own words are quite true: “What happens here has real consequences across our country.”  Politicians’ drive for votes could come at a high very real-world cost.  Increased liquidity limitations for banks could dry up lending again as the banks are forced to horde money by government mandate.  As a result, lending standards for mortgages, car loans, and student loans could tighten further, and no amount of indulging in blaming the evil bankers would change it.  Increased regulations on derivatives trading could have a similar effect, as the requirement that they be backed by collateral could raise transaction costs and tie down even more capital that would otherwise be circulating and building the tentative economic recovery that is just getting underway.

That’s not to say that some reforms might not be desirable, even mandatory.  But as long as the underlying attitude is vindictive (“get the rich”) instead of practical, the reform drive is extremely dangerous and prone to produce policies that could be even worse than the policies that produced the meltdown in the first place.  Just as many progressives noted after 9/11, overreaction can sometimes be even more dangerous than the original threat.  They might pause to give that lesson a rehearing now and take care to be cautious and deliberate in tinkering with the most complex financial system in the history of the world.