How to cut megabanks down to size
nytimes.com
nytimes.com
The robo-signing debacle[2] has demonstrated amply that the financial sector can't be bothered to verify their data before destroying the lives of thousands of people.
The LIBOR manipulation scandal[3] proves that even the industry's own measuring rods are bent and unreliable.
The last 5 years have revealed an industry rife with crime, deceit, and unabashed greed which has severely damaged the global economy and the quality of life for hundreds of millions of people. And the penalties for these actions pale in proportionate comparison to those imposed on a street-level drug dealer.
When a private enterprise becomes too essential to regulate effectively, it endangers the society in which it operates. Breaking it up into manageable chunks is the only viable option.
[1]: https://www.nytimes.com/2013/01/03/opinion/how-bankers-help-...
[2]: https://en.wikipedia.org/wiki/2010_United_States_foreclosure...
"well this time it will surely work!" "if only we had the right kind of regulation/people in charge!" they say.
That's never gonna happen. Breaking the system in chunks artificially will not work, because it will consolidate again and buy up the regulators. The true solution here is Bitcoin, precisely because it is not controlled by anyone.
If the USA kept the gold standard, I seriously doubt they'd be the number 1 economy in 2013.
So I really doubt most of the population benefits from inflation.
And as a rule of thump, every time I read a Austrian argument, I try to find the hidden assumption of markets working at full capacity. ( And every time I read a Keynesian argument I try to find the hidden assumption of an output gap.) Usually this is a nice way to understand the argument better.
As for "manageable chunks", vs. "artificial" chunks, I point you to this comment by Alan Greenspan, in http://www.freepatentsonline.com/article/Brookings-Papers-Ec..., that the current size is too large, and not manageable.
> For years the Federal Reserve was concerned about the ever-growing size of our largest financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest size (Berger and Humphrey 1994, p. 7; see also Berger 1994). A decade ago, citing such evidence, I noted that "megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail" (Greenspan 1999). Regrettably, we did little to address the problem.
> ... However, should contingent capital bonds prove insufficient, we should allow large institutions to fail and, if assessed by regulators as too interconnected to liquidate quickly, be taken into a special bankruptcy facility, whereupon the regulator would be granted access to taxpayer funds for "debtor-in-possession financing" of the failed institution. Its creditors (when equity is wholly wiped out) would be subject to statutorily defined principles of discounts from par ("haircuts"), and the institution would then be required to split up into separate units, none of which should be of a size that is too big to fail. The whole process would be administered by a panel of judges expert in finance.
This is based on issuing contingent capital bonds, which funds a "living will" "in which financial intermediaries are required to offer their own plans to wind themselves down in the event they fail."
On the other hand, rejecting idiocy like this gets us from Astrology to Astronomy, from Alchemy to Chemistry, and the Magna Carta to the US Constitution, and further, the amendments to it.
The incidents you cite above happened to exploit the fact that there is someone who will absorb all the risks of otherwise unprofitable practices.
>market discipline has worked to keep smaller institutions on the straight and narrow, it has been ineffective with megabanks
>market participants have proved [in]effective in monitoring risks at these [huge banks].
>They know they will be protected by a taxpayer rescue should a large institution teeter.
How is this not obvious to everyone involved?
Banks that are too big to fail are too big to be allowed to exist. Government protection only for the commercial/retail part is an obvious but insufficient requirement.
When big banks make money by taking crazy risks, they earned every penny and how DARE we try to tax or regulate them. When they lose money by taking risks, we need to bail them out for the good of the free world and how DARE we ask to be paid back. Small banks do not have this attitude.
If they were smaller the collateral damage is smaller and wind up manageable. There are real reasons for not letting big banks fail so we need to avoid them getting that big and complicated so they can be allowed to fail.
[1] http://en.wikipedia.org/wiki/Primary_dealer [2] http://en.wikipedia.org/wiki/Market_maker [3] http://en.wikipedia.org/wiki/Bid-offer_spread
Paul Krugman, for example, proposed that big banks like Citibank provide value by having a huge service network, and therefore he's skeptical of breaking up banks. Which is true--Citibank's size is the primary (and probably only) reason I'm a Citibank customer. But the unstated assumption that there must necessarily a 1:1 ratio of Too-Big-To-Fail bunches of assets to bank service networks is baffling to me.
There seems to be a TBTF blind spot in the sphere of wide-area economic and financial knowledge; that is just one example. The solution is always "more regulation", or occasionally, "better regulation" with the implication that everything is the government's fault.
I think they're quite familiar with the idea and have caught onto it long ago; they just don't want to be misrepresented as advocating a government takeover of the finance industry or as communists or whatever. It's not so much that they favor large institutions, as they're trying be moderate and consider both sides of the argument.
By contrast, read the editorial pages or the comment sections of the Wall Street Journal, in which Obama is regularly characterized as a Marxist ideologue and worse, and any sort of regulation or disciplinary action against the financial services sector is characterized a shakedown, at best. If the government actually proposed carving up the banks there would be (even more) howls for his impeachment. Much as only Nixon could go to China, a reset of the financial sector could only come from some prominent Republican, and a fiscally hawkish one at that.
I'm a member of a two-branch credit union, but I get to use a fairly extensive service network through the Credit Union Service Center system, where a large number of small institutions share the customer-service side of their operations. In the SF bay area, I get full service from any of the several dozen branches of Patelco and USE, plus several smaller CUs.
This should be mitigated by the fact that shareholders will lose value, even in the event of a taxpayer rescue. Meaning, a bailout isn't a good insurance policy for a shareholder because they lose anyway. But that fear of a bailout doesn't seem to limit the risk appetite as I'd expect.
I think it's because regulation and control hasn't made this type of risk transparent to the shareholder. The shareholder isn't calling for these types of regulations because of fear the regulation would be overbearing and hurt profitability.
Often, over regulation is a shortsighted concern that allows a company to take on more risk than an investor would typically allow for (at existing valuations).
http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem
More simply:
Taxpayers are suckers
Lenders are suckers
Shareholders are suckers
Managers and traders, not suckers.
2) the other 3 (Goldman, Morgan Stanley, Merrill Lynch) would have failed after Lehman, the entire financial system had to be backstopped by the government. (If you look beyond pure securities firms, the largest insurance company (AIG) failed as well as the largest bank (Citibank - it effectively got nationalized and shareholders were wiped out, look at a stock price chart (http://finance.yahoo.com/q/bc?s=C&t=my&l=off&z=l...)
The lesson learned is that the financial system can't survive a failure like Lehman without a government backstop.
So, pick your poison, either 1) permanent government backstop and some regulation to go with, it, ie don't let bankers run leveraged hedge funds on the public dime, take all the profits in good times and stick taxpayers with the bill when it goes south.
Or 2) smaller banks that can fail without taking the whole system down.
It's the smaller banks that struggled the most and continue to do so: http://articles.latimes.com/2012/jul/06/business/la-fi-banks...
of course there are always some people who believe whatever they want to believe.
not sure what you're advocating...in the Great Depression banks failed, the depositors lost all their savings, triggering runs on other banks, etc., hence the name Great Depression. so that wasn't a very sound policy.
on the other hand a government backstop for a bunch of traders making giant risky bets with depositors' money so heads they win, tails we lose, is not a sound policy either.
somewhere there's a reasonable medium, collectively safeguard the payments system and bank deposits, without giving banks carte blanche to use depositors' money and government backup to make risky bets.
and don't let banks get so big that it's both an administrative nightmare to shut one down, and they have enough political power to thwart shutdowns and effective regulation.
Let the banks go bust by all means, but let's also recognize that government regulation/incentives ($440B from Fannie Mae!) was a large part of what got us into this mess.
http://articles.cnn.com/2002-06-17/politics/bush.minority.ho...
Fannie Mae, Freddie Mac and the federal Home Loan Banks --
the government-sponsored corporations that handle home
mortgages -- will increase their commitment to minority
markets by more than $440 billion, Bush said.
Under one of the initiatives launched by Freddie Mac,
consumers with poor credit will be able to obtain mortgages
with interest rates that automatically decline after a
period of consistent payments, he added.
To fight this recession the Fed needs more than a snapback;
it needs soaring household spending to offset moribund
business investment. And to do that, as Paul McCulley of
Pimco put it, Alan Greenspan needs to create a housing
bubble to replace the Nasdaq bubble.
Paul Krugman, 2002However, just limit the amount of Federal Deposit Insurance that can be issued to one entity, if we can't figure out what they're doing.
But the flip side is: why don't we just let megabanks go bust? If they go bust, the government steps in, briefly nationalizes them, sells off the parts (the shareholders get nothing, of course), and life continues. As long as this period is kept as short as possible why is there any danger of "meltdown"?
One issue is some banks were on the border on if they needed bailing out, and shareholders might prefer the risk of catastrophic failure than taking a bailout which would lose them their shares.
That's the solution I would have preferred in 2008, but the political system has shown it can't commit to that solution. You lose any support for that resolution plan from conservatives at "briefly nationalizes", because they're afraid any nationalization won't turn out to be brief at all. So nationalization is off the table, and we have to stumble through with bailouts.
And then if I'm a bank manager, I'm going to borrow as much as possible, and do a lot of high-risk, high return type trading, if it works out I make a ton of money, if I lose it's the government's problem.
Finally, it's not that likely for a Treasury official to tell a TBTF bank they're taking it over - it's an administrative nightmare, and the banks have captured the regulators.
So if a bank gets weak, markets will keep extending credit as long as there's a government backstop, and it won't get taken over, and management will keep playing double or nothing with taxpayers' money.
Moreover, bigger companies are not necessarily more efficient. A smaller company (or country) has the agility of a shorter decision chain.
Someone has never worked in a large bank before.
Big companies combine the worst characteristics of state-owned and privately-owned enterprises.
On one hand, large amount of small shareholders makes them similar to state owned companies (in which everyone is a shareholder) with all the associated bureaucracy, parasitic management class, pathological incentives etc.
On the other hand, being private they lack even the weak control mechanisms that democratic societies impose on state-owned companies.
Bank runs are like forest fires. If you prevent all the small ones, eventually you get a giant one that's too big to stop.
[Price–Anderson Nuclear Industries Indemnity Act] http://en.wikipedia.org/wiki/Price%E2%80%93Anderson_Nuclear_...
These two departures from basic democratic control have freed the legislative body from proper accountability to the people, rendering the will of the people increasingly irrelevant to the operations of the government. Saying political will "is just not there" like this is some sad but immutable fact of life ignores the reality of the situation: America has suffered an unofficial coup. We are now suffering under an intrinsically illegitimate government that preserves its power thanks to very clear, very precise structural problems that have been magnified enough to effectively hinder the legitimate will of the people.
These are facts, and they are neither debatable nor acceptable. The situation must resolve itself and it must do so in favor of the people.
Aye: 171 D, 91 R. Nay: 63 D, 108 R.
http://www.opencongress.org/bill/110-h1424/show
Why are you complaining about the GOP holding the house? Based on their votes, they seem to be the party of letting banks pay for their mistakes.
Do you disagree? Perhaps Republicans hate the Tea Party so much that they decided to support bailouts just to spite them?
The bailout wasn't the issue, by the way. Faced with a catastrophic crisis, propping up a criminal enterprise that we are utterly dependent upon is very much a lesser of two evils choice. The real problem is with sparing these bastards from even a hint of prosecution after the fact.
If you want a more accurate view of where the GOP stands today, consider Eric Cantor (i.e. their leadership) who actively courted Wall Street during the election, promising that the Republicans would provide "better service" and getting a highly disproportionate of the bribes (ahem) contributions in return.
And don't get me started on Elizabeth Warren. She was actively and articulately opposed to the criminal class that's developed in banking. And the agency she designed (the CPFB) was the target for the most vitriolic rage that the House Republicans have managed to date, and that's saying something, given who we're dealing with.
As for "criminal enterprise" and "prosecution", could you remind me what crime was committed, and by whom? Last I checked, taking a long position on housing (the cause of the crisis) wasn't a crime. If it was, we need to jail every homeowner.
Keeping Elizabeth Warren out of the public policy arena is a fantastic move. She is driven primarily by ideology, and displays a remarkable ability to state correct facts in a manner that misleads reporters and the public. See, for example, her nonsensical claims that medical costs cause millions of bankruptcies, or her confusing presentation of data in the "Two Income Trap" which obscures the fact that the primary cause of the two income trap is taxes.
For someone who knows as little about what actually happened as you appear to, it's probably the best crash course available.
And not being one to suffer fools gladly, referring you to a comprehensive account of multiple, interlocking frauds spanning a variety of institutions spares me the effort of engaging with someone displaying a Creationist's level of epistemic closure. This particular discussion of rampant corruption and outright criminal conduct (fraud, mostly) has the added benefit of being a very high profile account. It has been widely circulated, closely examined, and generally accepted as a fair and accurate assessment. This level of exposure means you'll have an easy time verifying the claims, should you choose to do so (which, ha).
In the meantime, I'm going to go back to being amazed that someone discussing this in 2013 can do so without appearing to know what a derivative is, let alone how one works.
But honestly, that only makes him even more dishonest. After all, he was saying that there was no real difference between banks involved in the subprime crisis and any homeowner "going long" with a bet on rising home prices. Except that there's a world of difference between placing a bet on a specific piece of tangible property in an open, regulated market, and placing bets of derivations from that market so far removed that they have no clear connection to reality. And he, of all people, should know it.
This refusal to see how cynically the inputs for financial models were being manipulated supports my view that many of the quants who played a key role in this mess had no idea who or what they were working with, that they were oblivious to the fraud and corruption engulfing the firms that employed them, and that they failed to register what would happen when things like fraudulent AAA ratings on securities found their way into a system. Among a broader class of market observers this blindness was attributed to a quasi-religious belief in efficient market theory, rejected the possibility of fraud out of hand.
The basic problem can be summarized as mistaking the map for the territory. In this case, the map was the Black-Scholes Equation. Or rather, the source of the maps was this formula. People who learned to model various risks to determine prices without properly understanding the equation's limits (there were many of both) ended up with catastrophically misguided decisions to their credit.
For a bit more background on all this, see here: http://www.guardian.co.uk/science/2012/feb/12/black-scholes-...
If there's one thing that 'Inside Job' makes clear, it's that the policy framework that governs markets is absolutely critical to their stability and value. In America, this framework was subverted by the rise of an ideological (again, quasi-religious) form of market theory that say deregulation as both a practical and moral virtue. This was deep tissue corruption, and as it found its way into the laws that governed market players (or failed to govern, as the case may be), it opened the door to a cascade of fraud - people deliberately describing X as Y.
Like a ever-growing fog (toxic cloud, really) this continued until none of the major players had any idea what positions their counterparties were in. Knowing how fraudulent their own positions were, they had every reason to fear the worst from others in the same game. And then, on one horrible day in September, the music finally stopped.
To put it in very crude terms, a system built around bullshit eventually choked on the stuff. I'm not surprised that a person who shared more responsibility than most for the resulting catastrophe would respond by entering a state of deep denial. But it's sad, nonetheless.
http://www.pbs.org/wgbh/pages/frontline/business-economy-fin...
It is "common knowledge" that medical costs drive bankruptcies so I'm surprised to hear you say this; but of course, I know that "common knowledge" is often wrong. Can you explain how medical costs don't actually often result in bankruptcy?
(This is not an attempt at a sarcastic troll--I think you often, but not always, do have correct contrarian opinions, I just don't know what this one is.)
The gist of the flaw is this:
# Medical bankruptcies = # of bankruptcies x [P(bankruptcy | medical cause) - P(bankruptcy | no medical cause)] x P(medical cause)
However, she used verbiage hinting that P(medical cause | bankruptcy) x # of bankruptcies = # of medical bankruptcies (do the math - it's not). A bunch of innumerate reporters read the verbiage and ignored the math, leading this "fact" to become "common knowledge".
The claim may or may not be true - I don't know of good data on it. But all Warren did was deliberately confuse the issue to support her political allies.
See also http://www.theatlantic.com/business/archive/2009/06/elizabet...
Heck, that's how banking started. A handful Venetian traders got so rich they started lending money.
There problem solve.
BUT it's also a form of "insurance". If there's a suspect a bank won't be able to honor deposits, bank run ensues, THEN the given bank can't honor deposits obviously, because no bank works like that today, that is: self fulfilling prophecy
It's a necessary evil (for the customer's sake)
I will not bail out private money making banks via the FDIC via my tax dollar.
If you put money into a private bank, then when it fails, you should lose that money.
Never in American history has the FDIC had to take a "tax dollar" during a bank failure. The government does back it, yes--but the amount of private money in the FDIC makes it extremely unlikely that bank failures even at the scope we were looking at in 2008 will tap them out.
The FDIC also provides public benefits, like avoiding economy-crippling bank runs.
It's a good thing.
China does things right here, when it fails due to your corruption, you get executed, instead of bailed out.
https://en.wikipedia.org/wiki/First_Bank_of_the_United_State... https://en.wikipedia.org/wiki/Second_Bank_of_the_United_Stat...
Read Quest for Prosperity -- the private/public construct of distinction is a complete myth that is exposed by the titans in Asia and Latin America. The more we stick to the myth in the US, the longer it will take for us to have the same degree of success. Innovation comes not out of motive for profit, but ou of need and desire and capability.
So was the Asian Financial Crisis. And to a lesser extent Japan's "lost decades".
There are no simple answers in economics. Everything comes with ugly drawbacks.
Whatever we do, the parasites who can print and dilute our currency through systematic inflation must be appeased and satisfied, or else they will inject poison into the entire system as a retaliation for trying to remove the blood sucking parasite. The bitcoin angle won't work.