Reprivatization After Paulson

The worst possible way to nationalize would be to assume responsibility for the liabilities of banks, at the same time as not putting in place adequate oversight and failing to ensure that the taxpayer gets any upside.  Even worse, we could install managers with a proven track record of incompetence.  Anyone who proposed such a scheme today – as we collectively kick the tires of plausible alternative approaches – would be dismissed as an ridiculous crank.

Yet it is exactly this kind of nationalization that we – or, more specifically, Hank Paulson – already did.

It is true that there has been no change of control and bank shareholders have done remarkably well under the circumstances.  And it is also true that the amount of new capital, from the original TARP funds, is relatively small for most banks (Citi and Bank of America are exceptions).  But, make no mistake about it, the Federal Reserve and the Treasury – acting on behalf of taxapayers – saved the banking system in late September/early October 2008 through making available large and extraordinary lines of credit, as well as key injections of capital.

Of course, this was not formal nationalization – but it placed us on the hook for most, if not all, of these banks’ liabilities.  In effect, we provided a massive cheap insurance policy to the banks, the people who run them, and their boards of directors.  Focus on these boards for a moment; they are very much part of the problem.

Corporate boards are supposed to represent shareholders, but to a large degree they do not.  Most board members are appointed by the CEO or hold their position due to the CEO’s tacit support.  The idea that these board members effectively oversee the activities of these large banks seems almost quaint.  While I am sure they are all fine, upstanding citizens, many of them seem considerably out of their depth.  Others seem too deeply intertwined with the company executives, with other boards, and with the corporate elite more broadly.  Strikingly few of them have stepped forward to take any kind of responsibility.

Fannie Mae and Freddie Mac were “taken over” by the government – placed into conservatorship – in summer 2008 because the Treasury determined that they did not have enough capital, so there was a risk they might need to draw on the government.  Both boards of directors were removed at the direct instigation of Secretary Paulson.  He had the legal right to do so precisely because these institutions had special access to the public purse.  Note, however, that Fannie and Freddie had not actually drawn on the Treasury at the time they were taken over.  It was the view that there was a prospect of drawing that entitled the Secretary to act.

Since then, of course, all banks have received similar access – through TARP and the Federal Reserve, to be topped up by further such support announced last week by Secretary Geithner.  Some might still argue that accessing liquidity from the Federal Reserve is not the same thing as the Fannie/Freddie arrangement, as the Fed supposedly never takes credit risk.  But this is not a widely held position, particularly after the second round bailouts of Citi and BoA.  And Secretary Geithner, following in the footsteps of Secretary Paulson, clearly indicated that the Treasury would provide risk capital in all the schemes involving the Fed, i.e., the bookkeepers may quibble about the details, but you and I will be providing extraordinary financial support to the banking system for the foreseeable future.

Why did Secretary Paulson therefore not seek the legal authority to remove or change boards of directors when a bank drew – or potentially could draw – on the government?  Presumably, he did not want to upset the banks’ executives.  Perhaps there were other reasons. 

In any case, the issue today is not whether we should nationalize.  Mr Paulson effectively nationalized the liabilities of major banks without putting in place any effective supervision of banks’ operations.  This is not a winning combination.

What we really need is to reprivatize – to return the banks to real private owners, preferably with strong voices on boards, and perhaps with controlling ownership stakes.  And we must, above all, make sure those owners have the incentive to break the banks into smaller, more manageable pieces, none of which are “too big to fail.”  As part of this process, some boards of directors will either have to go or be reshaped dramatically.  And new boards can decide who should or should not run these greatly restructured banks.

52 responses to “Reprivatization After Paulson

  1. Thank you Simon–you say everything that i am thinking. I just don’t understand why no one seems outraged about the fact that there was an executive decision to deny Lehman a bridge loan of 6 billion dollars, yet AIG is “saved” which means all the entities who bet on Lehman’s collapse got their winnings from US taxpayer money; the investment banks left standing turn into bank holding companies while the TARP legislation is in discussion and yet it seems no one is asking for an investigation? If there is a retroactive audit of all of the related companies of both Morgan and Goldman back to the day prior to Lehman’s fall, and it is found that they were not technically viable at that time, wouldn’t that have an effect on the future of the GROUPTHINKTHINKTANK machine that is in place requiring all of us to believe that the world as we know it will end if we don’t give away the coffers of the USA to prop up insolvent institutions? I don’t mean to accuse here, i just mean that the public deserves to know that there was no conflict of interest acted upon, by anyone when the events of Sept-Oct occurred.

    The Congressional oversight panel already found that Treasury overpaid by 30% for the stakes they purchased wtih TARP1 money, why is there no panel to investigate why Fannie and Freddie were taken into conservatorship, yet by letting Lehman fail, a drama was defined giving a winning ticket paid by the US government to all Lehman credit default swap owners? Instead of the wild goose chase of scare tactics about he world coming to an end, why can’t there be a retroactive accounting (values as of September 14, 2008) for each firm that received TARP money?

    There was a gentleman from Houston who paid for a full page ad in the WSJ to ask rhetorical questions, could you find funding to educate the public on the ideas that you convey in your note here? Also, I hope you will be sure to find some way to defend your affiliations, because I am sure you will be attacked on all levels.

  2. One more question that makes the series of events that took place in the fall look even worse is the fact that although Glass-Stegall was repealed years earlier, and the day after Bear Stearns was purchased by JPMorgan, the Fed window was provided to the remaining investment banks and indeed it was used, but for all the months that Bear Stearns begged for assistance, why wasn’t Bear offered the Fed window in June of 2007 after their first hedge fund blew up?

  3. From your lips to Obama’s ears…

  4. “Why did Secretary Paulson therefore not seek the legal authority to remove or change boards of directors when a bank drew – or potentially could draw – on the government? Presumably, he did not want to upset the banks’ executives. Perhaps there were other reasons.”

    Presumably, he did not want to upset the banks’ executives? Perhaps there were other reasons? I mean really, why the blatant timidity when it comes to stating the obvious: That he was their cotton-pickin Steppin Fetchit, for God sake! You’re not hoping to be employed by these folks at some point, are you?

    Simon, step up to the plate. Quit hinting at the conclusions you’ve already drawn and own them. One gets the sense of being in the presence of the Caine Mutiny’s Lt. Thomas Keefer.

  5. Wow.

    I am not an economist. My son has a B.S in it, for what that is worth, and he was tops in his class, and what I say below he couldn’t really refute. I put it forward with trepidation, as it must have huge holes in it, but the questions I am asking are fundamental and relevant to the issue Simon Johnson is addressing. But it is VERY far out in left field – hence my trepidation in offering it. But here goes:

    First off, in medicine there is some kind of principle that if something will heal a condition, it will generally always also prevent it. This is pertinent to the economic situation with the banks.

    In the last two weeks the term nationalization is coming up more and more, especially as I am also hearing from more and more economists that nationalization seems to be on the table. But only temporary nationalization.

    And here I see SJ talking about ‘reprivatizing”, which means finding private investors with the balls and capital to become our new bankers, whatever the scale of their future endeavors (many are saying, “Break up the big ass banks so they can’t rape is next time with the ‘too big to fail’ mantra”).

    The stuffed shirt bigwigs with their insane salaries and perks and bonuses have, for the most part proven to be irresponsible to the nth degree. Now that we have a sane government, we are all of us putting a WHOLE lot of trust in the government to inject sanity into the mix.

    My question is basically, “If government is the cure, and government offers the sanity, why should we give the banks back over to private ownership?”

    In one of his most recent posts here, “Every Consensus Must End,” SJ talks about new directions in banking. I am questioning if private ownership of banks in itself is the paradigm that needs to be examined.

    Banks are – for better or worse – part of our functional infrastructure, every bit as much as highways and bridges, as airports and train stations, as water treatment plants and electrical grids.

    Government creates money, and then government filters that money to the citizenry through private banks. I have to ask, “IS THIS REALLY A NECESSARY STEP?” If the banks stayed under public ownership, what falls out from that decision? What gains are made, what problems arise, what harm is done to the public good?

    In asking those questions, I also wonder what would change if we don’t have those parasitical boards and CEOs (after the abuses and irresponsibilities that have come to light, is there any other way to put it?). It would appear from a Main Street POV that all they are is leeches on our economy. Granted that is maybe overstating it, but what arguments are there that they do a better job of managing this portion of our functional infrastructure than the government would be able to do?

    YES, we have been spoon-fed the mantra of Saint Ronald of Reagan that government is the problem, not the solution, and that the flow of functions should be the other way around – not TOWARD more government participation. BUT WE HAVE ALSO SEEN THAT AS A NEARLY COMPLETELY FLAWED AND DESTRUCTIVE POINT OF VIEW. Could even government have screwed us all this bad? Government under GW Bush, maybe, since the last administration tried its damnedest to make government a failure on all fronts, by design.

    But now that we have people in government again who believe that having serious people in government makes for government that works, can we say that government ownership/management of our banks is not a paradigm to consider?

    I do not know the history of banking, and its relationship to governments presently or in the past. But it seems that government ownership would afford options that are not available with private ownership of banks. One, we might revisit the entire principle of interest on loans. With the government managing banks, do they need to be profit-making endeavors any more? If banks were non-profits, is it possible to have loans so that interest is much less? Maybe not even necessary?

    I ask this with an eye to how MUCH is diverted out of our productive economy and into the hands of the irresponsible CEOs and board members – WHAT DO THEY CONTRIBUTE, other than pushing money this way and that? And making it harder for us to get at our own money – and CHARGING US for the right, on top of it.

    Literally: WHY DO WE NEED THEM?

    Secondly, supposing that loan interest is the one and only workable mechanism by which the system can work, if it is the government taking in all those trillions, does it not follow that taxes may be much less necessary? Maybe 100% less?

    SJ, in that other post you talk about “what next” for banks. Are we asking ALL the questions and considering ALL the possibilities?

    The most basic fundamental question here HAS to be, “Are private banks even necessary?”

    Like I said, this is out in left field. But if we can have a system that gets rid of a super-rich parasitical class, why would we want to keep them? For old time’s sake? While they are sucking so much out of our economy – and giving us WHAT? The days of big bankers as keepers of the esoteric flame is a bald faced anachronism. What the hell do we need them for – so they can do this again in another 80 years? How many folks out there on Main Street (especially those who lost their homes due to no fault of their own – maybe myself included) would rather deal with a one-stop government bank than the confusing panoply of competing private banks we now have?

    Leave no doubt about it, either: competition for loan interest money was behind this whole meltdown. Should we not consider how that in itself might be taken out of the equation?

    That’s it. Yell at me for being dumb and simplistic.

    .

  6. Last Tuesday, it emerged in the UK that Paul Moore, the HBOS chief risk officer, was sacked and gagged.

    Moore – a barrister – has allegedly documented the history of the UK government’s destructive interventions in the banking industry. Newspaper readers’ subsequent discussion has focused on the risk of Moore being inexplicably found dead (like Hutton who blew the whistle on government WMD lies). The best advice to Moore seems to be to get as many copies of his evidence lodged in as many places as possible as soon as possible.

    If Sophie is right: “I hope you will be sure to find some way to defend your affiliations, because I am sure you will be attacked on all levels.” Then, paradoxically, John Lowell might also be right: “Quit hinting at the conclusions you’ve already drawn and own them.”

  7. Sorry. Muddled up there. Lord Hutton headed the inquiry to whitewash the death of Dr David Kelly (the doubter).

  8. I don’t think they’re fine upstanding citizens at all.I think they’re incestuous oligarchs who have been in control of our economy since the beginning of our westward expansion.

  9. Banks owned by individuals are more likley to base their decisions on making money. Government owned banks are more likely to include politics in their decision making. Money making decisions have a better chance of helping us.

    This may be a simple way of looking at it; but the above comments call for a response.

  10. OK. Its all Paulson’s fault. He is a baaaad man. Just like Bush! Lets conveniently ignore/forget about Congress, Barney Frank, Chris Dodd and of course Tim Geithner. Seems to me Obama likes the Paulson strategy just fine. If there are no Bank execs left standing with a track record of being “shaken down” and who now owe their jobs to Washington, where’s Obama gonna get his campaign funds from?

  11. Demonizing the term “nationalization” has enabled a transfer of US coffers to entities that were possibly already bankrupt–and for whatever reason, people seem to forget what it means for a company to be bankrupt or they just dont understand what it means–so by appealing publicly to shareholder greed, the public has had enough of the koolaid to possibly cause koolaid intoxication.

    Calling for the pre-Lehman’s demise valuation (Sept 14, 2008 or before) is the only fair was to find the health of the companies that received TARP 1 money, and since the truth of where the AIG money went, all that is publicized is NET results of AIG written Lehman credit default swaps, we don’t know how much of that money was transferred to the balance sheet, free money from US coffers since it bought AIG’s obligations, 80% with +185billion–in bankruptcy many of those obligations would certainly not have been paid, only what was left to divey up, and if 185BILLION was needed to pass through to certain entities, isn’t it fair to know who really got bailed out?) So a retroactive valuation, combined with the complete and whole truth of where AIG/government money went is the only way to know which entities were bankrupt but given money to survive and the public was given koolaid,and more koolaid.

  12. “Why did Secretary Paulson therefore not seek the legal authority to remove or change boards of directors when a bank drew – or potentially could draw – on the government? Presumably, he did not want to upset the banks’ executives. Perhaps there were other reasons. ”

    Because when you put Wall St Scum in charge of such decisions, they protect their own. Frankly, Paulson, Rubin, Summers and Geithner are all part of the problem, not part of the solution.

  13. was paulson duped or did he allow his brotheren ,knowingly, to take millions in bonuses when he and the bank folk knew that the banks were headed for bankrupcy or gov’t takeover?….something tells me that we will never know….if there is anyone that can get close to telling us,,,it’s obama…obama’s campaign donors were primarily the ave joe with small contributions….he works for the people and believe he knows this….the gov’t,including congress, is pretty upset at these bank folks it looks like to me…. there is a fine line with dealing with these guys with public sentiment outrage and really trying to keep capitalism as we know it in tact….also,,,this is very political….

    bank management,,are you going to move forward and make some concessions and work with the american people to get out of this mess or are you going to take your last bonus and get out of town?please hurry up with your decision…

  14. Good points all, Sophie. We do need to follow the money trail. When very entity involved – as direct recipient or subsequent payee – isn’t known, no assessment can be made and no equitable (no pun intended) accounting of taxpayer moneys. It may be the most monumental effort of our time – if not the most important.

    We need to know WHO is worth WHAT.

    We most need to know who is worth squat.

    The question remains why such an effort hasn’t already been made.

  15. Barry,

    “Because when you put Wall St Scum in charge of such decisions, they protect their own. Frankly, Paulson, Rubin, Summers and Geithner are all part of the problem, not part of the solution.”

    Why, yes, of course. To raise a question that can’t but help to provoke your kind of an answer without one’s answering it in this way oneself strikes me as disingenuous, frankly. Why tiptoe around the patently obvious?

  16. Sophie –

    AIG was bailed out, in particular, because Goldman Sachs would have been seriously “wounded.”
    - – -

    As reported in the NY Times:

    “The only Wall Street chief executive participating in the meeting was Lloyd C. Blankfein of Goldman Sachs, Mr. Paulson’s former firm. Mr. Blankfein had particular reason for concern.

    “Although it was not widely known, Goldman, a Wall Street stalwart that had seemed immune to its rivals’ woes, was A.I.G.’s largest trading partner, according to six people close to the insurer who requested anonymity because of confidentiality agreements. A collapse of the insurer threatened to leave a hole of as much as $20 billion in Goldman’s side, several of these people said…..”

    ~ http://www.nakedcapitalism.com/2008/09/aig-bailout-saved-goldman.html

  17. This is a little outside the topic but I was wondering…..

    If there was an organized run on the big banks (Citi, BoA, JPM) would it force the FDIC to intervene? It seems that the only real fix to this problem is for the the banks to be brought under Govt control (temporarily) and broken up. As of yet it doesn’t seem that the govt has the balls to do it (too many bankers friends) and the banks aren’t going to sell their troubled assets on their own. If people started pulling their money out and moving into local banks and credit unions would that force the govt to act and in turn speed up the fix? It would also have the added side effect of strengthening local banks that help their communities?
    Just a thought….

  18. Simon – I love this paragraph:

    “Corporate boards are supposed to represent shareholders, but to a large degree they do not. Most board members are appointed by the CEO or hold their position due to the CEO’s tacit support. The idea that these board members effectively oversee the activities of these large banks seems almost quaint. While I am sure they are all fine, upstanding citizens, many of them seem considerably out of their depth. Others seem too deeply intertwined with the company executives, with other boards, and with the corporate elite more broadly. Strikingly few of them have stepped forward to take any kind of responsibility.”

    This phrase made me laugh: “While I am sure they are all fine, upstanding citizens…”

    Anyway, so many of the boards ARE intertwined as you noted. It is a club. This is how large corporations work, in general. A person’s ascent is due far more to how they fit into the culture, than their talent or performance. The idea that these execs can’t be replaced is another lie that has become embedded in our culture (one that seems to be changing, thank goodness). People MORE talented and willing to accept far less compensation are plentiful, but they don’t belong to right clubs and circles.

    This “club” is just another hazard of the concentration of power & wealth in our country. The primary hazard is that the concentration of power, wealth, and business is that it undermines Capitalism itself.

    Underlying Capitalism is a fundamental force and a fundamental need — opposing each other.

    * The force: profit motive — which pushes toward monopolistic competition and monoply (where it is maximized).
    * The need: competition — which creates value.

    The primary economic role of government in a Capitalist economy is to ensure competition in the marketplace.

    Business is interested in maximizing profits (at least in theory) which happens at monopoly, the polar opposite of competition. Thus, we can’t and shouldn’t count on business people to create and maintain competition – certainly “big business” (which we have glorified and idolized) will generally be a force against it — which is not a judgment, it is what is so.

    But Capitalism, to work (i.e. to create value: innovation and the best good & services at the best prices), needs to operate in a competitive environment. “We’re the phone company, we don’t have to care” is the antithesis of it working.

    Thus a governing body’s role is to make sure competition exists – keeping multiple players in the game, by restraining the tendency towards consolidation, AND keeping the game worth playing for businesses. It’s a balance.

  19. I’m posting this in support of and to further develop Steve’s point about public banking;

    I first began questioning economic orthodoxy by trying to figure out how Paul Volcker cured inflation by raising interest rates. Yes, inflation is caused by loose money, but higher rates hurt demand, ie, the borrower, while rewarding supply, ie, the lender. How do you cure an oversupply by reducing demand through higher cost and rewarding supply? You don’t. What cured inflation was Reagan’s deficit spending. Not only was it direct demand for capital, but the public spending had a multiplier effect in the private economy. Meanwhile those loaning the money have its value supported and get paid interest. Interesting how a surplus of currency gets blamed on those lacking wealth, while those with a surplus of capital get rewarded. So I’m concerned that Volcker is now President Obama’s financial guru.

    One of my arguments over the years has been that money has become a tax based public utility and our current financial system is a transition state between private banks issuing private currency, to now a publicly supported currency leased out to a private banking system and the next step will be a public banking system that will be incorporated at all levels of government, so that profits are re-cycled back through the communities which created them and depositors would naturally bank with those institutions that support the services they are most likely to use. Competition would be a function of the various communities trying to provide the best environment for people and business.

    That is why it is interesting to watch the banking system being rapidly nationalized. Rather than spending untold wealth to restore it to health and return it to the private sector, it needs to be broken up and distributed to the various levels of government, from counties and towns, to cities and states, with some degree of federal oversight of the banks and control of the currency. Though even the function of currency might be dispersed as well, with state and regional currencies supplementing a broad national currency.

    The problem with supply side economics is that money is saved by investing it. This means loaning it to someone else. Therefore total savings are determined by how much can be prudently loaned, not by how much can be reserved from earnings. In order to accommodate surplus savings, loan standards were lowered and fantasy investment vehicles were created, resulting in a bubble of excess circulation far greater than a few trillion can patch up. The borrower is the foundation of capitalism and when the borrower is tapped out, it’s like planting seed in barren soil.

    That is why it is necessary to understand money as the public commons/wealth that it is, not the private property we have been led to believe. As an analogy, you own your house, car business, etc. but not the roads connecting them. Money is similar to the roads. It’s the interchangeability that makes it work. It is both medium of exchange and store of value, but as store of value it amounts to fat cells in the economy. Necessary in moderation and broadly dispersed, but dangerous in excess and concentration. If those administering transportation systems insisted on squeezing as much profit from the rest of the economy as possible and that they were the only ones capable of making it work, it would be viewed as corruption, pure and simple. In fact, that’s what the railroads did and it was.

    Viewing money as a public utility would incline us to store wealth in our communities and environment, rather than drain value out to put in a bank. Like democracy, it’s about strengthening the bottom up growth process, while defining the top down control mechanism to its most efficient functions.

    Growth is bottom up, not top down. The problem with treating the economy like a game of Monopoly is that when one person owns everything, the game is over and then starts again. In real life, this stage is called revolution. The economy must function as a convective cycle of rising assets and precipitating benefits, otherwise we have the current situation of large storm clouds of marginally productive wealth hanging over a parched economy.

    This isn’t an ideology, just an observation of how to differentiate between public and private functions. There are potential problems with any model, but this seems to me to be what the next step up the evolutionary ladder entails.

  20. Not to annoy anyone, but:

    Where do we get the new and presumably better directors? Who are they? And who are the new managers? Where will they come from?

    Simon you are correct to say board oversight was a problem. Let’s dump the boards. But it is far too easy to glide lightly past the practical and obvious questions. We will need more managers in a system with more and smaller banks. We will need qualified regulators. We need better educated legislators. Where is the improved education going to come from? MIT?

    Of course I’m biased, being an ex-banker myself, but I think we should focus on the practical as well as the fun of bank bashing.

    The expansion of the derivatives business which is the heart of our problem was enabled by years of education at places like your own school Simon. Those ‘quants’ came equipped with economics PhD’s, many from MIT. So as we sweep up the elites and send them packing, do we include the economics profession? Do we need to take a look at the oversight of the curricula at our top universities?

    I realize this sounds a tad whining, but when I read some of the comments your blog elicits I feel impelled to point out that there are quite a few Nobel prize winners who’s work enabled the derivative business to be what it became. The yahoo’s at Goldman Sachs etc. thought they were acting on solid theory. Sure they were motivated by huge and wrongheaded incentives, but their managers thought the risks were safe. Why? Because the Nobel prize winners said so.

    This is a failure of ideas as well as of ethics. We should all, economists as well, look at ourselves as we try to find solutions.

  21. Thank you btraven. Did you see the 8 tarp recipients testify the other day? When asked about whether or not GS had benefited from the gov money that was given to AIG, LB forced out a response that said in effect that all their positions were protected so no. In other words, this company does such a good job hedging, that they never lose a bet….it seems to me, that this is the same redherring type info that is floating around about the money spent at AIG by the gov. A WaPost article in Oct. reported that AIG did such a good job protecting their positions, only a little over 5million net was paid out for Lehman credit default swaps. Sadly, all of this information, all the press releases and other such info being passed around still doesnt get to the heart of what glares like a sore thumb in my opinion—yet still, no one seems to be complaining except me. In December when Prof. Steiglitz was on the Congressional Oversight Panel, he politely requested being able to know who all of the counterparties were with AIG. I am resigned to accept that what may have happened might go without notice, but even if the public cannot articulate what is wrong, their hearts, lives and guts may be permanently wounded.

  22. to SteveGinIL, Kudos to you for saying out loud what needs to be said. I don’t know whether government running the banks is a good and workable idea or not, but we certainly need to consider ALL possible options. We need to ask ALL the questions, no matter how seemingly out of line. When you look at the wealth that has been amassed by the elites of the financial industry, and consider that it all came from you and me, it is critical to ask what they did to deserve it? What did we get in return? Do we actually need them?

  23. Mr. Merryman, you’ve got it!

  24. Rob:

    I happen to think we need to nationalize the banks. We need an efficient banking system as quickly as possible. It provides credit to industry and households. Without it our modern economy collapses, as we are now witnessing.

    The wealth was amassed primarily in the investment banks and hedge funds. They are not the focus of TARP, except for Goldman and Morgan Stanley. The big banks like Citi and JPMorgan Chase are vast bureaucracies run by overpaid bureaucrats. Lining these people up and grilling them in Congress is great fun, but it’s like the old days in the Soviet Union when they shot functionaries for failing to deliver on the 5 year plan, rather than fixing the ideology that underpinned that plan.

    As an ex-banker I find some of the comments here truly offensive: the people who I worked with were involved in making loans to small businesses, consumers who wanted to buy cars, and so on. They hardly fit the evil ‘oligarchs’ epithet Simon has thrown around so loosely.

    The rotten part of the system was never regulated. It was deliberately removed from regulation by politicians influenced by ‘free market’ economics. They thought that an ‘unfettered’ market could innovate and serve the community better. Instead the deregulation encouraged unprecedented investment in esoteric [and very 'innovative'!] derivatives. The banks thought they were eliminating risk. Instead they were investing in rotten assets. The sad part is that the theory that enabled all this is still being taught as if it were correct.

    So the responsibility extends beyond the boardrooms of banks back into the education system itself. The cleansing and urge for accountability needs to be spread wider than just bashing a few ‘oligarchs’.

  25. I have a question. I like the idea of breaking the banks into smaller units so that the failure of even a number of them won’t do any serous damage, but even if there are a large number of small banks how do you prevent them from all failing at the same time. It seems like a central problem is with things like insurance and more and more complex and linked banking “products” that banks will buy and hold from each other, you still can run into this problem, no matter how small you make them. This also seems like a much harder goal to accomplish then just making a maximum size for a bank (which I think could be made into a one page law).

    Thanks for any ideas.

  26. You know, every time I hear about breaking the banks by force into small units, I can’t help but wonder where are all the anti-trust lawyers from about 150 years ago – you know the ones who broke monoplies in all sort of industries at the turn of the last century because they threatened the economic security of the U.S. Didn’t we as a nation pass a host of federal laws to prevent that sort of thing happening again? Or am I wrong in thing that if Citi and BoA own it all, for all intents and purposes we are fighting monoplies again? And how can you not be a monopoly and yet be called “too big to fail?”

  27. Wow, Peter. I am quite amazed that as an ex-banker you would advocate nationalization. At the same time, my own thoughts about this (see earlier comment) do not take bankers out of the mix; nationalization only moves bankers into the government.

    What do you see as the system of a nationalized banking system?

    I couldn’t help but notice that Simon Johnson on Moyers said that nationalized banking has not worked out well. I don’t have any information about why that has not worked out. Does anyone else?

    Moving prudent bankers into a prudent program within the government would not be a horrible thing – just the logical thing. If we nationalize temporarily, won’t we have to have them answer to the government anyway, or actually on the government payroll, during the nationalization period? Of course we would.

    And if it works out temporarily, why would it be necessary to go back to privatized banks? Just because that is the way it’s always been done?

  28. SteveGinIL:

    I advocate nationalization because it makes sense as a practical extension of what has happened so far. In my view taxpayers already hold sway over the major banks anyway, so why not get on with it and take over totally?

    However, I don’t think it would work longer term. Simon probably has more access to the history of nationalized banks, but one objection I can see being raised is that a nationalized bank is subject, potentially, to politically motivated lending. Given the nature of our political system and the money that flows through it, I for one, am skeptical about a nationalized bank’s ability not to fall prey to political pressure.

    Plus, notwithstanding my criticism of ‘free market economics’ I think some form of market competitive pressure keeps large bureaucracies like banks on their toes when it comes to serving their customers. I would hate the local bank to become even more like the Motor Vehicles Department!

    So I would advocate re-privatization exactly because the competition it creates stops too much bureaucratic sclerosis.

    The current system failed for two reasons: first we deregulated too much which led to the formation of the mega banks that are supposedly too large to fail; and, second we allowed the derivatives market and the mortgage generation market to explode without bringing them under the regulatory framework at all.

    Lastly I would nationalize any and all banks that are insolvent. The big four: Citi; JPMorgan Chase; Bank of America; and Wells Fargo would be a good start. Wipe out their current shareholders who deserve to go based upon their inability to control management; force any bondholders to take a hair cut; re-capitalize with taxpayer money and then nurse back to health. We would be forced to use some of the current managers, so we would have to create incentives for them to behave in our interests.

    All of this is the much quoted ‘Swedish Example’. The Swedes managed to pull this off. I have to think we can too.

  29. Thanks, Peter.

    I read about the Swedish example way back when all this was just beginning, and I was completely skeptical about the U.S. following an example from such a socialist country.

    From what I’ve seen of banking, from the outside looking in, it appears banking is a very sclerotic bureaucracy in its own right. But I can’t know that as well as someone who’s been on the inside.

    My own thinking about nationalization is based on my new concept of money flow being part of our infrastructure. But that is only in my head, and look at what damage has been done to economies that went off based on theories like free-markets and trickle down and deregulation. So I am not going to push any idea on the real world.

    But I also do need to ask, why do we need competition in banking? Just to manage people’s access to money? Why does money have to be something bought and sold in the first place? It’s just a tool and something that represents value. I see banks as conduits, like highways, and I can’t see highways being in competition with each other for cars. But maybe they are…

  30. “However, I don’t think it would work longer term. Simon probably has more access to the history of nationalized banks, but one objection I can see being raised is that a nationalized bank is subject, potentially, to politically motivated lending. Given the nature of our political system and the money that flows through it, I for one, am skeptical about a nationalized bank’s ability not to fall prey to political pressure.

    Plus, notwithstanding my criticism of ‘free market economics’ I think some form of market competitive pressure keeps large bureaucracies like banks on their toes when it comes to serving their customers. I would hate the local bank to become even more like the Motor Vehicles Department!”

    This is why I think banking should be a function of local government. If you ran a business, different communities would very likely compete for your business and those communities which provided lousy service would lose to better run communities, both in terms of businesses and the people who work for them. Than the poorly run communities can vote our their management

    Correct me if I’m wrong, but most examples I can think of, national banks are some variation of crony capitalism, where the banks are adjuncts of the national governments and the parties that run them, so there was no real competition. We have that here already, it’s just that the bankers run the politicians and not the other way around. So instead of direct power, they simply dilute the wealth and skim off as much as possible.

  31. God is speaking at the Economic Club of New York to remind the world of how wonderful and essential the placing of TARP 1 was and how important it is to do more of the same. He has a timely appearance to assure the members of the GROUPTHINKTHINKTANK (all of America) that if we don’t continue to capitalize (GIVE) money the the banks the world will end as we know it. I think that our country would be in better shape if we still had the 1 trillion dollars that has already been given to banks, and instead, used in the process of selling off the pieces of the banks that chose to be involved in 40x leverage, to the highest bidders.

  32. SteveGinIL:

    From my experience once banking was opened up to more competition, especially across state lines, the services offered to consumes improved quickly. Plus the small business borrowers had more options about where to go to get loans. The payment system itself was improved with all sorts of innovations to make money transfers quicker. the banking of today is far more efficient and consumer friendly than it was back even as recently as 1980. So I think competition has an effect. This is all well and good as long as you accept the premise, which many don’t, that banks being open at all hours etc is a good thing!

    I agree that banks are simply intermediaries. That is their essential function. They can pool risks onto their balance sheets and so isolate borrowers and depositors from the higher risk that each would have to accept were they to ‘go it alone’ without intermediation. By accepting this middleman role banks actually create money by lending more than they have as capital. Which is why they were very conservative in the past.

    The current problems all stem from the muddled deregulation and consequent blurring of the old investment banks and commercial banks. Investment banks make much higher returns on their equity because they are much more leveraged. Once the old New Deal laws were relaxed commercial banks tried to enter those higher return businesses. Meanwhile the investment banks also changed: they started taking greater on-balance sheet positions for themselves [rather than managing financial transactions for others]. The result was an explosion of new and innovative products like the infamous mortgage backed securities we now all know about. Those products were developed using mathematics and techniques perfected at places like MIT and Chicago. We now know that the theory underpinning those products was flawed. But at the time everyone thought that they had found a nirvana of high return and low risk!

  33. John Merryman:

    I think there are a few examples of ‘cooperative’ and ‘mutual’ banks around the world. That model can be quite effective. But they are not truly ‘communal’ in the way I think you are suggesting. My fear is always that even local politicians will get involved in trying to make sure that the loans go toward a friend or supporter, rather than have the loans allocated by an analytical process. I recognize that banking will always involve an element of ‘cronyism’ … all those golf and country clubs are not purely social … but in general I think a bit of competition helps mitigate the cronyism.

    From my personal experience: sure we knew each other, just like the local car dealers get to know one another, but competition was fierce for the business of the customers who we thought could repay us the best! The profit margins in banking are very thin, so we always had to compete for the better clients. In a very real sense you make up for those thin margins through scale. Hence the pressure to grow really big.

    In any case I think a system of private banks is generally better because it keeps politics away from the allocation of capital. Having said that the banks should always be heavily regulated to make sure that social issues [like mortgage lending to minorities] are well covered. And I think none of them should ever be allowed to grow to the size of a Citi or Bank of America, because then they know they are too big to fail and can act stupidly by taking too much risk.

  34. peter,,,hey glad you got that minority ref in there===>NOT….you work for the fed already…ie,,,the fed reserve….maniputating int rates is your existance or else say let’s buy risky stuff and sell “knowingly” it is worthless====>FRAUD….american banking is a farce….you are not fooling me….

  35. John Merryman: “Correct me if I’m wrong, but most examples I can think of, national banks are some variation of crony capitalism, where the banks are adjuncts of the national governments and the parties that run them, so there was no real competition. We have that here already, it’s just that the bankers run the politicians and not the other way around. So instead of direct power, they simply dilute the wealth and skim off as much as possible.”

    Two things:
    1.) I am seeing the banks as needing to be no more than the Postal system or a county clerk’s office, where there are just bank clerks and loan officers instead of mail clerks and other clerks. If it were run like the National Parks, there is no need of politics getting into it. What is political about me wanting a mortgage loan? Nothing. It is not too much unlike getting a reservation for a camp site. It is just borrowing money,after all; it is not lobbying for cronies.

    2.) YES, they skim off. But when you add up how MUCH they skim off, to the economy – the REAL economy of jobs and buying and selling goods and services – it is like bleeding the patient: We all see the fallacy of that in medicine, but why do we need someone raking off a percent of EVERY loan made in the country? Do you have any IDEA how much money that is, TAKEN OUT of the economy and stuck in their pockets? The recent hubris in which they pocketed the many billions and gave no accounting of that – THAT is hubris, and that is theft and that is just taking because they THINK they can get away with it. And do they give us any value for that money? Do they?

  36. Peter:
    I hear all your points and see the value of the banks, in what they can offer more now. I understand that many of the changes have come about due to technology more than competition, though. See my post a few minutes ago about what I see as a government run banking system – more clerks and loan officers than cronies and backslappers. It would be like a passport office, but a passport to loan moneys. I don’t see why it would be all about insider loans, etc. That is THIS system. Being run like the Postal System would not entail any graft. Bureaucrats would go by the rules; they always do. You are talking about the system of competition and its inherent gladhanding.

    Would it be more like a 3rd world country, where you have to grease some functionary’s palm in order to get your loan, like a Chicago liquor license? It COULD be, but here in the U.S. (as opposed to Chicago!*) I would hope we could set up something better.

    * I live near Chicago, so I can say such things… Blago and all that… :-)

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  38. Peter:
    Great insight. I agree deregulation is what caused the problem and all the mergers of different types of banking. Investment banks should be separated from the retail/commerical banking. Investment banking currently is like gambling blindfolded.
    The taxpayer is now paying for the gambling addicts losses.
    The reward strategy in banking is quarter to quarter. Banking management looks at stock-market performance, quarter to quarter, and not at the long-term viability or welfare of the institution.
    If profits are down, lay-off people; gamble more is the philosophy.

  39. Peter,

    Your assumption seems to be that the public sector is inherently noncompetitive, but that’s a fallacy. Non-competition entails a monopoly and we assign the monopoly of power to the government for very good reason, since competition between governments is war. In those cases, there is little to no economy anyway. In fact, the function of government started as private enterprise and became formalized as monarchy. It was only by making government a public trust through the development of democracy that we institutionalized competition within government. Local governments can be very competitive with one another when it comes to attracting and developing resources and business. The real advantage of public institutions over private ones is freedom of information and the economic power of an expanded knowledge base.
    The fact is that money is a public utility that depends on the faith of the community and it is the government which insures its value, so the public is responsible for the real risk, as is currently obvious. With a private banking system, not only do private investors garner most of the profits from managing this utility, but use these rewards to further leverage their power and reduce their risk. The simple fact remains that they have massively mismanaged the process because they have lost sight of the basic economic reality, as I mentioned in my first post. Creating a massive bubble of extraneous circulation is not as productive as they would have us believe and when it pops, as it is currently doing, will be very destructive.

    Steve,

    There are far deeper philosophic issues at work here as well. Our moral model is based on an elemental attraction to the beneficial and repulsion of the detrimental, good vs. bad. This creates a linear view of reality that doesn’t seriously consider reciprocity, reaction, the laws of unintended consequences, etc. In fact they are derided as moral relativism. So we naturally assume that if a little is good, a lot must be that much better. Thus we create effectively infinite amounts of notational wealth, because zeros in the bank account is good and then must sacrifice our communities and environment to feed this illusion. Suffice to say, economics isn’t my specialty, but the economy is where the rubber meets the road. Your are right that money is a tool, it’s not a god. Now it’s a broken tool.

  40. well said,John….

  41. http://www.twincities.com/allheadlines/ci_11722986?nclick_check=1
  42. http://www.twincities.com/allheadlines/ci_11722986?nclick_check=1

    Sorry, here is the quote to look for, R. Davis, CEO of US Bancorp said in a speech:

    “…”We were told to take it so that we could help Darwin synthesize the weaker banks and acquire those and put them under different leadership,” he said. “We are not even allowed to mention that. … We were supposed to say the TARP money was used for lending.”

  43. Peter and John Merryman -

    Kudos from me to both of you. I fully fully appreciate not only all your comments that agree with my own understandings, but also the ones that don’t. This dialogue (trialogue?) is the most fruitful I’ve participated in, in several years of blogging (and that is a lot of blogging).

    John, in this: “Creating a massive bubble of extraneous circulation is not as productive as they would have us believe…” might the word “artificial” be better than “extraneous”? I agree with the sentiment.

    John, I also agree that money is a public utility. That is exactly why I ask in all seriousness why we need private profit-making entities to manage it for us. While the free marketeers all think that anything and everything can be better dealt with by private concerns, one does wonder if even a 3rd world government could have mismanaged things worse than these oligarchical potentates. It is because I see money as a utility that I ask if banks aren’t actually part of our infrastructure, and as such, might they be better off run publicly, and possibly as non-profits. WHY does everyone see money as a commodity to be bought and sold, rather than as a utility there for our use? Once printed (or in use as cyber money in our computerized world), money is are just for use, like highways and bridges are. We trust government to keep roads reasonably available (maintained) and adequate for our use. Government could easily do that for our money – just make it available and adequate for our use. Most of us only need it for that, with storage concerns for safe-keeping. Investment is another issue! It is spending/betting for those who want to play with it and hopefully get something for nothing. Most of us injured in recent weeks had done SOME of that, but we have all also been brainwashed into believing that if we didn’t, our stored money would lose value. We’d also been brainwashed into believing if we did not think of our houses in that same vein, we were suckers and rubes.

    Now we are all suckers and rubes, but for the opposite reasons – the ones behind our grandparents hiding money under mattresses. Our simple utility – money – became a game for players, and we all got taken in by their shell game. Shame on us? Yep. Grandpa could have warned us. Even those who didn’t play are now injured. The gangbangers of high finance have effected a drive-by shooting of Biblical proportions.

    None of us prudent citizens wanted anything to do with this. But here we sit.

    Given a choice between the private corporations and the government, give me the government. At least I can vote every 2 years and convince myself I have a say in things.

  44. Steve,

    You pretty much hit the nail on the head. Strip away and the details and it’s basically a bait and switch. Everyone puts up what they have on the promise of more and lose it all. It’s not that the underlaying premise isn’t valid. Life is a process of bootstrapping itself upward and each stage builds on what came before, but that’s why people will fall for it when it’s a trap.
    I think though that they seriously overshot their mark. Like you, I’ve been discussing these ideas for years and generally get little response and less positive response, but that’s been changing. I posted a shorter version of my first post in the comments to a Maureen Dowd column last week and it even made the editor’s selections.
    http://community.nytimes.com/article/comments/2009/02/11/opinion/11dowd.html
    A year ago and I would have been called a Marxist.

  45. The TARP program has many flaws, and granted some of the politically forced TARP purchases are pure bailouts, but frankly the government is making money from the capital injections and will almost certainly continue to do so.

  46. The case for not nationalizing the LEMON BROTHERS, since there are alternatives.

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