A brilliant commentary. I couldn’t agree more. I would add, that over the long term, this type of nonsense will ultimately bring down a nation. Can you say banana republic?
AA

These should work:

http://banking.senate.gov/00_02hrg/022900/paulson.htm

http://www.sec.gov/rules/final/34-49830.htm

Yours is a well-argued summary of the classic reply to the “greed and incompetence” position taken by people who are not inside the markets. It’s the financial market analog to inside baseball. In such an argument, bankers are, at best, amoral: If something is not illegal, per se, then it’s not proscribed. So, as long as no rules, regulations or laws are broken, bankers are free to “maximize profits.” Banks therefore have an incentive, naturally, to hire persons intimately familiar with the law — so as to navigate right to the very edge of legality — who know, to a reasonable degree of certitude, how hard they can push. When the system breaks down, it’s not that the bankers’ have caused any harm — they’re just following the rules, laws, and regs they’ve been handed and must observe. When things go off the tracks then, it’s merely a case of inappropriate or weak regulation. Or, as you summarized, greed wasn’t channeled into something useful to the economy, but that’s not the fault of the bankers.

This line of reasoning, which is trotted out in every instance of market failure, misses a key point: The reason for the market failure is the ceaseless working over of “controlling authority” (to borrow that well-turned phrase) that delimits what constitutes legally acceptable behaviour. This ultimately is a subversion of the Rule of Law, which as F.A. Hayek points out, relies on the legal and regulatory system being disinterested if it is to be effective. So regulation cannot be effective because it is always morphing into something that benefits whoever has been successful in changing (one could say bending) laws and regulations to benefit their particular interest. In this case the bankers. Specifically, the former investment bankers.

Just as a case in point, it is worthwhile to follow the line that begins with Hank Paulson lobbying the SEC to change the rules for calculating net capital laid out in his prepared testimony in the year 2000 as GS’s CEO ( http://banking.senate.gov/00_02hrg/022900/paulson.htm), thru to the adoption of rule changes that essentially allowed the former investment banks to not only lever themselves massively, but to also define their asset base to their regulator, the SEC. (http://www.sec.gov/rules/final/34-49830.htm). When this super-charged cycle of balance-sheet transmorgification reached its logical conclusion, these former investment banks no longer were recognizable as financial institutions per se. They no longer were able to fund in the short-term credit markets as before, and therefore had to run to the US government, restate their charters to become “Banks,” and go on the dole. And who was at the helm guiding them thru that process? US Treasury Sect’y Hank Paulson and his colleagues from GS (in- and outside the government).

If there was any doubt the managements at these failed institutions (GS, C, MER, LEH, etc.) were the direct beneficiaries of this legal-regulatory maneuvering, one need only look at the various metrics (chiefly ROE-based) used to “reward” those “adding value” to their franchises, and the payouts to the managements of these firms in the years immediately following the SEC’s adoption of the new Consolidated Supervised Entities rules. As one familiar with such metrics, Coffee Boy, I’m sure you’re aware the more you boost the leverage the higher your ROE get, c.p. So it all fits nicely together. It is not clear shareholders are going to accept the 2005-07 payouts as routine compensation decisions. So now there is at least the beginning of shareholder action attempting to get beyond the usual “greed and incompetence” arguments, and into the motives and actual behaviour of the custodians of their wealth. (http://finance.yahoo.com/news/Pension-fund-calls-for-review-apf-14975016.html?.v=2)

It is a fact that a select few inside and outside the GS-Federal government nexus were successful in bending rules and regulations to the benefit of GS et al. This was not a failure to regulate — the regulators were following their marching orders, which, btw, were crafted over the course of a few years, by the people and firms that were to be regulated. Can it be any clearer?

This is not a game-theoretic exercise viz “I’ve got to do it because my competitors will do it if I don’t, and I’ll lose.” This is deliberate bending of the entire regulatory edifice to benefit a few over a short period of time. And, in the mop-up after these actions destroyed the entire system, it is again the insiders who bend the system to ensure they survive. And, perhaps, prosper, since, out of the destruction they’ve wrought, they alone have their people on the inside making sure they benefit as the rules of the game are re-written. They not only know long before anyone else where the bending will occur, but they can influence this process and position themselves ahead of time so they reap the windfall that surely will come after the rules have been changed.

This is not profit-maximizing behaviour. It ultimately is destructive of the markets themselves. And the Rule of Law itself. When market participants no longer believe the rules, laws and regulations are being written and enforced by a disinterested Federal government — acting on behalf of a duly elected Legislative and Executive, and answering to a sovereign electorate — it will break down. Then there will be wailing and gnashing of teeth where once there was only whining and moaning.

Brian, go back to the farm.

Several weeks ago the Fed announced that it was engaging in a program to purchase several billion dollars worth of derivatives (“asset backed securities”, mortgages, consumer loans, student loans, etc.) in order stimulate demand for the securities in an attempt to “unthaw” the credit markets.

The Fed radically expanded its balance sheet, declaring a couple of trillion new dollars into existence, and then used this money to purchase the securities it is now holding. Where does the Fed go to buy such securities? Is the Fed GS’s new big customer? Does this qualify as helicopter money? (See Bernake’s 2002 speech on Helicopter Money and the failure of Monetary Policy.)

Is GS better-than-expected performance directly related to the Fed’s purchase program?

I agree with your last statement, and your argument is reasonable, but I still think you are leaving out alot about accountability of people.

Absolutely, the government is looking weak to the bank lobby, but, there are people running the institutions that failed, and greed did get completely out of hand and when you look at the racket of securitizing ‘known; garbage between the rating agencies and the packager of the securities, most would easily categorize this as fraud–

Sarbanes-Oxley is supposed to hold accountable the CFO and CEO’s of companies to the truth of thier company’s financial statements. But ever since this crisis, you hear alot of characters acting like they had no idea what was going on…i think shareholders to the “too big to fail” are also weak because to do what they need to do, it would cause great disruption in their companies,so they choose silence as the easy route…it is all very shameful.

If you read my post, you’ll see that my defense of the system does not extend to the government. My belief is that the system failed primarily and fundamentally because of the failure of government.

1) “home ownership” has been touted as some vague social goal for the last 50 years, and has thus been effectively subsidized by the government. Mortgage interest shouldn’t be tax deductible. Fannie Mae and Freddie Mac should have never been created. In 2004 Democrats PUSHED FOR LAX LENDING STANDARDS for mortgages in order to increase low-income home ownership.

2) Government failed to understand that continued consolidation of the banking sector was an anti-trust issue far beyond the scale of the puppet show that Microsoft was put through.

3) Politicians have not lived through a “real” recession since the early 90s, and haven’t had a meaningful one since the early 80s. Instead of the relatively steady business cycles of the 40s to the 80s (5-7 year bull markets, 2-3 year recessions), an entire generation of politicians has grown up over the last 30 years with few economic downturns to legislate around. Hence, rather than realizing that recessions are a necessary and healthy part of the capitalist deal, government works itself into a flurry of activity trying to do everything to prevent even the smallest uptick in either unemployment or inflation. The most direct beneficiaries of this are the financial institutions, whose livlihoods are probably most closely correlated with the business cycle.

4) Fastforwarding to Fall 2008, the crisis reached apocolyptic proportions PRIMARILY because the government had too much power and the rules were changed on a daily basis on the whims of individuals. The hypothesis that the market was prepared for a Lehman bankruptcy was flawed – just look at the bond prices. The friday before bankruptcy, the bonds were being lifted at 87cents. The government bailed out Bear, and just nationalized Fannie and Freddie…the market was prepared for another bailout. Paulson changed the rules that weekend, and the market went into chaos. Realizing his mistake, he bailed out AIG and the rest of the financial sector. Now, they are changing course again, and the next financial institution to reach crisis levels, will probably see creditors take a hit. This constant changing of the rules is what is undermining the ultimate recovery of the system.

The thesis of my post is that anger should not be placed upon bankers, as they, like any rational actor within an economy, are acting in their best interest as long as it is legal. If you believe in capitalism, you can ask no more of any citizen. It is up to the government to help sort out any externalities within the system. Unfortunately, far from plugging these externalities, our government created more. By promoting low-income home ownership, our government incentivized banks to fill their balance sheet with toxic loans. By “bailing out” the economy during every recession over the last 30 years, the government incentivized risk managers (investors, traders, entrepreneurs, the caretakers of the world’s capital) to leverage the upside, because they knew that Greenspan/Bernanke would come riding to their rescue with their now infamous “put.” And by failing to prosecute against the true monopolies that were being formed, our government allowed institutions to become “too big to fail,” thus giving bankers the free reign to operate without regard to the downside.

The solution isn’t an outcry against bankers and their greed. The solution is an outcry against a government that is too weak to let institutions fail, and too weak to uphold true capitalism.

They are still illegal.