Yesterday I highlighted an op-ed written by Desmond Lachman, a veteran of the IMF and Salomon Smith Barney (and currently at the American Enterprise Institute), comparing the United States and the current crisis to an emerging market crisis.
Saturday evening, Nicholas Brady, Secretary of the Treasury from the end of the Reagan administration through the entire Bush I administration, gave a speech at the Institute of International Finance – comparing the current crisis in the United States to an emerging market crisis, only in that case the banks were in the U.S. and the bad assets were in the emerging markets.
There are uncanny parallels between the situation we find ourselves in today and the one the Bush administration confronted a generation ago. . . . First of all there was a serious LDC [Least Developed Country] debt crisis. It’s easy to forget that in 1988 our banking system was in dire straits because the commercial banks held billions of dollars of loans in countries whose economic prospects had ground to a halt.
The solution, according to Brady, was identifying the fundamental problems and forcing all parties to recognize them.
Among the indisputable points we laid out were that new money commitments had dried up in the past 12 months and that many banks were negotiating private sales of LDC paper at steep discounts while maintaining their claim on the countries that the loans were still worth 100 cents on the dollar. There were more, and they were equally sobering. We used these irrefutable facts as a starting point in all subsequent meetings. Our rule was that no suggestions were permitted to be discussed if they didn’t accept the Truth Serum. They were off the table. Goodbye. Don’t waste time. . . . [W]e persuaded the international commercial banks—at first with great difficulty—to write down the stated value of the loans on their books to something close to market value in exchange for that lesser amount of host-country bonds backed by U.S. zero-coupon Treasuries.
Although Brady does not subscribe to the capture thesis that we outline in the Atlantic article, and is generally gentler on bankers than we are, his assessment of the financial industry is similar.
In broad strokes I would say that when I came to Wall Street in 1954, it was a profession, one that financed the building of this country’s industrial capacity and infrastructure. Year by year, however, the industry’s emphasis has moved away from that purpose and toward financial innovation for financial profit’s sake. . . . [T]he U.S. Department of Commerce figures show that from 1980 to 1982, the financial sector accounted for an average of 9.1 percent of U.S. total corporate profits. By 2005 to 2007 that three-year average had more than tripled, to 28.6 percent. . . .
First we should just come out and say it: the financial system that led us to the brink of disaster is broken.
And despite spending his career on Wall Street, and doing a stint as Treasury Secretary, he ultimately argues that banking should be more boring than it is today.
I believe that we need a simpler system centered on deposit-based banks. Under this approach, individual accounts in the depository banks would continue to be protected up to $250,000 and these banks would have access to the country’s central bank. These institutions would not be allowed to participate in markets involving inordinate leverage or equity transactions that would risk their deposit-protecting charter. In contrast to the current mode, when asked what their primary purpose is, the banks’ chief executives wouldn’t talk first about shareholder return. Instead they would stand up and say: “Our institution’s primary purpose is to repay the depositors’ money.” . . .
The highly innovative shadow banking system with its mantra of lower transaction costs, which would continue to introduce new concepts, would fund itself from the money markets and other sources but without federal guarantees and access to America’s central bank. Institutions that currently straddle the two funding markets would have to choose which type of business to pursue.
This reinforces a theme that Simon has been sounding recently: the divide is not between left and right, but between people who want to preserve the current financial system in its basic outlines (a little more regulation, a little more disclosure, exchanges for derivatives, etc.) and people who think it must be dramatically reshaped.
By James Kwak