The Consensus On Big Banks Begins To Move

Just when our biggest banks thought they were out of the woods and into the money, the official consensus in their favor begins to crack. The Obama administration’s publicly stated view – from the highest level in the White House – remains that the banks cannot or should not be broken up.  Their argument is that the big banks can be regulated into permanently low risk behavior.

In contrast, in an interview reported in the NYT this morning, Paul Volcker argues that attempts to regulate these banks will fail:

“The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company.”

Volcker may not have the ear of the President (as the NYT points out), and Alan Greenspan – also arguing for bank breakup, but along different lines – might also be ignored.  But watch Mervyn King closely.

Mervyn King is governor of the Bank of England and a hugely influential figure in central banking circles.  Time and again he has proved to be not only ahead of his peers in terms of thinking about the latest problems, but also the person who is best able to frame an issue and articulate potential solutions so as to draw support from other officials around the world.

Mervyn King also does not mince words.  In a major speech last night, he said, “Never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.” (full speech)

He hits hard (implicitly) at the White House’s central idea on large banks: ”The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion”.  And he lines up very much with Paul Volcker’s views – breaking up big banks is necessary, doable, and actually essential.

Remember and repeat this Mervyn King line: “Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.”

The big banks will push back, of course.  But Mervyn King’s words mark the beginning of a new stage of real reform; the consensus starts to crack.

By Simon Johnson

62 responses to “The Consensus On Big Banks Begins To Move

  1. But Mervyn King’s words mark the beginning of a new stage of real reform; the consensus starts to crack.

    I sure hope so.

    Simon’s post is much more optimistic than Yves Smith’s on the same topic:

    http://www.nakedcapitalism.com/2009/10/volcker-glass-steagall-and-the-real-tbtf-problem.html#

  2. King seems to have cultivated a Buffett-type image: conservative, eschewing personal aggrandizement. Perhaps the “tell” is that he’s a huge Aston Villa fan?

    Per Know-It-All, Villa’s fans are 98% white. It is one of the oldest soccer teams in england. (Now owned by Randy Lerner, Cleveland Browns and MBNA, ha! Both Kind and Lerner passed through Cambridge Univ.)

    “He is a great and loyal Aston Villa supporter, which shows that he’s very capable of coping with disappointment…”

    http://en.wikipedia.org/wiki/Mervyn_King_(economist)

    This is interesting:

    “He has also been Visiting Professor at Harvard and the Massachusetts Institute of Technology where he shared an office with then Assistant Professor Ben Bernanke.”

    http://en.wikipedia.org/wiki/Mervyn_King_(economist)

    Volcker & King: Tom and Jerry, or Mutt and Jeff?

    Comrade King likes Churchill quotes. Here’s one for him:

    “An appeaser is one who feeds a crocodile, hoping it will eat him last.”

  3. - Glass-Steagal to ensure only depositary institutions benefit from explicit government guarantees
    – Progressive and transparent capital requirements, such the leverage ratio increasing with the total asset size
    – Mandatory levels of convertible debt, which would convert into equity as the bank’s equity price is falling
    – Derivatives reform, including mandatory clearing houses
    – “Cooling period” of, say, 5 years between leaving an executive position in a financial institution or law firm and taking a government or lobbying job, and vice versa

    What else?

    I am not a big fan of two often cited reforms: (1) a compensation reform – Lehman had most of the compensation in its stock cliff-vested in 5 years, and it did not help and (2) absolute limit on the bank size – because Lehman or Bear were not that big

  4. Well, we can but hope.

    Simon,

    It seems to me there is a risk that even if banks are cut down to size, it might still be possible for them to tangle themselves in knots, creating a domino effect of bank failures. If lots of small banks fail at once, then we still have a ‘too big to fail’ problem, and the govt will have to step in a save banks that might be small enough to fail in isolation, but not if they bring down other banks with them.

    Apologies if you have already written about this elsewhere, but could you write something about what you think regulators should do about contagion?

  5. I agree here. Take the big financial institutions and split banks and investment houses again. Also, give the SEC the regulatory power to oversee derivatives and see that they use it.

    As for compensation reform, I think these companies should pay what the market will allow. However, I would like to see a tax on corporate payroll, call it a stupid money tax if you will (a tax on corporations throwing stupid amounts of money at execs.) Impose a tax on executive compensation that exceeds a certain multiple of non-managerial employee compensation and include wages from overseas plants/offices.

    Limiting bank size should be done on concerns for competition and consumer choice, and this gets back to actual banks, not investment houses like Lehman and Bear.

  6. Orthogonal Vision

    A common complaint in economics is that we can’t do real world experiments (like the hard sciences). Well in this case we did: Glass-Steagall was repealed and guess what – all hell broke loose. It would seem that not only can’t ivory tower economists develop real world mathematical models, they also can’t accept real world experimental results.

    Too big to fail is just too damn big period. Volcker may be old school, but then, most of the time old school works. For all the talk about a team of rivals, most of the Obama ecnonomic team suffers from Wall Street groupthink and can’t see even one block over. Until Wall Street is shown that the free ride is over adn that accepts that Main Street issues adn Wall Street do not go hand in hand, things will just get worse.

  7. Since at this point the banksters own the government and both parties, where does the impetus for reform come from?

  8. 1. Reinstate Glass-Steagall

    2. Ban all taxpayer bailouts and FED bailouts of investment banks, derivatives, CDS etc. These players should fund their own bailouts.

    3. Mandate capital requirements for all of the above.

  9. To paraphrase:
    What the Lord Fed giveth, the Lord Fed can taketh away. Why stop at two fiats? Just simply revoke the bank holding company status of JPMC and Goldman. What would be the ramifications? Not a rhetorical question; please enlighten me. The only thing I can see is that JPMC and GS will no longer be able to receive bailout money and, with reported profits, it would be astounding if they asked for Fed/Treasury largesse.

    As for reversing the mergers, the JPMC/Bear merger represented less than 1.1percent of the TARP funds ($25B)that made their way into JPMC’s coffers. Not a biggie finanacially for JPMC.

    There are plenty of Bank of America stockholders who paid through the nose for Merrill. They may wish to see the deal unwound. There is always the justice dept. to threaten an antitrust lawsuit just to bring the parties to the table—“for the greater good”—a utilitarian principle espoused by the current administration. Just pull an Eliot Spitzer (sans sex acts) on them: it worked with Hank Greenberg.

    A bigger question: Why has Volcker been marginalized? During the campaign, Obama said that, in matters of the ecomony, he relies on Paul Volcker and Warren Buffett.

  10. There is no “market” in executive compensation. Anyone who claims that has no idea how compensation works at the C-level.

    Not only the size, but more importantly, the structure of compensation must be heavily regulated. Currently, executives can get rich quick from taking reckless risks without any consequences on the downside when their gambles fail. It is no longer debatable whether this can be allowed to continue.

  11. Larry Summers runs the economic show; it’s his vision.

  12. “His vision.” Can you describe it for me as you understand it? I am familiar with his bio, but have never read anything he has written. The pablum he spews on the Sunday morning interview shows is so general it is useless information—like touting cash for clunkers and “sticking with the president’s program.”

  13. Paul Volcker was chosen around the time of 1998 if I remember right to head an audit of Swiss banks, so that Jewishh people could get their money and assets back that was stolen from them during the Holocaust of World War 2. So just on the fact he was chosen to do that, without the many other accolades Volcker has gotten, we can know that Volcker is an extremely intelligent man. Very God-blessed with high intelligence, Jewwish people would not choose anyone but the best to perform such a duty.

    My theory is that Volcker has been busting a gut to say these things publicly, but because he is a true gentleman and a very classy person he has delayed putting his true thoughts out on this publicly so as not to cut Obama’s economic team at the knees or seem like the old guy being spiteful because Lawrence Summers and Co were too arrogant to listen to his very sage and future crisis saving advise.

  14. Unlike the US, regulation of financial institutions is not the responsibility of the Central Bank ,in the UK. Aside from the merits of Mervyn King’s statement, my takeaway from his speech is that it is possible to get a clear statement of what the problem may be ,when the regulatory function is separate from the central bank function.

  15. It’s called Narrow/Limited/Utility Banking. With Volcker and King on board, as well as Buiter, John Kay, Bhide, Kotlikoff, and Martin Wolf, we might well see this idea debated. Of course, as Peston said today:

    http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/10/bank_reform_the_radical_way.html

    “And it is perhaps testament to the lobbying clout of the big banks that the proposal from Paul Volcker, the distinguished former chairman of the Federal Reserve, for the separation of banks’ investing and trading functions has not been embraced by Barack Obama or Gordon Brown.”

    Bingo! Anything less can be useful, but it won’t be real structural reform.

  16. Greenspan says when Standard Oil was broken up, the “spin off” companies created greater value. He implies this would be true for TBTF banks. Who knows … perhaps there will be bank shareholders activism to demand dismantling of their TBTF assets.

  17. Brave individuals who can lead. Are there any in either congress or the executive branch?

  18. Question: For shareholders in TBTF banks, what would be their financial gain if they too demanded that TBTF banks be dismantled?

  19. I might add, if any are found, they must be recognized for their leadership and courage without regard to their political party.

  20. Hold on there. I’d like to point out that Villa beat Chelsea this weekend 2-1. The symbolism of Villa beating Chel$ki, owned by Oligarch Roman Abramovich, certainly supports the beginning of some sort of consensus cracking. (Randy Lerner notwithstanding).

  21. Yay! The belief that big banks should be broken is sweeping like wildfire through people that can do nothing about it but talk!

    I don’t opinions like this will matter until you hear it from the lips of one the GS alums currently calling the government shots. The likelihood of that seems so insignificant as to be impossible, unfortunately. :-/

  22. Yves Smith makes some excellent points:
    1.) securitization has shifted traditional lending into capital markets
    2.) mechanisms exist in the capital markets to squeeze out small competition
    3.) derivatives!
    4.) europeans!

  23. America need to move forward – one group continually stands in the way. It’s time for MoveOn to Move Over! The group turned 11 this year, and has repeatedly been the source the drives American politics into the gutter. Stop embarrassing our nation, and move on. http://www.friendsoftheuschamber.com/moveover/

  24. World servitude…to him and his Harvard friends.

  25. Mervyn King makes a pretty speech, but it is not blunt enough for my taste.

    Paul Volcker states the argument clearly in NY Times story:
    “People say I’m old-fashioned and banks can no longer be separated from nonbank activity,” Mr. Volcker said, acknowledging criticism that he is nostalgic for an earlier era. “That argument,” he added ruefully, “brought us to where we are today.”

    Real experience has proven Volcker’s argument: that banks cannot be combined with nonbank activity. With that point now a proven fact, just what is it that the Obama financial team is hoping will happen next?

    I don’t know of anyone who knows of a good answer to the Obama financial team’s hope for the future of this mess, least of all anybody on the Obama team. As did Simon, I supported Obama, but he is in a complete fog on this very dangerous, and unprecedented experiment that he is choosing to let run its course.

  26. Yves Smiths view are much more thoughtful.

    Simon has been consistently simplistic in his analysis during this crisis at very turn. Simon is a distraction.

  27. All this talk is essentially useless since nothing serious will be implemented by way of reform. The banking system will crash soon, and then people will be free to rebuild it from the rubble in a more sensible way.

  28. I think it might be only half-right. Assuming all of this has been gamed out on a big napkin at a Bistro in London, Fish and Chips shop in Rome, Frankfurt, or Basel, the people will only feel like they’re freely rebuilding, while being shepherded gently in a very un-sensible way.

  29. Yakkis, If only it were that simple. Banks distorting social reality is dumbing down our society of cultures by the day. Buildings are easy to rebuild from the rubble, social patterns are a much greater challenge.

  30. Jessica,
    Do you have your own blog?? If so you should leave the address/link here. If you’re lucky James might even list you on the roll.

  31. I think they are all brave until they are faced with big campaign contributions being tossed their way.

  32. President should immediately fire Geitner, Summers and the whole list of people brought over from wall street. Frontline, 10/20/09 presented “The Warning” one of the best documentaries on the financial crises that I have seen in a long time. The way these MEN treated Brooksley Born who in the go go 90’s warned about unregulated derivitives was shameful and not one apology except at the end when Levitt said he thought she was a very intelligent person or something like that. I would invited everyone to download this documentary and tell everyone they know about it.And to think many of these same people are “advising” this president today. We all should demand hearings on possible criminal conspiracy by the big names that are receiving millions before they all run and hide on their yachts while we sheeple sleep in our cars and eat out of dumpsters since we may not have social security and our pensions have been robbed.

  33. The anathema of politicians is public embarrassment. Since this often comes from being caught alone in a wrong position, they find safety in not straying far from safe consensus. Isolating the Obama stated pro-big bank opinion is the first step toward moving Obama. If he ignores the gray-hairs and is shown to be a fool for it, his career ends. Every politician knows that.

  34. “If lots of small banks fail at once, then we still have a ‘too big to fail’ problem, ”

    Small banks will not fail all at once. There may be a string of failures over time but with the more exposed ones failing first. Instead of a giant blowup of the risk concealed in a big bank, you get early warning signals, so that policy makers and banks alike can change course, before it’s too big, too late.

    That’s only one aspect. In any industry allowing a dominant position is equated with an unfair advantage, such as that of bargaining with government, hence TBTF.

  35. What, and have Obama reject his lucrative career with these jackals that’s waiting for him when he gets out? Not on your life! No, I think we’ll see him continue to add GS alums to his roster until the day we replace him with the next criminal in the seat.

  36. Shareholders of banks and shareholders in general have been taken for big nasty ride, if you recall. At the core of this is the

    http://en.wikipedia.org/wiki/Principal-agent_problem

  37. This forum has become a playground for trolls.

  38. Plebeianswillrevolt

    Rude instigator, you remind me of Glenn Beck or Ann Coulter. Simon should disable your I.P.

    Anyway, let’s hope that somebody turns the blind and ignorant eye of Nobama and his banking buds. I am encouraged and inspired to see the big International picture. I feel a critical momentum turning against the cowardly White House. Democrat/Republican – not much difference under the retoric.

  39. Yves Smith’s post doesn’t strike me as thoughtful. In fact I find it disingenuous:

    “The big players have massive OTC derivatives exposures. You need a really big balance sheet to provide OTC derivatives cost effectively”

    Obviously the big balance sheets haven’t stopped these big banks from blowing up their books, precisely with OTC derivatives (CDS).

    The logical question to ask, on the contrary, is whether these big balance sheets induced greater risk taking, and if not whether the risk of OTC’s is elusive that they should be taken off the books of both small and large banks.

  40. As long as the big banks can write big checks to congressmen, it’s hard to see how any real reform will pass.

  41. The phrase “market will bear” refers to the ability of the corporation to pay stupid money to executives if it wants to. Look around and you will see that exactly how it works. I have seen it done in a company that was scratching and clawing to stay afloat. In the end, it didn’t, but the executives involved made out like bandits.

  42. Most sane individuals are keenly aware that the TBTF oligarchs own and control the government, that they are deleterious actors with regard to the best interests of the American people and the global economy, and that managed by they are ruthless unsavory predatorclass THIEVES whose only concerns are engorging their personal offshore accounts, and accumulating ungodly fortunes off the backs of America’s poor and middleclass. The TBTF oligarchs must be broken up, their FAILED managers must be fired, and prosecuted for crimes (insidertrading, tax exavasion, PONZI operations, predatory lending, deceptive accounting practices, fraud, collusion, bribery, and countless other SEC violations), and their FAILED PONZI scheme models must be forcefully regulated or eliminated entirely.

    The problem is how will these necessary ends be realized. Obama is surrounded by GS insiders who spew a constant chari vari of the necessity of salvaging the oligarchs and their predatorclass operators for the fate of the free world.

    The people are powerless to redress or right these wrongs, without turning to certain asymmetrical options, (which I personally believe is the only real hope). Outside of that kind of upheaval, the only other option is for leaders, voices of of influence like Simon Johnson, James Kwak, Volcker, Mervyn King, Buiter, John Kay, Bhide, Kotlikoff, Klugman, and Martin Wolf and others to apply unrelenting pressure on the Obama administration to reaxmine the TBTF logic, the purveyors and bruters of that toxic logic, and CHANGE direction. Predatorclass parrots like Giethner, Summers, and all the Obama economic team and GS insiders must be replaced. They have caused irrepairable damage to the futures and present lives of America’s poor and middleclass. The notion that any company or oligarch or individual is TBTF in the face of systemic lawlessness, deception, and thievery is absurd. For whatever Obama fails to fathom this harsh reality, and someone, or some group of individuals, must somehow glean his ear, and force real change. If not, then I fear the asymmetric options I warn of, will be the only viable options for righting the wrongs of the predatorclass oligarchs and wanton thieves in the US finance sector.

  43. Too Big To Fail: Fed Governor Tarullo responds to critics.

    http://www.federalreserve.gov/newsevents/speech/tarullo20091021a.htm

  44. Calomiris of National Bureau of Economic Research takes his shot at critics:

    http://online.wsj.com/article/SB10001424052748704500604574483222678425130.html

  45. markets.aurelius

    Right on! Good insight.

  46. Lehman executives lost much of their wealth with the firm’s bankruptcy, so they surely paid consequences given how the compensation was structured at Lehman. Yet that was not sufficient to prevent the downfall.
    Compensation of traders could be debated, compensation of executives is a red herring.

  47. The force of ignorance is strong with this one!

    By the way, IP blocking is only useful against the peasants.

  48. Or stressing a “strong dollar” without anyone asking him exactly what he intends ot do or recommend to stop it falling off a cliff!

  49. we are going to see banking basically turned over to the european financial powers, the stock market has already gone that way!

  50. Is it only obvious to me why Vollker is not in Summers position. Because the financial community decided that Summers was their guy (see Front Line from two nights ago), since he ALWAYS has the big guys at the top of his SAVE AT ANY COST LIST.

    Mervyn King is the right man to be speaking so loudly, and, I daresay that his advice will not go unnoticed by the rest of the world. International pressure has been moving this way, and now will probably intensify since he gave voice to it in public.

    We could accomplish the same ends through aggressive re-regulation, but Congress will never pass such strenuous regulation. Geithner and Bernanke would have to move toward it by taking a strong public stance, and even that is unlikely to happen in the current climate engendered by the massive financial lobby.

    I think that it is time for the President to go much further in his demand for the break up of those who would pay each other so generous bonuses for screwing up the lives of our society’s prolateriat.

  51. cracking consensus will have no effect on the fact that the privately held federal reserve is a monopoly and it’s owners buy most elected officials to legislate much that is criminal–it should be criminal to gamble with depositors money–Glass-Steagall Act revoked was in effect, legislating criminality. I am so worn out with the lies, and the scumbag criminals which include all the legislators that are making all the bailoutheists possible, basiclly understand that they don’t need consensus, they just need to be able to keep their jobs to legislate the criminality for the people who answer to NO ONE.

    Yesterday, Merkly and Corker came out with a new bit of legislation to usurp Ron Paul’s legislation to audit the Fed–their press release indicated that they wanted to keep the fed “independent” but to audit the new programs that are now being run because of the extraordinary time…this move makes it quite obvious that Merkley and Corker have sold their soul to the devil by trying to lie, once again, to the public about the fed’s independence: the concept of the fed being “independent” is a complete red herring–the owners of the fed, buy and sell all politicians so it is the politicians that have no independence from the criminals that own the fed.

  52. carping demon

    Hang in there, Don.

  53. Maybe we could bust up is administration like the phone companies or something.Seems The White House is too big to fail these days:

    http://americaspeaksink.com/2009/10/wall-street-the-president-and-the-rest-of-us/

  54. I think Obama saw initially that Summers’ way was the only politically possible way to stabilize the banks and the markets. The political situation was very difficult for Obama first coming into office. To take a guy like Summers head on, with Wall St and the banksters behind him, would have been political suicide. But I suspect Obama’s been setting Summers up all along, or rather, letting him set himself up, for a fall. When you’ve got Volcker, Greenspan, and Mervyn King against you, you’re vulnerable. I can’t believe Obama’s not really paying attention. He’s just biding his time. That moment will not come until after health care is passed. The Volcker/Summers debate will be increasingly in the spotlight (note, Obama keeps himself well off to the side), and then at the right moment it’s bye bye Summers. “I guess you were right, Mr. Volcker.”

  55. Priscianusjr, I sure hope this scenario plays out as you have framed it. It would be an untold blessing for the nation. Volcker is going way beyond what even Simon seems to be advocating in that he, Volcker, sees the clear need to go back to the complete separation of commercial banking from gambling banking. Commercial banking will be government supported, gambling will be on its own.

  56. C. Curtis Dillon

    One comment: Regulation is only as good as the regulator enforcing it. During the Bush admin, we had a group of regulators who were fundamentally opposed to any regulatory action which allowed Madoff and others to get away with murder. So the Obama stance on regulations being the solution is flawed. We need to break up the big banks so they can be allowed to fail when they screw up. Then the free market can really work as designed. Also, force commercial operations away from the risky investment banking activities that caused the crash. Restore them to regional status so they answer to the communities where they operate. Ever try dealing with a problem at BofA or Citi? Hard to find a real person let alone a solution! Let the investment bankers do whatever they want but with oversight and reporting so trends and abuses can at least be identified. But, keep them small too so failure is true failure, not a bailout. They can run a casino on Wall Street but isn’t it better to have hundreds of small casinos rather than a few big ones? When a big offering comes along, let several of the smaller casinos work together to get it done but prohibit them forming cartels which can then act as a single, large entity. Finally, require transparency in operations and oversight of complex derivatives and other instruments. No more slapping down of regulators who try to set off signal flares but run into the big brutes (Sommers, Geitner and company) who have a different agenda.

  57. Just a footnote. Governor King is nearing the end of his second term at the Bank of England and not wanting a renewal of office. Thus his comments may be less subjected to political influence and closer to what he truly believes. As Simon says, King punches well above his weight. We may well look back in a year’s time and see that speech as highly significant.

  58. Does anyone have a link to Mervyn King’s speech?

  59. Could not agree more!

  60. click on the blue (full speech) above in the post and you will get it.

  61. Dirk van Dijk

    We need to go back to the days of sleepy 3-6-3 banking.

    Banks borrow at 3%, lend it out to nice safe boring way at 6%, and the bankers can be on the first tee by 3 pm. Worked for decades just fine. Extreme risk taking is needed int the economy, but banks should not be the ones doing it.

  62. Simon,
    Governor King was a proponent of moral hazard as far as supporting highly speculative banking behaviour was concerned.
    During 2007 and 2008 I supported his stance on not bailing out failing banks and raising interest rates – given that easy credit was one of many forces that gave us the problems we witness today.
    During the final six months of 2008, Prof. Blanchflower – then an MPC member, was calling for interest rate reductions – a matter I thought was counter-productive as far as curtailing easy credit was concerned.
    Danny Blanchflower at the end of the day was proved correct in his analysis, the remainder of the MPC were caught rather off guard, including myself.
    However, and here’s the crux, I 100% support Governor King’s aversion to moral hazard and his statements since late 2008 on the banking crisis.
    Too Big To Fail is a huge issue, as the failure of Lehman’s demonstrated, and in the US at least, legislation exists to put an end to these great beasts – see Standard Oil for this resolution.
    Its clear from the mouth of the CEO of Goldman Sachs that they – in this instance the Bankster – clearly do not understand the outrage they themselves have caused by their financial recklessness and inability not to award themselves obscene salaries and bonuses.
    Lord Turner of the FSA has suggested one way forward, Governor King another, whilst the US at least has begun capping salaries within banks the taxpayer has funds in.
    Unfortunately, for all parties concerned in both governance and regulation, the big banks are in fact multinational corporations that can uproot and establish themselves anywhere – although the loss of US Treasury business may stop some relocating outside of the USA.
    As such, only international action can curtail the activities of the top ten global too big to fail banks – which was rather short in coming forward at Pittsburg last month.
    My own opinion would be to return to the pre-financial reform act of 1999 – when Glass Steagal was abolished – I note one year after this we got the first mega bank, JP Morgan Chase and CitiGroup.
    So the simple answer is yes, break them up and divorce deposit taking institutions from gambling institutions – if Governor King can achieve a consensus on this, he gets my vote.