Banking In A State

Banking on the State” by Andrew Haldane and Piergiorgio Alessandri is making waves in official circles.  Haldane, Executive Director for Financial Stability at the Bank of England, is widely regarded as both a technical expert and as someone who can communicate his points effectively to policymakers.  He is obviously closely in line – although not in complete agreement – with the thinking of Mervyn King, governor of the Bank of England.

Haldane and Alessandri offer a tough, perhaps bleak assessment.  Our boom-bust-bailout cycle is, in their view, a “doom loop”.  Banks have an incentive to take excessive risk and every time they and their creditors are bailed out, we create the conditions for the next crisis.

Any banker who denies this is the case lacks self-awareness or any sense of history, or perhaps just wants to do it again.

The Haldane-Alessandri “doom loop” is fast becoming the new baseline view, i.e., if you want to explain what happened or – more interestingly – what can happen going forward, you need to position your arguments relative to the structure and data in their paper. 

For example, at Mr. Bernanke’s reconfirmation hearing, these issues will come up in some fashion.  The contrast between the hard-hitting language of the “doom loop” and Ben Bernanke’s odd statements on the dollar yesterday could not be more striking.  Still, there is no reason to regard the Haldane-Alessandri version of the doom loop as the final word; in fact, this where the debate now heads.  (This link gives as useful introduction to relevant aspects of banking theory, as well as Eric Maskin’s insightful personal take.)

To help move the discussion forward, here are some issues for Banking on the State raised in discussions with top experts (who prefer to remain anonymous):

  1. The authors say that it is clear, in retrospect, that banks were excessively leveraged.  But how did regulators/supervisors miss the implications of this at the time?  Banks’ balance sheets started expanding from 1970 onwards (page 3) and by 2000 “balance sheets were more than five times annual UK GDP.”  This was not an overnight development – see the last sentence on page 8 which says “Higher leverage fully accounts for the rise in UK banks’ return on equity up until 2007”.  It may be difficult for a central banker to come clean on who convinced whom that modern banking in this form is safe – but at a minimum the authors should draw lessons from earlier failures of regulators/supervisors when discussing prospective changes in the framework of regulation. Could some of the changes being proposed suffer the same fate as all previous attempts to regulate big banks? It seems the authors answer is that just moving things to Pillar I (from Pillar II) will help.  This sounds like wishful thinking.
  2. The author are right that US banks faced a leverage ratio constraint, which European banks did not.  But US banks circumvented this by setting up SIVs – see the damage at Citi for details.  Again, what were the regulators/supervisors thinking when they allowed this?
  3. The authors assume that the equity owners of banks are almost always protected and therefore “the rational response by market participants is to double their bets”. This does not seem to have been true in practice.  For example, why was it so difficult for banks to raise capital after the initial flurry of new capital from Sovereign Wealth Funds (SWFs)? Why did some banks share prices fall so much (Citi, Merrill Lynch, Morgan Stanley, etc)? This cannot not be characterized as a rational response by markets if equity holders were implicitly protected. In fact, new capital (either from the state, or even in some cases from SWFs) came in the form of (expensive) preferred stock and diluted existing holders.  The doom loop is surely more about what happens to insiders (rich and powerful bank executives, with strong political connections) and creditors (investment funds run by rich and powerful nonbank executives, with strong political connections).
  4. Part of the (relatively) reasonable performance of hedge funds was due to them being forced quite early on to reduce leverage and asset holdings because banks were short of capital and tightened lending conditions. This fortuitously allowed hedge funds to reduce exposure before the crisis became most acute.  Haldane and Alessandri seem a little too inclined to believe the hedge funds’ own rhetoric at this stage.  This is worrying – the intellectual origins of our last crisis lie with central bankers believing that the private financial sector has evolved into a safer form. 
  5. To be clear, and a little contrary to what the authors imply: Most hedge funds do not operate with unlimited liability.  Often they have “watermark” provisions, limiting their fees while the fund shows losses.  But it is a simple matter to close down a failing fund and, a week or so later, open another (how many funds has John Meriwether closed?).  This will feed the next doom loop.
  6. The private sector is unlikely to be able to self insure (e.g., various proposals discussed on page 18) because of the potential size of losses in a systemic event. We know there was private insurance for a large portion of the assets (CDOs insured through monolines, for example) but these insurers did not have credible resources. Similarly, implicit state guarantees may also not be sufficient (e.g., Iceland). This suggests strict controls on size of the financial system relative to the economy (and the tax base) may be necessary.
  7. The paper is also relatively weak on the role of monetary policy in fuelling the doom loop.  But that is relatively easy to add on.

The overall conclusion of the paper follows uneasily from the main analytical thrust.  How can we believe that for the regulators, “next time is different“?  Most likely, next time will be exactly the same, with different terminology: the financial sector “innovates”, regulators buy their story that risks are now properly managed, and the ensuing bailout (again) breaks all records.

It’s all politics.  Unless and until you break the political power of our largest banks, broadly construed, we are going nowhere (or, rather, we are looping around the same doom). 

Barney Frank points out that small banks have political clout also, and of course he’s correct that this drives some issues.  But how many small banks spend their time (and lobbying dollars) on Capitol Hill insisting that large banks must not be broken up?

Our core problem is that we now have banks that are Too Big To Fail; if you don’t agree, read and publicly refute Haldane.  In theory, these big banks could be effectively regulated, but this is a leap of faith that experienced policymakers (e.g., Mervyn King and Paul Volcker) are increasingly unwilling to make. 

The biggest banks must be broken up.  This is not sufficient to end the doom loop, but it is necessary.

By Simon Johnson

47 responses to “Banking In A State

  1. Regulation Does Not Work; Financiers Are Smarter Than The Regulators

    From the Bank of England:

    The evolution of the banking and financial system has been accompanied by a growing support system from the public sector to the point where “Today, perhaps the biggest risk to the sovereign (state) comes from the banks.”
    Banks “game the state”, and exploit the state safety net. “State support stokes future risk-taking incentives, as owners of banks adapt their strategies to maximise expected profits. So it was in the run-up to the present crisis, “when banks adopted riskier strategies through a combination of increased leverage, proprietary trading, and by increasing the riskiness of their asset pool. The riskier strategies result in higher payoffs in good times and deep losses in bad times, “often cushioned by the state.”

  2. Exactly – not sufficient but necessary.

    Every reform proposal has to be judged first by that litmus test: does it proactively break up the big entities and ensure they never cohere again.

    “Doom loop” – great term for the boom-bust, bubble-crash, rent collect-disaster capitalize cycle. (I guess the establishment would still like to use “Great Moderation”.)

  3. “Banks have an incentive to take excessive risk and every time they and their creditors are bailed out, we create the conditions for the next crisis.”

    Insurance companies, too.

  4. The Austrians aren’t looking so nutty these days, are they?

    “Every truth passes through three stages before it is recognized. In the first it is ridiculed, in the second it is opposed, in the third it is regarded as self-evident”


  5. Now that I know how it works, I’m wishing they can do it one more time myself – though I hope it won’t be my money this time they do it with if that makes any sense.

  6. My professional experience is not consistent with your points 4 or 5 above. The banks were aggressive providers of leverage to HFs until they suddenly reversed course in October 2008. They forced liquidations by pulling lines at the worst possible time. Those borrowing relationships led to worse outcomes, rather than the better ones that you posit. Personally, I believe that the better outcomes were because the HF area is much more competitively Darwinian than the medium to upper management levels of the banks. Your point(5) regarding Meriwether is accurate but fails as a generalization. Pre 2008 I think you’d have a hard time assembling sufficient critical mass of HF managers who collectively ran large amounts of assets who had a really major blowup in their past.
    Notwithstanding these observations I love your work and believe you perform a great public service.

  7. Has anybody remotely credible even tried to make the case that the large banks should not be broken up?

    (Note: Those whose personal fortunes are tied to the sector — like CEOs of said banks or structured finance lawyers — do not qualify as “remotely credible”.)

  8. The typical political response is some variation of the “Genie is out of the bottle”, we cannot go back in time, and whatever problems we have can be solved by regulation.

    There are public policy issues that politicians would prefer not to address, such as W.T.O restrictions on re-regulation of financial institutions, and the implicit international rules of cross-border bailouts
    and loss-sharing arrangements. For example, Fed is rumoured to have bailed out some foreign banks; the Fed has a blank cheque, little accountability, and one of the least likely government entities to explain themselves.

    Obviously, there are technical issues in breaking up big banks, but here again policy-makers don’t feel pressure to debate the issues.

  9. The market tried to break them up, Nemo. The market tried.

    Unfortunately, the market was not listened to.


  10. Not that you haven’t said other wise things before (you have), but Carson that is no doubt the most intelligent thing you’ve ever said on this site.

  11. This may be a dumb question, but wouldn’t a lot of the risk be removed if financial derivatives were outlawed for any banks (and other finacials) operating in the US? That includes foreign based banks, that would be interacting with US banks.

  12. Simon, I believe that you know the exact truth of this matter regarding systemic risk.
    The answer is a throw to the Austrians – proceed to full-reserve banking.
    Eliminate leverage for all but the few high-fliers.
    Job done.

    Without fractional-reserves, we have no need for the Fed or any private bank to create the nation’s money, and this monetary function resorts BACK TO the United States Congress who adopt the revisions expressed by Milton Friedman in his “A Fiscal and Monetary Framework for Economic Stability”, and in the widely-supported-by-economists piece of legislation known as “The Chicago Plan for Monetary Reform”.
    Government-issue, debt-free money.
    You know it Simon.
    You have the license to say it aloud.
    We’re waiting.

  13. “Our core problem is that we now have banks that are Too Big To Fail; if you don’t agree, read and publicly refute Haldane.”

    Fine, I don’t agree. I think TBTF is about a third of the problem, and should certainly be fixed, but the “core” problem? No. I’m afraid that if we fix TBTF and call it a day, we’ll pay dearly for it in another decade.

    I take Haldane to invoke a much deeper observation than the TBTF argument – that the development of sophisticated financial markets has contributed to a national and international capital structure in which investment is largely funded by the creation of private money (debt). The extreme leverage compensates (and contributes to) the fact that investment is not financed out of savings.

    The private money (debt) plugs the gap between short term savings (which is close to base money) and long term investment. This intertemporal arbitrage is supposedly backed by private capital stocks (but that’s baloney, because the capital asset ratios are so thin).

    In other words, the modern economic structure relies on privately created money to close the savings/investment gap – but the extreme leverage discourages savings. Normally, this would cause interest rates to rise and money to tighten (which would permit the central banks to print more public money), but the continued expansion of credit (e.g. the increasing leverage ratios) “crowds out” the creation of public money.

    Thus you have an inverted pyramid, which is only stable as long as it keeps spinning. When it slows down for any reason (for instance, a massive oil shock or a credit channel catastrophe), the leverage unravels.

    But banks know this – not just the big ones, but the small and medium size ones too. Government cannot permit the inverted pyramid to stop spinning. When it tries (as happened in 08), then private money created through intertemporal arbitrage stops flowing, and we get a _huge_ savings/investment gap.

    The REAL source of moral hazard, and by extension the REAL subsidy to finance, is the promise of lowering interest rates at an accelerating pace to subsidize the expansion of private money. The problem with TBTF is a political one – that big institutions are better at preventing government from implementing effective capital controls (which would apply to all banks). But do not underestimate capture by small banks/mid tier finance, nor the intellectual hegemony of the anti-public-money monetarists.

    The only solution is to restore the dominance of public money over private money, and that means rigidly enforcing capital asset ratios (and taking them down a notch). Stabilize the inverted pyramid.

    Simultaneously, we need to increase savings, decrease consumption, and shift the structure of the economy by heavily promoting long term investment. For the next 5 years, we can finance this entirely by taking down capital asset ratios and creating more real money.

    And I mean more REAL, PERMANENT money – NOT what Bernanke has done (which as Brad DeLong notes is Credit Easing, not Quantitative Easing).

    Unlike folks like Scott Sumner, however, I would argue that at least some of this money should be injected into the economy through mechanisms OTHER than finance – preferably large subsidies/tax credits to long term infrastructure investment that are paid for with printed money.

    It’s all connected – credit explosion, smaller public monetary bases, the savings equillibrium gap, excess compensation in finance, declining median wages, the oscillating downward trend in capacity utilization rates since 1980 even as we approach the zero bound, the overvalued dollar, shortening of time horizons, the debt/GDP ratio, and yes, TBTF.

    But there are some major challenges – and one of them is the _international_ nature of finance. Unless the US can control the cap/asset ratios of banks OPERATING IN THE US (even through chains of subsidiaries or hedge funds or dark pools), then it will be placing domestic banks in a huge competitive disadvantage vis-a-vis European banks. Thus, we have a race to the bottom.

    IMHO, that is the core issue. TBTF is important because of its political implications more than its economic implications. Even if you fix moral hazard in TBTF institutions, you still have an unstable spinning inverted pyramid that is vulnerable to exogenous shocks (and waves of irrational exuberance/fear). But the root cause of it all is taking pure Friedmanomic ideology (which has many redeeming features) to unparalleled and unpragmatic extremes.

  14. Some corrections:

    “For the next 5 years, we can finance this entirely by taking UP capital asset ratios”

    “enforcing capital asset ratios (and taking them UP a notch).”

    Note one more thing about TBTF: With cap/asset ratios so thin, we _could_ have let big banks fail (back in 08) and pumped a _ton_ of public money into the system (if the Fed and Congress had the gonads), and we’d be better off than we are today. Yet even this means absorbing prior losses/malinvestments which cannot be clawed back. Bank owners are limited liability institutions… And it’s hard to prosecute them for criminal greed when they can simply claim (not quite criminal) stupidity.

  15. That’s the best short summary I’ve seen so far that gets to the heart of the current long-term financial issues. Having private financial institutions running around creating their own money (credit) has the same effect on societal stability as having private armies running around creating their own wars.

    However, since unlimited private (and at times public) credit has for forty years been replacing income and savings as a vehicle for both investment and consumption, and this has produced high levels of commerce (in the U.S. most of it in the F.I.R.E. sector) and persistently low interest rates – the mislabeled but much-beloved Great Moderation, governmental “corrective” action has been (and will continue to be) aimed at restoring commerce via reflating credit, including maintaining recently-restored low interest rates. Any talk of regulatind finance, including leverage limits and TBTF, is strictly political theater and will not prevent the government-finance nexus from attempting to fully reconstruct their beloved credit-driven “prosperity”.

  16. Agreed, an instructive and provocative summary. The question it begs from me is, if we are to replace privately generated money with a pool of public money (savings) to finance future economic growth, how big of a savings pool would be needed, by how much would the consumer portion of the economy have to shrink to create it, and how long would it take to create this pool? My completely uninformed guess would be: very large, 30%, 20 years. Any better estimates, StatsGuy?

  17. Probably far less than that – in the Great Depression, we had 25% savings rate, which is excessive. Historically, 10% seems fine – perhaps less.

    In terms of how much base money to feed into the system… enough to stabilize asset prices. At a _crude_ guess, the S&P 500 went from 180 in 1985 to 1100 today (down from peak in 2007). That’s a 6-fold increase. The monetary base went from 200 to 800 billion in that same time, a 4 fold increase. That suggests adding about 400 to perhaps 500 billion in _permanent_ base money into the system.

    Recent moves in the Base chart are misleading in the sense that the Fed has indicated it will withdraw most of that base just as soon as it can, which cripples the expectation of permanent price increases (unless you think the Fed will renege). As an alternative, the Fed could _slowly_ extract this “temporary” base, and replace it with a tax credit to match 30% of costs for high-priority long term infrastructure. That would finance 100 billion in long term credits per year for half a decade, which would match with >300 billion from the private sector per year. Of course, that requires Congress to actually do something useful since the Fed doesn’t run fiscal policy.

    Instead, Congress would rather wait till things get worse, and then finance repeated extensions to unemployment insurance and watch tax revenues tank. Absurd.

  18. I concur with virtually all you have said here.

    I didn’t think I’d ever be so “on the same page” with you. Interesting.

  19. If only we gave Timmy Geithner the authority, he would do the right thing! Really?! Really! (with regards to Amy Poehler, Seth Myers and Doug Kass)

    (the scene in Too Big To Fail of bankers rolling their eyes at Geithner’s cheerleading during the Lehman meltdown meetings at the NY Fed told me everything I needed to know and what I had always thought was true about Timmy.)

  20. How about a “derivatives diet?” No derivatives until you pay back all the bail out money. I’m also appalled by how the banks are now raising credit card rates before the new regulations go into effect, a little like a drug company raising “life or death’ medication for critically ill patients before a health care reform scenario.Chutzpah Capitalism.
    The “boom, bust bailout” cycle is on the money, so to speak. We’ve lost our manufacturing and our industrial unions and our standard of living. High finance , high risk. Maybe it would make sense and have a ounce of humanity in it, if we could make housing seriously affordable for those “low wage service sector “people who have replaced our manufacturing sector workers.But then again housing is a money maker or was.
    ARM’s should also be outlawed, if you can’t qualify for a fixed rate , where’s the logic in an ARM.The banks blackmailed legislators in the late 70’s to allow ARM’s otherwise they would not loan money to states and cities.
    Charity hospitals also do this, charging the least fortunate , those who don’t have health insurance double and triple what insured patients pay.Insult to injury, in spades.Charity ARM’s. Very Orwellian, adjustable rate medicine.
    Maybe call it “sugar high profiting,” quick sugar high followed by depression.

  21. Let me make it clear that I support breaking up the systemically threatening banks. But at the same time in the USA this has been a dead issue for months. So other than to make it clear “on the record” where you stand on the issue it’s kind of pointless at this stage. Volcker, Stiglitz, the hosts of this site, and vast majority of visitors to “Baselinescenario” have made it clear how we feel on the issue.

    All we can do now is put pressure on Congress (preferably your particular state’s U.S. Representative or Senator). The only question is will the next crisis hit banks first or money-market mutual funds???? Unless you’re also curious to see how many excuses Barney Frank can create for the same problem happening on his watch 2+ times.

  22. Socrates was furious against elected, but incompetent officials (Pericles, or Obama style: lofty rhetoric, grotesque decisions going towards the complete destruction of all that they claim to hold dear).

    Now what we have is rule by incompetent, unelected, un-officials, who present “risk to the sovereign” as the Bank Of England paper say.

    Who can pretend to have democracy. But then, when we have lofty unemployment, democracy is counterindicated. And that can work for a long time: after all the Roman empire, with lofty unemployment and a fake “republic” went on, in the “Orient Part”, for nearly 15 centuries. But then it did not contribute to civilization much, if at all…

    Patrice Ayme

  23. Next time it WILL be different: there will be no bail-out. It won’t matter if a bank is perceived as “too big to fail” or not, the public and Congress will have no stomach for a bailout again. Banks must beware. Excessive leverage going forward has MORE risk than before, not less.

  24. Interesting story from Bloomberg relating to bank regulations, FASB and accounting. It appears our lawmakers (Congress) have forgotten that the accounting rules are made for investors, not bankers.

  25. For what it’s worth, with this new “relaxing” of fair-value accounting rules, I wouldn’t invest one nickel in any bank where I didn’t personally know the managers, and even then I’d have to think about it.

  26. This is a hard problem, because MtM is inherently pro-cyclical. Strict implementation of MtM would enforce upon banks the same short-term time horizons as the markets.

    The problem, of course, is that excess relaxation of MtM (in the presence of weak willed regulators without specific guidelines) is like granting banks an open ended cheque to print their own money.

    “How much is that asset worth? OK.”

  27. The problem is the asymmetry.

    Prior to the crash risk was a god and government’s job was to get out of the way, then after the crash the government has to play god and rescue wealthy gamblers from risk-based losses. Prior to the crash MtM permits financiers to book big speculative gains and reap big personal rewards, then after the crash MtM is abandoned to let financiers avoid booking big speculative losses and continue to reap big personal rewards.

    If you operate a society with this kind of double standards – all directed at enriching private financiers – the chaos you create all gets directed downward to the masses.

  28. ‘Strict implementation of MtM would enforce upon banks the same short-term time horizons as the markets.’

    Yes, but surely this rule is for benefit of the markets? Then does not destroying MtM application disadvantage the markets? Given that everyone faces the reality of asset valuation via market, an immediate audited replacement of MtM is required and any demand for MtM relief by a bank should be refused. Previous opinions re bank destruction etc were never more than opinios and their uncritical (criminal?) acceptance has cost us taxpayers over a trillion dollars!

    We investors and plucked chickens must demand an immediate reinstatement of MtM and clawback of misdirectred public funds.

    Couple this with taking public control and operation of our nation’s money!

    I believe it will be better for banks for them to have a finite financial environment in which to operate. The particular concern is similar to that evinced when children behave badly with no boundaries.

    Many banks probably operate in a risky manner because competition ensure thay do so or lose the profit race?

  29. Bernanke on ‘Too Big Too Fail’, moves to the camp – “making banks smaller would not necessarily be the solution to the problem.”

    Spoken like a “two-handed” economist. President Truman when  asked by his adviser why he wanted  a one-armed economist, replied “Well, I am tired of this advice on the one hand and on the other hand.”

  30. Also this story related to FASB. A story by Ryan Grim at Huffington Post. This is an amendment which would take away the Securities and Exchange Commission’s (SEC) authority to oversee the FASB and give that authority to a new “oversight” board, which would allow them (the regulators, or “oversight” board) to change accounting guidelines depending on economic conditions.

    Everyone who is worried about too much concentrated power in large banks, this is a MUST read.

  31. By the way, Barney Frank can spin this any way he wants, this is dangerous dangerous stuff folks. In essence it’s making it easier for small banks to over-value their assets so they can meet capital requirements. Also when economic times get perilous, this would allow bank regulators to hide changes/removal of accounting standards.

  32. Can we take a step back here?
    Are we seriously looking at workable reforms that bow to no sacred cows?
    Beyond narrow banking.
    Public money is the only solution.
    The possibility exists to break the yoke of the debt-industrialists who have financialized us into our present straight-jacket.
    The Chicago Plan for Monetary Reform.
    The American Monetary Act reforms at monetary dott org.
    Supported by Milton Friedman and Irving Fisher along with Henry Simons and Frederick Soddy.
    Take the blinders off.
    Look behind the curtain, America.
    It’s our money system.
    How ’bout we create it ourselves, without debts?
    How bout WE regulate its value?
    Couldn’t do worse than these guys.

  33. The Pragmatist

    The discussion of regulation versus innovation is important. In the US we practically worship innovation as a God. Innovation can be a very good thing when it increases efficiency, makes a product work better or cost less. But innovation in banking and capital markets does none of these things. In many ways financial innovations are simply ways for some investors to capture a greater share of profits. Derivatives, short selling, credit default swaps etc. create nothing of value. In the end all investment returns have to come from the operating profits of companies that create goods and real services. Financial innovators find ways to capture a larger percentage of those profits, but it has to come from somewhere. That somewhere is other investors. In finances, especially in banking simple is fair and innovation is a way for the unsrupulous to prey on the unwary.

    If more regulation in the finance industry results in less innovation lets regulate the heck out of it.

  34. Innovation in banking is similar to innovation in education, where only the “educators” benefit (just as bankers…) instead of students (or customers/investors) from the supposed innovation.

    Abandoning time-tested phonics for look-say allowed persons too lazy to master phonics themselves to mop up teaching salaries, while providing no worthwhile benefit to the child. Same for the abandonment of multiplication tables and adoption of fuzzy math.

    And English? Once, I heard a striking teacher in Revere explain to a reporter on the eleven o’clock news, “I teaches English.” Eubonics was once touted as educational innovation.

  35. Libertarian economic theory, the freshwater econonists, the market triumphalists dominated econmomic policy in many countries and institutions. But this theory has been discredited by the need for massive government intervention in the markets. The socialization of the losses and privatization of profits.

    What are the economic theories that are taking leadership at this time?

  36. Interesting story from the New York Times journalist Mary Williams Walsh. It talks about The New York Federal Reserve (then headed by Timothy Geithner), AIG, and the Troubled Assets Relief Program (TARP).

    It does not portray Treasury Secretary Geithner in a positive light as far as his negotiating skills are concerned. The audit discussed in Walsh’s story also refutes Goldman Sachs’ assertions about Goldman’s exposure or vulnerability in relation to AIG’s failure. That IN FACT, though Goldman Sachs denies it, Goldman would have gone under without what Mr. Barofsky called a “backdoor bailout”. It’s all here in this link to NYT’s story.

    As a side note, I wonder if the folks in Treasury (Mr. Geithner??) mentioned any of this to the 8 bloggers who promised anonymity to Treasury officials to meet with them in person and ask questions. I guess they were too busy talking about “interconnectedness”.

  37. some guy in a cube

    Geithner used to work for the Fed and it obvious to anyone with half-a-brain that is still their dutiful and submissive errand boy.

    Re AIG: One man’s “botch job” is another’s windfall profit.

  38. Let’s face it, Simon, who comes out the other end (i.e. the end of the bust) with the most assets. I guarantee that it is the very ones who participate in bubble inflation. After all, aren’t they interested in bubblefying the economy perminently, so that they can rake off their billions before the bust and put those treasuries, hedges or commodities tied to bust economies? The answer is not just breaking the TBTF group, but the oligarchs who support the rape of the populace that transpires. Interesting that Tim Geithner is now taking flak for his role in the AIG rescue payouts (100% on the dollar), and that is just a small example of how we are getting gamed more and more by the oligarchs and their key wonks.

    Really, the bottom line is true election and lobby reform. Until that happens, the power structure will remain largely intact because no effective regulation of anything (financial, energy, healthcare, etc.) will ever be enacted. End of story.

    This was a cogent piece and I need you and James (and others) to keep throwing stuff against the proverbial wall, in hopes that enough will stick to ultimately move things.

  39. Richard Hoogesteger

    I agree with you though I wonder if its not just that these banks are too big to fail but also that they have too much market power. I think about my freshman economics class where we were told that for markets to be efficient you need a very large number of participants. Investment banking seems like it has too few providers of services to have a truly competitive market. Further I wonder if problems with assymmetric information-providers of products having more information about them than purchasers-doesn’t cause rent-seeking and lead to inefficiencies. Market failure seems more the rule than the exception in finance.

  40. “The big banks must be broken up.” With all due respect, – one thousand thanks for stating the obvious. This very intriguing paper graphs a massive redistribution of wealth through unregulated PONZI schemes, and the conjuring of money out of thin air, and government capture (or in my unwashed pedestrian parlance bribing, owning, and controlling those things called governments) to the predatorclass alone and exclusively. Andrew Haldane and Piergiorgio Alessandri eloquantly articulate what anyone who is not predatorclass already palbably knows. Over the last several decades – with a rapid increase in velocity in the last few decades, – and hyper increase in velocity in the last two years – the predatorclass has succeeded (by capturing the state, the socalled governments) in illicitly redistributing the worlds wealth and resources into a few exclusively predatorclass hands.

    We are in fact in a “doom loop”. All the bettors are compelled by the wildly speculative forces into betting on the next bubble, hoping beyond hope all along that they are wise enough, or have enough insider information to escape, or cash out before the inevitable collapse. Irrational exuberance alone is bruting, pimping, and propping up this market. The next crisis, (and it is inevitable that there will certainly be another horrorshow crisis because NOTHING has changed, and no one has been held accountable for wanton abuses and grotesque crimes) -will serve to further entrench the wealth and resources of the predatorclass from the blood and off the backs of the poor and middleclass.

    Since said predatorclass owns and controls the socalled governments, and will certainly privatize gains and socialize losses, – the “doom loop” will be inevitable and unending.

    The peoples only hope is to strike out at our oppressors. Governments are bought and paid for by the predatorclass and will not help us. There effectively is no law, since in harsh reality the predatorclass can and does play and operate by one set of laws and standards and is shielded and granted immunities and imponderable largess from the government they own, and control, – and an entirely seperate and oppressive set of laws and standards applied to the people with NO protections or good will from the government.

    Guns and ammo are the best investments for the poor and middle class, because the predatorclass and the socalled governments they own and control are bent on enslaving or culling us.

    In a short time, a months or a couple of years, – this entire nightmare (what we not endure and tolerate as civilization) is going pearshaped.

    Stop paying your bills, close out all your accounts and hold cash, precious metals, stock up on food, water, medicines and survival supplies, guns and ammo, and get locked, cocked, and ready to rock, because the America and the world we were born into has already ended. The future is ruthless domination, enslavement, and/or a massive culling of the unwashed masses by the predatorclass. Know this predators, many of us will not go sheepishly, or peacefully to the slaughter. There will be blood.

  41. StatsGuy, your summary above reminds me of something one of my economic history professors used to say: “Probably the only time in the history of the United Stares the people ever exercised real democratic control over the supply of money was in the colonial period before Great Britain outlawed colonial scrip.” Or something like that (it’s been a few years so I’m paraphrasing). Have you ever read anything by Dr. Richard A. Lester? He was an economic history professor at Princeton back in like the 1940’s who wrote about colonial economies, especially Pennsylvania. According to him the price level during the 52 years prior to the American Revolution was more stable than the American price level has been during any succeeding fifty-year period. Apparently Pennsylvania established a “land bank” that allowed landowners to borrow paper “scrip” money with their land as collateral. Sounds pretty good doesn’t it? Do you think people today could be trusted to implement a responsible monetary policy or is the (relatively) unaccountable Federal Reserve Board our only option?

  42. I haven’t… The only Richard Lester I’m familiar with run the Industrial Productivity Center at MIT. Not the same one, I assume.

    Libertarian monetarists are fond of private money systems – I personally am skeptical of something on that large a scale, primarily due to the concentration of power in the hands of agents that are beyond the control of democratic institutions. (Even more so than the Fed.)

  43. More from Dr. Lester:

    The colonies had their own script and could pay for their activities while taking less in taxes. Colonial scrip was not backed by gold or silver and therefore the colonies could control its purchasing power. This was similar to the “tally stick” system used by the British Empire for over 700 years. It was different from the conventional European mercantilist system of money which required governments to borrow from banks and pay interest for those loans, as gold and silver were the only regarded forms of money. Colonial scrip, were “bills of credit” created by the government, based on the credit of that government, and this meant that there was no interest to pay for the introduction of money. This went a considerable way towards defraying the expense of the Colonial governments and in maintaining prosperity. The governments charged low interest when it loaned out this paper money to its citizens, with land as collateral, and this interest income lowered the tax burden on the people, contributing to prosperity.

    *One of the commentators on Mark Thoma’s website turned me onto Dr. Lester’s work, but I can’t seem to find who it was so I can’t give them credit. My writing here incorporates a lot of that poster’ comments (I saved them in a word file) so if he/she is reading this I apologize for posting parts of your comments without giving credit.

  44. why isn’t Mr. Merryweather banned form the industry?

  45. No, not the same Richard Lester. The Dr. Lester I was referring to taught at Princeton and died in 1997:

    Also, when I asked if you thought people today could be trusted to implement a responsible monetary policy, I definitely was not trying to argue for private money systems. For the reasons you mentioned I think such a scheme would be the antithesis of democratic control over the money supply. What I was trying to ask was if you think some sort of an updated version of what Pennsylvania had almost four-hundred years ago would be possible today? Something along the lines of what Mark Thoma advocates here:

    Actually, Thoma isn’t really arguing for democratic control over the money supply here either. Thoma doesn’t think the Fed is independent enough, and only wants to allow elections in order to create the illusion that the people are in control. Personally, I would go much farther than this. I’d like to see direct elections of Federal Reserve governors and chairmen/women. Actually, I find the whole: “the Federal Reserve needs to be insulated from political meddling,” argument to be incredibly naive. There’s tons of evidence showing both Federal Reserve Board governors and chairmen have been influenced by political considerations in the past. More troubling, these kinds of arguments show an utter contempt for the democratic process. I’m continually shocked by how easy it is for so-called new-age liberals to show their complete disregard for basic democratic values like majority rule without getting called to task. Whoever Mark Thoma’s civics teacher was should be ashamed of him/herself. Social Studies teachers everywhere unite! Down with John Locke! It’s time we started listening to Rousseau.

  46. I can’t subtract. “Almost four-hundred years ago,” should be almost three-hundred years ago.

  47. Dave of Maryland

    So if the existing system doesn’t work & so far as we can tell, never will work, that it will only bring us eventual doom, then let’s go looking for some other system. Political system.

    What about Marxism? In its existence, did the Soviet Union suffer from this problem, YES or NO?

    If it was free of the bankers, then is it worth trading our system, warts vs: warts?