Month: April 2010

We’re Big . . . and We’re Connected

By James Kwak

MBIA, the big bond insurer, is actually headquartered in Armonk, New York, about forty miles from Wall Street, and it’s not quite one of the swaggering elite. But it plays its own crucial role in the financial system, insuring municipal bonds as part of a tight oligopoly. Then it recently expanded into writing credit default swaps on mortgage-backed securities and collateralized debt obligations, raking in profits during the boom while loading up on exposures that would almost kill it during the financial crisis.

But when it comes to attitude, MBIA wanted to be every bit the financial oligarch. Bloomberg has an excerpt from Christine Richard’s upcoming Confidence Game, which tells the story of hedge fund manager Bill Ackman’s short position on MBIA. (Here’s a previous Bloomberg story on the topic.) There isn’t much in the excerpt, but there is this choice quote from MBIA CEO Jay Brown, as recalled by Ackman:

“You’re a young guy, early in your career. You should think long and hard before issuing the report. We are the largest guarantor of New York state and New York city bonds. In fact, we’re the largest guarantor of municipal debt in the country. Let’s put it this way: We have friends in high places.”

(The next year, New York attorney general Eliot Spitzer began investigating Ackman for market manipulation, but Ackman was never charged with anything.) It doesn’t get much more clear than that.

(Disclosure: I knew Bill Ackman a long, long time ago. We took calculus together in high school; I was a sophomore and he was a senior. And I vaguely recall helping him with it. Nice guy. Yes, he had gray hair in high school.)

Michael Lewis on Wall Street

By James Kwak

The Big Short is a good story and provides some illuminating lessons about Wall Street. Lewis doesn’t really come out and say what he thinks about Wall Street; he lets his characters do that for him. But in his recent interview with Christopher Lydon, he really lets loose. Here are some direct quotations.

Lewis: “The people who were responsible for orchestrating the crisis, because they’re on top and they’re in the middle of it, they’re the only ones who are sort of fluent in the language of it. I mean, who’s to question Tim Geithner, the secretary of the treasury, about this or that, because he’s the only with the information . . . even though he is clearly culpable in what happened.”

Lydon: “Not to mention Larry Summers and Bob Rubin and all the other architects of the deregulation. They’re still calling the shots in a new administration after a change of party management. It’s unreal.”

Lewis: “It is unreal, because basically all of the people you mentioned all swallowed a general view of Wall Street, which was that it was a useful and worthy master class, that these people basically knew what they were doing and should be left to do whatever they wanted to do. And they were totally wrong about that. Not only did they not know what they were doing, but the consequences of not knowing what they were doing were catastrophic for the rest of us. It was not just not useful; it was destructive. We live in a society where the people who have squandered the most wealth have been paying themselves the most, and failure has been rewarded in the most spectacular ways, and instead of saying we really should just wipe out the system and start fresh in some way, there is a sort of instinct to just tinker with what exists and not fiddle with the structure. And I don’t know if that’s going to work. When you look at what Alan Greenspan did, or what Larry Summers did, or what Bob Rubin did, there are individual mistakes they made, like for example not regulating the credit default swap market, preventing that from happening. But the broader problem is just the air they breathe. The broader problem is just the sense they all seem to have that what’s good for Goldman Sachs is good for America.”

***

Lewis: “The question is how does Washington move away from those institutions and make decisions that are in the public interest without regard for the welfare of these institutions. It’s a hard question because . . . this is the problem. Essentially the public and their representatives have been buffaloed into thinking that this subject — financial regulation, structure of Wall Street — is too complicated for amateurs. That the only people who are qualified to pronounce on this are people who are in it. And there are very very few people who aren’t in it in some way who have the nerve to stand up and fight it. . . .

“The elected representatives look at the financial system, I’m sure, and they think, it’s too complicated for me to understand, I’m going to be quickly exposed as a know-nothing if I take the lead on regulation, and in the bargain I’m going to miss out on all these campaign contributions from the financial industry because I’ll alienate them.”

***

Lewis, on Barack Obama: “He’s been captured by his banker, just like the ordinary American’s  captured by their stockbroker. He’s been buffaloed by the complexity of it all, he doesn’t have time to sort it out for himself, and he has to trust the people who seem to know. The alternative is for him to set off on his own in a quixotic quest to reform the financial system without having any experience of the system. It’s sort of like the presidential version of regulatory capture, that he is at the mercy of the people who really don’t have probably his long-term best interests at heart but who seem to know what they’re talking about.”

The Few: Sensible Republican Senators On Financial Reform

By Simon Johnson

There are three kinds of Republicans in the Senate today.  First, there are those willing to follow the lead of Senator Mitch McConnell – whose approach to financial sector reform apparently amounts to little more than, “Don’t worry, be happy”.  If Senator McConnell has a reform plan he would like to lay out for review, now would be a good time to put some credible details on the table. 

Based on what we have seen so far, Senator McConnell proposes to do nothing regarding the systemic risks posed by today’s megabanks and just “let ‘em fail” when necessary.  This is a dangerous and irresponsible position, and it should be opposed tooth-and-nail by anyone who actually cares whether or not we run ourselves into a Second Great Depression.

The second group has remained silent so far, waiting to see which way popular opinion and their leadership will go.  Most likely, almost all will cast their lot in with Senator McConnell. 

And if Senator McConnell brings 40 Senators with him, they will defeat the Dodd bill – and then smash themselves into the rocks of November 2010 as the “too big to fail” party.  Perhaps we should welcome that.

But there is also a third group, not yet numerous, that is more inclined to be sensible or – as Senator Corker aptly put it – to “act like adults.” Continue reading “The Few: Sensible Republican Senators On Financial Reform” →

The Next Global Problem: Portugal

By Peter Boone and Simon Johnson

The bailout of Greece, while still not fully consummated, has brought an eerie calm in European financial markets.  It is, for sure, a massive bailout by historical standards.  With the planned addition of IMF money, the Greeks will receive 18% of their GDP in one year at preferential interest rates.  This equals 4,000 euros per person, and will be spent in roughly 11 months. 

Despite this eye-popping sum, the bailout does nothing to resolve the many problems that persist.  Indeed, it probably makes the euro zone a much more dangerous place for the next few years. 

Next on the radar will be Portugal.  This nation has largely missed the spotlight, if only because Greece spiralled downwards.  But both are economically on the verge of bankruptcy, and they each look far more risky than Argentina did back in 2001 when it succumbed to default. Continue reading “The Next Global Problem: Portugal” →

The Other Battle

By James Kwak

One battle in Washington — the one that has been in the news this week — is over resolution authority and the supposed “bailout fund” attacked by Mitch McConnell. Another battle will be over the Consumer Financial Protection Agency, which Republicans are likely to try to cripple behind the scenes. While most of the reviewers of 13 Bankers have seized on the call to break up big banks, few have discussed the first part of that chapter, which argues for strong consumer protection. Simon and I wrote an op-ed in The Hill to reiterate the point and warn against some of the tactics opponents may use.

Senator McConnell Is Wrong, Senator Kaufman Is Right. Any Questions?

By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

Senator Mitch McConnell continues to insist that the Dodd bill creates permanent bailouts – and that it would be definitely better to do nothing.  Apparently, he has indicated a willingness to make a Senate floor statement to that effect every day. 

Senator McConnell is completely wrong on this issue – and, if he gets any traction, we will feel the need to point this out every day.  His remarks today and yesterday go far beyond any reasonable level of partisanship.  This is about playing games with the financial stability of this country and the world; it should stop.

Don’t take my word for it – Senator Ted Kaufman is a strident critic of our current financial system and a tough voice for greatly strengthening the Dodd bill.  But today he was as clear and as forceful as you can be on the floor of the Senate:  Senator McConnell’s proposed approach is “dangerous and irresponsible.” Continue reading “Senator McConnell Is Wrong, Senator Kaufman Is Right. Any Questions?” →

“The Derivatives Dealers’ Club”

By James Kwak

Robert Litan of Brookings wrote a paper on the derivatives dealers’ club — the small group of large banks that control most of the market for certain types of derivatives, notably credit default swaps. It’s a blunt analysis of how these banks can and will impede derivatives reform in order to maintain their dominant market position and the rents that flow from it.

I haven’t had time to do it justice, so I recommend Mike Konczal’s analysis in parts one and two (but particularly one). As Konczal says, “In case you weren’t sure if you’ve heard anyone directly lay out the case on how the market and political concentration in the United States banking sector hurts consumers and increases systemic risk through both political pressures and anticompetitive levels of control of the institutions of the market, now you have.”

And note that Litan is no bomb-thrower; most recently he mounted a defense of most financial innovation (my comments here).

Senator McConnell Is Completely Wrong On Financial Reform

By Simon Johnson

At one level, it is good to see the Republican Senate leadership finally express clear positions on the financial industry and what we need in order to make it safer.  At another level, what they are proposing is downright scary.

In a Senate floor speech yesterday, Senator Mitch McConnell (Senate Republican leader) said,

”The way to solve this problem is to let the people who make the mistakes pay for them. We won’t solve this problem until the biggest banks are allowed to fail.”

Do not be misled by this statement.  Senator McConnell’s preferred approach is not to break up big banks; it’s to change nothing now and simply promise to let them fail in the future. 

This proposal is dangerous, irresponsible, and makes no sense.  The bankruptcy process simply cannot handle the failure of large complex global financial institutions – without causing the kind of worldwide panic that followed the collapse of Lehman and the rescue/resolution of AIG.  This is exactly the lesson of September 2008. Continue reading “Senator McConnell Is Completely Wrong On Financial Reform” →

Pack of Fools

By James Kwak

“I thought that I was writing a period piece about the 1980s in America, when a great nation lost its financial mind. I expected readers of the future would be appalled that, back in 1986, the CEO of Salomon Brothers, John Gutfreund, was paid $3.1 million as he ran the business into the ground. . . . I expected them to be shocked that, once upon a time on Wall Street, the CEOs had only the vaguest idea of the complicated risks their bond traders were running.

“And that’s pretty much how I imagined it; what I never imagined is that the future reader might look back on any of this, or on my own peculiar experience, and say, ‘How quaint.'”

That’s Michael Lewis in The Big Short (p. xiv), looking back on Liar’s Poker.

“Looking back, however, Salomon seems so . . . small. When the Business Week story was written, it had $68 billion in assets and $2.8 billion in shareholders’ equity. It expected to earn $1.1 billion in operating profits for all of 1985. The next year, Gutfreund earned $3.2 million. At the time, those numbers seemed extravagant. Today? Not so much.”

That’s the third paragraph of Chapter 3 of 13 Bankers. (This was a complete coincidence; I didn’t see The Big Short until it came out, and I have no reason to think that Lewis saw a draft of our book.)

I actually did not rush out to buy The Big Short, even though Michael Lewis is a great storyteller. I figured I knew the story already; Gregory Zuckerman’s The Greatest Trade Ever covered some of the same ground and some of the same characters, and I already knew plenty about CDOs, credit default swaps, and synthetic CDOs. But I’m very glad I read it, and not just because it’s a fun read.

Continue reading “Pack of Fools” →

Greek Bailout, Lehman Deceit, And Tim Geithner

By Simon Johnson

We live in an age of unprecedented bailouts.  The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.

The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures.  Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?

But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).  Continue reading “Greek Bailout, Lehman Deceit, And Tim Geithner” →

The Cover-Up

By James Kwak

Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.

The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.

I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.

Continue reading “The Cover-Up” →

Greece Saved For Now – Is Portugal Next?

By Peter Boone and Simon Johnson

The Europeans announced Sunday they would provide 30 billion euros of assistance to Greece, amid informed rumors that the IMF will offer another 10-15 billion.  With a total of say 40-45 billion euros in the bag – more than the market was expecting — the Greeks have time to make changes. 

The Greek government, helped by the market threat of a near term collapse, appear to have strong armed the other eurozone countries into a generous package without making efforts to change seriously their (Greek) fiscal policy.  This is good for near term calm, but it does not solve any of the inherent problems now manifest in the eurozone. Continue reading “Greece Saved For Now – Is Portugal Next?” →

Taxation and Prohibition

By James Kwak

Andrew Haldane (of “doom loop” fame) has another provocative paper, “The $100 Billion Question,” delivered in Hong Kong last week. A central theme of the paper is what Haldane sets up as a debate between taxation and prohibition as approaches to solving the problem of “banking pollution” — the systemic risk externality created by the banking industry. Taxation is higher capital and liquidity requirements; prohibition is structural reforms that limit the size or scope of financial institutions. Drawing on work by Weitzman and Merton, Haldane discusses when one approach would be superior to the other.

The advantages of prohibition include modularity (ability of a system to withstand a collapse of one component), robustness (likelihood that regulations will work when needed), and better incentives (since tail risk is a function of banker behavior — not weather patterns — the risk-seeking nature of banking means that no capital level will necessarily be high enough).

Continue reading “Taxation and Prohibition” →

Thank You

By James Kwak

13 Bankers is #11 on the New York Times hardcover nonfiction bestseller list.* I’m certain that could not have happened without the readers of this blog. (Actually, the book would not have existed in the first place without this blog, and the blog wouldn’t exist without readers.) It’s also #4 on the Wall Street Journal hardcover business list and #14 on the Indiebound hardcover nonfiction list.

In other major news, the book is Arianna Huffington’s pick for April, which means that there will be a month of blog posts by us and by other bloggers at the Huffington Post. Our first post in the series, arguing against the “banana peel” theory of the financial crisis, is already up. We’ve lined up a wide range of commentators, several of whom we expect to disagree with us rather strongly.

We also have some full-length video of presentations by Simon. Over the next week, I’ll be in Providence and Simon will be in Chicago and Los Angeles (schedule here). Simon has a bunch of interviews; I’ll be on Sense on Cents tomorrow evening.

* The list is for the week ending April 3. It goes on the Web on April 9 but doesn’t go into the print edition until April 18, by which point it is two weeks out of date. (One friend thinks the lag is to give bookstores enough time to stock their shelves.)