Is The New York Fed Making A Serious Mistake On Bank Dividends?

By Simon Johnson

An uncomfortable dissonance is beginning to develop within the Federal Reserve.  On the one hand, senior current and former officials now generally agree with the propositions put forward by Professor Anat Admati and her distinguished colleagues – our leading banks need more capital, i.e., more equity financing relative to what they borrow.

The language these officials use is vaguer than would be ideal and they refuse to be drawn on the precise numbers they have in mind.  The Swiss National Bank, holding out for 19 percent capital, and the Bank of England, pushing for at least 20 percent capital, seem to be further ahead and much more confident intellectually on this issue. 

But an important split appears to be emerging within the Federal Reserve system, with the Board of Governors and most regional Feds tending to want higher capital levels from today’s levels, while the New York Fed is – incredibly – pushing hard to enable big banks actually to reduce their capital ratios (in the first instance by allowing them to pay increased dividends).

The New York Fed will not go on the record in any detailed way and my attempts to engage constructively with them have proved futile, so it is hard to know if there is any analytical basis whatsoever for their position.  They have certainly put up no meaningful counterarguments to the powerful points made by Anat Admati and her colleagues – both in general and against allowing U.S. banks to increase their dividends today (see also this letter to the FT).

The key point is this.  Given that the final capital requirements under Basel III remain to be set by the Fed – and top officials say they are still working on this – what’s the big rush to pay dividends?  Retaining earnings (i.e., not paying dividends) is the easiest way to build capital (i.e., shareholder equity) in the banks.  There is strong logic behind not paying dividends until capital is at or above the level needed for the future.

Without any substance on their side, the New York Fed is increasingly creating the perception that it is just doing what its key stakeholders – the big Wall Street banks – want.

Bankers traditionally dominate the board of directors for regional Feds.  We can argue about whether this is a problem for most of those organizations, but for the New York Fed the predominance of big Wall Street institutions has become a major source of controversy. 

At the bottom of the NY Fed’s current board membership webpage, you can review who belonged to the board every year from 2000 to 2008.  Note the presence of influential bankers in the past such as Dick Fuld (Lehman), Stephen Friedman (ex-Goldman), and Sandy Weil (Citigroup).  Their firm hand helped guide the New York Fed into the crisis of 2007-08.

The Dodd-Frank legislation reduced the power of big banks slightly in this context, so that the president of the New York Fed is no longer picked by Wall Street’s board representatives (unlike Tim Geithner, the previous head and current Treasury Secretary, and Bill Dudley, the current head and former Goldman Sachs executive.)  But the current New York Fed board still includes Jamie Dimon, head of JP Morgan Chase, and an out-spoken voice for allowing banks to operate with less capital (by paying out dividends). 

In fact, Dimon has a theory of “excess capital” in banks that is beyond bizarre – arguing banks (or perhaps any firms) with strong equity financing will do “dumb things”.  This is completely at odds with reality in the US economy where many fast-growing and ultimately successful companies are financed entirely with equity.

If the New York Fed’s top thinkers have convincing reasons for not wanting to increase capital in our largest banks, e.g., because they agree with Dimon, they should come out and discuss this in public (and providing some evidence would be nice).  Hiding quietly behind official walls is, at this stage, beyond irresponsible.

If the New York Fed were really pushing for higher dividends at this time, for example by constructing a stress tests to justify this action, it would be setting us up to mismanage credit – allowing the megabanks to misallocate resources during the good times and crash just as badly when the next downturn comes.  The top leadership of the New York Fed has a responsibility to engage constructively and openly in the technical debate.

Some Federal Reserve officials act as if they have a constitutional right to run an independent central bank.  Fortunately or unfortunately, this is not the case.  Congress created the Fed and Congress can amend how the Fed operates.

The legitimacy of the Federal Reserve System rests on its technical competence, its ability to remain above the political fray, and the extent to which it can avoid being captured by special interests.

There is a very real danger that the New York Fed now will fatally undermine the fragile credibility of the rest of the Federal Reserve System.

An edited and expanded version of this post appeared this morning on the NYT.com’s Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.

59 responses to “Is The New York Fed Making A Serious Mistake On Bank Dividends?

  1. Thanks Simon!! Go go go!!

  2. Good point on central bank independence. Typically we think of this in terms of independence from the political process, and for good reason. However, we must also not lose sight of the value of independence from the interests of the individual banks.

  3. markets.aurelius

    The behavior of the NY Fed and the U.S. Treasury is beyond comprehension right now. Here we have the same people whose “firm hand helped guide the New York Fed into the crisis of 2007-08″ arguing for reduced equity at the very banks they are supposed to regulate. Nothing has changed at these institutions, except they are now able to pay like it’s 2007 (as if nothing happened), and to argue for even bigger payouts to the very people who destroyed the markets in which we all must function.

    It’s crazy. Oh, btw, how is it Rajat Gupta gets burned for insider trading while sitting on the GS and P&G boards but Stephen Friedman (ex-Goldman partner, GS board member and NY Fed Board member) gets off scott free after getting long GS stock on the lows following his inside information GS was going to get a federal bank charter and be bailed out on 100% of its AIG exposure? In what manner is this spun such that he did not break the law?

    to rephrase your question in the title of this post: Is the NY Fed the most profoundly corrupt part of the U.S. banking system or what? Is the Treasury secretary continuing to do the bidding of his erstwhile employers?

  4. Herbert Wetherby

    Perhaps the NY Fed belives that with a higher capital ratios the banks will gamble that money away in the underground economy and need to be bailed out in bad times. Without the higher ratios the banks have little to gamble with and simply pass it along to sharecroppers.

  5. The only reason I can see for Banks paying dividends is that the Banks are looking forward to raising equity in the not-too-distant future.

    This would be a BIG political win for the Obama-Geithner Administration before the 2012 elections AND allow the banks to leverage a) QEn-enhanced earnings.

  6. That the banks, or any corporation, are paying dividends at all under depression circumstances is yet more empirical proof that they serve no constructive social or economic purpose and therefore shouldn’t be allowed to exist at all.

    We should abolish them all.

  7. Seconded.

    The guys who designed Basel III specifically stated that Basel III capital levels were calibrated for banks that were NOT systemically important. They made clear that large banks “should have loss absorbing capacity beyond the standards announced” in Basel III.

    Here’s the link, in case, you know, helpful to anyone working at the NY Fed: http://www.bis.org/press/p100912.htm

  8. markets.aurelius

    One other interesting feature of the current regulatory environment, which is of a piece with what we observe vis-a-vis the NY Fed: Instead of actually adding anything of substance to understanding what’s going on at the former investment banks (now BHCs) it used to regulate way back in 2007-08 run-up — when it had an epic failure of comprehension and execution of its oversight function — the SEC now is seeking to rein in hedge funds’ risk taking.

    HFs typically operate with a fraction of the leverage of the BHCs that serve as their primary brokers. And they commit actual equity to their investing. Biggest distinction between the BHCs and HF/PE universe: HFs and PEs can fail — the top five or six BHCs will never be allowed to fail. So, in order to addresses this asymmetry of risk profiles, what did the SEC do? Why, it voted to “limit competitive compensation at hedge fund and private equity groups that had little or nothing to do with the financial crisis and never took any bailout money,” according to Politico this morning? (Scroll down a bit here: http://www.politico.com/morningmoney/)

    This does not happen without the advice and consent of the White House. And, yes indeed, Timmy G’s the chief oracle for financial and economic policy for the Obama administration. Hummmm … what could possibly be driving this action?

    Here’s what’s up: The BHCs are losing their best risk-takers to the HFs and PE shops. Oh, my! And, as noted in an earlier comment, these HFs and PEs can and will outcompete the BHCs. So in that Darwinian jungle known as the market, they’ll eat the BHCs’ lunch. That means, on average, they’ll be paid more than the chumps running the BHCs. While means they’ll be able to lure the best and brightest out of the BHC world. Oh, my!

    Need proof? How’s this from the FT 1 Mar 2011:

    “Top 10 hedge funds make $28bn

    By James Mackintosh in London

    Published: March 1 2011 22:16 | Last updated: March 1 2011 22:16

    The top 10 hedge funds made $28bn for clients in the second half of last year, $2bn more than the net profits of Goldman Sachs, JPMorgan, Citigroup, Morgan Stanley, Barclays and HSBC combined, according to new data.

    “Even the biggest of the hedge funds have only a few hundred employees, while the six banks employ 1m between them. According to the data, the top 10 funds have earned a total of $182bn for investors since they were founded, with George Soros making $35bn for clients – after all fees – since he set up his Quantum Fund in 1973.”

    The whole story’s here at http://www.ft.com/cms/s/0/24193cbe-4433-11e0-931d-00144feab49a.html#axzz1FXuPESPA and it is intriguing.

    The SEC, like the NY Fed, is doing the bidding of the BHCs. This is so blatant as to be laughable, but, alas, this is the world we live in. The BHCs’ economic value added is approaching zero — particularly as regards risk-taking and -management. So, the only thing they are now able to do is to hijack the regulatory process, and get their people on the inside to tilt the playing field in their favor. In a real markets, they’d all be out of business, and none of them would be paid. They know this, because this is the way markets work.

    A sad day all around.

  9. Andrew Macpherson

    Great piece as always Simon. I do now favor the banks being turned into tightly controlled utilies, as should the political parties.

    The corruption of the Wall St-Washington money train that the Pepsi/Coke political parties have come to rely on to run their campaigns has resulted in a rotten to core Rhodes/Collectivist power structure that is both destroying individual wealth and loosing the both the trust and love of the people.

    The consequence of this will not be pretty, if these institutions want to survive we need to see real change, and honestly real prosectutions too.

  10. “Is the Treasury secretary continuing to do the bidding of his erstwhile employers?”

    With all due respect, markets.aurelius, can we still even ask this question?

    Seems to me it has been answered for us repeatedly in the affirmative.

  11. NY FED = all those pallets of $100 bills, $ 9 billion reportedly, sent to Iraq, and disappeared.

    Seems to me a place out of control with no transparency. Guess who was in charge during the shipment?

  12. I noted a mistake:
    Is The Xxx Xxxx Fed Xxxxxx A Serious Mistake Xx Xxxx Xxxxxxxxx?

    That should fix it.

  13. While I would argue against the abolishment of all corporate entities, I certainly feel that money should be treated as a public utility. Private banks should be removed from the process completely. Banking should be boring and socialized so that society can have some modicum of stability to build business transactions on.

  14. Amen, Andrew.

  15. @ Simon, you forget to point out that Geithner, when he was head of the NY Fed, failed to properly oversee the banks and he was rewarded with S of T.

    Anat Admati should analyze how much of each $ of dividend is actually taxpayer money. If it is indeed taxpayer money, well it should flow back to the Treasury. She has a good operations research background and should be able to handle the statistical forensic accounting.

  16. I can’t help but think that if the regulators in other countries are calling for more disciplined capital requirements then it is because they are doing a better job of making sure that regulators don’t get paid off by banks.

    I can’t help but think that many regulators view their work as regulators as a stepping stone to working for the big Wall Street firms. They want that money, and they know they will be rewarded.

    I don’t evidence to back this up but I can’t help but think it must be out there. I wish I had the wherewithal to pursue it.

    How else can you explain

    A) holding a position that’s so silly on its face and

    B) their silence on the point (which suggests they know it’s silly so don’t really want to except being put in the position to defend it)

    ??

    Or is 13 BANKERS right, even more deeply. They don’t want to work for Wall Street, they just actually believe, deep down, that unfettered capital is what’s best for all? Can it really be brought down to dogma?

  17. @Simon Johnson: “Bank of England, pushing for at least 20 percent capital, seems to be further ahead and much more confident intellectually on this issue”

    Sheer lunacy! The 8 percent basic capital requirement in Basel I and II was and is completely sufficient for covering all banks lending to whatever is perceived as risky. What did not work, and as of course it should not work, were the arbitrary risk-weights that led to infinitesimal capital requirements on what was perceived as “not risky”. End the regulatory discrimination of risk and bring the capital requirements on everything up to 8 percent too and you’ve got it about right.

    The problem with these economists and PhDs like Simon Johnson and many others, is that they feel they are too important to waste time looking at bank regulatory carpentry.

  18. Unfortunately, I doubt we’ll see real change until we see “real” emergencies.

  19. One has to ask themselves, independence from what, and whom?

  20. Bayard Waterbury

    Simon, of course a stonger equity capital position isn’t just good business, but actual common sense (which in our plutocratic republic seems to be almost completely absent). I heard or read this week that Bank of America and others of the Wall Street Set, are considering forming “bad banks” to which to shift their rotting assets (which they continue to overvalue and play games with) to get them off the balance sheets. One has to assume that this is a ploy to satisfy concerns of the Oversight Board. This is really just an accounting ruse to obfuscate the necessity for prudent management of their assets and increase their ratios in a deceitful way. Good luck. Problem: how will these banks fund the purchases unless its by using FED money to do it. That wouldn’t be unthinkable, since the FED continues to play games in this realm.

    But the capital ratios are so necessary, since we are far from being out of the woods regarding a possible double dip, and equity position weakness would constitute major vulnerability to another major economic crisis, and might make for a far worse ride that the one we are now recovering from.

  21. The constitution gave Congress the power to create money. In 1913 Congress gave away that power toby creating the Fed., as a central bank. As such it is a private bank independent of Congress which has no power to govern or regulate it. And when Congress wants to create money it can do so only by borrowing it from the Fed. and then paying taxpayers money in interest on that loan (Currently around $300billion per year interest on our national debt.) Banks can create money and do so every day by loaning it and entering the loaned amount on their books as an asset. Congress is not about to change this rediculous arrangement, certainly not with Geithner or and other banker as Obama’s Treasury Director, and probably not with anyone else either because the Bankers have now own too many Congressmen and, apparently, the President also. In the best interests of the lower 98% of us Congress should end the Fed., create a government owned national bank to receive all government revenue and disburse all monies needed for connduct of government business. This bank would not nationalize any other bank but would actually support them in all their banking activities. This way, and only this way, we could wipe out (over time) our national debt entirely and remove the risk of economic collapse due to banks acting like a casino instead of a bank. Banksters argue this would cause runaway inflation but actual history shows it never has and would not now.

  22. I agree about the money. But what’s your rationale for why the corporate form is allegedly necessary, since for example it was never necessary in US history until it became “necessary” in order to enable the profits of the railroads and other rackets to keep escalating.

    Why, for example, did railroads ever need to be private corporations rather than public utilities? The same goes for classic corporate projects like canals, etc.

    And finally, even if the private corporate form were ever necessary during (i.e. because of) the rise of the Fossil Fuel Age and industrialism, why would they still be necessary as we pass into the decline of this historical stage?

    It’s clear that corporations, if they ever were a progressive development (which I dispute), are certainly decadent and reactionary by now.

  23. markets.aurelius

    That is a great idea. There’s enough data from the 2007 – 2010 period to pull it off.

  24. Per Kurowski

    I agree with much of what you say (and always say). But without resolving TBTF, are you seriously sure that 8% non-risk-weighted capital levels would work? While very reasonabley removing the power for regulators/non-bankers to decide what is “risky” and what isnt, with the inevitable consequnces, would this just make the distortions deeper and more explicit (e.g. same capital to be held against e.g. german sovereign debt as against RMBS)?

    I’m genuinely curious.

    George

  25. markets.aurelius

    http://www.cnbc.com//id/41899062

    … remarkably effective in getting rid of good people and keeping good people from wanting to enter that swamp.

  26. @George999x “But without resolving TBTF, are you seriously sure that 8% non-risk-weighted capital levels would work?”

    A single non-weighted capital ratio, of for instance 8 percent, would eliminate the foremost growth-hormone for the TBTF… it is when you are authorized to leverage your capital 60 times or more doing some operations that it is easier to become TBTF. If all risks have to be capitalized the same it will be harder for the big to become bigger because the smaller banks will retain competitiveness on the local level… which they have currently lost because usually the local level is perceived as riskier and therefore is required by regulators to have more capital.

    @George999x “would this just make the distortions deeper and more explicit (e.g. same capital to be held against e.g. German sovereign debt as against RMBS)?”

    No. The banks would still be able to perceive the credit ratings and the risk and adjust to it all through the normal market mechanism which is risk-pricing. The regulators interfered and distorted Ground Zero of the market by layering on a second source of bias based on what the market already perceived. Besides, regulators are not there to take care of risks perceived, at that moment it is usually too late, they are there to consider risks not perceived.

    In fact since there has never ever been a financial crisis that has resulted from excessive investments in what is perceived as risky, and it is only the excessiveness that makes it systemic dangerous, one could even argue (I am not) for having higher capital requirements for what is perceived as not risky. If that would have been the case with yesterdays AAA rated MBS banks would not have gone there… and who are you or I to be absolutely certain of that placing our moneys in German sovereign debt would not be the last nail in the coffin?

  27. Let me be as clear as I can about it. It is in the dark room of risk-weights that the cozy relations between regulators and TBTF banks develop… or what do you think of the possibilities of a small bank going to Basel Committee to make a case that they should be able to leverage their capital 60 to 1 when lending to the grocer at their corner because they know the grocer at their corner extremely well?

    Unfortunately, by not wanting to dig deeper into the nitty-gritty of regulations, experts like Simon Johnson are the TBTF best little helpers, since they keep sending of the readers in important but nevertheless absolutely secondary directions.

  28. Swiper the Fox

    Prof Johnson,

    While I whole-heartedly agree with your overall position on limiting bank dividends, I can’t seem to find any record of the NY Fed advocating this.

    As a former NY Fed employee in the Bank Supervision Group, policy was ALWAYS coordinated with the BOG. The NY Fed would never go out on a limb and front-run the BOG on a larger policy issue like that.

    As it stands SR 09-04 (and the update in November) remains the standard under which applications for dividend increases are judged.

    See http://www.federalreserve.gov/boarddocs/srletters/2009/SR0904.htm

    As a general matter, none of these issue would be as serious as they are if we simply broke up the large banks. Having been on a conference call when it occurred, I can say that there was discussion of attempting to dismantle a certain large bank but the difficulty made it impractical.

  29. “The banks would still be able to perceive the credit ratings and the risk and adjust to it all through the normal market mechanism which is risk-pricing.”

    Again, in principle I’m all for this – but how is this different from just allow banks to use their own risk models to determine regulatory capital? Banks push for use of IRB because it allows them to bamboozle the regulator and to reduce reg. capital levels, no?

    And thank you for your replies, salient points – personally, I think a risk-weights based system will always be vulnerable to arbing where the regulators/CRAs have got things wrong to the greatest extent (last time, RMBS, this time… who can know.)

  30. None of these issues would be a problem if we stopped feeding the banks the growth-hormones that permitted leverages over 12.5 to 1 (8 percent capital) signify.

  31. @George999x “how is this different from just allow banks to use their own risk models to determine regulatory capital? Banks push for use of IRB because it allows them to bamboozle the regulator and to reduce reg. capital levels, no?”

    When I say that the banks still see the credit ratings I mean they can use these for adjusting the risk-premiums they charge their customers… but in terms of capital requirements… no bamboozling whatsoever… no IRB… 8 percent on all assets… though we need to give banks some time until that.

    If they want to use IRBs in order to convince their shareholders about their risk level, so as to lower their cost of capital, that is perfectly ok with me… what I do not want them to do is to use their IRBs to convince the regulator about anything.

  32. Swiper the Fox

    I agree. In fact, I think something like a “marginal capital requirement” would be the best. Under such a system, the larger a bank, the larger the capital requirement on each additional dollar of leverage.

    To my way of thinking, the best way to get rid of TBTF is to make it so expensive as to be uneconomical.

  33. Yes, but the serious issue of some bank regulators being empowered to arbitrarily determine risk-weights which determines capital requirements, which determines where bank credit flows, is something that no one wants to discuss… not Simon Johnson in Baseline, nor the Financial Times and to which for the time being I have written 509 letters on the issue of subprime banking regulations…

    http://teawithft.blogspot.com/search/label/subprime%20banking%20regulations

  34. @ markets.aurelius

    “Is the NY Fed the most profoundly corrupt part of the U.S. banking system or what?”

    The NY Fed is the Federal Reserve Banking System, period!
    The “Twelve Banks (12 regional) that make up the system are under the umbrella of their original creator…that being (> 90% controlled) the NY Fed. All the others are (succumb?) just feeders, and breeders of various idiosyncrasies regarding the nations financial temperature keeping things democratic, you might say (yea)?

    http://www.wikipedia.org/wiki/Chairman_of_the_Federal_Reserve

    Note: Bernakee was Bush (#43)’s “Top Economic Advisor (July/2006)___take notice of the timing? **Please take special notice #7) “Marriner S. Eccles” – the very 1st Chair of the Board of Governors (BoG’s/FRS) of the Federal Reserve System (Eccles and Romney have much in common “Both being in the Right Place at the Right Time?” – whereas Romney will undoubtedly get the “GOP” presidential nod for 2012__JMHO?)

    For what it’s worth: there are currently twelve (12) states preparing legislation to use “Gold And Silver” as legal tender…with Utah at the forefront in 2011.

    The latest U.S. Census has the population at 315 million with approximately 75ml-85ml homeowners (Condo’s, Townhouses’s, Single Family, Duplex/Multi Family, etc.) at my guess`work analysis would have it (again at my figures only). Ironically because of these very NY Fed Banks, the entire homeownership in America have either lost their home in foreclosure/bankruptcy or by just plain old default (walking away) – or have “Lost 1/3 Plus the Equity Value” in what was thought of a buffer for their retirement upon selling. Wiped out! Never will come back for at least 10 Years minimum…and the blatant audacity of these “New York Federalist Banks” wanting to put peanuts of their free money aside? Somethings gotta give,…? Pathetic!

    I can’t stress enough to the folks here reading up on this simple yet knowledgeable expose of: “The Creature from Jekyll Island, The Federal Reserve” (talk by Edward Griffin)

    http://www.bigeye.com/griffin.htm

    PS. Enjoyed your read Markets:-)

  35. @ 3-D
    “I certainly feel that money should be treated as a public utility”

    Famous Quotes:
    “Anything that won’t sell, I don’t want to invent. Its sale is proof of utility, and utility is success” (Thomas Edison)
    “There is nothing so wasteful as doing with great efficiency that which doesn’t have to be done at all” (Anon)
    “Sometimes we stare so long at a door that is closing, that we see too late the one that is open” (Alexander Graham Bell)
    “When your through changing, your through” (Bruce Barton)
    *”Remember the Golden Rule – He who has the gold makes the rules!”* (Lyndon Forman)
    Lastly the Summary:

    **”If an individual sets an achievable goal that equitably creates winners,
    and that individual remains consistently focused on working toward their goal,
    that individual will achieve their goal or die trying,
    If a civilization sets an achievable goal that equitably creates winners,
    and that civilization consistently focused on working toward their goal,
    that civilization will achieve their goal.

    Therefore let us empower all in our civilization with open information systems so they can educate themselves,
    so more may better understand our universe,
    so we may dream large and true,
    so we may target a great vision,
    so we may lift ourselves, our children and our grandchildren up to the most wonderful future possible” (Matthew Keith Groves)**

    God Bless You, Julian Assange!

  36. “Therefore let us empower all in our civilization with open information systems so they can educate themselves, so more may better understand our universe”

    Well the bank regulations coming out of Basel and which were authorizing banks leveraging their capital over 60 to 1 just because a triple-A rating was involved and which discriminated blatantly against what is perceived as risky like small businesses was all public knowledge on the Bank of International Settlements site… but where were all those PhDs in finance and economist that should have known that was lunacy?… and by the way where are they even today… where are they even as mediocre Monday morning quarterbacks?

  37. SJ writes:

    “In fact, Dimon has a theory of “excess capital” in banks that is beyond bizarre – arguing banks (or perhaps any firms) with strong equity financing will do “dumb things”. This is completely at odds with reality in the US economy where many fast-growing and ultimately successful companies are financed entirely with equity.”

    Professor Johnson, it’s not entirely dumb if you consider the competitive context. Specifically, the return on equity of a leveraged vs. unleveraged bank in an atmosphere of euphoria.

    If a bank leverages to 5X capital, earning 2% on the spread, that’s a 10% return on capital (crude, yes).

    If a bank leverages to 20X capital, earning 2%, that’s 40% RoE.

    You can bet a bank’s board of directors will come under pressure from shareholders to leverage to the hilt, and the CEO will feel that pressure.

    In short, “when the music is playing, you get up and dance”. Why? Many reasons, from poor risk perceptions to short term incentive structures to short term markets to opaque balance sheets to… But, it’s probably true that if a bank is competing with massively levered players and it’s holding a lot of cash, it feels pressure to invest even if those investments are dumb. What you need to identify is that it’s not some “inherent human nature”, but rather the regulatory environment.

    Your comments about successful unleveraged companies is somewhat incomplete – it’s impossible to identify the route of causation. It could very well be that companies which exist in a high margin industry don’t NEED to lever, and likewise are not levered. High margin usually means higher profit. Hence, correlation.

    If you compare across industries, look at low margin vs. high margin industries. Compare, for example, shipping vs. software. Sure, software is often less levered because of the inherent business model. Shipping is very highly levered. If shipping was required to operate on a pure equity basis, this would demand much higher margins. The industry response to this has been to shift fungible capital assets into separate entities – so shippers often have limited liability vehicles that own ships and rent to a company. Likewise, an airline might rent airplanes from a company that owns the airplanes. Why decouple asset ownership from asset operations? Seems kind of expensive, high transaction costs, etc… There must be a reason.

  38. And if a bank leverages 60 times to 1 and makes 1 percent margin then that is 60% ROE as I have been writing on this blog for more than 2 years.

  39. @StatsGuy: “In short, “when the music is playing, you get up and dance”. Why?”

    Because nobody has gone to g.d. jail, that’s why.

  40. “Without any substance on their side, the New York Fed is increasingly creating the perception that it is just doing what its key stakeholders – the big Wall Street banks – want.”

    Oh, what a shock!

  41. When the idea of corporations that provided limited liability and encouraged people to start businesses came about, I think that was a good thing. It made small businesses a bit safer to start and encouraged entrepreneurs to do what they do best: create jobs. However, when it got twisted by the grotesque interpretation of the 14th amendment that corporations were people, that’s when things really started to break down.

    I would fully support the removal of corporate personhood, and a reversal of almost all of the modern additions to corporate law that have led to the modern accumulation of overblown corporate power and an atmosphere of corporatism. I feel that the basic, minimal concepts of a corporation were a good idea and worth keeping.

    Very often on many issues, the extremes are not the best choice. Allowing rampant continuation of corporatism and the expansion of corporate power is indeed a bad idea, but in the same stroke the internet (for example) would not be what it is today without corporations. The economies of scale and manufacturing of goods like computers and telecom gear have enabled what I see as one of the most beneficial advances to come out of the 20th century. Sure, a lot of the development was done by public money, but the manufacturing has been almost entirely handled by private enterprise.

    Lately, private enterprise has started to screw up the advances it brought, by pushing and lobbying for insane changes to patent and copyright law. This is just an overreach by corporate power that should be cut back.

    Corporations can do (and have done) much for the public good over the course of the past hundred years or so. They have grown so powerful now though that they need to be cut back and controlled more tightly. Once a good balance is reached, I feel they will become useful to society again.

  42. When the idea of corporations that provided limited liability and encouraged people to start businesses came about, I think that was a good thing. It made small businesses a bit safer to start and encouraged entrepreneurs to do what they do best: create jobs. However, when it got twisted by the grotesque interpretation of the 14th amendment that corporations were people, that’s when things really started to break down.

    It’s historically false that limited liability was ever needed to encourage people to start businesses. This may have been true only in the special examples I mentioned, where massive capital was needed. But I disputed the need for “private” business (which was really a joint government-corporate operation from the start) to have been involved in such things at all. You didn’t respond to that argument.

    (Getting back to your comment on money and the banks, why shouldn’t banks simply be cooperative public utilities? You already agree that money shouldn’t be privatized.)

    It’s absurd to still claim “entrepreneurs create jobs”. We know that’s a lie, and I can’t imagine why you’re regurgitating such a hackneyed corporate fundamentalist talking point. Jobs are created by people who need to work (using the materials of nature) to provide for their sustenance. Just like the output itself, jobs are created by workers and by no one but workers. All a capitalist does is illicitly seize control of existing jobs to be done, using his stolen capital. It’s been empirically proven innumerable times that trickle-down doesn’t work and was never intended to work. It was always a scam.

    BTW, any entrepreneur would be in much better shape if he didn’t have to face a “market” totally rigged and tipped in favor of oligopolistic big corporations. No small businessman who has any sense wouldn’t happily abolish all corporatism.

    You’re right about corporate personhood being a critical milestone in corporatism’s malevolent history, but it was only one of several. Also pivotal were “innovations” at the state legislative level like automatic general incorporation, incorporation “for any purpose”, allowing corporations to own stock in other corporations, and the transfer of power within the corporation from shareholders to management. Put these together with the SCOTUS campaign to award corporations fraudulent constitutional “rights”, most of it the work of the latter 19th century, and we have what’s really a corporatist coup.

    I suppose you’d consider it an “extreme”, but I just finished arguing this at greater length in two posts, so you’re invited to consider the idea further here:

    http://attempter.wordpress.com/2011/03/03/corporations-are-feudal-manifestations-1-of-2/

    http://attempter.wordpress.com/2011/03/04/corporatism-has-been-a-neofeudal-coup-2-of-2/

  43. Herbert Wetherby

    I think sometimes you people forget, or never knew of, the mousetrap effects of corporatism, (or the belief that corporations can be people). It works hand in hand with the fact that mathematics is the great equlizer. If you can put the 2 together and still bite then the 60-1 (or even 10-1) ratios that pay margins (which is simply something that passes thru ones hands) at all will be proved to be a scam itself, a situtation better managed by a Gvt that is not as corrupt as the business and people that support it. Once enough leverage has been aquired by a new world order, things will easly fall into place from the lack of resistance from todays managers of the corporate elite.

  44. I place little value on Basel III; Basel II and I proved to be insufficient and there is no reason to assume Basel III will not have similar flaws.

    No banking reforms should be based around banks having such huge capital requirements that they can absorb all of their losses.

  45. “No banking reforms should be based around banks having such huge capital requirements that they can absorb all of their losses.”

    Absolutely! 100% in agreement and I feel that a real 8 percent capital requirement for anything they do sounds as a reasonable place to start. Bank regulatory reform needs to start by defining a purpose for our banks and should be based on eliminating regulatory interference in terms of who they lend to, and on improving the mechanisms to handle the unwinding of a bank’s operations which obviously includes having the private creditors, instead of taxpayers, to pay for most of the banker’s mistakes.

  46. There’s a couple of things going on here:

    1) Fed must allow the banks to raise payout as part of the “we’re alright” message being pushed by JPM, C, BAC and WFC via Sell Side dealers and analysts. Thus optics is first driver of “yes” on dividends from Fed. Also confirms the economic recovery story from WH, by coincidence.

    2) The holders of bank stocks have been starving for three years. Despite what we read and write, the folks at the Fed are not indifferent to the impact of low rates on savers. Unfortunately, large banks all have betas > 2 now so not really prudent investments.

    3) Then there is regulatory convenience, a facttor many people underestimate. The BOG Division of Supervision and Regulation is now led by an pro-derivatives, pro-innovation economist named Pat Parkinson who basically is a lobbyist for the industry. Parkinson has purged the DSR of most of the key people who worked through the crisis and has replaced them with PHD economists. See my paper for ISU, “I am Superman: The Federal Reserve Board and the Neverending Crisis” http://tinyurl.com/29cpsoa

    Meanwhile in New York, you have described the motives of my former employer well, but you need to better understand the pathology of Sarah Dahlgren and the management of FRBNY supervision and regulation function. The key piece you need to read is “‘Systemic Regulator Risk: Does the Fed of New York Need a Haircut?’, The Institutional Risk Analyst, August 9, 2010:

    “Shall We Reward Incompetence? The Case of Sarah Dahlgren and the Fed of New York

    Despite initial indications that Congress would reduce the scope of Federal Reserve’s financial company supervision, in the end the Dodd-Frank legislation substantially increases the Federal Reserve’s responsibility. Chairman Ben Bernanke and other Federal Reserve officials made the argument that the Fed’s supervision function didn’t do any worse than any other financial regulators — an assertion we cannot validate. This combined with heavy lobbying by other Reserve Bank Presidents and the grudging acknowledgement to the Congress by Fed Chairman Bernanke and Fed Governor Daniel Tarullo that significant improvements are necessary ultimately won the day.

    Given its second lease on regulatory life, one might expect that the Fed’s bank supervision function would be gearing-up to take a fresh, smart, and tough line with respect to financial company oversight. However, a recent key supervisory officer appointment by the Federal Reserve Bank of New York (FRBNY) indicates this may not be the case. The largest and most important of regional Reserve Banks appears to be going back to the future with its choice of Sarah Dahlgren as Head of Supervision.”

    This piece was rhe collective work of half a dozen members of the Herbert Gold Society. I will let BS republish if you like. And a sequel is on the way.

    Chris

  47. In-as-much-as they’re backed by the government, ie, the people, then they should be treated as utilities. That’s my reasoning.

  48. Hello Per,

    Does this exerpt from Anat Admati’s opinion piece at Bloomberg address what you’re talking about when you speak against regulations that favor what the regulators label as low risk?

    “Isaac is right to point out that the structure of current capital requirements distorts banks’ decisions. The structure, which is focused on the ratio of equity to so-called risk- weighted assets, might induce banks to choose investments in securities over lending, because securities with high credit ratings require less capital and thus allow more debt funding.”

  49. Yes… but the word “might” is wrong.

  50. “But, it’s probably true that if a bank is competing with massively levered players and it’s holding a lot of cash, it feels pressure to invest even if those investments are dumb. What you need to identify is that it’s not some “inherent human nature”, but rather the regulatory environment.”

    Time to switch of the music! Our highly leveraged financial sector exerts a very high cost to the economy at large. We simply can’t afford to keep going to that disco any more…

  51. @ rc whalen

    As a connoisseur of “Fine Food for Thought”, that was an implicitly delectable dish of delightfully explicit cuisine.

    Thankyou for your contribution :-))

  52. No, I don’t think the regulators should go to jail… suffice to have them parading down 5th Av wearing cones of shame… and of course being banned from regulating for life.

  53. @Russ, “I suppose you’d consider it an “extreme”, but I just finished arguing this at greater length in two posts, so you’re invited to consider the idea further here:”

    Great post and links, thanks!

    If you’re getting paid, Russ, there’s millions of people hungry to do the right thing, also, so let us who the “person” is that is not nutz…

    My issue with corporate personhood is this – what kind of “person” is this corporation? A Supreme Being who collected all the data on us human slave ants and transformed it into a “thing” that has no “rights” of “personhood” other than to keep a made-up business model granting himself immunity from “law”?

    I can slide back to “logic” – what are corporations doing with the DATA they collect?

    Where is the data collected during that Tuskagee experiment with sexually transmitted diseases? Where’s the medical breakthrough in PRODUCT – a medicine to reverse any of the affects uncontrolled disease has on the human body?

    Meaning, how is the corporation a better PERSON now that it has collected all that data on disease?

    Hopefully, you get my drift….what kind of Supreme Being has been created? Makes the mean ol’ god of lightning bolts look like a pussycat compared to this corporate Supreme Being…

    Sure, I was excited about using the “computer” to program the punch cards to do my calculus homework for me – the Supreme Being has had a field day with crunching MY numbers…”more $$$ for ME ME ME”…

    What kind of “person” can contain so much math about so much ruin and be a “leader”…?

  54. Not a big fan of the Fe, but its not true that Congress has no “power to govern or regulate it”. When they passed the Federal Reserve Act, they reserved the right to amend or repeal it at any time, simply a question of votes. Congress can spend without borrowing, however until recently if it didn’t sell Treasuries to drain excess bank reserves, the Fed would lose control of Fed Fund rate and it would fall to zero. They have new (well since 2008) authority to pay interest on excess reserves (at FFR rate of .25%) which allows Tsy to spend without borrowing (to be precise, spending without adding to statutory debt celing).

    Absurdly enough, Tsy would have to first mint jumbo denomination platinum coins (Secretary has full discretion as to quantity and face value, regardless of metal value) and deposit it at the Fed or, it could mint gold proof coins (again, face value could be a million times more than metal value), put it in a Tsy safe and write gold certificates against it, depositing THAT at Fed (both coins and gold certificates are still legal tender). Done and done, spending without borrowing. I believe the Board of Governors’ collective brains would melt but they’d still have to credit Tsy General Fund with the deposit, the wonder of seigniorage.

  55. Swiper the Fox

    It’s pretty digusting to read Mr. Whalen’s hatchet job on Sarah Dahlgren without his ever having met her or worked with her. Your comment about “pathology” is particularly offensive given that you weren’t there and have no knowledge of the resource constraints were under.

    Suffice it to say Mr. Whalen, you don’t know what you’re taking about. Your “analysis” is the worst kind of Monday-morning quarter-backing there is. Nonetheless, you’ve done an amazing job at self promotion and for that my hat’s off to you.

    As for the facts, here they are:

    1) Bank Sup was always chronically understaffed. The on site staff for the largest institutions was at most a dozen people.

    2) After Gramm-Leach passed, the Fed became the umbrella supervisor for all BHCs and yet had no authority to obtain information on the broker-dealer affilitate of the LFIs. You can thank the The Paperwork Reduction Act of 1995 for that.

    3) The patchwork of regulators meant no one group had a complete and full view as to what the firms were doing. If anyone is to blame for that, it’s Congress.

    As someone who was there, I truly now believe that the Fed and the government in general should have just let everything fail. There’s nothing like a decade’s worth of 30% unemployment to focus the mind. At the very least we would have gotten real reg reform.

  56. Thanks, Annie. You’re right, this “person” is intellectually absurd and morally an abomination.

    Unfortunately, I’m not getting paid yet. Not much money in opposing the kleptocracy.

  57. Maybe not $$$ – although with *fiat* money, why not? :-)

    But there is real wealth in opposing a kleptocracy, there’s the wealth of intellectual integrity.

    Let me share a favorite scientific argument of mine,

    “Mathematics, material science, is indispensable to the intelligent discussion of the material aspects of the universe, but such knowledge is not necessarily a part of the higher realization of truth or of the personal appreciation of spiritual realities. Not only in the realms of life but even in the world of physical energy, the sum of two or more things is very often something more than, or something different from, the predictable additive consequences of such unions. The entire science of mathematics, the whole domain of philosophy, the highest physics or chemistry, could not predict or know that the union of two gaseous hydrogen atoms with one gaseous oxygen atom would result in a new and qualitatively superadditive substance–liquid water. The understanding knowledge of this one physiochemical phenomenon should have prevented the development of materialistic philosophy and mechanistic cosmology.”

    Finland has banned that quote from their local internet…witch hunting lives on….

  58. And this from the woman who inspired the “movement” to pass the United Citizens “ruling” creating the intellectual absurdity and moral abomination of a Personhood for corporations:

    Clinton, “March 8th is the 100th anniversary of International Women’s Day. And, as many of you know, this anniversary is important to me. At the 1995 Beijing conference, I was so humbled by the positive response to my message that human rights are women’s rights and women’s rights are human rights. But 16 years later, women still bear the brunt of poverty, war, disease, and famine. And when it comes to the boardroom meetings, government sessions, peace negotiations, and other assemblies where crucial decisions are made in the world, women are too often absent.

    It is clear that more work needs to be done — to consolidate our gains and to keep momentum moving forward.

    The United States continues to make women a cornerstone of our foreign policy. It’s not just the right thing to do. It’s the smart thing. Women and girls drive our economies. They build peace and prosperity. Investing in them means investing in global economic progress, political stability, and greater prosperity for everyone — the world over.

    So let us mark this day by finding ways to ensure women and girls’ access to education, health care, jobs, and credit, and to protect their right to live free from violence.”

  59. postmodernprimate

    Remove the “resource constraints” and somehow I don’t believe that Ms. Dahlgren starts channeling her inner Bill Black or Brooksley Born.