Big Banks Fall Back On Three Myths

By Simon Johnson

Global megabanks have had a tough summer.  Jamie Dimon, vociferous opponent of restrictions on reckless risk-taking by big banks, presided over large losses due to exactly such behavior in the London office of JP Morgan Chase.  HSBC, which prided itself on running a uniquely decentralized management model, was found to have violated – massively, over many years, and in a uniquely decentralized manner – US money laundering and other laws; the head of global compliance resigned while on the witness stand during a Senate hearing in July.  And Barclays – which had bulked up on the strength of its capital market activities – conceded that traders from that part of the company had conspired to rig Libor, a key benchmark for global interest rates; in the ensuing public outcry, the top two executives were forced out.

And last week Sandy Weill, who amassed a vast fortune building Citigroup and pushing to dismantle the constraints on such megabanks’ activities, concedes that the entire exercise was a mistake.

“I’m suggesting that they be broken up so that the taxpayer will never be at risk, the depositors won’t be at risk, the leverage of the banks will be something reasonable,..”

According to American Banker, former top executives calling for the biggest banks to be broken up now include Phil Purcell, former chief executive of Morgan Stanley; John Reed, former chairman of Citigroup; and David Komansky, former chief executive of Merrill Lynch.  (I am asking American Banker to bring their slide show on this issue out from behind their paywall.)

Backed into a corner, representatives of these Too Big To Fail banks and their allies are forced to fall back on perpetuating three myths.

First, their critics are “populists” who do not understand banking or economics.  But this is belied by the credentials of the people raising serious issues with how global megabanks currently operate.  The American Banker highlights the critiques of Richard Fischer, president of the Dallas Fed (and experienced financial sector executive), Tom Hoenig (former president of the Kansas City Fed and currently number two at the Federal Deposit Insurance Corporation, F.D.I.C.), and Sheila Bair (former head of the F.D.I.C. and now chair of her own Systemic Risk Council – of which I am a member.)

As I wrote here last week, Fed Governor Sarah Bloom Raskin has emerged as an important voice calling for rethinking key aspects of big banks, including why they should have implicit government backing for their securities and trading operations.  Mervyn King, governor of the Bank of England, and Jon Huntsman, former Republican presidential candidate, have also expressed articulate and well informed proposals for making big banks less dangerous – primarily by forcing them to become smaller.

In this context, you should read Neil Barofsky’s new book, Bailout, a compelling critique of how the bailout process was handled, including the treatment afforded to banks and the relative lack of effort that went into directly addressing problems with mortgages.  The pushback from the Obama administration is that Mr. Barofsky is some form of populist – in contrast with the supposedly responsible professionals of the Treasury Department (many of whom were previously or have subsequently become employees of large financial firms).

But a close reading of Mr. Barofsky’s narrative and analysis confirms what was evident to anyone who studied the reports he produced when he was Special Inspector General overseeing the Troubled Asset Relief Program (or SIGTARP, in the jargon).  Mr. Barofsky is a distinguished law enforcement professional who was given the job of preventing fraud and abuse in the congressionally-mandated bailout program.  His efforts to ensure TARP was run effectively and more in line with taxpayer interests were opposed by senior Treasury officials almost at every turn.

The true issue is not populism vs. responsible bankers.  Big banks have become a dangerous special interest with powerful friends.  It is the reformers who are responsible.  Executives who run megabanks – and anyone who supports their continued existence – are the ones who have become reckless and damaging to society.

The second myth is that a “cost-benefit analysis” would show that the Dodd-Frank financial reforms are not worth pursuing.  This is actually a clever – or perhaps devious – legal strategy that is being pursued in a low profile but effective manner.  Even well-informed people in Washington frequently have no idea how much damage this myth can still cause within the rule-writing process.

Fortunately, Dennis Kelleher and his colleagues at Better Markets are fighting hard against this myth.  In a report released this week, Kelleher, Stephen Hall, and Katelynn Bradley point out that the industry never wants to take into account the real costs of the crisis – millions of jobs lost, growth derailed, lives disrupted, and massive damage to our public finances.

We had a frank discussion of this report at the Peterson Institute on Monday, and I was struck by how many people have a hard time getting their minds around the scale of the damage wrought by large financial institutions that got out of control.

This relates also to the third myth – which is the claim that financial reform will hurt our growth prospects.  Again, as laid bare by Better Markets, it was reckless risk-taking at the heart of our financial system that led to the largest crisis since the 1930s; the damage will be with us for a long time.

Some dramatic government actions helped to reduce the impact on the real economy – and we avoided a Second Great Depression.

But, as Neil Barofsky makes clear, there is almost nothing about these bailout measures that should make you feel good.  Putting the big banks back on their feet, with essentially no conditions requiring real change, was a mistake – reinforcing the moral hazard and implicit government subsidies that are now at the heart of our financial system.

Today’s global megabanks are too big to manage.  It is not “the market” in any sense that keeps these firms at their current scale; this is the largest and most dangerous government subsidy scheme on record.  Such subsidies can only be ended by government action – it is time to break up the largest banks.  Make them small enough and simple enough to fail.

An edited version of this post appeared yesterday 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.

26 responses to “Big Banks Fall Back On Three Myths

  1. markets.aurelius

    Spot on, Simon.

    Here’s an interview of Neil Barofsky by Mark Crumpton of Bloomberg that is especially noteworthy:

    http://www.bloomberg.com/video/barofsky-s-book-bailout-treasury-s-missteps-O7tu~HfQRASbQqqaJDe0cQ.html

    See especially the segment ~ 1:40 – 45 in to it re being pulled aside by a “senior administration official” and being told he’s doing harm to his chances of getting a plump Wall St. job or federal judgeship following his service as SIGTARP, by being harsh in his assessments of the bailout and banks’ behavior. Reminds one of a mafia don putting the arm on a rookie cop new to his downtown beat.

    Speaking of which, Barofsky recounts being cursed out by none other than Timmy! Geithner, which, as he says, had to be just short of hilarious. (This is ~ 4 min into the loop.) Barofsky also recounts his near-death experience from a close encounter with narco-terrorists — a real threat — and the amusement evident in his expression when he compares this to Timmy! getting mad (oh, my …!) will bring a smile to even the most jaded among us.

    How Geithner ever got to the top of the NY Fed then to UST Sect’y is just baffling. Here’s a self-confessed non-economist, non-finance specialist who’s only real skill is doing exactly what he’s told by the banks he’s supposed to be riding herd on (at the NY Fed and later at UST). How did the fate of US banking and global-market coherence ever come to depend on such people?

  2. Moses Herzog

    Reached for comment on Mr. Barofsky’s obviously 100% accurate charges, Timmeh Geithner says it’s all a huge misunderstanding. In this video released from Washington D.C. branch of Boy Scouts, Timmeh explains that it is ALL actually his Boy Scout Troop leader’s (Sandusky??) mistake.

    (the above comment is obviously an attempt at satire, no matter how true to real events it may seem.)

  3. @ Simon, such lucid writing, I commend you:

    “…the industry never wants to take into account the real costs of the crisis – millions of jobs lost, growth derailed, lives disrupted, and massive damage to our public finances.”

    And these real costs are perfect justification for BREAKING up TBTF’s.

    The chorus is growing, too, bankster noise to the contrary.

  4. What about the argument (I believe it’s from Geithner on Charlie Rose the other night) that TBTF countermeasures would sink U.S. banks in the context of global competition? On the face of it, he seemed to have a point. But on further reflection it struck me that, while from a U.S. banker’s viewpoint the advantage might in many ways be to European & Asian banks, from the viewpoint of Joe the plumber the advantage would be to normal people not engaged in the “derivations of derivations of derivations on something that might once have had a defined value.”

  5. markets.aurelius

    @ wrybread

    The global competition argument is a red herring: the foreign banks competing against U.S.-domiciled banks are pathetically weak at risk management. They warehouse risks they cannot even catalog let alone understand or measure. As surely as night follows day they will continue to register spectacular blow-ups.

    The only thing gigantism among the U.S. banks ensures is these dopes will feel increasingly comfortable exchange large blocks of risk in the form of poorly understood derivatives trades. As a matter of fact, we’re already there: the four largest derivs trading banks in the US already account for 95%+ of ALL derivs worldwide. This is a black hole of risk that no one understands. And, protestations to the contrary, no one knows how to estimate the next phase of this black hole’s evolution.

    The only logical way to address these risks is to slowly and systematically force these firms to divest their various and sundry risk sinks by making it increasingly expensive (i.e., require higher capital) to carry such risk concentrations. With any luck — and it will be entirely a matter of luck — the smaller risk incarnations will at least be uncorrelated, which should lower systematic risk.

    If the Euro and Asian banks want to feed the gigantism of their banks let them have at it. Small U.S. based counterparts will find themselves on their own when they are find they are counterparties to these certain-to-fail giants offshore. It’ll be a problem for their central banks and governments next time — just like it became the Fed’s and US Treasury’s problem the last time because they were the only ones with the mandate and balance sheet to act quickly enough to address the global market collapse in ’08-09. (Check the list of beneficiaries of the Fed’s unconventional liquidity-provision programs last time around, if you need a reminder.)

  6. I caught sight of one of our Peerless Leaders this
    afternoon, and thought the Multitude Assembled here
    might like an account.

    The book tour for “White House Burning” brought
    Simon Johnson to the AFL-CIO HQ, on 16th Street
    a couple of blocks north of the White House, and
    since it is a subway ride away for me, I attended.
    There were about 80 people there, including
    Richard Trumka, the AFL-CIO head, who gave the
    introduction, and apologized in advance for having
    to leave after about an hour.

    Mr Johnson seems to be quite a young fellow, and
    he told us his(and James’ too, I guess) ideas of
    how to fix things. He seemed to think that we
    are all being drifted to the right, and we had
    all better learn more about economics, in order
    to deal appropriately with the crises brought on
    by the aging Boomers,which will impact Social
    Security(!) and Medicare.

    He ventured the opinion that the chief cause of
    our difficulties was(the envelope, please!) Newton
    Gingrich. I think this astonished some audience
    members; it certainly astonished me. Some questioners
    later suggested Reagan; or maybe Bush II. I might
    have suggested Pete Peterson, but I didn’t want to
    be impolite.

    At one point, talking about taxes Mr Johnson asked:
    “How many people here wouldn’t mind having their taxes
    raised?” My hand shot up; I always resist being
    manipulated by the speaker. Mr Johnson noticed, and so
    when question time came I got called on first.

    I asked him three things.
    First I asked: does he read the comments to his posts on
    baselinescenario? He mumbled something about trying
    to let his eye fly over them . . . I think we
    here must realize that Messrs Johnson and Kwak don’t
    pay much attention to our comments; we are talking
    among ourselves.

    I then asked him why he, like all other economists,
    compares our national debt to our GDP. He got the
    point right away, and agreed that the debt was a
    Stock and the GDP was a Flow. This is the way
    economists talk; mathematicians of course talk about
    functions and their derivatives. He seemed, maybe
    out of politeness, to agree that it didn’t make much
    sense. But I doubt he’ll change his ways; it would
    make him an outlier among economists.

    My final question — actually more a cry of distress —
    was: didn’t he realize that Social Security is paid
    for? it has been amassing huge credits from the
    Federal Government(Bush II and the filing cabinet in
    West Virginia!) and these credits will finally be
    completely drawn down in about 2037. Yes, he knew
    that; he knew about how clever FDR had been in 1935.
    But then, when answering other people, he kept on
    talking about “Social Security and Medicare”. Perhaps
    he’ll stop doing in future? I am skeptical.

    Conclusion: he, like all authors, is hopeful that his
    views will make a difference. I am older, and hence
    more pessimistic about the difference that contemporary
    writing makes. I certainly wish him and Mr Kwak good
    sales. The book was, obviously, on sale there. I
    didn’t hang around to see how many people rushed to
    buy it.

    I hope this post hasn’t been too long!

    Best wishes,

    Alan McConnell, in Silver Spring MD

  7. Daniel Barkalow

    Alan: it’s legitimate to worry that, while Social Security has a huge amount of money saved up, it’s saved in US Treasury Bonds, and it can’t actually withdraw that money without causing some other sort of disaster for government finances. The problem is not so much Social Security running out of money as Social Security contributors no longer loaning money to the government, and, in fact, those loans coming due. Furthermore, Social Security will be under a lot of pressure from Congress not to actually withdraw so much, which means that the money may be effectively unavailable.

  8. markets.aurelius

    @ Alan

    Thank you for your thoughtful comment.

    I heard an interesting vignette from Garrison Keillor yesterday. A rememberance of James Baldwin, actually, which noted the writer’s observation that “You write in order to change the world, knowing perfectly well that you probably can’t, but also knowing that literature is indispensable to the world. The world changes according to the way people see it, and if you alter, even but a millimeter, the way people look at reality, then you can change it.”

    Simon and James are not creating literature like Mr. Baldwin. However, they do write. And they do seek to affect the way we think, and our actions. I, for one, am grateful for what they do. And for your participation. Economics, like literature and math, can be beautiful. But first it must be useful.

    Still, as Mr. Keillor noted: “Although he lived in France, Baldwin’s work was rooted in the American experience. He said, ‘I love America more than any other country in the world and, exactly for this reason, I insist on the right to criticize her perpetually.’ ” So, too, for Simon and James.

  9. Breaking up the large financial institutions = creative destruction.

  10. Per Kurowski

    @Better Market “it was reckless risk-taking at the heart of our financial system that led to the largest crisis since the 1930s; the damage will be with us for a long time.”

    That is just wrong! And that myth is stopping the world from understanding and correcting what needs to be corrected.

    This crisis was not caused by reckless risk-taking but by reckless trust in our ability to measure risks, like when Basel bank regulators authorized banks to leverage 62.5 to 1 when lending to securities that were triple-A rated or to infallible sovereigns as Greece. http://bit.ly/1wj8V

  11. Bruce E. Woych

    Published on Friday, August 3, 2012 by The Real News
    Major Banks Help Clients Hide Trillions in Offshore Tax Havens
    James Henry: US media and politicians mostly ignore massive untaxed wealth that big banks help rich move to tax havens

    http://www.commondreams.org/video/2012/08/03-0

  12. Bruce E. Woych

    Major Banks Help Clients Hide Trillions in Offshore Tax Havens

  13. Bruce E. Woych

    97% Owned – Monetary Reform documentary – Directors Cut

  14. Bruce E. Woych

    … forced to fall back on perpetuating three myths?
    The ‘FOURTH” MYTH: AUSTERITY ! Hand in Hand with 2B2fail
    or:
    THE BIG LIE !!!!!
    http://rwer.wordpress.com/2012/08/02/wallowing-along-on-purpose/#comment-19543 “…an Old Snake…in New (Neo-Con) Skin
    Wallowing Along – On Purpose?
    ===============================================
    Published on Friday, August 3, 2012 by Common Dreams
    Latest Jobs Report Reveals Woeful Impact of US Austerity
    – Common Dreams staff

    http://www.commondreams.org/headline/2012/08/03-5

    “…a new report this week, “Prosperity Economics; Building an Economy For All,” authored by Jacob Hacker and Nathaniel Loewentheil, calls for “immediate action to jump-start our sagging economy” by spending on infrastructure, schools and the other public sectors of the economy that have suffered under the pressure of austerity economics.” – Common Dreams staff
    ————————————————————————-
    Prosperity Economics: Building an Economy for All
    Prosperity economics concludes that there is no trade-off between creating a strong, dynamic economy and fostering a society marked by greater health, broader security, increased equality of opportunity, and more broadly distributed growth.

    http://www.prosperityforamerica.org/read-the-report.php

    Download the Full Report
    Read the Executive Summary
    Key Policy Recommendations
    Quick Overview

  15. Mr Barkalow writes: “it’s legitimate to worry that, while Social Security has a huge amount of money saved up, it’s saved in US Treasury Bonds, and it can’t actually withdraw that money without causing some other sort of disaster for government finances”
    I would say: if the U.S. gov’t plans to default on its debts,
    let it default to the Chinese or the Germans, rather than
    its own citizens.

    Mr Aurelius writes: “Simon and James are not creating literature like Mr. Baldwin. However, they do write. And they do seek to affect the way we think, and our actions. . . . Economics, like literature and math, can be beautiful. But first it must be useful. ”
    My thought: before it is useful, or beautiful, it must be
    accurate. Mr Johnson talked about how wonderfully
    fact-checked his new book is; yet he conflates Social
    Security and Medicare, which isn’t accurate, as most
    of us hear know, and as I pointed out to him.

    And, like most other economists, he thinks that
    f’/f has a meaning. For mathematicians it does, it
    is the derivative of log(f). Maybe someone here can
    tell me what interest() the rate of change of the
    logarithm of the National Debt has. ? ?

    I shall go later to my local Barnes and Noble and see if
    the new J-K opus contains sections on Single Payer(I
    believe it does), on imposing a sales tax on financial
    transactions, or on the Keynesianism of the MIC.
    I would also be interested in a review of Wh-Hs-Bur
    by anyone here who has read it. Were you impressed?
    Did you learn anything you didn’t know before?

    Best wishes,

    Alan McConnell, in Silver Spring MD

  16. ‘First I asked: does he read the comments to his posts on
    baselinescenario? He mumbled something about trying
    to let his eye fly over them . . . I think we
    here must realize that Messrs Johnson and Kwak don’t
    pay much attention to our comments; we are talking
    among ourselves.’

    Wise decision by Johnson and Kwak. I’d be concerned for their mental health if they ever learned what a bunch of nincompoops read and like their stuff.

  17. “it was reckless risk-taking at the heart of our financial system that led to the largest crisis since the 1930s; the damage will be with us for a long time.”

    An idea which has been thoroughly discredited by anyone who has taken the time to inform themselves.

  18. markets.aurelius

    http://fcic.law.stanford.edu/

    We’ll wait while you catch up, Paddy.

  19. That’s why I always fly over pats comments, I was concerned about his mental health right from the start.

  20. Oh, I read the FCIC report a long time ago. The majority opinion is from six partisan Democrats led by former California gubernatorial hopeful Phil Angelides. It’s political hackery, not analysis.

  21. markets.aurelius

    You are neither serious nor informed, Paddy. Your agenda is entirely transparent. In sum, you are a waste of time.

  22. It’s now dawning, belatedly, on at least a few of the great minds on Wall Street that their capture of the regulators may not have been such a good thing after all. All the toys in the playroom broken, and at least a few of the babysitters are speaking out in anger.

    The lack of professionalism among the financial class is just appalling. Once again, we were subjected to wild gyrations, and real losses for retail investors as the chumps over at Knight implemented a new program with what appears to have been little or no real testing. In any other domain this sort of behaviour would be considered lunacy. In this realm it’s apparently the way business gets done. What a bunch of saps.

    The regulators are too old, too set in their ways to realize that they don’t have a handle on this (no one does). They are blind to the insanely dangerous trading operations they’ve allowed to come to life. This has a very real probability of ending in another destructive cycle, with the suits limping up through the smoke and fire, their hands out once again, for another big helping of public money. That, of course, is the same public they trash mercilessly through their political shills once their hides are saved.

  23. Bruce E. Woych


    Milton Friedman “DEFENDING GREED AS A SYSTEM OF ECONOMIC EFFICIENCY” in an old clip from 1979 / Phil Donahue interview.
    GREED IS GOOD comes back to haunt us on Wall Street but here is the devil’s apprentice himself laying it on the table in 1979.

    http://search.aol.com/aol/search?invocationType=webmail-hawaii1-standardaol&query=milton%20Friedman%201979%20Phil%20Donahue%20interview%20%22GREED%22 ;

  24. Bruce E. Woych

    George Carlin – You are a slave