Tag Archives: Banking

Michael Lewis!

By James Kwak

On the title page of my copy of The Big Short, in black ink, it says:

“For James Kwak

With admiration”

And then a scrawl that I take to be Michael Lewis’s signature. (Christopher Lydon got the book signed for me, since Lewis was on his radio show a few days before I was.) It may be the only book I’ve ever bothered to get autographed.

So I was especially happy to read that Lewis also wants to break up the big banks (hat tip Ezra Klein):

“Along with the other too-big-to-fail firms, Goldman needs to be busted up into smaller pieces. The ultimate goal should be to create institutions so dull and easy to understand that, when a young man who works for one of them walks into a publisher’s office and offers to write up his experiences, the publisher looks at him blankly and asks, ‘Why would anyone want to read that?’”

When Simon and I made that the centerpiece of the last chapter of 13 Bankers, I thought our chances were slim. When we wrote, in the epilogue to the paperback edition, that a proposal to do exactly that had been voted down, 61 to 33, in the Senate, I thought they had changed from slim to none. It’s still a long shot, but the issue hasn’t died, and if anything is getting more attention now, what with people like George Osborne threatening to break up banks if they don’t reform themselves. Perhaps it isn’t impossible.

Thomas Hoenig Read All of Basel III . . .

By James Kwak

. . . and doesn’t like what he sees. In a post for the Harvard Law School Forum on Corporate Governance and Financial Regulation, the former president of the Kansas City Federal Reserve Bank echoes some of the issues raised by Andrew Haldane, which I discussed earlier. The core problem, for Hoenig, is that Basel III “promises precision far beyond what can be achieved for a system as complex and varied as that of U.S. banking.” Banks were able to arbitrage the risk-weighted capital requirements of Basel II? Well, we’ll close all of those loopholes, one by one. But this cannot be done, given the incentives and power imbalances at work: “Directors and managers . . . will delegate the task of compliance to technical experts, and the most brazen and connected banks with the smartest experts will game the system.”

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Reports of Wall Street’s Death

By James Kwak

Gabriel Sherman wrote what I would call a hopeful article last week called “The End of Wall Street As They Knew It.” The basic premise is that the end of the credit bubble and the advent of Dodd-Frank mean lower profits, more boring businesses, and smaller bonuses on Wall Street—permanently (or at least for the foreseeable future). Sherman also says that the former masters of the universe are now engaged in “soul-searching”: “many acknowledge that the bubble­-bust-bubble seesaw of the past decades isn’t the natural order of capitalism—and that the compensation arrangements just may have been a bit out of whack.”

Call me a skeptic, but I’m not convinced. For one thing, there are few people quoted in the article who actually seem to be engaged in anything that might be called soul-searching (as opposed to complaining—like the now-clichéd banker who watches his spending carefully but has a girlfriend who likes to eat out). The story’s featured voices are ones that are not on Wall Street and have been critical of it for a long time, such as Paul Volcker and John Bogle. Another example of “self-criticism” comes from Bill Gross—but’s he’s on the buy side, not Wall Street.

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The Fourteenth Banker

By James Kwak

I wanted to bring your attention to a new blog that could turn out to be very important. It’s called The Fourteenth Banker (here’s why) and it’s hosted and written by a current banker who wants to see real change in the industry. This is from the About page:

“Despite being with a big bank, I support reform legislation ending TBTF, separation of Commercial and Investment banking, an independent consumer protection agency and other meaningful reforms.    Why?    I have seen first hand the perversions that happen because of some who believe that the an institution exists for them and the stockholders primarily.    Countless others have been hypnotized by this illusion as well.       Free market idealism is conveniently permissive of unbridled self interest.  I believe in the free market.   In fact, this blog is a free market of ideas and is meant to lead to a free market in banking where institutions self police as a matter of competitiveness.    I have hopes of a free market where being in community in a responsible and consistent way is the path to prosperity, a free market where we recognize that if we take care of the community, the community will take care of us.    It takes a sort of faith.    Or does it?     Is not all successful business enterprise based on providing more value than is consumed?

“That is why we are here.   I invite other bankers to engage in discussion about issues and excesses in our industry and possible solutions.”

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“Break Up the Banks” – in the National Review

By James Kwak

“Big banks are bad for free markets,” economist Arnold Kling (who usually blogs at EconLog) begins in the conservative flagship National Review, and it only gets better from there. “There is a free-market case for breaking up large financial institutions: that our big banks are the product, not of economics, but of politics.”

Like other conservative economists, Kling uses Fannie Mae and Freddie Mac as an example of financial institutions that grew too large through a combination of lobbying expertise and government guarantees . . . and frankly I agree with him. But he is equally unsparing of other large banks that were supposedly “pure” private actors but turned out to have their own government guarantees.

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Banks Paying Customers to Take Overdraft Protection

By James Kwak

I saw a bank ad in the subway yesterday. Basically, it said:

  1. If you set up direct deposit the bank will give you $100.
  2. If you set up overdraft protection the bank will give you $25.
  3. If you activate online bill pay the bank will give you $25.

1 makes sense because (a) it gives the bank more cheap deposits, which are its raw material and (b) it increases your switching costs. 3 makes sense because it increases your switching costs; it may also cause you to give the bank more cheap deposits, since you need money in the account to cover your bills.

2 makes sense because . . . the bank expects to get more than $25 in fees out of the average customer. A single overdraft fee typically costs more than $25. Now people will be making an explicit decision: “I want the $25 now because I don’t think I’ll ever pay an overdraft fee.” (To be fair, they might be thinking, “I already value overdraft protection at $35 per occurrence, so the $25 is just a bonus.” But I doubt many people think overdraft protection is worth $35 per transaction when the typical transaction is a lot less than $35.

There’s nothing illegal about this, and arguably it’s a smart business decision. It just makes things perfectly clear: the banks want those fees so much they are willing to pay you for them.

Banking Industry: Sicker, More Concentrated

By James Kwak

The rapid bounce-back of some of the big banks (notably Goldman and JPMorgan) has overshadowed (at least on the front pages of major newspapers) the continued plight of the banking sector as a whole. Calculated Risk highlights the FDIC’s Quarterly Banking Profile, which lists 702 problem banks with over $400 billion in assets — the highest year-end figures on both metrics since 1992, as the savings and loan crisis was tailing off.

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Big Banks Are More Expensive

By James Kwak

From Stacy Mitchell of the New Rules Project, also on the Huffington Post:

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“Please Keep This Valuable Service”

By James Kwak

Here’s a letter submitted by a reader, originally from Chase, encouraging her to keep overdraft protection on her checking account.

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Fear Mongering, Wall Street Style

By James Kwak

Jason Paez points out this Reuters story on the claim that new banking regulations will require an additional $221 billion of capital in the industry as a whole. I would take this a little more seriously if the source for the estimate were someone other than JPMorgan Chase, or even if there were a non-JPMorgan source to back it up.

As it is, I think this counts as another “nice little economy you’ve got there” attempt at hostage-taking or, as Paez says, “a threat levied against the entire non-banking economy if we allow the ‘extreme’ case (using the article’s words) of regulation to pass.” For one thing, I don’t see how any analyst could have come up with any number, given that the regulatory proposals I have seen have no numbers in them. That is, they say things like “capital requirements for large firms should be higher” but don’t say how much higher. (It’s possible I missed something recent here.) So what could $221 billion possibly be based on?

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Tim Geithner Says to Leave Your Money at Big Banks

But he’s not sure why. During an interview with Mike Allen of Politico, Tim Geithner said that the Move Your Money campaign is a bad idea, but didn’t actually give a reason why. Here’s the whole segment of the interview (beginning around the 3:30 mark):

Allen: “Arianna Huffington has been urigng Americans to move money from big banks to neighborhood banks. Do you think that’s a good idea?”

Geithner: “I don’t, but I do think the following is important that people recognize.”

“But wait, why is that a bad idea?”
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Design or Incompetence?

Or both?

In late summer or early fall, Citibank was running a promotion: if you opened a new account or moved a certain amount of money to your bank account, you would get a $200 bonus within three months. Someone I know took advantage of this promotion, but as of Monday he still hadn’t gotten the $200 bonus, so he visited a branch.

“I was given the ridiculous explanation that I didn’t surrender the promotion letter and  that the promotion code NP55 was not linked (?) in the application. I told them that: (1) the letter is not a coupon to be surrendered, (2) I should not have to tell the customer service rep how to process the promotion, (3) there was no requirement that the letter even  be presented (just go to a financial center, it states), and (4) the code only needed to be mentioned if applying by phone. They called me back in the afternoon and asked me to come back this morning. They first offered me some ‘thank you’ points, but I stood my ground.  After calling several places they finally reached a Texas office that would further research my problem. “

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“Appalled, Disgusted, Ashamed and Hugely Embarrassed”

No, that’s not someone talking about the banking industry. That’s Howard Wheeldon of BGC Partners (a brokerage firm) responding to Adair Turner’s statement last September that “Some financial activities which proliferated over the last 10 years were socially useless, and some parts of the system were swollen beyond their optimal size.” (Turner is head of the FSA, the United Kingdom’s primary bank regulator.) That’s from a recent profile of Turner on Bloomberg.

“‘How dare he?’ Wheeldon now says. ‘Markets will decide if something is too big or too small. It’s not for an individual, however powerful, to slam and damn nearly 1 million people.’”

Do we really need to point out that markets don’t always make the right decisions? Markets didn’t break up Standard Oil or AT&T–people did. And how is it wrong for public figures to be publicly stating their beliefs about what the objectives of public policy should be?

But the point of this post isn’t to single out another free-market zealot who apparently doesn’t think about the words he is saying. It’s to talk about John Paulson and Malcolm Gladwell.

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Bankers and Athletes

Bill George, a director of Goldman Sachs, defending the bank’s compensation practices, said this: “The shareholder value is made up in people and you need the people there to do the job. If you don’t pay them for their performance, you’ll lose them. It’s much like professional athletes and movie stars.”

The idea that the level of inborn talent, hard work, dedication, and intelligence you need to be a banker is even remotely comparable to that of, say, NBA basketball players is ridiculous. But leaving aside the scale, there are some similarities. Most obviously, athletes on the free market–those eligible for free agency–are overpaid. John Vrooman in “The Baseball Players’ Labor Market Reconsidered” (JSTOR access required) goes over the basic reasons, but they should be familiar to any sports fan. There is the lemons problem made famous by George Akerlof: if a team gives up a player to the free agent market, it probably has a reason for doing so. There is the winner’s curse common to all auctions: estimates of the value of players follow some distribution around the actual value, and the person who is willing to bid the most is probably making a mistake on the high side.

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Another Approach to Compensation

The problems with the traditional model of banker compensation are well known. To simplify, if a trader (or CEO) is paid a year-end cash bonus based on his performance that year (such as a percentage of profits generated), he will have an incentive to take excess risks because the payout structure is asymmetric; the bonus can’t be negative. That way the trader/CEO gets the upside and the downside is shifted onto shareholders, creditors, or the government.

I was talking to Simon this weekend and he said, “Why a year? Why is compensation based just on what you did the last year? That seems arbitrary.” When I asked him what he would use instead, he said, “A decade,” so I thought he was just being silly. But on reflection I think there’s something there.

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