By James Kwak
Which is to say, a basket case. Along with Citigroup, and Bank of America.
We all know that JPMorgan Chase is too big to fail. We all know that this means that it enjoys the benefit of a likely bailout from the federal government and the Federal Reserve should it ever collapse in a financial crisis. So why does that make it a poorly run company? It’s possible for a behemoth to be well run; think of Intel in the 1990s, for example.
One reason, of course, is that it’s too big to manage. Even if bribing Chinese officials by hiring their children wasn’t part of the master strategy, not being able to stop it from happening is a sign that things aren’t really under control. (And for “bribing Chinese officials,” you can insert any number of other things, like “betting on the relative values of various CDS indexes,” or “manipulating LIBOR.”)
Mark Roe (blog post; paper) points out another reason. For decades, the supposed cure for bad management has been the so-called market for corporate control. In other words, do a bad job, and someone will take over your company and you’ll be out of a job. That someone might be a corporate raider like T. Boone Pickens, or it might be a private equity firm, but in either case bad management is a sign of opportunity.
By James Kwak
Yesterday the House Financial Services Committee held a hearing on the too big to fail problem. Ordinarily a hearing includes a couple of witnesses chosen by the majority who say one thing and one or two witnesses chosen by the minority who say exactly the opposite thing. In this, however, it was hard to tell who was chosen by which side (although I can guess), given the extent of the agreement among former Fed bank president Thomas Hoenig, current Fed bank presidents Richard Fisher and Jeffrey Lacker, and former FDIC chair Sheila Bair.
All agreed that the too big to fail problem still exists, five years after the financial crisis, and that it continues to distort the market for financial services. For example, Lacker, who is perhaps the most sanguine about Dodd-Frank (he likes the living will provisions of Title I), said, “Given widespread expectations of support for financially distressed institutions in orderly liquidations, regulators will likely feel forced to provide support simply to avoid the turbulence of disappointing expectations. We appear to have replicated the two mutually reinforcing expectations that define ‘too big to fail.’”
There was disagreement over whether Dodd-Frank, and the Orderly Liquidation Authority regime that it created, would continue the practice of bailing out failing financial institutions, with Bair arguing that Dodd-Frank “abolished” bailouts. Of course, everyone is against bailouts, but at the same time everyone is in favor of protecting the financial system and the economy against disaster.
By James Kwak
The Federal Reserve is serious—about something.
On May 2, The Wall Street Journal reported that regulators were pushing to require “very large banks to hold higher levels of capital,” including minimum levels of unsecured long-term debt, as part of an effort “to force banks to shrink voluntarily by making it expensive and onerous to be big and complex.” The article quoted Fed Governor Jeremy Stein, who said, “If after some time it has not delivered much of a change in the size and complexity of the largest of banks, one might conclude that the implicit tax was too small, and should be ratcheted up” (emphasis added).
A few days later, Fed Governor Daniel Tarullo said roughly the same thing (emphasis added):
“‘The important question is not whether capital requirements for large banking firms need to be stronger than those included in Basel III and the agreement on capital surcharges, but how to make them so,’ said Mr. Tarullo, adding later that even with those measures in place it ‘would leave more too-big-to-fail risk than I think is prudent.‘”
Tarullo recommended higher capital requirements and long-term debt requirements for systemically risky financial institutions.
Last week, Governor of Governors Ben Bernanke quoted from the same talking points (emphasis added):
“Mr. Bernanke said the Fed could push banks to maintain a higher leverage ratio, hold certain types of debt favored by regulators, or other steps to give the largest firms a ‘strong incentive to reduce their size, complexity, interconnectedness.’
“The Fed chairman acknowledged growing concerns that some financial companies remain so big and complex the government would have to step in to prevent their collapse and said more needs to be done to eliminate that risk.”
By James Kwak
On the title page of my copy of The Big Short, in black ink, it says:
“For James Kwak
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.
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. Continue reading
By James Kwak
Jonathan Macey, a former professor of mine at Yale Law School,* recently wrote an op-ed for the Wall Street Journal (paywall; excerpts here) arguing that we shouldn’t worry about JPMorgan’s recent trading loss because market forces will ensure that the bank does a better job next time. Here’s a key paragraph:
“Thus, far from serving as a pretext to justify still more regulation of providers of capital, J.P. Morgan’s losses should be treated as further proof that markets work. J.P. Morgan and its competitors will learn from this experience and do a better job of hedging the next time. They will learn because they have to: In the long run their survival depends on it. And in the short run their jobs and bonuses depend on it.”
Macey’s central point is that companies don’t like losing money, so losing $2 billion means that they will do a better job of figuring out how not to lose money in the future. That’s obvious. But it’s also beside the point.
By James Kwak
Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.
“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.
“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”
So what does Jon Macey think of big banks?