The Economist is running an on-line discussion of Dani Rodrik’s article in their print edition on re-regulation strategy. The full discussion is here – follow that link for my contribution, the reactions of others, and Dani’s original piece.
Here’s what I said.
Dani Rodrik is right that good financial regulation begins and pretty much ends at home. Attempts to build a global regulatory structure, for example as currently under discussion by the G20, seem unlikely seriously constrain the ability of big banks to get themselves – and the rest of us – into major financial disasters.
These big banks are very powerful, exerting a great deal of political influence in the United States and arguably even more in some other industrialized countries. The U.S. bristles at potentially critical footnotes in IMF documents assessing its macroeconomic policies – how would it react to tough language or even real action from an international body that claimed supervisory authority over American banks?
The strong position of the U.S. vis-à-vis the International Monetary Fund (IMF) has, for a long time, been an awkward reminder that all members of the IMF are not created equal. But of late, with deep flaws in the heart of the world’s largest financial system, the asymmetry of international power and lack of effective oversight over the U.S. is actually dangerous for the world economy. There is no global solution to this very American problem.
The only way forward is to dramatically change the effectiveness of regulation in the U.S. But this will not happen primarily through tweaking de jure rules or attempting to create one regulator with responsibility for the whole system – whether or not this is the Federal Reserve. Again, the banks have too much power – they will capture, influence, or arbitrage their way around any regulatory structures so that the next bubble, whenever and wherever it appears, will be at least as damaging as the last.
We need to break or substantially reduce the political power of the banks in the U.S. and in all other countries where this is a pressing first-order issue. This is a tall order, but if the problems gain sufficient visibility and our political leaders focus, we can make progress.
The Baseline Scenario 
“we” being?
if you see this as being a good thing:
“Connecticut’s Bridgewater Associates has dethroned JPMorgan Chase as the largest hedge fund manager in the U.S…. The shakeup at the top was not the only movement among the top ten. Paulson & Co. and D.E. Shaw Group swapped places at third and fourth, with the former’s assets dropping 16% to $29 billion and the latter’s falling 22.9% to $28.6 billion…” http://www.finalternatives.com/node/7138
you disagree with Dimon?
“…Dimon called for the U.S. to create a “systemic risk regulator” and put procedures in place to deal with potential failures of large financial institutions…. Dimon said the U.S. needs to “fix” securitization because no one was responsible for underwriting standards…” http://www.bloomberg.com/apps/news?pid=newsarchive&sid=awlx29_M0qz4
and this seems to infer it isn’t the banks, its their clients:
“…dozens of British, European and Chinese banks have provided Angola’s opaque national oil company with billions of dollars of oil-backed loans…. “…banks must be made to stop doing business with corrupt dictators and their families.” http://news.bbc.co.uk/2/hi/business/7936335.stm
what is your alternative to the banks?
To paraphrase a famous quote, if the big banks owe the taxpayer a few million, then the taxpayer “owns” the big banks; but if the big banks owe the taxpayer hundreds of billions, then they own the taxpayer.
Bail-outs increase the political influence of the big banks. Indeed, they turn the notion of a public interest as distinct from the private interests of the banks themselves into an oxymoron.
I’d like the idea of banks as holding companies to be taken up. It’s a big problem for the FDIC and the size issue, but notice:
http://www.thedeal.com/dealscape/2009/03/bank_watch_96.php
“Bank of America is now valued at around $30 billion, but the bank’s retail bank, commercial bank, credit card business, mortgage lending, investment bank and its acquisition of Merrill Lynch are worth almost nothing, argues Breaking Views. The remaining value in the institution comes from stakes it owns in Banco Santander SA’s Mexico outfit, Brazil’s Banco Itau, BlackRock Inc. and China Construction Bank.
http://incakolanews.blogspot.com/2009/03/citigroup-and-banamex-theres-fight.html
Well, maybe yes and maybe no. It was interesting that Citi’s CEO, Vikram “still got a job” Pandit, spent two days down Mexico way earlier this month. He met with the bank honchos of course, but also gov’t lackeys and the regulator dudes too, so we hear. He also made it very plain that Citigroup plans to hold on to Banamex, saying things like the Banamex is Citi and Citi is Banamex and may sacred matrimory reign etc etc. Pandit dixit Feb 20th 2009:
“I want to make it very clear: Citi and Banamex are one and the same……The future of Citi is in emerging markets. It’s in Latin America. It’s in Mexico with Banamex.”
http://www.ft.com/cms/s/0/86c1cf26-aefc-11dd-a4bf-000077b07658.html?nclick_check=1
“Mr Liddy has said he wants to sell most of AIG’s life assurance operations, and close its troubled financial services unit, to create a smaller company focused on its general insurance business around the world.
However, he reiterated that he wanted to keep a majority interest in its Asian life assurance and savings business – one of the jewels in AIG’s crown.”
I added AIG to make the point. Do you notice anything funny? That’s right, the “crown jewels” and profits are all in their foreign holdings. That’s what they’re committed to keeping. That’s what our bridge loans are intended to do: Allow them not to have to sell their money-making foreign businesses.
So, what’s the plan about banks as holding companies?
You have my utmost respect Mr.Johnson for courageously speaking to the central issue in our current economic calamity, and the most critical political issue facing our nation: “We need to break or substantially reduce the political power of the banks in the U.S.”
The notion that we accept the de facto global control of these central bankers and would consider the surrender of our sovereignty is appalling.
The sooner the broader public understands the grip these individuals have on the money supply, and the means that provides to contrive against our interests, the better.
Soon we’ll be talking about Jefferson, Jackson and Johnson!
Well, now you’re making some serious enemies. The banks expect to be punished with new regulation (it’s tradition, right?), but “break their political power”? You’ll be smeared as a far leftist…
Also, it’s tough. Any law can be undone over time (chipping away at it). Any restriction on bank size can fall to repeated bank mergers and pressure to compete against international uber-banks.
History does have something to teach, however – it took 70 years to undo these, and part of the reason we decided to undo them was because our academic elite decried them as outdated, useless, and harmful regulation:
1) Glass-Steagal
2) Uptick rule
3) Removal of Mark-To-Market accounting (Buffett’s version of this, which Bernanke seems to have endorsed, may retain the benefits of MtM without the drawbacks)
4) Separation of retail/investment banks
5) Restrictions of Freddie/Fannie loan purchasing
6) Relaxing capital restrictions
We, being so much smarter than our grandparents (and having “disproven” Keynes and his contemporaries), allowed the banking lobby to have its way. Indeed, one could easily argue that the economics profession served as a willing tool for the banking lobby – providing them with the intellectual capital and credibility to make their arguments to Congress and previous administrations.
Maybe the Preambles to all of these laws should differ a bit from tradition. Perhaps they should start with:
“DON’T EVEN THINK OF REPEALING THIS LAW! If you do, YOU ARE AN EVIL MORON WHO IS JEOPARDIZING THE ENTIRE WORLD ECONOMY.”
But the banks would probably get past this. Maybe the best we can hope for is to limit Great Depressions to every 3 generations?
Still, good luck!
As long as we’re going to talk about history, Franklin pointed out that the primary reason for the revolution was the Bank of England’s success in taking over the creation of money from the colonies with the Currency Act.
Nonetheless, Hamilton, Morris and the central bankers in London managed to set up the First Bank of the United States; which took 20 years to stop. At which point Rothschild, and the rest of the banking cartel in London, convinced England to start the War of 1812 to “bring the impudent Americans back to colonial status.”
That war and its associated debts forced the US to accept a Second Bank of the United States which Jackson finally killed in 1836.
Abe Lincoln outmaneuvered the bankers and printed the “greenback” to finance the Union in the Civil War. We were on the right track finally, but Lincoln’s presidency was short-lived. Some evidence has been put forward that his assassin was hired by the London bankers.
We all know the unfortunate history of Jekyll Island and Wilson’s capitulation. Notwithstanding his soulful regret expressed later, we haven’t been able to throw off the central banking scheme created there this past 90 years.
After numerous recessions, and what appears will be two depressions, how hard is it to see that central banks and fractional reserve banking do not create economic stability?
StatsGuy – great post – right on the money – speaking about money – that is ultimately what this is all about – money and power – power and money. These people do not care about country or the world -only themselves – Kings of the Universe!!! May the Gates of Hell welcome these greedy suckers!!!
What should be the role of transparency in a new financial order? My understanding is that CDS could have been a great thing had the swaps been traded on an open exchange. Similarly, bank balance sheets are actually pernicious if they’re opaque.
StatsGuy – I agree with you about the political influence of greed, but there’s another dimension of the problem if you look at the combined political/financial system from the outside. The role of good regulatory laws, it seems to me, is to introduce some “friction,” so to speak, into the highly nonlinear financial system to prevent it from veering off into bad equilibria. Of course, that also prevents the financial system from heading into explosively “good” equilibria, i.e., bubbles. I’m willing to trade climbs and crashes for some stability.
Surely, all the discussion about policy is stuck in the groove of action that is top down and from the centre. The way to break the political power of the banks is to promote Radical Transparency as outlined by Wired (see http://www.wired.com/techbiz/it/magazine/17-03/wp_reboot?currentPage=all).
I quote:
“That’s why it’s not enough to simply give the SEC—or any of its sister regulators—more authority; we need to rethink our entire philosophy of regulation. Instead of assigning oversight responsibility to a finite group of bureaucrats, we should enable every investor to act as a citizen-regulator. We should tap into the massive parallel processing power of people around the world by giving everyone the tools to track, analyze, and publicize financial machinations. The result would be a wave of decentralized innovation that can keep pace with Wall Street and allow the market to regulate itself—naturally punishing companies and investments that don’t measure up—more efficiently than the regulators ever could.”
Thinking of the stock market as a complex adaptive system helps. If an epidemic of mortgage fraud lay at the root of this crisis, then innoculate the system with powerful antibodies it needs to combat it next time. Harness the power of emergent behaviour.
Dear BaselineScenario:
I have read many of discussion and have found them very enlightening.
I do have one suggestion. Much of the discussion has been qualitative. Can you guys put together some quantitative analysis our bank’s balance sheet with annotation so that we can a better sense of the scope of the problem?
Thank you very much.
For example, pick a part citibank’s financial statements. I think it will be very educational for all us readers.
The way the government handed the money to bail out the mega banks without reshuffling the top, and the resultant ‘victory’ statements by the same arrogant pundits(ex. Damon of JPMC) seem to suggest a ‘ransom’.
It suggests a power that is so strong that even the Congress, the Treasury, the Fed. and for that matter even the White House look like acting as their henchmen.
Since regulation or policy changes of any kind has to come from one of the above, the picture looks bleak.
Speaking of friction, whatever happened to the Tobin Tax?
I appreciate what you’ve said and I think it is the beginning of a courageous and necessary exploration into a new way of organizing how we do business with money.
Catherine
http://fullcirclefacil.wordpress.com/
Krugman raised the Tobin Tax issue recently…
http://krugman.blogs.nytimes.com/2009/02/27/this-age-of-tobin/
Reining in the banks is easy, with the unitary executive’s new totalitarian powers:
http://www.stratfor.com/analysis/20080923_russia_putin_pulls_oligarchs_strings
In a statist kleptocracy, the kleptocrats need to learn who’s boss.
Thanks for the link on the Tobin tax…Not being an economist, and having had no interest in finance until Sept of last year, I had never heard of it. It seems like an extremely obvious and good idea.
Stats,
I repeat Simon’s statement “We need to break or substantially reduce the political power of the banks in the U.S.” to myself frequently. I do it to remind myself that someone keeps pointing out a crucial fact. I am of course contemplating how to reduce such power, with little time to devote to such thought since I am busy running our own corporation.
However, I appreciated your list of laws chipping away at law to contain bank size. I would add the interstate banking law of 1994 that in the name of efficiency dissolved the containment that state boundaries created. I consider that a forerunner to massive banking growth that is part of our present situation, convenient as interstate banking is to me as a banking customer. Not simply that big is bad, but bigger reduces competition. And that is usually bad for everyone involved.
Actually, there is no question, all of the banks “creative attorneys” and lobbyists should be rounded up and relocated to Guantanamo, after it closes. This “All-American” oligarchy is about to destroy the planet, and Chris Dodd and Barnie Frank are willing to go along. Sheila Bair needs to take over the 19 troubled (to big to fail) banks) and restructure them so that they are small enough for us to survive in the future. We need to reinstate the “outmoded” sensible regulation, and demand that any bonus paid to a financial executive in the last year and a half be legislated as retroactively illegal, and, if not returned/repaid will result in criminal penalties. What’s all of this talk about paying bonuses to retain the best talent. (Now we’ll have to change the language that makes the equivalent term to “best talent” be “greedy moron.”)