CEO Semiotics And The Economics Of Vilification

CEOs of major banks have started to push back against the critics – their primary job, after all, is lobbying (rather than, say, risk management).  As such, they are typically sophisticated communicators who use a wide range of symbols, words, and modes of communication to get their points across.

Not everything they say, of course, should be overinterpreted.  For example, calling the hand that feeds the banks “asinine” (Richard Kovacevich, chair of Wells Fargo) seems more like an outburst than a promising way to enhance shareholder value – even if he is correct about whether today’s stress tests are actually meaningful.

Lloyd Blankfein’s February FT op ed famously made the case that we need banks as a “catalyst of risk.” But this argument raises awkward questions.  What does Goldman Sachs know about risk, and when did it learn this (presumably recently, after they settled up with AIG)?  My risk-taking entrepreneurial contacts feel their catalysts should be somewhat smaller relative to the economy – so these banks/securities underwriters can, from time to time, go bankrupt without threatening the rest of the private sector (and everyone else) with ruin.  Still, the main point of this FT article was the symbolism of the timing, appearing on the morning of what was scheduled to be Secretary Geithner’s first big speech; we were supposed to read Mr. Blankfein’s conceptual script, then look up and see the Secretary on TV.

Vikram Pandit’s recent letter to Citi employees was a nicely timed communication to his broader social and political audience.  His upbeat note was plausible because he put down some very specific markers, e.g., “best quarter-to-date since 1997”; the danger is that these come back to haunt him.  And as a document making the case for big banks more generally, it was weak.

The banking industry’s thought leader right now is definitely Jamie Dimon.  His point about vilification is straightforward.

Dimon gently points out that unless we stop vilifying corporate leaders (and presumably he would say the same of traders this week), we will not get an economic recovery.

And, at some level, he must be right.  If you create enough uncertainty around the future rewards for any activity, e.g., trading securities, setting up new companies, or fishing, you can easily get less investment of time and effort in that activity.  You may also, of course, get more speculative behavior as time horizons become shorter – i.e., “take the money and run” becomes more attractive relative to building up a reputation for good behavior.

“We are where we are,” is something I’ve heard (in other contexts) from people with authority who have screwed up very badly but who know that everyone wants and needs to move on.

But the reality in banking is somewhat more complicated, for three reasons.

1. We don’t know how much of banking profits in recent years were illusory and should not have been booked as GDP.  In fact, it would not be a big surprise if – eventually – we go back and mark down our true production of goods and services in 2007 by 2 or even 5 percent.  In this sense, we face a statistical situation similar to that of the Soviet Union at its demise – once they figured out that all their military production had no real value, they had to reduce measured GDP sharply.  It is not compelling to say we should necessarily go back to where we were in banking.

2. Clean-ups in banking and most other activities require bringing in new people.  But, as the AIG discussion over the past week has made clear, much of the finance industry has not yet reached the point where they see this as essential.  This is about good housekeeping, not vilification.

3. Going forward, Mr Dimon concedes that being Too Big To Fail is bad, but he does not apparently see the logical consequences.  Not all bankers made business-ending types of mistakes, but some did and under our current business-as-usual course, we will end up with fewer big players.  Mr Dimon proposes changing something (vague) about regulation and bankruptcy so that the taxpayer need not be afraid of the new behemoths failing.  But this cannot possibly be plausible, after all today’s problems are largely the result of weakly enforced regulation and politically powerful banks; in the future this imbalance will worsen.

There may well be short-run costs (i.e., in ways that really hurt: lower growth, more unemployment) to properly cleaning-up and restructuring the banking system.  The exact size of these costs is hard to know, but we should face reality on this point – there is a potential tradeoff between presumed costs of bank reform today and longer-run improvements in our sustainable growth potential.

But the real question is bigger.  Can we continue to live with the risks involved in having banks that are large relative to GDP and politically very powerful?  Banks of that size cannot commit not to screw up.  In fact, the people who work for them will know – based on what they have seen so far – that even if future bailouts do not ultimately save the business, one way or another, they will walk away with a lot of stuff.

Tell me if you perceive an alternative, but I can’t see any sensible way forward that does not involve breaking up large banks and making sure they stay much smaller relative to GDP.  This is surely not sufficient for stability and prosperity in the future, but right now it appears unavoidably necessary.

By Simon Johnson

43 thoughts on “CEO Semiotics And The Economics Of Vilification

  1. This is a problem that has plagued not only banking, but industries across the board. Remember the Sherman Anti-Trust Act? Remember the FTC? Once upon a time there was a genuine attempt to enforce the former, by the latter. But for decades now the mergers of already giant companies in pharma, news & entertainment, energy, and even health insurance, have been lauded as indicators of a healthy economy, even though each merger has brought us more unemployment, more internal corporate culture chaos, fewer and more expensive options as consumers, and have divested voting constituents of what little power they already had in the face of bigger lobbying empires.

    Looking at the current outbreak of anger against these overprivileged bubble boys from the Taoist perspective, it seems to me the anger is growing so great that it can’t last, but in the meantime it’s an unavoidable pendulum swing away from the days when they were being worshipped as near-gods for their prowess as money-grubbers. In other words, the time has finally arrived and there’s nothing to do but live through it. It’s the nature of the universe, and a point of satisfaction for those of us who thought the country had lost its mind the last few decades.

  2. One alternative is to simply re-separate the traditional “S&L” functions of a bank from the risk-taking elements. We will have in effect a “utility” banking sector for regular deposits and regular loans, and these banks will need to be tightly regulated and monitored to ensure they are sound. They will also continue to benefit from deposit insurance.

    The risk side of banks (hedge funds, PE, derivatives, etc.) will also need to be better regulated to avoid “systemic” risks (as much as possible, and I am not sure we are smart enough to see every freight train coming down the tunnel). But they will not benefit from bailouts, deposit insurance, or anything else. They will have to sink or swim on their own, without the benefit of free access to FDIC-insured deposits as a form of funding. Presumably this will lead to a significant global downsizing of the current over-grown hedge fund/PE/derivative-trading complex.

    The insurance sector will also need to be tightly regulated and separated entirely from deposits and risk-taking activities. In effect, it will also need to return to its “utility-like” roots. New products such as CDS will need to be regulated (and perhaps approved?) just as any potentially dangerous new product must be (e.g., drugs, new food ingredients, pesticides, etc.), with adequate matching capital reserves based on the risk. These two steps alone will greatly curtail the excesses we’ve witnessed recently in insurance-type products.

    Apart from this, I don’t think the size or number of institutions really matters. Looking back at the S&L crisis, there you had a huge number of small banks all pursuing the same strategy, and in effect they collectively were “too important to fail”. The government had to take what were then considered to be extraordinary measures via the RTC to stablize the system. I could imagine a situation where, if we still had thousands of smaller institutions issuing mortgages en masse, our current situation would be even messier and harder to resolve. With fewer institutions, the government actually has some hope of getting their arms around the situation and working with a small number of management teams to right things.

  3. The word vilification is of course a trap because it immediately dismisses constructive criticism as merely abuse.

    Yet make no mistake, there is something intrinsically vile in activities so self-serving that they are bringing even greater hardship to the estimated three billion poor in the world. As Muhammed Yunus – a different kind of banker – puts it: we must act in a way that does not hurt others.

    If do-as-you-would-be-done-by seems like childish moralizing that is because it is. I would urge any CEOs feeling unfairly vilified to read Margaret Atwood’s excellent “Payback: Debt and the Shadow Side of Wealth”.

    The theme of moral imagination, or the lack of it, is a key part of this discourse and must continue to be.

    See, for example, the thought piece “Morals: the one thing markets don’t make”, subtitled “No amount of regulation will restore our sense of honour and shame. Economics needs ethics”, by Sir Jonathan Sacks (Chief Rabbi of the United Hebrew Congregations of the Commonwealth) in today’s The Times (UK), here:

    Once again, as Susan Neiman notes in “Evil in Modern Thought”:

    “Saying that evil may be banal is simply saying that it need not be demonic. After Auschwitz, at the latest, we learned that the greatest crimes can be committed by people less likely to arouse terror and awe than contempt and disgust. Thoughtlessness can be more dangerous than malice, we are more often threatened by refusal to see the consequences of conventional actions than by defiant desires for destruction. “

    This is the important message of “The Reader”, the movie in which Kate Winslet won this year’s Oscar for best actress.

    Read my blog for an encounter with a thoroughly likeable banker, merely lacking in moral compass (

  4. Almost by definition, if we have companies that are too big to fail then we are an oligarchy not a democracy because some citizens are then vastly more important than others.

    I think what we are seeing now is the struggle between oligarchy (sophisticated CEOs making plausible, media savvy arguments to defend their too-big-to-fail fortresses) and democracy in the form of rabble rousing populism (yes, misdirected, inefficient, messy, but better than the alternative, democracy).

    As we just learned, removing moral hazard and ignoring the role of animal spirits is very risky because these seemingly crude and antiquated notions are still very powerful and necessary forces in economics. So too in politics we should not ignore the need for vilification and retribution. Millions of people are now out of jobs. Politicians need some scapegoats and that’s not entirely a bad thing. The sooner they feed a few bankers to the guillotine, the quicker the blood lust will be abated. And its not like there aren’t plenty of guilty bankers. Taxing bonuses is hardly the worst punishment one can imagine.

    After all, when someone commits a heinous crime like murder it devastates the lives of several dozen people close to the victim. The convicted murderer is sentenced to life or maybe even execution. But typically murderers are not very rational people so the punishment doesn’t do much to deter other murderers.
    When bankers of too-big-to-fail banks run wild with greed, they devastate the lives of millions of people. And bankers are by definition rational and calculating (even if unregulated they will eventually succumb to their baser motivations). Punishing bankers for their misdeeds is very likely to deter excesses by future bankers.

  5. Jamie Dimonn’s position is very simple and very sensible, from his pouint of view. It is “shut up and gives us the money.”

  6. Regulate financial institutions? Who would take on the job of regulating? The 537 buffoons who are this week shocked, stunned, outraged and dismayed? There will be no regulation as long as the regulators are permitted, even encouraged, to seek patronage from the Princes they are supposedly regulating. It is time to admit that the founding fathers screwed up and gave us a government that simply doesn’t work in the real world.

  7. Breaking up large banks and separating commercial (old style) from intestment (casino) is highly desirable. Maybe the larger the financial institution the lower should be the gearing so as to create a disincentive to mre growth but an incentive to efficiency (but not higher risks, please :-)

    At a national level we may need to define limits on the aggregate size of the financial services industry permitted. I think this means an Assets : GDP limit.

    Several european countries, notably the UK, host banks that are too large to save in the sense that the taxpayer simply won’t put up with the burden eventually. The extra burden that supporting Barclays would add maybe the breaking point. Barclays, one year ago, had gearing on its balance sheet of 60:1, the highest in the world. Deutsche Bank was at over 50:1 and is also too big for the German government to save.

    Has the IMF or World Bank ever established how large is too large for any country to support?

    To help the restructuring process private capital (trillions are available) needs to know the new rules before it will enter the fray in a meaningful way.

  8. Your well-reasoned argument neglects the political dimensions. Having only a few big banks makes it too easy for them to exercise disproportionate political power and unduly influence regulators.

  9. Vilification is something that Wall street is very good at and it was specifically used to create more wealth for the CEO’s. They have vilified workers, trial lawyers, regulations and regulators social security and medicare and taxes. But somehow when it comes to their bonuses and benefits, they loudly claim that it is necessary.

    They have played both the consumer and the tax payer for suckers. Look at the bankers, we deposit our money which becomes their capital. They use the capital to gamble and now demand that we bail them out and pay off their bad debts. Who among us would love to have such a cushy deal.

    How easy it is to be rich when you don’t have to pay you bills.

    They claim that they will not work without the incentive of big bonuses. Yet the never bother to explain how the managed to destroy the financial system despite being paid big bonuses and low taxes. Was a $100 billion in Wall street bonuses over the last 10 years simply not enough?

    Perhaps it is time for them to live like the rest of us. You see we work hard to keep our jobs. Yet it seems that the bankers are claiming a guaranteed job with large bonuses. Bankers it would seem are a special category of employee.

    How can we ever fix the mess that the “Talent”, “The Best and Brightest” made if we don’t take a hard look at economic policies and practices that brought us here to the brink of financial ruin? Why are they turning to the taxpayer to bail them out?

    The “Talent” made the decision to gamble in the derivatives market and now we have to pay to bail them out. Hank Paulsen convinced the SEC to deregulation the leverage limits, allowing him and the other Wall street gamblers to leverage 40 to 1.

    We need to break up the big banks and insurance companies and put them into receivership. Their debts need to be discharged just like the numerous other over stretched companies. The taxpayer should not be forced to pay their debts.

    If the they can not work for a reasonable salary then there are others out there who will. Why do they think that the average worker’s pay should be cut to save his company and the bankers / traders bonuses should be the same or greater so they can save their company?

    If they have enough money to pay hug bonuses, golden parachutes, add to the retirement of the executives then why do they need the taxpayer to bail them out.

    Why did these companies not save for a rainy day? Shouldn’t they use this bonus money to run the company and pay down their debt?

    No more bailouts.

  10. It seems as though we will remain stuck in limbo until some public house cleaning has occurred. The major parties who are responsible for a significant portion of the mess at the corporate level need to be fired and prosecuted if crimes were committed. The same is true for the regulatory agencies especially the SEC. The whole rated agency system needs to be re-evaluated. Last, but by no means least, members of congress, the senate, the whitehouse, both previous and present who played a significant role in creating the mess should have their role discussed on the news and maybe a couple of committee chairmanships should be lost. Maybe then we can begin to rebuild trust. The old laws and regulations (ie antitrust, etc.) could be reinstated and we could begin to dig or way out of this mess. Too much tme has been wasted.

  11. Dimonn’s “shut up and give us the money” may push many angry people to agree with what Jim Hightower once said: “The only things in the middle of the road are yellow lines and dead armadillos.” Populist rage can veer left or right. Sic transit….

  12. aren’t the banks in question all i-banks

    what do you do about the banks’ and regulators’ most powerful global clients, such as oligarchs and swfs

    how can break-ups be done in a way to ensure the transparency necessary for regulation

    what’s to stop smaller banks from being taken over entirely by billionaires – foreign or domestic – and PE buyout funds

  13. From The Telegraph – Feb 11, 2009 – The secret 17-page paper was discussed by finance ministers, including the Chancellor Alistair Darling on Tuesday.

    €18 trillion of exposure to bad loans in european banks sounds to me like a too big to save number, but assuming we muddle through how do we go about defining a target limit on the aggreagate size of european banks balance sheets and a maximum size for individual banks, insurers etc. Is the stability & growth pact? ( a regulatory model for use within europe, at least in normal times?

    When it comes to paying for this disaster I’m surprised that in europe we haven’t heard more of stamp duty taxes on all forms of derivatives trades. Assuming such activities are to be regulated in future (and exchange traded) the tax is very cheap to collect. In my view coupling taxation with regulation automatically gives two pairs of eyes on the job.

    In 1797, William Pitt the Younger described stamp duty as “easily raised, pressing little on any particular class, especially the lower orders of society, and producing a revenue safely and expeditiously collected at small expense.” He virtually doubled the tax that year.

    I like the reference to the “lower orders of society” – seems to fit the bill today too, but not as Pitt intended.

  14. Assuming that GDP was inflated as Simon considers in 1.) then how far off will Geithner’s calculation be, the one that the American gov’t can afford to guarantee the purchase of up to $1 trillion in toxic assets because the US is – relative to some other first world states like Italy and Greece – doing pretty darn well. According to that calculation we can handle more debt because US government debt is a modest 60-70% of GDP. But maybe Simon is on to something. Maybe it’s more like 75% of 2007. And maybe GDP will fall by 10% in ’09 while gov’t debt increases by about 30%. When this is over, say in 2020, what if US gov’t debt is 150%? One thing is sure: we’ll still have Walmart, and probably a lot more of them because it’s too big to fail too.

  15. Movable Beast makes good points.

    In terms of making poor risk-management decisions, where is the evidence that a plethora of smaller banks is more resilient? (Can anyone send a link?) On the other hand, we do know that it was a small (California) bank that created the first alt-A mortgages. (Small business can be innovative too!)

    Beast also (correctly) points out that the presence of the large banks has enabled the currently weak institutions of the Federal branch to intervene more rapidly than would have been otherwise possible.

    In other words, do we have any evidence that the size of the primary lenders is really a driver? And on the flip side, an argument can be made that it makes intervention easier.

    So it seems the primary argument being made here is one of political corruption – having fewer large banks (instead of many smaller banks) gives the banking industry more political power. The arguments (in the tradition of Mancur Olson, concentrated interests are more powerful because concentration facilitates collective action by special interests) has theoretical merit, but I have to be honest…

    The Too-big-to-fail argument as an explanation for this banking crisis is empirically weak. The argument basically goes:

    — Big banks are so big that a failure would cripple the economy (systemic risk)

    — Thus, they take one sided risks that smaller banks would not take, because govt. _needs_ to bail them out, and they know it; (moral hazard)

    — Eventually they get unlucky, and govt. must bail them out (political consequences; lack of strong leaders)

    — Version 1.1 (addendum): and we can’t regulate big banks because they have the political power to subvert those regulations

    Very tempting, except where are the facts? We KNOW that the deregulation process occurred over 30 years, in broad daylight, without our economist-defenders stopping it. We know that small and large banks participated, with government complicity, while the press looked on AND FINANCIAL EXPERTS DEFENDED IT. INDEED, FREE MARKET ECONOMISTS ENCOURAGED IT at many turns.

    Led, I might add, but their most-holy-champion, Alan Greenspan (whom they have lately thrown under the bus). When Congress reviewed ARMs in 2004, Greenspan extolled their virtues (among his other notable accomplishments). Again and again, Greenspan (and many others) came to the defense of banks.

    Naysayers like consumer debt advocates, and even many economists, were sidelined and made to appear socialist/liberal/crazy.

    The deregulation movement was NOT merely a conspiracy of the big banks. It occurred with the blessing of free-market economists (Friedmanomicons), over the objections of lawyers and conservative financiers and many others. At the same time, the US actively encouraged bad underwriting in order to extend homeownership (and drive up prices), which created the illusion of a growing economy (an illusion that no elected political official wanted to upset). The incredible expansion of Fannie Mae and Freddie Mac are precisely an outgrowth of this. (And Democrats have just as much blame to share as Republicans.)

    Certainly, many of those who benefited the most early on – and lost the least by getting out early – were hedge funds. And those funds were not at all big banks. Or even banks.

    So where is the data that “Too Big To Fail” is the real problem? Frankly, I think bankers (no matter the size) would be doing the same dumb things regardless of the size of their institutions. In the S&L crisis, it was small banks. In the Great Depression, bank failurs included hundreds of small banks… Many of them local “village” banks.

    Perhaps… just maybe… the real problem is not that banking is too concentrated (which suggests that big banks should be split into smaller banks), but rather that the banking sector is entirely too big.
    This suggests that the economy should have a higher ratio of cash (capital) to credit… That leverage levels are too large altogether. That we need to pay attention to the real economy in addition to the money economy.

    Achieving this, without imploding the world, would require governments to replace massive amounts of credit with currency, and then shrink allowable credit to a smaller multiple of capital going forward. Note that this gives government more power over society vis-a-vis the private sector (or, more accurately, the private banking sector). Why? Because if government creates the currency (unlike private banks), government gets to spend it (instead of banks). That’s a lot of power (scary).

    OTOH, allowing government to retain more of the money that gets created has some benefits:

    1) It allows a tax reduction (reducing the massive distortions caused by taxing productive activity).

    2) It allows the currency to keep growing at a fixed rate to accommodate a growing economy, WITHOUT resorting to massive leverage – indeed, the reduction in leverage diminishes systemic risk.

    3) In the short term, it allows government to redirect social efforts to some massively critical needs that have been ignored for 30 years.

    In short, I don’t buy the “Too Big To Fail” argument because I think it is a frail excuse for the real failure – which was the failure of ideas in modern economics as a discipline, and the failure of society to repudiate hollow theories when those theories allow people to justify the avoidance of hard choices (e.g. paying for what they consume, rather than borrowing money in the name of their kids).

    I simply do not believe that the CEO of Merril Lynch made dumb investments because he was counting on govt. bailouts (I think he was cocky and enamoured with his own genious, like most CEOs and financiers).

    Nor do I think that if the govt. was looking at 100 medium size banks failing instead of 9 big ones, it would have let them all fail – the consequences would have been just as wretched.

    “Too-Big-To-Fail” just doesn’t seem to be the main cause of this problem.

    Moreover, accepting “Too-Big-To-Fail” allows economists to avoid the hard work of fixing their incomplete models – it simply lays the blame on an old and well-worn enemy (oligopolies). It is intellectually lazy, and empirically suspect.

  16. What is it called when someone betrays the trust, confidence or faith of our country?…no not mendacity, the behaviors may have been mendacious but that is not the word…..

  17. Dimon’s warning is reminiscent of a wife-beater trying to persuade his spouse not to leave – “I know I hurt you, but you and me babe, we need each other”. It will only succeed to the extent that Americans lack self-respect.

    But what to do, so that bankers will be less reckless in future, and the finance sector will help rather than poison the economy? I’ve posted on this previously, but go to the Wikipedia page on the Savings and Loan crisis and read the FDIC paper listed in the footnotes (number 4). A key point that 1996 paper makes is to warn against fad-driven lending, which was obviously a big factor in today’s crisis. So aside from extremely tough regulation of capital adequacy, and extremely tough regulation of disclosure, regulation to ensure banks lend to all sectors of the economy is needed. If you do that, and break up big banks, the danger of finance sector collapse should be much lower. Certainly Savings and Loan institutions failed in large numbers, although none were “too big to fail”, but that was because they had acted like sheep. They followed a trend, and the trend was their undoing.

  18. “What does Goldman Sachs know about risk, and when did it learn this (presumably recently, after they settled up with AIG)?”

    Well, Goldman fully hedged its exposure to AIG, via collateralization and CDS on AIG. (See here:

    The fact that AIG has paid Goldman ~$12bn says NOTHING about Goldman’s exposure to AIG — had AIG failed, Goldman would have collected an equivalent amount on its hedge positions (e.g., payouts on the CDS it bought on AIG).

    So the more appropriate question is: What does SIMON know about risk?

    The answer: Not much, obviously.

  19. dear economics of contempt:

    Lehman failing allows a big market share possibilities for anyone left standing (GS adn MS) ….AIG failing wouldn’t have been as good for Goldman as keeping it standing for Goldman to get out it’s collateral (free money from the US taxpayers funneled through a bankrupt company–receivership would have caused Goldman to wait, and in case you were looking at the behavior of their stock at the time, they looked one step away from failure )….the idea that Goldman is so perfectly hedged is nonsense or else they would never make a penny…more smoke and mirrors.

  20. re: “…allowing government to retain more of the money that gets created has some benefits…”

    except that this never happens. the real tragicomedy of the economists’ vilification of the bankers for, as you point out, doing what the doctors prescribed, is that not only has it distracted attention from relatively wealthy economists/academics’ and government/politicians’ role in facilitating and profiting from the current situation – as they seem to have suceeded in generating public support for greater taxation and government powers when there is even more evidence of the ways that power is abused and the money is wasted (although impossible to assess, given the opacity of Large Complex Governments’ financials):

    “…Whether it be the private sector or the public, whether the culprits be bankers or hospital administrators, massive rewards for colossal failures have got to stop…”

    given the mention of Walmart above, and your mention of farm lending, haven’t the likes of Cargill, Bunge and ADM taken over much of that business – perhaps those entities should/will absorb AIG’s business in that area.

  21. It would seem that we are generally agreed that the fix required must not re-establish the BAU models. So concentrating on publicly funding the BAU brigade lacks correct focus. What constitutes success and please don’t tell us it is yesterday’s financial mess geration model?

    So can we agree a division of banking business together with a specific maximum entity size and requisite regulations for leverage etc?

    At least then we can address achievement of outcomes

    Addressing outcomes will enable progress to be made, monitored and reported. Confidence will return with achievements and not with spin pronouncements.

    Simon I want to see defined outcomes and related action plans which we can look to politicians and Central Banks to commit.

    D-Day this week please!

    Over to you pal.

  22. That assumes no counterparty risk to the CDS contracts on AIGs failure.

    If AIG _had_ failed, then the systemic shock could have induced other firms to fail, causing a cascade that may have been virtually impossible to stop.

    No one really knows, because no one knows who all the counterparties are to all the CDS contracts. AIGs failure is like a mini-version of the US Treasury failing; are you really sure you can collect?

    We don’t even know whether the counterparties were required to post collateral to escrows, or not (unless this has been published somewhere – if so, where?).

    To imply that GS was really ambivalent about AIG’s failure is rather bold – and suggests that GS had nothing to achieve through the industry-wide bailouts.

    Ahem… And Hank Paulson was the Treasury Secretary at the time? Right…

    (Please do not interpret this as either supporting or rejecting the current bailout efforts.)

  23. It’s very, VERY likely that the CDS Goldman bought on AIG was collateralized — in fact, it’s almost inconceivable that the CDS didn’t require variation margin, as variation margin for single-name CDS has been standard in the industry since at least 2005.

    You’re right that we don’t know who Goldman’s counterparties were on these CDS trades. But keep in mind that AIG’s counterparties have always been widely known by market participants, and Goldman is the premier trading shop and securities firm in the world, so the chances that Goldman bought CDS with significant wrong-way counterparty risk are very slim.

    Knowing that Goldman put on enough CDS trades that they actually OVER-hedged their exposure to AIG (which, if you run the numbers, turns out to be the case), it’s not “bold” at all to imply that Goldman was ambivalent about AIG’s failure. It’s bold to imply otherwise, actually.

    Whether Goldman was ambivalent about the “industry-wide bailouts” is another matter entirely. And the Hank Paulson suggestion? Oh please. Leave the idiotic conspiracy theories to the political pundits.

  24. Even if the CDS on AIG was well collateralized, the losses that GS could have suffered due to collateral damage from AIG’s failure probably well exceed the direct losses.

    In any case, as to conspiracy theories – I generally think the stupidity we observe among large companies is just that: stupidity (rather than ingeniously disguised brilliance).

    However, Hank Paulson’s very dramatic turnabout after the fall of Lehman Bros was rather dramatic.

    I truly have to ask myself whether Hank would have been so cavalier about letting a big investment bank just to prove a point if that bank had been Goldman Sachs – his own baby (which still employed many of his friends and former co-workers).

    That’s not a conspiracy theory at all – that’s simply coarse observation of well known facts, and a basic understanding of human nature.

  25. Simon Johnson says: “Clean-ups in banking … require bringing in new people. … This is about good housekeeping, not vilification.”

    Yes, absolutely, though let us not forget that exactly the same goes for the clean-up that is needed in banking regulations.

    There are plenty of those currently involved in destructive criticism that over the last decade occupied high places from where they could have provided a lot of constructive criticism but kept total silence.

    Vichy collaborators selling themselves as Free French, no matter how much they repent, are not those we could trust to speak out next time it is needed either.

  26. Dear Riggsveda,

    Please run for National Political Office. We need your clear thinking.



  27. Completely agree with Simon: banks are too large and have too much money making its way into the politicians campaigns’ war chest. how to make them smaller?

    Make them an offer they can’t refuse: Either they downsize themselves to a reasonnable level, (we’ll decide what’s reasonnable, not the banks) or the go-vermin will introduce all sorts of very nasty requirements that will make banking a much less profitable business without the casino-like attitude and insane risk-taking that has prevailed thus far.

    1) Shareholders must approve by a LEGALLY BINDING VOTE from a simple majority, any executive compensation scheme, that’ll be written in plain english, shall be accessible to shareholders 45 days in advance and where every perk, money, options, stocks of all kinds, pension benefits are clearly listed. Of course, ditto for bonuses doled out to this very special marvel of genetic engineering called “the best and the brightest”. I’m trying to avoid the dirty paws of Congress here and leave the interested parties decide what’s good for them.

    I love the smell of capitalism in the morning!

    2) Fractional reserve lending just got less fractional. 10% would become the minimal norm, no exceptions.

    3) Banks have no right to own proprietary trading desks. Wanna be a trading jock? Open a hedge fund and be gone already.

    I could go on and on, but the gist of it is simple. You can either be a smaller, very entrepreneurial bank with fairly good latitude to innovate (and not put everyone at risk while doing so) or, you can be a BIG bank reduced to be a Utility and regulated as such.

  28. Does anyone really believe this was all just a big misunderstanding and accident??Really?
    Look at the people behind the repeal of Glass-stegall.
    Phill Gramm=UBS=criminal enterprise
    Robert Rubin=Citi bank
    Larry Summers=Trillions to his bankster buddies
    This is the biggest robbery in the history of the world.
    Remember Obama said we are being held hostage by the banks.He described them as terrorists with a bomb strapped to their chest and a button in their hand.
    What do you think that means?

  29. Francois says “banks are too large and have too much money making its way into the politicians campaigns’ war chest. how to make them smaller?” and I agree, although of course this does not only apply to bankers.

    In May 2003, at a workshop on risk management for some hundreds of financial regulators, invited as an executive director of the World Bank to say some words, I said the following:

    “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

    Knowing that “the larger they are, the harder they fall”, if I were regulator, I would be thinking about a progressive tax on size.”

    You can find the rest I said at

    But since I never heard anyone else at the World Bank or much less the IMF saying something to that effect, I must make clear that many of those quarter-backing on Monday morning or kicking some banks now, when they´re down, have not earned my respect either.

  30. If they are already too big to fail why are they being allowed to buy up other banks.
    See who was at the meeting with Geithner and Paulson when they decided to let lehman fail.youll be shocked.

  31. Davos afforded a unique opportunity for Russian self-styled leader Vladimir Putin to storm the forum stage and to steal the show. Putin presented a basic Blueprint for what should be called “The Post-US World’ as the United States and United Kingdom have lost the mantle of leadership and control. They lost it from failed economic policy, wrecked banking systems, fraud-ridden bond markets, corrupted debt ratings agencies, abuse of IMF & World Bank, and the severe backfire of economies that depended upon housing bubbles. Inflation turned on its haughty financial engineers! Nations with insolvent banks, insolvent households, corporations in liquidation, economies in near collapse, they tend not to be good owners and custodians of the global reserve currency!!!

    Davos provided a flashpoint for a profound change in global leadership. The whimpering US-UK-EU bankers have been shamed. Then after the finger pointing, insults, hand wringing, and gut wrenching, Putin rode in on a white horse carrying a banner. Chinese Premier Wen Jiabao provided the confirmation to what Putin laid out, like a second of a formal motion. Wen Jiabao proceeded from the Davos stage to four European capitals to seal the new path and its legitimacy. The barter system has been launched in quiet, while the Western press continues not to comprehend a ruptured status quo limping along. It cannot; it will not; the transition is on.

    There is a brand new system being designed that will borrow from the past and apply 21st century tools for barter / counter trade / excess capacity etc. An Exchange Platform will cut out the banks altogether � [Chinese Premier] Wen delivered his speech in Davos and went straight to Berlin where they put the final touch on the new world currency basket , sponsored by Berlin-Moscow-Beijing-Tokyo-Riyadh. Moscow and Berlin already have a massive counter trade / barter trade agreement in place, and Beijing was eager to joint that platform as well.” The new global currencies are planned for launch in January 2010. They will be launched amidst growing chaos. Events up to that time will be tumultuous.

  32. @ Economics of Contempt:

    In all likelihood, the proximate cause of the US Government coming in and seizing AIG last year was it became all too apparent to AIG’s management, and that of its counterparts, that AIG could not post the increasing variation margin (collateral) required to sustain its derivatives positions. Absent a posting of such collateral, AIG would have been declared in default. The amount of collateral AIG would have to post as the marks started going against it — if the media numbers of $2.3 Trillion of notional exposure in CDS are correct — would have completely overwhelmed AIG. The only balance sheet capable of supporting such exposure was that of the US government. Unwinding these risk positions also would have overwhelmed the traded markets for AIG CDS and the different positions counterparties had on with the firm. All of the former investment banks (FIBs) and banks that sold protection on the AIG name would also have been overwhelmed, including those who provided hedges to GS et al.

    So, Uncle Sam had to come to GS’s and the other FIBs’ rescue. Following the US’s seizure, the collateral AIG posted on the derivatives was from the federal government, and the payouts on the CDS derivs were from the federal government. Without the US Treasury’s balance sheet, or the Fed’s willingness to step in to the breach, AIG most likely would have been vaporized within hours of telling its counterparties it could not post margin to cover its open position. One can almost see the bug-eyed desperation of the credit and risk personnel as they delivered this news to the senior management at the FIBs and banks.

    At that point, Treasury Secretary Hank Paulson probably was notified by his former colleagues that they and his alma mater were in dire straits. As was the rest of the financial market. Having just sent Lehman to non-performance Hell, and seeing the markets seize up, Hank did not want to visit this fate on his former colleagues and friends. They likely did not want to go thru this either. This undoubtedly was conveyed in the strongest of terms by GS’s management to Hank and his Goldman alums at Treasury often and loudly. Along with the senior managements of the other FIBs and banks.

    Things never should have gone this far at the FIBs. Long before it became necessary for the federal government to seize AIG, abrogate its contracts, and assume complete responsibility for contract performance — everything from the posting of margin to counterparts to the payoff on the CDS contracts — the SEC et al should have seen the problem developing and taken preemptive action to keep the entire financial system from melting down. The FIBs — led by none other than Hank Paulson when he was CEO at GS — lobbied for and ultimately were allowed to lever their balance sheets up to 30: and 40:1, as long as they could demonstrate via their precise calculations (one imagines Wiley E. Coyote, “super genius” at the whiteboard) that they understood the risk and had it fully contained. Here’s the summary of the dispensation in the 2004 amendments contained in the SEC’s “Final Rule:
    Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities,” received by the FIBs (GS, MS, MER, and LEH):

    “SUMMARY: We are adopting rule amendments under the Securities Exchange Act of 1934 that establish a voluntary, alternative method of computing deductions to net capital for certain broker-dealers. This alternative method permits a broker-dealer to use mathematical models to calculate net capital requirements for market and derivatives-related credit risk. A broker-dealer using the alternative method of computing net capital is subject to enhanced net capital, early warning, recordkeeping, reporting, and certain other requirements, and must implement and document an internal risk management system. Furthermore, as a condition to its use of the alternative method, a broker-dealer’s ultimate holding company and affiliates (referred to collectively as a consolidated supervised entity, or “CSE”) must consent to group-wide Commission supervision. This supervision would impose reporting (including reporting of a capital adequacy measurement consistent with the standards adopted by the Basel Committee on Banking Supervision), recordkeeping, and notification requirements on the ultimate holding company. The ultimate holding company (other than an “ultimate holding company that has a principal regulator”) and its affiliates also would be subject to examination by the Commission. In addition, we have modified the proposed rule amendments on Commission supervision of an “ultimate holding company that has a principal regulator” to avoid duplicative or inconsistent regulation. Finally, we are amending the risk assessment rules to exempt a broker-dealer using the alternative method of computing net capital from those rules if its ultimate holding company does not have a principal regulator. The rule amendments are intended to improve our oversight of broker-dealers and their ultimate holding companies.” (

    The whole SEC Final Rule thing above makes for really good reading. Reading it also explains what Lloyd Blankfein was trying to do in his FT op-ed 8 Feb 09 ( He wanted to inoculate himself and GS against the likely line of questioning that’s going to come out once everyone sobers up and realizes GS, MS, MER, LEH, and probably Bear were continually reporting their risk positions, providing precise calculations on these positions, and demonstrating — every month for the 4 years leading up to the meltdown — they were behaving prudently and not abusing the amended rules they’d worked so hard to secure.

    The fact that these firms — GS, MS, MER, LEH — no longer exist as investment banks does not obviate the need to go back into these reports and forensically reconstruct the past as best as can be done to see exactly what these former IBs thought they were doing, and whether they were deliberately misleading their regulator. That ought to keep a lot of folks busy for the next few years. A good starting point would be a detailed public accounting of the total risk position, and how much taxpayer money was allocated to posting of margin and paying off on the CDS. Tracking all of these funds down and fully — and publicly — accounting for them would seem to be an absolute necessity to restoring taxpayers’ faith in their Treasury and the folks running it.

  33. People say you would be frightened if you looked at the list of people at the meeting which decided to let Lehman fail.
    If you knew who was at the meeting which decided AIG had to be saved you would be really shocked.
    The Obama Administration has made it’s big choice this week. After yesterday’s meeting the chief of Citi and the White House spokesman both said 2we’re all in this together.”
    The White House says it is “relying on these people” to get the country out of the mess. So at least it is clear how seriously to take “Change you can believe in.”
    Pete Townshend got it right.
    “Meet the new boss,
    same as the old boss”

  34. Change you can believe in”… that is in the financial sector achievable mostly by changing regulators and regulating paradigms and of this we see little. Unfortunately there are very few prepared to do since we should not consider up to that those who have only come out screaming after the fact. The world needs and deserves more character than that.

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