What Next For Banks?

The case for keeping banks in something close to their current structure begins to take shape.  It’s not about traditional claims that big banks are more efficient, or Lloyd Blankfein’s argument that this is the only way to encourage risk-taking, or even the House Financial Services Committee view that immediate resumption of credit flows is essential for preserving jobs. 

Rather, the argument is: those opposed to banks and bankers are angry populists who, if unchecked, would do great damage.  Bankers should therefore agree to some mild reforms and more socially acceptable behavior in the short-run; in return, the centrists who control economic policymaking will protect them against the building backlash.  This is a version of Jamie Dimon’s line: “if you let them vilify us too much, the economic recovery will be greatly delayed.”

There are three problems with this argument: it is wrong, it won’t work, and it doesn’t move the reform process at all in the right direction.

The “center vs. the pitchforks” idea fundamentally misconstrues the current debate.  This is not about angry left or right against the center.  It’s about centrist technocrat (close to current big finance) vs. centrist technocrat (suspicious of big finance; economists, lawyers, nonfinancial business, and – most interestingly – current/former finance, other than the biggest of the big, particularly people with experience in emerging markets.)

 Just as an example, a broad range of entirely centrist people (including in and around the IMF; former Treasury; you’d be amazed) are expressing support for the ideas in our Atlantic article.  People on the left are, not surprisingly, also in line with this view; but we’re also hearing convergent thoughts from some on the right – many who emphasize improving the environment for entrepreneurship don’t see big finance as their friend.  So far, the only person who called to complain works for an “oligarch.”

You might think the “anti-pitchfork” strategy might work, particularly as it has in the past (e.g., in the early Clinton years).  The problem for this strategy now is not just the fragile state of banks – by itself this can be ignored for a long while through forbearance, behind a smokescreen of complicated schemes with confusing acronyms – but the ways in which the markets they created now operate. 

Just as global financial liberalization created the potential for capital to move violently across countries and greatly facilitated speculative attacks on currencies, so financial deregulation within the United States has made it possible for capital markets to attack – or, in less colorful terms, go short or place massive negative bets on – the credit of big banks and, in the latest developments, the ability of the government to bailout/rescue banks.

The latest credit default spreads data for the largest banks show a speculative run underway.  As the system stabilizes, it becomes more plausible that a single big bank will fail or be rescued in a way that involves large losses for creditors.  This would like trigger further speculative attacks on other banks, much as the shorting of countries’ obligations spread from Thailand to Indonesia/Malaysia and then to Korea in fall 1997.

The government’s own policies are facilitating these attacks, because as the Fed and Treasury make progress towards easing credit conditions, this makes it easier and cheaper for large hedge funds and others to take large short positions.  And keep in mind the underlying loss of confidence is self-fulfilling: as you lose confidence, you want to go short, and selling the credit causes further loss of confidence – and banks are forced out of business.

The government’s entirely reasonable and long overdue request for a resolution authority will set up runs on that authority.  If the authority is not granted, the runs will be on the government’s low and failing ability to save banks – given that the trust of Congress has been lost and no more cash for bailouts is likely forthcoming (presumably until there are large further shock waves or until Goldman Sachs itself is on the line.)

The continuing pressure on banks has nothing to do with populism and everything to do with the internal contradictions of the house of cards they built.  Now they will scramble to limit short selling or find other emergency measures that will protect their credit.  Such partial fixes would do nothing to stop the underlying deterioration of their credit; think about how countries facing currency attacks throw up futile defenses, try to change the rules, and squander their reserves on the way down

You can see where this is going, but do not cheer.  The likely result will be misery for many and further financial chaos around the world.

The big issue is of course the financial sector reform process.   Some of my colleagues expressed great satisfaction with the progress made by the G20.  But progressing down a blind alley is not something to be pleased about.  I have yet to hear a single responsible official in any industrial country state what is obvious to most technocrats who are not currently officials: anything too big to fail is too big to exist. 

If the bankers were just stupid, as suggested by David Brooks, then regulatory fixes might make some sense.  But we know that bankers are smart, so it is their organizations that became stupid.  What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy?  Answer this and you address what we need to do going forward.

At a high profile conference in the run-up to this crisis, someone destined to become a leading official in the Obama Administration responded to a sensible technocratic critique of the financial system’s incentive structure (from the IMF, no less) by calling it “Luddite”.  By all accounts, this is the prevailing attitude in today’s White House.

But the right metaphor is not breaking productive machines, or peasants with pitchforks, or even the poor vs. the rich.  It’s as if the organizations running the nuclear power industry had shown themselves to be stupid and profoundly dangerous.  You might wish to abolish nuclear power, but that is not a realistic option; storming power plants makes no sense; and the industry has captured all regulators ever sent after them.

The technocratic options are simple, (1) assume a better regulator, of a kind that has never existed on this face of this earth, (2) make banks smaller, less powerful, and much more boring.

By Simon Johnson

156 thoughts on “What Next For Banks?

  1. The U.S. can be counted on to do the right thing, after it has exhausted all other options. So, I believe we will eventually get the small & boring banks that Simon is calling for, but only after a lot of suffering and tears.

  2. Simon – An insightful article on banking. What you neglected to mention is that banks are no longer banks – they are investment/hedge fund/speculative/business operators who do way more than simply take in deposits and loan money to others in the community. The C’s of credit have long gone out the window as banks moved, in a post Glass-Steagall environment, to add fee income, regardless of the legality of the method. There are many days when I’m not sure who is more corrupt – big government or big business. The world is now flat – how on earth will it become round again? See http://www.bobgreenfest.wordpress.com for more information.

  3. Assume:

    1. A smart experienced banker with a record of success.
    2. A source of patient capital from smart experienced people with a record of success.

    Would 1 and 2 get together and start a bank in the current environment? Is banking a business that any rational person would enter today? If so why? If not, why not? Do we have too many banks? Is there too much “capacity” in the industry?

  4. This all makes it sound like the average American is utterly powerless to do anything about this. I am not so pessimistic.

    Just as consumers have the power to bring down brands and products with boycotts, they can similarly stop putting their money in the JP Morgan’s and Bank of America’s of the world. It’s not as if credit unions and small regional banks are illegal in the U.S. Heck the big banks aren’t really giving anyone decent lines of credit anyways.

    I was amazed by a recent NYT article (wish I could find the link) about a small-town Georgia bank that often gave loans based on just a verbal agreement, since the community links were so strong in the little town. The article went on to descibe how the locals were rueful of the eventual changes when the bank was sold off and “modernized”.

    Can’t the Obama administration do more to give this model support? Assign someone in the Treasury that can work independently and let this model grow. Don’t let Geithner and others have and hand in this. Something’s got to be in place ready to replace a banking model that no one likes anyways, besides the insiders themselves. Right now, Obama’s Presidency hinges on about 5 banks. Obama’s a smart guy he should hedge his bet with something else.

  5. You gave the big picture answer yourself about a month ago:


    and WFC CEO Richard “asinine” Kovacevich gave us all a model of confusion, tunneling and looting this morning that has CNBC positively giddy:

    “Business momentum in the quarter reflected strength in our traditional banking businesses, strong capital markets activities, and exceptionally strong mortgage banking results…[Wachovia] has proven to be everything we thought it would be.”

    Be interesting to see where WFC CDS are a week or so from now.

  6. What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy? Answer this and you address what we need to do going forward.

    Yup, it’s all about basing an entire civilization on exponential debt and debt consumerism. All mainstream lifestyles are based on it, the entire economy is based on it, the government and lack of regulation are based on it, the alleged rule of law is based on it.

    That’s why anodyne “reforms” cannot accomplish anything. By definition if they’re meant to prop up the same system, they have to be captured by the system.

    The system is not sustainable anyway. There’s no existential basis for infinite debt going forward. So the options are to burn away what little time and real wealth are left propping up a zombie system, or use that wealth and time to relocalize economies and social institutions, so that they can be functional and humanly fruitful in the age of energy descent and diminished resources.

  7. Sometimes the populists, er, suspicious technocrats, are right. Now is one of those times.

  8. The bubble boys who are the lords of Hedgistan and the CEOs invited to the White House are not stupid, but that are not politically astute, either. My guess is that they do not (and perhaps cannot) comprehend the intermediate to long term ramifications of the fact that the American political classes have lost confidence in the political elite to manage its own affairs.

    With all due respect to Mr. Johnson’s superior expertise and greater experience, I’ll hazard that when the elephant bumping begins in this country, our oligarchs will find the outcome more similar to what is happening to their Russian counterparts, courtesy of Putin, than the Thai-Indonesian outcome of a decade ago.

  9. “This is not about angry left or right against the center.”

    Some evidence (of course not conclusive) is that people who are making the most sense on the issues confronting us come from across the ideological spectrum.

  10. Ok..Let us assume that your premise is correct…and we make smaller banks out of big banks and break their stranglehold on the conomy and political power. And a decade from today, the Fed runs the same policy as is it did in 2002-2005 and China runs the same mercantilist/reserve accumulation policy that it has run for the last decade. What do you think the likely outcome is going to be. I would argue that the net result would be a similar situation…perhaps not in the same sectors but similar nevertheless. May be it would be your neighborhood banker handing out money to small businesses that will never be returned.

    The point of this is that bankers were mere implementation tools of a colossal misjudgement on the part of US policy makers and the Chinese mercantilist policies. These are the root causes. This in no way gets them off scott free — increased regulation is something they will live with for a long period of time and deleveraging will provide them far fewer opportunities to make the sort of money they did in the good times. A direct anology is the drug trade — the bankers weere the street peddlers while the Fed and the Chinese were the cartel owners and the US consumers were…well…the consumers. The peddlers are/were culpable (and got rich in their immoral trade) but were far from the evil kings that you and James portray them to be. The ultimate culpability lies with the cartel owners and the consumers. Therefore, if there is going to be an end to this sort of cyclicality, it would be from taking out the cartels — prohibiting the Fed from running hugely procyclical policies to deal with normal business cycles and from prohibiting the Chinese from running blind and totally uncontrolled mercantilist policies — and drug education — teaching the US consumer about the bad effects of having no savings. If all you do is take out the peddlers — which I believe is what you are suggesting — given the supply and demand, other intermediaries will appear on the scene.

    For some one who makes such cogent arguments about what went wrong and what the real solution is, it is extraordinarily disappointing to hear you, and James for that matter, keep beating on one drum — Kill the bankers and the world will be safe. As I said, bankers were culpable and should be controlled — Hopefully regulation with teeth will get you there — however, this alone will not solve the problem. More needs to be done on other, and perhaps more important, fronts.

  11. Simon, I enjoy reading your articles but disagree with you on one point. You call the big bank structures stupid. I don’t think they were stupid at all, and I think if you analyze their actions under a game theory context you’d agree each bank behaved rationally based on the incentives and penalties it faced. Wasn’t it Dimon who said that as long as the music is playing, you have to get up and dance? Each bank faced incentives to play the highly-leveraged MBS game, and each probably thought it could get out before the bubble popped.

    I’m not as convinced as you that a combination of prudent legislation and regulation could not modify the incentives such that banks no longer feel the need to play such a dangerous game. Instead of discussing regulatory capture and banks too big to exist, I’d love it if you could just address for a bit how you think we could align bank incentives such that banks no longer play such dangerous games. It seems to me that if we can get the incentives right, we may not need to break up the banks or have an omniscient regulator.

  12. Thank you Simon….keep telling the truth…. lies are eventually exposed (witness the Iraq war)…

    there is no difference in our response to this crisis than than that of crack pot third world dictatorships…these guys (financial elites) have got to go and criminal prosecutions must ensue

    right now, wall street owns washington and until there are riots in the streets that is not going to change

    “at length, the truth will out”

  13. That anything which is too big to fail is too big to exist should be obvious . The reason why it is not is perhaps the difficulty of figuring out when , for example, a financial institution is tending to become “too big”; there is also a reluctance to even think in those terms when things appear to go along nicely. When , however , the system runs into trouble it is discovered , in an entirely self-justifying manner, that some units have become “too big” to be allowed to fail. The same argument is seen to be at work when , for example , justifying subventions to any activity which is claimed to be “too crucial” on some ground or another. As Simon Johnson rightly points out , it will call for a better regulator than what has existed so far on earth to figure it out in practice.

  14. What you characterize as a “colossal misjudgement” is being rejudged. The system is fixing itself, and given time, will continue to. Trade imbalances are correcting quickly:

    08:30 ECONX Feb. U.S. Feb Trade Balance -$26.0 bln vs -$36.0 bln consensus; prior revised to -$36.2 bln from -$36.0 bln -Update-

  15. I agree with this message whole-heartedly, though I’m curious about your thoughts on the process for making banks 1) smaller, 2) less powerful, and 3) much more boring.

    1) Smaller – In the great financial industry consolidation that took place over the last 30 years or so, why was there no anti-trust chatter? Pan-Atlantic authorities went after MSFT like fiends, yet said nothing about the empire building going on at Citi, BoA, and JPM. My guess is that if Fannie and Freddie could exist with govt guaranteed monopoly power, then the bar for “monopoly” must have been set dangerously high.

    Unfortunately, even if local antitrust regulation keeps the market competitive, because banking is a global business, it seems hard to attack the problem when developed market banks go after developing market assets. Even excluding the extreme example of Iceland, a bank like Barclays developed a balance sheet that was larger than the UK economy. Who currently has the authority to stop Goldman Sachs from buying power plants in India and golf courses in Japan? Barring an internationally recognized Anti-trust/systemic risk authority, I don’t see how you prevent this from happening in the future.

    2) Less powerful – Does power beget size, or does size beget power? Albeit short, my experience in the finance world has led me to believe that bankers were generally “price-takers” of regulation. The government made the rules, and the banks operated within them. Of course, they found the loopholes and did the cross-border regulation arbitrage and all the rest, but I don’t seem to recall bankers having huge lobbying budgets through the bubble. The “power” they have now I think is solely from the fact that they have become “too big to fail” and can “hold the economy hostage.” Take away their size and you take away their power.

    3) Much more boring – Why was Glass-Steagall repealed? Maybe you’ve mentioned this already (I’ve read most, but not all of your posts), but it seems like the obvious answer is to keep the sexy world of investment banking apart from the boring world of deposits and loans. Investment banks operated quite successfully for the better part of the 20th century without the support of deposits. There seems no reason why that shouldn’t be the case still. Unfortunately, the forced mergers of BoA/Merrill, Barclays/Lehman, JP/Bear, etc. are taking us in the opposite direction.

    There was a great Michael Lewis article where he tells of a lunch he had with his old Soloman CEO. Gutfreund says that the start of this whole thing was when Salomon Brothers took itself public. Immediately, every trader and banker had an effective call option – they get a cut of the revenues, but participate in none of the losses. There was a brief debate around Lehman taking itself private a few months before it collapsed, and the argument against it was that the bank needed that funding and capital. How then, did it and every other securities firm operate as a private partnership for so many years?

    It seems that the fundamental problem was the separation of those who understood and took the risks, and those who bore the brunt of the consequences. The principle-agent problem exists throughout corporate America, but it has never been so acute as it has in investment banks. Investment banks have always been run for employees, and there’s no reason they shouldn’t continue to be. But, there shouldn’t be this farce of operating in “shareholder interests,” when clearly the shareholder has fared very poorly from their investment. Glass-Steagall should be reinstated, and all investment banks should go back to being privately held. They can take all the risks that they want, and beautifully, the management who takes those risks are composed of the partners who bear the consequences of them. It’s amazing how prosperous America became when this was the structure of our financial system.

  16. I find Simon’s analysis compelling, as usual. I also find a few points of convergence with David Brooks, except for his last statement about inbred oligarchs vs. dufusness, (is that a word?).

    Not to sure about the inbreeding, that was more during the days of monarchies, but the CEOs of Bank of American, et al, are for sure, oligarchs.

    In fact, in the various companies I’ve worked for in the IT industry over the last 28 years, (with the conspicuous exception of Digital Equipment Corporation under Ken Olson, may it rest in peace), the boards of these big companies behave and live as oligarchs as well.

    This was especially notable under Lou Gerstner when I was with IBM, (in one year, he took away $20 million in just stock options, forget his multi-millon dollar salary). That same year, I got layed off and was out of work for 25 months, went broke, and got a different view of the world.

    I think Lou did ok, though, thank goodness. He also spent 2.2 billion buying Price Waterhouse Cooper to replace the group I was in that was getting whacked. This all happened in 2001, and just as Enron tanked.

    In a lot of ways, I did not really see the U.S. recover from the tech and Y2k bubble, we just moved into a housing bubble with cheap money and greedy investors that allowed the financial industry to complete their going completely nuts with money.

    “And – here – we – go!” – The Joker

    Just my 2 cents,


  17. liberal,

    Wasn’t it Dimon who said that as long as the music is playing, you have to get up and dance?

    That was Chuck Prince of Citibank. I agree totally that the individual employees of the banks made rational decisions: a dollar today is worth more than any uncertain future earnings and, as expected, we’ve bailed them (or, in the case of Goldman, their counter-parties) out when the bill came due. Why would they do anything different in the future?


    I think there may be more demand for reform from the right than from the left at this point. The banks have come out as explicitly anti-capitalist entities and, since there isn’t a republican administration in place, the right can be more vocal in their opposition to bailouts. Recall, it was the House Republicans (the part of the federal govt. that most accurately represents the rank-and-file right) that blocked TARP initially.

    I agree that this debate doesn’t break down left-right. It breaks down along the NY-DC axis and everyone else. Broadly, the left wants to take down the banks due to income inequality and, to some extent, an appreciation of the banking cartel that has formed. The right wants to take down the banks to avoid socializing losses and letting markets do their job. It’s too bad that both sides have very different visions of the solutions (speaking broadly again, the left wants to nationalize and the right wants to allow bankruptcies) because it prevents a unified strategic partnership that could actual break the big banks up.

    Carson Gross

  18. Ok, I have to add, yes, I do see the administration that I voted for vilifying their critics and that is in and of itself a depressing development. What with congress owing so much to the financial industry, on both sides of the aisle), politics and money have come together again to save their day… for a while.


  19. Simon wrote:

    “The “center vs. the pitchforks” idea fundamentally misconstrues the current debate. This is not about angry left or right against the center.”?

    Not yet, anyway. But there is more brewing (in the States, anyway)than meets the eye. As long as people keep thinking that most of what they have lost will eventually come back, things will be heated, but non violent. But if it begins to dawn on people (correctly or not) that that 401K plan, and that job, and that pension, and the value of that house, and that health insurance policy, are not coming back, there will be big, big, trouble.

  20. Can you really shrink the banks without deleveraging even more? And can politicians give up the temptation of a more politically controlled banking system?

    Look at Fannie and Freddie as examples. They are “too big to fail” and should be cut back by this logic. But doing so would cut off a major (the majority?) of mortgage finance. It would also get the government out of the business of tinkering with rates and downpayments. It doesn’t look like this is going to happen.

  21. ““if you let them vilify us too much, the economic recovery will be greatly delayed.”

    Will the banksters ever stop blackmailing us? I don’t think so, it’s in their genes.

    More of these blackmailing nonsense

    “System Banks are too big to fail”
    “If we don’t pay these bonusses our talent will go elsewhere”
    “Without the Banks the economy will collaps”

    We give them our money and they’ll spent it plus hold us hostage. Reforms HAVE to take place.

  22. It is a red herring to think “banks too big to fail” is the root of the problem.

    Here is a simple scenarios to illustrate the point. Imagine there are 2 dominoes sets.

    1. One dominoes set have a million little dominoes.
    2. One dominoes set have a thousand big dominoes.

    Each dominoes set is setup in a 2D fashion where a particular domino can be knock over by multiple neighboring dominoes. In this setup, each domino is a bank and the neighboring banks are the banks that a particular bank does business with. The first dominoes set is a world with a lot of little banks. The second dominoes set is a world with a small number of big banks.

    Key Questions:

    Of of these 2 dominoes set, which one is easier to prevent a total collapse?

    It is illogical to argue that it is easier to stop the total collapse of a million little dominoes than a thousand big dominoes. From the financial system stability perspective, size of banks isn’t the issue. Also from a practical point point of view, we can’t mandate all foreign banks be less than a certain size either.

    Simon has misdiagnose the root cause of the problem in the banking. We should instead ask the following questions.

    It is unavoidable that a bank has to do business with other banks. Therefore, given the banking system is like a domino set to begin, what can we do to make the system more robust and resilent?

    To prevent a total collapse of a domino set, we need to have proper isolation mechanisms in place. For the banking system, this is also where we should focus on: better regulation and better isolation mechanisms.

    To illustrate what I mean by the isolation mechanism and it’s importance, let’s consider the market for stock options. Today, we can buy and sell stock options from anyone and to anyone in the stock market. We don’t worry much about counter party risk in stock options. The counter party risk is well isolated by the regulated stock market. If some one makes a bad bet in option, it is that particular person that get whip out and not others who traded with him. Now compare that with AIG. AIG made bad bets on CDS and it threatened to take down others who traded with it. The US govt had to bail out AIG because of the counter party risk from AIG to the whole financial system. Why isn’t CDS market more like the stock option market and can we make it more like the stock options market?

    Many derivatives traded by financial institutions are poorly regulated and lacked proper isolation mechanisms. Some aren’t even sold on regulated markets. The market for stock option is clear proof that properly employed isolation mechanism can be very affective. With proper isolation mechanisms, we can make banking system less like a domino set.

  23. This gets back to the built-in bias that too many have – that we need gargantuan banks and institutions to fulfill the needs of modern finance.

    Plenty of folks get mortgages with small institutions that hold on to the same mortgages until maturity. Are these mortgages a little tougher to get? Sure, but why is that a bad thing again? Credit is supposed to be hard to get. When credit is easy, one is simply inclined to not think it through completely.

    We all got sold on the idea in the 90’s that big banks gave us all these great new benefits. But underlying all this was the implication that banking could run better with a depersonalized orientation. Instead of shaking hands with a local banker you get to talk to someone in India and fight off the latest hidden fee. Credit is built on interpersonal relationships and mutual interest. Take that out of the equation and you get the mess we’re in now.

  24. Also, nowadays people depend too much on computer models and are too lazy or stupid to personally investigate the market and calculate risks. Seems that common sense is a thing of the past. All they do now is throw it in the computer and the models predicts the future*

    In the morgage computer models used by the banksters which created the subprime morgage crisis, decreasing house prices weren’t even included….

    *this goes for Global Warming as well, but that’s a different subject…

  25. More importantly, does Obama know he’s being held hostage by a few banks, and is he developing some sort of plan or strategy to counteract this? We know his personal disposition is to placate everyone, but we also know he has political advisors that wanted a much tougher stance towards the big banks (and have lost out for now). I personally believe that Obama has so much on his plate that he hasn’t had an opportunity to really think this through. The hope is he will eventually see the realilty and mobilize his political capital against the big banks.

  26. Definitely a bigger fan of option 2 – make banks small, more boring.

    However, given the economic revolution which the Internet and the online society is forcing the newspaper/media industry to experience, it seems to me that banking/finance could benefit from that experience as well.

    Peer-to-peer lending, micro-credit, etc. trends seem to be pointed north.

    What would happen if the SEC, FDIC, Treasury, Fed, B of England, IMF, World Bank, etc. allowed and encouraged a more community (albeit on-line community) oriented banking approach to develop? So that, specialty banks made up of members in that community would provide the banking services for their members & industry.

    For example, bio-tech companies, engineers, marketers, salesmen, & admin create a bio-tech bank which provides banking services for the bio-tech industry.

    An obvious benefit here would be that individuals with special industry knowledge and an innate “feel” for how their industry is doing would be able to better judge the risk to capital than a banker who is disconnected from the industry.

    I guess what I’m saying is maybe the days of the generic, disconnected bank might be over, given that specialized communities can now more easily assemble, interact and make collective judgments.

  27. you’ve just made the basic argument for securitization…we tried it once already without transparency, standardization and properly policed exchanges…we’ll get it right next time.

  28. Who is claiming that reducing the size of the banks is caving to the angry populists waving those pitchforks?

    Jamie Dimon and the like? The bankers who got us into this mess? The ones who’ve made any number of millions of dollars in compensation as their banks sucked billions out of the economy?


    The damage wrought by the financial institutions has been catastrophic. So just what additional damage can those angry populists create with their rage and pitchforks?

    Smaller banks that perhaps will garner CEOs something around $5 million a year instead of $50 million?

    Smaller banks that can’t possible turn the housing market into the biggest craps game this side of Vegas?

    Smaller banks that can’t make money out of mists and vapors?

    There is inherent absurdity in listening to the highly compensated individuals who took no action to stop this mess before the collapse. Stupid, greedy, whatever it was – those leaders were paid extremely well to know more about their business than they actually did.

    So if the highly educated, highly compensated “best and brightest” couldn’t figure out the complexities of the massive companies they led, then it’s time to chop up the companies.

    The argument about what to do with these banks is not a debate among the varying different types of centrists. We are seeing a calculated defense from the very smart, very powerful, very wealthy members of the US financial community who are protecting themselves and their assets from everyone else.

    Who gains by keeping the system as it is today? Certainly not anyone outside of Wall Street.

    The idea that just a little more regulation is needed to prevent such an epic catastrophe is utterly ridiculous.

  29. What continues to amaze me is this insistence that if we only re-regulate that which has been de-regulated, then everything’s gonna be just fine.

    Doesn’t anyone see how inflation-adjusted stagnant wages since 1975 had anything to do with this? It’s like nobody ever brings that up. If wages stagnate, then what do people use in order to keep the same standard of living? Aren’t they going to use credit? Isn’t credit going to be promoted in order to keep the economy going at the same rate of “growth?” What caused wage stagnation? Have those reasons disappeared? Why does it seem that the people who are designing possible solutions for the “financial crisis” think that these reasons will not be there when they finally get to implement their solutions?

  30. So wait, did I understand that correctly?
    From the comments on shorting bank stocks, it sounds like the general public could hasten the demise of the mega-banks by a lot of people shorting their stock?

    Maybe I’ll have a “shorting party” and invite all my friends…

  31. yes, greg.

    somehow, the fact that people are willing to pay more to insure their bonds from banks will cause the banks to flounder.

    how, it’s not clear. the banks are not getting wholesale funding anyway. the banks are not issuing equity. the only run on a bank that would hurt them would be depositors pulling money.

    in short, i’m not sure why i should believe the cds markets any more than any other market.

  32. From a game theory perspective, the banks were (are) engaged in a non zero sum prisoner’s dilemma game. What this means is there is no Nash Equilibrium and instead of ‘rationality,’ it will always be in the banks (financial industry) to cheat; to devise ever more clever means to ‘game’ the system. That is why Simon Johnson’s proposal to reduce the size of game players (the banks) makes so much sense.

    This resizing of game players makes it much more difficult and unlikely that players can ‘collude’ at any meaningful scale to affect the risk profile of the entire economy, which is exactly what has occurred in this particular case.

    The financial markets have failed, totally, at managing risk (all forms, not just systemic).

    Whether one approaches the problem from a complex systems perspective or from a game theory perspective, one will end up where Simon Johnson and Nassim Taleb do – the Wall Street banks (and other financial intermediaries) need to be much smaller, if one is interesting in actually diversifying and being able to implement regulatory controls to reduce systemic risk.

  33. You, all of your friends, and every single person in your income bracket (or lower) combined control less than 1% of the wealth.

    So, no.

  34. Postmodernism shed light on the flaws of the Hegelian dialectic (that good clashes with bad to make better, basically).

    Postcolonialism shed light on the oppressive nature of Imperialism.

    Both are relatively recent trends dramatically shaping academic thought and ultimately bringing about profound changes to the zeitgeist. — echoes of those ideas can be seen in the debate surrounding ‘net neutrality’, for instance.

    Dismal as the current financial crisis is, there may be some hope in that it could lead to a sea change in perspectives on the appropriate application of finance. Such a change would take time to translate from academic thought to economic policy, but meaningful change takes time.

    So, is there a postcapitalism? Might smaller, regional, more boring banks with management sensitive to the nuances of regional culture be part of the answer?

    Or, will the banking oligarchy bring about the economic equivalent of Fukuyama’s ‘End of History’?

    The importance of voices such as Mr Johnson’s in expressing a need for change should not be underestimated.

  35. Thanks for the details. I appreciate better your ideas about reform. I agree with everything except your persistence that the size of the organizations within the financial system must be limited (…too big to fail is too big to exist.)

    I argue that the markets themselves must be reformed and the instruments trading within those markets must be regulated. That done, money will find its way to those markets. It always does, and as it does it would be a shame if institutions that comprise the machinery of intermediation in this country are restricted, based on an absolute measure of assets held, as to their ability to extend credit.

    Internally, the US would be left with a very anemic private banking system just at a time when the public sectors needs to partner with the private sector not just to rescue banks but to repair, rebuild and transform our economy. Borrow two trillion dollars and you better perform!

    Moreover, the world needs a reliable financial system with sufficient capacity to accommodate its equally pressing needs for capital. Such a system will function only if it employs a currency that is sound, markets that are “free and swinging” and where information to participants is non-asymmetrical. For the time being this cannot be done as a matter of international cooperation, the forces of economic nationalism being as yet too strong.

    The US is in a unique position to provide such a system. We have deregulated and witnessed the venality that flows right in behind departing regulation. All here, regulators and regulated, have been duly horrified and agree reform must be undertaken. Our currency remains a reserve currency held by foreign banking systems and NY remains a significant financial capitol. This is no commendation of our currency; rather, it reflects the absence of any viable alternative. It is a measure of the world’s desperation.

    Our need is just as great as any emerging market nation for a robust engine of credit. We are contemplating going into debt by the trillions of dollars. (I heard one bug-eyed estimate of twenty-three trillion by 20squat.) Without the ability to create and move credit in significant quantities we have no hope of upgrading our own economy or creating infrastructure elsewhere that will support the level of trade that will benefit both trading partners.

    If banks are regulated into positions of greatly reduced economic and political power and management of secular credit, i.e., non- budgetary, falls largely to the Treasury and the Congress at a time when the country is taking on enormous debt, there is absolutely no hope – none – of either rebuilding the economy or working off the debt in any reasonable time frame. You would be correct to say that we won’t export our way out of that one, but you would fall far short. Such a move would be an invitation straight into debasement and directly toward default. To advocate this would be to consign the world, as a consequence, to a financial dark age.

  36. Bob, it’s possible to regulate corruption in banks; it’s far less possible to regulate corruption in government. You are absolutely correct, the entity that grants credit and holds security against that credit must be kept far, far away from the entity that issues the security that the first entity holds.

  37. Your domino comparison misses the point completely. Your analogy by design causes complete collapse of the system regardless of the size of the dominos. The size of the banks has real and direct impacts on the ability of the shock/damage to be transmitted between institutions.

    The problem we have is a few very large banks and they are highly interconnected. Therefore by design any ailment is always transmitted to the others. With smaller institutions, by design, you limit there ability to do damage to other institutions. If they are interconnected to every other institution, their connections have to be very small per institution. Or if they are heavily connected to other institutions it can only be a few other institutions. So, when something happens the effect is either mildly transmitted across all institutions without significant harm or it is concentrated in an area and the damage limited.

  38. If we make our banks smaller, won’t we just make them less competitive relative to international banks?

    If we’re not willing to set up protectionist barriers to prevent those banks from “attacking” our economy, then we won’t be any better off, but we don’t really want protectionist barriers.

    In short, perhaps the Obama administration worries that if we make our banks smaller, then banks will just move to London or Hong Kong or Tokyo.

  39. Simon, I am shocked, SHOCKED at the way you are raising your voice. We do not do this in polite society.
    Yes, we are all Luddites, smashing the looms of entrpreneurial progress. Who is this up and coming Obama administration official? Anyone we know?

  40. The bigger a business entity is, the more it must be regulated. A water company or an electric power company are to big to fail because you can’t leave people in the dark without water if these companies go bankrupt. This is why utilities are highly regulated as public utilities. Banks in effect are also utilities and the big ones should be regulated as other public utilities are.

    Admam Smith’s model for an ideal market is based on the premise of a very large, essentially infinite number of infinitesimally small players, whose actions effect the market only in aggregate. Giant banks certainly do not fit this model, especially when they have so much influence over the government.

  41. JB, you have hit it dead on! Why can’t I say it so elegantly?

    I was reading Willem Buiter blog in the Financial Times (FT.com)and came across these words, “…our financial institutions, what’s left of them….” The culture in the city banks has already changed drastically. They have been shorn of much economic power (and therefore political power.) Their survival depends on re-aligning incentives and re-ordering priorities away from the dangerous games. They know it.

  42. “We are seeing a calculated defense from the very smart, very powerful, very wealthy members of the US financial community who are protecting themselves and their assets from everyone else.”

    Which is why we really have to RAISE OUR VOICES to overcome the noise of the mass media which is owned and controlled by these “very smart, very powerful, very wealthy members”.

  43. So greater size means greater competitiveness? The Canadian Banks aren’t big players on the international scene, but I don’t think Canada is in danger of being taken over by HSBC. In-country banks should be able to have a homegrown advantage. Maybe the Canadian model is a good case study.

    To turn your argument on its head, isn’t it our huge banks – like Citibank for instance – that have had an oversized influence on other countries in the past few decades?

  44. Narrow banking?


    “Limited Purpose Banking

    Sunday, March 15, 2009

    By Scott Burns and Laurence J. Kotlikoff

    In case you hadn’t noticed, the foxes are still guarding the banking henhouse. The only change: President Obama is reducing how many hens the foxes can kill while on guard duty.

    The foxes, of course, are the financial wizards whose leadership almost entirely wiped out the capital of the banking system.
    The old system relied on trusting people who lied and cheated. They are still running the show. They will lie and cheat again. We will be called upon to pay the bill, again.

    We need a new financial system. We need limited purpose banking. It should be transparent, trustworthy and unsinkable. The key is to limit banks to their legitimate purpose. Not gambling, but financial intermediation, connecting savers to investors and lenders to borrowers.”

    “Finally, banks would accept checking account deposits. To ensure they have zero exposure to a bank run, the banks would be required to hold 100 percent reserves (in cash and short-term Treasuries) against these deposits. Incidentally, this aspect of the plan – moving from the current 10 percent to 100 percent reserve requirements – is called Narrow Banking. It was proposed by Irving Fisher, Frank Knight, and other leading economists during the 1930s. It was also advocated by Nobel Laureate Milton Friedman.

    By requiring banks to stick to their fundamental purpose – financial intermediation – and to proscribe their taking risk of any kind, we will never again have either bank runs or the specter of major financial companies going under.”

    I favor a variation on this.

  45. Bill, do you believe today’s world needs credit less than it needs power and water? Currency is a form of credit. Consider what happens when it is abused. The Zimbabwean currency is (or was) the Zimbabwean dollar. It was once valued 4 to the US dollar. By intentionally printing money the Zimbabwean dollar was rendered worthless, 750,000,000,000 or 1 trillion to the US dollar. This has reduced the country to a tribal fiefdom. Tribal police take what they want by force; the rest of the population has resorted to barter with the consequence of starvation and widespread malnutrition. The US is in the process of borrowing several trillion dollars to patch up its economy and save its financial system. If instead of saving banks we turn to smashing them, how will we generate the credit to keep employers in business so people can work and pay sufficient taxes to pay the interest on the money we have just borrowed? I know. We’ll have government projects and everyone will work for the government. How will we pay those people? I know. We’ll just print the money. Don’t you think there is a more intelligent way forward than smashing big banks??

  46. I do not accept the premise in which you suggest the two sets of dominoes are set up.

    The “million small” set would, by definition, be arranged in such a way that the tipping of one would have no chance of toppling all the others. That is the whole point.

  47. Canadian banks are surprisingly large. The largest is the Royal Bank. There are only about twenty five US banks that are larger than the Royal Bank. Canadian banks have been very active acquiring banks and brokerage businesses in the US – RBC Dain Rauscher, for instance, is Royal Bank of Canda, Dain Rausher. TD America is, in fact, a subsidiary of the Toronto Dominion bank. Canadian banks are a fine example of very large financial institutions that are regulated responsibly and that function very well internationally without threatening the middle world.

  48. economist Scott Sumner writes:

    Even during the prosperous 1920s the U.S experienced about 600 bank failures per year, as small rural banks often failed. During the Great Contraction (1929-33) about 4000 banks failed, and many more merged, reducing the total from about 25,000 to about 15,000. In Canada (a country one tenth our size), there were 11 banks, each having nationwide branching. None failed and one merged during a Depression comparable to that experienced by the U.S. So we might want to reconsider the view that smaller banks are a foolproof remedy for our current problems.


  49. Yes, Simon, it sounds lovely and I’ll be all for it just as soon as you explain how to make the banks smaller, less powerful and much more boring without impairing the banking system’s collective capacity to generate credit. Until then or until the prospect of a complete collapse of the global credit structure has vanished safely behind us, I think what you are quietly suggesting is quite dangerous.

  50. …dangerous to the bigbank interests, beneficial to everyone else.

    And with the historic power behind the bank lobby, maybe dangerous to all who suggest there should be questions and investigations about all laws and “bailouts” that have been provided since it appears quite obvious that self-dealing was the motivation, but the public was told that ‘the world would end as we know it” if the banks didn’t get all laws and money that was demanded…now the US taxpayers are on the hook for more than 12TRILLION dollars…dangerous, yes dangerous to all of us who are not the recipients of this MONUMENTAL SCAM.

  51. “without impairing the banking system’s collective capacity to generate credit”

    You mean you think it isn’t already?

    You believe the current situation doesn’t create the prospect of a complate collapse?

  52. Just as global financial liberalization created the potential for capital to move violently across countries and greatly facilitated speculative attacks on currencies, so financial deregulation within the United States has made it possible for capital markets to attack – or, in less colorful terms, go short or place massive negative bets on – the credit of big banks and, in the latest developments, the ability of the government to bailout/rescue banks.

    actually, the first part of your statement is exactly what the DFH (see atrios for DFH definition) have been saying for years (when the imf’s policy was as enforcer for financial liberalization).


  53. Re: Rather, the argument is: those opposed to banks and bankers are angry populists who, if unchecked, would do great damage.

    Oh, I see. Great damage has not been done yet. The U6 unemployment in the U.S. is 15.6% and rising exponentially. A survey of economists in the WSJ today said unemployment would not stop rising until late next year. (See “Economists See No Job Recovery Until Late 2010”)

    As long as the hoi polloi are effectively invisible, we have Radio Finance blasting all day long. They’re offering TARP money to other big insurance companies now. We need to get rid of Eric Janszen’s FIRE economy (Finance, Insurance, Real Estate). People have been swimming in this water so long, they don’t know they’re all wet.

    To big to fail = too big to exist. Yes, I would like to see great damage done … to Goldman Sachs.

    PS: good news, go over to Calculated Risk. Larry Summers got heckled today!

  54. Thank you selise! If you don’t mind, would you please expand on what you have said here.

  55. The truth is that we did effectively abolish nuclear power because the people running the industry were utility people instead of nuclear energy people. They were frozen in the traditional economies-of-scale mentality that might have been manageable for fossil-fueled electric generation but was not for nuclear. Hence, unmanageable costs and negative public perception stemming from the lack of standardization compounded by managers that were more akin to plumbers than technicians. Meanwhile, the Navy, using its nuclear power model became highly successful at operating reactors under shipboard conditions.

    What’s so different about the banks?

  56. hi agrotera,

    i’m not sure what you are looking for. maybe this paper by stiglitz?

    Capital-Market Liberalization, Globalization and the IMF, Oxford Review of Economic Policy, Vol. 20, Issue 1, Spring 2004, pp.57-71.

    pdf is available here:

    i hesitate to write much on the topic because i was quite late to the issue — only meeting anti-corp globalization activists in 2002 (during anti-war organizing). but i benefitted greatly from their knowledge and analysis.

  57. keep beating on one drum — Kill the bankers and the world will be safe

    That’s not a sufficient condition, but it’s necessary (leaving out the “kill” hyperbole). Because, as the blog authors have pointed out, the financial sector will not allow themselves to be controlled in their present form.

    No meaningful reform can happen while Wall Street is controlling the reform, because there is too much money to be made, short-term, from the present disastrous system.

    Only when the situation becomes so desperate that the government has the nerve to tell off Wall Street, will it be possible to begin a full recovery. We appear to be some ways off from that point.

  58. I hear that alleged all the time, but I just don’t get it. If the American people conclude that their governor or their senator is corrupt, they can vote him out. But if we conclude that the CEOs and senior management of Citi or BofA are corrupt, how do we vote them out? We can’t even do it indirectly, by voting for a party that will take criminal action against them, because once a bank gets bigger and more powerful than the government, then both parties work for them.

  59. Yet another concern of Simon has been proven to be misplaced.

    US Banks are lending! Today, Wells Fargo announced they expect to earn $3 billion dollars in the first quarter of 2009. Banks are doing everything they can rake in the money. How do they it? They do it by lending and making money from the highest interest spread in recent memory!


    This brings up another important point. We’ve discussed many times here about saving tax payer money. Some how we missed the obvious point that the best way to do that is to help banks earn their way out of their mess! Duh!?

    Here is another piece of information that is very interesting. The US savings rate is under 2%. There were a couple of years under 1%. Today, the saving rate is above 4% and is projected to go higher. Just imagine how much money from that 2 additional percent everyone’s paycheck represent! Where is the first place that money go?! The banks’ balance sheet.

    I’ve ask before if we are repeating Japan’s lost decade. Do anyone know if Japanese banks enjoyed this level of profitability back than? I don’t have any data on this and very curious to know.

  60. Adam,

    Imagine a domino set that is line up in a line. Here you can knock down the whole set by knocking down just 1 domino.

    In other words, if each bank is strongly connected uniquely to just 1 other bank, the whole thing can in theory collapse.

    Anyway, this is getting too theoretical for my taste.


    I don’t know how to make sense of what you said.

  61. An important point Ben implied in his post, but both Adam and Mike missed, is what is the priority for fixing the financial system? My reading is:

    Improve regulation for financial products, improve regulation for financial products markets and employ isolation mechanisms (to use Ben’s words).

    It is debatable rather bank size is an issue. I agree with Ben’s view that it is a red herring. Some day a bored professer may spend the time on figuring out what the optimal bank size should be. My view is the system as whole will figure it by itself. We can compare the banking system to a living biological system. In nature, we have amoebas to whales. However, we don’t have anything bigger than a whales simply because something much bigger won’t surivive in the current natural environment.

    In this regard, Bernanke is clearly smarter by suggesting changes to the regulatory rules so that it is not profitable to have banks bigger beyond some point. Bernanke is basically saying change the environment so that humongous bank animals can’t survive!

  62. How great! Thank you so much selise! i just wanted to hear all you might have to say on the issue, so, i’ll watch for your posts! Thank you again!

  63. Massive risk exposure concentrated in the form of a handful of fragile megabanks got us into this mess.

    Continuing to do so cannot possibly get us out of it.

  64. I would like to believe that cutting banks down to size would fix this, but I am concerned. Here is a list of reasons (some borrowed from posts above):

    1) The Banker’s Dilemma. This is sort of like the tournament effect among hedge fund managers. If you are a bank CEO, and you consistently take conservative measures that will disadvantage your bank in the short run and cause you to be less profitable than others, then if a stretch of 5-6 years goes by in which your bank is earning below average, you have a good chance of losing your job. Thus, there is tremendous incentive to “follow the herd”. It’s easier to keep your job when everyone is losing (and you are too), than when everyone is winning but you are not.

    And frankly, when every mainstream economist is projecting growth until the cows come home, how many CEOs do you think are going to be able to stand against this pressure? It’s much easier in retrospect to see how obvious this catastrophe was.

    2) Govt. likes big banks because they are useful internationally and politically, in many ways

    3) Big banks may have some international competitive advantages, including the ability to get capital cheaper (e.g. GE Money’s former AAA rating); if we cripple domestic banks but foreign banks are allowed to grow big, we risk disadvantaging a very powerful economic sector.

    4) Any short term break-ups would be hard to sustain long term due to M&A activity

    5) If our “solution” to providing stability to small banks (aka, distributing risk over many small institutions to approximate the risk distribution achieved by a large integrated bank) is the securitization markets, then I am terrified.

    6) We have several historical examples of lots of small banks doing lots and lots of damage (e.g., the Wildcat Banks in the west, the mass failures of small local banks in the Great Depression).

    7) Overseeing hundreds of smaller banks could be harder than overseeing a few dozen big banks.

    8) Collusion, for all its problems, has positive aspects. For example, the recent moratoriums on foreclosures. There is nothing selfless about this on the part of big banks. They all got together and agree to this policy as a de-facto price support program for housing. (And yes, I’m in favor of this.) While certainly possible to achieve in a sector with less concentration, it’s much harder.

    I’m certainly not against cutting up the big banks. I simply don’t think it’s nearly enough, nor even the most important thing, to fix the system. Moreover, if we do cut up the banks, we’ll need to build some institutions to address some of the new problems we’ll be creating.

  65. If you have proof, the corrupt CEO and management will go to jail.

    On the other hand, if there is only suspicion but no proof than the US justice system presume innocence. This is a good thing!

  66. I think you miss the point that it was the government that in a large part created these large banks, with the forced buyout by JP Morgan of Lehman, and the gunshot marriage of Wacovia with Wells-Fargo. The reason they did this was quite clear: Paulson and Bernanke feared the derivative market was collapsing and would swamp the U.S. banking system with bad debts from credit default swaps, etc. We are still not beyond that point, so it is too early to talk about the government now reversing course and dismantling the banks. I found it cute that Obama told the bankers at their recent White House meeting that he was the only thing between the banks and the pitchforks. Obama is the problem, not the solution. He is the one supporting the big banks, and without his support of legislation, nothing is going to move that will change the current structure.

  67. “If the bankers were just stupid, as suggested by David Brooks, then regulatory fixes might make some sense. But we know that bankers are smart, so it is their organizations that became stupid. What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy? Answer this and you address what we need to do going forward.”

    While I am clear you’re (Simon’s) head and heart are in the right place, I believe you are overlooking the obvious. Neither the bankers NOR their organizations are stupid. The bankers are gaming the government stooges (“stooges” here applies to those who are stupid regarding financial matters, or those who are complicit – “in” with the bankers for their own benefit (think lobbying moolah)).


    To think otherwise is an understandable, but dangerous, naivity.

  68. And, YES, smaller, less powerful, more boring banks would be better.

    In the meantime, I encourage everyone to take their money out of the big banks and deposit the money in credit unions and/or small regional banks.

    Do it today!!

  69. Maybe in the Forties Mister Churchill’s optimism was not misplaced. It sure is now.

    1. Making banks smaller will not solve the regulation problem (other than temporarily) because banking legislation and regulations are written by K Street lobbyists for Congresscritters to vote upon without even reading. If the Big Five banks were broken into 500 banks, they would all pay monthly dues to a common lobbying organization, and K Street would go right on with the same level of funding it has now, writing Bank legislation and regulations.

    As we all know, the first goal of banking lobbyists is to shake off restraints and regulation so they can make some real money in the current quarter . . . and away we go again.

    2. Making banks boring again will surrender economic advantage to any nations that pursue a more exciting banking approach. The incentives for taking more risk than your neighbor are built in, and very profitable short term.

    The ultimate solutions have to be agreed upon internationally, and that means some serious rethinking of the control — and concepts — behind the IMF and World Bank. They are largely viewed as strong arm institutions for the Americans, and it is hard to disagree with this unless you are a friend of American banking.

  70. big banks are not that evil. tide looks to be turning. i think we can thank tim for steering us in the correct direction. just something that i like about our sec of treasury. don’t know what it is.

  71. Simon,

    Regarding you point below, you should look up how the Hong Kong handle it. The Hong Kong government pop up the local stock market and made it unprofitable for the speculators. The Hong Kong society was better off than all it’s neighbor as a result. This is exactly what the US government should do to defend banks against speculators.

    “…much as the shorting of countries’ obligations spread from Thailand to Indonesia/Malaysia and then to Korea in fall 1997.” – Simon

  72. Simon,
    I believe you have the argument for what will happen to the industry reversed. The banks are not going to get smaller, less powerful, and more boring. Quite the opposite, is already becoming very clear the cream of the crop are rising to the top and are becoming larger, more powerful, and perhaps temporarily more boring – until joe public has forgotten about the mess and has gone back to being fat, happy, stupid & watching American Idol.

    The bankers and their organizations knows this; they are not stupid and yes, the top tier banks GS, JPM, MS & their alumni private equity and hedge funds are using this current financial crisis and the bailout economics to consolidate the industry with taxpayer money. It is all a very simple game – does anyone really think that GS didn’t know they had the better side of CDS trades with AIG? Of course they did, otherwise they wouldn’t have piled into a trade where the risk of getting it absolutely wrong was assumed to be a catastrophic loss that would be bailed out by the government. This is what banks do – they sell risk to the public, it’s what private equity firms do, they exit with an IPO and sell all the risk down the road to a much stupider and less informed John Q Public retail investors & pension plans. The only difference between this crisis and a busted private equity transaction is that instead of an IPO these top banks are cashing out with a handy check called TARP, TALP, & PPIP made out by Uncle Sam and guaranteed by you, me, and the rest of the now angered but still disenfranchised general taxpayer population.

    And by the way whoever said that it would be better to have a million small dominoes versus a thousand large ones clearly has forgotten history that is not even 30 years old. While the size of this crisis may be much larger due to its global scale and intendent deleveraging, the root causes are fundamentally the same as the S&L crisis of the 80s. In that episode, we had a million dominoes all falling down in the same direction – having taken the same stupid bets, which were permitted if not downright encouraged by a confluence of monetary policy, poor oversight of a de-regulating industry, and laws favorable to the bankers who to facilitate a relatively risk-free way of making money by borrowing short to loan long.

  73. It is astonishing how much b—sh– is taken for fact and as you report in your note, so many in positions of power used just that kind of language to brainwash the country (and the world) into believing the whole scam of “let’s confiscate trillions of dollars” all in the name of saving the world! It is scary to have this kind of corruption at the heart of all our government’s decision making.

  74. I am so sad to report that Mr. Obama had his chance to decry the paulson/bernake plan, but he instead chose to embrace it…the currency of our country will suffer, and possibly lose all credibility, from this decision more than from the money printing that our country might have done without the bankrobberyfactor( aig, backstops, blah, blah, blah, all stolen from the US coffers in the name of “we have to save the world”)

    If you will remember, it was the day after the so called “geithner” plan was set into motion, that the Chinese government announced that they would be diversifying away from the US dollar, and shortly thereafter, the United Nations made a recommendation that other nations do the same…clearly, this is a response to the now fact, that Obama is a puppet to the bankers just like other Presidents have been.

  75. Simon, can you detail exactly how the speculators are mounting a speculative attack on the banks? I don’t understand the follow quote at all.

    “The latest credit default spreads data for the largest banks show a speculative run underway. As the system stabilizes, it becomes more plausible that a single big bank will fail or be rescued in a way that involves large losses for creditors. ” – Simon

    Are you saying people are short selling the mortgages in citigroup’s asset? How exactly does that work? Can you literally borrow mortage from citibank and sell it?!

    We can rule out short selling attack by shorting the CDS market directly. This is obvious since CDS for citigroup is high. Normally, a speculative short will drive price down.

    We can also rule out short sell attack by shorting the stock. The stock went up 300% in the last month. Any short seller left who has cover by now!?

    Anyone who can offer a better exlaination than Simon’s hand waving?

  76. …many bank stocks, can only be purchased for those who are not “socially conscious” investors.

    So many bank stocks can now officially be a part of the “sin stock” portfolios, for those who like that kind of thing–banks can be purchased right along with casinos, alcohol, tobacco, abortion andcompanies in support of Darfur.

  77. Not that i am against gambling, alcohol, tobacco, or letting people chose to have an abortion, i just don’t care to invest in companies that support these activities, and i would really hate to invest in any company that had ties with countries that condone mass murder.

    I am concerned that since our president supports the bank scam, our country will be viewed as corrupt–imagine how that will put the brakes on people wanting to invest here in America.

  78. Everything you say makes so much sense…common sense.

    I’ve already moved my money from wachovia to my local credit union (DC Area), and encouraged my son do the same in Boston from BoA to his local credit union. People have the power to decide which banks fail and which ones don’t. Change comes from the bottom up.

  79. Ben,

    I am having a tough time believing one of your assumptions…

    you say, “If some one makes a bad bet in option, it is that particular person that get whip out and not others who traded with him.”

    Any kind of irresponsible use of assets has a ripple effect…that is why Sarbannes-Oxley came about, and although the size of the domino effect may be bigger, it seems strange that the US taxpayer is the one on the hook for the 185Billion dollar give away instead of a consortium like the one devised for LTCM. I know, anyone that who might have put up money was already being pulled down…well, that is the rub, and that is why it is so scandalous. Effectively it looks like the AIG free money give away did absolutely save Goldman Sachs from bankruptcy in Sept 2008 and probably a bunch of affiliated hedge funds. I just don’t think that any person, aside from those who are stakeholders in the large banks, would have ever agreed to the AIG free money give away if they had known that it went to keep a bunch of hedge funds from going under–nor would they have ever allowed TARP 1 if it hadn’t been for the scare tactics, and the insistence by the makers of TARP frankenstein hank/ben, if they had known that it was to start a chain of money injected into banks just to keep them proped up…in the meantime, the member banks will do so well with a crisis of this proportion because the amount of money in the system, trillions, makes a tidy sum of interest even if it is a tiny sliver of what gets rebated back to the US treasury.

  80. Ben, you must have missed the post a few months ago, with an article on how the CEO of US BANCORP was announcing at a luncheon that treasury instructed all the takers of TARP to NOT lend with the TARP money, but to buy smaller banks so that they could be part of the DARWINIAN cleansing necessary during this time of crisis, and that they should just tell the public that the money was for lending. Recall all of the communique at the time out of both the fed and the treasury was that the TARP infusion was to allow banks to lend–LIES LIES LIES

    I think this article may have been expunged from the record because i tried to get it the other day to no avail.

    You are just missing alot of information on this one.

  81. It was so unbelievable to hear our President “encourage wall street” to come up with creative products…to help mainstreet invest in the toxic assets…good GOD! In your words, “devise clever means…”

  82. “…we know that bankers are smart, so it is their organizations that became stupid. What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy?

    Fraud, if not criminal, in the sense that there are no laws prohibiting the behavior, then certainly ethical fraud.

    Simple really.

  83. lefty27 you are right!

    fraud legislated! The compensation on the imprudently leveraged balance sheets are being forgotten while the “good deed doers” are all taking one dollar salaries in a show of solidarity for the common citizen…all the while, after the signing off on the balance sheets to these bloated corrupt entities, it is amazing to me that, although the law is hated, no one is invoking Sarbanes and requiring accountablitiy to every bank that is alive, or failed…it smells very bad….just like the smell of the most egregious fraud.

    Yet, these guys in October, got called to the secret meeting to get the TARP infusion—-

    i grew up in Chicago, close to one of Al Capone’s old houses. And, in my neighborhood, every so often, one of my neighbors would have a meeting in the middle of the day, with a dozen guys that came in dark Cadillacs, and wore dark suits—always the same scene.

    I couldn’t help but be reminded of my neighbors meetings when i saw the the heads of Merrill, Goldman, Morgan walking up to the treasury that fateful weekend…i just can’t believe that our country is allowing this to take place. I am really sad. But, maybe justice will come one day–i know that is wishful thinking, but i have no other choice.

  84. The banks are getting taxpayer money and are able to resist change because they are holding a gun to the head of the Obama administration; they provide an “essential” service and there appear to be no backup providers at present. By banks I mean the current bank leadership, their underling supporters, and their allies in the government. These people have to go and maybe to prison. One way to get rid of them is to vigorously investigate and prosecute criminal activity (i.e. fraud) perhaps utilizing the help of the FBI’s organized crime unit. One byproduct of the investigations could be detailed information which could help explain how such large stupid organizations came to be. During this process, replacement management could be trained who are change friendly. Once in place, these individuals could assure the continued functioning of the banking system while the banks are restructured. A pipe dream?

  85. Tom, a really good indicator for your stock market adventure is you asking strangers for stock market tips!

  86. most excellent post and it gives me hope…that someone out there is making this happen!

  87. “maybe to prison” you say Tom–really, evreyone knows that prison is not good enough for a cartel leaders who signed off on balance sheets full of lied and deception! The reason that Sarbanes-oxley got such a bad name is exactly the reason why it may be part of the tools that can imprison the kingpins for starters! Yes, a dream…and scary as it sounds, it is really very frieghtening to even talk about this issue because with the kind of corruption that is going on, i am sure life means nothing if it gets in the way of the cartel plans and their sacred money laundering operation.

  88. I have yet to hear a single responsible official in any industrial country state what is obvious to most technocrats who are not currently officials: anything too big to fail is too big to exist.

    Is Bernie Sanders not responsible, then?

  89. Mr. Johnson, I for one would also appreciate follow up commentary on the trend in credit default swaps for big banks. Here’s my comment:

    Today’s earnings news from Wells Fargo and Obama’s recommendation that more people refinance tells us a lot about how the Administration hopes to find a way out of this mess.

    There is chain reaction that goes as follows: Fed induced low long-term rates give credit-worthy borrowers incentives to refinance home mortgages, refinancing provides fee income to the banks, lending spreads are wide given expansionary monetary policy, the zero Fed Funds Rate and higher household savings showing up in CD’s, and with earnings banks can take write-downs and add to loss reserves without further impairment to their capital. Add in the demise of mark-to-market accounting, talk up stocks and . . . . crisis is averted.

    Refinancings will eventually winnow out the better loans from mortgage securitizations, leaving a slag which will be off-loaded to the PPIP, which in turn is a praiseworthy pre-emptive effort to establish institutions and procedures that will eventually be necessary under any scenario to handle the non-performing junk that will have to be recycled, like thrice-worked credit card charge-offs, at pennies on the dollar.

    There are plenty of reasons to favor a more decentralized system for delivery of retail credit products, with smaller banks and less overall reliance on securitization, without analogizing, as does Simon Johnson based on his tenure at the IMF, to disasters experienced in emerging economies controlled by an oligarchic financial class–increasingly true as the analogy does seem.

    Our present predicament indicates that financial services conglomerates–the “banks” that are operating on trans-national platforms and engaged in high-velocity arbitrage of internally manufactured synthetic securities and financial hedges–are effectively beyond the span of control of the most expensive management money can buy and beyond the bandwidth of effective regulation.

    Fearful of the consequences of a collapse or nationalization of one or more of the largest US financial institutions, with good reason when you consider the national security implications, the US is not going to fight excessive concentrations in the banking industry.

    That does not mean US consumers and taxpayers are powerless to exert influence. We could be doing our refinancing with our community banks and we could move our savings and checking accounts there, out of the mega-brokerbanks. After all, if the recent alarming trends in credit default swaps indicate a global run on the big US banks is underway, why shouldn’t Mom and Pop and Dick and Jane and Spot run too?

    The smart money, and not-so-smart money, in countries that have experienced crises, of the kind Simon Johnson describes, does not trust government, regulators or deposit insurance in the way we do here in America. In them, the sanctity of contracts and the entire judicial system is suspect, or at any rate open to bribes. Where to keep your savings is a problem for anybody who has anything, excepting those who have connections. The disparity between rich and poor would, if visible to tourists, would be discomfiting to the uninformed presumptions of most Americans today. In unstable economies, unlevered ownership of residential real estate is considered an unimpeachable store of value. If it all goes to hell, at least you have a roof over your head–so the thinking goes. Dollars and gold coins stashed away in a safe deposit box or a hiding place are seem like a good idea.

    The blogsphere is full of people sounding off about policy and theory, but short on the responsibilities of individuals. Patriotism, for God’s sake, demands that we do for our government what it cannot do by itself, lest we end up hoarding hard currencies if the face of a devasting devaluation. It’s our money, our deposits and loans, after all and, short of a panic, it seems the time has arrived to vote with our feet.

  90. DEFrank,

    You have great wisdon. The word BOYCOTT has been floating through my head since October.

    But, the web of deception is so expansive, I wish you could advise how to select a safe and uncorrupt bank….there is so much power being exerted by the big banks, it really makes me feel that if i chose to move my money to a “small local bank” the small local banks will eventually be some kind of target for attack since our government seems so determined for the big 19 banks to consolidate all the smaller banks and effectively then we have monopoly money (really to call the system an oligarchy is too polite and naive ). How do you suggest navigating out of this trap?

  91. Extremely well put argument. Agreed that a grass roots efforts to get consumers to “localize” their accounts would go a long way towards doing what our government either refuses to, or is politically constrained from, accomplishing.

  92. Why don’t we, tax payers, vote with our feet? This is a free economy, we can go with our money where we want. Why isn’t there a true bankers entrepeneur who establish a bank with a policy that does exactly what Simon Johnson is preaching and makes it known to everybody.

    Clearly there’s a lot of anger under the saving taxpayers who want change. A clear policy, savers friendly, bank will flourish today and will force other banksters to absorb simular policy because of the competition. Free market at it’s purest…

  93. Size matters because size is the best comparator for compensation. The bigger the bank, the larger the banker’s pay check. At a certain size, ROE declines for the institution but pay checks keep growing.

  94. Ben,

    With credit default swaps, you short an institution by buying the swaps, pushing the price up. You make your money by selling the swap later when the price has risen. So rising CDS spreads can be an indicator of a speculative run.


  95. Ben,

    Also, one bank press release does not say much about aggregate lending in the economy. Look at the Fed flow of funds reports (http://www.federalreserve.gov/releases/z1/Current/). Household borrowing was negative $300 billion in Q4. Wells’s results may indicate that it will not be that bad in Q1 – although one thing they claim is that they are taking business from Citi and B of A – but I’d prefer to see the Fed data before assuming the credit crunch is over.


  96. I agree with Simon Johnson, however I find the argument at the end of the article circular:

    How do you actually “make banks smaller, less powerful, and much more boring”, and make sure they stay that way, except by properly regulating them ? I guess we all agree that bankers are smart, and them having tasted the power and money that comes with running a big bank, you can be sure that they will try everything to make big banks again out of small ones.

    So, we will still depend on “smart regulators” that see their job as a public duty. Do we have those, and if not, where do we find them, and who is going to install them ?

  97. Yeah, I have learned not to expect too much from the justice system when the rich and/or powerful should be punished. I like to think that some shark lawyers will go after these people and make their lives miserable once there is blood in the water.
    I don’t think anyone should feel afraid. The worst thing would be to sell your soul to them. Nothing else really matters.

  98. “But we know that bankers are smart, so it is their organizations that became stupid. What is the economic and political power structure that made it possible for such stupid organizations to become so large relative to the economy? Answer this and you address what we need to do going forward.”

    Ideologically, in a perversion of Adam Smith over the past three decades the collective elevation of self-interest to virtue led to banks serving bankers not vice versa. It also led to politicians and regulators serving those who were supposed to be regulated. The rhetoric has changed since the collapse but, it seems, little else. Whether there it is possible to construct a formal legal structure that would preclude such pervasive corruption or just keep it from becoming catastrophic seems dubious.

  99. I see that you are suggesting that technocrats can solve this problem exclusively trough regulation. Yeah I agree there is a role for the technical class of bureaucrats in resolution of this crisis… of convenience. I might suggest that eliminating the “Fiat currency” system and replacing it with a “System of Competing Currencies” which includes the use of gold and silver will bring a multi-pronged attack on the corruption that we are now experiencing. So yes we do need a great technical class of bureaucrats, but we without a free-market outlet we are setting up a system that is going to end up as a breeding ground for corruption. I hope you agree.

    I have some other problems with your argument specifically “what is your problem with pitch forks?” You should realize that a pitch fork is a great weapon and symbol of grass roots revolt.

    “It’s about centrist technocrat (close to current big finance) vs. centrist technocrat (suspicious of big finance; economists, lawyers, non-financial business, and – most interestingly – current/former finance, other than the biggest of the big, particularly people with experience in emerging markets.)” What is this crap? Are you suggesting that this is just a battle between technocrats? If I see a Banker on a pitch fork I know that things have finally reached a low that justifies it. But do we really to sink to that level?

  100. I think the domino analogy is wrong, because domino pieces can be in only one of two states: up or down.
    By contrast, a bank has many states between healthy and failed.

    So while a “failing” domino piece will bring the piece next to it down, a failing bank does not necessarily bring the bank connected to it down. Yes, it will affect it, but not necessarily to the point of total collapse.

  101. Uhm, no, they are not lending.

    Saw some entrepreneurs the other day on TV talking about how it is almost impossible to get any credit at decent rates, even if you’re a healthy business with a strong business plan.
    And if you don’t have a stellar credit score you can forget about any bank giving you a mortgage.

    So … no, lending is still not happening.

  102. Uhm, I think “corrupt” is the wrong term to use when talking about CEOs. “Unlawful” might be the better word.
    In that case, he/she is either punished by the justice system (if he/she broke the law of the state) or by shareholders (if he/she broke a “law” of the company).

    Sorry, but ordinary citizens do not get to “vote” a CEO out, not unless they are shareholders. No skin in the game, no say.

  103. i think i am done with this little think tank (if you can call it that). tired of the calling banks corrupt even though everything they did was within the law. this little muscle flex is nothing more than hey look what i found while searching the internet or look i can spew econ jargon. the country will get better. and you can take that to goldman sachs. please no further communications for me. thank you

  104. Hi James Kwak,

    I still don’t get it. How does a speculative bidding up of citibank’s CDS increases citibank’s probability of default? Someone manipulating the CDS market can rip off other CDS buyers. How does that increase citibank’s chance of default?


  105. You are very disconnected, Ben. Wachovia made those loans, and last year Wells did not own Wachovia. This is smoke and mirrors about a one-time revenue peak, no different than BofA swallowing Fleet of Boston. Wells bought Wachovia to get their deposits, the surprise is that people are defaulting less than expected on Wachovia mortgages.
    Until the corporate bond market is restarted, and small businesses can get loans, we are going nowhere. Regional banks will prove to be small business owners’ last hope.

  106. You are spot on, Mark. Wells was scared to get into a bidding war with C for Wachovia’s deposits, particularly when C had TARP money available. Mr. Kovacevich is just a Monday morning quarterback.

  107. Hi Ken,

    Thanks you for the feedback. Can you show me the numbers that led you to your conclusion? Or at least point me to where to look?

    At any rate, I am open minded about being wrong. However, I do need to see the numbers.


  108. You give me $1 and I can lend $0.90. The next bank takes the $0.90 and lends $0.81. Every major financial crisis has fractional reserve lending and/or government printing at the root.

  109. “First-quarter net income rose 50 percent to about $3 billion, Wells Fargo said last week in announcing preliminary results that topped the most optimistic Wall Street estimates and sparked a 32 percent jump in the stock. The bank attributed the profit to a surge in mortgage originations and revenue from Wachovia Corp., acquired in December. Full results are scheduled for April 22.

    “Details were scarce and we believe that much of the positive news in the preliminary results had to do with merger accounting, revised accounting standards and mortgage default moratoriums, rather than underlying trends,” wrote Cannon, who downgraded the shares to “underperform” from “market perform.” “We expect earnings and capital to be under pressure due to continued economic weakness.”

    Wells Fargo raised its provision for loan losses by $4.6 billion in the quarter, below Cannon’s estimate of $5.4 billion. FBR Capital Markets analyst Paul Miller wrote after the announcement last week that he expected a $6.25 billion increase. ”

  110. The solution is simple: end legal tender laws. Allow a free market in currencies, and a crisis in one will be largely isolated from all others. The size of a bank does not matter, nor does fractional reserve lending, nor even fiat money. Let people trade freely, and these things will take care of themselves. Why would I take your monopoly money bill on the promise of bank x or government y when I can get physical silver from this guy over here? The finance industry as a whole is dependent on people being forced to take their dirty notes, and this parasitic horror would largely disappear without it. Producing value in physical goods is the only way to create wealth, so anytime you see wealth in the hands of those who produce nothing (banksters and financiers, for instance), you know that a distortion away from free, voluntary markets has occurred.

  111. So I give a concert enjoyed by hundreds, or teach thousands of young people vital skills. I produce nothing of “value”? Just the sort of thinking which gave specie a bad name. The gold standard is nothing more than an artificial speed limit on productivity.

  112. No, you’ve produced something of value. It’s ephemeral, but people buy it. Banksters don’t sell anything of value; they lend money at interest, the money you are forced to use, which they and the government alone are given the right to issue, so you HAVE to get it from them.

    I did not call for a gold standard. I called for free market currency. Banksters and financiers can charge you interest for money because only one currency is legal tender. They are helped, of course, by regulations and which make it very hard to produce and market anything on your own on a small, local scale, and thus accumulate wealth without borrowing as you expand.

  113. 1) The banks, etc., are not too big to fail; let them fail, and we shall have smaller banks, or at least solvent ones.

    2) The Fed. & the Treasury are using public funds to protect private interests (bank stock & bond holders). This is the crux of the current crimewave.

    3) Obama = no change.

    4) Thus, the current crimewave is being used to protect the criminal fraud cabals of pre-’08.

    5) Like Spain’s attempt to bring the Bush criminals to justice, if we do not clean up our own mess, others will have to do it for us. We shall most likely be “somewhat uncomfortable” when this international economic “adjustment” really begins to happen.

    6) Better to let the gamblers really go broke. Then those who committed crimes will be seen for who/what they are and can be prosecuted, not protected.

    7) Any real assets can then be PAID FOR and re-deployed by folks who are not on trial or incarcerated. Of course, the stock & bond-holders of the bankrupt enterprises, after their “haircut”,will be totally bald, but the nation itself will be protected.

    8) Enforce the Constitution of The U.S.

    9) Change the “law” that “corporations are people” and have “1st Amendment rights to free speech” in the form of purchasing the politicians.

  114. THe average empire lasts 250 years under the fractional reserve banking system. The banking system that the we have been under is designed to fail. the people lose EVERYTHING and the bankers win EVERYTHING. That is the way of fractional reserve banking always has been always will be. We are all slaves to their system. This does not happen by mistake it happens by design. Why doesn’t anyone just do a little research on the history of fractional reserve banking and find out for yourself? Also if you have a CENTRAL BANK then all the currency will eventually be devalued. That is how bankers i.e. the rich become richer and the poor become poorer. Of course this time around you pseudo rich people will fall. So the game is over and like the Bolshevik Revolution millions of people will starve to death in the next 5 years here in this country. If you think socialism will save you think about Stalin. If you think Obama will save you well nothing can.

  115. Simon Johnson says “It’s about centrist technocrat (close to current big finance) vs. centrist technocrat (suspicious of big finance……)

    Not necessarily. I am mostly against all those technocrats (close to current big technocrats) that played with the world and created more misery than many wars, and now want to dig us even deeper in the hole we’re in.

    Not only were they totally incapable of handling very simple risks, such as vanilla mortgages to homeowners in the USA, but now they have the galls of trying to manage the world’s systemic risks as well.

    Wake up! The regulators are themselves the most dangerous source of systemic risk. Did you not hear the Joker in “The Dark Knight” speaking about the financial regulators?

    The Joker said “You know they’re schemers. Schemers trying to control their worlds. I’m not a schemer. I try to show the schemers how pathetic their attempts to control things really are. So, when I say that … was nothing personal, you know that I’m telling the truth. It’s the schemers that put you where you are. I just did what I do best. I took your little plan and I turned it on itself. Look what I did to this city with a few…”… collateralized debt obligations.

    When I think of a small group of arrogant technocrats in Basel thinking themselves capable of exorcizing risks out of banking, forever, by cooking up a formula of minimum capital requirements for banks based on some vaguely defined risks of default; and thereafter creating a risk information oligopoly by empowering the credit rating agencies, which was all doomed, sooner or later, to guide the world over a precipice of systemic risks, like what happened with the lousily awarded mortgages to the subprime sector, I cannot but feel like reaching out for the pitchforks to stop giving even more powers to these scheming technocrats.

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