Brazen Tunneling and Inflation

In most societies it is traditional to be somewhat sneaky in squeezing your shareholders or the government.  You might set up a complicated transfer pricing scheme or perhaps you arrange for a family-owned firm to acquire assets on the cheap from the publicly traded corporation that you control.  Or you could always arrange for the Kremlin to provide foreign exchange at a “special” price.

In the New United States, life is much simpler and bank tunneling considerably more brazen.

I’m starting a bank blotter.  Here are some early entries, from the WSJ on Wednesday:

  1. We’ll pay ourselves very high wages, rather than substantial bonuses (p.C3 in print edition).  This is brilliant.  These banks are supposed to be recapitalizing themselves, which means earning profit – and this is usually harder to do if you increase wages.  Lower wages would mean the exit of employees at some of the world’s least well run firms – entities consistently plagued also by the world’s most blatant agency problems – but the banks simply assert that would be a bad thing.
  2. We’ll use the PPIP money to buy toxic assets from ourselves and thus “participate in the upside” (p.C1 in print edition; reviewed here yesterday).  In any decent society, this would set the red flags flying, but the banks have apparently lost all sense of moderation.  Look carefully at (perhaps) the most fantastic angle here – these assets will be moved “off balance sheet”, as if that does anyone any good; remember many such assets started off there and moved on balance sheet as the crisis developed.  Come to think of it, the complexity inherent in the implicit conflicts of interest in this scam scheme would go over well in Russia.

What does any of this have to do with inflation?  If you want to the Fed ever to be able to tighten, you need a healthy enough financial sector – i.e., given what we now know about policymakers’ preferences, banks in the “too big to fail” category better not be close to failing. 

Big banks that pay higher wages will have less capital for the next round of difficulties.  Banks that keep legacy assets close at hand will likely find out (again) why these loans and securities were called toxic.  A weaker set of big banks will encourage the Fed to allow the yield curve to steepen, so monetary tightening happens later and perhaps too late to prevent inflation from taking off.  Tunneling makes it harder for the Fed to tighten when inflationary pressures appear. 

And if you think that inflation is not possible in the US any time soon, please see my column on NYT’s Economix (usually appears at around 7am Thursday morning, New York time) – post comments there or here.

By Simon Johnson

45 thoughts on “Brazen Tunneling and Inflation

  1. As far as point #1 is concerned, I can think of two plausible reasons why wages would be rising among bank executives.

    First, they are so well-connected and and confident in the administration’s determination to stay the course that they just don’t care. This also assumes a high level of social tone-deafness.

    Or, these corporations might have become so complex that the top level management simply doesn’t know who they should keep and who is worth what. This can easily happen in an M&A environment, which these banks clearly have been in. and this isn’t a problem which sorts itself out. Contrary to the popular belief in high economies of scale among large institutions, they are often unmanageable, and this is one of the ways that that unmanageability manifests itself.

    I would tend to lean towards the second explanation. This, of course, is another reason the government should break these banks up. As a major shareholder in many of them, the government has interest in good management.

  2. The solution to this financial thuggery rests with the U.S. Congress. Until things get much worse there is little possibility of a serious restructing of the banking industry. However, if things get that much worse for the U.S. economy, inflation won’t be an issue. So the U.S. winds up with either high inflation or a long term depression (call it a steep recession if you like). The banks have won until they collapse again in 10 years. Please be sure to thank your elected representatives.

  3. it’s easy to see why C / BAC would propose raising base pay.

    first, pay restrictions in TARP left that open, so it was of course going to happen. why did paulson/geithner (i forget who was responsible for this one) leave this open — imho he gets all the credit / blame for this.

    second, C / BAC have already lost a lot of senior people and they may see themselves as being in danger of falling apart from the inside.

    now it may be a good thing to break up Citi / Bank of America, and it might be a good idea to have healthy banks, but gutting banks and then keeping them around is a really bad idea.

  4. Why are people so focused on the short end of the curve as the determinant for monetary policy? If the last few years proved anything…its that we have to look at the long end of the curve as well.

    People talk a lot about monetary policy being kept too loose after the dot-com bubble. In truth, it probably wasn’t THAT loose, at least at the short end. The problem existed in the long end of the curve…kept depressed because of the global savings glut. 30 year mortgage rates don’t track overnight lending rates…they track 30 treasuries. If you can borrow over 30 years more cheaply than you can borrow overnight, then surely assets which require 30 year financing (houses, LBOs, etc.) will rise in value.

    If yield curves steepen, I reckon the market will inherently choke off inflation, regardless of where fed funds is.

    Now suppose we look at QE and the Fed’s attempt at keeping the long end tight. As far as I understand it…two different agencies of the US govt are engaged in the transaction. Treasury sells 2T of bonds to finance its stimulus. The Fed buys those bonds to keep prices high (yields low). The US is AAA but still has credit risk. Isn’t this the same kind of self-dealing which we are now accusing the banks of wanting to do? I’m not saying that we should allow the banks to participate in PPIP (we should not), and I’m not saying that QE is a bad idea (haven’t decided on this one), I’m just saying that our government is involved in a whole slew of programs aimed at artificially inflating asset values by some form of self-dealing. This helps prevent debt-deflation…but you can be damn near sure some pretty nasty inflation is around the corner. (Luckily, I’ve got a whole pile of student debt amassed during the credit boom, so inflation sounds like a dream to me).

  5. Minor technical correction: 30-year mortgage rates correlate more highly with 10-year Treasuries than with 30-year Treasuries. Enough people pay early (refinance) that the effective duration of the average mortgage is closer to 10 years than to 30. This does not affect your point, of course.

    As for inflation sounding “like a dream”, it will help with those student loans only if it shows up in your income. ($4/gallon gas, for example, is unlikely to be helpful.) Good luck with that when unemployment hits double digits.

    In my opinion, our government and central bank are playing a very dangerous game of “Keynesian Roulette”.

  6. I remember Paul Krugman saying in his analysis; Japan needed to make fears of inflation credible in order to jump-start the demand. Aren’t we in the same situation? If so, then possibility of inflation near term is not so bad, right?

  7. Van Hoisington and Lacy Hunt are two economists/fund managers whose views I have been following since about 2002. Their most recent quarterly commentary is entirely devoted to the question of inflation vs deflation. I highly recommend it to anyone interested in this question:

    Click to access HIM2009Q1NP.pdf

    One should pay attention to them because they are not late to the deflation call. Their conclusions are not new. They were among the very few consistently calling for lower inflation if not outright deflation over the last ten years and made a lot of money for their investors by keeping them out of the stock market and in long dated treasuries. Most impressively they continued to call for lower yields (higher prices) on 10 and 30 yr treasuries before, during and after Greenspan’s “conundrum” (Wow, doesn’t that seem like a long, long time ago!)

    For the record I am not an investor in any of their vehicles although I wish I had been.

  8. The paradox is that both of the brazen acts you cite are more or less transparent. This is what makes the US different from a true banana republic – you can actually publish the details of this stuff and still get away with it, at least until proven otherwise

  9. Yhey’ve got a Bank Boy in the White House. A few scolding words and then the hands go right back into the cookie jar.

  10. Thanks Nemo – didn’t realize about the shorter duration on mortgage bonds.

    As for “Keynesian Roulette,” its probably true. Except that there 5 bullets in the chamber: 1 for deflation, and 4 for massive inflation. And they’re trying to convince us that they can beat the odds…

    Though, (and this just occured to me), sparking inflation is probably the single most comprehensive method for wealth transfer out there. Lets assume poor people are more likely to have debt, and rich people more likely to have saved. We all know that inflation benefits the indebted and screws over those with savings (ceteris paribus). Thus, a period of inflation essentially allows poor people to get richer, and rich people to get poorer in real terms. Is this a good thing?

  11. This is just one more straw on the Camel’s back of zombiehood for the banks. But, yahoo, let’s get as much of it as we can, for as long as we can, and make sure to keep the funds flowing to the red herring and smoke screen Excuse Department. By the way, “did we remember to pay the guys in ED the REALLY big bonuses for their excellent work. Who needs lobbies, when you got Summers? He’s our “hero mole” in the White House, and may not even know it. But we trained him well in “institution think.” Etcetera, etcetera….

  12. I think this is precisely what the Federal Reserve is up to. They have to frighten people enough with their “irresponsibility” to make out of control inflation seem more possible to alter expectations. There are people that are worried that once inflation emerges there will be no way to tighten and it will get out of control. However, the Fed recently received authority to pay interest on reserve deposits. This is an under-appreciated and powerful new tool they can use to rein-in lending. They can raise the interest rate paid on the reserve deposits as high as needed to keep new money creation by banks (loans) from exploding. A less blunt tool than raising the federal funds target which would have been needed previously.

    However, that all said, I’m still of the opinion that debt deflation is the greater likelihood and it will prevail because businesses and consumers are going to be obsessed with paying off debt and the *demand* for those loans isn’t going to be there. IMO, the only way we get out of this is to *enhance* the ability for businesses and consumers to clean up their balance sheets, not *worsen* them.

  13. We have already seen that the banks have no instinct for self-preservation whatsoever. While that may have been merely our of ignorance pre-2008, it has now been codified, and the moral hazard trap is well and truly upon us. There is no indication, anywhere, that any behavior by the banks will lead to significant peril – not reprimand, not bankruptcy, not nationalization, nothing.
    With a government guarantee of absolutely no downside, who in their right mind wouldn’t grab all the cash and power they could? It’s human nature.

    As for social tone-deafness, these folks surround themselves with people like themselves. They don’t care what the general public thinks, because they don’t interact with, or answer to, that group. The death threats against the BoA/ML bonus recipients a few months ago was the only thing that even slightly punctured this bubble, and that only resulted in a whiny NYT op-ed by a guy looking for pity because he could afford to give his $750k bonus to charity.

  14. @Nemo

    Team Obama is at risk of losing the game of Keynesian Roulette because of their prefered mechanism for injecting printed money back into the system – bank subsidies. The govt. needs to create moderate inflation by injecting cash into households to decrease debt levels (both by slowly devaluing debt and also increasing spending power), not by subsidizing banks to expand credit. A little wage pressure would be a great thing right now, particularly if it’s in some non-finance sectors that serve worthy purposes.

    Unfortunately, Team Obama (aka “Larry Summers and Friends”) is utterly obsessed with reflating the monetary supply by re-expansion of credit (ignoring the fact that household debt remains well above historical inflation-adjusted norms even though real median wages have been flat for decades).

    With re-expansion of credit solidly established as Mission One, Team Obama now observes that banks are still hoarding reserves. Confound it! How did that happen?

    In their paradigm for understanding this crisis (it’s a liquidity problem), the hoarding is bad and unnatural. Conventional explanations (consumers are rationally saving more at long last, and credit-worthy borrowers aren’t eager to lever themselves up) are dismissed as small-minded. Observations by millions of Americans who are still being actively courted by healthy banks are ignored.

    Instead, Team Obama insists banks are hoarding because they have bad assets on their books, and those assets need to be “taken off the books”. Except they’re not bad, just liquidity-challenged.

    So, the solution? Force-feed money into banks as fast as we can, and with so much cash, banks will feel better about their liquidity position. These good feelings will magically translate into a vast increase in credit expansion which will magically drive increased consumption.

    In Team Obama’s defense, they have identified financial sector stabilization as only one pillar of their plan. It’s clearly the favorite pillar, however, judging by the attention and financial it’s been receiving.

    Financial stabilization is indeed necessary, and previous efforts have all been reasonably defensible due to a system in shock. The consequences of meltdown were unconscionable, and our moral anger at behind held hostage did not change the fact that banks and bond markets had a gun pointed at our head.

    That is no longer true.

    Policies in the next few months will finally provide an acid test of where this administration stands. We’re not longer hostage to bankers. But is Team Obama suffering from Helsinki Syndrome?

  15. The Bilderberg Plan for 2009: Remaking the Global Political Economy

    After the meetings finished, Daniel Estulin reported that, “One of Bilderberg’s primary concerns according to Estulin is the danger that their zeal to reshape the world by engineering chaos in order to implement their long term agenda could cause the situation to spiral out of control and eventually lead to a scenario where Bilderberg and the global elite in general are overwhelmed by events and end up losing their control over the planet.”[3]

    Bilderberg investigative reporter Daniel Estulin reportedly received from his inside sources a 73-page Bilderberg Group meeting wrap-up for participants, which revealed that there were some serious disagreements among the participants. “

    Estulin reported, “that some leading European bankers faced with the specter of their own financial mortality are extremely concerned, calling this high wire act “unsustainable,” and saying that US budget and trade deficits could result in the demise of the dollar.”

    One Bilderberger said that, “the banks themselves don’t know the answer to when (the bottom will be hit).” Everyone appeared to agree, “that the level of capital needed for the American banks may be considerably higher than the US government suggested through their recent stress tests.” Further, “someone from the IMF pointed out that its own study on historical recessions suggests that the US is only a third of the way through this current one; therefore economies expecting to recover with resurgence in demand from the US will have a long wait.” One attendee stated that, “Equity losses in 2008 were worse than those of 1929,” and that, “The next phase of the economic decline will also be worse than the ’30s, mostly because the US economy carries about $20 trillion of excess debt. Until that debt is eliminated, the idea of a healthy boom is a mirage.”[9]

    More reveals – see article link

  16. The point to me is that all this excess expense comes from the customers, individually and collectively. We are each getting squeezed like an orange. My American Express travel account balance interest rate has been raised to 28.99%. I have been turned down for a car loan at my bank. I have been cut back from full time to part time at my job.

    Finance is like that lamprey that is attached to the whales jugular vein. The host and the parasite relationship. Cannot get rid of it, forced to tolerate it. I am waiting for someone, anyone to destroy the leach. It’s not going to be Obama, …. maybe it will be the Chinese? At this point I really don’t care what periphral destruction occurs in its wake. How could I personally be affected any worse than I already am. Starve the host almost to death to kill the disease. Why not?

  17. StatsGuy: ¨(ignoring the fact that household debt remains well above historical inflation-adjusted norms even though real median wages have been flat for decades)¨

    I think it´s the other way ´round: real wages have been flat for 3 decades, and even declined during the last/current one. Initially, this was handled by taking on additional jobs and going from 1 to 2 incomes per household. When that wasn´t enough, people started to pile on credit card upon credit card debt, and using house as ATM.

    These latter 2 methods were assured to end in tears: spending future income and consuming capital gains from real estate investment BEFORE selling the house, i.e. before realizing the profit.

    Now many people realize there may not be a future income, and the housing profit was an unrealized paper profit.

    If only people had demanded livable wages and realized that one better saves before one spends.

  18. It makes all the sense in the world to put compensation limits on recipients of federal funding. The argument that “they’ll go somewhere else” if their compensation is reduced is silly.

    We have a weapon in our hands – a weapon that can be used to help the bankers understand their compensation structure has sucked out capital from the economy like the very best Dyson vacuum cleaner.

    That weapon is the fact that there really is no other industry (at least as far as I know) where people can make the unimaginable sums of money that investment bankers have been making over the last few decades. They have no other place to go to make the kazillions they need to survive.

    And think about it – if compensation in finance had to become more in line with compensation in other industries, perhaps these brilliant innovators would move out of finance and and into industries where they can innovate some products that actually help other people instead of rob them blind.

  19. Coffee Boy, while inflation may seem to benefit the poor at the expense of the rich, it didn’t work out that way in Latin America. The rich know how to protect themselves, including sending cash offshore, while the poor see wages not keep up with inflation. Consider, also, that owners of assets may benefit from inflation, and who owns most of the assets?

  20. That’s true, but only because in those instances inflation went hand in hand with a currency crisis. If you were wealthy, you were more able to get out of your useless domestic currency and into something stable like USD.

    When there’s rampant inflation in the US, there are few alternatives for people to hide their assets in. And while many wealth jet-setters may no-doubt switch into EUR or something else, given the largely domestic nature of our wealth (created by and kept within america), it is likely to hurt the rich.

    I’m not saying hyperinflation is a good thing…we all know that because of sticky wages, it could cause problems. However, moderate inflation above trend (somewhere between 3 and 5%), would be quite useful. The question is can this inflation be capped at our “comfortable” level? Also, if we don’t get a wage/price inflation, but instead inflation of another form, (low rates caused a housing bubble…another form of inflation), will we be smart enough to see it and do something about it?

  21. “C / BAC have already lost a lot of senior people and they may see themselves as being in danger of falling apart from the inside”

    I think it is a fallacy to automatically equate “senior people” with competency. In the case of the bankwrecks, we have good cause to think otherwise.

  22. the good people are going to find a way to get paid well, even if it means leaving.

    in addition, some people who aren’t very good get paid well.

  23. Interesting brief, thanks for the link. The part of their argument that i don’t follow, though, is where they say government deficits aren’t inflationary. Are they saying that’s true because we’re in the flat (perfectly elastic) part of the aggregate supply curve (and therefore we can pump up demand within limits without testing the limits of available capacity & therefore not generating a response in aggregate supply); or are they saying that government deficits crowd out private investment even in deflationary environment? The former makes some sense alongside the rest of their argument, but they seem to be making the latter argument (“government debt will weaken the private economy”) and that seems to fly in the face of the rest of their economic theory. Am i missing something?

    What they don’t say, but what i think their argument strongly suggests, is that (a) because the primary obstacle to recovery is the low velocity of money, and (b) because velocity is depressed due to the fact that American consumers as a group are ‘poorer’ i.e. so many of our assets have depreciated while our debts have not, then (c) one of the primary strategies for getting us out of this mess sooner rather than later should be accelerating the pace of write-downs on those debts. I think that’s the fatal flaw of the Geithner strategy at this point: he’s emphasizing better capitalization for the banks, which will lead them to hold out longer for something close to the nominal value of the debt instruments they’re holding – the gambler’s strategy of keep rolling & hope for a miracle. That’s why something along the lines of facilitated reorganization of the big banks – with a receiver cutting them down to size, writing down their more troubled assets & handing them over to a ‘bad bank’ for resolution – is what’s so sorely needed right now.

  24. I really like StatsGuy’s analysis above talking about Team Obama. I am an Obama supporter and all my family voted for him. But I am starting to wonder about his leadership skills a little. You have a guy traipsing around America now going “Hey folks, look!! I got a female/hispanic from a poor background nominated for the Supreme Court!! Lets all get giddy now!!!” Meanwhile the banks are robbing us blind with housing foreclosures, inflated(and increasing) base salaries for bank executives, higher credit card rates (even if you’ve paid your monthly balance religiously), and making requests to the FDIC for what amounts to unarmed robbery in broad daylight. All this while at least 4 states are in double digit unemployment. I think it’s great Sotomayor was nominated. Wonderful!! But when it’s a FOREGONE CONCLUSION she’s going to get the appointment, I don’t see how having pep rallies about it are a useful way for the leader of the free world to spend his time.

  25. Thanks for the Bilderberg link. I’m reserving judgment until the Knights Templar and the Elders of Zion weigh in.

  26. Coffee Boy: “Though, (and this just occured to me), sparking inflation is probably the single most comprehensive method for wealth transfer out there. Lets assume poor people are more likely to have debt, and rich people more likely to have saved. We all know that inflation benefits the indebted and screws over those with savings (ceteris paribus). Thus, a period of inflation essentially allows poor people to get richer, and rich people to get poorer in real terms. Is this a good thing?”

    I think that the poor, if they have debt at all, mostly have short term debt that is not much affected by inflation. Borrowing against the next pay check, for instance. Pawn shop debt is longer term for them.

    Aren’t the main beneficiaries of inflation as a class the middle class, who have mortgages, student loans, debt for small businesses, and credit card debt?

    It is different, I expect, in places like India, where you have people who are essentially indentured servants, paying off their grandparents’ debts of a few hundred rupees, and in places with tenant farmers and workers who “owe their souls to the company store.”

  27. Resistance is not futile. Unlike long-term welfare recipients, I’m guessing that these financial moguls have both faces and reputations they might wish to protect.

    So rather than throwing your arguments at straw men, why not set up a “Wall Street of Shame”, providing a list of names for those responsible?
    If you’re worried about being sued, then just provide me with the list. I’m not scared of the financial bogeymen or their lawyers :) They’re beneath Scientologists at this point.

    Obviously, we’re at the mercy of our elite ruling class, who are in turn showing us absolutely no mercy. So given the bankers have no sense of honor, maybe it’s time we started holding them personally accountable for their actions.
    Normally, I’d agree that unleashing mobs is a VERY bad idea – but in this case, fear of that group dynamic is really the peoples’ only protection. No one else is going to save them.
    To cut to the chase –
    I’m perty sure Billy Bob ain’t got NO problem whatsoever drivin’ his pickup truck up to NYC and opening up a can of whoop ass on some bankers. Just tell him WHO stole Momma’s life savings – give him a name.
    I hear tell he’s awful angry about them thievin’ bastards – and with every passin’ day, well he’s just gettin’ more and more burnt up ’bout it.

    Or are we still operating under the pretense that we live in a civilized society? :) Please…

    Apparently the banker is free to strip away Billy Bob’s mama’s life savings – with absolutely no fear of retribution. And not only is the banker free to raid Mama’s cookie jar, but he’s throwing Billy Bob’s unborn children deep in debt. And you know how Billy Bob feels about his unborn children… :)

    Contrary to their own belief, these bankers are NOT smart people – otherwise, we wouldn’t be in this mess. They only happen to have more money, simply because their social standing placed them in a position to steal money from people of “lower” class. How condescendingly convenient.

    So let’s play this out. Eventually, Billy Bob’s blood is gonna boil over to the point he’ll show up at my door (or your door) seeking retribution. And personally, I’d prefer to steer clear of him. I didn’t hurt him or his mama. So let’s just toss everyone’s cards out on the table and let it ride.

    Because, apparently, the longer we pretend to be “civil” about any of this, the worse it’s going to get. And again, I’d much prefer that those responsible faced the consequences of their own actions. Else it’s eventually going to fall on me.

    And given the Billy Bobs outnumber the William Roberts by a staggering margin – I’m guessing they’ll sort all of this out amongst themselves in short order.

    Then we can all get back to dinner and stop worrying about this mess. If anyone’s got a better solution, let me know :)

  28. That ‘s a great article be Hoisington.

    It is my believe there is going to be a bad mix of deflation and inflation.

    Interest rates are rising because the Treasury must unload a huge amount of debt. ( $900 billion by September). The 10 yr yield has moved from around 2% to 3.71 % yesterday. If the market is already resisting the $100 billion in US debt this week, how is the market going to respond to $2 trillion in debt and trillions in debt down the line?

    I think it is safe to say not well. Therefore, the dollar is going to be devalued because at some point the Fed will resort to printing money. Literally- the Fed buys the Treasury’s debt. It has too. This will cause foreign products, good and services to inflate in dollar terms.

    But at the same time the higher interest rates will doom the recovery and the demand for domestic products will decline causing the price of domestic products to decline.

  29. Simon,

    You seem to (as always) have an amazing understanding of the obvious. Tell me, what are you prepared to do about this corruption?


  30. 2big2fail is a real problem… how can you hold people accountable when they just push the envelope cuz thats where they live… fantasy land

  31. Inflation would be disastrous for the poor and working class. With real unemployment (underemployed-discouraged and self employed workers with no work) rate hovering at 15%, there is no pressure for rising labor cost.

    The combination of stagnate wages and rising cost for basics; food, shelter, medicine, etc would not help those who live paycheck to paycheck.

    I suspect the next new federal program in 2010 will be a modern WPA. People have to have jobs and the private sector will not be creating them.

  32. Coffee Boy: “[The rich in Latin America protected themselves], but only because in those instances inflation went hand in hand with a currency crisis. If you were wealthy, you were more able to get out of your useless domestic currency and into something stable like USD.”

    The rich can protect themselves from inflation by purchasing things like real estate, jewelry, art, and commodities. They do not need liquid investments.

  33. And perhaps entering the dangerous waters of inflation to top it up you insist on navigating blindfolded having no idea of where for instance the interest rates for the 10 year US bonds would be without the quantitative easing of the Fed, and without the truly mindboggling zero capital requirement for the banks when they hold such public debt.

  34. Pete, with all due respect, I disagree with your comment above. Specifically, “these corporations might have become so complex that the top level management simply doesn’t know who they should keep and who is worth what. This can easily happen in an M&A environment, which these banks clearly have been in. and this isn’t a problem which sorts itself out.”

    These firms are simple: There are multiple trading desks — dealing in everything from Pakistani Rupee to crude oil and bio-diesel — that have to be able to buy from customers below the bid in the traded markets, or sell above the traded-markets offer. This is how the banks make their money: they retain the margin between where they take a position vs their customers, and where they can immediately unwind it. It does not matter if we’re talking about FX or CDO or MBS — the basic idea is to know at all times where the traded market actually clears, then find customers who don’t have that immediate information and arbitrage the difference.

    Of course, there will be residual positions (you can’t always unwind immediately), which is why the banks create “risk-management” functions. These are the folks that create the models that allow the banks to tell their regulators what their exposures are. They also, btw, are the functions that allowed the former investment banks to tell their regulator (the SEC) what the value of their assets are.

    That’s where it starts to get complicated: The banks have demonstrated they have no idea of how the residual risk behaves. Not to worry: It still doesn’t prevent them from loading up on more and more risk, based on the “risk-management” models they’ve developed. Wait a sec … I see myself creating an absurd universe in which nothing is understood, but I’m still allowing the absurdity to proceed unabated. It’s crazy. Pretty soon I’ll need to create a “sink” where all the mistakes can be dumped — maybe I’ll call that sink taxpayers … oh, I’m becoming too obvious. G2G

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