Too Big To Fail, Politically

What is the essence of the problem with our financial system – what brought us into deep crisis, what scared us most in September/October of last year, and what was the toughest problem in the early days of the Obama administration?

The issue was definitely not that banks and nonbanks could fail in general.  We’re good at handling some kinds of financial failure.  The problem was: a relatively small number of troubled banks were so large that their failure could imperil both our financial system and the world economy.  And – at least in the view of Treasury – these banks were so large that they couldn’t be taken over in a normal FDIC-type receivership.  (The notion that the government lacked legal authority to act is smokescreen; please tell me which statute authorized the removal of Rick Waggoner from GM.) 

But instead of defining this core problem, explaining its origins, emphasizing the dangers, and addressing it directly, what do we get in yesterday’s 101 pages of regulatory reform proposals?

  1. A passive voice throughout the explanation of what happened (e.g., this preamble).  No one did anything wrong and banks, in particular, are absolved from all responsibility for what has transpired.
  2. A Financial Services Oversight Council, which sounds like a recipe for interagency feuding, with the Treasury as the referee and – most important – provider of the staff.  The bureaucratic principle is: if you hold the pen, you have the power.
  3. Some of the largest banks (“Tier 1 Financial Holding Companies”, or Tier 1 FHCs) will now be subject to supervision by the Federal Reserve Board – although under the confusing jurisdiction also of the Financial Services Oversight Council in many regards (e.g., in the key setting of material prudential standards) and subsidiaries can have other regulators.
  4. Tier 1 FHC should have higher prudential standards (capital, liquidity and risk management), but “given the important role of Tier 1 FHCs in the financial system and the economy, setting their prudential standards too high could constrain long-term financial and economic development.”  Sounds like a banker drafted that sentence.  None of the important details/numbers are specified, although the Fed should use “severe stress scenarios” to assess capital adequacy.  Is that the same kind of actually-quite-mild stress scenario they used earlier this year?
  5. In terms of risk management, “Tier 1 FHCs must be able to identify aggregate exposures quickly on a firm-wide basis.”  There is no notion here that risk management at these big banks has failed completely and repeatedly over the past two years.  How exactly will FHCs be able to identify such risks and how will the Fed (or anyone else) assess such identification?
  6. In case you weren’t sufficiently confused by the overlapping regulatory authorities in this plan, we’ll also get a National Bank Supervisor (NBS) within Treasury.  Regulatory arbitrage is not gone, just relabeled (slightly).
  7. There is no greater transparency or public accountability in the regulatory process.  We still will not know exactly what regulators decided and on what basis.  Such secrecy, at this stage in our financial history, clearly prevents proper governance of our supervisory system.
  8. There appears to be no mention that corporate governance within these large banks failed totally.  How on earth can you expect these banks to operate in a responsible manner unless and until you address the reckless manner in which they (a) compensate themselves, (b) destroy shareholder value, (c) treat boards of directors as toothless wonders?  The profound silence on this point from the administration – including some of our finest economic, financial, and legal thinkers – is breathtaking.

There’s of course more in these proposals, which I review elsewhere and Secretary Geithner’s appearances on Capitol Hill today may be informative – although only if his definition of the underlying “too big to fail” issue uses much stronger language than yesterday’s written proposals.

But based on what we see so far, there is little reason to be encouraged.   The reform process appears to be have been captured at an early stage – by design the lobbyists were let into the executive branch’s working, so we don’t even get to have a transparent debate or to hear specious arguments about why we really need big banks.

Writing in the New York Times today, Joe Nocera sums up, “If Mr. Obama hopes to create a regulatory environment that stands for another six decades, he is going to have to do what Roosevelt did once upon a time. He is going to have make some bankers mad.”

Good point – but Nocera is thinking about the wrong Roosevelt (FDR).  In order to get to the point where you can reform like FDR, you first have to break the political power of the big banks, and that requires substantially reducing their economic power – the moment calls more for Teddy Roosevelt-type trustbusting, and it appears that is exactly what we will not get.

By Simon Johnson

116 thoughts on “Too Big To Fail, Politically

  1. And no mention of the re-imposition of the Glass-Steagall prohibition on deposit and investment banking under one roof. Just what I would expect from Larry “DE Shaw” Summers.

  2. “…he is going to have to do what Roosevelt did once upon a time. He is going to have make some bankers mad…” unfortunately, when you make some bankers mad, they tend to engage in right-wing conspiracies to overthrow your government, as they did FDR’s. Maybe that is the historical model the Obama administration is drawing its “wisdom” from.

  3. 3rd paragraph – sounds like he blames the regulatory agencies for not regulating the banks. i guess when you put your people in charge of the agency that regulates you, it’s the gov’t’s fault.

    he continues on into the next paragraphs blaming the regulators for not exercising their power or not having the motivation. So I would expect this proposal to give the regulators tons of power over the banks, right?

  4. Simon, here is a one page plan to motivate good behavior by the lending industry. The major ingredients in the plan, 1) the retention of a stake in a loan and 2) transparency, are well known; however, what I believe is different are the way they are applied. While the plan is not applicable to all situations nor a substitute for regulation and consumer protection, I believe it could be an effective tool to promote good loans, particular good consumer loans. (Some of the operations of Fannie Mae and Freddie Mac come to mind.)

    I should warn you that I am a psychologist, not an economist. I do not have nearly the economic expertise of those who use this board. Nevertheless, economists like psychologists are also students of behavior; they just specialize narrowly and deeply in human economic behavior so you may find my suggestions relevant.

    Finally, if this form fails to reproduce the one-page plan adequately, I would be happy to send it as a MS Word document, if you supply an email address.

    Bob Elmasian

    Motivating Good Lending During a Recession

    Suppose the government funded lending institutions at the cost of inflation to make loans under the condition that they be held responsible for the outcome of a loan until its completion. As usual, a lender would decide the terms of a loan and whom to offer a loan in competition with other lenders. If the loan made a profit, the lender would profit. If the loan makes a loss, the lender would eat the loss, just as if it had used its own funds. Lending institutions own profit motive would drive lenders to make as many good loans as possible and to avoid bad loans.

    Because loans can take many years to complete, the government could pay lenders prorated profits each year a loan performs. Lenders could borrow against an anticipated profit stream in future years, buy private insurance against loan failure, sell loans, repackage loans in bonds, and even put loans in derivatives. Loans could enter virtually all the financial instruments now in use. The one thing that would not be allowed is to remove the originating lender’s responsibility for the outcome of a loan. If, for example, insurance or a loan buyer did not cover the losses of a failed loan, the loan originator would be held ultimately responsible for the uncovered losses. Using government funds, loan originators able to make good loans should do very, very well; loan originators making bad loans will suffer.

    Also suppose every quarter loan performance was reported on the Internet, not only for each lending institution but broken down for individuals originating a loan and the chain of individuals supervising loan originators up to CEOs. The simplest metric of good lending would the profit or loss produced, but other measures could also be posted. Loan dollar days (DD) provided by the government broken down into DD outstanding, DD repaid, and DD in default is one such measure. The purpose would be to make it obvious to everyone which lenders are applying government funds well and which are not, again motivating good lending.

    Banking experts will see complications in implanting the above plan. For example, they will probably want to tweak the interest costs to lenders below or above the cost of inflation, depending on how much lending they want to encourage. Experts will also want to ensure that only reliable lenders participate. No one should let loan originator Sam loan his uncle Joe $20 million of the taxpayers’ money and then go laughing into bankruptcy. Obviously other implementation details also will have to be handled, but this is not the place to elaborate.

    The proposed plan targets lender motivation and rewards lenders for making good loans. Control is bottom up and profit driven; lenders who understand their clients decide what loans make sense in terms of their own bottom line. Societal and lender self interest are aligned. Potentially, except for administrative costs, the plan is revenue neutral, low risk, and politically more palatable than other programs such as TARP. While the proposed plan does not substitute for government spending needed to save critical institutions or for things such as infrastructure and research, it is likely to inject more money in more good places than most alternative methods[i].

    [i]Although this plan to motivate lending was developed from the perspective of cognitive, operant, and social psychology (I am a psychologist.), economists might see a similarity to the Grameen Bank. Let G = Government/Grameen Bank; I = lending institution/individual; P = press & public/peers; then for both this plan and the Grameen Bank, G supplies funds for I to use as I sees fit under the condition that I return the funds with interest. Meanwhile, P regularly applies encouragement or social pressure, as necessary.

  5. Oh Simon, you’re kidding me, right? I haven’t had a chance to glance over the document – are they really saying that the financial community is blameless?

    We do need the Rough Rider right now. TR left his presidency proud of the fact that his administration would be known as “an administration of ideals.” He went after the banks and the trusts early in his presidency – and was reelected resoundingly afterwards. (Errol Morris’ Theodore Rex is a great read about this man during his presidency.)

    The difference in how the feds handled the automakers compared to how they handled the financial community tells me that Obama was wrong back in 2004. We are not THE United States of America – we are but two states – and they are not divided up into the bright colors of red and blue. The Two States of America consist of those who have power and money – and everyone else….

  6. Simon, you argue that the reform process appears to be have been captured by lobbyists at an early stage. You are wrong. Politicians in both the executive branch and Congress have been always in charge of the financial system–before, during, and after the crisis. They are selling protection to anyone interested in providing financial services (as well as other goods and services). You should analyze regulations as conditions for protection.
    By the way, you have never mentioned any politician in your posts–do you need a list?

  7. “please tell me which statute authorized the removal of Rick Waggoner from GM”
    The same one that authorizes the government to give taxpayer money to private companies to cover shortfalls in operating expenses. The government did not “remove” Waggoner, they only made it a condition of the loan. GM could have declined the money and kept Rick, no problem. Are you saying that the government can’t provide conditions on its loans?

    A quote from the USA Today story you reference:
    “In a statement, Waggoner said that administration officials asked that he “step aside.” Yes, they “asked,” which is completely legal.

  8. I think “regulate” should mean what it does in the classic rap song of the same name. If someone (Citi, Countrywide) misbehaves or steals [Warren G’s] property, a regulator [Nate Dogg] will enforce justice, harshly, and restore stability [car full of girls].

    I see the Obama administration speaking softly — Where is the stick?

  9. Was there any mention of how the Credit Rating Agencies should operate (specifically who should pay them)? I thought that was a crucial issue too.

  10. I agree. The plan is a list of causes, with no prioritization, which gives an interest based solution for each cause. By interest based, I mean a plan that sacrifices simplicity and logic in order to leave everything in the system more or less intact, and all of the players still sitting at the table. It does appear that the underlying assumption is that, since we have avoided a Debt-Deflationary Spiral and Social Disturbances, this crisis has not been awful enough to rethink the foundations of the financial system. My solution, going nowhere, would be a Narrow Banking/Investment Services split, with the following principles:

    If it’s guaranteed, it has low innovation.

    If it has high innovation, it’s not guaranteed.

    We want a structure that doesn’t permit the non-guaranteed to infect the guaranteed.

    This plan does not address Too Big/Powerful To Fail at all. Maybe the plan is realistic, and assumes that such businesses will always exist in our system.

    As Justin Fox says, where regulators are concerned, the plan is a model of Wishful Thinking. The plan oozes lax enforcement going forward in time. It’s just a matter of time before we are easing restrictions because conditions have changed. Fox gives us decades. I don’t think that it will take that much time.

    So, bottom line, just like the S & L Crisis, it leaves Implicit Guarantees and Too Big Too Fail intact, and adopts a wishful thinking attitude towards regulation. It does provide many improvements, and so it’s worthwhile, even if flawed.

    The plan does promote an agency to deal with Fraud, Negligence, Collusion, and Fiduciary Mismanagement, which is a necessity. But, unless a serious investigation is done on these problems in our current crisis, the agency will have too much business to handle going forward. We need to develop a culture in govt that takes these financial crimes seriously, instead of always falling for The Stupidity Defense, in all it exculpatory guises.

    The fact that Fisher’s Debt-Deflationary Spiral almost occurred, even though we’ve known that allowing it to occur would be an enormous debacle since the Great Depression,tells me that our system is in bad shape, and that we should consider seriously Fisher’s proposals for a financial system that does not allow such a possibility.

    The solution to our crisis, QE and a Stimulus, were part of the 1933 Chicago Plan. It’s members also proposed Narrow Banking. It would be nice to at least consider their proposals. We needn’t construct a plan exactly like theirs, but we should at least consider some sort split system. I might also suggest that, if it’s innovation you crave, then only such a split system will allow real innovation going forward. Instead of real innovation, our current system, and the one being left in place, is largely concerned with avoiding the rules, not innovation.

    One final point: I believe that we should focus on what allowed Debt-Deflation to occur, and how it can be stopped. Under the plan proposed, we are really left with an implicit govt guarantee under the entire system, as we were in this crisis.

  11. Rockfish, I don’t think Simon was criticizing the removal of Waggoner. I think Simon was saying if they could do it with GM then they could ALSO do it with leaders of the banks that had acted irresponsibly.

  12. You are right in many respects, E.

    However, the immense money of Wall Street has definitely tilted the playing field in their direction. How else can you explain the insane lessening of investment bank capital requirements? There is a reason why 40% of the profits of those companies on the big board went to investment banks. It is called undue influence.

    One of the earlier commenters thought this game was a rich versus poor struggle. It is not. It big vs. small.

    The big fish have often rigged the game against the little guys. That is why Big Business embraced the Sarbanes Ox. They could comply, the little guys not so well. Heavy regulation and regulatory obstacles to market entry increase the bigs market share and decreases the likelihood that some start up will create a product market that upsets the bigs applecart. That is why the Bigs often support the Democrats.

    IPO’s under our Dear Leader have gone to near zero. That takes care of a threat to the bigs nicely. Job well done, Buraq. Now we don’t have to worry about America’s innovations dominating the world anymore. You know we just have to stop being that evil world Superpower thing. NRO had a post recently on how all those Silicon Valley start ups that who enthusiastically supported the One and are now feeling the pain of backing a marxist.

  13. I understand that the proposed changes eliminates the thrift institution? What exactly does this mean and what is the potential impact? What advantages do thrifts currently enjoy over banks and what restrictions on their activities have been put in place? Does this mean that banks (sorry – financial institutions) are to be the sole source of mortgage debt?

  14. TR and FDR were both heroes for America. My father was born in 1927 and he believes FDR was our greatest president ever. I found this old film on a NYT Economics blog. Made in 1933. The writer (Catherine Rampell) says it’s a propaganda film, but I halfway wonder if it was meant to be a satire. There are 4 or 5 funny moments in the 10 minute film. When we watch this we might imagine what it was like to be FDR and have extremely high unemployment, and a nation depending on your decisions. Or we might chuckle at what life was like when America was more innocent. Remember if things get rough, you can fricassee a wolf at your door.

  15. King, Govenor of Bank of England just called for an English version of Glass-Steagall AND a cap on bank size!

    “As far as individual banks are concerned, we face some uncomfortable choices about the structure and regulation of our banking sector. If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure.”

  16. … OK, maybe he didn’t specifically call for Glass-Steagall, but he definitely thinks it should be considered. It’s a great speach anyhow.

  17. The times when it was still possible to curb the power of the wealthy are over. They have become exponentially more organized, sophisticated and subtle.

    It’s like watching tennis players in the 70ies and now. Players now are like powerful machines infinitely more polished than their predecessors.

    Game’s over. Just submit.

  18. The Plan does not require a close read and, probably, there will be tweaking, in future. But, it does nothing corrective. As Simon wrote some time ago, we are acting like a banana republic. It will get worse and the putrid leaching is flowing elsewhere. It’s the Supreme Court nomination of a “nice” lady from a “poor background” who believes competent white men shouldn’t be promoted, unless you find an incompetent minority candidate to pace alongside. It’s firing an Inspector General who disses your NBA friend, the mayor of Sacramento.

    Goldman Sachs rules the world and none of these “reforms” challenge that. Moreover, to the extent that the GS Masters of the Universe are worthy of multi-million compensation packages, what is the worth of the sycophants who dispense the largesse? Surely not a mere professor’s salary. A million dollar piece of property, perhaps? A bag of gold? Much, more more…?

    The changes coming to America greatly exceed the repercussions from the mere economic meltdown. “Mistakes were made,” there. Tut-tut. Other mistakes, being made every day now, are very much deliberate and active voice mistakes, intended to promote change.

    Is it possible for America to look like Zimbabwe? (Once upon a time I went to college with a brilliant, idealistic young man from Rhodesia. Remember Rhodesia? The young man would be old now, but is probably long dead.)

    I mentioned Jane Jacobs’ book, Systems for Survival, a bit ago. (I have always found it strange that a person which such an unassuming name could think and write so well, consuming minimal quantities of paper.) Another book of hers, five years old now, is Dark Age Ahead. She explains our preference for credentials, not education; the abandonment of science (follow the climate change priests); dissolution of the family and more. She has one chapter titled: Self-Policing Subverted.

    The time required to move from an age of enlightenment to a dark age is hardly an eye blink, a couple of generations and, then, no more computer chips, internet, cell phones, electric grids, or, even, Fiats.

    What Obama proposes will ripple far beyond our borders. China is selling Treasuries and becoming protectionist. Russia wants it to buy oil with rubles, dump the dollar.

    Yesterday’s WSJ had a wonderful article about Stanley McChrystal’s new plan to sustain military memory, experience, contacts, while rotating troops in Afghanistan. Reads like a good idea, but he’s a mere boy with a finger in the dike in the face of the forces pulling us apart.

  19. I think you and Joe Nocera capture it well – if the regulations aren’t making the banks mad, then they aren’t the right regulations. That’s probably true to some extent of all government policy.

    Everyone, whether corporate or non-corporate wants more than they ought to and thus unless you’re stepping on someone’s toes, you’re probably not doing your job.

  20. Between the DOMA report and this, I’m incredibly disappointed in Obama this week ( I was already disappointed with Geithner and Summers). And very worried that health care reform is going to be less than we need, too.

    We need to start pushing back on these issues that are important to progressives. I’ve already decided to tell the DNC to pretty much go to hell when they ask for support. I’m back to supporting those politicians who follow through on their promises.

  21. Until we hold Bernanke & Geithner and their thousands of subordinates accountable (punish) for their inept failure to prevent the crash & the stupid bankers accountable (punish) for their stupid investments with billions of other people dollars, everything else is just masturbation.

  22. Paul, all your examples support my point. If you want to do “big” business you have to negotiate with politicians to get protection against government officials and competitors as well as against some risks. Your Dear Leader and his comrades want to increase the price that big banks have to pay for protection, so big banks are trying to secure a larger benefit to pay for it. They are just starting to negotiate a new agreement to prey on all of us.
    My point is that Simon has completely left out from his analysis the critical, active role played by politicians in the financial system for many years (he relies on the old Stigler’s model of capture but this model is at best good to explain the behavior of bureaucrats). If you want to reform the financial system, first you have to reform politics. Remember what Willie Sutton said: That’s where the money is.

  23. What are you doing here when you obviously use the NYT for information. Liberals are so gullible.

  24. Your remarks are exactly what we need to be hearing from economic authorities right now. The political power of the phony “financial system” (drawing 40% of the nation’s paycheck) is breathtaking.

    It would be comforting if we hear this administration providing good arguments for the position the average person finds themselves in. A moratorium against further foreclosures and “cram down” of principal are so obvious that these should always be mentioned in every comment on economics made.

  25. With all the lip-service being paid to “Too Big to Fail” as being a bad thing; how is it that Blackrock – with its contracts with the FED is not being looked at? They are now the largest money manager in existance.

  26. OK. Thanks for that clarification.
    I would be very surprised if the same conversation did not in fact occur between the Administration and several banks. However, in the post-Lehman environment the bank could simply call the government’s bluff. Once you remove the threat of failure or nationalization there is no bargaining position. That was not the case for GM.

  27. Why am I surprised?

    When banks started failing in the last 19th/early 20th century, the scheme was creating a pyramid of important banks, less important banks, regional banks, community banks, farmers banks, etc.

    All they’re doing here is putting another level of banks higher than “important banks” calling them “Tier 1”. Forcing another level of the pyramid to keep the game going.

    We’re going to have more Federal Reserve banks than Tier 1 banks at some point, then we’ll get a 3-level Fed (we already have a 2-level fed with NY on top of all the others) as the next “fix” following the next deleveraging.

  28. It is clear that the best way to protect the Financial System and the interest of the US taxpayer begins and ends with transparency. In our history, the most prescient bellwether of an impending collision of human fallibility exacerbated by greed with man’s inability to see past his desire and man’s inability to anticipate the true result of his actions, IS the very moment transparency goes missing. If appearance is any indicator, the end-run front loading of Energy Policy we saw with Cheney and the Energy companies in the run up to the fuel crises, is making an appearance again, only in a new administration and with Wall Street front and center. Then as now, there are quiet a few ex-representatives of the industries they represent, pretending to represent the people as part of the administration.

    What is stunning is that the Financial Crisis is supposed to be behind us and yet it is clear that neither the Obama administration nor Wall Street get this. A ‘systemic meltdown’ was dodged and here we are whistling past the graveyard as though possessing no memory of ‘what just happened’. Increasingly I am of the mind that Bankers and this Administration have no concern with shareholder value nor protection of the tax payer. Why because transparency is the greatest single tool, in an arsenal designed to do away with market jitters and build confidence. Everyone has to know what they are getting and what the true upside is, or recent history entertained, if there is any real upside.

    The administration should have known something when the banks wouldn’t extend credit to each other. To me that said quite obviously, that they each knew the other to be a liar. That bankers can only feel safe to be themselves, sans any kind of meaningful oversight and transparency for the public demonstrates quite emphatically that the public is not a true concern. President Obama would do well to consider who he’s dealing with.

    I’ve seen many refer to a ‘lapse in judgement’ when speaking of Wall Street and the Financial Crisis. If you want to do what is best for all involved, then ‘lapse in judgement’ is appropriate. If however, you are a cheat and a thief, ‘lapse in judgement’ has no place on the tongue. The riskiest possible investments were not MISTAKINGLY labelled to appear the safest. How could they be, when they KNEW they were NO LONGER requesting Proof Of Anything for people requesting mortgages. They were actively MISLEADING everyone that asked, even other Banks and COUNTRIES.

    Wall Street exemplifies every trait common to criminality. Predilections towards lawlessness, as they advocate for as little oversight as possible; a desire to operate under the cover of darkness by assailing transparency at every turn; possess no conscience as they, knowing their policies yielded the poor results, will layoff thousands for a short-term fix and take a bonus for doing it and keep to their big spending ways while in the very throws of Systemic Collapse they co-created; all the while demonstrating a complete lack of appreciation for the gravity of their callousness, constantly repeating that this could happen to anyone and it can. Anyone who LIES in Banking! When all said and done, they can’t wait to get right back out there and right back at it. Heretofore; a hardened and career criminal.

    I say criminal in jest, but the traits they demonstrate are real, real dangerous, and leave real people really broke and really homeless. If there is no substantive and real change to the banking sector, this country will revisit this calamity again and perhaps sooner than later because the system will continue to be vulnerable for some time, but these guy’s don’t seem to show any desire to reform or hold themselves in check.

  29. Compare Administration’s moves to a game of Monopoly.
    Obama’s political capital is the $1,500 he got at the start of the game. His opponents (and sometimes allies) are the Congress, lobbies, industries, and the public. Some of these groups start with more than $1,500. Some of them have hidden resources and nasty surprises.
    — Should the administration put all its efforts into Park Place and Boardwalk? (Assuming that these are equivalent to the financial reform.)
    — Should they build on Green streets (healthcare coverage)?
    — Should they get quick wins on St. Charles Place, and up (domestic partner reforms)?
    — Should they do all of the above?

    Any Monopoly experts here to advise Obama? ;-)


  30. Fox, here’s the henhouse. We corvids get the leftovers!

    Seriously, what can anyone say to such a total failure of governance and democratic politics. Krawk!

  31. It has nothing to do with the NYT. Look up General Smedley Butler (wikipedia is but one source, but it’s part of the historical record), and how he turned down the right wingers who tried to get him to overthrow FDR. Wingnuts are so ill-informed.

  32. What is wrong with the financial system is not that some institutions are too big to fail although that surely is a problem.

    Rather the problem lies deeper.
    There is a staggering amount of corruption systemic in all levels of the financial system.

    Unless the crooks are destroyed there is no rational basis for confidence to be reestablished.

  33. Clearly, this ‘plan’ is worse then no plan. should something as tepid as this become ‘law’ and the deck chairs get moved around..then we will be worse off then we were before
    because we will have lots a moment in history when change might have happened while the pain was still obvious.
    real change would be met with the banks/brokerage houses taking the markets down…an ironic show of how powerful they really are.
    does anyone still believe that this tail is not wagging the dog? Do folks really believe that is is OK to have a tail larger then the dog..but somehow regulated?
    and so curious how the forces line up already…headlines in all the financial news outlets..”some say new regs are too tough, so say not enough” a set up to ‘compromise..the art of politics is the art of ‘what is possible’

    in this case..what is possible is worse then nothing at all..tepid nothings is not worth the effort…more power in the hands of the FED is not progress;

    not examining the issues of TOO BIG is the tell of the joke..of the smoke screen and mirrors. not creating clear separations of banks and brokerages is not progress at not seeing the problems as they exist, hence no solutions available…
    garbage in, garbage out.

  34. The aggregate failure of many smaller bank failures would also be “too big to fail”. I’m not sure individual bank size per se is really the problem here. I don’t understand the details but it seems to me that the underlying problem is that bank risk is getting shifted to the public. Banks should pay premiums for this rather generous insurance policy or abide by rules that minimize what essentially becomes our risk.

  35. donthelibertariandemocrat: “It does appear that the underlying assumption is that, since we have avoided a Debt-Deflationary Spiral and Social Disturbances, this crisis has not been awful enough to rethink the foundations of the financial system.”

    I think that you have hit the nail on the head.

  36. “The time required to move from an age of enlightenment to a dark age is hardly an eye blink, a couple of generations and, then, no more computer chips, internet, cell phones, electric grids, or, even, Fiats.”

    RIght on. Right on. Right on.

  37. Not so fast. The tenth amendment does not grant the power for the Feds to compete and run companies in the private sector. Conditioning the loan is just an end run and a strong arm. What is Ford to do? Are it’s rights equally protected? Hardly.

    Where is the legal limit in your mind of what the Feds cannot control? I don’t think you believe there is one.

  38. I’ve been reading and studying economics for 25 years. I don’t know about anyone else but I am just flat scared as I watch a system that, to me, is absolutely out of control and plunging ever farther down the same old road. In my late sixties, I find myself feeling powerless and helpless in spite of being, relatively, in a good financial situation.

  39. Adam,

    Well spotted. It was, indeed, a powerful speech and clashed with the views expressed by the UK’s Chancellor, Alistair Darling, at the same event.

    With London supposedly the largest centre for financial activity in the world, one wonders just what the hidden agenda was/is behind King’s words.

    Like the Chairman of the Fed, the Governor of The Bank of England does not make public statements that aren’t very carefully crafted.

    With the current Labour Government more or less dead in the water, and with the UK Opposition’s shadow Chancellor being surprisingly ‘sensible’ and highly likely to be The Chancellor in a right-wing Government in less than 12 months, this is very interesting politics.

    At least there is a glimmer of hope that somewhere in the Western world, the banks, and their power brokers, will be brought back under control.

  40. Thanks for the cogent overview, it confirms my suspicions about human nature, little has changed over the years.

  41. Wow! Baseline Scenario is 59 out of 100. The first
    handful are Big News and iPhone features. Number Two
    is not even in English. Wow.

    The problem, even today, is less 1984 and Big Brother watching over, but, more, Brave New World as the pre-
    programmed people-pods simply amuse themselves, uncaring
    about all, except their new iPhones.

  42. People of good will: The hero you are looking for is not the compromising Theodore Roosevelt, but Robert La Follette. Roosevelt initiated lawsuits that ended up turning monopolies and oligopolies into smaller big companies that were still oligopolies, with all the political pull and market power of a monopoly. (Thank you Joan Robinson.)Fighting Bob called for breaking up any company with more than 30% of market share. He also called for selective nationalization, e.g., the railroads. Note: T.R. does deserve credit for his advanced views on labor union recognition (under government regulation). What we need today is some serious trust busting, as Simon Johnson says; but the model for this is not TR. (See David Thelen’s excellent biography of La Follette.

  43. It seems to me that resuscitating Glass-Steagal would go a long way to putting risk back where it belongs (with the speculators on the Street), and to simplifying the challenges of regulation. You can’t correct a complex problem by adding complexity. Such renewed separation might even go a long way to resolving the “Too Big To Fail” problem (“Tier1FHC” – yukh). The argument that such a move would compromise the international competitiveness of the US financial community seems fallacious to me. The measure of world-standing is financial soundness, not leadership in excessive risk-taking. Let the US be an example of rectitude and responsible innovation, and let others fail if they wish. A sound currency (as the world would understand it) needs to be our prime objective now.

  44. While an Executive Director at the World Bank in May 2003 I told a workshop of some hundred regulators for all over the world “Knowing that the larger they are, the harder they fall, if I were regulator, I would be thinking about a progressive tax on size” and so I believe I have more right to talk about this issue than those who did not say a word about it while the large were seen as ever larger.

    And I tell you the too big to fail problem is peanuts compare to the problems brought on by the minimum capital requirements based on risk. Not one of these too big to fail banks would have put a cent in the problematic securities had these securities not been rated AAA and had the regulators not authorized minimum capital requirements for anything rated AAA. You worry about the bankers? That is understandable but you would do much better worrying about the regulators.

  45. Other than generally nodding my head in agreement with SJ and most comments (although there are a few things in the plan that deserve some bit of positive reinforcement), the most useful thing I can add is the hope that when Congress gets ahold of this proposal, it will strip Treasury of any primary oversight role.

    Treasury – like other executive agencies – is easily subverted by a President who is closely aligned to powerful financial lobbies (who fund his campaign). The Fed has more independent status, but that’s a lot of concentrated power. If Congress doesn’t want the Fed to have too much power, it can create another independent commission (with some degree of separation from the exec branch), with a board that has overlapping terms (6 governors with 6 year terms, 1 being nominated/replaced each year, with senate approval required for confirmation). Also, write into the law an anti-revolving-door provision.

  46. Also, it could write the law so that any change to financial regulation requires a 2/3 majority of the board to approve… That should make it slightly harder to undo prior rules/regs.

    Team Obama should favor this solution. They ought to be wise enough to know that they won’t always have a friendly face in the White House; one lousy President can do a lot of damage.

  47. I would add a couple of points to your analysis. First one of the policies TR promoted was the development of a proper civil service. This institution has been weakened in recent years. Reagan tripled the number of political appointees in the executive branch making regulatory capture much easier in this country than it had been and easier than it is in many other English speaking countries which do have a proper civil service. The obvious example here is Canada.

    Second even though big investment banks seem to pose more of a threat to democracy than smaller institutions part of the problem is the role of campaign cash. During the run-up to the savings and loan collapse S&L PACs financed candidates who supported cutting capital requirements for them. Regardless of whether or not these Congressmen and Senators understood what they were doing the effects were inevitable. Somehow we must reduce the role of money in politics.

  48. The most powerful, dumbist regulators I can think of are Bernanke & Geithner. I agree we should be worrying about them.

  49. No man made system is infallible,in fact all systems ,irrespective whether human or otherwise slowly disintegrate as the system eventually overgrows the regulatory mechanisms in place.And there is no regulatory system that can curb desire and therefore greed ,which leads to tweaking and fudging of results knowing fully well that eventually that the system will collapse as not all interlinked players are fudging or tweaking the finacial system. Suppose few played this game nd a few did not, we have a mountain of fancy lies piled on a very precarious point,a kind of inverted pryamid,tottering on the verge of collapse all the time.

    The answer is in multiple accounting, where every transaction is seperately entered,purely as outgoing and incoming without balancing and then mandatorily setting the inward and outward transactions between the two participants or between two internal transactions and creating pryamids will become impossibe,instead you have a fairly straight forward vertical system,up and down ,which does not deviate side ways.

  50. As usual, Obama was clear and straightforward in his speech about regulatory reform of banking. He’s about health care and education. Having to address the financial crisis and the insolvency of the car makers were pre-existing problems he has had to take up. He’s a believer in the power of free market economies to create wealth and well being. That was the preface. As regards the financial crisis, there were three major points. 1. Obama finds it intolerable that it crashed without advance warning, requiring emergency government assistance with people making decisions into the night. 2. He believes that financial innovations have overtaken regulatory regimes and are sometimes not understandable to those who create them. 3. He is sensitive to the depredations wreaked on consumers. Accordingly, recasting supervisory roles and enabling legislation will address the first. The requirement of a small bit of skin in the game is his solution to the second issue. Clear disclosure is the answer to the third. Why would anyone bother to resist it?

  51. Tax payers must wake up and say NO MORE to the banksters, same as they are doing in Iran, We the people should not and can not pay for their mistakes!! No More!!

  52. I feel betrayed by Obama. I just don’t get it. The moral outrage was so thick 3 months ago you could choke on it in the air, daily. We were ready to hang John Thain, Citibank shares were .84 cents, AIG was one spark away from being burned to the ground with the London Traders in it.

    An then…. a 30% stock market rally. Jim Cramer dancing the kabuki with his thumb in Obama’s eye. All is forgotten. The reptiles climbed out of the trenches, opened their checkbooks, made backroom promises and threats, and we wind up with a curly haired love-child like Geithner and a Tony Soprano freak like Sommers baffleing us with bull sh__. A page out of Alan Greenspan’s playbook … (the only page). It all blurs together and whooosh, clear over our heads. We are passified that our 401k’s weren’t going to $-0-. And the result is what we got today. A ridiculous rule book of fanfare that will mean absolutely nothing. Deja vue….. The Foreign Corrupt Practices Act (81) Sarbanes-Oxley (98). The Obama of Oz Act (’09). Pepole, realize, …. the lemmings (USA) are already over the cliff, in freefall, you have a few more years to eat, drink and be merry, because there is only one way this show can end….. Splat!

  53. Is GE too big to fail? Seems like the GE financial blackbox is bust and looking like GM and GMAC!!

  54. It seems with like history is repeating the year 1930. Big stock market moves up but with seriously eroding world and domestic economic climates. No more federal economic bullets left in the gun! Now only time will can be the cure, along with lots of pain.

  55. Is GE now too big to fail unlike GMAC and GE?

    The GE Financial black box is bust and only the Feds. can keep this company a float!

  56. Obama is just like Chance the Gardner in the movie Being There.
    Obama having never left the public dole, wonders through life saying strange and vacuous stuff, which many other dumb people perceive as profound and important! All the while bumbling along believing in his own simplistic reality and ignorance.

  57. Simon,

    I’m a huge fan of yours and deeply grateful for your good efforts on the crisis. But, it seems to me, your posts are getting increasingly shrill. Your comment about Rick Wagonner, for example, is neither informative nor relevant. The government was not seizing GM. One doesn’t need a “statute” to put conditions on granting a REQUEST for assistance.

    More to the point, it now seems that your only goal is to break up the big banks. To punish them for their mistakes. Anything short of that is truly awful.


    this seems to be the complement of the WSJ and Bloomberg who think that ANY restrictions on the banks will permanently harm the ability of the US to compete in the world (blah, blah, blah)….. Thus the Obama proposal is the end of capitalism…etc.

    Isn’t it possible that restrictions on lending practices, requiring anyone who securitizes loans to own part of them, and requiring all of the “tier 1” (read BIG) financial institutions to maintain large capital reserves might help?

  58. Check out Cdn banking system. No problems there at all but why would the US want to imitate regulatory success?

  59. I cannot understand why even you, Simon Johnson, refer to Bernanke, Summers, Geithner and other people who have consistently failed in their analyses and decisions and been completely unethical in their actions using the expressions “the best”, “the brightest” and “the finest”.

  60. The difference is… Iranians have not been idiotized by a culture of immediate gratification and consumption… They are thinking beings able to think that their authorities are wrong and to make it clear.

  61. This is simple:

    We put President Obama in office to do whatever it would take to change the (negative) status quo. but as long as he wants to be liked by everyone, he can’t make the tough decisions.

    If we don’t reform the financing of campaigns, the results will always favor the large special interest groups. It’s just a fact of life, like it or not.

    Whatever happened to the recommendations of the COP make in January. It was perfect. 109 pages of genius. And put together under the supervision of the very best person to do it: Elizabeth Warren. I think we need to elect her next time around.

  62. SJ: “In order to get to the point where you can reform like FDR, you first have to break the political power of the big banks, and that requires substantially reducing their economic power – the moment calls more for Teddy Roosevelt-type trustbusting, and it appears that is exactly what we will not get.” You pull the key point from those 101 pages nicely here, friend. Once the decision was accepted that Too-Big-to-Control aggregates would not be reduced, everything else malfeasant in this tawdry pretense of a re-regulation followed. We can have no reform without breaking up the ring of financial speculators. Big Finance is so powerful politically, however, has so captured the US Executive as well as most of the Legislative branches, that they still succeed in exempting themselves from any sovereign control—and in billing the public for their prerogatives. What we see here is like the first failure of trustbusting in the 1890s, when the Big Boys simply shrugged aside plaints from Congress and the judiciary. Shameful then, and shameful and worse now.

  63. Richard Kline, you say “Big Finance”? And what about the Big Basel Regulators?

    How would you arbitrate a game of hockey if depending on how some external consultants perceived the strength of the players to be each player had to carry different protective gears? The strong AAA players would have less protection, exposing them to additional risks, while the poor BB- weaklings would have to carry more protection weighing them down even further. And, if you were a hockey reporter how would describe the team? The protective-gear weighted strength of it?

    Well the above is exactly what the regulators have done to the game of financial risk allocation with their minimum capital requirements based on risk.

  64. This is not all that complicated. We can never again have banks that are too big to fail. Not much more to say than that.

  65. “A passive voice throughout the explanation of what happened (e.g., this preamble). No one did anything wrong …”

    This is what makes me come back to your site. You nailed it. The rest is just machinery for sorting things out, doomed to failure absent agreement on right and wrong.

  66. I don’t think many people on this blog are arguing that the provisions are all bad.

    I believe the concerns are that this crisis is the singular opportunity to make fundamental change (due to the temporarily weakened political power of oligarchic banking and financial interests). The concern is that Obama’s team is squandering this opportunity by making incremental change that could easily be overturned in ~10 years. It’s just not enough, and the next time we have a financial crisis, we’ll have a federal debt that’s 80% GDP instead of 40% GDP, and we’ll be pretty solidly hosed (much more so than we are now).

    And the deeper concern is that the people who are structuring the master plan – Summers and Geithner – are in the pockets of the very financial interests that need to be severely weakened and regulated.

    From the populist side, the massive concentration of wealth (and the enrichment of the super-wealthy class) that occurred since 1980 appears to have _not_ been driven by real wealth creation (due to wealthy people contributing more to society), but by a set of financial rules that heavily favors the moneyed classes and impoverish the middle class. Hence SJ’s comparisons of the US to banana republics.

    The recent financial crisis was the inevitable consequence, and the response was even more unfair/destructive than the cause.

    Judging from recent actions, it does not look like Obama is really in the pocket of the financial sector – like others have said, Obama doesn’t seem to care about finance as much as structural issues like health care, environment, education. It’s hard to blame him for a moderate/consensus (and therefore weak) response to the crisis. When he’s been called out on the worst abuses of the bailout, he and some of his team have responded. It certainly is disappointing – one gets the sense he doesn’t really understand what’s going on. From reports of his management style, he probably sits a bunch of economists in a room, let’s them argue, and tries to come away with a solution (while managing a hundred other problems).

    Geithners and Summers are another matter – this is their day job, and much of what they’ve done (Summers even more than Geithner) has been to “improve” the previous system without making fundamental reform that can survive for 4 generations. The littany of mistakes they’ve made, and the arrogance with which they’ve made them (especially Summers) is mind boggling.

    But there’s one side benefit – if Obama ever needs a 10 point bump in approval rating, just fire Summers and Geithner.

  67. This is going to keep industry consultants in business for many many many years to come… ie… gov’t confusion = more mess = more money to consultants to figure it all out for all parties affected.

  68. Also – I certainly defended Obama’s non-confrontational response (and focus on energy, education, health, environment) during the height of the crisis. Now that we’ve moved out of “crisis mode”, it’s time for a more aggressive response that yields long term solutions. The financial regulatory infrastructure is tightly coupled to the structural problems the economy now faces.

  69. Despite their being the willing tools of a hostile Western media, the demonstrators in Iran display a kind of cheek entirely absent from the character of their Western counterparts. Emersed in the moral sewer that has become their every living breathe and instead of taking to the streets literally to tear apart the connections between the banking, foreign policy and arms lobbies and their so-called “public servant” Stephin Fetchits that make this sham “democracy” the disaster that it is, the American public will likely accept on its face the lying descriptions of this economic policy vomit Geithner gave to PBS’s nauseatingly servile Jim Learer last night. There will be no change in the conditions Johnson condemns in this article until the filth that brought them about are in concentration camps awaiting the consideration of peoples’ courts.

  70. The large media outlets must also have given up questioning the absolute necessity of big banks that can literally afford to write their own regulation bylaws using US taxpayer credit. Why it is you must actually understand that the law provides protections for fraud and accounting lies, to even be upset enough to find that other people are just as foolishly questioning why there is so little being done to re-inforce the integrity of the 21st century market.

  71. We need a receivership process strong enough to handle any bank failure. It would also be wise to drop the corporate income tax on regulated commercial banks. This would bring more banking activity from the shadow banking system into the regulated banking system. Cutting the cost of equity capital for commercial banks would also reduce leverage in their capital structure. Both of these outcomes would be in the public interest.

    The big banks were over-leveraged. It is easier to deal with excess leverage than it is to try to control executive compensation schemes.

  72. You’ve also hit upon one of many criticisms of Objectivism; the idea of noble capitalists struggling against lazy moochers bears little resemblance to the real world.

    The “producers” are often quite ready, willing and able to strike a deal with the “looters”, especially as it is in their rational selfish interest for them to do so. By supporting additional regulation and re-distribution, established businesses can set up formidable barriers to entry of new competition.

    Established businesses fear leaner hungrier competitors far more than the government.

    This is one reason why banks did not complain about the Community Re-investment Act until after the crisis and a scapegoat was needed. Banks were fine with the CRA for decades.

  73. Couldn’t agree more. Seems to me that this is the crucial step: the government should only insure (and only ever intended to insure) the relatively low risk commercial and community banking activities that are required to make credit available through deposit-funded loans. The rest is risk/reward balanced stuff; it doesn’t need to be regulated like commercial banking activities if the risk isn’t enmeshed with traditional banking system. There’s no reason i-bankers shouldn’t enjoy the big upside on their securities innovations as long as they’re taking the hit on the downside.

  74. We need to break up the financial behemoths. My own post this morning “Mr. President, break up the financial behemoths now!” ( ) was first written as a response to a NYT Op-ed piece by Paul Krugman. It lists 7 serious, chronic problems created by excessively large institutions, not addressed by the President’s proposals or by Krugman, and indirectly minimized by breaking up major financial institutions. Related posts address more issues and include proactive steps to sustain a healthy economic system.

  75. Coincidentally, was reading a Forum on European aviation and this jumped off the page:

    “start from the premise that any legally-based rules must be absolutely clear as to the problem that the regulator is trying to solve; the problem must be clearly identifiable and of a sufficient significance to warrant a rule; evidence should be taken over a sufficiently long period to see what works and does not work in existing [national] rules and experience before creating a new [EU] rule”

    My brackets.

  76. Ditto on the non-confrontational response. However, in hindsight that might have been the best time. The unfortunate truth is that the vast majority of the country seems disinterested with anything of significance or merit. Unless of course the majority is outraged, which sadly makes them as unreasonable as they are angry. The result tends a desire to see heads role, often no matter the head, and any legislative response is almost guaranteed to go far past what’s needed.

    Over on CNN Paul Begala discusses the hearings on healthcare and several cases brought to fore of the previously insured, who paid premiums for years, only to become deathly ill and have their coverage taken. Insurance heads were asked, “Will your company pledge to end the practice of rescission except in cases of intentional fraud?”, and the response was no. We see these stories all the time and yet apparently they don’t even merit attention from the press.

    How can there still be so much wariness of universal health care, when having insurance is no guarantee of coverage if and when you actually have to use it. The culprit I believe is that the population lacks even a semblance of the empathy required to imagine the plight of others or even the capacity to surmise, that the only way to protect any is to protect all, because literally it can happen to anybody.

    President Obama, if anything close to what’s needed had a chance, probably should have dealt with this while the country was livid. We might have ended up with more checks and balances on the markets than necessary, but maybe there is no such thing as too much safety vs. what we’re looking at returning home with now; next to nothing.

  77. Our “too-big-to-fail” banks, whose move from greed to fear has created and magnified our financial crisis, continue to represent systemic risks to our economy and our social stability.

    Their “heads I win and tails you lose” approach to business is unacceptable to the millions of American taxpayers and investors who been robbed of their financial security and dreams. Our financial institutions need to be smartly regulated and our government needs to enforce these regulations….including revising regulation regarding foreclosures and credit cards.

    The final reform act should at least state the responsibility of our credit rating agencies, banks, mortgage, and insurance companies, as well as our federal regulators, in creating this financial and economic crisis — otherwise it is intellectual dishonesty that is an insult to the millions of Americans who have lost their jobs, life savings, and homes,…their American Dream is now an American Nightmare.

    Our Federal politicians and “too big to fail” bankers are underestimating populace anger that can easily erupt into destructive acts targeted to disrupt their security and dreams.

    Kamact, a capitalist who believes in regulation, but not trickle-down

  78. Even Krugman doesn’t buy the “too big to fail” argument.

    Simon Johnson and James Kwak,

    Aren’t you guys tired of being wrong on every major issue in the last 6 months yet? You guys are very good at jumping on the obvious and superficial views but also the often wrong views. It is clear that you guys opine too much and don’t read enough!

    I look at those who still post on your site. It is clear that you’ve lost a lot of good posters. Well, at least you can still get new readers! It is mildly interesting to see how long you can keep this up.

  79. Lehrer has Geithner on the News Hours this week and failed to ask about “Too Big to Fail”, instead he kept on begging Geithner to declare that all is well now.

  80. Simon Johnson is right– we need some Teddy Roosevelt trust-busting. TR wasn’t opposed to trusts, he just thought they should not be monopolies or, in other words, “too big to fail.” Here’s what he wrote:
    “The true friend of property shall be the servant and not the master of the commonwealth.” The language is early twentieth century but the sentiment can be translated into twenty-first-century terms: “The true friend of capitalism shall serve, not ignore, the public good.”
    Louise W. Knight

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