Obama And Brandeis

President Obama’s speech yesterday was disappointing.  As a diagnosis of the problems that let us into financial crisis, it was his clearest and best effort so far.  He didn’t say it was a rare accident for which no one is to blame; rather he placed the blame squarely on the structure, incentives, and actions of Wall Street.

But then he said: our regulatory reforms will fix that.  This is hard to believe.  And even the President seems to have his doubts, because he added a plea that – in the meantime – the financial sector should behave better.

The audience was comprised of our financial elite, but the Wall Street Journal reports “not one CEO from a top U.S. bank was in attendance” (p.A4).  How’s that for demonstrating respect, gratitude, and a willingness to behave better?

Louis Brandeis, of course, would have seen things differently.  The author of “Other People’s Money: And How The Bankers Use It,” was under no illusions concerning the underlying financial power structures and how they operated.  He would have regarded an appeal to the better nature of bankers as somewhere between humorous and sad.

The only thing that will make a different is regulation.  This is the lesson of the 1930s in the US – the regulations imposed at that time created a financial sector that did not impede growth after World War II; basic intermediation (connecting savers and borrowers) worked fine and destabilizing frenzies were avoided.  During this period, the financial sector came up with venture capital, ATMs, and credit cards – arguably the three most important financial innovations of the past 100 years, and much more helpful of real innovation than anything you’ve seen since 1980.

President Obama claimed that three regulatory proposals will make the system safer.

“First, we’re proposing new rules to protect consumers and a new Consumer Financial Protection Agency to enforce those rules.”  This is a very good thing, and of course the banks are adamantly opposed.  But this Agency will not by itself bring us financial stability; that requires change at the level of how banks and other financial institutions are operated.

Second, he talked about “gaps in regulation”; this is international finance bureaucrat code for mush (doesn’t the President know this?).  The specific potentially interesting pieces he put under this heading were run together in this paragraph,

“While holding the Federal Reserve fully accountable for regulation of the largest, most interconnected firms, we’ll create an oversight council to bring together regulators from across markets to share information, to identify gaps in regulation, and to tackle issues that don’t fit neatly into an organizational chart. We’ll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior. That’s one of the lessons of the past year. The only way to avoid a crisis of this magnitude is to ensure that large firms can’t take risks that threaten our entire financial system, and to make sure they have the resources to weather even the worst of economic storms.”

Making the Fed responsible for the largest firms could work, but only if the Fed throws out pretty much everything about the Greenspan doctrine of cleaning up after financial messes, rather than preventing them.  There is no indication they are moving in this direction.

The oversight council is unlikely to make a difference.  If you ask someone, “Who is responsible for this problem?” and they answer, “Well, we have a committee,” does that make you feel better or worse?

The administration will not tell anyone the exact capital and liquidity requirements they are proposing, but close observers of the internal administration process have taken to calling the likely increases “dinky”.  Remember, the last time our financial system showed this taste for risk and a comparable level of incompetence (prior to 1935), it had equity relative to assets roughly three times current levels (e.g., put into tier one-equivalent terms).  There is no proposal on the table, either in the US or within the G20, that is even remotely in the right ballpark.  President Obama has put his finger on the problem but is apparently unwilling to do anything about it.

The most remarkable phrasing is probably, “Even as we’ve proposed safeguards to make the failure of large and interconnected firms less likely, we’ve also proposed creating what’s called “resolution authority” in the event that such a failure happens and poses a threat to the stability of the financial system. This is intended to put an end to the idea that some firms are “too big to fail.””

It is very hard to understand how the administration can say this with a straight face.  Certainly a resolution authority would help, but all bank interventions are negotiated receiverships or conservatorships of some kind.  When banks are failing, they need a lot of money fast and you have them over a barrel.  But if they are vast, complex, and – remember this – cross-border, then taking them over or shutting them down can be scary, whether or not you have a “legal authority”.  Please point out to me (a) what the US is pushing the G20 to implement in terms of a cross-border resolution authority, and (b) how you would intervene in a bank like Citi without a cross-border authority.  This rhetoric around this issue is completely not serious – in fact, it’s a distraction from the real issues.

And, of course, the real issues were not mentioned at all.

1)      The largest financial institutions have to be made smaller  — aim to make them under $100bn in assets, roughly the size of CIT Group which even this Treasury was willing to leave to its own devices.  We can do it with legislation now or by regulatory fiat next time the behemoths get into trouble, but we should do it before they ruin us.

2)      The people who run banks like to talk about “skin in the game” in various contexts, but they generally have only a small proportion of their wealth at risk in these financial institutions.  This is not a panacea of course, but it is completely fair to ask them to stake a large part of their fortunes.  If they respond that this is not fair because all kinds of things can happen that are beyond their control, you should say, “Agreed – so split your bank up and manage something much smaller.”

3)      The revolving door between Wall Street and Washington is out of control.  There is no way people should be able to go directly (or even overnight) from a failing bank to designing bailout packages to benefit such banks.  In any other industry, in any other country, and at any other time in American history, this would have been seen as an unconscionable conflict of interest.  Let’s get our principles back and impose a 5 year moratorium on such flows in either direction.

4)      The way the Fed operates means that, in the absence of tough regulation, the finance industry has at its disposal the world’s greatest ever bailout machine.  Our financial elite knows this and is acting accordingly.

Brandeis was scathing about the individuals behind the financial structures.  For him, it was about power and it was about control.  He was appalled by how big finance operated and he worked hard – an uphill slog – to rein it in.

But Brandeis never saw anything like what we have now experienced, with regard to the amount of taxpayer money that the banks are able to expropriate when downside risks materialize.  The big banks that Brandeis feared did not, in the end, dominate the 20th century.  But they are back now, with unfettered power and an arrogance that spells trouble.

Ultimately, we will put the banks back in their regulatory box or they will bankrupt us all.

By Simon Johnson

137 thoughts on “Obama And Brandeis

  1. In some of the commentary on NPR after Obama’s speech, one of the reporters said something to this effect: “Yes, but if the U.S. puts into effect very tight standards and controls on banks, then other banks in other nations will be more than willing to step in and do what the U.S. banks could no longer do.” Therefore, I agree with the need for cross-border rules and regulations. And … I also share your skepticism that the U.S. will seriously promote true cross-border crack downs. I am reminded that U.S. weapons sales have soared in recent years, and when folks try to put a stop to all our arms selling abroad, the response back usually is, “If we get out of the arms export business, some other country will just get right in.” Either way — in international financial regulation or in true arms control — we seem to be fated to continue bad behavior because “If we don’t do it, someone else will.” It seems to be a never-ending spiral down!

  2. The parasite knows better than to kill the host; the parasite knows just how far to go without killing the host.

  3. I honestly don’t think that ATMs and credit cards played a huge role in helping society prosper. Big conveniences, yes, but you paid for that ten times over.

  4. “The people who run banks like to talk about “skin in the game” in various contexts, but they generally have only a small proportion of their wealth at risk in these financial institutions. ”

    I read somewhere in the last 48 hours (but I can’t remember where) that Lehman’s folks *did* have substantial skin in the game, but that didn’t stop them from overlevering.

  5. Here in Germany the weekly Spiegel runs a story about the speech with the headline “Helpless against the gamblers”. It ends with CNN asking a Wall Street pundit how Wall Street reacted to the speech. Her answer: “With a collective yawning”. That sums up the state of affairs pretty well.

  6. “If we don’t do it, someone else will.”

    to me it seems the international stuff we have is good as meeting ground for people to either synchronize action considered to be beneficial as well as to collude for the latest fad – but once somebody decides to break any of those rules there seem to be no effective repercussions.

    maybe we should have public fights between finance wizards where the one who wins gets a Roman style triumph and all the money he/she wants who can explain the most complicated stuff in just one sentence
    – I know that’s a frivolous idea and will not find support because it would cost also the jobs of so many decent experts whose livelihood is to explain to us the evil machinations of the indecent experts.

    Another method would be to tell the public that it is NOT shameful or a sign of lack of education or intelligence if one insists on checking things up with just paper and pencil.

  7. President Obama still remains sadly dependent on Robert Rubin, and of course Rubin’s to proteges, Larry Summers and Tim Geithner. This is probably the tragic flaw of his administration. Ironically, perhaps because Franklin Roosevelt knew Wall Street so well, through his family, friends, politics, and occasional practice as Wall Street lawyer, he never felt in awe of it or intimidated by it. There is also a question of timing in that Obama in a sense has becomee President in the equivalent of 1930-31, not at after the winter of 1932-33 when the whole economy seem about to come to an end as described in Schlesginer’s “The Crisis of the Old Order.” Roosevelt really did have much more freedom of action in 1933-35 then Obama does now (for one thing, the Conservative Southern Democrats were stil in Roosevelt’s big tent and only really moved into opposition against Roosevelt with the court-packing fight of 1937 (and Roosevelt had weakened himself when his Fiscal restraint helping to trigger the 1936-37 recession) while today they are the core of the Republican Party reprsenting the White South in total opposition to anything Obama might try). Ironically, Obama’s, Geithner’s, and Bernanke success, so far, in preventing Great Depression 2.0 is making the political fight for reform more difficult. And if the Supreme Court rules that anything restraint on Corporate spending for political activity as unconstitutional, the country will be completely a financial oligarchy since any politician for Federal office who steps on the interests of a major corporation or bank would face hundreds of millions of dollars being used to defeat him or her for election while if the propery serve tha interest, they would receive like amounts to sustain them in office forever.

  8. Your point is well taken, but I think the parasite is close to killing the host. The CEO’s that did not attend are the very ones who ended up in La Place de la Concord. Perhaps these CEO’s don’t read history, a point you’ve made before.

  9. But they have been part of the problem. They have allowed much of the “middle class” (whatever that means) live beyond their incomes. They have helped the bank prosper because a cardholder is gouged everytime they are late with a payment or over draw their account.

  10. There is an historical parallel to the way the bankers and industrialists saw Hitler in 1933 and the way Wall Street is reacting to Obama. I suggest nothing ill about President Obama. He is a genuinely good man, but he just doesn’t get how perilous the situtation is. But what happens in the next election cycle if there is no noticeable improvement in the state of the economy, job creation, and wealth distribution? The obstructionist politics of the right have a rational goal.

  11. What if we match private sector financial innovation (“innovation”?) with a little of the same from the public sector, a la massive government spending? Marshall Auerback is pushing that, and by the end of his argument, I’m convinced. Big government spending certainly says more, more powerfully, than anything Obama is willing to these days.

  12. The conservative side of me dislikes this ever growing debt, especially since we are funded by foreign sources. That seems to have been one of the underlying problems in the crisis. Because our debt was being bought off shore and not competing domestic sources of credit, it did not drive up our interest rates as it should have, which would have cooled the economy and limited the bubble.

  13. Brilliant!

    Now we need to boil this all down to a rallying cry that everyone can understand, that can be put on placards, spray-painted on walls, and used to confront every politician and candidate in the land.

    What do we want?

    BUBB– Break Up Big Banks

    When do we want it?

    Yesterday (but we’ll settle for Now)

    If you are willing to break up the banks, you are with us. If not, you are against us, and against democracy, capitalism, Mom and apple pie.


    Pass it along.

  14. Is it possible to have free trade all around the world and at the same time shield some aspect of your economy from the trading partners?
    I guess that you have a choice, either you go for splendid isolation/autarchy or some such thing or you will have to fight unwelcome influences and competitions. The art, if you go for the latter, is to balance this nicely and in order to do that stop first of all spreading the idiocy that free trade is without its draw backs.

  15. I am as weary of reading brilliant commentators who can articulate the weaknesses and dangers in our system as I am of Obama who can read a teleprompter even better that George Bush could. Listening to that Obama nonsense is like listening to Maddoff pitch his fund. Wow! That sounds great…. ummm, except it is meaningless and disappears like smoke as fast as it leaves his mouth.

    Everything could be different if an outsider was the Director of the N.E.C. instead of this manipulative Lawrence Summers. And Obama’s selection is unforgivable.
    The National Economic Council is composed of numerous department and agency heads within the administration, whose policy jurisdictions impact the nation’s economy. The NEC Director works in conjunction with these officials to coordinate and implement the President’s economic policy objectives. The Director is supported by a staff of policy specialists in various fields including: agriculture, commerce, energy, financial markets, fiscal policy, healthcare, labor, and Social Security.

  16. Why is the ATM a “financial innovation”? A customer service and IT innovation, absolutely, but it doesn’t do anything a bank teller couldn’t do before it.

  17. Can anyone seriously still believe that Obama could save us all–truly WANTS to (needs to!) save us all–but is surrounded by conniving viziers and subalterns who mislead him and betray the country??

    The man is the package. His subordinates serve at his will. It reminds me of the creepy cover from my college paperback edition of Hobbes, in which the king’s armor turns out to be composed of thousands of individuals who look just like him.

    The myth of the just but mislead sovereign is the oldest trope in the world. It is a Grimm Fairy tale. Give it up.

  18. if you want to experience a “little” fright about the forces outside the US and their potential influences listen to this one http://www.bbc.co.uk/programmes/b00mgy5h
    at least the Chinese up to now have not fancied paralyzing the French capital for the duration of a visit like this guy did and after listening to the above of what he is all up to and in to, finding him as ridiculous, as he undoubtedly is, becomes increasingly hard

  19. The situation is genuinely much more worrisome than in 1933. Then there was a crisis mostly in the minds of a number of right wing fascists, racists, exploiters, vengeful minded nationalist individuals, rabid left wing Leninist type fascists, etc. In other words, the crisis was mostly psychological, and man made. Without counting the Great Depression crisis, a recent sharp downswing.

    Now the downswing is not recent, but well installed on what seems to be a secular basis: the West’s intellectual, scientific edges and economic advantage are fading, while the energy and climate crises are falling as walls on us. Many sorts of environments are starting to crash down, and many of the ways out being tried presently will only make the situation worse.

    And i do not have to mention WMDs, which were not tried in WWII (but for the sharp nuclear conclusion).


  20. Definitely Simon Johnson’s background in the IMF weighs heavily on him and he is just like all the other regulators, more concerned with the stability of the banks than with the purpose of the banks.

    Since 2004 we are living with bank regulations which came out of Basel and that orders lower capital requirements for operations perceived as having a low chance of default and high capital requirements for operations perceived as having higher risks of default. This effectively channels the funds of our financial system towards anything perceived as low risked without the slightest consideration to whether this serves any purpose or not.

    I thought that Simon Johnson was younger but no, it seems he has already joined the baby-boomer’s in their risk adverseness, only looking for a place to lie down and die.

    Or could it be that he is so ideologically enamored with the concept that with these Basel regulations the banks can lend to the government with zero capital requirements… as if a government running amok in spending represents no risk… as if a government does not represent a counter-party risk.

    Problem with regulators like Simon Johnson is that they cannot get into their heads that even if the credit rating agencies had been totally right and there had been no losses in the quite useless financing of a housing boom in the US, the regulatory system would still be wrong since the world needs to take risks in order to move forward.

    Problem with regulators like Simon Johnson is that they are always more concerned with avoiding the defaults of banks than avoiding the default of the world.

    This does not mean that Simon Johnson’s real issues are not important too, only that, in the great scheme of things, they are of a secondary importance and that, when you design regulations, it is always better to start thinking on what you want to achieve than on what you want to avoid.

  21. in my book the owners of commodities have cash and I still think that banking problems are related to money

  22. Hi Per – glad to read you again
    one slightly off the topic question:

    do you have any idea why Basel became the city of Basel?
    Could it have anything to do with the anthroposophic community? Do not laugh at me, Berthold Beitz (Krupp) was one and a club with such a powerful member certainly does not have only one of that caliber.

  23. I would not even try to advance an answer on that but “maintaining that by correct training and personal discipline one can attain experience of the spiritual world” has little to do with the bank regulators I have met in my life.

  24. You’re correct: banking problems are related to money. And owners of commodities have cash. So have a lot of other people. But do these people (i.e. Gaddafi) pose systemic risk to the world economy? I don’t think so.

  25. The most interesting thing about that speech was the utter strangeness that it was delivered by the President. It was… odd. That’s the type of speech one would expect from someone at Geithner’s level. The delivery of that speech speaks volumes about what Presidential historians would call his “Presidential style”.

    As to substance, this post does a good job of boiling down the entire debate to three strong _prescriptive_ suggestions, and we now appear to have names for all three issues:

    Too Big To Fail
    Skin in the Game
    Revolving Door

    It would be nice to see a President focus on such a concise marketing message in his own speeches. It would also be nice for him to come up with some less jargonish ways of expressing the leverage problem (which, perhaps, there is some passion to fix). For example, the metaphor of an Upside-Down Pyramid. Our financial system is like a spinning top – so long as it doesn’t slow down, it’ll stand up, but if it starts to slow down it wobbles, and then it falls. In general, we DO need a rallying cry to deal with systemic stability in a way that tells the public the problem is real.

  26. This is part of a general trend towards preserving institutions while forgetting what those institutions were supposed to do.

  27. A separate comment on political tactics and economic costs:

    It’s time for Obama to start using our short time horizon and excessive discounting to his advantage. In particular, and sharp regulatory change is going to cause front-loaded suffering and shock, and is going to incite a huge opposition. So what should we do?


    This beautiful strategy has been used with lots costly regulation… it alerts companies of something in the future, gives them warning to reconfigure their business models and adapt hiring and capital investments, and… puts off the day of reckoning enough that it greases the skids of legislation. But once it’s passed, it’s hard to then change as the deadline approaches. The only drawback is lack of enforcement, but enforcement of sufficiently well written legislation can be compelled by private court litigation.

    Of course, people like Cass Sunstein know this. If we start to see real talk of phasing in stronger regulation over the long term, then I suspect that would be a signal that Team Obama really intends to do something. That would be a good sign. If, however, we see a rush to pass weak legislation, that means they’re just trying pass something nominal fast to “claim victory”. The action on executive pay (specifically relevant to AIG and Citi, etc.) is an example of mere grandstanding.

  28. >Can anyone seriously still believe that Obama could save us all–truly WANTS to (needs to!) save us all–but is surrounded by conniving viziers and subalterns who mislead him and betray the country??

    Well, talk about a strawman argument, eh? You ascribe a behavior and set of values to the man that has nothing to do with what he is trying to achieve.

    President Obama inherited this economy, already tanked, flat on its back, when he took office in January. Period.

    So, me, personally, I’ll give him more than 8.5 months to fix a 16.5 trillion economy that took a decade to break before I start talking about him as a problem. And frankly, he deals with a financial world still awash with money and power who is trying to block him whenever and whereever it can, and he is not free to do whatever his heart may want. But he knows that.

    Give it up?


  29. …other banks in other nations will be more than willing to step in and do what the U.S. banks could no longer do.

    And, those other nations will have to come up with ways of bailing them out when they do it.

  30. “If we don’t do it, someone else will” is also the argument Greenspan used for preventing derivatives regulation. The someone else was England (other countries had the good sense not to go buck wild), and we all know how that turned out.

  31. You left out a key part of the story, namely the last 8 months where he appointed the unrepentent architects of the crisis to all key posts…with the expected results.

  32. Obama was elected because he’s good @ getting elected. He’s still a better organized, clearer leader than Hillary Clinton will ever be on her best day, and (my candidate of choice, oy!) Bill Richardson’s shenanigans speak for themselves. In other words, in this media-dominated age, Barack Obama was the best candidate we could find. If people and nations get the leaders they/we deserve, this situation doesn’t augur well. May fortune favor us in the long run, because the short run doesn’t look so good.

  33. The biggest single systemic risk, as I have argued for years, are the bank regulators trying to live out the bedroom dream of a world with no bank defaults, while the best way to reduce systemic risk in the banking sector, is to see that they are swiftly put out of business when they can´t make it, and of course making sure they never grow so big it hurts too much when they fall on you.

  34. “Systemic risk” seems like a very muddy term. Define it for me, or show me a formula for how to compute it. I’m not even sure what it’s referring to.

    Is it risk taken on by everyone in the banking system by lending badly? Risk of universal bank runs? Bank runs on specific big banks? I don’t know.

  35. If you think the world’s economy has ground down first gear (stripping the gears in the process!) because not enough risk was taken………..there is no rational argument to address your ideas.

  36. Yakis writes: “Systemic risk” seems like a very muddy term.

    You are right and it is getting murkier day by day.

    As I interpreted it used to be a risk of something that the system could not self correct and that could make the system spin out of control. When I wrote about it 2002-2004 I referred primarily to the risk of empowering the credit rating agencies too much so that too many would follow some ratings that we knew that sooner or later would be wrong since sooner or later the credit rating agencies would be captured.

    Then nowadays many refer to systemic risk as the risk that some banks have grown too large for a system that is not prepared to digest the failure of it.

    Lately I have been arguing that the largest systemic risk is the introduction of a regulatory risk-adverseness that could have far reaching implications for the whole world system… as there is absolutely nothing out there to tell humanity that what it should concentrate on is keeping the banks stable.

  37. Central Banker: The New “It” Career

    Young men and women, I invite you to consider a career in the “new and improved” Central Banking. The “old” central banker was pretty dull; you traveled a lot and gave boring speeches on such topics as inflation targeting and the heterogeneity of investor expectations. The financial crisis changed that. Here are some noteworthy Fed actions in the current financial crisis:

    1. Money For All
    Historically, we restricted lending to depository
    banks. This represented a “line in the sand” that
    was not crossed for 75 years, since the Federal
    Reserve Act of 1913. We have always found that Act
    somewhat restrictive. Fortunately, we found an
    obscure provision in the Act, which allows us to
    lend to virtually anyone under “unusual and
    exigent” circumstances. Under cover of this clause,
    we bailed out Bear Stearns – an investment bank,
    AIG – an insurance company.

    2. Liberal Credit Terms
    Traditionally, the Fed loaned money based on secure
    collateral at a penalty interest rate. Collateral
    had to be top quality, and a substantial “haircut”
    was applied. The penalty interest rate was above
    the market rate, and was designed to encourage loan
    repayment at the earliest time possible. In the
    current crisis, the penalty rate was abandoned as
    it conflicted with the more important goal of
    rebuilding bank capital. We were also able to
    assist our bank clients by expanding the range of
    acceptable collateral to include “toxic” bank

    2. Market Maker Not Just Liquidity Maker
    A strict interpretation of the Fed’s Lender-Last-
    Resort function limits the function to providing
    short-term liquidity when markets are disrupted
    and banks are unable to raise cash by selling
    assets, except at “fire-sale” prices. Loans were
    repaid when markets normalised.

    We waited patiently for financial markets to
    stabilize, but that did not occur; banks were
    unwilling to sell assets at the “new” fair value
    prices which were substantially below the pre
    crisis levels. Some even suggest that banks were
    waiting for the Fed to “hang out its shingle”.
    Regardless, we were not going to wait for markets
    to self-correct; we stepped in , purchasing a wide
    variety of mortgage related securities. We became
    a Market Maker of Last Resort. Economic historians
    will be discussing this event for a long time.

    4. World Leader
    New York city is rightfully regarded as the world’s
    foremost financial center. This leadership was
    threatened in the current crisis, as many of these
    institutions, like Goldman Sachs, suffered losses.
    The crisis threatened to downsize these
    institutions and reduce their power. We infused
    capital and used other measures to protect their
    franchises and remain powerful players in world
    Some observers suggest that our actions increase
    moral hazard by encouraging banks to push risk to
    the limit. We are mindful of the risks, but
    believe the benefits exceed the costs. There were
    also other issues related to market concentration
    that we overcame; J.P.Morgan Chase, and Bank of
    America bank acquisitions were approved, even
    though long-standing rules of market concentration
    were exceeded.

    The current financial crisis was somewhat of a
    surprise, but not totally unexpected. Crisis are a natural part of a dynamic economy. Excesses develop over time as a result of our “animal spirits” . Some even suggest that ,we the Fed, contributed to its development with easy money policies and acquiescence to unfettered deregulation.
    You know – we may be independent, but we are not stupid; we know what politicians and administrations want. The Fed has been in this business a long time; when we testify before congress, it is clear they want economic growth and low interest rates. Sure, there are occasional questions about financial stability, but Congress would “chew up and spit out” Fed officials who even hinted that interest rates would be increased without explicit evidence of excessive inflation.

    The Fed has many career paths; we need people with a variety of skills. You will have ample opportunity to demonstrate your skills and advance careers. Who knows – you may even aspire to be “top dog” – Fed Chairman. It is a position of supreme national importance. Greenspan was widely regarded as the second most important person in government. Bernanke, the current Fed Chairman is hailed as a “savior” for his work in the current financial crisis.

    You might even consider the number two job as a stepping stone to the number one job – President. Then you can “save” the nation from the next crisis, which is likely developing from the mountain of government debt. Now ordinarily you would not be able to move from the number two position to President, because of our two party system; but I suspect that the next crisis will be so big that the people will be looking for an independent candidate.
    The time may come when a smart financier is called upon to lead our nation. That time may be sooner than you think.

  38. Per has explained this so many times, but if you are new to the blog, you might have missed it:

    People thought they were being risk averse in buying AAA rated junk that was actually very risky.

    If they had taken the effort to take real risks as bankers should and must, they would have been more circumspect about the risk and the payoff would have been more socially useful if the loan was successful.

  39. and if I take the spinning top image of StatsGuy,does the knob where it contacts the earth stand for the actual money inflated further up by leverage and the energy that makes it spin are the regulations?

  40. That is exactly what I think. When the regulators informed the world that through the credit rating agencies they could access risk-free areas and stimulated the banks to finance those sectors by means of very low capital requirements, the regulators helped to channel the funds were they should not have gone so massively.

    We are in this mess not because some investors with very high risk appetite enter risky ventures like constructing railroads in Argentina, but because many highly risk-adverse investors thought they could make a couple of more basis points in returns by investing in safe assets, mortgages, in the safest country, the US and in the safest instruments the AAA rated.

    The losses in triple-A rated investments surpass by far the losses sustain in those areas perceived as much more riskier

  41. Bernanke has just announced that the recession is likely over.

    Is this not a bad idea, nay, elitist, let them eat cakeism?

  42. If it means he’s going to try to sop up the liquidity now rather than later, then I’m all for it.

  43. I have not heard it but if so it means he should increase the interest rates urgently in order to control inflation, but if he does not do that then this most probably means he does not believe in his own statements.

  44. Simon, please continue to push on the “real issues”. Question, if Obama stated the goals as clearly as you just did what would be the result? Do you really believe it would provide the momentum needed to ensure those changes are made? Have you watched the health care reform debate? While I understand part of your concern is with the outline provided, the real difference seems to be the timeframe. You believe our best chance at preventing a future depression is to act while we are still in the midst of crisis. It’s a fair argument, but I think the crisis itself is what makes it near impossible. We needed the stimulus and need to keep some stability. I believe a bit of time and measured approach actually increase our chances of success. I’m sure Obama is ok with the bankers yawning during his speech, just as I am ok with being called naive (as was during the election). We will continue fighting for the changes that are needed to make America better. Your efforts here are part of that. Yes, it’s likely his plea will be ignored but does it really deserve scorn?

  45. well, your explanation of the 62,5 Basel II scenario definitely seems to indicate the existence of a highly spiritualized if not spirit-soaked world view

  46. Excellent analysis, except the #1 post is only nominally #1. Good for motivating the young people though.

  47. I find this argument silly: “other banks in other nations will be more than willing to step in and do what the U.S. banks could no longer do”. We have the reserve currency, no other currency is ready to step into the breach — so no other country has access to the bailout resources that we have. (The Euro countries have far too many coordination problems to be relied on in a bailout.)

    In short, the only reliable source of bailout money is the US. Where we go others will follow. End of story.

  48. But you no longer need a bank teller, or the bank to even be open to access your account. Think of having to actually go INSIDE the bank and wait for a teller to get cash, deposit a paycheck, etc.
    Ya dig?

  49. whess: “There is an historical parallel to the way the bankers and industrialists saw Hitler in 1933 and the way Wall Street is reacting to Obama.”

    Then there is hope that Obama will prevail! ;)

  50. If the government is going to spend anything, it should be for the benefit of the Nation as a whole, and not for the financial elite.
    Bailing out corporations doesn’t benefit the nation. Spending money to allow the bad actors to fail (without collapsing the system as a whole) due to their own actions (or lack of them) would be IMO acceptable. The bailouts have proceeded on the concept that the TBTF banks and the system are the same thing. Let them go and let the next generation of TBTF banks germinate – my grandkids can deal with them in 65 years.

  51. I saw an interview w/ Taleb in May (approx) where he said (paraphrasing) “We can have global trade or debt, but not both.”

  52. whess: “The conservative side of me dislikes this ever growing debt”

    Then you are not one of those modern conservatives, who purposely saddled the government with debt, to cripple it. They succeeded only too well.

  53. Larry Kudlow is Giddy: “who can read a teleprompter even better that George Bush could”

    Isn’t it obvious that Bush did not have a teleprompter. Besides, he was not into reading that much, anyway. ;)

  54. I am convinced that the current regulatory paradigm (the first pillar and basically the only pillar of Basel) and which is based on a vaguely defined perceived risk of default, is utterly wrong in that it; first messes around with the risk-allocation mechanism of the market which prices risk in interest spreads and has no way to evaluate what the arbitrary risk-weights imposed by the regulators really mean; and second and even more important, channels and pushes financial flows into economic areas based only on that these have a perceived low risk of default, and which basically has nothing to do with nothing… except defending the status-quo.

    I have made these comments on about 50 Baseline posts and they have never been acknowledged with the slightest comment from any of the authors of the Baseline blog. How come? Have they some conflicts of interests they have not disclosed?

  55. A very important piece.
    When will both parties realize that tapping populist anger is an easy victory strategy in the next few elections?
    I don’t think they will. This may be the right time for one of the 2 to fade away, and I’ll be shorting the GOP.

  56. Min, according to conservatives there are two types of debt: good debt and bad debt.

    Good debt is the debt used to bomb other countries, buy weapons, give corporate welfare, and put people in prison.

    Bad debt is any money spent on education, health, social services, scientific research or pensions.

  57. No offense intended, but it is their blog so they aren’t obligated to.
    Keep asking and maybe someone will help you answer that one independently…

  58. I don’t deny that he inherited a terrible hand. But that terrible hand could actually have served him well if he showed the least inclination to undo the damage of the last 30 years of deregulation. Have you seen any evidence that this is the path he plans to go down?

    It’s not a partisan fight. Left and right critics agree that the window for serious, root and branch reform is only open for a short time–it’s probably already too late. Somehow saving American capitalism and democracy (from its own worst excesses) was not at the top of Obama’s to-do list. Fill in your own reasons why, but the outcome is undeniable.

  59. Per
    if that picture on your blog is you, you are past your twenties and you still have not accepted that looking at a problem from a definitely not-mainstream angle is acknowledged only when it comes from “certified” sources?

  60. fwm: “[Crises] are a natural part of a dynamic economy.”

    This is a mindset we have to leave behind us, unless we want the pain of the many (during a crisis) to pay for the pleasure of the few (during the preceding boom).

    “The time may come when a smart financier is called upon to lead our nation. That time may be sooner than you think.”

    Like the recent past? That time has come and gone.

  61. Yes Silke, that photo is of me and I am way past my twenties and of course I know that as someone who has not even a PhD I cannot be a sufficiently certified source for fine persons to answer out of the box-statements that do not belong in their out of the box. That said why should I not keep on telling it as I know it is? Who knows one day perhaps these fine persons have to explain why they felt they were above this issue, since, at the end of the day, it is really not the person that is important, but the issue. (And by the way even when I was a bit more of a certified source, like an Executive Director of the World Bank, I could still not get one of these regulators to react)

  62. Well, I’m old enough to remember what it was like to have to go inside a bank to conduct routine transactions. It was inconvenient, to be sure.

    But I still have trouble seeing the introduction of ATMs and direct deposit of paychecks as anything more than conveniences, and describing them as “financial innovations” seems like quite a stretch to me.

  63. Per
    don’t you dare to stop explaining your point of view …
    – that I have become a “believer” and that Yakkis can paraphrase you so well may not count as much as “real” recognition would but you gave me something solid that feels in unison with my experience of “normal” life and maybe that good deed will give you some points in the big book in heaven ;-)
    btw why some people are listened to and some are not tends to have little or nothing to do with their academic titles – in fact figuring out the criteria by which that works is one of life’s unsolved mysteries to me (and I am not talking about my tending to be abrasive self)

  64. Simon is a very smart guy, but he has this completely wrong. He’s way too confident that regulation will work, which it won’t, even if real regulation were promoted, which it isn’t.

    Regulation only works if the system isn’t broken. You can’t fix a broken system with regulation. You need to fix, and/or rebuild the system. It’s the only way to do it. There are no other options.

    I’ll give you an analogy that is very appropos, and one that every uneducated backwoods Hillbilly worth his salt understands. You’re racing your 1984 Monte Carlo dirt stock car and as you exit turn four and are running down the front straight past the flagstand turning 6500 rpms, you feel the motor tighten up, loose power, and sound different, the oil pressure drops, and the temp shoots up. You have yourself a very serious systemic engine problem.

    So, what do you do? If it’s a $500 claimer motor, and you’re doing well in the race, you may stay on the track, keep your foot in it, and hope the motor stays together for 8 more laps. You probably would regulate the rpms back to 5500 or 6000, change your corner entry line to be higher to keep your momentum up and reduce the rpm change range, and baby and not twist the motor as hard to help in this effort.

    If it’s a $35,000 race engine, and you’re not doing well in the race, and you don’t feel like spending another $35,000 for a new race engine, for a very preventable catastrophic engine failure, the sensible Hillbilly pulls off the track, parks it, hoses the radiator down to cool it off, loads the car up, pulls it home, yanks the motor, rebuilds it, replacing broken and damaged parts. A bent rod, burnt piston, or a set of bearings and rings will set a guy back a couple hundred bucks, plus time. If you sucked a valve, took a lobe off the cam, or scored the crank, a few hundred more. A pain in the ass, but no where near a $35,000 pain in the ass.

    Now, sometimes a Hillbilly can get lucky, and his regulation worked, and he makes it to the end of the race, and doesn’t cause much more preventable damage to the engine. But, some times not…..it’s a basic question and calculation of risk, probability, and downside.

    See, if your race motor has a bent rod, a burnt piston, a sucked valve, a lobe off the cam, or a scored crank, no driver regulation will ever fix these maladies. You can swear at it, you can pray for it, you can burn sage or incense, you can blame the guy who cut you off going into turn 3 which required you to dynamite the brakes right before it happened.

    But, at the end of the day, you’ve got a race engine with a bent rod, sucked valve, a lobe off the cam, or a scored crank. Period. And, the only way to fix any of these systemic engine problems is to rebuild the engine system.

    Now, from much experience I can unequivocally tell you that if you choose to continue to run your race engine in this state, with any one of these individual maladies, very bad things happen. And, they tend to compound. Quickly. For instance, a minor sucked valve that simply requires pulling one head to fix, if continued to be run, will ultimately beat a hole in a piston, and maybe score the cylinder and destroy the head. The piston chunks will fall into the oil pan, and the small ones will end up in the bearings thereby destroying the bearings, and if run long enough, score the crank. This in addition creates heat. The big piston chunks will end up blocking the screen on the oil pump, thereby restricting and reducing oil flow to the engine components. Which in turn, leads to the lifters, push rods, rockers, and bearings not getting adequate lubrication, thereby causing all kinds of problems including wrecking the cam, and creating more heat. Metal expands with heat…

    Now, if your race engine is still running at this juncture, and it’s a $500 claimer motor, and you’re mad at it anyway, and don’t care, come off turn 4 hard, run the rpms up to 7000, and it should result in a perfectly timed horrendous and catastrophic engine grenade right at the flagstand with all kinds of noise, smoke, and maybe even some fire when the oil that used to be in the engine contacts the headers. And, the fans will love it…

    But, in the pits, and in the hauler on the way home, and most definitely in the shop when you pull what’s left of your oil pan off the motor and it weighs 75 pounds as it is full of all kinds of twisted and broken modern art looking metal pieces of all shapes and sizes, a Hillbilly questions his judgment in the whole debacle….you know, if I had only pulled in right away…all I would have to do is maybe pull a single head…now my motor is a collection of cool looking paperwights and I need a complete new motor…and a new starter because a rod came through the block so hard it knocked my brand new high torque starter right off the block…

    Folks, the system is broken. Regulation will not fix the broken system. The system needs to be rebuilt. And, the immensely intelligent Ivy Leaguers in charge aren’t even moderating rpms, changing their line, or limiting the rpm change range with the non-regulations they are advocating. They are ignoring the change in the sound. They’re avoiding looking at the guages. And, to compensate for a drop in performance, they’re pushing harder on the accelerator.

    Problems are compounding. Fast. And, it’s not a $35,000 race engine. It’s a $12 Trillion economy that 300 million people depend on in the United States alone. Not to mention the 7.7 Billion other people on the planet that will get hit by the schrapnel.

    We need more uneducated Hillbillies with common sense enough to pull off right away, and repair the system while the opportunity is still there to do so for a nominal cost. Ones who have grenaded a few systems before, and have the wisdom to understand that it’s really not a good idea, or worth it. Based on the risk, probability and downside.

    Do you think they’ll regret not pulling off sooner…..?

  65. Simon,
    Excellent post!
    However, I do not see regulation coming to town anytime soon. Congress, “the only American native criminal class” (Mark Twain) will make sure it does not happen, because their financial interests and ideology about “what is politically possible” (read: not much) are still too strong.

    It’ll be more of the same, until the People start revolting for real. Said revolt could take place at the ballot box…or elsewhere.

    Is America immune to the “elsewhere” case?


    “Bruce Judson is a Senior Faculty Fellow at the Yale School of Management, and the author of the forthcoming book, It Could Happen Here: America on the Brink, which will be released by Harper Collins on Oct 6, 2009.”

    Disclosure: I have no relationship of any sort with Bruce Judson. I happened to stumble upon his blog and upcoming book via Yves Smith’s Naked Capitalism blog.

  66. “Do you think they’ll regret not pulling off sooner…..?”

    Not if they can escape with their personal wealth intact and can spread the blame wide enough.

    BTW, very good post; loved it!

  67. Per, they could well be doing the devil’s work, but don’t know it. Well, it’s easier to believe this about James than about Simon, who has played many positions in this game. If you can corrupt entire countries without them realizing it, it’s probably not too hard to sell even a very bright individual.

    James, we can assume, is pouring over the books and cases most every day, all day. But Simon, what do you actually do? You have a new government appointment (btw, are you an american citizen??) and run an MIT G-Lab?

    From this, it looks like the G-Labs are quite active:


    “This website is focused on providing potential host companies with an in-depth view of the program, and the value it has provided since the year 2000 to over 250 companies around the world.” That’s over 27 4-person G-Lab teams per year? Over 108 students each year, out helping foreign companies? Accurate? Is this what you did full time before CBO? Are you finding it hard to juggle both lately?

  68. How would limiting the size work in an international setting, if you say that instituting cross-border resolution authority is not being done?

    Won’t the banks have simply have affiliates/off balance sheets entities somewhere where there are no size limits and still remain to big/interconnected?

  69. Another reason why we’d be better off with Hillbillys running things.

    I think this story needs a little adjusting:
    *let’s pretend the driver has his car insured for twice what it’s worth. Payouts go directly to him.
    *let’s also pretend that for every lap he’s ahead
    someone is kicking back 1/2 the winnings to him personally from bets which are 50x the prize money.
    *no matter how many times he wrecks his car or how many times he loses, he knows that they will still have him drive next time.

  70. Looking at stock prices and P/E ratios is another way to gauge the problems with wall street – namely, the fact that financial firms took up a growing share of the earnings in S&P 500 companies, reaching almost 30-40% in the middle of 2008.

    The financial sector is a necessary part of the capitalist machine, allocating capital and determining market values. But for it to become too big a part of machine it is supposed to be greasing leads to conflicts of interest and unsustainable practices.

    You don’t want the owner of a casino down at the tables gambling with company stock, after all!

  71. Did people at the IMF ever place any importance on the M3 measure of the US money supply? The Fed did away with reporting it right after Bernanke stepped in and just as the trend started going vertical. I never checked back to see if the velocity of the repos being done subsided, but I imagine that it wouldn’t have considering the amount of money they needed to create to keep things going. At the time they left us a short note saying: “It’s an unimportant measure” and “it’s too expensive to keep reporting it,” both of which didn’t feel right.

  72. Another stray question: We had a Henry Cisneros who was on the board of Countrywide. He and Kathleen Brown — Jerry Brown’s sister (who I think works/worked in the public finance division of Goldman Sachs, both parachuted out of CW just before things got ugly there. Do you know if Henry Cisneros is related to the Cisneros family of Venezuela? They are quite chummy with the William Rhodes of Citigroup from what I remember.

  73. Excellent points!

    And don’t forget that Darrell’s brother Daryl, and his cousins Darol and Darrel all race. And, they’re thick as thieves and they all look out for each other.

    Thus, Darrell buys and holds Daryl’s junk at a “fair” market price based on its value “rating”, Daryl buys and holds Darol’s junk, Darol buys and holds Darrel’s junk, and Darrel buys and holds Darrell’s junk. As appropriate “convenient” transactions occur to allow for quarters to be made, losses to be pared or increased as appropriate, and revenues to be increased as needed.

    And, they all bet on and against each other, at the same time, amongst themselves, and with themselves, as they collectively serve as the bookmaking consortium. They set the juice, establish the over/under, and the spread…and pocket the winnings.

    Amazingly, the “Darrell” who has the least amount bet on him with the bookmaking consortium always wins. And, the “Darrell” that has the most money bet on him with the bookmaking consortium always loses, and finishes out of the money…..

    And when the next year roles around, it becomes Darol’s turn to hold Daryl’s junk, and the junk gets moved one notch counterclockwise around the table. Transactions occur. Ratings are established. Profit and loss entries made……and the wheel keeps moving, as long as the music doesn’t stop….

    But, Darrell and Daryl and Darol and Darrel all know that they collectively own nothing but a bunch of blown up race motor junk that looks great on paper…..

  74. just listened to most of Slate Money Talks from Sept. 3 – they say all who refuse to believe in the upturn do it due to some blockage, ideological or out of spite. Sounded exactly like “before”, who doesn’t believe is a dumbhead or an obstructionist … http://itunes.apple.com/WebObjects/MZStore.woa/wa/viewPodcast?i=59529314&id=288947288

    strange and I have read stuff I liked from Daniel Gross and now he calls me ideologisch verbohrt=ideologically stubborn – same I was called when I refused to believe in the certainty of a up, up, up, forever up – well that Gospel seems to be back for good, other than all the times before they also didn’t put in a nice understanding word for the jobless this time.

  75. Simon,
    Many Americans appreciate your voice for better financial regulations (laws and enforcement). We are grateful. We hear some other voices such as Alan Blinder over at Princeton University. He recently wrote this Op-Ed for the New York Times

    Blinder was also on The Diane Rehm Show this morning on NPR which you can listen to on this website.

    You remember when they were trying to pass NAFTA and every economist under the sun signed the paper to show their support? How about a similar type petition signed by you, Alan Blinder and other like-minded economists calling for a certain specific criteria of financial reforms outlined in the “petition” signed by as many famous/respected economists as you can muster??? If a “petition” of famous economists helped pass NAFTA, could it not also help pass real financial regulations and help Obama in his battle???

  76. “petition” signed by as many famous/respected economists as you can muster??? … and who had warned about the financial crisis… and who had spoken out on what was wrong in the financial regulations before it all exploded…
    not only regulatory Monday Morning Quarterbacks

  77. While it is true that reform is needed including legislation, regulation, and oversight, that is not enough. There are plenty of laws and regulations on the books right now that are not being implemented. This crisis is a forensic issue more than a financial or economic one, and so far there has been almost zero accountability, let alone reform of the system. As a result, the main perps remain in power and are continuing to game the system in ever novel ways. Until there is accountability that ends what John Kenneth Galbraith called “the bezzle,” short for “embezzlement,” there will be no real change. You can institute all the reform you can think of, but without enforcement, it all comes to naught. This crisis was the result of a criminal conspiracy far greater than Enron, and no one has been investigated, let alone prosecuted.

    Extracts from “The Great Crash: 1929”, John Kenneth Galbraith, First Published 1955, Page 152 to 153.

    “In many ways the effect of the [’29] crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should be called the bezzle. It also varies in size with the business cycle.”


  78. VERY bad metaphore. Tell that false reassurance to the millions who die every year of malaria.

    That plasmodium must have missjudged how far it could go without killing the host.

    Still want a parasitic banker???

  79. Against apple pie??!!
    Now I am truly irritated. Let’s get these anti-apple pie cruds.

    1. Come monday each TBTF bank ansd bailed out entity (eg AIG)is to divided across three shell banks/entities.

    2. Brandweis type rules pomulgated and executives breaching same risk prison term without the option.

    3. A global reserve facility created with units valued on a basket of products. Basket revaluation done each year or 3 years.

    4. All existing national debts (prior to reserve facility create date)to remain with each country. Pending optional transfer arrangements (no magic copouts)

    5. All global trade to be valued at reserve units only. Other contracts unenforceable. Eliminate exchange ripoffs.

    6. Mr.President we can start October 1st!

    Can I find any supporters to polish this? The whole project to be run by non-bankers.

  80. Could thjis be possible? Is China still achieving this shielding with their twin currencies? There was an internal domestic currency and the external currency. Exchange control was rigid. Maybe this has gone away?

    Re world trade, someone suggested that to employ the continuing Chinese migration of workers from farm to factories will exceed total current installed European and US manufacturing employment! Does our employment displacement and outsourcing have a point of equilibrium? If so how is it defined?

    Is the only ‘fix’ government ownership as per GM?

  81. A super-petition signed by famous/respected economists, maybe a few Nobel Prize winners, that’s a great idea. Media will have to talk about it.

  82. Let’s take the long view on this. Neither Congress, the President, nor the Fed will step up to the plate to control the moral compass as it needs to be controlled, and so on goes the moral hazard. It doesn’t matter who sits in the White House, the Fed, or on Capital Hill until we get true leadership, and with the campaign and lobbying laws the way they are, that won’t happen any time soon. The chances of getting Obama reelected grow dimmer by the day, and I’m not even sure that he will want to run again anyway, since by the time the innauguration takes place in 2012, no one in their right minds would wish for that job. He better get passed what he wants to by spring, because after that he will be on lame duck watch. I had high hopes, but with Congress in essential deadlock, and Geithner, Summers and their cronies running the country, he doesn’t stand a chance. Sorry, Barrack, you are a fine, intelligent and well meaning man with a lovely family, and no road to governance that isn’t blocked by the power elite (including much of the media, unfortunately).

  83. Could be that the people who proffered “ATM” as an innovation were being tongue in cheek. Might need to check the video, but if they were smirking when they said it, they were probably referring to the innovation of turning real estate into ATM’s.

  84. Not trying to be hyperbolic here, but there was a time when the automobile was a convenience. For all but those who live near realistic urban transit systems, it is a plain necessity.

    I think of credit in the same way.

  85. just in case somebody enjoys listening to the smart guy – it is a very soothing experience as listening to truly intelligent people tends to be http://www.uctv.tv/search-details.aspx?showID=7126

    as to the coming tinto existence of the bezzle I’d like to add that I would bet that quite a number of them originally come into being through sloppiness/oversight i.e. unintentionally and only after their “birth” and after their discovery by a pirate/marauder may be made to mature into an embezzlement.

  86. ” A global reserve facility”

    I am all for a try but is it not only noble but also possible?
    what is the true success record of international let alone global facilities to date?

    no matter how savvy the founding rules and regulations will be you will have to live with the world/basic conditions changing faster or rather more fundamentally than the facility can adjust or the original writers of the charta could foresee. Then either the facility adjusts by adjusting the rules when in reality it should write totally new ones but no majority will be found for that etc etc … and after a pretty short time arteriosclerosis will have set in

  87. if I feel in worrying mood I imagine what happens when Chinese labour upgrades to machines or yet to be invented machines, increases productivity, creates unemployables?

    “Is the only ‘fix’ government ownership as per GM?”

    in a way that’s probably what we are already doing …

    If I look out of my window I seem to be seeing a lot of unemployed and unemployables – how many there are is hard to find out, there are so many “training” programs out there that result in the figures kept low not least by giving the trainers something to do – but if I go downtown and see all the young people during the day time sporting hair styles no employer would tolerate I can’t believe they are all making a living waiting tables in night clubs – and to be just all the “middle” people are obviously recovering from some abusive use of something – of course this area is kind of the poor house of Germany but still the extent is frightening.

  88. Bayard,
    I note your comments re moral compass and moral hazard. Now what moral absolute anchors the ‘game’? Seems you are reaching back only to Chapter.2 (moral compass)? Without a foundation moral compass remains a matter of opinion?

    One other CSF seems missing from the perceptive postings.

    It is the promise of benefit if the fix is put in. Our president needs a sizzling steak to sell.


    Do the following and:
    1. fast track returning employment (job numbers by date)
    2. recover bailout funds (dollar amounts by date)
    3 improve voter satisfaction measures (5 by date)
    4. deliver a healthy banking system

    People (including presidents) do things and put themselves out for reasons. Currently the financial game plan provided by the current team is seen as the only game in town. Until someone proposes an alternative we indulge in merely a genteel talkfest. Any one of the contributing experts want to step up to the plate?

  89. Bayard,
    I note your comments re moral compass and moral hazard. Now what moral absolute anchors the ‘game’? Seems you are reaching back only to Chapter.2 (moral compass)? Without a foundation moral compass remains a matter of opinion?

    One other CSF seems missing from the perceptive postings.

    It is the promise of benefit if the fix is put in. Our president needs a sizzling steak to sell.


    Do the following and:
    1. fast track returning employment (job numbers by date)
    2. recover bailout funds (dollar amounts by date)
    3 improve voter satisfaction measures (5 by date)
    4. deliver a healthy banking system

    People (including presidents) do things and put themselves out for reasons. Currently the financial game plan provided by the current team is seen as the only game in town. Until someone proposes an alternative we indulge in merely a genteel talkfest. Any one of the contributing experts want to step up to the plate? Can we deliver a breakout?

  90. Friends I am trying to find the right words to get my message through to Simon and the other regulators. It is not an easy task and so if you have any suggestions or can help me in editing what’s below I appreciate it. (I will now be out for the day) perkurowski@gmail.com

    The current bank regulatory system is fundamentally flawed, at its core!

    “The First Pillar” of our current bank regulations (Basel) establishes the “Minimum Capital Requirements” for the banks (MCRs).

    The MCRs depend on a risk assessment of a quite vaguely defined risk of default. The risk assessment is to be carried out primarily by the Credit Rating Agencies but, in the case of larger banks, also by using their internal risk models. In this respect, as an example, the MCRs rule that if a bank lends to an ordinary not rated client, it is required to hold 8 percent in equity, which is equivalent to an authorized leverage of 12.5 to 1, but, if lending to a client that is rated AAA, then it only needs to hold 1.6 percent in equity, which is equivalent to an authorized leverage of 62.5 to 1.

    The above represents two risks, both clearly evidenced in the current crisis.

    The first is that the credit rating agencies, by being captured by other interests or plainly because of human fallibility, could be wrong in their assessments, with the consequences that too much capital will follow the wrong ratings in the wrong direction. The current crisis did not result from investment in anything that could be considered as risky but almost exclusively from investments in instruments carrying an AAA rating and which were considered to be absolutely free of risk.

    The second risk with the structure of the MDCs is that they effectively imply a subsidy to anything perceived as having a low risk and, comparatively, a tax on whatever seems to carry a higher risk. The subsidies, or costs, of these regulatory risk-weights, are layered on whatever risk differentials the market already prices in their interest rate spreads. This creates confusion in the risk allocation mechanism of the market as the signals are obscured and no one knows for sure whether the low spreads are the result of low risks or the result of low capital requirements. But, so much worse, these risk-subsidies or risk-taxes help to channel and push capital flows into “risk-free” territories that could already be swamped or serve no real societal purpose, or stop capitals from flowing into dried areas much in need of capitals and which represent important societal purposes.

    All human endeavors to move forward are risky by nature, and there is absolutely nothing that in economic terms justifies a regulatory bias in favor of what is perceived as having a low risk. In the current crisis immense amounts of capital were lost sustaining a useless and artificial housing boom in a developed country, and not lost in projects that for instance tried to combat climate change or create sustainable jobs.

    The Gini Coefficient, in economics, measures the inequalities in the distribution of wealth and income, from cero, no inequalities, to 1, absolute inequality. The current bank regulatory system, by design, with the MDCs pushes up the world’s Gini Coefficient. Do we really want that?

    Please help us mend the faulty core of our bank regulations. Without this, all our other important and needed efforts to reform our financial sector are meaningless.

    Per Kurowski


  91. Sobering stuff my friend. Over here I guess we think of Germany as being in pretty good shape. Where are you in Germany? I feel I should have been more informed/concerned but CNN has not given this picture.

    I trust things are on the improve?

  92. “I trust things are on the improve?”

    if the industry manages to make enough money with very little highly qualified personnel the public coffers may be able to support it all for quite a while longer – as to our industry one pundit called it some years ago a bazaar industry meaning that we buy lots and lots of stuff abroad and then just assemble it here to be able to stamp it “made in Germany”

    but don’t listen to me – I am a gloomist and a hedonist, so I have moved for retirement to one of the most beautiful areas of my beautiful country which seems to see its best chances for its economy in building assisted living homes for the elderly – besides tourism of course but with a very short high season (thanks to the crisis? this summer seems to have been pretty good) – http://en.wikipedia.org/wiki/Ostholstein

  93. Many bankers and industrialists, in Germany and USA loved Hitler in 1933. Actually they had financed him hard for nearly 13 years.

    Anyway, Min: did Hitler prevail then?

  94. That’s the true irony of the Global Financial Crisis. A Wall Street-created mess that put world economies on the brink of armageddon — has made Wall Street banks even more powerful then a year ago when Lehman failed. Goldman, Morgan Stanley and their “competitors…” now know for a fact that any downside will cushioned by generous government handouts. Wall Street is having the last laugh… I even think they are startled at how easy it was — at least for the ones still standing — to con the U.S. tax payer.

  95. Not only have they been conned, but they will cheer the next round of Democrats and Republicans into office, so that it can happen once again.

  96. Yakkis,
    in our early years we had a 3rd party which regularly dominated the government it went into coalition with, even though it had only been elected by a meager percentage and it was dominated by a mixture of what we’d consider wild capitalists and unsavory leftovers from our recent past. Then the Greens were added who amongst other things brought the street fighters of 1968 back to respectability and now we got as the latest addition Die Linke (the Left with is a mixture of leftovers from the GDR’s SED and a populist nutcase who seems to misread Keynes. This history has made me always long for a clear cut two party system – now you tell me one is as dismal as the other …

  97. Yakkis: “Good debt is the debt used to bomb other countries,”

    They pay tribute, right? Just like Iraq has paid for our invasion and occupation.

    “buy weapons,”

    Weapons are cool! Have you seen the one in Heston’s cold, dead hand?

    “give corporate welfare,”

    They give it back. Trickle down. Just like we have seen for the last 25 years.

    “and put people in prison.”

    Where else do we get slave labor these days?

    You are right. These kinds of debt pay for themselves. ;)

  98. you have a one sided view on tribute
    Empires pay tribute also, these days it is called foreign aid
    in the old old old days empires paid it to be left undisturbed
    (btw I never knew that until it revealed itself to me last winter – maybe they do not tell us that the Romans did it because they want us not to know it because it would make foreign aid look less saintly)

  99. The BOFA investigation highlights the fact that the NY Attorney General’s office makes more progress in investigating financial shenanigans than the SEC could ever dream of. While this low level of competence at the federal level is breathtaking for the public, the financial industry must find it quite comforting as they plan their next big bubble.

  100. Yakkis,
    Happy with who? reelect who for what position (president or dogcatcher?)? I will pass until I see what options are available. Sinking feeling with the current incumbents (once is enough), or do you mean we can vote for Simon?

  101. I was responding to the comment
    The chances of getting Obama reelected grow dimmer by the day.

    …proving that it’s literally impossible for some people to be betrayed.

  102. Of course Simon is the expert on this, but I always thought foreign aid was used to foment armed conflict or give countries loans that would bankrupt them so that U.S. could sieze their natural resources.

  103. Yakkis
    once more:
    in the old old old days when foreign aid was still called tribute it was of course up to the so aided state to use the money to fight with his neighbours on its other side – or take the case of the Bulgarians when they would get uppity with Byzantium then the Hungarians might get a little subsidy encouraging them to keep Bulgarians busy with defending their northern border and of course a month later the incentives might be placed quite differently.
    The most recent time I have read an extensive description of is WW1 and at the end of it your president Wilson was aghast (according to Churchill) at the terrible dealings between allies we Europeans find normal. Thus when I talk of the use of foreign aid for power politics I am talking exclusively of the old world using them that way.

  104. Further to Rickstersherpa:

    The US has always been a nation of the oligarchs, by the oligarchs, for the oligarchs- for better and worse.

    Now, as expected, the Supreme Court (slim majority) as a matter of its (oligarchist) “false consciousness” inclination, will rule for Corporate/Labor Union unrestricted fundings of political campaigns, ostensibly to uphold the right of free speech (as much as I wonder if they would uphold Hitler’s right, then)

    The issue at hand, though, for The Supreme Court to consider, simply, is this- POWER DIFFERENTIAL.

    If the COURT does not rule accordingly OLIGARCHS win-FOREVER. One can, then, hope for benign oligarchs. Good Luck.

  105. Obama is a lawyer by training and economically-illiterate. There was an article in Newsweek in January or thereabouts that reported that Obama and his equally-clueless advisors were very happy when Larry Summers stopped by with his PowerPoint presentation and explained to them how the world financial system worked. Soon after, Summers got the NEC job. Terrifying, truly terrifying. Faced with the collapse of the world economy and impending Depression, the out-of-his-depth Obama listened to morons like Summers who said “we must save the banks that are Too Big To Fail or we will all fail”.

  106. Yes, but wise people would take heed after the tremors and build earthquake-proof houses instead of building the same flimsy shacks that just got decimated in the earthquake.

  107. Absolutely! Just that here we keep on using the same engineers (the credit rating agencies) in exactly the same way as before (the capital requirements for banks).

  108. Hello, I’m new to this blog, so I just want to take a second to maker sure I understand the different points of view being put forward. Dr. Johnson seems to be arguing that if institutions have to keep a great deal of money on hand they will be reluctant to take on excessive amounts of risk. Even better would be for bankers to be forced to have their own wealth/compensation invested in their institutions because this way if they make lousy decisions they lose their own shirts as well. That won’t bring back anyone’s money, and it might not even do much to induce bankers to make better decisions (quite a few CEO’s had a great deal of their personal wealth invested in their company’s and have lost huge sums of money), but hey misery loves company.

    As I understand Per Kurowski’s arguments, the whole high capital requirements for risky investments/low capital requirements for “safe” investments, framework established at Basel (and possibly before?) is misguided, and even dangerous. The bad apples of the current financial disaster were not your fly by the seat of your pants daredevils, but actually quite risk averse. Counter-intuitive as this assertion may seem, it is supported by the fact that the overwhelming majority of losses have come from AAA rated investments. Risk is inherent in any human activity and is actually a good thing (or at the very least necessary). The desire of the current crop of masters of the universe to create riskless investments and make what is essentially free money, lead to the recent bubble in housing. As has been pointed out by many others, this bubble took place in an already developed nation and had practically no useful social benefits, as building a railroad in Argentina for example might have. Therefore, the already existing financial regulations amount to little more than a subsidy for rich nations and a tax on poorer ones. Why would we want to continue, let alone strengthen, the current system?

    Sorry for the lengthy summary, but I want to make sure I’m reading the arguments correctly. I’m not an expert on economics or finance (actually, I’m a social studies teacher so I do sometimes teach intro 12th grade economics, but I’m well aware of my own ignorance), so it’s quite possible I’ve misread some of the arguments. It seems to me that one of main reasons why the argument that financial institutions need to maintain higher levels of capital reserves has so much traction is because it is very easy to understand. Even a non-expert such as myself can intuitively grasp “skin in the game.” Per Kurowski puts forward a pretty compelling argument that this is a misguided worldview, but I come away from reading his comments without any clear idea of what his recommendations are. If a 1.6% equity ratio for AAA rated investments is too low, what would be an appropriate number? Who decides that number if we are not going to rely on private rating agencies or the government? If risk differentials are already priced into interest rate spreads as Per Kurowski claims should we get rid of government mandated capital requirements altogether and just let the market decide? This seems to me to be a little too close to the efficient market hypothesis way of thinking that got us into this mess in the first place. Dr. Johnson’s recommendations can be summed up in three words, “triple capital requirements.” Again, this is very easy to understand, even if it may be somewhat extreme. Per Kurowski makes a convincing argument that this is a misguided approach, but I am not at all sure what he means when he says wants to “mend the faulty core of our bank regulations.” Without a clearer explanation of what mending the core of our bank regulations entail, I find myself gravitating toward Dr. Johnson’s simpler approach.

  109. Thank you for your comments and from what I read you have a quite good understanding on the underlying issues.

    I have never argued against capital requirements for our banks and for instance 8 percent sounds like a good place to start and this would allow for a 12.5 to 1 leverage. What I am against though is the regulators arbitrarily setting different capital requirements for different risks, for many reasons. Here are just a couple:

    It gives extraordinary powers to the official risk surveyors the credit rating agencies and who because they are humanly fallible or because they will be captured by interested parties will sooner or later lead too much capital over a precipice or into a swamp.

    There is nothing that says that just because something has a low risk that it should be favored more than it already is by the market by means of arbitrary regulatory concoctions.

    The market is used to allocate risks through spreads in the interest rates and here, under the table someone plays around with risk-weights and confuses the market which does not any longer know how much of a lower risk spread is the result of a lower risk and how much is the result of a lower risk-weight.

    Given that what is perceived as having low risk could lead to more carelessness than what is perceived as having higher risks… is there not a regulatory argument that points in the opposite direction? …the less the perceived risks are the higher the capital requirements?

    And the list goes on but since you describe yourself as a teacher of social studies let me end with the following one:

    The current minimum capital requirements for banks based on risk assessments, by favouring the low risk that normally resides more in rich and developed countries and castigating the higher risk that is more prone to be perceived as being part of the poor and the developing world increases the world’s Gini coefficient.

  110. Thank you for your reply. Before reading the comments in this thread I had never considered how the high capital requirements for risky investments/low capital requirements for “safe” investments, framework established at Basel discriminates against poorer nations. This is an excellent point and has made me think deeply about the unintended consequences financial regulations can have. The kind of power these regulations give to the international gatekeepers of finance can easily be abused and I’m sure even a cursory amount of research will reveal some pretty outrageous instances of such abuse (Chas T. Main’s “Confessions of an Economic Hitman,” comes to mind) However, while I concede that all of your arguments are quite compelling, I am still not sure what concrete recommendations you are putting forward. So far all I’ve heard is an 8% equity ratio. Is that supposed to be for AAA rated investments? Why 8% and not 24%? What about making banks smaller? What about shifting the pay incentives for CEO’s so that they are more concentrated on the long term than the short? Is the market going to accomplish these things on its own? There are real problems with having regulators arbitrarily assign risk spreads (you mention capture, hubris, and normal human fallibility), but I am not sure what the alternative is. Ideally, I would like these types of evaluations to be done in an open, transparent, and even democratic manner. Maybe this is too radical an idea, but I’d even like the interest rate for certain types of investments to be based in part on whether or not the project contributes to social well-being. For example, maybe a loan for a water-treatment facility in Peru should have a lower interest rate than a Goldman Sacks loan for currency speculation. How this would be accomplished though is beyond me. Certainly leaving it up to the market is not going to do the trick.

  111. “Basel discriminates against poorer nations”
    You might want to read more on this here http://bit.ly/44ERtR

    I am still not sure what concrete recommendations you are putting forward.

    First …Do no harm! And which in my mind is foremost “do not mess around with arbitrary risk-weights!”

    But perhaps the following letter that I wrote to the Financial Times in August 2004 explains it better

    “Towards a counter cyclical Basel?

    Sir, the financial system is there to safeguard savings, to generate economic growth by channeling investments, and to promote equality by providing full and free access to capital and opportunities.

    Currently, our bank regulators headquartered in Basel are primarily concerned with the first goal, that of avoiding bank collapses, and how could it be otherwise, if you have only firemen on the board that regulates building permits.

    Now, one of these days, the financial system, neatly combed and dressed in a tuxedo, but lying more than seven feet under in the coffin of financial de-intermediation, is going to wake up to the fact that it needs the presence of others in Basel. At that moment, perhaps we might start hearing about flexible capital requirements, moving up to 8.2 % or down to 7.8% by region, in response to countercyclical needs.

    Meanwhile it’s a shame that even their first goal might turn out to be elusive, since although the individual risks have fallen with Basel regulations, the stakes have increased, as those same regulations accelerate the tendency towards fewer and fewer banks.”

    And then you say that “for example, maybe a loan for a water-treatment facility in Peru should have a lower interest rate than a Goldman Sacks loan for currency speculation. How this would be accomplished though is beyond me. Certainly leaving it up to the market is not going to do the trick.”

    Well I have for years argued that if we absolutely have to keep the current Basel methodology we should at least demand that the minimum capital requirement for the banks be calculated using a matrix with, on one axis some better defined risk of default weights and, on the other axis, “societal purpose” weights. Why should bank finance “riskless” but useless or even dangerous projects for the society and not worthier projects even though they carry more risk?

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