Protect Consumers, Raise Capital, And Jam The Revolving Wall St-Washington Door

Ben Bernanke has a great opportunity to lead the reform of our financial system.  His standing in Washington and on Wall Street is at an all-time high, as a result of his bailout/rescue efforts.  He is about to be reappointed with acclaim for a second term as chairman of the Federal Reserve’s Board of Governors.  And he has a lot to answer for.

Look, for example, at his speech of May 17, 2007, which discusses some of the problems in the subprime market and contains the memorable line: “Importantly, we see no serious broader spillover to banks or thift institutions from problems in the subprime market; the troubled lenders, for the most part, have not been institutions with federally insured deposits” (full speech; marks in the margin are from an anonymous and careful correspondent.)

Three points jump off these pages.

  1. With the kind of analytical capacity and world view demonstrated in this speech, there is no way that Fed can be regarded as capable of protecting consumers vis-a-vis financial products going forward.  The Fed’s claims to that effect undermine their legitimacy and plausibility.  They failed consumers completely, and they should reflect deeply on the organizational culture and internal incentives that brought them to this sad point.  “Give us another chance” is not convincing; there is too much at stake.
  2. If the Fed is capable of such mistaken views as Bernanke expressed in May, 2007, you must assume that regulation will break down again in the future.  Tightening the rules on bank behavior is fine, but the banks will down the road again fool the Fed, other regulators, and perhaps even themselves on the true risks they face.  It is therefore essential that our financial system carry much more capital than has been the case in the recent past.  We should go back to pre-1935 or even pre-1913 levels (see slide 40 in this presentation).  In a New York Times op-ed today, Peter Boone and I call for at least tripling current capital requirements as the right goal (of course, this should be phased in over a few years.)
  3. The intellectual capture of Washington by Wall Street was well underway in May 2007; it is now complete.  This is why the banking barons felt no need to show up and show respect for the President on Monday.  They have so many of their people (mindset-wise) placed throughout the administration, and the principle of revolving between Wall Street and Washington so well established, that they know: If they ever need another massive bailout, the people standing behind this or any future President will say there is no alternative.  That’s why Peter and I also call for a 5 year gap between holding a responsible position on Wall Street and a top job in Washington, and vice versa.  Stop with the political appointment of regulatory “doves” and end the notion that you can go directly from a failing bank to directing efforts to rescue such banks.

Ben Bernanke can play the broad reformist role of Marriner Eccles, chair of the Fed during the Great Depression.  Or he can go back to being a cheerleader for the financial sector, following in the discredited footsteps of Alan Greenspan. 

This is his choice.

By Simon Johnson

153 thoughts on “Protect Consumers, Raise Capital, And Jam The Revolving Wall St-Washington Door

  1. So we put our faith in Ben Bernanke. Hopefully, He has read “Greenspan’s Bubbles” by Fleckenstein or read a few of your reviews of Greenspan’s shortcomings and therefore realizes – He is being watched. History will not treat him well if he glosses over what is becoming an ill-conceived policy regarding the banksters.

    We need a fearless leader. We need a Paul Volcker for our times. Who will tell the truth? Who will put their foot down and call for real reform and a return of credible regulation?

  2. The Fed has proven and continues to prove that it is unwilling and incapable of regulation.

    Mortgages and credit cards? It refuses to take action on these even now, let alone in the past.

    Systemically important entities? It has always refused to recognize even their existence, on principle. Now it’s supposed to revamp its entire culture and then take effective action?

    No, to listen to the Fed say “trust us…give us another chance” is like the fraudulent call for a “trigger” for a public option, giving the insurance racket yet another chance after they’ve proven for decades that they cannot and will not provide value.

    Anyone who wants to give more chances to proven anti-public, anti-reform forces is really anti-public and anti-reform himself.

  3. In their op-ed in the New York Times, Peter Boone and Simon Johnson hold that “The Obama administration should at least triple the current capital requirements for the financial sector”.

    This evidences that they have not sufficient knowledge of what they are talking about; that they are either too lazy or that they find it beneath them to read and understand the current capital requirements.

    The credits to unrated or from BBB+ to B- rated clients, those usually not perceived as risk-free, those for which the banks take their ordinary precautions, have an 8 per cent equity requirement. This requirement is most probably quite sufficient and it would be pure crazy Puritanism to elevate these to 24 percent. What was highly insufficient though was 1.6 percent capital requirement allowed by the regulator for any operation involving an AAA rated security or client. And so what has to be done is not to increase the basic 8 percent capital requirements but to eliminate that arbitrary regulatory risk discrimination that channels or pushes financial flows massively into anything perceived as low rate; and as if anything having a low perceived or real risk is more worthy of financing than anything that has a higher perceived or real risk.

    No Mr. Boone and Mr. Johnson, you see, it was not the risky which provided the explosive material for this crisis but the not-risky. Do not propose simpleton adjustments just to have us again feel the bliss of believing we are safe… or, much less, so that we place ourselves even further away from the risks we need to take in order to move the world forward.

    Again Mr. Boone and Mr. Johnson, both of you should start by understanding what happened better, even if that entails reading some boring regulations. A general dislike of bankers is not enough to guarantee our financial regulations move in a better direction.

    Finally and as you both seem to loath “financial boom-bust cycles” Where can we find a study that indicates that the world would, in general, be better off without the growth impetus provided by boom-bust cycles? Would it not be a better thing that instead of just looking at averting a crisis we do our most to maximize the results for humanity of the whole boom-bust cycle?

    In the 347 pages of the bank regulations known as Basel II there is not one single phrase, much less a paragraph that has anything to do with establishing the purpose of our banks. When regulating should you not start by doing that?

  4. “You tell me whar a man gits his corn pone,” Mark Twain recalled a childhood friend telling him, “en I’ll tell you what his ‘pinions is.”

    Who does Ben Bernanke work for?

  5. > a 5 year gap between holding a responsible position on Wall Street and a top job in Washington

    how is this legal?

    plus, who would consider taking a government job?

    you could lose your job after an election and have to go five years without work. nobody would do that.

  6. I agree with Per above that saying “triple the capital requirements” does not make much sense.

    We need banking regulation that involves regulators having some sense of what the banks are actually holding. Our capital requirements are not merely insufficient, they are nonsensical, because they rely on market proxies for analyzing risk.

  7. That’s classic Dave, great stuff. I got a big laugh and smile out of that one, because it is so very very true. I read Huckleberry Finn as an adult in my 30s and got so many more laughs out of it than I did in my teens.

  8. The Federal Reserve’s mandate is “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Despite all the challenges related to defining what “stable prices” mean, the Fed has been reasonably good at controlling the inflation over the past 20 years (future impact of its current programs is a separate issue). The Fed should take on the explicit responsibility to monitor aggregate price levels of asset classes, such as real estate, equities, commodities, and to prevent boom-bust cycles (not just mop up after them!). Making this objective part of the Fed’s official mission will go a long way in changing the Fed’s mindset.

    Secondly, the explicit promise of government support has to be clearly linked to permissible activities financial institutions are allowed to engage. Depositary institutions that want to rely on the FDIC insurance should not be allowed to engage in inherently risky businesses such as proprietary trading. If a financial institution wants to have a little trading book, either directly or though its affiliated entities, then its deposits will not be insured by the FDIC. The consumers themselves and the consumer protection agency will then ensure that the deposit base of such institutions does not become too big to fail (yes, Citi and BofA, that is aimed directly at you).

    Thirdly, regarding the legality of not allowing moving back and forth between Wall St and Washington. Non-compete clauses in employment contracts routinely have limitations on ability to work for a competitor, so extending them to limit ability to work for a regulator is easy, just as it is easy to limit ability for regulators to work for a private company in the regulated industry. That said, most people do have to work somewhere and not everybody would be able to find a job in academia or think tanks between Wall St and Washington jobs. Such limitation can only apply to senior-most positions such as Fed Governors, Treasury Secretary or Undersecretaries.

    Lastly, the non-risk sensitive capital requirements (such as liquidity ratio) should be made proportional to the asset size of a financial institution: say 4% for the first $100 Bil in assets, then 6% for assets between $100 Bil and $500 Bil, and 8% for assets above $500 Bil. This will be a reasonably good tax on the size to control TBTF problems.

  9. Simon,
    This is the best post you have made since I have been reading this site. It is the best for 2 reasons.


    Bernanke may not have been able to overrule Greenspan, but he was there in the shop when it happened, and even as of May 2007 we can see he clearly didn’t get what was going on. He needs to take that responsibility and he now needs to clean up the mess. He has no excuses now as Fed Chairman that he doesn’t have the power to clean things up.


    No wishy-washy “this should be better in this area, this should be better in that segment”. Sometimes economists need to specify not just areas of improvement but quantify EXACTLY what needs to be done. You did that, specifying 3 times the current capital requirements and specifying 5 year gap between Wall Street and Washington jobs, and you should be roundly and thoroughly applauded for it. Right or wrong (very right I think), you had the cojones to do it. Many University professors don’t have the cojones to make specific policy actions that should be taken and YOU did!

    Hats off to Simon Johnson!! Keep up the fight Professor Johnson!! Many Americans support you!!

  10. Says Ritholtz. “Overturning the so-called Bear Stearns rule allowing leverage beyond 12 to 1 The SEC’s 2004 rule change, which eliminated some leverage restrictions on investment banks in favor of capital requirements by type of asset was a mistake. Without overturning that, give us 5-10 years, we’ll be right back where we started.”

    This is, with some minor adjustments, quite correct.

    Basel II and that was signed in June 2004 by the G10 Ministers (and the Fed acted accordingly) established capital requirements not based on type of assets but based on the perceived risk of default of those assets. That is when an operation with anyone rated AAA required only 1.6 percent in capital and could therefore be leveraged 62.5 to 1.

    And, as I wrote in the Financial Times in January 2003 “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds” of course if we insist on following them sooner or later we are doomed to be “right back where we started”.

    And not only because the credit ratings could be wrong but also because they could be too right and we channel too much of our scarce financial resources into financing something useless, just because it is subsidized by means of very low capital requirements when being perceived as of “low-risk”… like perhaps the building of an inventory of coffins at zero interest rates.

  11. BG – some of the capital requirements indeed rely on market proxies (such as risk-based capital ratios), other do not (such as the liquidity ratio). There is always risk associated with any asset other than cash or UST. What should be included, and may well be tripled, is the capital charge for complex financial instruments linked to the performance of other instruments, such as CDO, MBS, ABS – for all ratings bands.

  12. It takes more than “cojones” to recommend a capital requirement for banks of 24 percent when lending to an unrated grocery store or an unrated geothermal energy installer; 4.8 percent when lending to a AAA client and cero percent when lending to the government. It requires not knowing enough!

    Now the difference between the AAA and the rated is 6.4 percent in bank capital (8 minus 1.6) with this proposal that would shoot up to 19.2 percent difference (24 minus 4.8) Sort like having Boone and Johnson working for those “too safe too fail”

  13. I don’t think there is a “right” answer for most things, and certainly not something as complex as the problems of making finance perfect. There are good ideas and bad ones, and many with pros and cons, which we can’t avoid and unfortunately too often do not acknowledge honestly.

    Volcker’s most important point is to separate ordinary banking (simple, safe, deserving of public support and regulation) from i-banking, prop trading, private equity, and all the other stuff that makes a firm like Goldman Sachs much more profitable than, say, Wells Fargo.

    On pay, people focus on the absolute numbers, like Citi’s $100mm commodity man, but it isn’t the payouts that are the problem. The issue is risk, and being able to claw back the bonus if he loses it in the next few years. Selling way OTM options should not be a profitable strategy for an employee. Right now, it is.

    Clearly, there is also a need to think outside the box on capital structure. Obviously relying on ratings is ocmpletely absurd and should be nixed. Banks need to justify loan-loss reserves based on trading risk and leverage of their borrowers, and the quality of the assets, as well as covenants in the loan docs. More importantly, what this crisis has demonstrated is a need for banks to have much bigger buffers of subordinated debt that can convert into equity if needed, and a streamlined way to give bondholders a haircut as well, instead of being bailed out 100%. A very small haircut in extreme circumstances would probably not be extremely expensive in terms of spreads, but would add immense relief for liquidity needs and capital. In all these cases equity could get massively diluted and that’s the point.

    Finally, why are investors who bought into the credit bubble (cov-lite junk bonds, subprime CDOs, bonds of banks that got ever more risky at spreads of 25bp) escaping blame in all this? They are as culpable as greedy real estate investors, but should be considered more guilty, as they are purportedly professional. Perhaps any CIO who bought a Mez tranche of a CDO-squared for an investment-grade bond fund, or bought commercial paper from a 20-times leveraged SIV for a money market fund, should be banned from money management for ever.

  14. Non-compete clauses in employment contracts routinely have limitations on ability to work for a competitor, so extending them to limit ability to work for a regulator is easy, just as it is easy to limit ability for regulators to work for a private company in the regulated industry.

    But this would be the nefarious government doing it! That’s tyranny.

    When decent, wholesome, apple pie-baking corporations do it, it’s freedom and prosperity exemplified!

    Just like with everything else…

  15. I assumed we were talking about risk-weighted capital ratios. This discussion is going to have to get a lot more technical to be of any real use.

    Yes, there is risk associated with any asset. My point (and Per’s point, I believe) is that there are more fundamental questions than how much capital should be required to offset that risk: 1) how do we quantify that risk, and 2) who is doing the quantifying.

  16. If you equalize the capital ratios, this will create an implicit tax on low risk investments. Think about this – the cost of financing low risk investments (if they REALLY are low risk) is the cost of borrowing that money plus the cost of putting up your private capital to secure the borrowed money (the latter can be thought of as an opportunity cost). That’s a pretty steep opportunity cost for a low return investment, meaning that banks will have an incentive to go after riskier investments to maintain returns – making it harder for governments to finance (rollover) their debts.

    That doesn’t mean that 1.6% isn’t too low, but rather that we may not want the requirement for AAA debt to be quite as high as lower risk debt. (And yes, this does mean we need to really fix the ratings agencies.)

    I suspect the real reason that govts were so eager to offer low capital requirements in Basel II was to create a massive subsidy for govt. debt; it may be a matter of time before scholars start linking this capital requirement differential to “crowding out” as govt. can acquire credit cheaper than others.

  17. 1.6% vs. 8% may be excessive, but do you really think that (assuming risk ratings actually meant something) they should be equal?

  18. Per – I do not think Boon and Johnson are arguing for flat increase of capital requirements by a factor of three. They argue that the aggregate capital amount should be tripled. It may well be accomplished by increasing capital requirements for exposure to banks by exposure to AA/A rated banks, securities firms and complex instruments like CDO/MBS/ABS, and by increasing floor on internal PD estimates from 3 bps to say 10 bps

  19. Lehman executive had the bulk of their compensation in stock vested after 5-years. It is essentially a clawback, which did not prevent Lehman from taking on a lot of risk, but it did penalize Lehman executives, who have lost much of their wealth with the firm’s collapse.

  20. Relying *only* on ratings is absurd, but so is completely risk-insensitive approach to capital. Would you want banks to hold the same amount of capital for the same level of exposure to IBM bonds, a loan to American Airlines and a subordinate CMBS tranche?

  21. There are some interesting moves afoot, and I’m not sure what they mean… Talk of a consumer financial regulatory commission is subdued, but the SEC just unloaded…

    There seems to be a general preference to handle these new changes through existing technocratic institutions (SEC rules changes, + commentary, implies they believe that their current legal authority allows them to make these changes through standard Notice and Comment process rather than requiring new legislation). Legislation is more stable, and enduring, than rules changes… So in that sense, this is dissappointing. But, it does mean that something is happening (though whether it can survive a deregulatory push from a new Administration is questionable).

    It could be that the SEC is moving pre-emptively, to deter Congress from writing new laws (and potentially punishing them for failure) or to stake a claim in the upcoming turf war. Or it could mean the current administration and technocratic core believe the answers should be left to the “experts”, and handled “quietly” in order to avoid Congressional grandstanding that could yield bad outcomes.

    I’m sure this will liven up the democracy/technocracy debate a bit, but the material question is whether administrative rules changes can “Hold the Line” next time regulation comes under fire.

  22. This is the problem with even debating capital requirements before sorting out the idea of how risk is assessed. What is the point of the regulatory exercise if risk is mischaracterized from the beginning?

  23. Granular quantifying of risk will have to be done by banks unless you really want to grow the regulatory staff very substantially and make their compensation comparable to that of the private sector.

    Short of that, the regulators will have to rely on fairly crude measures, such as the leverage ratio, to benchmark banks’ self-reported capital numbers against.

  24. Bernake also said “the recession is over.”
    Does anyone doubt he means the opposite of what
    he says when he describes what is going on?

  25. Bernanke is just too stupid to understand the damage he’s done to our economy & to the long term viability of our (and his own) country.

    To plow a corn field with a mule one first needs to get the mule’s attention. We just don’t have Bernanke’s attention yet. Hopefully Simon’s insightful post will help accomplish this. However, to get a mule’s attention one needs to hit it in the head with a two-by-four.

  26. I suspect the real reason that govts were so eager to offer low capital requirements in Basel II was to create a massive subsidy for govt. debt

    Another reason is that governments of advances industrialized countries do not default on their own debt. If you don’t want banks to hold capital against UST, why would you want them to hold capital against debt issued by governments of Spain or Sweden (leaving aside the FX risk)?

    Sovereign ratings act as proxies for “advances industrialized”.

  27. Tripling the capital requirements does not necessarily mean tripling across the board, maybe just tripling the total capital reserves. That could mean significantly less than triple at the riskier end and significant’y more than triple at the so called risk free end of the spectrum. Or you might even come up with a formula that requires add’l capital reserves because the total of an entity’s risk is greater than the sum of it’s parts.

  28. They don’t mean much; that is the point. They really need something akin to regular stress tests. But then that requires regulators to be both honest and sophisticated, and we already know they are neither.

    I’d like to see someone quantify how things would be different if capital requirements had been tripled.

  29. One last comment – I’m 90% onboard with the NYT article. I’d say 100%, but I don’t believe 100% exists. It’s a great article, with a good historical perspective and strong prescriptions. But permit me to express just a modicum of fear – whatever the phase-in looks like, let’s hope our leaders handle it well:

    1) Even with phase-ins, we have substantial uncertainty in the international realm due to national governments subsidizing risks for their domestic banks, and banks having nearly free reign in foreign economies. This is a trade subsidy, and that means if we drop it and other countries don’t, we’ll have harsh claims that our financial sector is “disadvantaged”. And they _might_ be right.

    My hope is we see real movement from the G8/G20 on this dimension.

    2) When we increase capital ratios, money velocity may shrink… Something needs to inject new money into the system if we’re going to avoid depression due to sustained massive deleveraging, and we’re going to see all sorts of distributional conflicts over how that new money enters the system (or even if it _should_ enter the system). Doing this properly may require some “big” changes and real vision, almost on the scale of Bretton Woods… I hope our leaders are up to it.

    Those are some fears, but they shouldn’t stop any of the recommended prescriptions.

  30. “Despite all the challenges related to defining what “stable prices” mean, the Fed has been reasonably good at controlling the inflation over the past 20 years”

    Reasonably good, if you consider ignoring the existence and impact of asset inflation. But to be fair to his intelligence, if not his integrity, Greenspan did recognize the danger of asset inflation (“irrational exuberance”). He just chose to switch from being a deficit hawk under Clinton to being a deficit whore under W so he could set in motion the collapse of Soc Sec and Medicare. And he chose to hold interest rates down and ignore the housing bubble so W could get re-elected.

  31. I rather like SJ’s proposal in the NYT article:

    “It should be up to the financial sector to make its practices clear and simple enough for these professionals to understand, and any that are too complex should not be approved.”

    I like this because that’s the same criteria implemented in the private sector – as a technical person, it’s YOUR job to explain your technical work to (impatient, untrained) senior management in simple terms. If you can’t explain it to your manager, then by definition it’s too complex.

    We can call it the “Dilbert Filter”.

  32. If we really want to address systemic risk, we have literally no option other than to adopt more robust measures of risk. They are going to need to get granular on bank holdings and look at counterparty scenarios.

    It really does not matter what fiction we invent to explain capital if regulators can’t understand the actual risks involved.

  33. Yes. Because the market allocates risks through spreads in the interest rates and so when someone, under the table plays around with risk-weights, it confuses the market which ends up not knowing 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.

  34. From having followed this blog for many months and clearly having established that Johnson is not into this kind of “technical minutia” that distracts him from his other agendas I am absolutely sure that at least he does not mean what you say.

    Question… do you feel that the 8 percent capital requirements for operations perceived as more risky should be increased even when for these operations the 8 percent capital requirement has sufficed? If so you are close to implying that the high-risk world should go on subsidizing the world perceived as low-risk.

  35. Two brief comments on Ritholtz’s suggestions:
    1. According to the Center for Responsive Politics, $200 million was spent lobbying for the repeal of Glsss-Steagall—in the year preceding the reapeal! The money came from the finance, insurance and real estate sectors. From what sectors are we going to get that kind of money to argue for its reinstatement?

    2. Overturning the rule prohibiting leverage beyond 12 to 1—if I understand Ritholtz correctly from the video Goldman, Morgan, Merrill, Lehman, and Bear managed to obtain exemptions from the rule for themselves and any other entity bigger than Bear. What good are regs if they only apply to the bit players? [The 14th Amendment provides for “equal protection” but not equal application of the law.]

    Such behavior lends credence to the view that laws and regs have no intended consequences (ignoring unintended consequences) except to give power and its attendant wealth to the lawmakers and their agents.

  36. “It should be up to the financial sector to make its practices clear and simple enough for these professionals to understand, and any that are too complex should not be approved.”

    Come on, is it not even more important that the regulators of the financial sector make its practices clear and simple enough for the regulators and the citizens to understand, and any that are too complex should not be approved?

    I invite you to read the Basel Epistle that regulates our banks and that are obviously so tedious and complex that even an IMF regulator like Simon Johnson does not read or does not get.

  37. Concerning the problem of “complexity”, I’ll quote Taleb again:

    “5. Counter-balance complexity with simplicity. Complexity from globalization and highly
    networked economic life needs to be countered by simplicity in financial products.”

    Click to access tenprinciples.pdf

    I think we’ve established enough that all the “financial innovation” of the last decades was basically horseshit. If we roll back all this “innovation” we should arrive at products that will pass the “Dilbert filter”.

  38. Asset inflation is not a well defined concept, boom-bust is. Greenspan was well aware of the difference. As you said, he chose not to interfere because of his political views, which gave him too easy a way out – “Who am I to judge if the price levels are too high?”. If oversight over asset bubbles were an explicit responsibility of the Fed, even Greenspan might have acted differently.

  39. Per – my position is two fold:
    1) I fully agree that better risk-sensitive metrics are required with regulatory imposed caps and floors on inputs such as PDs or LGDs. It might mean that in some case 8% is sufficient, in other it might be increased or decreased.
    2) At the same time, I think one needs very simple, transparent and difficult-to-game metrics, such as leverage ratio (with the numerator changed to to tangible equity).

    How banks assign internal cost of capital and whether they choose to subsidize some business lines by others should be left to the banks.

  40. Per – does Obama bother with technical elements? No. There is a balance of strategic thinkers over a sea of implementation moles. Wall street is crawling with them. They, of the credit default swap and collateralized debt obligation mentality. In other words, we need someone with big shoes to stomp the roaches. Sadly, the role is not being perfomed in the W.H.

  41. The “yes” answer will force the banks to invest more heavily in risky assets in order to maximize return on capital. That is precisely the type of behavior one wants to discourage.

  42. I recall years ago, maybe incorrectly, that the overall leverage required was 7:1 which would mean banks maintained capital at about 15%. Of course this was in a time when glass-steagall was in force’

    The banks probably managed the mix of loans to meet prudent lending requirements while maximising their business profits? Things couldn’t have been too bad as loanable funds generated out of thin air via leveraging was money for jam. Although bankers who wanted more, more, more would and will always complain.

    How successful would such a capital ratio be today?

  43. Seems to me that banks complaining that they are ‘disadvantaged’ by denying them unrestricted leveraging rules in the world scene misses the point! We are concerned with banks being prudent lenders and able to meet risks if loans fail. So what if they constrain themselves by not employing more capital?

    Maybe we are overdue for a law which bars bank management from ever managing banks if their bank fails! If they as business folk went to a bank for a loan after failing, their track record would probably mean the bank refuses them a loan?

    Time to get real people.

  44. Oh yes, I understand only too well why Dilbert is funny. But if we _only_ allowed financial instruments that Dilbert’s boss could understand, that would solve the problem of regulatory complexity.

    Leaving aside my inadequate attempt at humor, the underlying notion is this:

    If we only allowed instruments that regulators could understand to be implemented, then this yields two effects: 1) limiting innovation in the short term 2) incenting the private sector to encourage investment in regulators with more capabilities. Somewhere in there is an equillibrium. The hard part is making sure regulators understand what they claim to understand.

  45. From what sectors are we going to get that kind of money to argue for its reinstatement?

    I think if we held enough bake sales…

  46. “The Fed should take on the explicit responsibility to monitor aggregate price levels of asset classes, such as real estate, equities, commodities, and to prevent boom-bust cycles (not just mop up after them!).”

    That means the Fed needs to be able to identify bubbles reliably – which is an explicit rejection of efficient markets.

    Your point 2 is Taunter’s Boring/Safe distinction.

    More on the liquidity ratio please – it strikes me that without strengthening the legal definition a bit, this might be end-run by some creative financial engineers. Maybe just cash only. So are you arguing that banks must essentially keep their collateral in cash (on deposit with the Fed or in vault) rather than investing it in liquid assets alongside money they borrow from depositors/bondholders?

    One nice property of a stable cash asset ratio and variable capital asset ratios is that it would encourage a mix of investments by banks, so that banks don’t become overly specialized.

    That’s a lot of cash on deposit, though – the Fed better be prepared for the impact on money velocity and supply.

  47. plus, who would consider taking a government job?

    Exactly. What’s the point of working for the government if you can’t peddle influence later?

  48. I’m making a stand in defense of mom and apple pies! How come apple pies are at risk again. We should have an amendment which prohibits any such un-American risk? All bankers showing any disrespect of apple pies should be tarred and feathered and ridden out of town on a rail (huck finn penalty) Call me if you want further hi-speed penalty suggestions.

  49. Anyone who wants to give more chances to proven anti-public, anti-reform forces is really anti-public and anti-reform himself.

    But has it been proven beyond any possible doubt?

  50. I deeply question the adequacy of regulatory reform since the job of a good lawyer is often to find his client’s way around the law.

    We have not questioned the advantage these boom and bust cycles provide for those who allow them. Not only did the 1980’s usher in a drive to deregulate markets, but it also ushered in a shift in social philosophy. Prof. Johnson keeps referring to a two track economy, and this is exactly what the boom and bust cycle encourages and what the financial elites Mills) want. Why else would the CEO’s not show en masse for President Obama’s speech last week? Why should they want re-regulation? The system works for them.

    Regulation cannot address the deeper problem of the loss of a social concensus in this country on a variety of social, political, and economic issues. Regulation, which I agree is needed, is insufficient to address the more fundamental problems. Without a fundamental shift in social norms, banks, investment houses, and insurance companies will always be one step ahead of the regulators.

    Allow me one specific: How long was it going to take the attorney generals of the various states to crack down on predatory lending practices? Although they were far from the cause of the current crisis, they contributed to it. In these fields, government and regulation is always reactive to innovation and often fails to recognize the problems and the need for regulation until a fair amount of damage has been done. How long have health insurance company practices been suspect? And now we finally want to regulate them?

    Without a strong social concensus that certain behaviors are inherently wrong or irresponsible, regulation merely tries to play catch up.

  51. Basically, I think it comes down to who do we trust, the market or the regulators? 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?

    Dr. Jonhson’s recommendation has the advantage of being easy to understand (even a non-expert such as myself can intuitively grasp “skin in the game.”), but as Bond Girl and others have pointed out there is no real reason to expect that higher levels of capital requirements in and of itself will stop bankers from making lousy decisions. Systematic risk regulators who decide what is risky may even abuse their power to the detriment of poorer nations (see Chas T. Main’s “Confessions of an Economic Hitman,” for example). Then again simply assuming that risk differentials are already priced into interest rate spreads as Per Kurowski claims 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. In conclusion, I don’t know what to believe.

  52. “From what sectors are we going to get that kind of money to argue for its reinstatement?”

    You’d think we could find some politicians who cared enough about our country to get it done…..or bake sales.

  53. Reading these posts is a continuing education in banking witchcraft. In the comments re risk and related capital requirements, I see 62.5:1 is acceptable ratio for AAA risk.

    Wasn’t the current problem substantially caused or magnified by AAA ratings being incorrect for securitised sub-prime mortgages etc? Rating agencies are clearly at fault (criminal?). How did banks believe AAA for such securities? Are the bankers negligent? Did they lean on the rating agencies for AAA ratings? Are the bankers criminally liable as well? How did a bank’s auditors certify accounts as true and reasonable? Maybe we will change the regulations and etc but forget to nail responsbility firmly to the bankers and their accomplices!

    I want to see some bank management and their accomplices sent up the river for a long, long time and quick time.

  54. In manufacturing, we had several products that used some of the same parts, and we had a software system that helped us determine how much of the similar parts to buy to minimize inventory and stock outs at the same time. I´m sure a system could be developed that would look at all the risk (if it was honestly valued) and come up with how much capital you need based on the risk of your various products. Seems to me the problem is that the banks would rather fly by the seat of their pants and later get bailed out.

  55. I agree, thanks for coming up with proposals, that´s where you start. I love Baseline Scenario, although I find our country´s situation quite depressing, and am not sure what I can do to help. Personally I am not enamored with Ben, I don´t see why you should get a medal for handling the emergency when you helped drive the train off the tracks in the first place.

  56. Mr. Johnson, why only a 5-year gap between working on Wall Street and working as a regulator?

    Is that simply what you see as the maximum feasible period, or does it have other significance?

  57. It is difficult to pin-point precisely when it is in one’s experience of Bernancke that one realizes one is in the presence of just the most loathsome maggot. Perhaps it’s when one first encounters the feigned thoughtfulness, the hands clasped prayerfully, fingertips touching, while dodging the questions of posturing congressional pond scum.

    “With the kind of analytical capacity and world view demonstrated in this speech …”

    Oh, goodness, zeitgeist? What zeitgeist? A frog like Bernancke never looks past the question of personal security and that entails minimally an awareness of whose back to scratch and at least some networking such as his recently undertaken sales tour aimed at re-appointment. To cast this man as a kind of philosopher has all the substance of an Obama promise.

    “The intellectual capture of Washington by Wall Street was well underway in May 2007; it is now complete.”

    This whole notion of “intellectual capture” is all-too-frequently introduced as a kind of euphemism, or even deus ex machina, to avoid calling the observed phenomenon precisely what it is: Corruption. One finds it rather easy to locate merit in the expressed outlook of someone considered vital to one’s wellbeing, eh? But the thought of these slugs operating in some conceptual supermarket choosing for themselves one outlook as opposed to another is unadulterated burlesque. These are simply an aggregate of the most noxious, self-seeking reptiles, nothing more than that. There’s really no further requirement again to call financial capture, “intellectual capture”, Simon. You can come out now. :-)

  58. I am afraid I misspoke – I was obviously referring to the leverage ratio, not the liquidity ration (an embarrassing slip). My apologies.
    I am not sure if the liquidity ratio can be of much help with fixing the problem as it applies only to on-demand accounts.

  59. Mr. M I agree 100%.
    And I would want to be especially insistent on making sure that the banks interact with the rest of the financial sector in a clear and transparent way since having them play with a different set of cards, the risk-weights deck, makes it very hard for everyone to understand the real price of risk. (A bit like when the Fed is out there with their quantitative easing it becomes very difficult to get the real signals in many debt markets).

  60. Hang on a minute. It seems that the central point of Simon’s piece in today’s New York Times is being missed. Consider these facts;
    *Robert Rubin is the God Father of the U.S. Treasury. He was Secretary of the Treasury during Clinton’s administration and is currently an unofficial adviser to the President. Before Washington, he was chairman at Goldman Sachs. During the years of the Bush administration, he collected $126 million from Citibank for undisclosed services.
    *Henry Paulson was CEO at Goldman Sachs before becoming Bush’s Secretary of the Treasury. Goldman paid him $29.8 million the year before he went to Washington.
    *Neel Kashkari is responsible for managing TARP. He was a VP at Goldman before he came to Washington.
    *Larry Summers is the chief economic adviser to the President today. On April 16, 2008, Goldman Sachs paid him $135,000 for a one day visit.
    *Gary Gensler is now head of the CFTC and he came to the job directly from Goldman Sachs.
    *Edward Liddy, Chairman until last month of AIG was on the board of Goldman Sachs and remains a stockholder.
    *Timothy Geithner is a protege of Larry Summers. As Governor of the New York Fed, he was responsible for designing the truly awful TARP which transferred $10 Billion directly to Goldman Sachs.
    *Geithner’s replacement at the New York Fed also came directly from Goldman Sachs where he was a partner and managing director.

    There is more, but you get the idea. You can find all of these facts, and a whole lot more in our new book, The Great Ression Conspiracy, at It is also a Kindle book.

    I know Ted K hates this book, but then he hasn’t bothered to read it either.

  61. “as a technical person, it’s YOUR job to explain your technical work to (impatient, untrained) senior management in simple terms. If you can’t explain it to your manager, then by definition it’s too complex.”

    if that were so and they’d really understand anything of what they’re told instead of just feigning it how then came it to pass that lots of silly computer programs were forced on us unlucky cubiclers?
    I think that in those meetings there is a competition between the managers (at least of those in big corporations) going on who is understanding it faster – nobody would even dream of asking “is the emperor naked?”

  62. “Honesty is the best policy – when there is money in it. Mark Twain”

    there is the story of a Bahai businessman who by his religion is forbidden to lie and apparently took it seriously – he failed as a carpet salesman in Germany and thrived as producer of matches in Albania

  63. lambert strether asks: Why is it bad “that the high-risk world should go on subsidizing the world perceived as low-risk”?

    First let us remember that the high-risk world already pays a higher interest spread than the low risk-world, and so, in this case, we are talking about the regulators placing an additional layer of costs on the high risk when compared to the perceived low-risk; which is the same to say that in relative terms the high-risk world subsidizes the world perceived as low risk.

    Then as to the why, let me ask you in terms of human and societal development… which country do you see as growing stronger a country that goes for financial risk aversion or a country that has more financial risk-taking? I for sure want my descendants to grow up in the latter as the first sound more compatible with a baby-boomer generation that wants to lie down and die in tranquility… “Après nous le deluge”

    Are we going to finance what has no risk just so as to avoid the default of banks or are we to finance the risk that needs to be taken in order to save the world?

    Does this sound very out of context for your taste? Well no, this is exactly the kind of implications you would want your financial regulators to be aware of, before they try to save us from all bad.

    Finally let´s be real, there is nothing as risky like that which is considered not-risky. The ordinary human is set to be risk-averse so that if you set up signs that indicate AAA no-risk they will stampede there.

  64. Plebeianswillrevolt: “Per – does Obama bother with technical elements? No. There is a balance of strategic thinkers over a sea of implementation moles.”

    I am sure there have to be some out there but the last of some statute that I can think of in this area was Paul Volcker. Indeed it is a sad state of affair when hands and feet win over hearts and brains. One of the reasons for this is that we as a society are not sufficiently willing to call out b.s.ers for what they are. For instance if you set up a panel of independent thinkers to judge what is coming out of the Universities in research their first conclusion might be, “forget about tenures” it is not producing the critical thinking that it is supposed to produce.

  65. “I suspect the real reason that govts were so eager to offer low capital requirements in Basel II was to create a massive subsidy for govt. debt;”

    Indeed if a bank lends to an ordinary industry rated BBB+ to B- then the bank needs to put away 8 percent of the capital but if it lends that same money to the government so that a bureaucrat makes the same loan then it is required zero capital…. I am sorry but the world’s gone mad!

  66. Absolutely, though it is even worse, since the first you have to define in order to regulate is… what do we want to achieve with our regulations? And that was not debated, but all left in the hands of some firefighters just wanting to avoid fire at any rate… Well there you have it, they try to build such safe fire systems that the building, overloaded, came tumbling down.

  67. Wendy, forget it! In manufacturing the risk is very clear that of producing a faulty product. In finance in terms of risk a possible default is only a fraction of the risks involved since just for a starter the risk of our banks not performing the correct intermediation is even larger than the risk of a bank defaulting. I much prefer to be left standing in a viable world with all our banks in rubbles than to be left in an unviable world with just the only bank left standing.

  68. I like the notion of intellectual capture because it suggests a subtlety that corruption does not. Corruption is illegal and has to do with conflicts of interest and failures in fiduciary responsibility. It is criminal because the corrupt individual understands that he or she is acting improperly. But “intellectual capture” suggests what the snake did to Eve, convinced her that the misdeed was the correct deed. When the 2001 tax cut went through, it had all sorts of intellectual camouflage. Through the process of intellectual capture it became the right thing to do. Greenspan supported the cuts although he acknowledge a few years later that they substantially added to the deficit.

    Deregulation became the in idea after deregulation of the airline industry in the late 70’s. Just as open marriages became the thing in the 60’s. Is there an element of self-deception? Probably.

  69. I don’t like conspiracy theories. Instead I see class behavior. Belonging to the same country club is not a conspiracy but it happens because you want to socialize with people of your own kind (read class).

  70. With respect to this important issue the following is an extract of a letter of mine that the Financial Times published in May 2006, just around the time I was blacklisted by them

    “I would argue that it is solely the way how inflation is measured that creates the confusion. Let us not forget that inflation as they, our monetary authorities know it, is just obtained by looking at a basket of limited consumer goods chosen by bureaucrats and that although they might be highly relevant to the many have-nots, are highly irrelevant to measure the real loss of value of money. For instance, who on earth has decided for that the increase in the price of houses is not inflation? And so what should perhaps be argued is that really our monetary authorities have not been so successful fighting inflation as they claim they have been.”

    And now they are telling us we do not have deflation!

  71. Mr.M “The “yes” answer will force the banks to invest more heavily in risky assets in order to maximize return on capital. That is precisely the type of behavior one wants to discourage.”

    The “No” answer that was given, led the banks to invest more heavily in “risk-free” assets in order to maximize return on capital. That is precisely what created this mega crisis.

    A crisis resulting from the investment in risky assets will always, almost by definition, be smaller than a crisis resulting from investments that were misjudged to be “risk-free”.

  72. notabankers writes “Rating agencies are clearly at fault (criminal?). How did banks believe AAA for such securities? …. I want to see some bank management and their accomplices sent up the river for a long, long time and quick time.”

    And what about the regulators? The absolutely least they should get for their stupid wrong doings, or their complicit silence, or their sheer ignorance or arrogance, is a Paris Hilton type of weekend behind the bars… and have their names exposed… so we get rid of those who now play innocent victims but never spoke out before.

  73. And I don’t like conspiracy theories because they assume too much intelligence and capacity of keeping conspiratorial silence among the conspirators… but foremost because it normally only diverts from the real truth.

  74. Perhaps you can explain why Wells Fargo and Bank of America, among hundreds of others, executives are not part of the revolving door that Simon writes about. The dictionary definition is “to act in harmony toward a common end”.

    Whether you like conspiracy theories or not, is beside the point. They do, in fact, exist.

  75. Also, Per, read the Informant. Written by a skilled, honorable New Times investigative reporter. You will then understand that even a bunch of incompetent nitwits can conspire to rig prices of an agricultural commodity for years and years without being caught.

  76. Such a convincing, well-researched, well written post. I’m glad you take time to write & post here.

  77. With all personal respect to you, whess, this analysis is so much sophistry. To assign a lesser moral culpability to and to liken “intellectual capture” to the events in the third chapter of Genesis as though there were some distinction to be made between it and out-and-out corruption is both to miss the point and to misunderstand the biblical story egregiously. There, in Genesis, one is dealing solely with a question of innocence and temptation. There are no “subtleties” involved, no convincing as such, there is simply the matter of the lie and its subjective acceptance at the level of act. You might wish to inquire of Eve whether she were let off the hook for this acceptance. What you describe, a kind of coming-to-believe as it were, is more properly understood, given the circumstances and the people involved, as a rationale – or better yet a rationalization – proffered after the fact for a course of action already decided upon. And, further, any question of legality here is quite secondary. We are dealing most importantly with a moral question. One – and this is decisive – acceptably presupposes a fiduciary responsibility, that and more, in the case of a “public servant” and a failure of any description is precisely that, a moral failure. Hopefully, we can now comfortable dispense with these
    mealy-mouthed distinctions.

  78. The Rube Goldberg device employs so many, and lets them siphon off so much.

    Per, it’s a common thought that conspiracies require too much intelligence and silence to work. On a small scale though look at how many people were involved with Madoff, and he kept things going for 20-30 years. It wasn’t genius to put together the scam. It did require some half-clever cover-up once in a while, but hardly the work of an evil genius. All he needed really was that little bit of larceny in everyone’s heart that the conman preys on, and some influential friends.

    So in this case, at least, all that was required was a decent plan and some friends in the right places. Take the privatisations in Russia an other countries. The overall plan is quite simple — conspire with a few influential people to nationalize a business, and then hand it over to a confederate.

    In the larger picture, the broad strokes don’t seem like they require genius, or even the complicity of more than a few dozen people: Flood the US and other countries with cheap money and credit, chop down all possible regulation, place sleazebags at the head of regulatory agencies, spread the “free market” religion through thinktanks and media, make a ton of money as the bubble inflates, prick the bubble, make money as it deflates, have cash ready to buy up property and businesses at “fire sale prices,” suck up all the money the government throws at you to keep things propped up. The basic operating principle is pretty well known: Give people enough rope and they will hang themselves. Appeal to their greed and fear and you can drive their behavior by the millions.

    It will probably be another year or two before the breadlines and hyperinflation drive us into the “we need a strong leader,” and “let’s nationalize everything” mentality. After everything has been nationalized nicely, then the distribution to the cronies begins as it always does.

    If it’s all been engineered, I’m still holding out hope that it’s the geniuses at Oxbridge/LSE that masterminded it, using the criminals to help them achieve their dream of a global socialist utopia. Could be the other way around though, and the criminals have suckered the smart kids into helping them achieve their much more limited private utopias.

  79. “Madoff… All he needed really was that little bit of larceny in everyone’s heart that the conman preys on, and some influential friends”

    And of course some regulators not doing their most basic job… and now they want to regulate for systemic risk… if you can’t get the board agree on what coffee to serve then have them discuss a nuclear device (A Parkinson sort of dixit)

    As to your geniuses and your criminals, I have difficulty establishing who are the most criminal… why should the search for much more limited private utopias be worse than the imposition of a global utopia? That is of course as long you do not belong to any of these particular utopia groupings, if you do, then there might be some understandable bias in the answer.

  80. Ah Per, you are still missing the point. My point, and Simon’s, is that there is a revolving door between the U.S. government and Goldman Sachs. The senior senator from Illinois says about Congress, “the financial industry owns the place”.

    The great problem is that Goldman Sachs continually gets its way with Congress. Here are just two examples;

    1) U.S. Bankruptcy judges have the power to re-write every contract written in the U.S. except one kind, e.g., single family owner owned houses. They can re-write contracts on vacation homes, motorcycles, etc. etc. Everything except that one contract. Last spring, Congress tried to remove this exclusion. Even Citibank agreed. The House approved it. The Banking Industry killed it dead in the Senate. For your information, look up how much money the financial industry and Goldman Sachs contributed to Christopher Dodd and the members of the Senate Banking committee. As a result, foreclosures will continue and will drag this recession out for a very long time.

    2)Banks currently are required to have 5%, or less, on the money they have lent out on hand as reserves. Simon wants to triple that and David Zetland and I think it should be 50%. The financial industry is on track to defeat this new requirement without breaking a sweat.

    The New York Times summed it up nicely last week with the headline, “One Year Later, What Has Changed?”, and they answer their own question with “Nothing”.

    So let me try to make this clear here. If we do nothing to reign in the financial industry, this little recession will be remembered fondly as the next catastrophe sets in.

  81. Look, we don’t have to have (exogenous to the banks themselves) any capital requirements, leverage ratios, counterparty scenarios, risk quantifications, compensation controls, etc, etc ad nauseum. The byzantine systems – in the past, in the present, and as proposed for the future – for “controlling” the operations of the banking industry are unable to stop risky behavior and invite control of the political process by the financial industry. The whole Rube Goldberg contraption gets more bizarre and ineffective with every passing year because of the increasing sophistication, wealth, and power of the financial industry. The only regulatory requirements on the financial industry (other than consumer protection) needed to stop the wild gambling at all levels are:

    1) Forbid securitization. All loans must be held to maturity (or sale) by the lender.

    2) Forbid all government bailouts other than FDIC deposit insurance with its original limits indexed for inflation.

    Sure, the size and complexity of the financial industry would shrink drastically and there wouldn’t be all those handy “liar loans” and self-destructing LBOs, so the profits of the industry and the GDP generated by credit bubbles would drastically shrink as well. But the gambling would cease (by choice or by bankruptcy) and we would – believe it or not – continue to do the rest of our national business.

  82. Yes Per, I am indeed remiss. I omitted to include the regulators who surely qualify for at least an all expenses infinitely long weekend at hornswoggler’s hotel. Is it not surely an ominously amazing non-event, that none of these actors have made even an indirect mea culpa comment (to my knowledge)?

    Even more amazing, the main players (Bernanke, Geithner, Summers et al) appear not to be suggesting any cleansing of the Augean stables by removing the nags? If these tricks had been pulled on main street by non-bankers the perpetrators would be out of circulation but fast!

    Why no good ‘ol lye-soap cleansing?

  83. Whess, you open and then close with two very meaningful comments.

    I deeply question the adequacy of regulatory reform since the job of a good lawyer is often to find his client’s way around the law.
    and close with:
    Without a strong social concensus that certain behaviors are inherently wrong or irresponsible, regulation merely tries to play catch up.

    How are we to find a reliable base for the statement ‘inherently wrong or irresponsible”? It seems the cat can’t be belled until a certain reliable base in place? ‘Strong social concensus’ is also somehow missing in the current scene?

    Otherwise those smart lawyers will drive a truck through our regulations?

  84. James Taylor writes “Ah Per, you are still missing the point. there is a revolving door between the U.S. government and Goldman Sachs.” “the financial industry owns the place”.

    No that is a point that I, as a foreigner, simply do not address, especially since I have more than enough with the political craziness in my own country, and so would you. I discuss exclusively the financial regulations as such because even if you stopped your revolving doors that would not be of any help if you insist in applying the wrong regulatory paradigms.

    And so, for instance, when you write “Banks currently are required to have 5%, or less, on the money they have lent out on hand as reserves. Simon wants to triple that and David Zetland and I think it should be 50%”…. that is when I get in the discussions, because you are so factually wrong.

    The banks are NOT currently “required to have 5%, or less, on the money they have lent out on hand as reserves”. They ARE required to have 28% for some assets; 12% for others; 8% as the basic reference requirement; 4% for others; 1.6 % for anything that relates with an AAA rating; and 0% when lending to the government.

    And so considering this reality your and Simon Johnson’s comments lacks applicability, and evidence you have not read what you should have read in order to participate in the debate. You and Mr Johnson have quite some homework to do.

    A tripling of those rates as suggested by Simon Johnson or much worse the 50% of David Zetland, are proposals made by zealots, who are pushing other agendas, and do not care about facts.

    What do I suggest? To start out an 8 percent for all assets, and even this must be phased in, since there is a general lack of much needed bank equity, and since it will not get easier or cheaper to access bank equity while investors hear about proposals such as Johnson’s and Zetland’s.

    That something has to be done, before the next catastrophe ensues, on that we can fully agree on though.

  85. “3.The intellectual capture of Washington by Wall Street was well underway in May 2007; it is now complete. ” It won’t be complete until they have disabled Elizabeth Warren, Director of the Congressional Oversight Committee. If she is seduced into running for Ted Kennedy’s senate seat, whether she wins or loses, that will effectively take her out. Her opponents will destroy her credibility somehow, and Wall Street would succeed in getting rid of one of its most effective opponents.

  86. Per, we are now making progress. We are like that old Washington story. A man approaches a woman at a Washington cocktail party and says, “Will you sleep with me for $2,000? She thinks about and says Yes. He says well then how about for $2? She says No, what do you think I am, a whore? He says we have already established that. What we are doing now is haggling over the price’.

    Now explain why your 8% will stop the next crash and our 50% won’t?

  87. This makes absolute sense — and therefore will be given no credence since it amounts to an unAmerican hindrance on innovation. Only average people are interested in stability. Everyone else is in it for the money, of course.

  88. It’s called employment. You can’t expect people who take a government job in finance to lock themselves out of the private sector all their lives. Or people working in the private sector of finance never too take a government job again. 5 years is a reasonable ground to stand on. Frankly I think that’s pretty damned obvious Mr. Hanson. There will be people who grill Simon for 5 years being too long.

  89. Not interested in paranoid diatribes telling me things I can get for free on the internet. AND NOT INTERESTED IN THIS SITE BECOMING YOUR PERSONAL BILLBOARD FOR YOUR BOOKS.


  90. Stats Guy: “2) When we increase capital ratios, money velocity may shrink… Something needs to inject new money into the system if we’re going to avoid depression due to sustained massive deleveraging, and we’re going to see all sorts of distributional conflicts over how that new money enters the system (or even if it _should_ enter the system). Doing this properly may require some “big” changes and real vision, almost on the scale of Bretton Woods… I hope our leaders are up to it.”

    How about printing money to pay for public works? That would accomplish a number of things. First, it would reduce unemployment. Second, our infrastructure is crumbling, and it would provide maintenance and repair. Third, it would give money to people who did not get us into this mess, rather than to people who did. The latter may have been necessary, but we could get some balance, and serve distributive justice. Fourth, it would stimulate the economy by giving money to people who would be more likely to spend it instead of to people who stash it away, as the banks have done. Fifth, it would increase our money supply by having people produce something of value rather than by having people go bankrupt.

  91. James Taylor, supposing we are talking about the same capital requirements, which we are not, as you clearly show you do not know about the current capital requirements, I prefer my 8% to your 50% because I am also interested in having a banking system that helps to finance growth while you, with your 50%, seem to be satisfied just avoiding bank defaults.

  92. Perhaps I take this topic a little too seriously sometimes :)

    It would be nice if, as Mr. Coffman from the SEC suggested, market participants did try to contribute positively and genuinely to the maintenance of industry standards (not just in securities, but in every dimension of finance). This is a complicated project, but it is one that can be solved by the people who understand what is going on. Alas, there is money involved, and people do not always see that the sustainability of the system is in their long-term interest.

  93. See Ted K. He seems to have a different idea. But you have to love people who don’t know anything and revel in that fact.

  94. Ratings that are paid for by the seller should be banned, if there is to be objective assessment of risk.

  95. Ah Per, we are still making progress. The number that we can agree on balances the need for financing new ventures with the need to restrain rich, beyond belief, bankers. I am a firm believer in the ability of small businesses to find financing and that ability outweighs the need to support huge financial monstrosities. We are willing to bargain down to 40% because we are not the ideologues you accuse us of being. So what is your number?

  96. Bond Girl “This is a complicated project, but it is one that can be solved by the people who understand what is going on”

    Absolutely… when there is a full understanding of the role of the financial sector, which extends to much more than the financial sector… The problem is to separate from the discussions those interested exclusively in the well-being of the financial sector and the charlatans that only carry a political agenda. Unfortunately these two groups are those who speak the loudest.

  97. Patty, I happen to believe that Elizabeth Warren may be the single most important person in the U.S. government today. What troubles me deeply is that I cannot find her political cover. Who keeps her from being stabbed in the back by the financial industry? Is there something you know that I don’t?

  98. 8 percent for all… which is a huge increase for those who created the problem the AAAs with their 1.6 percent.
    Get it, the 40 percent has no reason whatsoever… try to calculate how much bank capital you would need just to support 50% of current bank lendings?

  99. Agreed, Ted K. With the exception that he appears to be conceding that “Too Big To Fail” is here to stay, Professor Johnson comes up with some common-sense measures under this unfortunate reality.

    It’s not the tweaking of capital percentages and other minutiae (the trees) that brought us to this, it is the lack of oversight – at both the regulatory and enforcement levels – (the forest) of those who will always inevitably outsmart themselves. Financial industry regulations have to be every bit as much about human characteristics as those of the industry itself, as Paul Krugman pointed out.

    If the engine governors, shock absorbers and seat belts make the ride less pleasurable for some, tough. Maybe it will keep the rest of us safer.

  100. We are not yet at a stage of “Fear & Loathing,” but we are close. My partner & I run a small business in the near South, and we have been terrified by collapse after collapse in finance, the hollowing out of our economy by export of jobs and technology, and the general NHIMBY (not happening in my back yard) attitude, which is sleight of hand for the rich using sleight-of-hand to avoid political consequences. Now the rich are getting scared.

    Finally1, I agree. But can we wait for history? By the time you are proven correct, it will be too late. I say, let’s oppose President Obama on this one: let’s rise up and reject Bernanke, whose true record is quite lame. Paul Volcker is a member of the President’s team and could exert considerable influence on Bernanke’s reappointment. It sounds like a done deal, but it’s not so yet: Congress still has an up-or-down vote here.

  101. I strongly disagree with #3. Henry Hu’s appointment to the SEC and the creation of the new division which he heads is a clear sign that Washington is not intellectually beholden to Wall St. That said, I hope he is given the freedom to implement his policy goals and strategies by others inside the Beltway. He truly does understand what is going on, and is now in an excellent position to do something about it.

  102. “That means the Fed needs to be able to identify bubbles reliably – which is an explicit rejection of efficient markets.”

    Sure bubbles are traumatic, but are they inefficient?

    It seems that bubbles begin when a fundamental improvement is extrapolated way to far. Would curtailing bubbles way too early (i.e. curtailing lending to high growth sectors in their initial stages of growth) be an improvement, on curtailing them way too late? Not so sure…

    p.s. I am not advocating the Greenspan/Bernanke approach of see no bubble/hear no bubble/feel no bubble and then drown the market with excess liquidity once a bubble bursts. But just looking for a rule that can prick bubbles before they became too big, but not sooner.

  103. Yes, Simon, a little more spittle into the gale blowing in your and my faces. Let’s face it, Bernanke has Obama and the Whitehouse (and the powerful friends of the oligarchy on Capitol Hill) completely eating (cake) from his hand (a rather rough looking Marie he is). The very idea of meaningful reform seems to be escaping all but the Warrenites and Johnsonites (like me and your other toadies). What you propose is far too wise and rational to be accepted as a real part of reform by those who would propound it. AND, you failed to mention the other MAJOR KEY COMPONENT: The Ratings Agencies, who continue to operate in Derivatives II (the sequel) unchecked, uncensored, unregulated, and uncontrolled. What matters what capital ratios are set, so long as the “creative” derivatives continue to get AAA ratings, and are still widely traded as being truly valuable.

    Simon, my hope is that you and Elizabeth, and friends will lead a REAL REVOLUTION, so that we, the people, for whom a more perfect union has been formed, can actually live in a society where laws and regulations are meaningful, and where morality is respected more than greed. We need to excommunicate the perpetuators of the oligarchy from our society. My greatest hope is that we can tar and feather the violators and run them off to some small third world island where they can cheat each other into oblivion.

    I’m never going to hold my breath for Bernanke to get some nads or even care about us enough to do the right thing. DO NOT GIVE HIM ANY MORE REGULATORY LEVERS THAN HE ALREADY HAS, AND CONSIDER TAKING A COUPLE OF THOSE AWAY FROM HIM, PLEEEEZE!!!!!

  104. Ted K
    why do you protest this book especially
    – there are lots of comments trying to draw traffic to their blogs – my “favourite” is Patrice Ayme (or so) trying to get “his” Franks admired.
    On the other hand there may be useful stuff to be found
    – is the uninteresting or even weird stuff so troublesome that its banishment is worth running the risk of excluding useful stuff

  105. It all comes down on the banking system of TRUST. As long as we can keep the people to TRUST the banksters then all is nice and dany. Nothing can be said about bubbles, crashes or crisises as this will damage the TRUST people have in the banksters as this will cause the people to loose TRUST and will trigger a run on the banks which cause them into bankruptcy.

    In Holland our Fed Director Wellink KNEW about the Iceland Bankster Bubble but he choose NOT to say anyhting as this would cause the people to lose TRUST in the Iceland Banks and have the people to withdraw their money from the banksters.

    ALL play the same game and WE have to PAY for it.

    It’s unfrickingbelieveble that they get away with it!

  106. another way to raise capital – what a miser our German banks seem by comparison – and probably the money collected that way is guaranteed by the state and thus the taxpayer has a chance to get his money back or get screwed worse than ever???

    “Cash savers continue to be offered returns of 5 per cent in spite of the base rate remaining at its 0.5 per cent low for the past six months.”,dwp_uuid=6997947c-a442-11dd-8104-000077b07658.html

  107. What it states primarily is how difficult it is going to be, in the midst of a recession, to raise bank capital to levels where they should be… especially after allowing these to drop to 1.6 percent for the AAAs… and while bank bashers, like Simon Johnson, predicating furiously from their pulpit, want the capital requirements to go much higher than ever, so as to cramp the whole economy… for whatever flagellation or other purpose he might have in mind.

  108. Conspiracy theories??? Has anyone on this blog ever heard of the Theory of Converging Probabilities?

  109. No Silke. This is not about raising “capital” it is about deposits and don’t feel bad this is just a marketing ploy referred to some minuscule amounts (who knows it might be the banker’s own grandchildren’s saving accounts)

  110. Jessica
    never heard this term before but seem to “know” what it is about
    Google leaves me quite alone on it – do you have a link or further reference?

  111. thanks Per
    but didn’t Obama run the biggest campaign fund collection via miniscule amounts or was that a cover up for the real funders? and what about lotteries?
    I believe that all this is miniscule to the bets out there but even if you are betting way beyond your means you must still have some cash to show at the start or has that precondition vanished also?

  112. I found my best argument against a new set of regulations here – I like it because I have seen that happening over and over again albeit in the lower regions of society.

    “This distinction is important, because if we misunderstand the history of the crisis, we will learn the wrong lesson. Washington loves to pass new laws conferring additional power whenever there is a major mishap or crisis.

    Doing so implicitly confers immunity on those who were in power at the beginning of the
    crisis by sending the following message: The appropriate authorities did not have the power
    to forestall this problem. But now that we have granted new powers to these authorities,
    they will avert the next crisis.

    The problem with this grant of immunity is that we then fail to ask why no one used the power they had and whether rigid ideological thinking got us into the crisis in the first place.”

  113. Silke, there was no reply option on your post so I am replying to myself. Convergence was something I studied eons ago in statitstics class. I searched MIT’s website (a likely source) and found quite a few references. The first .pdf below coincidentally discusses the financial crisis on p.45-46.

    Click to access mathcamp2009-probability.pdf

    For more:,

    A body of circumstantial evidence, when pointing to the accused, is very persuasive evidence, often leading to a conviction. However, we have no “accused” in this case.

  114. thanks Jessica
    I’ll go through your links tonight

    I asked because after asking Google for “Theory of Converging Probabilites” the only answer I got was this one and that sure intrigued me
    and as you get to the example of the “accused” I was reminded of this guy who once upon a time said very interesting things about data leading to wrong impressions and consequently convictions – he called it Kontextveränderung (context change)
    right now I can’t see the relevance to this post, however, since the crisis is all-encompassing maybe looking into remote corners for enlightenment might get the “grey cells” come up with something useful. Lame excuse I know but one has to come up with something …

  115. I do not disagree with Spitzer except for the last sentence in your post from his essay. Spitzer lists two possibilities for failure to forstall the crisis: 1. failure to use power and 2. rigid ideolgical thinking. What ever happened to malfeasance or conflict of interest? James Kwak is studying law at Yale. Surely he has some ideas.

  116. I once saw on TV something showing the abacus in action
    – incredibly effective thing and for individual operations probably faster than or as least as fast as the computer
    – a pity we, the “west”, never seem to have acquired the skill to use it properly

    but of course any gadget that does not need electricity and all kinds of other infrastructure and costs a lot more must be considered as hopelessly backwards

  117. The money angle is quite simple, albeit almost impossible to enact right now.

    Public campaign financing ONLY! Let’s be perfectly clear; campaign donations by interested parties is way too close to factual bribery to be tolerated. It is legal because those who make the laws made sure it was OK. Since no politician will enact public financing on his/own, it is incumbent upon us to force them.

    Because the bottom line is rather obvious: every time there is a discussion about regulatory reform, the topic of money in politics comes up as a stumbling block. The one who pay get the goodies from the one who get paid.

    So, who do we want the politicians to work for?

    Us, or the fat cats?

  118. There are plenty of good things to do with the money – my main concern is that it does not get used to temporarily fund a structural federal deficit, ill-conceived tax cuts, and rapidly growing unsustainable transfer payments (e.g. medicare, in its current form).

  119. ” What ever happened to malfeasance or conflict of interest?”

    Spitzer is all over the web with his argument that there were enough tools in the tool box – I am in no position to judge whether the gaps they exploited where forbiddable or not

    According to Gillian Tett in the FT the US legal machinery is just getting into gear

    “Insight: A matter of retribution
    3. Sep, 17:33 Uhr – Thousands of financiers were punished after the Savings & Loans scandals in the 1990s. Gillian Tett examines why so few prosecutions have emerged from the current crisis”
    – sorry no link my monthly quota with the FT has been used and they do not even let me outsmart their site anymore.

  120. Speaking of Marriner Eccles, there’s a great quote from his autobiography “Beckoning frontiers” about the origins of the Great Depression:

    “As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth — not of existing wealth, but of wealth as it is currently produced — to provide men with buying power equal to the amount of goods and
    services offered by the nation’s economic machinery. Instead of achieving that kind of distribution, a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”

    I think that also applies to our current crisis where the middle class has been progressively impoverished and had to live more and more on credit.

  121. “that would justify a reinvestment of their capital accumulations in new plants. ”

    there’s a slight difference there, isn’t it?
    – nowadays the plants they may be investing in are not in the same country/economy where they do the sucking.

    btw that’s closely connected to something I started wondering about around 1980 for the first time and what was talked about at work a lot in the following decades – nobody had an idea except those with the vacuous pompous incomprehensible language of course

    – when one knitting machine can produce ten times as many sweaters with one tenth of the personnel who will have the money to buy all those sweaters

    – that must have been around the same time when they started telling us what a great thing the coming service society would be. Maybe they were right about that but nobody ever explained to me who of all the people not making money in production anymore would have the cash to buy all those services on offer. Would it work on an I service you you service me basis? just like the ancient trading goods for goods markets? but who would finance food and housing i.e. the material things even servicing eachother humans would still require?

  122. I know this will make Ted K go ballistic, but the ideas I want you to consider, come down to just three major points.

    1) Business Cycles have been around all developed economies for roughly five hundred years, and they have very consistent characteristics which are widely known.

    2) Business Cycles have two, and only two, phases. The economy is either expanding or contracting. Each of those phases have some bad effects and some good effects.

    3) Government policies should re-enforce the good things that the Business Cycle does and should minimize the bad things. U.S. government policies do not follow these sensible actions because the U.S. Treasury and the President’s economic team has been hijacked by Goldman Sachs.

    You can read all about these facts at, and it is available as a Kindle book.

    When you have read the book, you can follow current events and make your own comments at

    O.K., now stand back because this is where Ted K starts yelling. Sorry, Ted, Larry Summers made me do it.

  123. Anyway we can stop any of these guys, including Obama, I’m with. Bernanke is a bad actor. Stopping him would be a slap in the face to Wall Street, showing it that the public can fight back.

  124. “How did banks believe AAA for such securities?”

    Believe? How about “Believe” as in “Let’s Pretend? Everybody involved (bankers, rating agencies, regulators) knew what was going on, but, they were making lots a money until they couldn’t anymore, i.e. until the system crashed, then they played stupid (Who could have known?) then they got bailed out (by us), then they’ll repeat.

  125. Believe as in “believe”. If they had not they would have not kept these securities, they would have sold them, shorted them or have done all other kinds of things.

    In fact when these AAA securities lost some of their initial value… many bought them at “bargain” prices and died in the process.

    Except for some really crooked mortgage originators most believed… and why should they not? The regulators certainly believed.

  126. This is so Brilliant I have to pass it on. Henry Blodget has a site he calls The Business Insider. He has started a count down clock to measure how long it will take for Tim Geithner to take a multi-million dollar job at Goldman Sachs.

    That is good. I wish I had thought of it.

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