By Simon Johnson
As we fast approach the unveiling of the Dodd-Corker financial reform proposals for the Senate, it is only fair and reasonable to ask: Does any of this really matter? To be sure, some parts of what the Senate Banking committee (and likely the full Senate) will consider are not inconsequential for relatively small players in the US market. For example, putting consumer protection inside the Fed – which has an awful and embarrassing reputation in terms of protecting users of financial products – would tell you a lot about where we are going.
But our big banks are global and nothing in the current legislation would really rein them in – no wonder they and their allies sneer, in a nasty fashion, at Senator Dodd as a lame duck who “does not matter”.
For example, the resolution authority/modified bankruptcy procedure under discussion would do nothing to make it easier to manage the failure of a financial institution with large cross-border assets and liabilities. For this, you would need a “cross-border resolution authority,” determining who is in charge of winding up what – and using which cash – when a global bank fails.
To be sure, such a cross-border authority could be developed under the auspices of the G20, but there are not even baby steps in that direction. Why?
Part of the answer, of course, is that big cross-border banks know how to play governments off against each other – dropping heavy hints that “international competitiveness” is at stake. These are empty threats – if the US, the UK, and the eurozone cooperated on a resolution regime, this would get serious attention. If they went further and truly integrated their regulations – including communications and practices (and inspections) across regulators/supervisors – this could have major impact.
But national governments like to run their banks in their own way. In part, this may be sensible public policy – who, after all, really wants the US to be in charge of deciding how a bank failure (in another country) is handled? (The US and the UK had a major row in the weeks after Lehman failed). Even within the eurozone, there is a long standing refusal to specify in advance who is responsible for saving what part of which bank – motivated in part by the desire to protect the bureaucratic turf of national central banks, which ceded power over monetary policy to the European Central Bank.
In part, no doubt, this also reflects varying degrees of “capture” in different places – sometimes by bankers, but sometimes it’s the politicians who do the capturing. As examples, see the work of Asim Khwaja and Atif Mian or Mara Faccio on how political connections really work in and around financial systems.
In any case, hoping that we can constrain banks through some form of international governmental cooperation is a complete illusion. The IMF and the WTO have no mandate on this issue. The Financial Stability Board is a paper tiger – really just a talking shop between regulators (and the same goes for the Bank for International Settlements more generally).
The big global banks know all this – and have known it for years. When Jerry Corrigan – former head of the NY Fed, no less – says Goldman did “nothing inappropriate” in arranging Greek debt swaps, he is in effect saying “catch us if you can”.
You will never stop the international banks at the international level. You need to curtail them at the national level. And you can’t afford to wait for other countries; you have to do it for your own country as a matter of pressing national priority.
Unfortunately, the Dodd-Corker proposals seem most unlikely to move us forward along this dimension.
The Baseline Scenario 
Global financial firms regulate national governments, not vice-versa.
I probably suffer from congenital excessive optimism, but I can’t help hoping that if the resolution authority is ever used our government will let the losses fall abroad where they may and offer direct payments to the governments abroad — as an act of political appeasement — to compensate in some measure for the losses.
Nemo,
Well done. Incisive, concise and accurate.
Expectating reform from Dodd is akin to expecting health care reform from Tom Daschle:
Dodd On Most Wanted List For 2009. He’ll probably be on the list for 2010.
Cheers
Mr. Johnson wrote:
“You will never stop the international banks at the international level. You need to curtail them at the national level. And you can’t afford to wait for other countries; you have to do it for your own country as a matter of pressing national priority.”
You may not have control over unfolding financial events, but you do have the control to bootstrap your own response.
http://en.wikipedia.org/wiki/Bootstrapping
Simon — What a breath of fresh air. “Does any of this really matter?” It’s going the way of no. As you are well aware.
Agreed.
As Michael Lewis in his latest book, The Big Short, amply identifies that the Wall St banksters and their ownership of Congress and White House have learned NOTHING. We all await the L recovery to become an I.
Simon is one of the very few to outline the necessity for an international response the the banksters to have any hope of avoiding the next disaster.
“You will never stop the international banks at the international level. You need to curtail them at the national level. And you can’t afford to wait for other countries; you have to do it for your own country as a matter of pressing national priority.”
Wrong! It is exactly at that supranational level called the Basel Committee that you can stop them.
Just have the Basel Committee decide that one should not fight excessive risk-taking by subsidizing what is perceived as being of lower risks and slap the same capital requirements on all banks independent of their assets and you will be surprised how the large ones that should not be large ones fade away, even though some of those can remain large will do so.
Michael Lewis’ The Big Short
“Lewis’ book about the ongoing financial collapse has a name: The Big Short: Inside the Doomsday Machine.
ECON wrote: “As Michael Lewis in his latest book, The bog Short, amplify indentifies that the Wall St banksters and their ownership of …..”
THE BIG SHORT
“A brilliant account — character-rich and darkly humorous — of how the U.S. economy was driven over the cliff. Truth really is stranger than fiction. Who better than the author of the signature bestseller Liar’s Poker to explain how the event we were told was impossible — the free fall of the American economy — finally occurred; how the things that we wanted, like ridiculously easy money and greatly expanded home ownership, were vehicles for that crash; and how shareholder demand for profit forced investment executives to eat the forbidden fruit of toxic derivatives.”
http://kottke.org/09/05/michael-lewis-the-big-short
Per Kurowski, March 2, 2010 at 6:51 pm., wrote:
“It is exactly at that supranational level called the Basel Committee that you can stop them.”
:-) Good Luck.
http://en.wikipedia.org/wiki/Basel_Accord
http://en.wikipedia.org/wiki/Basel_Committee_on_Banking_Supervision
May 2008 – Basel I, Basel II, and Emerging Markets:
A Nontechnical Analysis
The Johns Hopkins University School of Advanced International Studies (SAIS)
“The Basel Accords are some of the most influential—and misunderstood—agreements in modern international finance. Drafted in 1988 and 2004, Basel I and II have ushered in a new era of international banking cooperation.
…..even when the Basel accords have been applied accurately and fully, neither agreement has secured long-term stability within a country’s baking sector. ”
http://tinyurl.com/basel-accord
http://tinyurl.com/ygrng37
Professor Johnson,
I really have enjoyed listening to you testify in front of the numerous panels in Congress; I haven’t gotten around to I believe the Budget Cmte; but I heard your testimony on 2/12 and I thought you got this point home very clearly.
The other point you made was the capital requirements; and I believe this has not been hammered home clear enough. Anyone who has this type of cross-currency-interest-swap or synthetic CDO whould be required to pay an innovation tax… that is to say the regulators say “this product is new, not like a fixed mortage; you need to triple your capital requirements because you are holding this… we don’t know what this could do.”
There are very simple solutions that can stop this cycle. I think the global aspect is also a very big political issue Congress needs to tackle. Think of the outrage if the next AIG isn’t AIG but is “Chinese Insurance Group” and we have to bail them out in order to save Goldman? Oh wait, I forgot… it’s laughable that we saved Goldman when it became a bank holding company… silly me…
Simon, I am in agreement with virtually all you propose. But I have not noticed if you have commented specifically on the idea that hastening the process of creative destruction, which would gore many oxen, might get us through this malaise more quickly and eventually to job creation. This would involve letting the foreclosures roll, stopping “extend and pretend” marking more assets to market through realization of loss, right sizing property values and perhaps even lowering cost of living, etc.
Incidentally, health care reform without creative destruction in that industry may be just but it won’t help the economy. We don’t need TBTF or its equal in health care. Take that sector down as a percent of the economy as well.
The collapse was a run on the shadow banks. No?
How about Deposit Insurance on shadow banks. All Investment banks, Hedge Funds, everyone who rolls over his debt in the overnight market, required to pay a percent of these transactions into a fund, calculated by an honest actuary as that needed to settle a run on the shadow banks. Hold a reserve of a few trillion.
Simon, I love you, man, but why the question as the theme? We know that the local oligarchs are buying favor everywhere, just look at Greece and consider how many governments might suffer if our big players stop hiding their problems for them. If Goldman fails, even if Treasury, the Fed, and Capital Hill refuse to bail them out, China might step in. Who knows. The interconnectness argument relating to effectiveness has more to do with them being effective for themselves, both internationally and nationally, than for customers and potential customers. This is why there will be no move to regulate across borders. Arbitrage works, especially across borders, where almost no one is really able to watch effectively. This is not a real global conspiracy, it’s really effective domination in the financial sector. Scary, but very real.
On the matter of money the world is always zero-sum. There is only so much ‘cooperation’ you could get from the ‘international community’.
“Therefore, it is highly beneficial to the safety and stability of the international financial
system—and moreover, the international economy—to include emerging market economies in future
revisions of the Basel Accords.”
And let’s not forget that the U.S. is a soon-to-be emerging market.
And the two felons together molest the tax payers.
Why does it seem more and more that the theme of financial “reform”, for those of us looking in from the outside, should be “Give up, we’re screwed”? Perhaps because it is?
While waiting for international financial regulations just tax them and make the finance industry to pay.
http://mgiannini.blogspot.com/2010/03/make-finance-industry-to-pay.html
August 2006, the Financial Times published the following letter I wrote them.
Long term benefits of a hard landing
Sir, While you correctly argue (“Hard edge of a soft landing for housing”, August 19,) that “even if gradual, a global housing slowdown would be painful” you do not really dare to put forward the hard truth that the gradualism of it all could create the most accumulated pain.
Why not try to go for a big immediate adjustment and get it over with? Yes, a collapse would ensue and we have to help the sufferer, but the morning after perhaps we could all breathe more easily and perhaps all those who, in the current housing boom could not afford to jump on the bandwagon, would then be able to do so, and take us on a new ride, towards a new housing boom in a couple of decades.
This is what the circle of life is all about and all the recent dabbling in topics such as debt sustainability just ignores the value of pruning or even, when urgently needed, of a timely amputation.
I think you are making the case for some sort of world government. It is difficult for this bird to see how nationally regulated banks are going to help the international problem. A race to the bottom in international banking is likely. Without international regulation, there are always going to be some firms willing to gamble on the international markets and then all the processes we have already seen come into play, with bad banking driving out good.
Hominids, cooperation, competition, croak!
Simon – Agree with a lot of these points.
But why do you insist on suggesting that the WTO “has no mandate on these issues”?
In fact, the WTO has the most meaningful enforcement for violations of its banking and capital control rules of any international agency. If countries limit bank size, restrict capital movements, or institute domestic regulations that violate the financial service terms of the General Agreement on Trade in Services, they can face dispute settlement and ultimately trade sanctions, including cross-retaliation against non-financial sectors of the economy.
By any one’s read, that’s not only a “mandate,” it’s a very potent stick to beat down reregulation.