Month: April 2010

Fix The Dodd Bill – Use The Kanjorski Amendment

By Simon Johnson

At the heart of the currently proposed legislation on financial reform (e.g., the Dodd bill and what we are expecting on derivatives from the Senate Agriculture committee), there is a simple premise: Key decisions about exact rules going forward must be made by regulators, not Congress.  This is obviously the approach being pushed for capital requirements, but it is also the White House’s strong preference for any implementation of the Volcker Rule – first it must be studied by the systemic risk council (or similar body) and only then (potentially) applied.

Treasury insists that Congress is not capable of writing the detailed rules necessary for a complex financial system – only the regulators can do this.   This is either a mistake of breathtaking proportions, or an indication that the ideology of unfettered finance continues to reign supreme. Continue reading “Fix The Dodd Bill – Use The Kanjorski Amendment” →

The Oracle of Kansas City

By James Kwak

Many of you have probably already seen Shahien Nasiripour’s interview with Thomas Hoenig, president of the Federal Reserve Bank of Kansas City and the most prominent advocate of simply breaking up big banks. (Paul Volcker is more prominent, but his views are more nuanced; the famous Volcker limit on bank size, it turns out, would not affect any existing banks, at least as interpreted by the Treasury Department.) It largely elaborates on Hoenig’s positions that we’ve previously applauded in this blog, so I’ll just jump to the direct quotations:

On megabanks:

“I think they should be broken up. . . . We’ve provided this support and allowed Too Big To Fail and that subsidy, so that they’ve become larger than I think they otherwise would. I think by breaking them up, the market itself would begin to help tell you what the right size was over time.”

Continue reading “The Oracle of Kansas City” →

Another Great TAL Episode on the Financial Crisis

By James Kwak

ProPublica has a long and detailed story of Magnetar, the hedge fund that helped fuel the subprime bubble by providing the equity for new subprime collateralized debt obligations — precisely so that it could then go and short the higher-rated tranches. In other words, Magnetar wanted to short some really, really toxic CDOs. But either there weren’t enough toxic CDOs to short, or they weren’t toxic enough. So they provided the equity necessary to manufacture more toxic CDOs. Then they shorted them. Yes, the math works out.

Yves Smith told the story of Magnetar in her book ECONned. The ProPublica story adds a bunch of details. But the best part is that This American Life is doing a story on Magnetar in this weekend’s radio show, which I’m sure will be great.

A Failure of Corporate Governance

By James Kwak

(I’ve gotten several great articles forwarded to me via email by readers. It may take a few days to do them justice. Here’s one.)

In the great consensus of the past twenty years, government regulation was unnecessary because the free market provided better tools for constraining private companies. One force was the market, idealized by Alan Greenspan, who believed that counterparties could even police effectively against fraud. The other force was shareholders, who would punish managers for acting contrary to their interests. The market would prevent companies from abusing their customers, while corporate governance would prevent them from abusing their shareholders.

For those who still believe in the latter, McClatchy has a good (though infuriating) article on what went wrong on Moody’s, the bond rating agency that, we previously learned, responded to warnings about the toxic assets it was rating by . . . firing the people making the warnings. In the words of an executive on a Moody’s risk committee:

“My question the whole time has been, ‘Where the hell has the board been?’ I would have expected, sitting where I was, that I would have got a lot more calls from the board. I got none of that.”

Another Moody’s executive added, “There was no (corporate) governance at the firm whatsoever. I met the board, I presented to them, and it was just baffling that these guys were there. They were just so out of touch.”

The story that Kevin Hall tells about Moody’s has been told many times before. Board members often serve at the pleasure of the CEO, who controls who receives the perks of board membership. The result is often, but not always, boards that rubber-stamp the decisions of the CEO and his or her inner circle. Court precedents make it difficult to hold board members personally liable for anything, and companies buy liability insurance for their board members just in case. As Lynn Turner, former chief accountant of the SEC, said to McClatchy, “I personally think until law enforcement agencies start holding these boards accountable, . . . you’re probably not going to get a lot of change.”

This is why I am skeptical of proposals to, for example, increase the number of independent board members. There’s nothing wrong with it, but I think it betrays a certain amount of naivete over what independent board members actually do.

The Repo 18: It’s Not the Collateral, It’s the Cover-Up

The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here).  Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.

Since reading portions of the report issued by Anton Valukas, the examiner in the Lehman bankruptcy and writing about the firm’s accounting tricks in “A Whiff of Repo 105,” I’ve been thinking about footnote 69.

Perhaps ‘obsessing’ is a better description of my state of mind. Consider that I possess a printed copy of the nine-volume, 2,200 page report. However, that obsession seemed justified, very early this morning, when the Wall Street Journal broke the story, Big Banks Mask Risk Levels, revealing the early results of the SEC’s probe of repurchase agreement accounting practices at major firms.

According to the WSJ, based on data from the Federal Reserve Bank of New York, eighteen banks “understated the debt levels used to fund securities trades by lowering them an average of 42% at the end of each of the past five quarterly periods.” These banks include Goldman Sachs, Morgan Stanley, JP Morgan Chase, Bank of America and Citigroup.

Continue reading “The Repo 18: It’s Not the Collateral, It’s the Cover-Up” →

What Would Really End “Too Big To Fail”?

By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

As we move closer to a Senate – and presumably national – debate on financial reform, the central technical and political question is: What would prevent any bank or similar institution from being regarded – ultimately by the government – as so big that it would not be allowed to fail.  If you are “too big to fail” (TBTF), credit markets see you as lower risk and as more attractive investment – enabling you to obtain more funding on cheaper terms, and thus become even larger.

Everyone agrees, in principle, this is a bad arrangement.  It’s an unfair distortion of markets – giving huge banks the opportunity to grow bigger, because they have implicit government guarantees.  It is also manifestly unsafe, because it encourages reckless risk-taking: If things go well, the TBTF bank gets the upside; if there is mismanagement of risk, or just bad luck, the downside falls to the taxpayer and to society more broadly.  These costs can be huge: 8 million jobs lost since December 2007.

But there remains sharp disagreement on what exactly would end too big to fail.  The main views fall primarily into three camps. Continue reading “What Would Really End “Too Big To Fail”?” →

Standing At Thermopylae

By Peter Boone and Simon Johnson

No one in official Washington is seriously worried about Greece.  It’s far away, relatively small, and – anyway – “we already sent the IMF”.  Under current circumstances, this is very much like saying 2,500 years ago: We sent 300 Spartans to stand against a horde of Persians, so what’s the problem?

The Greek economic situation is worsening fast – with government bond yields rising rapidly today (currently the 10-year rate is around 7.5 percent).  Unless there is rapid action by the international community, this has the potential to get out of control.

There are three scenarios to consider: the nightmare, the “savior”, and the decision. Continue reading “Standing At Thermopylae” →

Greenspan: Love Him, Hate Him

By James Kwak

Alan Greenspan is just as maddening in his retirement as he was during his nineteen-year reign over the global economy. Today in his appearance before the Financial Crisis Inquiry Commission (extensive coverage by Shahien Nasiripour and Ryan McCarthy here), Greenspan seems primarily concerned with passing the buck and preserving the remaining shreds of his legacy, a pathetic quest epitomized in his “I was right 70 percent of the time” remark. At the same time, however, he does make some very blunt statements about the financial industry and financial regulation that policymakers should ignore at their peril. (I’m not saying that because Greenspan was wrong before, he must be right now; I’m saying that when the most ardent defender of free financial markets reverses course, that should increase your skepticism toward free financial markets.)

Greenspan’s prepared testimony begins with a massive attempt to pass the buck. The first two pages of his account of the financial crisis have to do with rapid economic development overseas and the accumulation of the fabled global glut of savings. But he reaches even farther back to . . . the fall of the Berlin Wall and the discrediting of communism.

Continue reading “Greenspan: Love Him, Hate Him” →

Book News

By James Kwak

(This is an occasional update on this blog. For more frequent news and reviews, see the 13 Bankers site.)

Since the last update here, we’ve gotten several more reviews: The Daily Beast, Fortune, The Aleph Blog, and Rortybomb, to name a few. Links to many reviews are here. (If you wrote a review and want us to link to it, send me an email at baselinescenario at gmail dot com.)

I’ve also updated the list of past media appearances that you can view online, so you can see Simon’s suit from many different angles. In particular, I’d like to flag the Firedoglake Book Salon from this past weekend, where Bill Black hosted an in-depth, online discussion with Simon. I’ve also updated the list of upcoming events (in-person and media). For those in Rhode Island, there’s a last-minute addition: I’ll be talking at Brown this Sunday.

Some people have asked how the book is selling. I know little about the publishing industry, but I believe the accurate answer is always, “I don’t know.” Our Amazon book ranking is in the 40s, which we are grateful for. (Michael Lewis was #1 for a couple of weeks until he was completely blown out of the water by Stephenie Meyer’s next vampire novel, which isn’t even shipping until June.) But as for bookstore sales (which are still several times Amazon sales), you really don’t know, because bookstores can return unsold copies. So it’s too early to tell.

Update: Simon’s entire event (over one hour) at the World Affairs Council of Washington is available on C-SPAN.

Greece And The Fatal Flaw In An IMF Rescue

By Peter Boone and Simon Johnson.  This is a long post, about 3,500 words.

In 2003 the International Monetary Fund published yet another internal review with an impressively dull title “The IMF and Argentina, 1991-2001”.  But hidden in that text is explosive language and great clarity of thought – in essence, the IMF staff belatedly recognized that their decision to repeatedly bailout Argentina from the mid-1990s through 2002 was wrong:

“The IMF should refrain from entering or maintaining a program relationship with a member country when there is no immediate balance of payments need and there are serious political obstacles to needed policy adjustment or structural reform” (p.7, recommendation 4).

If Mr. Trichet (head of the European Central Bank), Ms. Merkel (German Chancellor), and Mr. Sarkozy (French President) have not reviewed this document yet, they should skim it immediately.  Because one day soon Greece will be calling on the IMF for a loan, and it seems mostly likely that the mistakes made in Argentina will be repeated.  Continue reading “Greece And The Fatal Flaw In An IMF Rescue” →

Financial Regulation and Fools

By James Kwak

Last week I disagreed with Paul Krugman’s dichotomy between limiting banks’ scale and scope and restricting banks’ risky behavior. Today Krugman has another op-ed, this time criticizing the current Senate bill for not being sufficiently “fool-resistant.” This time, I basically agree with him.

The problem with the Dodd bill, in Krugman’s words, is that “everything is left at the discretion of the Financial Stability Oversight Council, a sort of interagency task force including the chairman of the Federal Reserve, the Treasury secretary, the comptroller of the currency and the heads of five other federal agencies.” Citing Mike Konczal,* Krugman points out, “just consider who would have been on that council in 2005, which was probably the peak year for irresponsible lending” — Alan Greenspan, John Snow, and John Dugan. (If you’re following the logic of Krugman’s argument, those would be “fools.”)

Continue reading “Financial Regulation and Fools” →

The Fourteenth Banker

By James Kwak

I wanted to bring your attention to a new blog that could turn out to be very important. It’s called The Fourteenth Banker (here’s why) and it’s hosted and written by a current banker who wants to see real change in the industry. This is from the About page:

“Despite being with a big bank, I support reform legislation ending TBTF, separation of Commercial and Investment banking, an independent consumer protection agency and other meaningful reforms.    Why?    I have seen first hand the perversions that happen because of some who believe that the an institution exists for them and the stockholders primarily.    Countless others have been hypnotized by this illusion as well.       Free market idealism is conveniently permissive of unbridled self interest.  I believe in the free market.   In fact, this blog is a free market of ideas and is meant to lead to a free market in banking where institutions self police as a matter of competitiveness.    I have hopes of a free market where being in community in a responsible and consistent way is the path to prosperity, a free market where we recognize that if we take care of the community, the community will take care of us.    It takes a sort of faith.    Or does it?     Is not all successful business enterprise based on providing more value than is consumed?

“That is why we are here.   I invite other bankers to engage in discussion about issues and excesses in our industry and possible solutions.”

Continue reading “The Fourteenth Banker” →

Larry Summers: “Senator Kaufman is exactly right”

By Simon Johnson, co-author of 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown

Senator Ted Kaufman (D., DE) has given three blistering speeches recently, individually and collectively cutting to the heart of the financial reform matter: the deregulation of finance has gone too far and big banks now need to be reined in; the continued prevalence of fraud among Wall Street’s biggest bankers; and why the administration’s proposed “resolution authority” would do nothing at all to end the problems associated with Too Big To Fail financial institutions.

You might think no one listens to Senate floor speeches, but you’d be wrong.  Yesterday, on “This Week” (ABC), Jake Tapper asked Larry Summers – head of the White House National Economic Council and key strategist on financial reform – point blank about one of Senator Kaufman’s most important points.

Summers started this part of the interview with a fiery anti-finance industry moment, citing their lobbying spending against financial reform (“$1 million per congressman”) and arguing that the legislation currently before Congress will provide basic consumer protection, more effective regulation, and the ability to handle the failure of large financial firms.  “How can anyone take the position … that we don’t need comprehensive financial reform?”

To which, Jake Tapper responded,

“TAPPER: Some Democrats say it doesn’t go far enough. Here’s Delaware Democrat Ted Kaufman talking about the Dodd bill.”

  Continue reading “Larry Summers: “Senator Kaufman is exactly right”” →

Now We Are “Ill-Informed and Under-Educated”

By James Kwak

A couple of weeks ago, Max Abelson got some investment bankers who used to work at Lehman to say what they really think about ordinary people:

“[Lehman]’s just not that big of an event. But that’s not what people want it to be, so they’ll make it not that way if they can. They just want to be mad and don’t know what they’re talking about and want to be outraged.”

“When I read this, I giggle a little bit. Because $50 billion is a s—load of money, but in the grand scheme of things, $50 billion is a drop in the ocean.”

“Yappers who don’t know anything.”

Well, the commercial bankers are not taking this lying down. They are out trying to prove that they can be just as offensive.

Continue reading “Now We Are “Ill-Informed and Under-Educated”” →

Krugman on Financial Regulation

By James Kwak

Several people have asked us to comment on Paul Krugman’s op-ed yesterday (both by email and in our bookstore event yesterday), in which he contrasts the Paul Volcker school (“limiting the size and scope of the biggest banks”) with the other school (“the important thing is to regulate what banks do, not how big they get”). Krugman says he is in the latter group. But Mike Konczal* beat me to it:

“For me, it’s not an either/or but a both/and question. I think we should do both (a) and (b), impose a hard size cap of $400 billion to $500 billion and then expand regulation over all the broken-up shadow banks. If you look at the conclusion of 13 Bankers, I think Simon Johnson and James Kwak are in a similar boat.”

Continue reading “Krugman on Financial Regulation” →