Year: 2010

Senator McConnell Is Wrong, Senator Kaufman Is Right. Any Questions?

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

Senator Mitch McConnell continues to insist that the Dodd bill creates permanent bailouts – and that it would be definitely better to do nothing.  Apparently, he has indicated a willingness to make a Senate floor statement to that effect every day. 

Senator McConnell is completely wrong on this issue – and, if he gets any traction, we will feel the need to point this out every day.  His remarks today and yesterday go far beyond any reasonable level of partisanship.  This is about playing games with the financial stability of this country and the world; it should stop.

Don’t take my word for it – Senator Ted Kaufman is a strident critic of our current financial system and a tough voice for greatly strengthening the Dodd bill.  But today he was as clear and as forceful as you can be on the floor of the Senate:  Senator McConnell’s proposed approach is “dangerous and irresponsible.” Continue reading “Senator McConnell Is Wrong, Senator Kaufman Is Right. Any Questions?” →

“The Derivatives Dealers’ Club”

By James Kwak

Robert Litan of Brookings wrote a paper on the derivatives dealers’ club — the small group of large banks that control most of the market for certain types of derivatives, notably credit default swaps. It’s a blunt analysis of how these banks can and will impede derivatives reform in order to maintain their dominant market position and the rents that flow from it.

I haven’t had time to do it justice, so I recommend Mike Konczal’s analysis in parts one and two (but particularly one). As Konczal says, “In case you weren’t sure if you’ve heard anyone directly lay out the case on how the market and political concentration in the United States banking sector hurts consumers and increases systemic risk through both political pressures and anticompetitive levels of control of the institutions of the market, now you have.”

And note that Litan is no bomb-thrower; most recently he mounted a defense of most financial innovation (my comments here).

Senator McConnell Is Completely Wrong On Financial Reform

By Simon Johnson

At one level, it is good to see the Republican Senate leadership finally express clear positions on the financial industry and what we need in order to make it safer.  At another level, what they are proposing is downright scary.

In a Senate floor speech yesterday, Senator Mitch McConnell (Senate Republican leader) said,

”The way to solve this problem is to let the people who make the mistakes pay for them. We won’t solve this problem until the biggest banks are allowed to fail.”

Do not be misled by this statement.  Senator McConnell’s preferred approach is not to break up big banks; it’s to change nothing now and simply promise to let them fail in the future. 

This proposal is dangerous, irresponsible, and makes no sense.  The bankruptcy process simply cannot handle the failure of large complex global financial institutions – without causing the kind of worldwide panic that followed the collapse of Lehman and the rescue/resolution of AIG.  This is exactly the lesson of September 2008. Continue reading “Senator McConnell Is Completely Wrong On Financial Reform” →

Pack of Fools

By James Kwak

“I thought that I was writing a period piece about the 1980s in America, when a great nation lost its financial mind. I expected readers of the future would be appalled that, back in 1986, the CEO of Salomon Brothers, John Gutfreund, was paid $3.1 million as he ran the business into the ground. . . . I expected them to be shocked that, once upon a time on Wall Street, the CEOs had only the vaguest idea of the complicated risks their bond traders were running.

“And that’s pretty much how I imagined it; what I never imagined is that the future reader might look back on any of this, or on my own peculiar experience, and say, ‘How quaint.'”

That’s Michael Lewis in The Big Short (p. xiv), looking back on Liar’s Poker.

“Looking back, however, Salomon seems so . . . small. When the Business Week story was written, it had $68 billion in assets and $2.8 billion in shareholders’ equity. It expected to earn $1.1 billion in operating profits for all of 1985. The next year, Gutfreund earned $3.2 million. At the time, those numbers seemed extravagant. Today? Not so much.”

That’s the third paragraph of Chapter 3 of 13 Bankers. (This was a complete coincidence; I didn’t see The Big Short until it came out, and I have no reason to think that Lewis saw a draft of our book.)

I actually did not rush out to buy The Big Short, even though Michael Lewis is a great storyteller. I figured I knew the story already; Gregory Zuckerman’s The Greatest Trade Ever covered some of the same ground and some of the same characters, and I already knew plenty about CDOs, credit default swaps, and synthetic CDOs. But I’m very glad I read it, and not just because it’s a fun read.

Continue reading “Pack of Fools” →

Greek Bailout, Lehman Deceit, And Tim Geithner

By Simon Johnson

We live in an age of unprecedented bailouts.  The Greek package of support from the eurozone this weekend marks a high tide for the principle that complete, unconditional, and fundamentally dangerous protection must be extended to creditors whenever something “big” gets into trouble.

The Greek bailout appears on the scene just as the US Treasury is busy attempting to trumpet the success of TARP – and, by implication, the idea that massive banks should be saved through capital injections and other emergency measures.  Officials come close to echoing what the Lex column of the Financial Times already argued, with some arrogance, in fall 2009: the financial crisis wasn’t so bad – no depression resulted and bonuses stayed high, so why do we need to change anything at all?

But think more closely about the Greek situation and draw some comparisons with what we continue to learn about how Lehman Brothers operated (e.g., in today’s New York Times).  Continue reading “Greek Bailout, Lehman Deceit, And Tim Geithner” →

The Cover-Up

By James Kwak

Wall Street is engaged in a cover-up. Not a criminal cover-up, but an intellectual cover-up.

The key issue is whether the financial crisis was the product of conscious, intentional behavior — or whether it was an unforeseen and unforeseeable natural disaster. We’ve previously described the “banana peel” theory of the financial crisis — the idea it was the result of a complicated series of unfortunate mistakes, a giant accident. This past week, a parade of financial sector luminaries appeared before the Financial Crisis Inquiry Commission. Their mantra: “No one saw this coming.” The goal is to convince all of us that the crisis was a natural disaster — a “hundred-year flood,” to use Tim Geithner’s metaphor.

I find this incredibly frustrating. First of all, plenty of people saw the crisis coming. In late 2009, people like Nouriel Roubini and Peter Schiff were all over the airwaves for having predicted the crisis. Since then, there have been multiple books written about people who not only predicted the crisis but bet on it, making hundreds of millions or billions of dollars for themselves. Second, Simon and I just wrote a book arguing that the crisis was no accident: it was the result of the financial sector’s ability to use its political power to engineer a favorable regulatory environment for itself. Since, probabilistically speaking, most people will not read the book, it’s fortunate that Ira Glass has stepped in to help fill the gap.

Continue reading “The Cover-Up” →

Greece Saved For Now – Is Portugal Next?

By Peter Boone and Simon Johnson

The Europeans announced Sunday they would provide 30 billion euros of assistance to Greece, amid informed rumors that the IMF will offer another 10-15 billion.  With a total of say 40-45 billion euros in the bag – more than the market was expecting — the Greeks have time to make changes. 

The Greek government, helped by the market threat of a near term collapse, appear to have strong armed the other eurozone countries into a generous package without making efforts to change seriously their (Greek) fiscal policy.  This is good for near term calm, but it does not solve any of the inherent problems now manifest in the eurozone. Continue reading “Greece Saved For Now – Is Portugal Next?” →

Taxation and Prohibition

By James Kwak

Andrew Haldane (of “doom loop” fame) has another provocative paper, “The $100 Billion Question,” delivered in Hong Kong last week. A central theme of the paper is what Haldane sets up as a debate between taxation and prohibition as approaches to solving the problem of “banking pollution” — the systemic risk externality created by the banking industry. Taxation is higher capital and liquidity requirements; prohibition is structural reforms that limit the size or scope of financial institutions. Drawing on work by Weitzman and Merton, Haldane discusses when one approach would be superior to the other.

The advantages of prohibition include modularity (ability of a system to withstand a collapse of one component), robustness (likelihood that regulations will work when needed), and better incentives (since tail risk is a function of banker behavior — not weather patterns — the risk-seeking nature of banking means that no capital level will necessarily be high enough).

Continue reading “Taxation and Prohibition” →

Thank You

By James Kwak

13 Bankers is #11 on the New York Times hardcover nonfiction bestseller list.* I’m certain that could not have happened without the readers of this blog. (Actually, the book would not have existed in the first place without this blog, and the blog wouldn’t exist without readers.) It’s also #4 on the Wall Street Journal hardcover business list and #14 on the Indiebound hardcover nonfiction list.

In other major news, the book is Arianna Huffington’s pick for April, which means that there will be a month of blog posts by us and by other bloggers at the Huffington Post. Our first post in the series, arguing against the “banana peel” theory of the financial crisis, is already up. We’ve lined up a wide range of commentators, several of whom we expect to disagree with us rather strongly.

We also have some full-length video of presentations by Simon. Over the next week, I’ll be in Providence and Simon will be in Chicago and Los Angeles (schedule here). Simon has a bunch of interviews; I’ll be on Sense on Cents tomorrow evening.

* The list is for the week ending April 3. It goes on the Web on April 9 but doesn’t go into the print edition until April 18, by which point it is two weeks out of date. (One friend thinks the lag is to give bookstores enough time to stock their shelves.)

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”?” →