By Simon Johnson
In a column now running on Bloomberg, I review the new Inspector General report on what exactly happened during the “Citi Bailout Weekend” of late November 2008.
The big question lurking in the background is how acutely we face a problem of Too Big To Fail (TBTF) today, i.e., the perception in the credit markets that very big banks will be supported in a crisis, therefore enabling these banks to borrow more cheaply during a boom – and thus enabling them to become larger and increasing their debt relative to equity (leverage).
According to the report, Treasury Secretary Tim Geithner now completely backs away from claims that the Dodd-Frank reform legislation ended TBTF.
Standard and Poor’s appears to be on the right track with their latest revised Bank Ratings methodology – presuming that “potential government support” is, going forward, always available to megabanks. This is exactly the conclusion of 13 Bankers. We should worry greatly about the implications.
To read the full column, click here, or cut and paste this address: http://www.bloomberg.com/news/2011-01-18/-citi-weekend-shows-too-big-to-fail-endures-commentary-by-simon-johnson.html
The Baseline Scenario 
This bolsters the idea that even though the largest banks can not fail, each and everyone smaller than the big 2 or 3 actually can and maybe should.
This would send a clear message to the risker banks, weed them out so the more practical ones can carry on until they either find commen ground or fail themselves.
IMF’s counter proposal:
http://www.prisonplanet.com/new-imf-strategy-document-charts-launch-of-bancor-global-currency.html
As long as we don’t guarantee a bailout when not in a crisis. During a crisis we’d bail out a bunch of small failing banks too. The guarantee is already there.
And even without a guarantee our system is set up to make banks(and other companies) plan only for the short term. Big or small, If the bank prices tail risk during good times, they’ll be less competitive than a bank that doesn’t. They might well be out of business by the time the crisis comes or at least they’ll have gotten a lot smaller.
What we have to worry about is a TBTF acting irresponsible enough to fail when times are good. We wouldn’t think twice about letting a small bank fail under these circumstances, but we’d probably consider it for a TBTF.
J.P. Morgan was the most powerful member of the “Money Trust” that decided which banks would fail and which banks would survive during the Panic of 1907. Today, Jamie Dimon, the CEO of JP Morgan, is the most powerful New York Federal Reserve Bank board member. Jamie Dimon decides which banks will fail and which banks survive.
“plus ça change, plus c’est la même chose”
Nothing is too big to fail, as I’m afraid this country is about to find out.
“But this doesn’t apply to our largest global banks; there is nothing in the Dodd-Frank authority that applies to the overseas operations” [Deep Six]*
These companies have been relocating offshore for years now and methodically embarking on a massive acquisition trail throughout every continent. Consolidation is the new mantra for these financial behemoth road warriors backed-up by what China calls, “A Failed/Outdated and Flawed Fiat System {FRB}”! Where once was a fortified, and structurally calcified skeleton..now but a putrid decaying mass of cartilage!
The Chinese have made it clear that if we don’t get our own fiscal house in order that there is an entire global market out yonder (implicit language, indeed?) that will gladly accommodate their wares, and “Yaun Might”! India on the border is a big cornerstone, a plus, plus you might caution?
The United States and China are currently in the spring training of a long baseball season, and China has drafted all the “Best Players”, like it or not (Yankee’s ,…Yipes!!!) Mr. Geithner!
TBTF’s will not worry? They’ve already transferred great amounts of assets off shore to various continents and will gladly take up business with the Emerging Markets – leaving America and it’s broke Federal Reserve Banking System holding the bag! Why? Because as I said previously, there magicians at the shell game – where the prize has already found a new allegiance with Europe, China, Russia, Africa, and South America.
Lastly , our only savior is reinstating the original Glass-Steagall Act of 1933! JMHO
God Bless You, Julian Assange !
PS. Until next time…Thankyou Simon and James (Here’s hoping I on stayed on subject :-)
On most intelligent blogs the tone is dark and bitter. But it doesn’t square with Americans increasingly positive view of Obama and their total indifference to the real issues destroying this country. You have the feeling often that you’re not living on the same planet. Here’s a link I found over at Yves’ blog that’s worth a mention:
http://www.foreignpolicy.com/articles/2011/01/02/unconventional_wisdom?page=0,9
In addition to and more worrisome than the economic implications of TBTF to tax payers, are the conclusions the citizenry has drawn about their political process. We have been disabused of the slim, last-best-hope, that the United States possesses a functioning representative democracy. Clearly the constituency that our elected officials represent are the corporate ones that buy the political process. What little recourse the average American possessed against the hegemony of corporate malfeasance has evaporated, the courts the legislature and the executive branch have been usurped in the service of global capital and stacked against the over-matched, enfeebled middle class.
This at a time when the emerging global economic powers are either totalitarian, criminal kleptocracies or some blend; India is reputedly the world’s largest democracy, some would dispute the characterization, certainly it is not a beacon of representative governance. Brazil? The final repository of middle class power are the maligned social welfare democracies of Europe. There are scattered others but the balance is shifting against them. As the new world order forms (surely the previous one is fading), the likelihood that mankind is embarked on some dark, miserable journey towards an oppressive dystopia seems to be increasing.
Reality is conflated by corporate media and under the weight of a parallel universe of information produced by special-interest think tanks, corporate funded university departments, corporate propaganda the MSM is obliterating the vestiges of humanistic, rational, fact driven social organization.
Perhaps the most that can be said for our own government is that when one wing of the business party turns over power to the other it does so relatively peacefully.
Appendum:
Dated Material {1989-96}
“International Multinational Corporations” – the United States accounted for approx. 65 pc in 2008…and how the growing pains have receded – thusly, the cause and effect of stunted and crippled growth for the foreseeable future, and beyond? Ref:
http://www.itcilo.org/english/actraw/telearn/global/ilo/multinat/multinat.htm
Note:The Bush Dynasty #41 & Slick Willy Clinton/Hillary___NAFTA {Walton’s & Auto Industry}
“Why the Economy is not Recovering”: The Economic Populist [2011]
Note: Nixon decommissions the “Bretton [1944] Woods Act in 1971, and takes U.S. off the “Gold Reserve Standard” making our newly created {fiat?} hegemony currency the worlds’ problem? Ref:
http://www.economicpopulist.org/content/why-economy-isnt-recovering
Please note: The Chinese coming to America could very well be a blessing in disguise. Both sides have greatly benefited from free trade, especially the U.S. MNC’s! This should be a wake-up call to the average citizen that Chinese cheap labor isn’t necessarily what got us here in the first place. Rather that the citizenry was sold out by our political leaders passing the trade laws – currently all posturing (who me?) now as a bunch of faux`naif’s! Where we are today in America is to be laid solely at the feet of America’s Big Business in favor of profits over dignity for its country, and responsibilty. The Chinese just went along…JMHO
whatcouldpossiblygowrong
I wish the general public would give me cause to believe the optimists instead of the pessimists. Unfortunately, they give me no choice but to agree with that article. The whole thing is going down in flames, and nobody’s going to do anything to stop it. A few very powerful people will grab everything they can as things wind down, and the rest of us will be left fighting for the scraps.
My only hope is that we find ways to preserve the human knowledge gained to this point. If the population suffers a massive die-off, like bacteria that have consumed all the resources in their current environment, I hope whatever remains will have our technology combined with the knowledge and wisdom gained from our collapse. Perhaps they can rebuild without the failures we suffer from.
The Dodd-Frank financial reform was brought about by a troubling trend of more frequent and larger economic crashes. In undertaking a complex reform, sequence and timing are critical. Policymakers had to determine whether the capital market needed reform by amending the existing deterministic, one-size-fits-all system; or, whether the capital market system was broken and required fundamental structural repair.
• If the former, what is new or innovative in the 2,000-plus pages of Dodd-Frank?
• If the latter, which proposals introduce REAL structural change?
The problem is not Too-Big-To-Fail (TBTF), but Too-Random-To-Regulate (TRTR). The solution for Dodd-Frank-type legislation with one-size-fits-all deterministic regulatory metrics is to segment randomness into: predictable (money market investments), probable (positive cash low, earnings-driven, NYSE and NASDAQ issuers that are marked-to-the-market) and uncertain (negative cash low, event-driven issuers that are marked-to-the-model) regimes.
@ Tania, 3-D, Myshkin
I caught the PBS documentary Frontline this evening. The topic was the terrorism-industrial complex. It looks like the infrastructure to repress democracy is already in place. Sobering proof that the dystopia Chris Hedges recently wrote about is rapidly evolving.
Simon,
The claims and liabilities (incl contingent ones) resulting from overseas operations of (also US) banks are threefold: (1) claims of/on the US operations on/of foreigners (incl foreign operations of US banks) (2) claims on/of foreign branches (i.e. the same legal person and thus sharing the same estate in bankruptcy as the US “parent”) (3) claims on/of locally incorporates subsidiaries and interests.
Useful to note that banks like Citi tend to “ring fence” their liabilities in countries with significant cross border risk, turning them in claims on the local office only.
Useful to note also that Lehman (although it had the occasional bank charter here and there) was not a bank in the sense of standard bank regulation and did not (probably) comply with Basle II and likewise US regulators would not have been able to rely on reciprocal treatment by foreign regulators wrt a Lehmann failure.
In terms of bankruptcy, there is no reason why the full branches of a US bank would not be included in an “orderly liquidation”. There is certainly no reason why the foreign creditors would be treated differently than local creditors. In fact, given the Basle accord’s aspect of supervisor cooperation, more than likely, local supervisors would cooperate with the relevant US authorities towards an orderly liquidation. The US regulators could elect to “walk away” from the incorporated foreign operations and do not seem to have much US authority to exercise discretion in those cases.
All in all then, technically there is no reason why the international operations would not be included in a Dodd-Frank liquidation, and, especially that the US gvt liability limit implied in that legislation would not apply to those as well.
In practical terms, this would of course be very difficult, also given the interconnectedness and the sheer volume of transactions.
Life for the US taxpayer (in that capacity alone) would be much easier if the gvt would leave the financial system entirely to the market (backed by legislation to make it illegal for the US gvt to bail out financial institutions over and above the formal FDIC/SPIC insurance liabilities (and preferably those would be funded by risk-based premiums, which would make then unaffordable and limit the liability base considerably). That would reduce the activities under US gvt financial liability to payments-related deposits and the payments and clearing systems themselves. Funds raised by financial institutions for commercial activities like lending, carrying trading, underwriting and investment positions and to fund collateral for derivatives operations should not be “credibly uninsured”.
That would make the taxpayer happy, but what would be the (a) long term welfare- and (b) short term adjustment effects of moving to such a system. Despite your eminent group’ insistence that banks could operate well with much higher levels of capital (I suspect up to three times current levels, much of it laying idle in anticipation of a systemic crisis that may never happen again in the same way), I suspect that two things would result from such a state of affairs: (1) given existing trade-politcal arangement(free trade) there is no reason why foreign banks with lower capital requirements (based on the Basle III) would not be able to conduct highly profitable arbitrage and target the most profitable niches in the US market, only to abandon that market in the face of an impending economic downturn. Such a “solution” (like the case where foreigners would be absent (barred from operating in the US unless backed with resident capital following US rules) but banks highly capitalized, competing for capital with normal firms) would be extraordinarily pro-cyclical.
Maybe academics should think a little about what can be achieved given initial conditions, political energy and globalization. Small (town) banking is nonsense..But working (1) towards more intensive regulatory scrutiny and (2) including the shadow banking system and (3) clarifying exactly what claimants may rely on and what not in the case of a financial institution’s failure (include Fanny and Freddie!) should improve the taxpayer’s position and need not lead to large disruptive effects with probably many unintended consequences.
A regrettable typo in the final sentence of para 7: The funds should of course be “credibly uninsured” rather than ” not “credibly insured”
http://www.washingtonpost.com/wp-dyn/content/article/2011/01/18/AR2011011801416.html
Obama orders all fed agencies to review regulations
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By Lori Montgomery
Washington Post Staff Writer
Tuesday, January 18, 2011; 3:04 PM
“President Obama on Tuesday ordered every federal agency to conduct a systematic review of existing regulations, a concerted effort to banish red tape at a time when the administration is eager to promote economic growth and to repair its fractured relations with the business community.”
This “is” the next time; all under different wording.
Wow: tat was way more than intended. The link and headline from the Washington Post today sounds much like the same basic neoliberal strategy of days gone by; only crafted to sound more efficient. Is that really the emphasis that regulatory agencies need to be struck with? It would seem intimidating if I were to receive such a directive from the President. Especially since the SEC was essentially treated to the same type of messaging when they began to scale back any serious accountability. Judge for yourself:
http://www.washingtonpost.com/wp-dyn/content/article/2011/01/18/AR2011011801416.html
“President Obama on Tuesday ordered every federal agency to conduct a systematic review of existing regulations, a concerted effort to banish red tape at a time when the administration is eager to promote economic growth and to repair its fractured relations with the business community.”
This “is” the next time; all under different wording.
I kept a close track of this topic and even my analysis makes me agree with the author.
@ Rien Huizer
Very interesting comments.
For “more intensive regulatory scrutiny” I have argued that one-size-fits-all deterministic metrics to be segmented into predictable, risky, and uncertain regimes (unknown, unknowns with negative cash flow instruments that are marked-to-model). Consider that you can insure but not hedge uncertainty (non-correlative information that like a metastasized cancer cell cannot be bound), how then would banks like Citi “ring fence” their liabilities in countries with significant cross border risk?
Ref: “Global Finance Awards” (Awards & Financial Rankings) *have fun?
http://www.gfmag.com
Ref: “J.P. Morgan Expands Latin America Presence” (2009)
http://www.jpmorgan.com/cm/cs?pagename=JPM_redesign/JPM_Content_C/Generic_Detail_Page_Template&cid=1255280575994&c=JPM_Content_C
Ref: “Why Global Banks are Banking on India” (2007)
http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4145
Ref: Deal Book…”J.P. Morgan Chase & Co.(JPM) Forms Joint Venture with China’s First Capital Securities Co.” (6/2009)
http://www.bullfax.com/?q=node-dealbook-jpmorgan-morganstanley-approved-form-chinese-
Ref: “Hype Doesn’t Deliver for Agricultural Bank of China IPO” (7/10) *Noteworthy of “Special Interest” – Aaron (Ivan?) Boesky, CEO of ‘Marco Polo Investments’*
http://www.istockanalyst.com/article/viewStockNews/articleid/4314138
Ref: “TPG Plans Its First Yaun Fund” (8/10) et.el.?
http://www.bizjournals.com/dallas/stories/2010/08/23/daily3.html
PS. How’s it feel to have the U.S. Treasury go to the FRB for money – thusly giving it to the “Deep Six” for investment in other countries? Letting the homeowners hang literally on a Hickory Tree for the “Vultures” to pick what’s left of their life savings…how’s it feel? Until Next Time???
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CALL FOR PAPERS
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http://mail.aol.com/33124-111/aol-6/en-us/Suite.aspx
Also the alternative to austerity:
[The link will not post: search “Bank Tax”]
A bank tax (“bank levy”) is a proposed tax on banks. One of the earliest modern uses of the term “bank tax” occurred in the context of the Financial crisis of 2007–2010.
On April 16, 2010, the International Monetary Fund (IMF) proposed the idea of a “financial stability contribution” (FSC), which many media have referred to as a “bank tax.”
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CALL FOR PAPERS
OSGOODE GRADUATE LAW STUDENTS ASSOCIATION
2011 CONFERENCE
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Keynote Speakers:
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Globalization has converged states and non-state actors
(civil society, corporations and hybrid public-private
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In light of globalization, has transnational law influenced
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What is the role of transnational law in solving global
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This conference will debate whether we are entering a new
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Citi and others include language in their documentation to the effect that claimants will be restricted to the bank’s assets in that country only. So a Zimbawean depositor in XYZ bank’s Sudan branch might be able to claim only on that branch without recourse to the bank’s assets elsewhere. I do not know it this has ever been challenged, but I do know quite a few emerging markets governments have a problem with it.
It has nothing to do with what you appear to be concerned about (instruments with “uncertainty” characteristics). Intuitively there may be merit in your argument but how would you divide available and future instruments that way. Many transactions have several dimensions of risk (for instance default/counterparty risk, market risk (itself consisting of, eg interest, equity, commidity and currency) and operational (risk of errors occurring in either party’s handling of the transaction, legal and documentation risk, fraud, etc). The sorry soap opera about mortgage-based instruments in the US, associated credit derivatives and counterparty failure, all bundled into, say a Lehman liquidation should teach people that segmenting trades into discrete (and one-dimensional?) boxes is unworkable. In that case it would be better to have a regulator (analogous to what goes in in a derivatives clearing house) vet transaction types and declare them subject to, say a ban for all institutions (too hot to handle) under the regulatory umbrella (which would mean that they could also not act as an agent or broker), a qualified ban (for instance collateral requirements, holding period restrictions, marking to bid or offer, or marking to a regulator-approved model), restrictions on dealing in them with certain counterparts, or little or no restrictions. Likewise institutional investors (especially pension funds) should follow the same regulations wrt marking, requiring collateral, and abstaining from all but permissible transaction types (not only instruments). That plus the basic sterilization of the banking system would probably such the air out of the ability of more parasytic side of trading and investment to create “events” with predictable market imperfections or disturbances that are the main source of abnormal returns, very often at the ultimate expense of the taxpayer.
I guess that if we took the proprietary models and the myth of innovation out of the equation, that would make finance both cheaper and less risky. Innovation could be something happening only among the most entrepreneurial and well capitalized, rather than the current situation where the gvt ends up seeing its credit card meant for a public purpose being hijacked by leveraged gamblers.
However, one has to keep in mind that the opportunity to do that has passed. The culprits have plenty of hostages..
Those banks that were too big to founder
Have grown bigger without growing sounder;
So, what to do then,
If they founder again,
As sooner or later they’re bound ter?
Be it recession or any other catastrophe the big is becoming bigger thanks to our elected representatives.
Barney simply picks up your pieces and begins anew, and bids you adieu. Toot a loue.
Once again, interesting comments that I will address specifically.
Huizer: Citi’s ringed fences have nothing to do with what you appear to be concerned about (instruments with “uncertainty” characteristics).”
Boyko: Stands to reason given Citi’s deterministic perspective. I contend that where there is complexity there is uncertainty. I argue that conflating risk and uncertainty in a one-size-fits-all governance system is a flawed construct. This requires force-fitting correlation where little exists or as Taleb says correlation borders on charlatanism.
Huizer: Intuitively there may be merit in your argument but how would you divide available and future instruments that way.
Boyko: This is a key question that requires establishing capital market structural bright lines to differentiate risk from uncertainty as I hold that uncertainty is different from rather than a higher form of risk as is inferred in the sentence
“Many transactions have several dimensions of risk (for instance default/counterparty risk, market risk (itself consisting of, eg interest, equity, commodity and currency) and operational (risk of errors occurring in either party’s handling of the transaction, legal and documentation risk, fraud, etc).”
The bright-line drivers that differentiate risk from uncertainty are juxtaposed in terms of financial (cash flow and mark valuations) and operationally bought (unsolicited or marketing department/salary driven) versus sold (solicited or sales department/commission driven). Thus, uncertain investments would have negative cash flow, marked-to-model valuations, and products that are sold. For a more detailed explanation see: “Best Fit for Best Practice Governance” http://www.sfomag.com/article.aspx?ID=1281&issueID=c that posits that disclosure of the underlying economic environment randomness as either determinate or indeterminate is a precondition for effective capital market governance. The current “one-size-fits-all” legacy approach is obsolete and requires continual updating to accommodate capital market complexities. I argue that trying to reconcile the informational discontinuities of determinate and indeterminate domains in a one-size-fits-all regulatory regime is analogous to having one motor vehicle code for the US and UK.
Huizer: A Lehman liquidation should teach people that segmenting trades into discrete (and one-dimensional?) boxes is unworkable.
Boyko: That is why I argue that it is not scale (TBTF), but TRTR (Too-random-to-regulate) or as you put it “Too-Hot-To-Handle that should be the focus of the regulatory effort. It is also why I believe that the legacy, one-size-fits-all deterministic system is toxic and irreparable. Ergo the title of the book “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System” http://w-apublishing.com/Shop/BookDetail.aspx?ID=D6575146-0B97-40A1-BFF7-1CD340424361
Huizer: In that case it would be better to have a regulator (analogous to what goes in a derivatives clearing house) vet transaction types and declare them subject to, say a ban for all institutions (too hot to handle) under the regulatory umbrella
Boyko: Unlike risk, where you both can hedge and insure, you can only insure uncertainty. Thus, those derivative contracts that are part of a hedging strategy are questionable at best.
Huizer: I guess that if we took the proprietary models and the myth of innovation out of the equation that would make finance both cheaper and less risky. Innovation could be something happening only among the most entrepreneurial and well capitalized, rather than the current situation where the gvt ends up seeing its credit card meant for a public purpose being hijacked by leveraged gamblers.
Boyko: Agreed, if randomness is segmented into predictable, risky, and uncertain regulatory regimes.
Huizer: However, one has to keep in mind that the opportunity to do that has passed. The culprits have plenty of hostages.
Boyko: Given the trend of larger and more frequent crashes, that may be soon revisited.
“We should worry greatly about the implications.”
Amen. And I fume about the causes as well.