Simon and I are both on Bill Moyers (first half) tonight. Then Simon is on Real Time with Bill Maher. Enjoy.
Author: James Kwak
Michael Lewis on Wall Street
By James Kwak
The Big Short is a good story and provides some illuminating lessons about Wall Street. Lewis doesn’t really come out and say what he thinks about Wall Street; he lets his characters do that for him. But in his recent interview with Christopher Lydon, he really lets loose. Here are some direct quotations.
Lewis: “The people who were responsible for orchestrating the crisis, because they’re on top and they’re in the middle of it, they’re the only ones who are sort of fluent in the language of it. I mean, who’s to question Tim Geithner, the secretary of the treasury, about this or that, because he’s the only with the information . . . even though he is clearly culpable in what happened.”
Lydon: “Not to mention Larry Summers and Bob Rubin and all the other architects of the deregulation. They’re still calling the shots in a new administration after a change of party management. It’s unreal.”
Lewis: “It is unreal, because basically all of the people you mentioned all swallowed a general view of Wall Street, which was that it was a useful and worthy master class, that these people basically knew what they were doing and should be left to do whatever they wanted to do. And they were totally wrong about that. Not only did they not know what they were doing, but the consequences of not knowing what they were doing were catastrophic for the rest of us. It was not just not useful; it was destructive. We live in a society where the people who have squandered the most wealth have been paying themselves the most, and failure has been rewarded in the most spectacular ways, and instead of saying we really should just wipe out the system and start fresh in some way, there is a sort of instinct to just tinker with what exists and not fiddle with the structure. And I don’t know if that’s going to work. When you look at what Alan Greenspan did, or what Larry Summers did, or what Bob Rubin did, there are individual mistakes they made, like for example not regulating the credit default swap market, preventing that from happening. But the broader problem is just the air they breathe. The broader problem is just the sense they all seem to have that what’s good for Goldman Sachs is good for America.”
***
Lewis: “The question is how does Washington move away from those institutions and make decisions that are in the public interest without regard for the welfare of these institutions. It’s a hard question because . . . this is the problem. Essentially the public and their representatives have been buffaloed into thinking that this subject — financial regulation, structure of Wall Street — is too complicated for amateurs. That the only people who are qualified to pronounce on this are people who are in it. And there are very very few people who aren’t in it in some way who have the nerve to stand up and fight it. . . .
“The elected representatives look at the financial system, I’m sure, and they think, it’s too complicated for me to understand, I’m going to be quickly exposed as a know-nothing if I take the lead on regulation, and in the bargain I’m going to miss out on all these campaign contributions from the financial industry because I’ll alienate them.”
***
Lewis, on Barack Obama: “He’s been captured by his banker, just like the ordinary American’s captured by their stockbroker. He’s been buffaloed by the complexity of it all, he doesn’t have time to sort it out for himself, and he has to trust the people who seem to know. The alternative is for him to set off on his own in a quixotic quest to reform the financial system without having any experience of the system. It’s sort of like the presidential version of regulatory capture, that he is at the mercy of the people who really don’t have probably his long-term best interests at heart but who seem to know what they’re talking about.”
The Other Battle
By James Kwak
One battle in Washington — the one that has been in the news this week — is over resolution authority and the supposed “bailout fund” attacked by Mitch McConnell. Another battle will be over the Consumer Financial Protection Agency, which Republicans are likely to try to cripple behind the scenes. While most of the reviewers of 13 Bankers have seized on the call to break up big banks, few have discussed the first part of that chapter, which argues for strong consumer protection. Simon and I wrote an op-ed in The Hill to reiterate the point and warn against some of the tactics opponents may use.
“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).
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.
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.
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).
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.)
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.”
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
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”
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.
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.
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.”)
The Baseline Scenario 