Category: Commentary

The Administration Starts to Fight On Banking, But For What?

By Simon Johnson

Speaking to the American Enterprise Institute, Treasury Secretary Tim Geithner had some good lines yesterday,

“The magnitude of the financial shock [in fall 2008] was in some ways greater than that which caused the Great Depression.  The damage has been catastrophic, causing more damage to the livelihoods and economic security of Americans and, in particular, the middle class, than any financial crisis in three generations.”

Like Ben Bernanke, Mr. Geithner also finally grasps at least the broad contours of the doom loop,

“For three decades, the American financial system produced a significant financial crisis every three to five years. Each major financial shock forced policy actions mostly by the Fed to lower interest rates and to provide liquidity to contain the resulting damage. The apparent success of those actions in limiting the depth and duration of recessions led to greater confidence and greater risk taking. “

But then he falters. Continue reading “The Administration Starts to Fight On Banking, But For What?” →

Bloomberg Reviews “13 Bankers”

By Simon Johnson

Bloomberg’s reviewer, James Pressley, emphasizes our historical parallels between big banks today and big business more generally at the start of the twentieth century.  In 1900, the forces supporting the status quo seemed unassailable, yet real reform proved possible – making the economic system both fairer and more productive.  We can rein in huge banks today – but only if our political leadership is willing to take the most powerful people on the planet. 

“Though Jamie Dimon won’t like this (any more than John D. Rockefeller did), incremental regulatory changes and populist rhetoric about “banksters” are getting us nowhere. It’s time for practical solutions. This might be a place to start.”

The full review is here.

Volcker And Bernanke: So Close And Yet So Far

By Simon Johnson

In case you were wondering, Paul Volcker is still pressing hard for the Senate (and Congress, at the end of the day) to adopt some version of both “Volcker Rules”.  It’s an uphill struggle – the proposed ban on proprietary trading (i.e., excessive risk-taking by government-backed banks) is holding on by its fingernails in the Dodd bill and the prospective cap on bank size is completely missing.  But Mr. Volcker does not give up so easily – expect a firm yet polite diplomatic offensive from his side (although the extent of White House support remains unclear), including some hallmark tough public statements.  It’s all or nothing now for both Volcker and the rest of us.

But at the same time as the legislative prospects look bleak (although not impossible), we should recognize that Paul Volcker has already won important adherents to his general philosophy on big banks, including – most amazingly of late – Ben Bernanke, at least in part.  In a speech Saturday, Bernanke was blunt,

“It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms. If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation [like fall 2008].” Continue reading “Volcker And Bernanke: So Close And Yet So Far” →

Metternich With A Blackberry

By Simon Johnson

If watching the twists and turns in European politics – “should we bailout Greece?”, “should we bring in the IMF?”, “should the Greeks go directly to the IMF, cutting out the EU?”, etc – has your head spinning and reminds you of overly complicated and opaque episodes from the history books, then you have actually caught the main point.  European power structures and alliances webs are being remade before your eyes.

Is this all random – just the collision of disparate national interests with no coherent plans on any side?  Or are there some strong, deliberate, and very personal hands at work guiding key pieces into place?  

Prince Metternich worked long and hard to manoeuvre countries and people before and after 1815, cynically and cleverly building a system of interlocking interests that suited him – and his employer, the Austrian/Habsburg Emperor.  Is there a modern Metternich now at work?  Most definitely: Yes. Continue reading “Metternich With A Blackberry” →

Could The US Become Another Ireland?

By Peter Boone and Simon Johnson

As Greece acts in an intransigent manner, refusing to act decisively despite deep fiscal difficulties, the financial markets look on Ireland all the more favorably.  Ireland is seen as the poster child for prudent fiscal adjustment among the weaker eurozone countries. 

The Irish economy is in serious trouble.  Irish GDP declined 7.3% as of third quarter 2009 compared with third quarter 2008.  Exports were down 9% year-on-year in December.  House prices continue to fall.  While stuck in the eurozone, Ireland’s exchange rate cannot move relative to its major trading partners – it thus cannot improve competitiveness without drastic private sector wage cuts.  Yet investors are so pleased with the country that its bond yields imply just a one percent greater annual chance of default than Germany over the next five years.

Ireland’s perceived “success” is partly due to its draconian fiscal cuts.  The government has cut take home pay of public sector workers by roughly 20% since 2008 through lower wages, higher taxes, and increased pension payments.  As the head of the National Treasury Management Agency John Corrigan proudly advised the Greeks (and everyone else):  “You have to talk the talk and walk the walk”.

So is Ireland truly a model for Greece and other potential problems in Europe and elsewhere? Definitely not – but it does provide a cautionary tale regarding what could go wrong for all of us. Continue reading “Could The US Become Another Ireland?” →

We Are All “Yappers Who Don’t Know Anything”

By James Kwak

According to ex-Lehman executives interviewed by Max Abelson (hat tip Felix Salmon). To summarize, they say that using borderline-legal transactions to massage your balance sheet at the end of a quarter is completely normal, everyone does it, $50 billion is no big deal anyway, only “nonprofessionals” would even notice, and the only reason the bankruptcy examiner made so much noise about it was to justify the fee for his work. (Abelson does point out that, according to internal Lehman emails cited in the report, there were Lehman executives at the time who were worried about what they were doing and did not think it was standard practice.)

Continue reading “We Are All “Yappers Who Don’t Know Anything”” →

Mario Draghi and Goldman Sachs, Again

By Simon Johnson

In its previous response to us, the the Bank of Italy pointed out that Mario Draghi (its current governor) did not join the management of Goldman Sachs until 2002 – hence he was not there when the controversial Greek “debt swaps” were arranged.

We agree that he joined Goldman only in January 2002 (this was in our original post).  But the latest revelations regarding the Goldman-Greece relationship (on the Senate floor, no less) clearly indicate that Goldman was a lead manager of Greek debt issues in spring 2002, i.e., when Mr. Draghi was on board.

This raises three entirely reasonable and straightforward questions. Continue reading “Mario Draghi and Goldman Sachs, Again” →

Enron and Merrill, Greece and Goldman

By Simon Johnson

Did big banks break the law during our recent global debt-fuelled boom?  The usual answer is: no – they just took advantage of loopholes and captured regulators.  The world’s biggest banks are widely supposed to be too sophisticated to be tripped up by the legal system.

But is this really true?  The new Valukas report on Lehman suggests there are grounds for civil action, i.e., people can sue for damages.  News reports give no indication of potential criminal charges, but this may change soon.  The hiding of Lehman’s true debt levels – through the so-called “Repo 105” structure – is strikingly reminiscent of how Enron’s balance sheet was disguised through fake asset “sales” (as Senator Kaufman now points out).

And, of course, the people who ended up facing criminal charges and – in some prominent cases – going to jail, included not only Enron executives, but also responsible bankers from Merrill Lynch (see The Smartest Guys in the Room, Chapter 13).  Arthur Anderson, Enron’s accountant, was also effectively broken by the scandal.  It is a serious crime for professional advisers and financiers to assist in securities fraud.

The failure of Lehman therefore opens a can of worms for close and potentially productive examination in coming weeks.  But so does the issue of Greek government debt in April 2002. Continue reading “Enron and Merrill, Greece and Goldman” →

Senator Kaufman: Fraud Still At The Heart Of Wall Street

By Simon Johnson

Last week, Senator Ted Kaufman (D., DE) gave a devastating speech in the Senate on “too big to fail” and all it entails.  A long public silence from our political class was broken – and to great effect.  Today’s Dodd reform proposals stand in pale comparison to the principles outlined by Senator Kaufman.  And yes, DE stands for Delaware – corporate America has finally decided that its largest financial offspring are way out of line and must be reined in.

Today, the Senator has gone one better, putting many private criticisms of the financial sector – the kind you hear whispered with conviction on the Upper East Side and in Midtown – firmly and articulately on the public record in a Senate floor speech to be delivered (this link is to the press release; the speech is in a pdf attached to that – update: direct link to speech, which will be given tomorrow).  He pulls no punches:

“fraud and potential criminal conduct were at the heart of the financial crisis”

He goes after Lehman – with its infamous Repo 105 – as well as the other entities potentially implicated in those transactions, including Ernst and Young (Lehman’s auditors).  This is the low hanging fruit – but have you heard even a squeak from the White House or anyone else in the country’s putative leadership on this issue?

And then he goes for the twin jugulars of Wall Street as it still stands: The idea that we saved something, at great expense in 2008-09, that was actually worth saving; and Goldman Sachs. Continue reading “Senator Kaufman: Fraud Still At The Heart Of Wall Street” →

A Few Words on Lehman

I have a trip coming up at the end of this week, and in the meantime I have two articles to write, and a section of a legal thingy, and I’m sick, and my daughter’s sick, so I won’t be able to do justice to the Lehman report issued by the bankruptcy examiner on Thursday. So here are just some moderately quick thoughts.

  • The report is great reading (I’ve read some sections of it). You can get the whole thing here, in nine separate PDF files. If you want to get an overview of the report, Volume I has a comprehensive table of contents. Note that the TOC is thirty-eight pages long. Like many legal documents, some of the section heads are written as sentences, so you can sort of “read” the TOC. In particular, you can see from the TOC which parties might be the subject of legal causes of action. (Note that the “Volume” numbers have nothing to do with the logical organization of the report; they only reflect how it was chopped into nine PDFs.)
  • Continue reading “A Few Words on Lehman” →

Does Meaningful Financial Reform Have Any Chance?

By Simon Johnson

Senator Dodd’s financial reform bill will be introduced in the Senate Banking Committee today.  Unfortunately, on the major issue – too big to fail financial institutions that caused the 2008-09 crisis and that will likely trigger the next meltdown – there is nothing meaningful in the proposed legislation.

The lobbyists did their job a long time ago.  Treasury sent up a weak set of proposals – Secretary Geithner apparently felt that to do otherwise would be just to seek “punishment” for past wrongdoings; there is too little concern at the top levels of this administration regarding what comes next.  And Senator Dodd was pushed hard by various interests to weaken all potentially sensible proposals – including anything that would bring greater transparency and safety to the derivatives market.  The Republicans have also demonstrated their mastery of delaying tactics; by emphasizing “procedural” issues, they have so far managed to conceal their fundamental opposition to real reform.

A few strong voices have emerged on the Democratic side – Senator Jeff Merkley (on the committee) stands out as someone who both understands the issues and can craft the right message.  Let’s hope he has a good week – if he can bring Senator Sherrod Brown with him, there is a chance that the legislation could move in the right direction.  With all 10 Republicans on the 23 member committee steadfastly opposed to anything at all, any two Democratic senators have some negotiating power – as they can potentially hold up a bill.

And there is something pro-reform forces can reasonably work for at this stage. Continue reading “Does Meaningful Financial Reform Have Any Chance?” →

Are Regulators Trying to Make Bank of America Smaller?

By James Kwak

Last week, Charlie Gasparino reported at Fox Business that “Executives at Bank of America are coming under increasing pressure to downsize the firm as federal regulators seek to prevent large, cumbersome financial institutions from once again tanking the financial system as they did in the fall of 2008.” Later, he writes, “people close to the bank and government officials say government regulators have made it clear to BofA executives, including its new CEO, Brian Moynihan, that they want the bank to become much smaller.” The article refers to officials at Treasury and the Federal Reserve.

This would be interesting for a couple of reasons. One is that the administration and its allies in Congress are insisting that breaking up large financial institutions is not the answer to the too big to fail problem. If regulators are pressuring BofA to get smaller, that would seem to imply the opposite.

Continue reading “Are Regulators Trying to Make Bank of America Smaller?” →

Underwater Second Liens

By James Kwak

Mike Konczal did some more great work earlier this week in two posts on the not-so-exciting topic of second liens. I don’t have much in the way of new insight or analysis to provide, so let me just summarize.

A second lien is a second mortgage on a house. The second lien is junior to the first mortgage, meaning that if the borrower defaults and the first lender forecloses, the proceeds from the sale go to pay off the first mortgage; the second lien only gets paid back if the sale proceeds exceed the amount due on the first mortgage. You can see where this is heading.

Konczal’s first point was that in the stress tests almost a year ago, the big four banks held $477 billion of second liens and estimated that these assets were worth 81-87 cents on the dollar, so they would take $68 billion in losses (under the “more adverse” scenario). Konczal estimated that they were instead worth 40-60 cents on the dollar, implying $191-286 billion in losses.

Continue reading “Underwater Second Liens” →

What’s Wrong with the Financial System in Eight Minutes

By James Kwak

Yesterday I was at a conference on “New Ideas for Limiting Bank Size,” hosted by the Fordham Law School Corporate Law Center. Simon gave the keynote speech over lunch. It’s actually the first time I’ve seen Simon give a presentation; we’re rarely in the same city at the same time.

I don’t have video of yesterday, but Mike Konczal linked to video of the presentations, including Simon’s, from last week’s all-star conference, “Make Markets Be Markets,” hosted by the Roosevelt Institute. You can see sneak previews of a few charts from 13 Bankers. You can also see eight-minute presentations by other luminaries such as Elizabeth Warren, Frank Partnoy, Joe Stiglitz, Rob Johnson, and Mike Greenberger.

Get Rid of Selection Sunday

By James Kwak

I have a lot to catch up on from this past week, like the Lehman report, but first I have more important business to attend to: the NCAA Division I men’s college basketball tournament. Tomorrow is Selection Sunday, the day when sixty-five teams are selected for the tournament. Thirty-one conference champions automatically make the tournament, leaving thirty-four at-large spots handed out by a committee.

Today, the general approach, uncontested by virtually everyone, is that the committee selects what it thinks are the best teams, based on things like record, strength of schedule, and Ratings Percentage Index. Invariably it leads to controversy at the margin. There are also many people who think the system is biased in favor of mediocre teams from major conferences and against good (though not champion) teams from “mid-major” conferences.

I think there are two things wrong with this system. The first is that decisions are arbitrary at the margin, since they are made subjectively by comparing teams that cannot be directly compared. The second is that the process selects for the wrong thing: it selects teams that a committee thinks are good teams, rather than teams that deserve to be there because they win games that matter. To make an analogy, it’s as if at the end of the baseball regular season a committee subjectively decided which were the best teams and let them into the playoffs, rather than taking the three division winners and the wild card team from each league. Yes, sometimes a team misses out on the playoffs despite having a better record than a team in the playoffs. But everyone knows what the rules are at the beginning of the year, and the point is to win your division (or the wild card), not simply to be a good team.

Continue reading “Get Rid of Selection Sunday” →