Category: Commentary

Further Proof That Nothing Has Changed

Overheard on the streets of New Haven, just ten minutes ago:

Two young women, almost certainly Yale undergraduates, are walking down York Street, discussing their efforts to get jobs as bankers.

Student #1: “Why does everyone want to go into banking?” [Note: When an Ivy League undergrad says “banking,” he or she invariably means “investment banking,” meaning underwriting or trading.]

Student #2: “We should advertise – ‘Being a lawyer is so much better than banking.'”

Student #1 (after a pause): “Seriously, everyone wants to go into banking.”

End scene.

Also further proof that no one does campus recruiting better than a Wall Street investment bank. Or do undergrads these days want to work in investment banking after the financial crisis? At least, after the last twelve months, no one can claim that he didn’t know what kind of business he was getting into.

Update: I edited out a crack I made that, on reflection, was gratuitous. I’ll let the rest speak for itself.

By James Kwak

Who Needs Big Banks?

At a panel discussion at the Pew Charitable Trusts (captured for posterity by Planet Money), Alice Rivlin floated the idea of breaking up big banks. Luckily for us, Scott Talbott of the Financial Services Roundtable (a lobbying group for big banks) was there to slap that idea down.

Talbott: “We need big companies, and they can be managed, and they are being managed …”

Alex Blumberg (Planet Money): “But why, why do we need big companies?”

Talbott: “They provide a number of benefits across the globe. We have a global economy, and these institutions can handle the finances of the world. They can also handle the finances of large, non-bank institutions like General Electric or Johnson & Johnson. They need these institutions [that] can handle the complex transactions. Simply breaking them up … then you’re discouraging a company from achieving the American Dream, working hard, earning money, producing products, and getting bigger.”

There are two things I object to strongly. The second is easy. The American Dream is for people, not companies. And people dream of working hard, being successful, making money, and having an impact on the world. The American Dream does not imply any particular company size. There are situations in which your products are just so much better than anyone else’s that your company becomes big as a result; Google comes to mind. But Citigroup is the product of no one’s American Dream. When Talbott says “American Dream,” what he really means is “American Bank CEO’s Dream” — because, as we all know, CEO compensation in the financial sector is extremely correlated with assets.

Continue reading “Who Needs Big Banks?” →

What Is Risk Adjustment?

I think I know what it is, and if I’m right it’s very important to health care reform, but it hasn’t gotten a lot of attention.

Risk adjustment is the solution to the following problem. Imagine you tell all the health insurers that they have to accept the healthy and the sick, and they have to charge each the same insurance premium. You may not have to imagine for much longer; this is at the core of all the proposed health care reform bills. (In the Finance Committee bill you can discriminate based on a small number of factors, like age and tobacco usage, but that’s it.)

If you’re a profit-maximizing insurer, what do you do? You try to cherry-pick the healthy, since the revenues will be the same as for the sick and the costs will be lower. If you can do this successfully — say, by only advertising in gyms and in Runner’s World, or maybe by offering additional benefits that only the healthy will want — then you can dump the sick on someone else. That someone else will eventually (after all the private insurers get smart or go out of business) be the public option or the non-profit cooperative, whichever we end up with, which will end up losing money; the net effect is a transfer from taxpayers to private insurers. Now, the fact that insurers participating on exchanges have to take everyone should mitigate this problem, but it won’t go away. In effect, insurers will compete by marketing in ways that attract the healthy and hide from the sick, instead of competing to offer better health care at lower cost.

Continue reading “What Is Risk Adjustment?” →

What’s Wrong with a Phone Call?

Yesterday Simon pointed out the AP story highlighting Tim Geithner’s many contacts with a few key Wall Street executives — primarily Jamie Dimon, Lloyd Blankfein, Vikram Pandit, and Richard Parsons — while leading the government’s rescue efforts as Treasury secretary. It’s certainly useful for the nation’s top economic official to talk to people in the banking industry, and it’s also useful for him to talk to banks that are being bailed out by the government. But the AP story did come up with a few important distinctions. Geithner talked to these Wall Street executives more than the key people in Congress — Barney Frank and Christopher Dodd — that he needs to pass his regulatory reform plan. And he talked to them much more than to, say, Bank of America, which is equally big and equally in debt to the government. So to be clear, Geithner is talking to these people more than dictated by the requirements of his job (or he’s not talking to Ken Lewis enough).

Still, you could say, what’s wrong with that? Can’t Tim Geithner talk to whomever he wants to talk to?

Continue reading “What’s Wrong with a Phone Call?” →

Tonight On Bill Moyers Journal, This Morning On NPR, And Louis Brandeis

On PBS this evening (first airs at 9pm eastern; on the web from about 10pm), Bill Moyers, Rep. Marcy Kaptur, and I discuss where we stand – and what we’ve learned – a year after the US financial system almost collapsed.

There’s a detailed preview on Bill’s website – our conversation moved back-and-forth between people losing their homes in Ohio, how bank behavior brought us to this point, and where we go from here. 

We also discussed the latest revelations that, at the height of the crisis earlier this year, Treasury Secretary Tim Geithner spoke primarily to a very small group of top bankers (at Citi, Goldman, and JP Morgan).  Further implications are taken up in my Daily Beast column this morning.

Also today, coincidently, on NPR’s morning edition (about 21 minutes into the first hour; will be on-line around 9am), Alex Blumberg, Charles Calomiris, and I role play whether the administration’s reform proposals are “Jamie Dimon-proof”, meaning that Too Big To Fail will really be brought under control.  I’m Jamie Dimon, Charles is Charles, and Alex is the President.  It doesn’t go well for the taxpayer.

On behalf of the administration, Diana Farrell (Larry Summers’s deputy at the National Economic Council, NEC) responds by saying effectively: “big has its benefits”, and the best we can hope for is to regulate our massive banks.  As I said in my NYT Economix column yesterday (reproduced after the jump here), I take the position of Louis Brandeis on this one: our biggest banks have simply become Too Big To Regulate.

The NPR story didn’t get into the tragic human dimensions of the crisis, but Rep. Kaptur was forceful on this point during the Moyers conversation.  In part, this strengthens the case for a consumer protection agency focused on financial products – a point on which we agree with Ms. Farrell and her colleagues. 

But, hopefully, senior staff at the NEC will have a chance to review the Moyers segment (it only takes 30 minutes or so) and reflect on whether big banks are really ever so beneficial when they make, facilitate, and now refuse to renegotiate loans that have ruined so many lives. 

Continue reading “Tonight On Bill Moyers Journal, This Morning On NPR, And Louis Brandeis” →

Too Politically Connected To Fail In Any Crisis

Over the past 30 years Wall Street captured the thinking of official Washington, persuading policymakers on both sides of the aisle not to regulate (derivatives), to deregulate (Gramm-Leach-Bliley), not enforce existing safety and soundness regulations (VaR), and to stand idly by while millions of consumers were misled into life-ruining financial decisions (Alan Greenspan).

This was pervasive cultural capture or, to be blunter, mind control.  But when the crisis broke it was not enough.  Having powerful people generally on your side is not what you need when all hell breaks loose in financial markets.  Official decisions will be made fast, under great pressure, and by a small group of people standing up in the Oval Office. 

If you run a big troubled bank, you need a man on the inside – someone who will take your calls late at night and rely on you for on the ground knowledge.  Preferably, this person should have little first-hand experience of the markets (it was hard to deceive JP Morgan and Benjamin Strong when they were deciding whom to save in 1907) and only a limited range of other contacts who could dispute your account of what is really needed.

Goldman Sachs, JPMorgan, and Citigroup, we learn today, have such a person: Tim Geithner, Secretary of the Treasury. Continue reading “Too Politically Connected To Fail In Any Crisis” →

Casey Mulligan’s Straw Man

Casey Mulligan argues that bank recapitalization under TARP was a failure because it did not lead to increased bank lending. He argues that this was a necessary outcome, because (a) public purchases of bank capital crowd out private purchases of bank capital, and (b) new capital does not necessarily flow into lending, and concludes: “This episode is an expensive example of public policy promises that were doomed to failure because they were known at the outset to defy economic theory.”

I have often argued that there were many things wrong with TARP. But this is not one of them.

Continue reading “Casey Mulligan’s Straw Man” →

The Problem with Securitization

The New York Times has a story on “Paralysis in the Debt Markets” which says, basically, that credit has dried up because of lack of demand for asset-backed securities. In English, that means that since no one wants to invest in securities that are made out of home mortgages, the people who originate mortgages have no place to sell the mortgages to, so they don’t have any money to lend. And this is also true of commercial real estate, student loans, and so on. For example, “A once-thriving private market in securities backed by home mortgages has collapsed, from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year.”

The response of the Fed has been to prop up the securitization market by buying the stuff itself when no one else will buy it. But that program is reaching its provisional limit — according to the times, the Fed has bought $905 billion out of a budget $1.25 trillion in securities — and with the Fed hawks on the warpath, it is likely to be pulled before the private market recovers.

Continue reading “The Problem with Securitization” →

Imbalances, Schmalances

We’ve been at first amused but more recently alarmed at how “global imbalances” are becoming many people’s preferred explanation of the financial crisis. At first you could brush it off this way: “global imbalances (read: ‘blame China’) . . .” But this explanation is going mainstream, not least because it is always more convenient for policymakers and bad actors to blame someone far away. For example, Dealbook (New York Times) kicked off a roundtable on the causes of the financial crisis this way:

“There is a conventional view developing on the financial crisis. The Federal Reserve’s policy of historically low interest rates spurred a worldwide search for higher risk and return. Concurrently, the entrenched United States trade imbalance led to a huge transfer of dollar wealth to Asian and commodity-based countries. The unwillingness of Asian economies, particularly China, to stimulate their own domestic consumption led these countries to reinvest the proceeds into the United States. This further contributed to lower American interest rates and further fueled the search for return.”

(Mortgage securitization gets mentioned, but only in the fourth paragraph!)

Simon and I took this on in our Washington Post online column this week, but I thought it was interesting enough to repost here in full, below.

***

The time is here for our nation to actually do something about the recent financial crisis — that is, do something to prevent it from happening again. But instead, many people are finding it easier to pass the buck than to, say, regulate the financial sector effectively.

The recent Group of 20 conference in Pittsburgh was replete with talk about “global imbalances,” which means — in the spirit of the “South Park” movie — “blame China!”

Continue reading “Imbalances, Schmalances” →

Actions Vs. Words At The IMF

Buried in the avalanche of meaningless press releases from Istanbul is a highly significant item.  Dominique Strauss-Kahn, Managing Director of the IMF,  “has proposed the appointment of Naoyuki Shinohara, to the position of Deputy Managing Director. Mr. Shinohara, a former Vice Minister of Finance for International Affairs of Japan, will succeed Takatoshi Kato.”

This is a disaster. Continue reading “Actions Vs. Words At The IMF” →

Did Anything Happen In Istanbul?

Sunday’s communique from the International Monetary and Financial Committee (of the Board of Governors of the International Monetary Fund) is incredibly bland, even by their usual standards.  The degree of self-congratulation and complacency is slightly less pronounced than what we saw from the G20 in Pittsburgh, whose final statement contained a classic moment of hubris when the entirety of paragraph 5 read: “It worked.”

Still, the IMFC (representing all IMF member countries) seems to be in the same cloud cuckoo land as the G20 leaders. Continue reading “Did Anything Happen In Istanbul?” →

A Short Question For Senior Officials Of The New York Fed

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve.  It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman’s shareholdings.

Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China (People’s Daily; CNBC).  US banks or bank holding companies would not generally be allowed to undertake such transactions – in fact, it is annoyed bankers who have asked me to take this up. Continue reading “A Short Question For Senior Officials Of The New York Fed” →

Too Connected To Fail

Over on the Economist Roundtable, my colleague Daron Acemoglu makes several important points.

  1. We now have some financial institutions (and perhaps nonfinancial firms also) that have such strong and deep political connections, they will not be allowed to go bankrupt.  This is a reality we must face.
  2. Assuming that we can address such a deep political problem with a tweak of our regulatory arrangements is a dangerous illusion. Continue reading “Too Connected To Fail” →

The Economics of Models

Economic and financial models have come in for a lot of criticism in the context of the global financial crisis, much of it deserved. One of the primary targets is models that financial institutions widely used to (mis)estimate risk, such as Value-at-Risk (VaR) models for measuring risk exposures (which we’ve discussed elsewhere) or the Gaussian copula function for quantifying the risk of a pool of assets.

In September, the Subcommittee on Oversight and Investigations of the House Science and Technology Committee held a hearing on the role of risk models in the financial crisis and how they should be used by financial regulators, if at all. The hearing focused largely on VaR models, which attempt to quantify the amount that a trader (or an entire bank) stands to lose on a given day, with a certain confidence level. (For example, a one-day 1% VaR of $10 million means that on 99% of days you will lose less than $10 million.) Continue reading “The Economics of Models” →