Volcker, Warren, and Kaufman: There Must Be New Law

By Simon Johnson, (13 Bankers, out tomorrow)

Some people at the top of the administration begin to understand that it makes both economic and political sense to impose binding constraints on our largest banks. But even the clearest thinking among them still has a problem – breaking up banks seems too much at odds with the way they saved these same banks in 2009. At best, this would be most awkward for the individuals involved on all sides.

“We’ll achieve the same general goal by imposing capital requirements that increase with the size of the bank” (not an exact quote) is the administration’s latest whispered idea, and in principle this has some appeal. If done properly, this could level the playing field – and therefore should be supported politically by small banks. By increasing the buffer against future losses, it would put in place greater protection for taxpayers against too big to fail (TBTF) institutions. And it would push TBTF firms to break up if they really have nothing better than cheap funding – based on implicit government subsidies – to support their continued existence.

But this “let’s do it with capital requirements” proposal is deeply flawed and completely unacceptable. From different perspectives, Paul Volcker, Elizabeth Warren, and Ted Kaufman all agree, we cannot rely on our existing regulations (and regulators). We need new law. Continue reading “Volcker, Warren, and Kaufman: There Must Be New Law” →

I’m Back

By James Kwak

If I were Tyler Cowen or Paul Krugman, I would have original insights from my eight days in Bogota, Colombia. But I’m not. So here are just a few random observations:

Apparently there was a financial crisis about ten years ago because of faulty mortgage products that led to a high number of defaults. To clean up the financial system, the government nationalized about 70% of the banking industry (by assets), and then sold the assets back into the private sector over the next several years. Colombia now has restrictive banking regulations that prevent capital from subsidiaries from being taken out of the country (except for repatriation of profits). As a result, the Colombian subsidiaries of U.S. banks (Citibank, that is) and Spanish banks seem to be doing better than their overseas parents.
There was an indoor jungle gym in a mall a few blocks from our hotel that my daughter loved — trampolines, slides, climbing thingies, the works. Not only does the thing exist (we were wishing we had one where we live), but we didn’t even have to sign a release first.
Colombia — or at least the area around our hotel — is able to sustain several times the number of hamburger chains that the United States can sustain. And they look better, too. Maybe Barry Lynn is onto something in Cornered. (Or maybe all those chains are really subsidiaries of the same company.)

Most importantly, I did a little first-hand testing of various ways to pay for stuff. The first weekend I was there, the exchange rate was 1,907 Colombian pesos to the dollar. The rate for exchanging dollars on the street was 1850 (well, in the shopping mall — it might have been a little better on the street itself), or about a 3% fee. The net rate for using an American Express card (that is, the price in pesos divided by the number that showed up on my bill) was about 1840 — about 3.5% (although that is partially offset by my 1.25% cash back). But when I used the debit card from my local bank (PeoplesBank), I got a rate of 1906-1907 — that is, no fee whatsoever — whether I stuck it in an ATM to get cash or used it like a credit card to buy something.

I used to use my Bank of America debit card to get cash out of foreign ATMs, and I recall that every time I used it I would see three lines on my bank statement — one for the cash and two for the fees. So that’s yet another reason to ditch your big bank.

What’s Next for Health Care?

By James Kwak

I should leave the country more often: I go away and suddenly we have (near-)universal health care coverage! (Well, we’ll have to wait a few years for all of the health care reform provisions to kick in, but you know what I mean.) Not only that, but Ezra Klein reminds me that we even got rid of the pointless subsidy to the banking industry in the student loan program (where the government guaranteed the loans but let private lenders earn profits making the loans, even though the guarantee obviated the need for underwriting).

Continue reading “What’s Next for Health Care?” →

“13 Bankers”: National Public Radio Interview

By Simon Johnson

On Friday afternoon, NPR’s All Things Considered broadcast Robert Siegel’s interview with me on 13 Bankers (further down that link there is an excerpt from the very beginning of the book).

We talked, naturally enough, about how the ideas in 13 Bankers connect with the current policy debate – specifically the financial reform legislation now before the Senate. As anticipated when the book went to press in January, some sensible measures to protect consumers of financial products seem possible – yet this progress just emphasizes how and why we have not yet broken through on Too Big To Fail issues.

But there is a broader point here also. What happened in 2008-09 should not be allowed to happen again. The nature of power in and around the financial sector has become so great – and so distorted – that it harms the rest of us.

I don’t think a majority of Americans understand how much influence financial institutions have in Washington, DC. Banks used to answer to Washington. They were once held accountable for their actions. That is no longer is the case. Continue reading ““13 Bankers”: National Public Radio Interview” →

Who Will Tell The President? Paul Volcker

By Simon Johnson: link to NPR radio interview (and book excerpt) on how 13 Bankers got their hands on so much political and economic power – and why this spells serious danger for the rest of us.

Against all the odds, a glimmer of hope for real financial reform begins to shine through. It’s not that anything definite has happened – in fact most of the recent Senate details are not encouraging – but rather that the broader political calculus has shifted in the right direction.

Instead of seeing the big banks as inviolable, top people in Obama administration are beginning to see the advantage of taking them on – at least on the issue of consumer protection. Even Tim Geithner derided the banks recently as,

“those who told us all they were the masters of noble financial innovation and sophisticated risk management.”

In part this is window dressing. But in part it recognizes political opportunity – the big banks are unpopular because they remain completely unreformed and unrepentant. And in part it responds to a very real danger – Senator Dodd’s bill is so obviously weak on “too big to fail” issues that it will be hard to paint its opponents as friends of big banks.

Senator Richard Shelby knows this and is taking the offensive. The administration can convert an easy win into an own goal if it fails to toughen substantially Senator Dodd’s bill.

Fortunately, there is an easy way to address this issue. Continue reading “Who Will Tell The President? Paul Volcker” →

Hard Pressed, Senator Dodd Gives Ground

By Simon Johnson

Senator Chris Dodd has good political antennae. He knows that his financial reform bill will come under severe pressure because it has a weak heart – the provisions that deal with “too big to fail” are simply “too weak to make any sense.”

Stung by the hard-hitting critique of Senator Ted Kaufman earlier on Friday and unsure exactly where an increasingly combative White House is heading on the broader strategy vis-à-vis banks, Mr. Dodd took to the Senate floor yesterday afternoon – actually immediately after Senator Kaufman – in an attempt to sustain the momentum behind his approach to “reform”.

Note the prominent and rather defensive mention of Delaware, Senator Kaufman’s state, in what Senator Dodd said (the wording here is from the verbatim recording, not the official transcript):

“A business, as I say respectfully, in Connecticut or Delaware or Colorado, a homeowner in those states shouldn’t have to pay the price because a handful of financial institutions got too greedy, too risky, they were unwilling to examine what they were doing or did, recognizing that the federal government would bail them out if they made a bad choice, which they did.”

Perhaps it was this picture that did it: Continue reading “Hard Pressed, Senator Dodd Gives Ground” →

Senator: Which Part Of “Too Big To Fail” Do You Not Understand?

By Simon Johnson

When a company wants to fend off a hostile takeover, its board may seek to put in place so-called “poison pill” defenses – i.e., measures that will make the firm less desirable if purchased, but which ideally will not encumber its operations if it stays independent.

Large complex cross-border financial institutions run with exactly such a structure in place, but it has the effect of making it very expensive for the government to takeover or shut down such firms, i.e., to push them into any form of bankruptcy.

To understand this more clearly you can,

Look at the situation of Citigroup today, or
Read this new speech by Senator Ted Kaufman. Continue reading “Senator: Which Part Of “Too Big To Fail” Do You Not Understand?” →

The Canadian Banking Fallacy

By Peter Boone and Simon Johnson

As a serious financial reform debate heats up in the Senate, defenders of the new banking status quo in the United States today – more highly concentrated than before 2008, with six megabanks implicitly deemed “too big to fail” – often lead with the argument, “Canada has only five big banks and there was no crisis.” The implication is clear: We should embrace concentrated megabanks and even go further down the route; if the Canadians can do it safely, so can we.

It is true that during 2008 four of all Canada’s major banks managed to earn a profit, all five were profitable in 2009, and none required an explicit taxpayer bailout. In fact, there were no bank collapses in Canada even during the Great Depression, and in recent years there have only been two small bank failures in the entire country.

Advocates for a Canadian-type banking system argue this success is the outcome of industry structure and strong regulation. The CEOs of Canada’s five banks work literally within a few hundred meters of each other in downtown Toronto. This makes it easy to monitor banks. They also have smart-sounding requirements imposed by the government: if you take out a loan over 80% of a home’s value, then you must take out mortgage insurance. The banks were required to keep at least 7% tier one capital, and they had a leverage restriction so that total assets relative to equity (and capital) was limited.

But is it really true that such constraints necessarily make banks safer, even in Canada? Continue reading “The Canadian Banking Fallacy” →

Financial Reform: Will We Even Have A Debate?

By Simon Johnson

The New York Times reports that financial reform is the next top priority for Democrats. Barney Frank, fresh from meeting with the president, sends a promising signal,

“There are going to be death panels enacted by the Congress this year — but they’re death panels for large financial institutions that can’t make it,” he said. “We’re going to put them to death and we’re not going to do very much for their heirs. We will do the minimum that’s needed to keep this from spiraling into a broader problem.”

But there is another, much less positive interpretation regarding what is now developing in the Senate. The indications are that some version of the Dodd bill will be presented to Democrats and Republicans alike as a fait accompli – this is what we are going to do, so are you with us or against us in the final recorded vote? And, whatever you do – they say to the Democrats – don’t rock the boat with any strengthening amendments.

Chris Dodd, master of the parliamentary maneuver, and the White House seem to have in mind curtailing debate and moving directly to decision. Republicans, such as Judd Gregg and Bob Corker, may be getting on board with exactly this.

Prominent Democratic Senators have indicated they would like something different. But it’s not clear whether and how Senators Cantwell, Merkley, Levin, Brown, Feingold, Kaufman, and perhaps others will stop the Dodd juggernaut (or is it a handcart?)

This matters, because there is more than a small problem with the Dodd-White House strategy: the bill makes no sense. Continue reading “Financial Reform: Will We Even Have A Debate?” →

The Brown Amendment: Do the Volcker Rules Live?

The administration may be distancing itself from the Volcker Rules, but the same is not true of all Senators. (Why did President Obama go to the trouble of endorsing Mr. Volcker’s approach to limiting risk and size in the banking system, if his key implementers – led by Treasury Secretary Tim Geithner – were going to back down so quickly?)

Among a number of sensible amendments under development in the Senate, Senator Sherrod Brown (D., OH) proposes the following language: (update: text now attached)

“LIMIT ON LIABILITIES FOR BANK HOLDING COMPANIES AND FINANCIAL COMPANIES.—No bank holding company may possess non-deposit liabilities exceeding 3 percent of the annual gross domestic product of the United States.”

And a few paragraphs later, an essential point is made clear: this includes derivatives,

“OFF-BALANCE-SHEET LIABILITIES.—The computation of the limit established under subsection (a) shall take into account off-balance-sheet liabilities.”

And there is a strong provision for requiring prompt corrective action if any bank exceeds this hard size cap.

Naturally, the Federal Reserve is pushing back. Continue reading “The Brown Amendment: Do the Volcker Rules Live?” →

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” →

Away Message

By James Kwak

I’ll be traveling and probably not blogging (hopefully not using a computer at all) until next weekend (March 27 or 28). Simon will be around, though. Bye.