Big Banks Fail

In the Wall Street Journal on Tuesday morning, Charles Calomiris, a leading banking expert, published an op ed entitled “In the World of Banks, Bigger can be Better.”  It begins,

“Legitimate concern about the risks to taxpayers and the economy posed by banks that are “too-big-to-fail” has prompted some observers, among them Simon Johnson, former chief economist of the International Monetary Fund, to favor draconian limits on financial institution size. This is misguided. There are sizable gains from retaining large, complex, global financial institutions—and other ways to credibly protect taxpayers from the cost of government bailouts.”

And the article goes on to make the detailed case for keeping intact our largest banks – in contrast to the recently expressed views of two former Federal Reserve chairs (Paul Volcker, Alan Greenspan) and – late Tuesday – the current governor of the Bank of England (Mervyn King), who are calling for these banks to be broken up in some fashion. Continue reading “Big Banks Fail” →

The Problem at Moody’s

Kevin Hall of McClatchy has an article  about Moody’s that goes beyond the usual — giving AAA ratings to products “structured by cows” and taking money from the cows (actually, the “cows” comment was from S&P). He documents how Moody’s forced out executives who questioned the lax rating policies, replaced them with executives from the structured finance division, and filled its compliance division with people from that same division.

In this week’s column at The Hearing, we discuss this as an example of a common tension within businesses — between the revenue-generating side of the business and the people responsible for product quality. The problem is that in the short term, you can maximize revenues by cutting corners on quality, but in the long term, cutting those corners can come back to hurt you. Or it can hurt your customers. Or the whole economy, as it turns out. Unfortunately, however, there is no particular reason to believe that companies will resolve this tension in a way that is good for them in the long term, let alone the economy.

By James Kwak

The Consensus On Big Banks Begins To Move

Just when our biggest banks thought they were out of the woods and into the money, the official consensus in their favor begins to crack. The Obama administration’s publicly stated view – from the highest level in the White House – remains that the banks cannot or should not be broken up.  Their argument is that the big banks can be regulated into permanently low risk behavior.

In contrast, in an interview reported in the NYT this morning, Paul Volcker argues that attempts to regulate these banks will fail:

“The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company.”

Volcker may not have the ear of the President (as the NYT points out), and Alan Greenspan – also arguing for bank breakup, but along different lines – might also be ignored.  But watch Mervyn King closely. Continue reading “The Consensus On Big Banks Begins To Move” →

Revisiting the Crime Scene

Mike Konczal has a post featuring the Grayson/Clay/Miller amendment to the current Consumer Financial Protection Agency proposal. The basic idea is that the agency would be required to do a periodic, statistical analysis to identify those financial products that were most implicated in causing bankruptcies and foreclosures in each state. The CFPA would then have to announce what these products are and who sold them, and could then take corrective action to restrict those products.

Continue reading “Revisiting the Crime Scene” →

Why Is The Chamber Of Commerce Defending Big Banks?

On Warren Olney’s radio show To The Point yesterday, I had a chance to talk with US Chamber of Commerce management directly regarding the issue posed here last week: Why would an organization representing 3 million small businesses come out in support of our largest banks?  My question was picked up and focused by the host.

Warren Olney (at the 36:35 mark): “Mr. Hirschmann, back to you.  Are you serving the interests of your own members, if you resist the idea of breaking up the big banks?”

David Hirschmann (leading the Chamber’s financial lobbying efforts): “I just don’t think the question is whether we need to break up the big banks.  The question is how do we ensure that the kinds of practices that they engaged in — and others outside the banking system — don’t happen any more.  Which is why we pointed to transparency in areas like derivatives and leverage.” [my transcription]

Mr. Hirschmann then goes on to talk about the consumer protection agency (he’s opposed).

The conflict between the Chamber’s principles and its actions becomes increasingly clear. Continue reading “Why Is The Chamber Of Commerce Defending Big Banks?” →

Fox, Henhouse?

One of our readers emailed in a link to this Bloomberg story about the new “chief operating officer” of the enforcement division of the SEC: Adam Storch, “a 29-year-old from Goldman Sachs Group Inc.’s business intelligence unit” who “had worked since 2004 in a unit at that reviewed contracts and transactions for signs of fraud.”

I went back and forth about posting this because, as far as I can tell, it’s not that important a job; according to the WSJ, “Mr. Storch will oversee division operations that include budget, information technology and administrative services. He will also supervise the workflow associated with the collection and distribution of fair funds to harmed investors.” It’s back-office administration, not deciding whom the SEC is going to pursue. I don’t think this is in the same league as, say, Goldman’s chief lobbyist becoming the Treasury secretary’s chief of staff. (Note, however, that Zero Hedge says it is “arguably the most critical post at the SEC.”)

But still, even if it is a routine back-office job, why someone from Goldman who makes Neel Kashkari look like an elder statesman? As our reader pointed out, there are some relevant themes here. One is the revolving door. Another is cognitive capture: why does the SEC think it needs a Goldmanite to handle its budget, IT, and administrative services? There are other good companies out there, really, somewhere, or we have a much bigger problem on its hands.

Maybe he’s independently wealthy and immune to job offers from Wall Street. Maybe he’s a genius and aced his job interview. You’d think there must be something special about him that convinced the SEC to give him the job despite all the additional “Government Sachs” fodder it creates. I hope he does a wonderful job.

By James Kwak

Hey, Where’s My Free Advance Copy of Superfreakonomics?

Just kidding. I don’t have time to read it anyway (nor am I all that interested).

In case you’ve missed it, there has been an enormous controversy (by blogosphere standards) over a chapter in Superfreakonomics (to be released tomorrow, I think) on climate change, carbon reduction, and geo-engineering. Brad DeLong has the most coverage (I believe this was his first post; read backwards from there), including links to some people who are supportive of the book. The summary is that a number of people have accused Levitt and Dubner of saying silly things about climate change (bad), accepting an “expert’s” opinion without doing due diligence (more bad), and possibly distorting the opinion of another expert (very bad), with the assumed goal of being contrarian and controversial. Levitt and Dubner disagree. Paul Krugman has some interesting thoughts on the dynamics involved.

This did, however, make me think a little about the difference between blogs and books. [Note: After finishing this post — which is over 1,300 words — I realized it is not as interesting as I thought it would be. So feel free to go do something else fun.]

Continue reading “Hey, Where’s My Free Advance Copy of Superfreakonomics?” →

Where Else Are You Going to Go?

Yves Smith returned from book-writing land to catch up on the Andrew Hall story, which is one that I pretty much decided to ignore from the beginning. Hall is the Citigroup trader who, according to his compensation agreement, was due a $100 million bonus. The bonus was so big because Hall and his team were due 30% of the profits from their trades, which is even more than typical hedge fund fees. (This tradition of particular trading groups negotiating a share of their profits dates back at least to Salomon in its heyday; AIG Financial Products also had this type of deal.)

But Smith focused on one element that got me thinking. Hall’s division, Phibro, was bought by Occidental Petroleum. “Oxy paid $250 million, the current value of Phibro’s trading positions. There was NO premium, zero, zip, nada, for the earning potential of the business. Zero. Oxy bought the business for its liquidation value.” Smith infers that no one was willing to pay more because the success of Phibro depended on its being part of Citigroup and benefiting from Citi’s low cost of funding; in other words, the massive profitability of Phibro was in part due to an accounting error — not charging it an appropriate cost of capital given the risk it was taking.

Continue reading “Where Else Are You Going to Go?” →

Cognitive Dissonance and Global Macroeconomics

One of our readers not only suggested this post, but even sent me all the links; I’m just now getting around to writing it up. Thanks.

There has been a lot of talk about global imbalances, with most opinions varying from somewhat important (us) to very important (many global policymakers). Here’s Jean-Claude Trichet, for example, president of the European Central Bank, as reported by Reuters:

“The G20 has to address the issues of the domestic large imbalances between savings and investments, and of the set of unsustainable external imbalances.

“We know that these imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis. And this of course would be totally unacceptable.”

Continue reading “Cognitive Dissonance and Global Macroeconomics” →

Who is Carlos Slim?

The US increasingly displays characteristics that we have seen many times in middle-income “emerging markets” – new dimensions of vast inequality, forms of financial instability that benefit the best connected, and consistently easy credit for the privileged.  But this raises the question: who exactly is going to dominate our economic and political landscape moving forward?

In most emerging markets, a major crisis means that some powerful people and their firms fall from grace.  After the Asian Financial Crisis (1997-98), some of the biggest Korean chaebol disappeared or broke up, numerous Thai bankers lost their top positions, and there was a discreet reshuffle among the Malaysian business elite.  Russian oligarchs rise and fall with the price of oil; the process in Ukraine is similar, although somewhat murkier.

With every sharp turn of the cycle, new people rise to the front – taking advantage of low asset prices and the fact that most people struggle to borrow on reasonable terms.  In Mexico, after the crisis of 1994-95, Carlos Slim consolidated his position in telecoms and used this as a launching pad to become one of the world’s richest people.

Three sets of players look positioned to do the same in the US today, mostly based on the amazing set of “carry trades” available if you have access to large amounts of cheap short-term funding (e.g., along the yield curve, from dollars into other currencies, and – arguably – into equity in some parts of the world). Continue reading “Who is Carlos Slim?” →

Move Along

Yves Smith has a very good post on how hard much of the mainstream media has fallen for the “everything is OK, go on with your lives” theme. She cites the Pew Research Center to show that media coverage of the financial crisis and recession has focused primarily on political battles – stimulus, bailouts, etc. – rather than on problems in the real economy. What’s more, economic coverage in general has fallen off since the stock market rebound earlier this year and the Obama administration’s “all clear” signal. She also discusses psychological research that shows that people can be easily influenced to believe things that are not true, simply because people around them seem to believe those things.

Smith traces this phenomenon to two main sources: the steady evolution of journalism into a traditional profit-oriented business than can no longer afford to invest heavily in investigative journalism; and the increased ability of political leaders, following the lead of private corporations, to control the message that is transmitted via the media. The Bush administration was allegedly the master of the latter, although the fact that they were so obvious about it sort of undermines that claim. (Although probably their attitude was that they didn’t care if the “New York liberal elite” saw how they were manipulating press coverage.) But the Obama administration is no slouch either.

Continue reading “Move Along” →

The Chamber of Commerce Has It Backwards

The US Chamber of Commerce is opposing the administration’s proposed Consumer Financial Protection Agency, on the grounds that it would hurt small business.  Their argument is that this agency will extend the dead hand of government into every small business.

For the Chamber of Commerce, government is the enemy of small business and should always and everywhere be fought to a standstill.  Chamber Senior Vice President (and former Fred Thompson campaign manager) Tom Collamore sees this as “advocacy on behalf of small businesses, job creators, and entrepreneurs” (quoted in the WSJ link above), and the Chamber has launched the “American Free Enterprise” campaign.

Somewhere, the Chamber’s senior leadership missed the plot.  What brought on the greatest financial crisis since the 1930s?  What has hurt, directly and indirectly, small business of all kinds to an unprecedented degree over the past 12 months?  What is killing small and medium-sized banks at a rate not seen in nearly 80 years?

It’s the behavior of the financial sector, particularly big banks and their close allies – by consistently mistreating consumers.  And the letter and spirit of the regulatory regime let them get away with it. Continue reading “The Chamber of Commerce Has It Backwards” →

Calvin Trillin’s Theory

According to Calvin Trillin (or, more accurately, the probably-at-least-semi-fictional interlocutor he meets at a bar in Midtown), the financial crisis was caused by smart people going to work on Wall Street. In the old days, the story goes, it was the lower third of the class that went to Wall Street, and “by the standards that came later, they weren’t really greedy. They just wanted a nice house in Greenwich and maybe a sailboat. A lot of them were from families that had always been on Wall Street, so they were accustomed to nice houses in Greenwich. They didn’t feel the need to leverage the entire business so they could make the sort of money that easily supports the second oceangoing yacht.”

Then, however, as college debts and Wall Street pay grew in tandem, the smart kids started going to Wall Street to make the money, leading to derivatives and securitization, until finally: “When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was.”

Continue reading “Calvin Trillin’s Theory” →

Diana Farrell And The White House Theory Of Bank Size

On Friday morning, Diana Farrell – a senior White House official – made a significant statement on NPR’s Morning Edition, with regard to whether our largest banks are too big and should be broken up.

 “Ms. DIANA FARRELL (Deputy Assistant for Economy Policy): We understand Simon Johnson’s views on this, and I guess the response is the following….  

 “Ms. FARRELL: We have created them [our biggest banks], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.” (full transcript)

Ms. Farrell is Larry Summers’s deputy on the National Economic Council and the former director of McKinsey Global Institute, and she has a strong background on banking issues – based on extensive professional experience with global financial institutions.

Her statement contains three remarkable points. Continue reading “Diana Farrell And The White House Theory Of Bank Size” →