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
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.
Uncle Billy pointed out this post by The Epicurean Dealmaker, which he described as “smoking.” TED actually is an investment banker (or an excellent imitator of one, down to the expensive tastes), so he can say things in more detail and more convincingly than I. Like this:
“But the assertion that large, multi-line financial conglomerates provide customers with services no smaller institutions can deliver is pure poppycock. The mid-1990s concept of globe-striding financial supermarkets has been completely discredited, most notably by their sad-sack poster child, Citigroup. Wholesale institutional clients make a point of using more than one investment or commercial bank for virtually all their financial transactions, no matter what they are. In fact, the bigger the deal, the more banks the customer usually uses. This is because banking clients want to 1) spread transaction financing and execution risk across multiple service providers and 2) make sure none of these oligopolist bastards has an exclusive right to grab the client by the short and curlies.”
By James Kwak
Paul Volcker, legendary central banker turned radical reformer of our financial system, has won an important round. The WSJ is now reporting:
President Barack Obama on Thursday is expected to propose new limits on the size and risk taken by the country’s biggest banks, marking the administration’s latest assault on Wall Street in what could mark a return — at least in spirit — to some of the curbs on finance put in place during the Great Depression.
This is an important change of course that, while still far from complete, represents a major victory for Volcker – who has been pushing firmly for exactly this.
Thursday’s announcement should be assessed on three issues. Continue reading
She’s probably already said this before, but I just saw this in an interview by Tim Fernholz, which I completely agree with:
“There are a lot of ways to regulate ‘too big to fail’ financial institutions: break them up, regulate them more closely, tax them more aggressively, insure them, and so on. And I’m totally in favor of increased regulatory scrutiny of these banks. But those are all regulatory tools. Regulations, over time, fail. I want to see Congress focus more on a credible system for liquidating the banks that are considered too big to fail.”
But what really caught my eye was this: “I’m teaching my classes, doing my research, and helping out where I can.” I always assumed she took a leave from Harvard Law School when she became chair of the TARP Congressional Oversight Panel. Now that is remarkable.
By James Kwak
One of our readers pointed me to a paper by Edward Kane with the unfortunately complicated title “Extracting Nontransparent Safety Net Subsidies by Strategically Expanding and Contracting a Financial Institution’s Accounting Balance Sheet.” The paper is an extended discussion of regulatory arbitrage — not the specific techniques (such as securitization with various kinds of recourse) that banks use to finesse capital requirements, but the larger game played by banks and their regulators. This is how Kane frames the situation:
“Regulation is best understood as a dynamic game of action and response, in which either regulators or regulatees may make a move at any time. In this game, regulatees tend to make more moves than regulators do. Moreover, regulatee moves tend to be faster and less predictable, and to have less-transparent consequences than those that regulators make.
“Thirty years ago, regulatory arbitrage focused on circumventing restrictions on deposit interest rates; bank locations; charter powers; and deposit institutions’ ability to shift risk onto the safety net. Probably because regulatory burdens in the first three areas have largely disappeared, the fourth has become more important than ever. Today, loophole mining by financial organizations of all types focuses on using financial-engineering techniques to exploit defects in government and counterparty supervision.”
“Banking on the State” by Andrew Haldane and Piergiorgio Alessandri is making waves in official circles. Haldane, Executive Director for Financial Stability at the Bank of England, is widely regarded as both a technical expert and as someone who can communicate his points effectively to policymakers. He is obviously closely in line – although not in complete agreement – with the thinking of Mervyn King, governor of the Bank of England.
Haldane and Alessandri offer a tough, perhaps bleak assessment. Our boom-bust-bailout cycle is, in their view, a “doom loop”. Banks have an incentive to take excessive risk and every time they and their creditors are bailed out, we create the conditions for the next crisis.
Any banker who denies this is the case lacks self-awareness or any sense of history, or perhaps just wants to do it again. Continue reading