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. Read the rest of this entry »
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? Read the rest of this entry »
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. Read the rest of this entry »
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. Read the rest of this entry »
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. Read the rest of this entry »
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].” Read the rest of this entry »
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. Read the rest of this entry »
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.
A Little Book News
By James Kwak
So, we have a book that goes on sale a week from Tuesday (although you can pre-order it now). We created another blog for book-specific news, in order to avoid cluttering this blog with too much book stuff. But we are going to provide occasional updates (like this one) here with a few highlights.
In the last week, we got a friendly review by Arnold Kling, we learned that the books do actually exist, and we put up a page with some in-person events in case you’re wondering if we look like our photos. We also put up our first factual correction, having to do with the 10 percent cap on deposits. Note that we are interested in correcting errors of fact — we put a lot of effort into getting the facts right, including hiring our own professional fact-checkers (that’s another blog post for another time). If you think we made an error of interpretation (or an error of theory) . . . well, we’re happy to think about it, but don’t expect a correction.
Freefall
By James Kwak
I only recently finished reading Freefall,* Joseph Stiglitz’s book, so this review comes about two months late. It took me a while partly because I was busy, but partly because I didn’t feel a lot of dramatic tension . . . since I agreed with almost everything he said.
Unlike most crisis books, Freefall is relatively short on what caused the financial crisis. The historical background is mainly laid out in Chapter 1, “The Making of a Crisis,” although there is discussion of specific problems in later chapters, such as Chapter 4, “The Mortgage Scam.” Mainly this book is about the response to the crisis, what was wrong with it, and what needs to change in the future.
Reading the book gave me a familiar feeling. You see, our book (13 Bankers) is largely about historical and political background–our Chapter 1 begins with Thomas Jefferson and Alexander Hamilton, although most of the book is about the period since 1980–so there is relatively little topical overlap between the two. But where they do overlap, particularly in the discussion of government responses to the crisis, I had the sensation that we were saying much the same thing.
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. Read the rest of this entry »
Richard Posner Has Another Book?
By James Kwak
Fresh on the heels of A Failure of Capitalism, the new title is A Crisis of Capitalist Democracy. Maybe the next will be The Downfall of Everything Good in the World.
I haven’t read it. BusinessWeek has a curious review (curiously titled “Slapped by the Invisible Hand” . . . which is the title of Gary Gorton’s book). Here’s the funny bit:
“Posner, who less than a year ago began his dissection of the crisis of 2008 with A Failure of Capitalism (Harvard, May 2009), has enormous credibility when he casts a skeptical eye on Wall Street. As an influential free-market thinker, he helped shape the antiregulatory ideology that inspired so much public policy since 1980. Belatedly he admits error.”
Wait a sec. Being wrong for decades gives you “enormous credibility”? So if, say, James Inhofe were to admit that he is wrong and that climate change is occurring, then he would suddenly be an important voice on what to do about it?If James Gilleran (former director of the OTS) were to write a book about the problems with lax regulation and what needs to change, would you buy it?
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.)
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. Read the rest of this entry »
Orientation
leave a comment »
Pre-order now: Our book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, goes on sale March 30.
First time reader? See our latest Baseline (02/09/10), “The Quiet Coup” in The Atlantic (April 2009), or BusinessWeek, Democracy, TNR, and NYTimes (all 2009), and TNR, Vox, and WSJ (in 2010). Reviews of On the Brink and Too Big To Fail.
Like the site? Get free updates via email, RSS, Twitter, or Facebook (and tell your friends).
Written by James Kwak
October 20, 2008 at 9:11 am
Posted in Commentary