Does Felix Have Criminal Tendencies?

Joe Weisenthal asks, provocatively enough, whether I, had I been a banker during the credit boom, might not now be held criminally liable were the crime of bankslaughter on the books:

We wonder if Felix had been a banker whether he’d be guilty of bankslaughter. After all, in his research into the subject, he concluded early on that the issue of mortgage defaults wasn’t likely to be a huge deal. Later he changed his mind and of course, defaults proved to be a gigantic problem.

But if I were a prosecutor, I’d have no problem convincing a jury of 12 that a “reasonable” banker should’ve known that lending money to people of dubious credit risk, with low loan-to-value ratios, in an inflated market would’ve been a recipe for disaster.

Well yes — but that’s kinda the whole point. You don’t want the managers of systemically-important banks being as careless as I was on the subject of default risk. Here’s what I wrote in the piece that Weisenthal links to:

A little knowledge is a dangerous thing: I would have been much better off with a completely naive view than I was with a very basic grounding in mortgage finance.

I did some paddling around in the shallow end of the theory of mortgage bonds, and what I found surprised me: no one seemed to be the slightest bit interested in default rates. The prices of mortgage bonds were entirely a function of prepayment rates, and default rates simply didn’t enter into the equation.

Now I’m a finance blogger who prides himself on being wrong every so often (my slogan is that “if you’re never wrong you’re never interesting”) and who has essentially zero equity in being right. My job is to hold up my end of the conversation, not to be some kind of all-seeing market guru.

The manager of a systemically-important bank, on the other hand, is in a very different position, with vastly more responsibility. If such a manager did no more than do “some paddling around in the shallow end of the theory of mortgage bonds”, and on the basis of that took hundreds of billions of dollars of potentially highly-toxic assets onto his balance sheet, then yes, that’s highly reckless activity. And it’s probably reasonable to assume that if the crime of bankslaughter had been on the books at the time, then maybe such a manager might have thought twice before rushing in to such markets.

The key insight is that “financial innovation” is not the kind of thing you want too much of at too-big-to-fail institutions. Writes John Carney:

Collier doesn’t seem to have given much thought to the costs of over-deterrence. Bank executives faced with the prospect of a criminal investigation and possible conviction would likely be overly cautious. We’d lose a lot of socially beneficially risk taking by criminalizing bank failure.

For me, over-deterrence is a feature, not a bug. We’ve seen where Carney’s “socially beneficially risk taking” has landed us, and frankly I’d rather have rather a lot less of it.

Carney concludes:

Because bankslaughter is backward looking but conducting business is forward looking, it would almost certainly result in wrongful convictions. Lots of activity that looks reckless after the fact can seem perfectly sensible ahead of time. Unless the crime required bankers to know they were being reckless—in which case it would deter almost no-one and result in approximately zero convictions—it would wind up punishing bankers for just being wrong.

In an ideal world, of course, there would be no wrongful convictions simply because there would be no convictions and indeed no prosecutions. And Carney is right that it seems unfair to convict a banker of a crime just because he was heading up a too-big-to-fail institution and made a bad decision.

On the other hand, having the statute on the books would certainly increase incentives not to become too big to fail: it would help keep banks small. A capitalist society works by having private businesses take risks and fail. A capitalist society fails when private businesses are too big and systemically important to be allowed to fail. And so I think there is a case to be made that the managers of those businesses should be held to a significantly higher standard than managers elsewhere.

Comments

[Pat Shuff:]

Amongst the blindsided on the issue of mortgage defaults
you are in good company with White House economist Austan Goolsbee.

query.nytimes.com/gst/...

By AUSTAN GOOLSBEE
Published: March 29, 2007

"Congress is contemplating a serious tightening of regulations to make the new forms of lending more difficult. New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much.

And this study shows that measured this way, the mortgage market has become more perfect, not more irresponsible.

~~~~~~~~~~~~~~~~~~~~~~...

With the mortgage market on the verge of collapse in March, 2007 economist Goolsbee argues for more
subprime lending and against tightening standards.
Goolsbee was the senior economic advisor to Barack Obama's 2008 presidential campaign and subsequently
appointed the Council of Economic Advisers.

Question: Is demonstrated gross incompetence a prerequisite for appointment to high office and staff positions in mainswamp media.

Jul 09 11:07 AM

[kohalakid:]

Not only is it a prerequisite for appointment to high office and staff positions, but it seems to be in the job description for election to legislative office too.

Exhibit items: Barney Frank, Chris Dodd, Nancy Pelosi.


On Jul 09 11:07 AM Pat Shuff wrote:

>
> Amongst the blindsided on the issue of mortgage defaults
> you are in good company with White House economist Austan Goolsbee.
>
>
> query.nytimes.com/gst/...;sec=&spon=&am...
>
>
> By AUSTAN GOOLSBEE
> Published: March 29, 2007
>
> "Congress is contemplating a serious tightening of regulations to
> make the new forms of lending more difficult. New research from some
> of the leading housing economists in the country, however, examines
> the long history of mortgage market innovations and suggests that
> regulators should be mindful of the potential downside in tightening
> too much.
>
> And this study shows that measured this way, the mortgage market
> has become more perfect, not more irresponsible.
>
> ~~~~~~~~~~~~~~~~~~~~~~...
>
> With the mortgage market on the verge of collapse in March, 2007
> economist Goolsbee argues for more
> subprime lending and against tightening standards.
> Goolsbee was the senior economic advisor to Barack Obama's 2008 presidential
> campaign and subsequently
> appointed the Council of Economic Advisers.
>
> Question: Is demonstrated gross incompetence a prerequisite for appointment
> to high office and staff positions in mainswamp media.

Jul 09 03:31 PM

[H2KOLOB:]

Felix you obviously don't get it. I was a bank CEO in So. Cal. during the 1990's. Luckily, I sold my bank to to a large national Bank in 1999. during that period of time we were makig all kinds of stupid loans because our wonderful Federal government was beating us over the head with the Community Reinvestment Act (CRA) and a miriad of other programs designed to put low income people with bad credit into homes and small businesses. Now, all of those loans are blowing up, just as any "reasonable Banker" knew they would. Should I now be on my way to Jail.

Mine was one in the top 10% of all banks in the US in ROE. now at age 50, I am asked all of the time to get back in the game as a Bank CEO.

no GOOD banker I know needs money. they only work for the personal satisfaction of the job. however if the reward is potentially Prison for making reasonable decisions, then only fools will be willing to play the game.

Isn't it enough that we, the media and government, have made it impossible for any intelligent person to run for politcal office? Are we now going to chase them of of the business world also?

heaven help us

Jul 09 03:32 PM

[kohalakid:]

Isn't that what Obama and his wife suggested when they said young people should pass on going to work for corporations and just go into government service? This administration thinks business is evil and those who run businesses are unethical and should just be taxed into oblivion.

Heaven help us indeed!!!


On Jul 09 03:32 PM H2KOLOB wrote:

> Felix you obviously don't get it. I was a bank CEO in So. Cal. during
> the 1990's. Luckily, I sold my bank to to a large national Bank
> in 1999. during that period of time we were makig all kinds of stupid
> loans because our wonderful Federal government was beating us over
> the head with the Community Reinvestment Act (seekingalpha.com/symbo...)
> and a miriad of other programs designed to put low income people
> with bad credit into homes and small businesses. Now, all of those
> loans are blowing up, just as any "reasonable Banker" knew they would.
> Should I now be on my way to Jail.
>
> Mine was one in the top 10% of all banks in the US in ROE. now at
> age 50, I am asked all of the time to get back in the game as a Bank
> CEO.
>
> no GOOD banker I know needs money. they only work for the personal
> satisfaction of the job. however if the reward is potentially Prison
> for making reasonable decisions, then only fools will be willing
> to play the game.
>
> Isn't it enough that we, the media and government, have made it impossible
> for any intelligent person to run for politcal office? Are we now
> going to chase them of of the business world also?
>
> heaven help us

Jul 09 04:07 PM

[xxxx:]

I find the whole issue funny. All someone needs to do is just look at the outcome and the answer is clear. derivatives, securisation leads to being careless with risk and playing games. Make a company bankrupt and short it's stock so the CDS contracts will pay off. (Goldman). Package shit and sell it off.

One would think listening to these people that the world did not exist before all this financial innovation. What they label as innovation is really a way to reduce capital requirements and increase leverage thereby increasing salary and bonus.

I don't know if it that they lie so much they actually believe themselves, or they lie and they know it. Notice how every thing needed to fix the economy in a banker's view just happens to increase their salary, involves government giving them a free luch, and costs the taxpayer.

Fecal matter comes from their mouths. It is just one big game. Notice how each and every argument involves how I will suffer if they don't get what they want. Strange, and always the same playbook

Jul 09 04:13 PM

[Wisdom vs. ...:]

on the practical side, Felix forgets that the bankers did the 'smart' thing and secured their risks with insurance-- from AIG. oops, who is criminal there? as far as criminalizing risky behaviour, 1. all of society benefits from bankers' risks as capital is created which would not be, and 2. as J Carney explains quite eloquently, you only wind up criminalizing risky bank behaviour during recessions, which makes the law arbitrary. the arbitrary nature of enforcing this prospective law makes this the second stupidest idea i have heard this year, right behind the new class of too-big-to-fail federally regulated, federally protected banks that the administration wants to create

Jul 09 05:05 PM

[klarsolo:]

You know, sometimes complex systems blow also up because of a huge multitude of reasons and uncalculatable, unprecedented feedback loops. It's not always a mountain of stupidity and criminal behavior. Tiny acts can huge effects.

As with every black swan it is now easy to look back and say "Any reasonable person should have seen this coming". But fact is, almost nobody foresaw it. We all knew housing was in a bubble in a handful of States, but not in your worst nightmares could you have foreseen the cascading effects this would have on the entire global economy.

Guys, please keep this in mind when you wants heads to roll.

Jul 09 05:33 PM

[kohalakid:]

Yes, but sometimes flaws in a system are apparent. The Wall St Journal had been saying for over 5 years that Freddie and Fannie were too big, doing too much business that should be handled by the private sector and that the government enablers were blocking needed reform because of Freddie and Fannie lobbyist contributions.

The WSJ was spot on well before the poop hit the fan.


On Jul 09 05:33 PM klarsolo wrote:

> You know, sometimes complex systems blow also up because of a huge
> multitude of reasons and uncalculatable, unprecedented feedback loops.
> It's not always a mountain of stupidity and criminal behavior. Tiny
> acts can huge effects.
>
> As with every black swan it is now easy to look back and say "Any
> reasonable person should have seen this coming". But fact is, almost
> nobody foresaw it. We all knew housing was in a bubble in a handful
> of States, but not in your worst nightmares could you have foreseen
> the cascading effects this would have on the entire global economy.
>
>
> Guys, please keep this in mind when you wants heads to roll.

Jul 09 07:03 PM

[donzelion:]

"And it’s probably reasonable to assume that if the crime of bankslaughter had been on the books at the time, then maybe such a manager might have thought twice before rushing in to such markets."

Possibly, but I find it more likely that he would have thought twice before assuring shareholders and others that "everything was safe and contingencies were all in order."

The issue really comes down to one of trust: you would not trust your local used car salesman with your life savings, simply because he could show that he made a long set of good deals over the last five years. However, millions did trust bankers, even when their incentives were quite comparable.

Criminalizing betrayal of trust, under the correct circumstances, is part and parcel of all securities regulation: it is essential to the function of a legitimate market. "Over-deterring" betrayal would hardly constitute a major risk.

Jul 09 07:44 PM

[Moon Kil Woong:]

Greenspan issued garbage for 8 years talking about how the appreciation of the mortgage market was no threat, increasing property asset values had no negative impact, and prolonged low rates were not a big issue. In fact, thanks to his enouragement some economic pundits almost declared the end to the economic cycle. Nowadays I wonder if they meant a permanent Janese multi-decade long QE down cycle.

Jul 09 08:23 PM

[Yohei:]

Lots of people saw it coming. Warren Buffett, for one, said that "Derivatives are financial weapons of mass destruction." Bennett Sedacca at Minyanville held similar opinions; he saw that the CDOs were highly unsafe investments. Doug Noland at Prudent Bear has given exact analysis over the years of the continuing deterioration in credit quality.

Myself, when the Feds starting requiring banks to write bad mortgages and business loans for political reasons I thought it obvious that this trend continued long enough a blowup must result. Actually I was surprised at how long the blowup took to occur.

One of the only truly infinite things is the foolishness of humankind. As Shakespeare put it, "What fools these mortals be!"


On Jul 09 05:33 PM klarsolo wrote:

> You know, sometimes complex systems blow also up because of a huge
> multitude of reasons and uncalculatable, unprecedented feedback loops.
> It's not always a mountain of stupidity and criminal behavior. Tiny
> acts can huge effects.
>
> As with every black swan it is now easy to look back and say "Any
> reasonable person should have seen this coming". But fact is, almost
> nobody foresaw it. We all knew housing was in a bubble in a handful
> of States, but not in your worst nightmares could you have foreseen
> the cascading effects this would have on the entire global economy.
>
>
> Guys, please keep this in mind when you wants heads to roll.

Jul 09 09:06 PM

[klarsolo:]

I'm personally not aware of anybody who saw *this* epic mess coming (nutjobs and permabears excluded). A lot of people expected problems & blow ups (me included), but AFAIK nothing on this scale and this quick.

Buffet's warning is amusing when you consider that he didn't hesitate utilizing these WMD's himself. His long term short puts clearly indicate that even though he regarded derivatives as dangerous he did not expect the scope of the problem and the vicious feedback loops created by media enforced panic & pro-cyclical accounting rules.

I'm sure people expected problems along the lines of LTCM (bad enough), but not this towering Mount Everest of a sh*tshow that transpired last year.


On Jul 09 09:06 PM Yohei wrote:

> Lots of people saw it coming. Warren Buffett, for one, said that
> "Derivatives are financial weapons of mass destruction." Bennett
> Sedacca at Minyanville held similar opinions; he saw that the CDOs
> were highly unsafe investments. Doug Noland at Prudent Bear has
> given exact analysis over the years of the continuing deterioration
> in credit quality.
>
> Myself, when the Feds starting requiring banks to write bad mortgages
> and business loans for political reasons I thought it obvious that
> this trend continued long enough a blowup must result. Actually
> I was surprised at how long the blowup took to occur.
>
> One of the only truly infinite things is the foolishness of humankind.
> As Shakespeare put it, "What fools these mortals be!"

Jul 09 09:59 PM

[klarsolo:]

Absolutely, I agree. But every system will have flaws, just like every mathematical system will be incomplete. As you fix one flaw you open up the door for another. That's not to mean that you shouldn't do it, but to ever expect a flawless system is unrealistic. Also, the more you truncate the downside of a system, the more you shave off of the upside as well. The more regulation, the less creativity.

On Jul 09 07:03 PM kohalakid wrote:

> Yes, but sometimes flaws in a system are apparent. The Wall St Journal
> had been saying for over 5 years that Freddie and Fannie were too
> big, doing too much business that should be handled by the private
> sector and that the government enablers were blocking needed reform
> because of Freddie and Fannie lobbyist contributions.
>
> The WSJ was spot on well before the poop hit the fan.

Jul 09 10:11 PM

[kohalakid:]

The "flaw" was government intervention by Fannie and Freddie in a system that shouldn't have needed the government. I don't expect the private sector to be "flawless". Capitalism is all about the right to take risks and make mistakes. But Fannie and Freddie were in it for political goals, not reasonable economic purposes.

And we want the government to get involved in our health care????

YIKES!!!!

Jul 10 12:58 PM

[TinyTim:]

"who has essentially zero equity in being right. My job is to hold up my end of the conversation"

very sorry to hear you feel like you have no skin in the game.
I'll keep that in mind while reading future articles.

Jul 10 04:13 PM