Economic Donkeys

By Peter Boone and Simon Johnson

An edited and shorter version of this post appeared today in the Sunday Times (of London).

Early in the First World War, British generals decided to attack German trenches with an initial light bombardment, followed by infantry walking in close order across No Man’s Land. The result was tens of thousands killed in a series of military disasters, but the generals reacted with only small adjustments to their approach and essentially persisted in repeating the same mistakes for years. “The English soldiers fight like lions,” one German general remarked. “True. But don’t we know that they are lions led by donkeys?” was the reply.

Today, a year after global financial collapse and the ensuing tragedy for millions, our economic leaders are lining us up to suffer again (and again) through the same horrible experiences.

The collapse of Lehman Brothers in September 2008 demonstrated just how far our economic system in general and bank management in particular have gone awry. Lehman borrowed at low interest rates in global credit markets, and invested over half a trillion dollars of other people’s money in assets which, today, are worth next-to-nothing: failed ski hills in Montana, now empty suburban housing in California, and crazy bets on derivatives (options to buy or sell securities, in various complex combinations).

Worries about these failed investments sparked a run on the bank. And, after a mad weekend of trying to save Lehman, the U.S. “authorities” – meaning Henry Paulson (Secretary of the Treasury), Ben Bernanke (chairman of the Federal Reserve Board), and Timothy Geithner (President of the New York Fed) – decided to let it go bankrupt. Creditors, realizing no major bank is safe if our leaders might now let them fail, pulled cash from major financial institutions and bought relatively safe US Treasuries and UK Gilts.

Today Lehman’s senior debt trades at a mere 10 cents on the dollar, suggesting its $600 billion in assets were a mirage. This outcome is even more startling when compared to senior debt at Kazakhstan’s defaulting large banks, where management is now accused of serious malfeasance, yet that debt trades at 20 cents on the dollar – twice the price of Lehman’s debt.

At the G20 meeting of finance ministers last week, political leaders united behind two key steps which they claim will “prevent another Lehman”: tighter controls on the pay of executives and more capital for banks. France and Germany blame the crisis on lax regulation in Anglo-Saxon markets and excessive pay packets that encourage irresponsible risk taking. The British and Americans counter that European banks have too much debt (i.e., in the jargon, are “overly leveraged”), and need to raise more capital. The final communiqué proposes to do both, and we will hear more of the same at the upcoming G20 heads of government summit in Pittsburgh. But, in reality, both sides want only minor adjustments that cannot solve the real problems posed by our financial system.

Tim Geithner, now US Treasury Secretary, is pushing for higher capital requirements for banks, i.e., they need to have more shareholder funds to protect against future losses. But he surely knows that two weeks prior to its bankruptcy, Lehman’s management reported they were well-capitalized, with a tier one capital ratio of 11% — roughly twice what the United States currently considers is needed for a well-capitalized bank, and much higher than the American side is proposing in private conversations.

Christine Lagarde, France’s Finance Minister, and Angela Merkel, President of Germany, helped convince the G20 that bank compensation policies need to be amended to encourage long term incentives. They want compensation packages to be limited and bonuses to be locked up, so we can be sure employees’ incentives are consistent with the long term survival of their banks.

President Merkel and Minister Lagarde need to look no further than Lehman for a model of how to introduce a good policy to align incentives. The top management and many employees in the company were largely compensated in shares of the company which vested over many years, so when Lehman Brothers went down, it brought crashing down the lives and finances of its 20,000 employees. Dick Fuld, the highly compensated head of Lehman, lost many million dollars – and presumably a large part of his total wealth. Apart from criminal penalties (of the kind not seen for banking in a century), can we think of a better way of aligning incentives with the outcomes for a bank?

The real problem with our financial system is that our economic and political system work together to encourage excessive risk, and this risk in turn leads to cycles of prosperity and collapse. In 1998, a much smaller Lehman Brothers was placed in financial peril by the aftermath of the Asian financial crisis and failure of Long Term Capital Management, a major hedge fund. The Federal Reserve responded by lowering interest rates and other central banks followed suit. This reduced the cost of obtaining funds, effectively bailing out Lehman and other institutions in trouble.

As markets have grown to recognize how quick the Federal Reserve is to bail out institutions (and executives) in trouble, they naturally respond. In the 1990s, people talked about the “Greenspan Put” a term which derisively suggests that it is always safe to invest in risky assets, because the Federal Reserve is ready to bail out investors (a put is effectively a promise to buy an asset at a fixed price if you are unable to sell it to someone else at a higher price – this is a way to lock-in profits or limit losses on investments). However, in months following the collapse of Lehman, we learned that the “Bernanke Put” is even more valuable since Chairman Bernanke, alongside the Bank of England, the European Central Bank, and central banks in much of the rest of the world, is prepared to take drastic measures to prevent asset prices from falling when there are risks of global collapse.

This policy of responding to the aftermath of bubbles, rather than addressing them before they get going, through tighter regulation, has become the mantra of most central banks. It is usually combined with fiscal policy stimulus and other measures to support the economy. Each time banks fail, by bailing the system out again, we teach our finance sector a lesson: you can safely take too much risk because, when you lose, the taxpayer will pick up the bill. We also send a simple message to creditors: it is safe to lend to Goldman Sachs (GS), or Barclays Bank (BCS), because taxpayers and our nations’ savers are standing by to cover your losses. Rational bank executives and creditors respond as any person would: creditors lend to banks at low interest rates, and our banks gamble heavily hoping to make large profits. Such a system is destined to fail, but the party can run for a long time.

While Ben Bernanke has done a wonderful job of preventing financial meltdown, his calls in 2002-2003 for very low interest rates, without fixing our financial system, contributed to the credit expansion that led us into the current mess. In the United Kingdom, the Conservatives plan to transfer regulatory powers to the Bank of England, despite the fact that, like the Federal Reserve, the Bank of England has been a key component of our ever growing cycles of credit expansion and bust.

The “collapse or rescue” decision forced by Lehman’s failure is a symptom of a much larger systemic problem. We need leaders, both in the financial world and in public service who recognize that our financial sector too often causes social harm. There is no doubt that it also provides valuable services that are vital to the well-being of our pensioners and savers, and help manage and mitigate risk for our corporations. Yet too often these activities cause losses, which, either directly or indirectly, become a burden on the rest of society.

The pre-crisis activities and portfolios of Barclays, Goldman Sachs, and other “survivors” of this crisis were only slightly different from Lehman Brothers or Bear Stearns, which failed. The “good” banks also securitized subprime assets, helped build the intricate web of IOUs between banks and insurance companies, and leveraged their balance sheets to enormous levels. The winners were not better, they were just smart enough to make sure someone else held the bad assets when the music stopped, and they were powerful enough to win generous bailout packages from their governments.

The danger we face is that, by bailing out these institutions and rewarding failed managers with new powerful positions, we have now created a much more dangerous financial system. The politically well-connected, knowing they will most likely do fine in the next crisis, is now highly incentivized to take even greater risk.

Once we admit this profound problem in our system, we can begin to think of the radical measures needed to solve it. There is no doubt these solutions will include much greater capital requirements, so that bank shareholders know that they face substantial losses if their ventures fail.

But, we also need to ensure that our regulators are not captured by the banks that they are meant to oversee. This means we need to put checks on financial donations to political parties, and we need to buttress our regulators with more intellectual firepower and financial resources, along with rules that ensure independence, in order to be sure they can act in the interests of the broader population.

We also need to close the revolving door, through which politicians and regulators leave office to earn their nest eggs in finance, and “financial experts” move directly from failing banks to designing bailout packages. The conflicts of interest are abundant and most dangerous.

Last week the UK’s chief financial regulator, Adair Turner, faced heavy criticism from the City, Chancellor Darling, Boris Johnson, and editorials in the Financial Times and Wall Street Journal. His main offense was daring to raise the issue of whether parts of our financial system have become socially dysfunctional, in an interview with Prospect Magazine. He called for greater capital requirements at banks, and he pondered how it would be possible for regulators to preserve the valuable parts of our financial system, while ensuring that regulation limited the harmful parts. These are eminently sensible questions which anyone with a public spirit should understand are critical policy issues today.

Sadly, these public rebukes to Lord Turner are a further indication that very few of our leaders are prepared to even discuss the real problem, let alone seek a sufficient solution. Smart people and well-organized governments can, as in the past, behave like donkeys.

Comments

[Big Bubbette:]

Re-instate the Glass-Steagall Act which served us well since the 1930's until it was repealed in 1999. The repeal paved the way for the savings and investment banks to join and build the massive mortgage bundled derivatives. There are those in the government that say re-instating Glass-Steagall is not viable as these banks are now too big to separate. On the other hand, the Government say these same banks are too big to fail. Never too big to bail-out at taxpayer expense.

The 900 pound Gorilla in the room remains what to do with the trillions of toxic assets these banks still carry. If the banks are separated who carries the toxic load? Should they be shown the door to the bankruptcy court?

Sep 13 04:21 PM

[bob adamson:]

Boone and Jonson make a vital point well. The US and EU (particularly UK) investment banking sector is having severe difficulty identifying the dividing line between appropriate and dangerous risk taking in an economy marked by the twin information technology and globalization revolutions. Arguably, the challenge extends beyond the investment banking sector to include the consumer, manufacturing and other producer sectors of each national and the global economies. The challenge therefore is find ways to transform models for investment and consumer banks and banking, the private sector industrial corporation and the public sector institutions to both preserve the benefits of liberal democracy and the free market, on the one hand, and protect these from undue levels of inappropriate risk.

Undoubtedly others will advance arguments derived from a Libertarian or Austrian School perspective to the effect that the crisis we face built up because of government attempts, particularly since WW II, to limit risk in the economy. That argument is similar to that of professional foresters who now make an excellent case that 60 years of fire suppression in the west of the US and Canada (and undoubtedly elsewhere as well) simply made the forests more vulnerable to more severe fires (i.e. more frequent small fires periodically are natural and forests are healthier and safer for them). I acknowledge that a case can be made for extending this perspective to the current economic situation but I believe that the suggested cure would be even worse than the current problems. In short, it isn’t simply a matter of allowing creative destruction of inefficiencies to take their course (acknowledging that this would be especially harsh in the short term at present because of the accumulated problems from the past 70 or so years of risk suppression). Rather, the problem with this radical free market approach is that sufficient credit necessary to finance and manage a modern economy can not be mobilized and managed safely and efficiently if we revert to an idealized version of 19th century financial and industrial institutions. Clearly, however, the versions of Keynesian and Friedman monetary and fiscal policies employed heretofore since WW II are also inadequate and classic Marxism (even in a liberal democratic mode) is equally flawed. What therefore is to be done?

This is not the place for a lengthy proposal and analysis (nor do I claim to have some clear and detailed final answers). Here, however, is a brief bundle of suggestions that seem worthy of further development:
- The observation that the banking sector is comprised at its top by institutions (‘near banks’ as well as those formally recognized as banks) ‘too big to fail’ is not an excuse for simply accepting the need for periodic massive public bail-outs coupled with emergency but minimal tweaks to regulatory and capitalization rules. Such institutions are, because of their importance to society generally, more analogous to public utilities than a corporation of, say, $30, 000, 000 capitalization operating some restaurants. The comments of Boone and Jonson reflect this needed clarity of thinking but I would go somewhat further.
- The role of the business cycle has been undervalued for many years while the predominant view was that monetary or fiscal fine-tuning could do the job (take your pick of short term tools from the ‘bastardized Keynesian’ or the purported Friedman tool kit). Renewed interest in the driving function of uncertainty in the economy as seen by Minsky, Akeroff and others helps refocus our perspective.
- Private employers have been forced to take on too great a responsibility for provision for the health, development and retirement needs of their workforce. The public sector must therefore (in intelligent, effective and efficient ways) take back from employers a greater part of this load leaving corporations freer to focus on their primary business functions. In other words, the public sector needs to organize and finance health, pension, education and training and ancillary benefits to assist citizens generally to manage their personal needs and leave the private employers better able to finance and manage their production and sale of products more efficiently and effectively.
- The aggressive efforts of the past to move functions from the public sector to the private sector must be rethought. As suggested above, there are areas where the public sector can develop to the benefit of both the citizen and the private sector itself if only the question is looked at afresh without ideological blinkers. One important benefit of a larger but fine-tuned and well managed public sector would be that it will also serve as a counterweight in the national and regional economy to buffer the local economic disruption of recessions. In short, risk and an appropriate level of private sector ‘creative destruction’ is beneficial, but not general disruption and chaos attendant on a deflationary depression vortex, and a public sector functioning on a different growth and pause cycle than that applying to the private sector can moderate the boom/bust effect on the general society without unduly shielding private sector industries and companies from the need to be efficient and effective.

Sep 13 05:25 PM

[derryl:]

Keep pushing Simon. We're behind you.

Sep 13 05:35 PM

[Pat C:]

Thanks for the article and Bob Adamson, thanks for the excellent comment. My thoughts as well, creative destruction and capitalism is great for private industries that are competitive and in their early and midstage development. When industries become big and/or priviledged the needs of society as a whole need to come first. Shareholder and management expectations need to be adjusted accordingly.

Sep 13 06:48 PM

[untrusting ...:]

The largest shareholders are institutional investors such as pension funds, mutual funds, insurance companies, endowment funds, sovereign wealth funds, etc. They control the vast majority of shares and they rarely object to virtually anything the board or management put forward. In fact many of them are on the same gravy train of high compensation, big fees for assets under management, and many personal friends and associates in the larger finance industry. The "professional" compensation consultants that are frequently hired by public companies to attempt to justify big compensation awards, options, and golden parachutes, etc. are heavily biased towards giving management what they want, because management pays them. It really is similar to rating agencies and their bias towards rating junk securitized mortgages as AAA instead of DDD, because the issuer paid their ratings fees. Even the large public accounting firms are paid multi-million dollar annual fees by the large publiccompanies, and that has compromised their reporting for decades now as well. If you remember, Arthur Andersen-CPA's were a key reason for the massive fraud not being exposed in Enron and Worldcom until it basically was impossible to hide it anymore.

There are no easy answers to executive compensation, mainly because a tiny minority of people (be it management, large investors, politicans, or lobbyists) who benefit the most from it do not want to change the gravy train and they are the ones who get to make all the decisions.

On a more realistic level, probably the only truly effective method to deal with hugh compensation is to tax it away, but that too would be met with massive resistence from the tiny group of vested interests. Typically that is how the US dealt with high compensation from 1900-1985. If you check Federal Tax brackets from 1900 to present you will see that top tax brackets for both individuals and corporations have been dramatically reduced since the mid-80's.
Unlikely that this will happen anytime soon in the US, as the vested interests are simply too powerful to permit such to happen without a fight to the death.

On Sep 13 03:47 PM walleke wrote:

> Many of the problems are cause by a failure of corporate governance.
> Too often the CEO and chairman of the board of directors are one
> and the same person. The board is appointed and controlled by management.
> I believe it is contrary to fiducial responcibility to allow any
> member of management on the board.
>
> A board of directors should be adversarial to management. An adversarial
> board would not permit excessive pay - endemic across industries
> not just finance - and would not permit excessive risk. They would
> be our best regulators.

Sep 13 10:26 PM

[C.S. Jefferson:]

I like to say: Ride that donkey as people are kickin' and screamin' all the way up!


The more doubt and reason to invite shorts to the party is a continual catalyst to drive the markets higher.

We all know the macro-economic reality is still in crisis but the market can and will move much higher despite people screaming fire in a crowded theater.

My question is how are you going to trade it?

Remember: There is no "back up plan" in case the global financial markets collapse. This isn't about the fundamentals, it's about keeping the liquidity flowing to prevent another heart attack.

Sep 14 01:10 AM

[Moon Kil Woong:]

You are 100% correct to mention Lehman's capital ratio was 11% going into this. The problem is not just capital adequacy but the fact that the government has been allowing the watering down of strict accounting for banks for decades to the point their real assets are a pale reflection of their real value. This hasonly gotten worse with the suspension of mark to market in some instances.

We could say we set the groundwork for the derivatives meltdown by allowing off balance sheet accounting for banks after the 2001 meltdown. This only encouraged even further risk taking in derivatives. Rather than lessening risk it actually set the stage for CDS, CDO's and other derivatives to go from $1-2 trillion up to $400-500 trillion in a ten year period.

Now with the protection of AIG insurers are learning they can bundle and sell derivatives of life insurance risk. Not only is this a bit grim since you're betting for or against specific people dying (even though they are lumped in a collective pool) it is just one more example of unrestrained and unnecesary risk taking on the part of financial institutions wanting to turn and burn existing risk. In reality these derivatives are zero sum games. It is creating nothing socially beneficial save redistribution of money from suckers to con men and a faster rotation of theoretical gains and losses (gambling is the same and does the same thing).

If this is the way we build an economy no wonder ours is becoming such a mess. It's about time people figure out that we need productivity to increase our standard of living. Magic tricks and pick pocketers will never our economy better or more solid, even if the government pays some of the people spinning the illusions and reimburses some of those who lost their money.

Sep 14 01:50 AM

[tripleblack:]

Best, most common sense approach I have seen, and a simple regulation to write. Excellent!


On Sep 13 03:47 PM walleke wrote:

> Many of the problems are cause by a failure of corporate governance.
> Too often the CEO and chairman of the board of directors are one
> and the same person. The board is appointed and controlled by management.
> I believe it is contrary to fiducial responcibility to allow any
> member of management on the board.
>
> A board of directors should be adversarial to management. An adversarial
> board would not permit excessive pay - endemic across industries
> not just finance - and would not permit excessive risk. They would
> be our best regulators.

Sep 14 09:06 AM

[leonb105:]

Yeah . . . all of this would be fine if you could trust political institutions to act in the best interests of the people. Currently, it is not about helping people but more about accumulating power and maintaining it.


On Sep 13 05:25 PM bob adamson wrote:

> Boone and Jonson make a vital point well. The US and EU (particularly
> UK) investment banking sector is having severe difficulty identifying
> the dividing line between appropriate and dangerous risk taking in
> an economy marked by the twin information technology and globalization
> revolutions. Arguably, the challenge extends beyond the investment
> banking sector to include the consumer, manufacturing and other producer
> sectors of each national and the global economies. The challenge
> therefore is find ways to transform models for investment and consumer
> banks and banking, the private sector industrial corporation and
> the public sector institutions to both preserve the benefits of liberal
> democracy and the free market, on the one hand, and protect these
> from undue levels of inappropriate risk.
>
> Undoubtedly others will advance arguments derived from a Libertarian
> or Austrian School perspective to the effect that the crisis we face
> built up because of government attempts, particularly since WW II,
> to limit risk in the economy. That argument is similar to that of
> professional foresters who now make an excellent case that 60 years
> of fire suppression in the west of the US and Canada (and undoubtedly
> elsewhere as well) simply made the forests more vulnerable to more
> severe fires (i.e. more frequent small fires periodically are natural
> and forests are healthier and safer for them). I acknowledge that
> a case can be made for extending this perspective to the current
> economic situation but I believe that the suggested cure would be
> even worse than the current problems. In short, it isn’t simply
> a matter of allowing creative destruction of inefficiencies to take
> their course (acknowledging that this would be especially harsh in
> the short term at present because of the accumulated problems from
> the past 70 or so years of risk suppression). Rather, the problem
> with this radical free market approach is that sufficient credit
> necessary to finance and manage a modern economy can not be mobilized
> and managed safely and efficiently if we revert to an idealized version
> of 19th century financial and industrial institutions. Clearly,
> however, the versions of Keynesian and Friedman monetary and fiscal
> policies employed heretofore since WW II are also inadequate and
> classic Marxism (even in a liberal democratic mode) is equally flawed.
> What therefore is to be done?
>
> This is not the place for a lengthy proposal and analysis (nor do
> I claim to have some clear and detailed final answers). Here, however,
> is a brief bundle of suggestions that seem worthy of further development:
>
> - The observation that the banking sector is comprised at its top
> by institutions (‘near banks’ as well as those formally recognized
> as banks) ‘too big to fail’ is not an excuse for simply accepting
> the need for periodic massive public bail-outs coupled with emergency
> but minimal tweaks to regulatory and capitalization rules. Such institutions
> are, because of their importance to society generally, more analogous
> to public utilities than a corporation of, say, $30, 000, 000 capitalization
> operating some restaurants. The comments of Boone and Jonson reflect
> this needed clarity of thinking but I would go somewhat further.
>
> - The role of the business cycle has been undervalued for many years
> while the predominant view was that monetary or fiscal fine-tuning
> could do the job (take your pick of short term tools from the ‘bastardized
> Keynesian’ or the purported Friedman tool kit). Renewed interest
> in the driving function of uncertainty in the economy as seen by
> Minsky, Akeroff and others helps refocus our perspective.
> - Private employers have been forced to take on too great a responsibility
> for provision for the health, development and retirement needs of
> their workforce. The public sector must therefore (in intelligent,
> effective and efficient ways) take back from employers a greater
> part of this load leaving corporations freer to focus on their primary
> business functions. In other words, the public sector needs to organize
> and finance health, pension, education and training and ancillary
> benefits to assist citizens generally to manage their personal needs
> and leave the private employers better able to finance and manage
> their production and sale of products more efficiently and effectively.
>
> - The aggressive efforts of the past to move functions from the public
> sector to the private sector must be rethought. As suggested above,
> there are areas where the public sector can develop to the benefit
> of both the citizen and the private sector itself if only the question
> is looked at afresh without ideological blinkers. One important
> benefit of a larger but fine-tuned and well managed public sector
> would be that it will also serve as a counterweight in the national
> and regional economy to buffer the local economic disruption of recessions.
> In short, risk and an appropriate level of private sector ‘creative
> destruction’ is beneficial, but not general disruption and chaos
> attendant on a deflationary depression vortex, and a public sector
> functioning on a different growth and pause cycle than that applying
> to the private sector can moderate the boom/bust effect on the general
> society without unduly shielding private sector industries and companies
> from the need to be efficient and effective.

Sep 14 10:41 AM

[Harry Tuttle:]

The American banking system is designed to work for those who work in the industry an it serves its purpose well. As Madoff described in the recording made public last week, the regulators really hope to someday work for those whom they regulate because they pay better. This is NOT a recipe for strong regulation.

The fact that the majority of the population is fighting over Health Care reform while multiples are committed elsewhere shows the effectiveness of the financial lobby. In this sense, they are the best and the brightest which makes the rest of the taxpayers the worst and the dumbest.

We deserve what we get.

Sep 14 11:04 AM

[Jimbo:]

Both political parties have been co-opted and corrupted by the Bankster-Gangsters on Wall Street. When the repeal of Glass-Stegeall took place, I was alarmed. We need strict term limits in Congress to prevent career politicians being elected out of law school and then spending all their lives in Washington without a job in the economy.(see the biography of Senator Cox of Connecticut)

Sep 14 11:14 AM

[Andrew Butter:]

YOU HIT THE NAIL ON THE HEAD: "But he surely knows that two weeks prior to its bankruptcy, Lehman’s management reported they were well-capitalized, with a tier one capital ratio of 11%"

BUT: Then you lost it, the reason that they went bust was that their assets turned out to be worth a lot less than they were valued at. The reason no one knew that (possibly even their incompetent management (either they were lying or they were stupid - only two options), was that third parties were not provided access they needed to value those assets, they were obliged to "trust" the bank, the rating agencies, the auditors, the SEC and other "gatekeepers".

So counter-parties, shareholders, stakeholders (the government) were not given the information they needed to make informed and rational decisions, that's how bubbles are created.

seekingalpha.com/artic...

That policy continues today, for example whilst it is perfectly easy to value a CMBS and a MBS properly (not from the AXA exchange or a CDS, and TARP and PPIP are still trying to figure it out, but that does not mean its hard), the problem is that information to do that is not available to investors and market participants.

seekingalpha.com/artic...

For example the "value" of MBS held by FDIC insured banks went UP from Q2 2008 to Q2 2009. That makes no sense, but can anyone get information on the actual value of what they are declaring as an asset ($1.3 trillion - about what their equity is), NO WAY.

So nothing changed.

Fix that, allow investors and counter parties to check if they are being lied to (accidentally or on purpose) and this all goes away, keep secrets and it will be one big surprise after another.

seekingalpha.com/artic...

One other thing:

RE: While Ben Bernanke has done a wonderful job of preventing financial meltdown, his calls in 2002-2003 for very low interest rates, without fixing our financial system, contributed to the credit expansion that led us into the current mess.

The mistake that Bernake made and so did Greenspan was not to realize how inflationary the $17 trillion of liquidity that was pumped into the economy over five years, and how THAT was creating a bubble.

Sep 14 11:20 AM

[axelrod608:]

Excellent article. SA has been running some truly extraordinary pieces this week. with Mauldin and Lounsbury over the weekend. Kudos.

Another reason for capitalization dysfunction is that it is computed against the balance sheet, yet these megabanks hold portfolios of tier 2 and 3 "assets" off the balance sheet. Until and unless ALL assets are on the balance sheet, we will continue to have megabank accounting that is little more than smoke and mirrors.

Transparency should be a prerequisite for any financial entity.

Sep 14 01:16 PM

[kmf:]

Wonderful article!
It's almost 1 year since the meltdown of our credit system. Now what has been done about the problems? Nothing! Lots of possible solutions, lots of arguments about what should be done, lots of analysis of what caused it ( like this article), but nothing to help the situation. Does this tell you something?

Sep 14 01:26 PM

[HBWOW:]

One year since the meltdown and still the same people who largely
caused the problem ARE STILL IN CHARGE, ie in the financial institutions and government. Greed and lust for power/control by a small group has brought this great country to its knees and the worst
is yet to come. Yes, financial terrorists do exist.

Sep 14 02:17 PM

[Steve Owen:]

Once again, you have hit the nail on the head. Econ 101: If you want more of something, subsidize it. Apparently we want more bad behavior from our banks.


On Sep 14 01:50 AM Moon Kil Woong wrote:

> You are 100% correct to mention Lehman's capital ratio was 11% going
> into this. The problem is not just capital adequacy but the fact
> that the government has been allowing the watering down of strict
> accounting for banks for decades to the point their real assets are
> a pale reflection of their real value. This hasonly gotten worse
> with the suspension of mark to market in some instances.
>
> We could say we set the groundwork for the derivatives meltdown by
> allowing off balance sheet accounting for banks after the 2001 meltdown.
> This only encouraged even further risk taking in derivatives. Rather
> than lessening risk it actually set the stage for CDS, CDO's and
> other derivatives to go from $1-2 trillion up to $400-500 trillion
> in a ten year period.
>
> Now with the protection of AIG insurers are learning they can bundle
> and sell derivatives of life insurance risk. Not only is this a bit
> grim since you're betting for or against specific people dying (even
> though they are lumped in a collective pool) it is just one more
> example of unrestrained and unnecesary risk taking on the part of
> financial institutions wanting to turn and burn existing risk. In
> reality these derivatives are zero sum games. It is creating nothing
> socially beneficial save redistribution of money from suckers to
> con men and a faster rotation of theoretical gains and losses (gambling
> is the same and does the same thing).
>
> If this is the way we build an economy no wonder ours is becoming
> such a mess. It's about time people figure out that we need productivity
> to increase our standard of living. Magic tricks and pick pocketers
> will never our economy better or more solid, even if the government
> pays some of the people spinning the illusions and reimburses some
> of those who lost their money.

Sep 14 02:35 PM

[jimmy46:]

Today Lehman’s senior debt trades at a mere 10 cents on the dollar, suggesting its $600 billion in assets were a mirage""""""

YOU DON'T SEEM TO UNDERSTAND THAT BANKRUPTCY COURTS TREAT DIFFERENT ASSET CLASSES DIFFERENTLY.

SOME PEOPLE GET 100¢ ON THE DOLLAR,
OTHERS 50¢
OTHERS 10¢
AND SOME NOTHING.

LEH BONDS RANK NEAR THE BOTTOM.

Sep 14 03:04 PM

[Plant the s...:]

Lehmann did sell most of its valuable assets broker dealers in the immediate aftermath to Barclays.

No question that changing the duration of incentives is necessary. It is much more easier to create short term results (< 1 year) but it takes a strategy, operational strategy and real ability to generate 3, 5 year returns. Tying compensation to extended duration will also make the clawbacks unnecessary, since the bonus are based on longer term outcomes.

Sep 14 06:08 PM

[MSimon:]

The conceit that Chinese bankers are more honest or not beholden to special interests is laughable.

Sep 15 06:35 PM

[alajac:]

"Regulation" is how the spider gets the fly to sit down and get comfortable. The problem is the system rewards greed, avarice, and short-term risk-taking. If EVERY stock market transaction had a half-percent "infrastructure maintenance fee" automatically deducted (like the old brokerage fees were) in place of capital gains taxation, how many nano-second long trades would be put on?

HOW TO FIX THE ECONOMY (abridged version):

First, a commonsense definition of "government":
Government: "One or more persons who claim natural resources, are willing and able to defend their claim on those resources, and make and enforce decisions regarding the allocation of those resources."

1. Every government is the "de facto" owner of everything (including EVERYONE) within its domain; governments create "de jure" ownership in order to get resources into the hands they believe will be most productive and thus most conducive to the government's prosperity and longevity. Ever since the invention of the guillotine, government administrators have stopped claiming ownership of everyone and everything within the government's domain, but continue to act as if the ownership is a fact concerning which, like "Santa's secret identity", every mature adult is (or certainly should be) aware.

2. Regardless of who administers a government, the actual government (and, consequently, the actual owners of everything within the government's domain) is whomever the administrators SERVE (in the current instance, "a bunch of rich guys that own a bunch of banks and stuff").

3. In order to obtain ownership of the government (and thus, of ourselves) we need to get the government to serve our needs, first and foremost. And the first thing we will need to do towards that end (after we have taken over the administration of the government) is to replace Federal Reserve money with our own, backed by all the wealth within the government's domain (of which the government is the de facto owner).

4. Our first and pretty much only need (once the inequities created by the bankster regime are redressed) is for suitable compensation for government's impairment of everyone's right to free access to all land (see Paine's "Agrarian Justice" plan for cogent argumentation). All other forms of corporate and personal welfare and subsidies and free market interference need to be ended or phased out. No FDA or other corporate protection schemes, no Minimum Wage laws, etc.

[Before the "Cybernetic Revolution" began destroying most of the rest of the need for human labor that the Industrial Revolution missed, the "job system" of economic resource distribution (along with some Lockian BS) was adequate to mask the inequity of governments taking away everyone's right to free access to all land (an impairment that ALWAYS puts the capital-poorer at a bargaining disadvantage: due to the physical needs of human bodies, whoever has more capital is always further from homelessness and starvation, and thus always has a bargaining advantage over someone closer to homelessness or starvation who MUST, at some point, accept inadequate wages or else lose their home or starve to death), but now, like a runner who had a bad heart all along that didn't stop him until the final mile of the marathon, we find ourselves the possessors of a "bad economic resource distribution system". If we replace that inadequate economic resource distribution system with one that pumps out the same amount of economic resource "blood" to every "cell" (legal resident) and then lets those cells work and save or slack and waste as they will (in other words "pursue happiness" in whatever way they choose), we can create a totally stable economic system with no more "booms and busts", much less poverty and crime, no more "homeless vets", MUCH less excuse for government in general, etc.. The plan suggests impairment compensation of at least $1000 per month per legal resident (compensation for minors to be placed "in trust"); since everyone gets the same compensation there is no "redistribution" involved. Just to make sure we are clear: people will be free to work as hard as they like and make as much money as they like and spend it any way they like.]

5. All federal income-based taxation is to be replaced (ending the IRS's reign of terror) by a small, flat "infrastructure maintenance fee" on all electronic debit transactions, whatever is necessary (certainly less than one percent) to keep prices stable (keeping gold at a fixed price could be used as a measure). If you take out of a system (in a given time period) as much as you put in, there can be no inflation. The "infrastructure maintenance fee" (being charged as funds are spent) is directly related to "benefits already received", unlike the highly regressive federal income tax which charges kids just out of school a greater percentage of their accumulated wealth than many of the seriously rich and certainly all of the biggest corporations.

6. There should be one set of laws that applies to everyone equally: everybody gets the same, everybody pays the same, no special treatment for anyone.

Sep 16 12:23 PM