Too Big to Fail Banks: A Simple Solution 40 comments
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One of the unfortunate corollaries to my enforced absence from regular blogging has been little time to carefully follow the threads of discussion on various topics among the blogs. Curiously, I find that when I do have time to devote to a bit of reading, much of the discussion has changed very little.
A case in point is banks and the “Too Big To Fail” issue. Reading a couple articles today I was struck by how much the discussion seems to be mired in the same old arguments. Though it’s well written and contains some highly pertinent comments, an article that appeared in Clusterstock today by Henry Liu illustrates the point.
Mr. Liu does an admirable job of noting that the crisis has actually enhanced the market power of TBTF banks and opines, properly I think, that the various schemes being floated about to address the problem fall short of what is most likely needed.
Unfortunately, he doesn’t propose anything concrete as a solution, preferring to talk about the need for firebreaks and the necessity of stemming systemic contagion. I suspect he has some ideas about how to do that and I also suspect that they are going to sound an awful lot like the other technocratic proposals to solve the problem.
There is no dearth of that sort of thinking about. From debt securities that convert to equity in the event of a firestorm, to taxes on financial transactions, to breaking up the banks, to elaborate plans for super-regulators and higher capital standards for TBTF fail banks or those that engage in casino banking we are not at a loss for ideas. And as each has been advanced we have also not been short of pundits who point out the obvious flaws in the proposals.
The very real fact is that the more you try and impose a complex regulatory framework on a complex financial system, the more likely it becomes that those regulated will find a way around the rules. Complexity tends to breed loopholes and lawyers tend to be quite adept at discovering them and developing means of avoidance. Moreover, time tends to favor the regulated as they know very well how to chip away at the ties that bind them and regulators and politicians quickly lose the missionary zeal that prompted them to rein in their friends.
Given all of this, I find myself more and more drawn to a proposal from John Hempton. It’s simple, has been proven to work in the real world and probably has as good or better a chance of being enacted as anything else floating about.
His idea is to copy the Australian and Canadian banking systems. Make the banks big, profitable and boring. Regulate the hell out of them but leave them fat and rich. A quick look at both countries and the way they have fared in this meltdown provides a pretty good argument for similar banking systems. Neither has seen any sort of real crisis in their systems and their economies have largely been spared the slings and arrows that those of the U.S. and Europe have endured.
Will it happen? Most certainly not, just as any other sort of reform is not going to come to pass. Lots of new rules and probably some sort of new regime that involves those technocratic solutions so beloved by bureaucrats will no doubt be visited upon the banks. The banks will make the appropriate noises about free markets and then set to work finding their way around roadblocks standing between them and profit. Much will be written and spoken about the new world and little will have changed.
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This article has 40 comments:
Congress is very busy at present setting up the smoke and mirrors along with the guilty TBF's in preparations for the great "Disappearing Dollar" magic trick.
Now all we need is an intelligent voting populace. Simple.
The only foolproof way is break them into pieces small enough to fail and them let'em. No ineffective regulators involved !
The extremely watered-down "reforms" currently before the U.S. Congress are completely bogged-down - due to INTENSE opposition from the oligarchs' political servants.
The problem which exists is the oligarchies, themselves. We have known since the days of Adam Smith that this day was coming. At one TIME, the U.S. government rigorously prevented the CREATION of oligarchies. Sadly, as the corporate oligarchies have grown (and grown in power) anti-combines enforcement (and prevention) has virtually ceased to exist.
Removing oligarchs from power (through breaking up the oligarchies) is an incredibly difficult task. However, it is 100% necessary - and the only way this problem will EVER be dealt with is through the support of an overwhelming majority.
It is thus of critical importance for commentators to explicitly name breaking up these oligarchies as the #1 priority of the American people - ahead of (literally) everything else.
1. The US and UK are pre-eminent global investment banking centre and Australia and Canada are not, and
2. The role of risk in investment banking is different than in other banking roles.
Arguably in the modern world the pre-eminent global investment banking centres are comprised of banks, hedged funds and other ‘near banks’ and insurance bodies to back-stop investment banking. The focus of investment banking is properly on accepting and managing risk of a nature and extent that is very different than what is acceptable for the other, properly ‘boring, banking functions.
Can’t a good case not therefore be made that the following needs to be done?
1. The first need is to decide to segregate ‘boring banking’ from investment banking by creating a modern version of Glass-Steagall.
2. A regulatory and governance framework analogous to those in Canada and Australia should be created for boring banks.
3. The US and UK (and other significant global investment centres) should in consultation devise a regulatory and governance framework for the banks, hedged funds and other ‘near banks’ dedicated to investment banking and for insurance bodies that back-stop investment banking. This framework needs to encompass the facts that (a) globalization and information technology have both increased the possibility that unforeseen risk will arise and the means for its better management, (b) it is often difficult and unnecessary to distinguish banks, hedged funds and other ‘near banks’ dedicated to investment banking from each other by role or function and therefore the new framework needs to cover them all, and (c) given the nature and extent of risk involved, the fact that a banks hedged fund or other near bank dedicated to investment banking or one of their insurers becomes insolvent can not be allowed to endanger the solvency or ongoing functioning of the system generally.
It might be argued that the demarcation line between investment banking and boring banking isn’t as clear as the forgoing implies. This is true and it follows that the modern version of Glass-Steagall alluded to above should therefore forbid banks that assume specified classes of investment risk to engage in boring banking and require that they be registered within the investment banking regime described above.
No doubt you and other commentators can improve on the forgoing suggestions but my basic point is that investment banking is unique and requires segregation and unique forms of regulation and governance.
Second, then throw them in prison for 20 years.
Third, then your solution should be given a try.
Of course the banks are not too big to fail - they are failing. There isn't enough money to bailout Buffet's economic weapons of mass destruction! And there is no reason that the society won't implode around them.
Want to see where this ends up? Look at the kleptocracies in Africa.
This is the Social Hazard, see seekingalpha.com/insta....
Glass Steagall should be reinstated.
Regulation should focus on leverage.
In general, leverage ratios should be set with a view, not of risk, which gets confused with market fluctuation, but the CONSEQUENCES of failure; i.e. not IF this deal goes bad, but what if this deal DOES go really bad?
The more that there is ANY implicit or explicit government support, the lower the leverage ratio.
So, any bank offering FDIC insurance should have very low leverage ratios. Any financial institution that has had any access to the Fed lending facilities should have low leverage ratios.
Goldman and Morgan Stanley have commercial banking subsidiaries.
They should be divested immediately. However, higher leverage ratios should be allowed, and the primary regulation should be that the I-Banks are required to mark to market daily.
On Nov 11 01:49 AM bob adamson wrote:
> Mr. Lindmark, there are two significant factors that your article
> does not fully address:
> 1. The US and UK are pre-eminent global investment banking centre
> and Australia and Canada are not, and
> 2. The role of risk in investment banking is different than in other
> banking roles.
> Arguably in the modern world the pre-eminent global investment banking
> centres are comprised of banks, hedged funds and other ‘near banks’
> and insurance bodies to back-stop investment banking. The focus of
> investment banking is properly on accepting and managing risk of
> a nature and extent that is very different than what is acceptable
> for the other, properly ‘boring, banking functions.
>
> Can’t a good case not therefore be made that the following needs
> to be done?
> 1. The first need is to decide to segregate ‘boring banking’ from
> investment banking by creating a modern version of Glass-Steagall.
>
> 2. A regulatory and governance framework analogous to those in Canada
> and Australia should be created for boring banks.
> 3. The US and UK (and other significant global investment centres)
> should in consultation devise a regulatory and governance framework
> for the banks, hedged funds and other ‘near banks’ dedicated to investment
> banking and for insurance bodies that back-stop investment banking.
> This framework needs to encompass the facts that (a) globalization
> and information technology have both increased the possibility that
> unforeseen risk will arise and the means for its better management,
> (b) it is often difficult and unnecessary to distinguish banks, hedged
> funds and other ‘near banks’ dedicated to investment banking from
> each other by role or function and therefore the new framework needs
> to cover them all, and (c) given the nature and extent of risk involved,
> the fact that a banks hedged fund or other near bank dedicated to
> investment banking or one of their insurers becomes insolvent can
> not be allowed to endanger the solvency or ongoing functioning of
> the system generally.
>
> It might be argued that the demarcation line between investment banking
> and boring banking isn’t as clear as the forgoing implies. This is
> true and it follows that the modern version of Glass-Steagall alluded
> to above should therefore forbid banks that assume specified classes
> of investment risk to engage in boring banking and require that they
> be registered within the investment banking regime described above.
>
>
> No doubt you and other commentators can improve on the forgoing suggestions
> but my basic point is that investment banking is unique and requires
> segregation and unique forms of regulation and governance.
The simple solution... Let them fail.
On Nov 10 11:37 AM Anthony Alfidi wrote:
> The TBTFs will survive as long as they contribute campaign cash.
> Perhaps credit unions and community banks should step up their own
> giving so they get a seat at the table should a big bank need to
> be wound down and sold off.
When Congress passed many banking regulations in the 1930s, such as the vaulted Glass Steagall Act, the intelligensa of Congress in the 1990s deemed it an unnecessary impediment to banking and revoked it and called it 'Market Reform'. Since that time, our banking industry, the cornerstone of the American economy, has become more and more susceptible to swings and almost completely fell apart last year and would have if not for vast infusions of taxpayer money to prop up a broken system.
Isn't it time that Glass Steagall be re-enacted as well as other reforms which will lead to a more stable banking sector?
The problem as I see it is that Congress and the Financial Sector over-estimate their intelligence and under-estimate their ignorance and greed.
Without effective leadership, and there hasn't been any for almost 40 years, the USA is doomed to failure. The failure of Congress to put the needs of America first despite the harm it may cause to themselves will lead to a Third World America.
Whether we like it or not our country is quickly headed there and it's time for people to acknowledge reality and do something about it.
with the wild west casino personality traits that we see in the megabanks today i don't see much possibility of grafting the canadian banking system principles onto the u.s.a banking system.
i'm all for credit unions & community banks, however the community banks keep getting taken over by the voracious megas.
> jack
Consider for example, the current income tax system. Income tax law that is thousands of pages long imposes massive costs for compliance. It skews investments, opens massive opportunities for fraud and abuse, and ties up hundreds of thousands of people in both the public and private sector labor forces in non-wealth producing work. The current tax gap alone is $290B according to the IRS.
Clearly, the compliance costs for Medicare/Medicaid and Social Security are similarly distorted by the ridiculous complexity of the underlying legislation and thousand plus page Obamacare does not promise to improve the situation.
To Congress and the bureaucrats these costs are simply irrelevant – personal power and money are everything.
While I agree that banks should be banks, not casinos for wannabe "Masters of the Universe" the disparity in economic focus between Canada, Australia, and the U.S. changes the playing field in such a way that a direct comparison between their banking systems and ours doesn't adequately address the underlying problems......
and......as a few others have said......you still have the lawyers......
And Canada and Australia also prove that vigorous regulation of banking keeps bankers from destroying the landscape.
What else is there to prove?
The idea that huge amounts of money at zero interest is a LOAN is ludicrous. Call it what it really is - these are GIFTS. And the average fifth grader could make profits on free money.
The US federal government is the poster child for "too big to fail". Run by idiots whose financial plan is to spend 50% more than their income FOREVER. Is it any wonder they're pumping free money into megabanks ?? And people wonder why gold and other commodities is where the smart money is going...
EVERY empire in history has failed. This one will too. It's only a matter of time.
Unchangable humans and variations on the above theme will go on until we cannot sustain it and are no more. Many "lesser" humans do not possess this ultimately self defeating behavior, but not enough of them to change our destiny as these have little power, but all of the rich and powerful decision-makers everywhere are of this ilk, so due to them we as a species are approaching the end of our tenure because those who are that way have to win everything and care nothing about those who cannot or will not compete with them for all the riches.
See Goldman Sachs and Washington DC et al for proof of this.
Get TR's Big Stick out of the back of the closet and dust it off?
On Nov 11 01:49 AM bob adamson wrote:
> Mr. Lindmark, there are two significant factors that your article
> does not fully address:
> 1. The US and UK are pre-eminent global investment banking centre
> and Australia and Canada are not, and
> 2. The role of risk in investment banking is different than in other
> banking roles.
> Arguably in the modern world the pre-eminent global investment banking
> centres are comprised of banks, hedged funds and other ‘near banks’
> and insurance bodies to back-stop investment banking. The focus of
> investment banking is properly on accepting and managing risk of
> a nature and extent that is very different than what is acceptable
> for the other, properly ‘boring, banking functions.
>
> Can’t a good case not therefore be made that the following needs
> to be done?
> 1. The first need is to decide to segregate ‘boring banking’ from
> investment banking by creating a modern version of Glass-Steagall.
>
> 2. A regulatory and governance framework analogous to those in Canada
> and Australia should be created for boring banks.
> 3. The US and UK (and other significant global investment centres)
> should in consultation devise a regulatory and governance framework
> for the banks, hedged funds and other ‘near banks’ dedicated to investment
> banking and for insurance bodies that back-stop investment banking.
> This framework needs to encompass the facts that (a) globalization
> and information technology have both increased the possibility that
> unforeseen risk will arise and the means for its better management,
> (b) it is often difficult and unnecessary to distinguish banks, hedged
> funds and other ‘near banks’ dedicated to investment banking from
> each other by role or function and therefore the new framework needs
> to cover them all, and (c) given the nature and extent of risk involved,
> the fact that a banks hedged fund or other near bank dedicated to
> investment banking or one of their insurers becomes insolvent can
> not be allowed to endanger the solvency or ongoing functioning of
> the system generally.
>
> It might be argued that the demarcation line between investment banking
> and boring banking isn’t as clear as the forgoing implies. This is
> true and it follows that the modern version of Glass-Steagall alluded
> to above should therefore forbid banks that assume specified classes
> of investment risk to engage in boring banking and require that they
> be registered within the investment banking regime described above.
>
>
> No doubt you and other commentators can improve on the forgoing suggestions
> but my basic point is that investment banking is unique and requires
> segregation and unique forms of regulation and governance.
www.econtalk.org/archi...
Does anyone remember the law -- there are clear definitions of bankruptcy and ALL the TBTF banks meet every single standard.
Sorry all you shareholders and Executives, but it is time for some severe pruning to strengthen the core plant. LET THEM FAIL - they are simply too big NOT to.
Yes, it will be tough, but we will rapidly rebound and more importantly have the opportunity to simply set up the new systems based on sustainability -- not just quarterly profits.
Does anyone else see that it is time to say NO! and inclue the N in NTBTF?
The TBTF mentality of the last year has led to increased concentration of financial power, at exactly the time we should have been dispersing power. Why have the government hand Bear Stearns resources to Chase? Why hand Merrill Lynch to B of A? Why Not let other firms bid for those resources, so those resources might be allocated to the best team?
Require all financial institutions to be transparent to rating agencies.
Federal regulators should audit those agencies vigorously, and if there any clouding of the picture, enforce enforce extreme criminal penalties.
Let everybody know that everybody else can fail. So, if you depend on them, if you are interconnected with them, they can take you down with them. So protect yourself accordingly.
Does anybody really believe that AIG would be at $36 if they were not a government guaranteed firm?
Please visit my blog on this issue. Comments on the blog most welcome. libertythruknowledge.com
N2keco@bellsouth.net
n2kecosystems.com/
Author of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System”
w-apublishing.com/Shop...
Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
readingthemarkets.blog...
If there is complexity, there is uncertainty. Capital market governance requires moving beyond risk management to randomness metrics. Legacy, one-size-fits-all deterministic metrics create errors of conflation causing larger and more frequent economic dislocations.
Solution? Segment market to govern randomness.
• Predictable: (GSA) money market (break-the-buck)
• Probable: (33-34 Act) earnings-driven issuers
• Uncertain: Entrepreneurial Exchange for event-driven issuers
“Small is Beautiful”, The National Interest, Fall 2004. www.findarticles.com/p...
Illustration
If Citigroup’s one-size-fits-all financial supermarket did not provide a net benefit, why does the SEC try to govern with a one-size-fits-all regulatory regime? If you can’t cross-sell and you can’t cross-regulate due to non-correlative information. It is like trying to have one driving manual for US and UK.
Stephen A. Boyko
803-644-7295
N2keco@bellsouth.net
n2kecosystems.com/
Author of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System”
w-apublishing.com/Shop...
Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
readingthemarkets.blog...
There is no reason to go beyond that statement.
The answer is simple...just cut up these giants.
Then their failure would not comprise devastation
on national economies.
Just no need to agonize over some expensive, convoluted and complex maze of laws and regulations.
On Nov 10 11:08 AM fizzicyst wrote:
> Not simple and not effective enough. You just gave the reasons why:
> lawyers/loopholes.
>
> The only foolproof way is break them into pieces small enough to
> fail and them let'em. No ineffective regulators involved !
Break them up!.
We did that to the oil trusts, and the industry far from died. It has in fact it flourished these last hundred years. As somebody already pointed out above, the regulations are too easy to get around. Besides, we are already over-regulated.
You'll be interested to read that Credit Unions are also a large and vigourous factor in the banking scene in most Canadian Provinces. Credit Unions are seen by many Canadians as a more community supportive and Member friendly but also sound alternative to the Banks. While the Banks are Federally chartered and regulated the Credit Unions are incorporated and regulated in each Province under Provincial statutes. Credit Union Member deposits are insured; in British Columbia where I live the full amount of a Member's deposits without limit are so insured by the BC Government. A significant portion of the mortgage and consumer credit lending in most Provinces is through Credit Unions.
bob adamson
On Nov 11 09:56 AM john s. gordon wrote:
> it is encouraging that the canadian banks are run by responsible
> law-abiding people.
> with the wild west casino personality traits that we see in the megabanks
> today i don't see much possibility of grafting the canadian banking
> system principles onto the u.s.a banking system.
> i'm all for credit unions & community banks, however the community
> banks keep getting taken over by the voracious megas.
Expecting big banks to share with depositors isn't logical, so there will not be competitive pressure, and both depositors and borrowers will get stung, more punishment of the less advantaged to pay bonuses to people CEO's like to call talent (if you think of it in relationship to Hollywood and fantasyland, that is kind of how it works).
Liquidating Freddie and Fannie could send some paper back to local solvent banks and credit unions in return for the payments to cover the failures. Maybe this would help to keep solvent ones from going out because they can't predict budgets, what with being held up for unpredictable amounts by the Feds or even by local robbers.
As for the big banks, as long as the CEO's maintain enough slush to support the protection racket (Congress and the Executive Branch), then it seems to be pretty much a closed loop, except that some of the big banks have investments in cities and companies that could bust if the little guys can't or won't buy stuff the companies and cities are counting on them to buy.
The timing of the shake-outs is what is hard to predict.
In the meantime, the foot soldiers of Empire are checking out, one way or another, so that loop is in some doubt as well. This is the saddest loop of all. Surely this would give the bonus brothers pause if they had eyes to see and hearts to feel with.
And then there are the drones, and I hear the latest weapons are called killer bees, to fuel war forever, unless the protection loop breaks and some perps do some walking.
What they will do at that point is to break themselves up into banks that are no longer too big to fail.
Solved that one.
Next problem; housing recovery.
Solution, stop Freddie and Fannie from lending for houses built after 2009. Private lenders can service the housing market. More money for private lenders, less construction of new homes.
Solved another one.
On Nov 12 06:02 PM whack'em wrote:
> the solution is very simple; re-instate the Glass Steagal Act in
> it's entirety. the second part is harder- throw all the incumbents
> in the House and Senate out and allow only public financing of elections;
> no PACS, no campaign contributions. take a page from the brits-
> 90 days in which to campaign, then hold elections.