John Lounsbury

More Goldman Outrage

Janet Takavoli has a clear opinion that Viniar was lying pragcap.com/goldmans-l...

ING Shows How Bank Dismemberment Is Done

DonFurio - - -

I am pleased you have apparently acquired great wealth. Congratulations. Perhaps you will come back frequently and share your wisdom with those less fortunate.

ING Shows How Bank Dismemberment Is Done

DonFurio - - -

Thanks for your informed and respectful comment.

ING Shows How Bank Dismemberment Is Done

Glenn Hall, Edtor-in-Chief of TheStreet .com, has an article this morning about the fading expectation for bank reform (www.thestreet.com/stor... )

Ultimately, Who Benefits from Too-Big-To-Fail

Amit - - -Great article.

You gave an example:"...offers to "help" its issuing client by doing a bought deal, assuming the nonexistent underwriting risk by offering to give Company X IPO proceeds priced at $47 per share. Due to information asymmetry, Company X accepts this while the bank can now sell those shares to its institutional clients for perhaps $52 per share, pocketing a nice spread. In this instance both customers of the bank lose out."

This is standard operating procedure. This could not happen in a truly competitive environment. The spreads would be squeezed if all IPO transactions by the underwriter faced competition from other financial intermediaries. The underwriter should be guaranteed a small commission of 2-3% (that would be $1 to $1.50 in this case) and that cost would be shared by seller and buyer. With competition, the $5 spread illustrated might be no more than an average of $1. More important than the reduced cost (by about 1/2 in this example) would be the increased free market transparency of the entire transaction.

Of course, the argument will be made that we have reduced the compensation that the underwriter needs to motivate assumption of underwriting risk. I answer that with one question: How many underwritings have ever lost money? I have not done the research, but I expect it is a very small percentage. How about a guess of less than 1%? Someone who is more knowledgeable is welcome to provide a more correct number.

What will happen in my scenario is that billions of dollars that accrue annually to investment banks will, instead remain in what I call "the productive economy". The giant sucking sound I hear (does anyone else hear it?) will be diminished as money that has been removed from the production of goods and services by outsized bank profits (more than 40% of S&P 500 earnings at times in this decade) remain in the rest of the economy.

Imagine if the average compensation of the 20,000 plus Goldman Sachs employees would decline from more than $600,000 each to something only two or three times the national average. That would be in the range of $150,000 to $200,000 plus or minus. Would that be inadequate compensation for the value they add to the economic system? If 10% of the leaders in Goldman Sachs made over $1,000,000 each annually would that be under compensation for the value they add to the financial system? If 1% made over $5 million, would that be under compensation? It might be argued the numbers I quote still could be over compensation. But at least they would be closer to "earned" compensation. I say earned to mean compensation for value added to the financial system rather than value added to their bank accounts.

Goldman Sachs employees are being paid like athletes who have a very short viable career. And many Sachs employees do indeed act like athletes in terms of how long they stay with the firm. Some have a short (10-20 year) career and then "take the money and run" to other careers. Unlike athletes, whose careers are limited by injury and fading ability, the short careers at Goldman are by choice. Some go into politics, other government related positions and second career activities doing something they love. A spokesman for the firm would call this giving back. See www.bloomberg.com/apps...;sid=a8upOpH5Q3Tw . I would call it "taking more". In some cases more good results from the new "taking" than the original, but, in the case of government service, that can be debated. The questions about Paulson's lingering connections to Goldman Sachs are an example. See Felix Salmon's piece seekingalpha.com/artic... .

The arguments about the value of oligarchy are largely self serving. Once you create a monopoly, of course that monopoly and their accomplices will argue that disruption would be dangerous. They are entirely correct – it would be dangerous for them. What about the other 99% + of us? In your concluding statement, you state, “…it appears that preserving these types of institutions is the real economic risk.” Point, set, match.

Wasted Lessons from AIG

rockrimmon, wakeup call, User 501173 - - -

Ignore Reggie's analysis at your peril. The first time I read a Middleton post here I left a comment suggesting better proof reading. After looking further into what he has done, I wished I hadn't left that first comment. I know a lot of people who have written well polished articles that could help you go broke.

Mixed Outlook for Banks and Financials

The copy of this article on my Instablog has links to four earlier related articles at the end of the text. seekingalpha.com/insta...

Diana Farrell And The White House Theory Of Bank Size

Let me add one more factoid for Ms. Farrell. The most recent doubling of real GDP took 25 years (1984-2009); the doubling before that took 20 years (1964-1984); the doubling before that took 21 years (1943-1964); and the doubling before that took 9 years (1934-1943). There is nothing in the growth rate of real GDP to support her argument that the concentration of economic power over the last 25 years was an advantageous event compared to the preceeding 50 years.

Diana Farrell And The White House Theory Of Bank Size

Simon (and commenters) - - -

I find some absolutely ridiculous factors in this situation.

1. Farrell said: "We have created them [our biggest banks], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.”

If we have created these structures, it is disingenuous to maintain that we can not "uncreate" them. The only reason for proposing what Ms. Farrell does could be called a "Dr. Frankenstein complex". By my analysis, the model of Dr. Frankenstein's monster has some relevance. But I reject Ms. Farrell's illogical conclusion that the monster can not be deconstructed.

We can do something as simple as segregating commercial and investment banking for starters.

2. Simon wrote: " If I have missed a convincing quantification for “bigness also has its benefits,” please draw that to my attention."

Simon is right on target. This implication that "bigness has benefits" has validity for critical mass arguments. Larger than that, the best that can be obtained after some point is minor gains achieved against the tide of the law of diminishing returns.

3. Consider this paragraph: "Third, “we’re unlikely to ever … want to come back to”. Ms. Farrell’s specifics on this point were summarized by the interviewer, Alex Blumberg, “The problem with Johnson’s approach, [the administration] decided, is that bigness also has its benefits. Sure, the economy used to be simpler and financial institutions weren’t so big and dangerous, but GDP was smaller then, too, and people were poorer.”

Ms. Farrell is living in an antiseptic bubble. When our GDP was approximately half of what it is today, the financial sector had less than 15% of S&P 500 earnings (recently they have been over 40%), the percentage of income concentrated in the top 1% was much lower (11% then) than today (23%) and the percentage of the people in poverty was about the same (13-14%). The transfer of income has come from 85% of the people between poverty and the very rich to the top 1%.

Further examples, using 1984 as a reference. That is when real GDP was about 1/2 of what it is now.

a. In the 25 years befor 1984, nominal average annual personal income gains were 8.9%; since 1984, they are 5.2% annually.

b. In the 25 years before 1984, real disposable incomes rose at 4.1% annually; in the 25 years since 1984 real disposable incomes have risen 2.6% annually.

In the bubble Ms. Farrell lives (the top 1%), things have not been so good since 1929. For the other 99%, her perspective is nonsense.

Simon's concluding two paragraphs are crucial:

"If Ms. Farrell and the White House (or anyone else) has hard numbers we can put on the benefits of big banks, please make these public. We can then weigh these against the obvious costs of running our financial system in this fashion – on this round alone: fast approaching 40 percent of GDP, i.e., the increase in government debt as a direct result of our financial fiasco; plus persistently high unemployment; millions of homes lost; likely permanent loss of output, etc.


Simon has isolated the critical factors: The mythology generated to perpetuate economic advantage for the wealthy bankers at the top of the food chain (Ms Farrell) and the rational argument implying that the law of diminshing returns may have been ignored in the power grab (Mr. Hildebrand).

This is a great article.

Bailouts Through the Back Door

My cynical view is that Lehman failed and AIG was covered because of counter party interests. For example, Goldman Sachs had a much larger loss if AIG failed than it experienced because of Lehman's failure.

If true, the moral of the story is that if you want to assure bail-out when under duress, sell large numbers of CDS contracts that you can't cover to all the banks that are too big to fail.

Monoline Mania: MBIA and Ambac Included in the Dash to Trash

Tom - - -

One thing you didn't discuss is the relationship of the "dash to trash" to the state of the overall market. This type of speculative excess often occurs at major tops. There are more and more people with good track records calling for a correction or a major sell-off. Three people I follow in that camp are Doug Kass, Richard Arms and Ron Insana. This week advance/decline lines have weakened noticably. Candlestick charts are loaded with dojis.

I like your reference to a full moon event, but I think I am going to get ready for Dow 8000 +/-.

When Journalism Misses the Big Picture

Felix - - -

Sorry. I neglected to thank you for writing about this topic. Good article on a subject that all who are trying to contribute to news, analysis and opinion should be thinking about.

When Journalism Misses the Big Picture

If journalists (and bloggers) would force themselves to write two versions of every article, one for the professional reader and one for the general public, they would determine how much they really understand about the topic. If you can't do both, you probably have some blind spots. Leftfield, derryl and nobby73 are, essentially, expressing this opinion.

Secondly, some are writing editorials rather than news analysis for reasons mentioned by the hand.

How AIG FP Brought Down the World

Felix - - - Excellent article.
nym - - - Thanks for the link to the full article.
nobby73 - - - Great tutorial. The information you provide explains why models need to be tested extensively with "out of sample" data. The truly wise also use "stress tests", i.e., out of sample data with hypothetical distortions. The result of following this procedure is that many seemingly good models would be discarded. Perhaps that is why so many models are implemented without exhaustive testing. And why we keep repeating disasters. I like to use models, but always with a close monitor for when reality shows relatively minor divergence from the model prediction. Yes, I get stopped out prematurely from a modeled trade at times, but I avoid going down in flames. Finally, I don't run the liquidity risk that a major player like AIG does.
John Gordon - - - You understand everything I just said. I hope you don't object to my expanding on the subject.

Questioning Conventional Wisdom on Credit Default Swaps

James - - -

This is a good article. You wrote, "Risk never goes away; if you think you’ve eliminated it, it’s just gone someplace else to hide." Actually, it only hides for a little while if risk is realixed. Recently the hiding place was found to be the public coffers.

By "diversifying" risk you are not controlling it, merely transferring risk. Ultimately, if carried to the leveraged extreme, risk is transferred from individual firms to the financial system as a whole and multiplied. We have been there, done that.

The risk of default is not diminished by all the financial engineering in the world. Looking at mortgages, for example, it could be argued that the risk of default is increased. I'll give two arguments for that:
1. Collateralizing mortgages makes it easier for marginal loans to be made because the originator is not going to be held responsible for collecting the repayment.
2. Once the mortgage is sliced and diced, the relationship between the lender and borrower is no longer straightforward and workouts of distressed situations that might have been feasible are not pursued.

So the risk of defaults occurring has been increased by financial engineering, and the cost has been amplified by leverage.

James, you have touched on these ideas, so I am merely restating some of your points in a way that makes sense to me. Your article is addressing issues that need to be understood by a broad audience and are not, although many SA readers probably do understand.