derryl

The State of Banking: Banking on the State?

I found it interesting that the authors cited the structure of the hedge fund industry as a possible model for a more "robust" banking industry. A growing number of diverse, specialized and increasingly decentralized hedge funds as contrasted with the growing size of a homogenously 'diversified' and increasingly dominant megabanks. The authors point out that while diversification of business reduces risk for individual banks, when all the big banks pursue the same kind of diversification the consequence is an increase in systemic risk. The banks are individually diversified but collectively homogenous.

The too big to fail banks are pleading that their size (and dominance) is necessary for conducting global business and realizing economies of scale. While it may be true that this strategy increases the scale of profits for these banks in rising economies, the strategy conversely increases the scale of losses during downturns. And because all these banks have 'diversified' into all asset classes it cannot be the case that some of them specialized into lucky assets while others specialized into losers. The whole megabanking system rises and falls in synch, with the profits privatized on the way up and the losses socialized on the way down. There are no big "lucky banks" to pick up the assets of failed big 'loser banks' in a receivership sale, which makes an orderly dissolution of big banks difficult to do, so all the big banks are propped up at taxpayer expense.

The US has over 8000 banks. If the too big that failed had been dissolved, or if they are going to be dissolved as the mortgage crisis and their insolvency worsens, then America's 8000 smaller banks can pick up the pieces and the US banking system will be structured more like the decentralized and truly diverse hedge fund industry. This looks to me like a good way to start the needed reform of this dangerously out of control megabanking system.

Sound Lending Practices in One Simple Sentence

I like Karl's idea. It immediately separates taxpayer backstopped gambling from good old fashioned banking by putting the banker's own skin on the line. If JPM really is prepared to accept its own failure then it should be prepared to lose its own capital on every unsecured loan it makes. This restores the incentive for TBTF bankers to take a realistic look at their potential losses on loans, rather than merely seeing all the potential upside as they do now. If big business needs big banks to lend big bucks, then all parties should be prepared to lose their money, like us small fry do, if our plans go awry.

U.S. Handling of Financial Crisis - A Less Optimistic View

Obama is certainly not the first President who got elected and then discovered that "the world is ruled by very different personages than it would appear" (I think I'm misquoting what FDR said upon leaving office, though I may have the wrong President, but that's the gist of the message).

I think Obama really believed that the Presidency would give him the power to implement the kinds of changes that he thought would improve America. Then he discovered that banksters own the economy and various sub-system interest groups rule their own fiefdoms within the country; the medical-industrial complex for e.g., and the trial lawyers.

I think most of us on SA have to admit that we have learned a lot about how the financial system is run, things we didn't know before, over the past year. And there is no reason to think Obama understood the system and its rulers when he took office. Only a few Wall St insiders know what has been going on over the past decade or more and it is only recently that investigative journalists and bloggers like Matt Taibbi and Edward Harrison have been making that information widely known.

To make the changes he wanted Obama would have to pry all the entrenched interests out of their fiefdoms and subject them to the kinds of regulations that serve America as a nation rather than merely serve the interests of the fief-lords and their vassals. But how can a President hope to win battles against trillionaire banksters who understand their system, when Obama has no money and no understanding? Likewise with other captured industries. The entrenched interests have all the weapons and all the power.

It's not too late for Obama. He's still in his first year in office. But if he's to succeed he'll have to transform himself from a naive idealist into a hardass realist. He'll have to be a trustbuster, an enemy of oligopolists and entrenched interests, a restorer of free markets. Obama still seems to think central planning can solve a lot of America's problems. So I'm not sure he's the right guy to break up the central planners in America's captured financial, health care, military and other industries. But I wouldn't be shocked if Obama did a mid-term about face in his thinking, after realizing the true state of the nation that he genuinely wants to heal.

Re: Banker's Pay - The Paper of the Year

"Now in one sense the defenders of high Wall Street pay are correct: people are probably getting roughly what they could make if they walked across the street and went to another bank. But that doesn’t answer the question of whether the whole industry is making a mistake and transferring wealth to employees that should go to shareholders."

All oligopolies tend to harmonize both their cost structure and their pricing structure. Oil companies pay essentially the same rates for exploration leases and the same rates for office space and they pay the same rates to drilling contractors and they offer essentially the same compensation packages to their employees, and they charge the same prices for gas at the pumps. But it has NEVER been the case that 1000s of employees of a single oil company ALL receive an average of $600k 'bonus' for a single year's work.

Yet Goldman Sachs is able to do just that. Among oil companies there is at least a passing degree of competition that keeps prices and employee pay realistic. If the oil industry shared a new miracle technology that allowed them to produce the same amount of energy at one one hundredth of the cost then maybe for a year or two they could pay all their employees 6 figure bonuses. After that they would either drop the price of their energy to match its new low production cost, and eliminate the 'bonuses', or they would be nationalized and clawed back and lynched and drawn and quartered, just as a warmup to the real nastiness they would be subjected to.

Wasn't it you, James, who explained that prices in an efficient industry go down, in contrast to finance where prices for services keep going up? If the megabanks justify their bonuses on the grounds of how productive their workers are, then wouldn't those benefits disperse into the broader economy over a couple of years by way of lower prices and a reversion of megabank profitbability back down to reality?

The only other economic sector where prices and wages always go up is government, and they do it by exercising monopolistic power over us backed up by the exercise of deadly force. We didn't elect the megabankers. We have the right and the obligation to regulate them. We do not have to let them financially pillage our economy and share the spoils among themselves. It's bad enough having elected governments doing that. We don't need private sector copycats.

Breaking Up the Big Banks: Ackermann vs. Hoenig

Many commenters have been pointing out that we're barely into the first stages of this financial crisis. First came the desperate bailing out of the sinking ship of finance. Now that the threat of imminent catastrophe is past we are starting to take a cooler look at what caused the crisis and how to ensure the ship is made more seaworthy.

During the early panic phase the money center banks were indeed too big to fail, we had to keep the ship afloat. But now that the ship is floating the consensus is emerging that a main contributor to the severity of the crisis was that the financial system was way too top heavy. The listing of just a couple of the too bigs threatened to capsize the whole boat. The solution is to reduce their height and spread their mass around more evenly. These behemoths are not seaworthy. They need to be broken up and their business spread around more horizontally.

We tried big and in the past 10 years, after Glass-Steagall and other limiting regulations were repealed, we tried too big. We were told that economies of scale enjoyed by too big banks would make our financial ship more seaworthy, not less. They were wrong. They nearly sunk us all. I think we can now safely agree with Mr. Johnson and Mr. Hoenig. "Too Big Has Failed".

ING Shows How Bank Dismemberment Is Done

Put Paul Volcker and Thomas Hoenig in a room for a few days and they can write up a detailed plan to do for US money center banks exactly what is being done with ING. We already have the expertise and the willingness on the part of these honest central bankers. Unfortunately guys like these are not the ones who own the government. But if US citizens could control their government then their government could control the banksters via a Volcker-Hoenig plan to break up the too bigs.

Are Big Banks Better?

Very large companies really do enjoy gains due to their size. They become more effective political lobbyists to shield themselves from competition which increases their market share and profits which shows up as, hey presto!, increased 'productivity'. They enjoy oligopoly pricing power which increases their profits which shows up as, hey presto!, increased 'productivity'. A skinny little guy with a knife can only steal $100 per day because most of his potential victims run him off. A 6'8 300 pound guy with the same knife can steal $1000 per day because his terrified victims simply hand over the cash. Hey presto! Big = more 'productive'.

Why We Must Act Now on Our Economic Structural Problems

Kimball,
I think the simplest way to revive US mfg and address the trade deficits is to allow the US$ to continue to fall. The US would have to ramp up domestic production of energy as imported oil becomes prohibitively expensive, as well as domestic production of all other resources that are necessary inputs into mfg. Imported commodities and consumer goods would become expensive and this would open the domestic market for domestic production of these. Currency devaluation is the historic way of fixing trade deficits and it should work again now.

One way to ensure the currency continues to fall would be a program of naked QE whereby the Fed and Treasury print money and deliver it to all Americans as 'stimulus checks', with the provision that anyone who has debt must use the money first to payout their debts. This would reduce US household and small business indebtedness and increase aggregate demand and savings.

The money would not be issued in the normal way as new bank loans or new Treasury debt. It would be naked QE, creating free money and giving it away free to all Americans. I have suggested checks of $1000/month to everyone over 18 with a SS number, continued for a year and renewable thereafter if it is working. It would put about $2.5 trillion per year of non-debt money into the system.

This new money can be used to liquidate old debt so the money and the debt cancel each other out with no change to money supply, just a reduction of debt (it's kind of a partial debt Jubilee program, among other things). Unless increased savings encourage banks to lend more, which it probably wouldn't, all the stimulus money that is saved would not be inflationary; it would simply be removed from circulation and stored in savings accounts paying nearly no interest.. Only the stimulus money that is spent on consumption would be CPI inflationary, and the stimulus money that was invested in financial assets like stocks would inflate those markets somewhat.

Really, it's a way of deleveraging American households without simultaneously driving the financial system into insolvency. The financial system would enjoy deleveraging of its balance sheets as borrowers repaid their loans, but bank asset values (mortgages, etc.) would not be pressured down like they are when loan losses are written off after foreclosure sales at firesale prices.

So the simple act of introducing new free non-debt money into the system could restore the balance sheets of both US households and US banks while generating enough money supply inflation to keep the US dollar declining, which would ultimately revive the US goods producing economy and employment.

Real Cause of This Financial Crisis? Global Hunger for Savings Instruments

Jaysan,
That is the most concise and elegant presentation I have seen of the gold standard trade balancing mechanism. The mechanism's virtuous discipline is utterly thwarted by the ability and eagerness of the post-gold fiat reserve currency issuer to solve all domestic problems by creating more money.

But Mr. Goldman is right. All this created money ends up as somebody's savings, seeking yield. The simple fact of our present state is that there is way too much money in the world chasing way too few productive places to put it to work. So excessive demand for financial investments led to a declining interest rate and the invention of 'innovative' financial products to absorb the money by promising yield.

It must be remembered that investment in "financial products" is investment in somebody's debt. Savers have money, borrowers need it, so savers "invest in" borrowers' debt. It is ultimately the borrowers' payments of interest on their debts that provides "yield" on MBS and other CDOs.

And Keynes was also right about the "paradox of thrift" in a fiat money, debt-money monetary system. Savings is money that is removed from the circulating money supply, the producing and consuming economy. So if borrowers have collectively borrowed $1 trillion and spent it into the economy, and savers have collectively saved $300 billion, there is only $700 billion left in the economy for those borrowers to earn back and repay their loans. Musical chairs. There are $300 billion too few chairs in this equation if the money supply expansion music stops.

When money supply is growing new borrowers get new bank loans and spend new money into the economy fast enough to replace the money lost to savings. But we are entering a new normal where borrowers have collectively reached their debt ceiling so nonexistent new loans will not solve this problem. Money supply is actually shrinking as debts are repaid or bank capital is extinguished covering loan losses.

So savers have been relending money to the borrowers and borrowers have been using ever increasing debt just to stay liquid. Like Treasury borrowing money to pay interest on its old debt. This arithmetic obviously cannot go on forever, so it didn't.

Big Banks: The Consensus Is Cracking

greencanbgood wrote, "All you "break up" propoenets out there have yet to come up with a reasonable strategy for calculating how you would do so (by business line, by assets, by geography [which, by the way already occurrs], by deposit base). Everyone has opinions but no solutions."

Actually no less a luminary than Kansas City Fed President Thomas Hoenig has laid out a detailed strategy for dissolving these "Too Big Has Failed" institutions.

www.kansascityfed.org/...

So we have Hoenig, Alan Greenspan and Paul Volcker all arguing for the breakup of the too-bigs. That's three highly prominent central bankers who agree that too big has failed and needs to be broken up. And we thought the Fed was just running interference for the too bigs. But now that these wise gentlemen are speaking out it is apparent that many of the central bankers are actually interested in saving the American financial system from the banking oligopoly that is destroying it for its own perverse gains.

Numerous less high profile monetary authorities, many right here on SA, agree. I would suggest that if there is any "consensus" about too big to fail, the consensus is restore Glass-Steagall and carve these money suckers down to size. The only people who seem to have a consensus that "too big is ok" are the too big bankers themselves. Their bonuses depend on being too big to fail, which explains the "logic" behind their opinion and their increasingly desperate rationalizations for their continued existence.

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

Calomiris wrote, "Limiting the size, complexity and global reach of financial institutions is fraught with downsides for the international economy. We can solve the too-big-to-fail problem without destroying global finance."

Is he talking about the same "international economy" that has seen all the benefits for the past 3 decades flow to corporate profits and zero to US workers? And the resultant overconcentration of wealth in the top 10% and overconcentration of debt among the middle class? The same international economy that saw China sell $2 trillion more goods to the US than it bought from the US creating a debt fueled US consumer bubble whose ongoing collapse is still threatening to bring down the very global finance that Calomiris defends? The global finance that securitized unpayable US mortgages on bubble priced houses and sold them to suckers across the planet to earn fees and commissions? The same MBSs that the Fed is now buying en masse to prevent a Depression?

If that's the "international economy" and "global finance" that Calomiris seeks to defend then I suggest this man is our enemy, not our ally.

Debunking the 'Too Big to Fail' Myth Once and for All

bob adamson wrote, "The danger, if fundamental reform does not occur, is that the global and US economies will simply be recreated as they existed in 2005 except that government debts and deficits will be much higher; a recipe for true disaster."

I think this is exactly what the powers that be are trying to make happen. Not the future disaster part, just the keep the party going awhile longer part, so each of the banksters can glean their last few hundred million in bonuses and the politicos can take their rightful thrones on the boards of the TBTF. But it will end in calamity as the nation's monetary wealth is transferred to a few while the nation's debts are spread to everybody. This is a classic recipe for Depression.

By last January I was pretty sure that this is not "the big one". But I am pretty sure the next one, not too many years out, will be.

The Problem with Smart Bankers

Letting the quants play with banks' real money based on mathematical theories is no different than letting the chemistry students try out their theories in the lab. The professor is dazzled by the brilliance of his students and doesn't really understand their newfangled equations (the prof is too proud to admit he doesn't understand), but for awhile they work and the students get A+. Until they blow up the school. Because the brilliant students didn't know how their theories were going to turn out either. They were just too young, well paid and empowered to understand and be constrained by the concept of "consequences".

Our Banks Are Nowhere Near Up to the Task of Serving Big Global Companies

"Global reach"---into US taxpayers' pockets.

Diana Farrell And The White House Theory Of Bank Size

greencanbgood wrote,

"All you "too big" people out there, I wonder why you aren't writing to your congressional representatives to break up Microsoft also. You can't have it one way for one industry and anohter way for a different industry. Let a free market reign and eventually, the poorly run will fail."

This is precisely our complaint. Too big HAS failed, but unlike companies in any other industry these banks still exist. Their shareholders have not been wiped out. Their employees have not been thrown out of work with no severance pay and no pensions as happens in other grossly insolvent bankrupt companies. Their successful, solvent competitors are not presently feasting on their assets at firesale liquidation auctions.

Instead the TBTF honchos are still paying themselves billions of dollars in "bonuses". I suppose they deserve a big bonus for "succeeding" in controlling the government and f___ing American taxpayers out of hundreds of billions of dollars.

I'm not arguing that we should have let capitalism run its course and wiped out these failures last winter. I don't want a Depression any more than Ben Bernanke does. What I do want is for the failure to be acknowledged and some discipline to be accepted by these people. Failure is supposed to be humbling, not exhilarating and highly profitable.

Shortly before the central bankers get-together in Jackson Hole last summer Kansas City Fed President Thomas Hoenig (who was hosting the conference) published "Too Big Has Failed", in which he advocates an orderly unwinding of these failed businesses. So even among the monetary elites within the Fed there is not consensus that these megabanks should be allowed to exist. Sadly, I saw no mention of Hoenig post-Jackson Hole. His rational approach to actually solving the financial logjam was likely ignored just like BIS economist William White was ignored by Greenspan when he stridently warned of the bubbles that were forming. These TBTF guys are making WAY too much money to let a little thing like causing an economic crisis with mass unemployment and currency devaluation bother them.

There are valid arguments for economies of scale. A one man shop can neither afford nor utilize a $400,000.00 machine that does the work of 100 men. A larger scale operation can afford and use the machine to vastly increase its productivity which ultimately reduces costs to consumers.

But when an operation gets so large that no individual ever knows everything that's going on in the company at any given time, then the operation becomes LESS efficient. All kinds of redundancies and other waste happen because the big picture of the company is too big for one person to see. From that point up the only reason these too-big-to-be-efficient companies appear to be 'efficient' is that they enjoy oligopoly pricing power. The consumer (or the taxpayer) can be made to subsidize the inefficiencies so the company remains highly profitable even while overpaying its employees and wasting large amounts of its resources.

I would argue that the TBTF "bank-like businesses" are in this latter category. They get laws and regulations written that favor them over their competitors. They have large scale money that enables them to move markets, and profit on the moves because they alone know beforehand which direction they are going to move the market. They are allowed to park their computers at the NYSE to front run and 'tax' equity trades.

All of this enhances profitability for these companies, but all of these "excess profits" are not from creating additional value but from sucking money away from everyone else in the economy. By this standard IRS employees should also be paying themselves billions in bonuses because the taxman is the money sucker par excellence.

As John Lounsbury implies in his comment above, overconcentration of wealth is an economy killer. It is not "envy" that should motivate policymakers (and shareholders) who want to rein in the big bankers. It is the desire for a sustainable economy and for sound economic policy that should motivate them.