WHAT DOES KRUGMAN HAVE AGAINST STRUCTURAL REFORM?
By not ever directly answering to the problems that come about when you do get big enough that you’re too big to fail, Krugman is wiping away the problem of too-big-to-fail with one fell swoop, as if the problem were simply a problem on a dry erase board.
“So what’s the moral of this story? As I see it, it’s a caution against silver-bullet views of reform, the idea that cracking down on just one thing — in particular, breaking up big banks — will solve our problems. The case of Georgia shows that bad behavior by many small banks can do as much damage as misbehavior by a few financial giants. And the contrast between Texas and Georgia suggests that consumer protection is an essential element of reform. By all means, let’s limit the power of the big banks. But if we don’t also protect consumers from predatory lending, there are plenty of smaller players — both small banks and the nonbank “mortgage originators” responsible for many of the worst subprime abuses — that will step in and fill the gap.”
He is taking a fundamentally important reform measure, breaking up the banks, and squashing it in the palm of one of his mighty hands by hinting that we advocates are using it as a silver bullet. I don’t think any of us are — we simply think it is a reform measure that definitely needs to be on the list of bank reforms. And on the list of structural changes to our economy and democracy, it’s number one for various reasons, but not singular either (there is a whole host of large corporation distortion issues that should be on this list).
I haven’t seen an article from him that significantly addresses the problems of excessive and collusive political power of extremely large banks, the issue that there is no efficiency gain for banks over a certain size, the overpricing and the trend of big banks to hide their risks, the inefficiencies of our political system introduced by heavy lobbying brought on by “big-banks-or-other-big-corporations-are-freedom” lobbying groups (Chamber of Commerce spends more than the RNC and DNC), the distortion of the market when big banks pass policies in their name and get regulation waivers, the ability of the biggest and most catered-to banks to take on disproportionately greater risk, the fact that the big 5 is responsible for 95% of the derivatives market.
Let’s see Krugman tackle these issues without looking at the macro-issue of banks just being too big, and our financial industry being too big. Krugman is well-loved by liberals who depend on Krugman for updates. If you’re one of them, just get a few more sources to round out your understanding (other readable big time economists are Baker, Stiglitz, Reich, Akerloff, etc. etc.).
BIG IS A CYCLICAL PROBLEM FOR ECONOMICS AND POLITICS
Another way that big banks can take on more risk is because they can pay out bigger bonuses. Being big is a cyclical problem, that’s the main problem that those intent on understanding how free markets can actually work must tackle (those who have a leg up just get bigger and turn consumer choice into consumer defaults). When compensation is linked to short-term profit as it is now, CEO’s have tended to make riskier bets that show a gain in the short-term and not worry about the long term. Compensation is cited as one of the reasons for the huge leap in subprime loans, securities, OCD, etc. activities.
Treasury Secretary Timothy F. Geithner can look no further than Wall Street where the banks that received the biggest taxpayer bailouts are seeking to reap trading profits from securities rescued by the government.
Only months after it was started, the U.S. program designed to purge debts of no immediate discernable value from the balance sheets of troubled banks has helped transform the frozen debt into a money-maker as the bonds have rallied. Bank of America Corp. and Citigroup Inc., who received 22 percent of the $418.7 billion American taxpayers loaned to troubled financial institutions, boosted holdings on their trading books of home- loan bonds that lack government guarantees while investors were raising cash for the program, according to Federal Reserve data.
Charlotte, North Carolina-based Bank of America along with Citigroup, Morgan Stanley and Goldman Sachs Group Inc., all based in New York, added a combined $3.36 billion of the debt, for which there were few buyers as recently as March, to their short-term trading assets during the third quarter, up 16 percent from the second quarter, the most-recent data show.
Prices of these securities may slump again, leaving the banks exposed to potential losses that the Treasury Department’s rescue plan was designed to mitigate, said Joshua Rosner, a managing director at New York-based Graham Fisher & Co., which advises regulators and institutional investors.
“It’s a trade that will likely work out, but it’s still a speculative trade, which is not what a taxpayer should want from firms that have only recently come out of critical care,” Rosner said.
The Public-Private Investment Program was introduced in March by Geithner as a means of helping struggling banks by reviving the market for unpackaged loans and mortgage securities that aren’t backed by government-supported institutions, such as Fannie Mae or Freddie Mac. Under the program, asset managers were supposed to raise money from investors and, with additional capital and loans from taxpayers, buy as much as $1 trillion in toxic assets from U.S. banks, freeing up money for lending.
It’s “absolutely ridiculous” that banks, which were expected to reduce their holding of such volatile mortgage securities, bought them before the government program was running and may now profit, said Michael Schlachter, managing director of Wilshire Associates, the Santa Monica, California- based investment-consulting firm. “Some of them created this mess, and they are making a killing undoing it.”
In a paper by a Fed Chief and an academic professor, we get to see how big banks have a market and political advantage.
In the paper, How Much Did Banks Pay to Become Too-Big-To-Fail and to Become Systematically Important? which was recently made publicly available on SSRN, we estimate the value of the too-big-to-fail (TBTF) subsidy. The special treatment provided to too-big-to-fail institutions during the financial crisis that started in mid-2007 has raised concerns among analysts and legislators about the consequences of this for the overall stability and riskiness of the financial system.
Our empirical results are consistent with the hypothesis that large banking organizations obtain advantages not available to other organizations. These advantages may include becoming TBTF and thus gaining favor with uninsured bank creditors and other market participants, operating with lower regulatory costs, and increasing the organization’s chances of receiving regulatory forbearance. We find that banking organizations are willing to pay an added premium for mergers that will put them over a TBTF threshold. This added premium amounted to an estimated $14 billion to $17 billion extra that eight banking organizations in our data set were willing to pay for acquisitions that enabled them to become TBTF (crossing the $100 billion book value of total assets threshold).
While these amounts are large, they are likely to underestimate the total value of the benefits that accrue to large banking organizations. Organizations seeking to obtain TBTF benefits are not likely to be forced by the marketplace to pass on anywhere near the full value of these benefits to the shareholders of their acquisition targets.
BIG BANKS ARE A FAILURE OF COMPETITION, LET’S TALK ABOUT COMPETITION THEORY
If you look at competition theory, which has not been brought into this debate about the big banks enough, the financial industry is considered over-concentrated and barriers to entry for new or small to medium-sized banks are high. Williamson recently won a Nobel for his research on regulation as it relates to competition. Williamson summarizes a thoughtful position that deserves further investigation: direct regulation or size caps? He is obviously being thoughtful here:
“According to Williamson’s theory, large private corporations exist primarily because they are efficient. They are established because they make owners, workers, suppliers, and customers better off than they would be under alternative institutional arrangements. When corporations fail to deliver efficiency gains, their existence will be called in question,” according to information on the research released by the Royal Swedish Academy of Sciences. “Large corporations may of course abuse their power. They may for instance participate in undesirable political lobbying and exhibit anticompetitive behavior. However, according to Williamson’s analysis, it is advisable to regulate such behavior directly rather than through policies that limit the size of corporations.”
Nevertheless, size restrictions is a matter of politics and therefore the market. Honestly, whether or not size caps are the best way is irrelevant economically on one level — if we allow our political system and cultural capital to be taken over, economics follows suit.
I’ve seen this one article on competition theory as it applies to banks in the mainstream media. I applaud the article. Here’s to the Financial Times:
However, as a policy the case for examining competition in banking – provided it could be done fairly without obvious political rigging – is not at all outlandish. A far-reaching investigation could enrich our understanding of the financial system in the years running up to the crisis. What share of record financial sector profits before 2008 was attributable to market power as opposed to undercapitalisation and the sale of innovatory financial products, whether those that created value or those that did not?
Moreover, a push on competition would support legislative efforts to tackle the problem of banks that are too big to fail. Given near-universal agreement that it is undesirable to have a system dominated by relatively few, big and highly-interconnected firms, why not investigate why it is so difficult for smaller banks – and boutique investment firms – to take market share from dominant rivals?
Tax cuts are an egotistical and masturbatory idea and contribute to making the advantaged bigger. Economists View writes: “What, after all, is the difference between a direct spending program and a refundable tax credit? Nothing, really, except that Republicans oppose the first because it represents Big Government while they support the latter because it is a “tax cut.” I think these sorts of semantic differences cloud economic decisionmaking rather than contributing to it.” Big banks and our largest corporations have gotten hidden subsidies and tax cuts for being big.
CFPA IS A SCAPEGOAT OR A BLACK SHEEP OR A SACRIFICE
A few months ago, I argued that maybe we should let the banks win on the Consumer Financial Protection Agency and slip in real structural reform where they’re not looking… I still support efforts to pass a CFPA, but we do need to make sure we’re gaining overall rather than losing overall in the financial reform fight. Last week, is turning out to either be a scapegoat or what I hope, a sacrifice.
In light of this, Republicans seem to be settling on a strategy: Give the Democrats much of what they want on the consumer agency and bet that Democrats won’t be too picky about the rest. If the bet pans out, the industry and its GOP allies would, in effect, be trading a robust consumer agency for a chance to scale back a number of highly consequential but below-the-radar reforms. But will it?
ANTITRUST – BREAK UP THE BIG BANKS
As the case of Wal-Mart’s largesse shows, and the fact that all the big banks once owned both Visa and Mastercard, antitrust has an important role to play to protect consumers against the big guys. Antitrust should be triggered by political over-concentration or distortion — that would be one other needed reform not currently on Krugman’s list.
And finally, the state of inequality in this country is touched on by this segment on Bill Moyers. He’s absolutely thoughtful. Big banks have a lot to do with inequality in this country.
Anyone who is not serious about fixing Too-big-to-fail and thinking about the implications of big banks and their size is not serious about reform. Just plain not serious.
Surprise: Hedge Fund Managers made a killing last year with help of Treasury. Shows that big investors perceive Wall St. as a game of people’s lives, the sneaky win the money and the outcome for regular people is inconsequential. April 1 joke is always on us.
Top from left: David Tepper, George Soros, James Simons, John Paulson, Steve Cohen; Bottom from left: Carl Icahn,
At least the notion of TBTF is gaining traction and the word on the street is that more insider people are going to attack size. “Speeches by central bankers tend to be dry affairs. For this reason alone, remarks by Andrew Haldane, the Bank of England’s executive director in charge of financial stability, deserve attention. In a discussion about bank size, he made reference to the limits of Facebook friendship and the structure of Al Qaeda. Rhetorical flourishes aside, Mr. Haldane delivered a serious message: regulators are thinking increasingly radical thoughts about tackling big banks.”
Geithner says “it’s “deeply unfair” that some financial institutions that got taxpayer-paid bailouts are emerging in better shape from the recession than millions of ordinary Americans.” Well, we have a sense that he might push harder now that health care is over in Congress. He should have some leverage to go after size and if he doesn’t, he’s not being sincere about fixing the disparity.
To know who else is not serious about the interests of a safe/fair/prosperous economy, look at who is in bed with Wall Street. This is a great article that chronicles Wall Street’s “best hope” (Clinton and Obama have chummed up with them in the past too):
Republicans are stepping up their campaign to win donations from Wall Street, trying to capitalize on an increasing sense of regret among executives at big financial institutions for backing Democrats in 2008.
In discussions with Wall Street executives, Republicans are striving to make the case that they are banks’ best hope of preventing President Barack Obama and congressional Democrats from cracking down on Wall Street.
GOP strategists hope to benefit from the reaction to the White House’s populist rhetoric and proposals, which range from sharp critiques of bonuses to a tax on big Wall Street banks, caps on executive pay and curbs on business practices deemed too risky. [Wall Street Journal, 2/4/10; emphasis added]
Bernanke in the NYTIMES: “Giant banks that are perceived as “too big to fail” are among the “most insidious barriers to competition in financial services,” the Federal Reserve chairman, Ben S. Bernanke, said on Saturday… “One of the greatest threats to the diversity and efficiency of our financial system is the pernicious problem of financial institutions that are deemed ‘too big to fail,’ ” Mr. Bernanke said.”
Clive Crook’s op-ed in Financial Times sums up the bill nicely: “Current proposals for financial reform inspire little confidence. The administration has published a blueprint; the House passed a bill along the same lines; and last week the Senate banking committee produced a third, similar plan. These designs are not stupid or incompetent but they are incomplete. They focus on form, not substance, and they neglect the international aspect. The failings are no accident.”
Sheila Bair again: The head of the Federal Deposit Insurance Corp. said Friday loopholes need to be filled in new Senate legislation to ensure an end to the disastrous “too-big-to-fail” approach that brought the government rushing in to bail out big banks in the financial crisis. “The bill would create a powerful Financial Stability Oversight Council to monitor the health of the financial sector and push for the breakup of large complex firms to prevent them from becoming “too big to fail.” The nine-member council, which would include the FDIC, the Treasury Department, the Fed and other agencies, could place big, interconnected financial institutions under the Fed’s supervision.”
We can remember who to blame for not restoring our economy and jobs and giving away public treasures to Wall Street. It’s all true, as Reuters reports:
“A wide assault on a plan by Democrats to overhaul U.S. financial regulation is planned by Republicans for Monday as a Senate panel begins drafting a much-disputed bill, documents obtained by Reuters show.
About 300 amendments from Republicans will seek to weaken or kill key provisions of legislation that was unveiled on March 15, after months of informal negotiation, by Senate Banking Committee Chairman Christopher Dodd, a Democrat.”
Today, Mary Bottari put a funny twist on big banks. Here it is from Bankster USA:
“America’s Women to Dodd — Size Matters”
U.S. Senator Chris Dodd
Chairman Senate Banking, Housing and Urban Affairs
Dear Senator Dodd,
As women and as taxpayers, we are writing to you today to tell you that size matters.
Usually we love big. Big boxes of chocolate, big boxes of wine, big — well you know. But when it comes to big banks and big bank bailouts, it’s a whole different story.
As you get ready to take up bank reform in your committee next week, we need to talk.
When Congress voted to repeal depression-era Glass-Steagall protections, it put the big banks on Viagra. Since then they have had a big problem and it has lasted a lot longer than four hours.
The top five banks hold 50% of all bank assets. That hurts. They are simply too big for their britches. They have been ramping up those big bank fees, paying out big bank bonuses and spending big bucks on bank lobbyists to defeat reform.
We know what those big banks are telling you — “size doesn’t matter.” JP Morgan’s Jamie Dimon may be cute, but he is just a player. Big bank bravado only leads to big bank bailouts. After spending $4 trillion on the latest one, we simply can’t afford to get knocked up for another.
Pearlstein of WPost makes a good summary of the stalemate in financial reform in Congress (not in the public mind you):
“There are many parties to thank for this stalemate: Liberal Democrats who insist that the only solution is to micromanage the financial services industry from Washington. Conservative Republicans who can’t accept that their deregulation went too far and can’t bear the thought of handing a legislative victory to President Obama. A financial services industry that says it supports regulatory reform in general but can’t agree to any specific changes. And regulators, in denial about their own failures, who remain determined to preserve their power and influence. “
Unfortunately, Pearlstein, a well-informed financial crisis writer shortchanges fundamental plans to real reform that were left out of the “new solution” by calling the solution attractive. The bill has no Volcker rule as recently pushed for by Obama and which would cap the size of banks at their current size and a stopping of some propietary trading; or that Glass-Steagall separation that keeps your money away from out-of-hand growth for big banks and extreme risk for the American taxpayer, and pushes for an undemocratized single regulator and passes by our most important crusader, Sheila Bair. Our litmus test for financial reform is still “nationalize, reorganize, decentralize” in the face of a crisis and in the construction of a financial industry in the present.
The shape of the regulator doesn’t matter, but its harmony, function, accountability and transparency.
Here’s what the compromis[ed] bill has:
“The compromise hammered out between Dodd and Corker would establish a single regulator of federally chartered banks with a dual mission and an independent source of funding, based on my conversations with several key players. One division would promulgate and enforce rules to protect consumers; the other would fulfill the traditional role of supervising banks for safety and soundness. Supervisors from both divisions would participate in the periodic reviews of bank operations, and any conflicts between the two would be resolved by the head of the agency.”
Why the change? Pearlstein says, “Some credit also goes to Obama, whose decision to embrace a more populist critique of Wall Street in recent weeks has rattled financial markets and persuaded big banks to push for a compromise rather than leave a cloud of regulatory uncertainty hanging over their heads. Apparently nothing focuses the mind of a Wall Street banker so much as the prospect of being forced to shut down his proprietary trading desk.”
The bill includes our “nationalize/receivership” rallying cry that would stop the bailouts to too big to fail banks and put them through an insolvency process in order to contain crises and keep capitalism on an even keel: “Dodd, Corker and Democratic Sen. Mark Warner of Virginia are putting the finishing touches on a plan reflecting these judgments. As they envision it, any time a big financial institution is threatened with insolvency, the government would be authorized to take it over and close it down in a bankruptcy-like process. The government could provide temporary loans to ensure an orderly liquidation process and prevent financial panic, but only to the extent that the loan would be repaid from proceeds of the sale of the bank’s assets. Although insured depositors would be protected, creditors, counterparties and investors would all suffer losses.”
Insider scoop from Politico: “Treasury Secretary Timothy Geithner meets with Senate Banking Committee Chairman Chris Dodd (D-Conn.) and Sen. Bob Corker (R-Tenn.) this afternoon to get a briefing on the progress they’ve made hammering out a compromise on financial regulatory reform and to strategize about how to move things forward.
MEANWHILE, SIGNS OF PROGRESS – POLITICO’s Victoria McGrane reports: The widespread consensus forming Tuesday was that the Dodd-Corker bill won’t be ready until next week – multiple industry sources heard Dodd tell his ranking Republican, Richard Shelby, as much. But the signs are auspicious for a bipartisan bill – and one that might actually be able to pass the Senate. Corker told POLITICO Tuesday that Republican support for the Dodd-Corker product is building behind the scenes.””
The banks are bigger than they’ve ever been, the only good financial reform bill is still nationalize, reorganize, decentralize, tuned for the different stages of a financial crisis and a steady economy.
As Simon Johnson and Peter Boone say, “As a result of the crisis and various government rescue efforts, the largest six banks in our economy now have total assets in excess of 63 percent of GDP (based on the latest available data).”