As economist Joe Stiglitz says, “But if the final bill that emerges from conference reflects the lowest common denominator, then we can only pray to be spared another financial crisis in the near future. Our economy and our Treasury can ill afford another such episode.”

In a profile piece by the WSJ titled, “The Three Men of Regulation”, it’s clear that the men who helped to define the crisis also helped to define the terms of our financial overhaul plans. They chose to pit activists and banking lobbyists against each other around the debate of regulation. We should not be so silly to let conflicted politicians define the course of our financial system on terms that start and end around broken lines.

As many of you know, we thought that Congress had the ability to think more structurally and fight for structural change in the face of extreme big bank abuses and a financial crisis. They have not done so, except a few like Senators Kaufman who have fought for the interests of the public. But even as we fight for the toughest parts of the regulatory bill, we still have a long haul fight to define the debate in terms of structural issues. Break up the banks has its political constituency now and it’s on the table. We can define the debate on appropriate terms.

WSJ writes:

“To some extent, some of the people who did the most to help precipitate the crisis are now in charge of writing the legislation to make sure theoretically it doesn’t happen again,” Mr. Hensarling said.

Messrs. Geithner, Dodd and Frank each vigorously defend their reputations, often with fervor and equally barbed words for their critics.

Politically, the three move very differently. They also answer to different political constituencies, which could challenge their ability to deliver a completed package by an unofficial July 4 deadline.

Mr. Geithner was a political novice before joining the Obama administration. Mr. Dodd is a classic Senate deal maker. Mr. Frank benefits from a broad Democratic majority but has been known to catch lawmakers off guard.

On May 21, coming out of the White House meeting after the Senate vote, Mr. Frank had the endgame in sight.

“It’s hard to even think that this is going to take us a month,” he said.

Even Moody’s, a credit rating agency at the center of a firestorm on what to do about credit rating agencies, reports that the bill does not end too big to fail: “So much for ending Too Big To Fail. The financial reform bill championed by the Obama administration and Senate Democrats as permanently ending the idea that large, interconnected financial institutions are too big to fail does no such thing, analysts at Moody’s Investors Service cautioned today in a new report. “[A] key issue that challenges the feasibility of the proposed legislation is that it would not fully eliminate the issue of interconnectedness, nor is it likely that resolution authority could fully eliminate the systemic implications of allowing a large and/or highly interconnected firm to default, especially with respect to large international groups, and it certainly would not eliminate the risk of contagion,” the team of analysts led by Robert Young wrote.”
Fed Chief Fisher has come out fighting to square this bill as a small effort, he points out that the regulators failed: “Regulators have, for the most part, tiptoed around these larger institutions [big banks]. Despite the damage they did, failing big banks were allowed to lumber on, with government support. It should come as no surprise that the industry is unfortunately evolving toward larger and larger bank size with financial resources concentrated in fewer and fewer hands.”

As the bill that is going through conference now mostly focused on the battle of regulation, and should be called thus — the financial regulatory bill rather than financial reform bill — here is a very succinct take on the importance of regulation, via Angry Bear:

The obvious problems of graft and the revolving door between government and industry, in other words, were really symptoms of a more fundamental pathology: regulation itself became delegitimatized… This view was exacerbated by the way regulation works… Too many regulators, for instance, are political appointees, instead of civil servants. This erodes the kind of institutional identity that helps create esprit de corps, and often leads to politics trumping policy. Congress, meanwhile, often takes a famine-or-feast attitude toward funding, allocating less money when times are good and reinflating regulatory budgets after the inevitable disaster occurs. … This … also contributes to the sense that regulation is something it’s O.K. to skimp on.

[T]he history of regulation both here and abroad suggests that how we think about regulators, and how they think of themselves, has a profound impact on the work they do. … So reforming the system isn’t about writing a host of new rules; it’s about elevating the status of regulation and regulators. More money wouldn’t hurt: as … George Stigler and Gary Becker point out, paying regulators competitive salaries … would attract talent and reduce the temptations of corruption. It would also send a message about the value of what regulators do. That’s important… If we want our regulators to do better, we have to embrace a simple idea: regulation isn’t an obstacle to thriving free markets; it’s a vital part of them.


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.

Krugman says,

“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.).


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.

On the inefficiency of policy making when excessive corporations are allowed to reign supreme, Bloomberg reports:

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.
‘Speculative Trade’
“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.


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.


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?


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.