The law can’t touch them at all

“Too big to prosecute” is the recurring headline this week after Attorney General Eric Holder’s remarkable statement before the Senate Judiciary Committee on Wednesday:

“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”

Where to begin? “Too big to fail” is one thing, but to say these institutions are too big to clean up their act is another. The attorney general seems to be implying that the big banks are more important than the laws themselves. It is one thing to say that the outright collapse of these institutions would bring economic ruin. It is quite another to assume that prosecuting criminal acts by them or some of their employees would also bring ruin.

Skeptics have long called the big banks “too big to prosecute” because their lavish campaign contributions give them unparalleled access and influence in Washington, but Holder’s remarks point to something more insidious: ideological capture. When cabinet officials are products of Wall Street or, worse, credulously believe Wall Street claims that their firms are delicate life-giving flowers that must never be disturbed, we have a problem that won’t go away anytime soon.

Fortunately, several members of Congress, including Republicans David Vitter and Charles Grassley and Democrats Sherrod Brown and Elizabeth Warren, are pushing back. Vitter and Brown have co-sponsored a bill to limit the size of the big banks. But we have been here before, as recently as 2010, when a similar bill lost by a vote of 61-33 and was opposed by the Obama administration. Until further notice, it’s hard to disagree with these words of Huey Long from 1932:

“They’ve got a set of Republican waiters on one side and a set of Democratic waiters on the other side, but no matter which set of waiters brings you the dish, the legislative grub is all prepared in the same Wall Street kitchen.”

The law can’t touch them at all.

Dean Baker on banks, bailouts, and reform

Naked Capitalism has an excellent two-part interview with Dean Baker, one of the Cassandras who spotted the housing bubble years before it burst and who has been a much-needed gadfly in the ointment of economic news reporting and the economics profession. Baker’s new book, The End of Loser Liberalism: Making Markets Progressive, is available for free download here, including in Kindle and Nook formats. Here are some highlights from the interview, conducted by Philip Pilkington. I’ve highlighted in boldface some lines I found particularly compelling:

PP: Moving on, in the book you make the claim that had the financial system been allowed to melt down we would not actually have ended up in another Great Depression. This is not to say that you don’t recognise that letting the financial system melt down would have caused a lot of problems – for banks, of course, but also for pension funds and the like – but you say that those in charge of the bailouts exaggerated the importance of the financial sector. Could you explain briefly what you mean by this? And what do you think should have been done at the time of the bailouts?

DB: The point here is that we know how to reflate an economy. Massive government spending will do it. It got us out of the Great Depression, although not until World War II created the political consensus for the level of spending that was necessary to actually do the job.

A financial collapse cannot condemn us to a decade of stagnation and high unemployment. That only comes about from a prolonged period of political failure. If we had allowed the banks to collapse in the financial panic of 2008 then we would [still?] have had the opportunity to pick up the pieces and get the economy back on track with a massive stimulus program.

Of course it was best to not let the banks collapse. However the bailout should have come with real conditions that would have ensured the financial system was fundamentally restructured. This would have included breaking up the too big to fail banks (on a clear timetable, not necessarily at that time), serious caps on compensation, a commitment to principal write-downs and other real conditions.

At that time the banks were desperate. Without a big dose of public money they would almost certainly have been insolvent, so they would have had little choice but to accept whatever conditions were imposed. As it was, they almost got President Obama thanking them for taking taxpayer dollars in the bailout.

PP: Any ideas about what could be done with the banks now? Or is the damage already done?

DB: We still need to reform and downsize the financial sector. We don’t have the same leverage over the banks as we did at the peak of the crisis when we could have slapped whatever conditions we wanted on the loans and guarantees they needed to stay alive, but Congress can still pass laws that will rein in the industry.

At the top of the list is a financial speculation tax. A modest tax on financial transactions will do much to reduce the rents in the industry and to eliminate or drastically reduce short-term trading that serves no productive purpose. It will also raise a ton of money.

The second thing is breaking up the too big to fail banks. There is no justification for allowing banks to be able to borrow at below market interest rates because they enjoy an implicit government guarantee.

The third item on my list would be re-instating a Glass-Steagall type separation between commercial and investment banking. The Volcker rule, which limits proprietary trading by banks with insured deposits, was a step in the right direction. However it looks as though the industry is using the rule-making process to turn the law into Swiss cheese. It is likely that most banks will be able to find loopholes that will allow them to do as much proprietary banking as they want.

Anyhow, these would be my top three reforms. Politically, all of them would be very tough sells right now. By contrast, at the peak of the crisis, the industry would have voluntarily agreed to the last two in order to get the money they needed to stay alive.

PP: You write in the book that the idea that the banks repaid all the money from TARP is misleading. Could you explain this, because this myth is very prevalent in the mainstream media?

DB: Yes, this is really kind of a joke. The banks got loans at way below market interest rates from the government, and we are supposed be grateful that they repaid the loans? The difference between the market interest rate and the rate they actually paid amounted to a huge subsidy. This is something that anyone with even a passing familiarity with business or economics would recognize, which is why it is so insulting when political figures go around yapping about how the money was repaid with interest.

To see this point, suppose the government gives me a 30-year mortgage at 1 percent interest. If I make all my payments and pay off the mortgage has the government made money? By the logic of the politicians claiming that we profited by the bailout, the answer is yes.

A serious assessment would look at what the market rate for these loans was at the time they were made. To take one example, just before we lent $5 billion to Goldman through TARP, Warren Buffet lent $5 billion himself. He got twice the interest and a much more generous deal on warrants. Plus he knows that it was likely that the government would bail out Goldman if it got in trouble.

Elizabeth Warren commissioned a study of the implicit subsidies in the bailouts when she was head of the TARP oversight panel. As I recall, it came to over $100 billion on just the first batch of TARP loans to the large banks. This didn’t count the value of later TARP lending, the much larger lending programs from the Fed, nor the extensive set of guarantees provided by the Fed, Treasury, and the FDIC.

All of these commitments involved enormous subsidies. In the business world firms pay huge amounts of money if they want their debt to be guaranteed. And everyone understands that a below market loan is essentially a gift. That is why it is so insulting when they try to imply that the public has profited from these loans.

You can make the argument that it was good policy to subsidize the financial industry to get through the crisis, but to pretend that we did not subsidize them is just dishonest.

Incidentally, the reforms Baker suggests are similar to those recently suggested by Rolling Stone‘s Matt Taibbi as a starting point for the Occupy Wall Street protesters. More on those later.

 

Thomas Hoenig (“Too Big Has Failed”) tapped for FDIC

Kansas City Federal Reserve Bank President Thomas Hoenig was my favorite recent member of the Federal Open Market Committee, mainly for his outspoken and eloquent criticism of the “too big to fail” policy. I’ve written about his ideas a few times, including here. So now that the Kansas City Fed’s rotating term on the FOMC has come to an end, it’s good to see that President Obama has nominated Hoenig to be Vice Chairman of the Board of Directors of the Federal Deposit Insurance Corporation (FDIC).

Hoenig’s views are summed up in this quote from the article: “We must make sure that large financial organizations are not in position to hold the U.S. economy hostage. We must break up the largest banks.” His March 2009 speech “Too Big Has Failed” lays it out in detail.

Now, I have no idea how much policy-shaping ability the vice chairman of the board of directors of the FDIC has, and Hoenig himself has said the FDIC still lacks adequate resolution-authority powers for closing big bank holding companies, but I’ll be glad to have him back in the loop. Assuming that Senate Republicans don’t block his nomination for one reason or another.

Exiled From Main St. / Start Breaking Up

Thomas Hoenig, president of the Kansas City Fed and one of the most incisive critics of the “too big to fail” policy, has an op-ed in today’s NYT about the current financial reform bill before Congress.  He says it does far too little to end “too big to fail” — while it sets up a mechanism for big failing financial institutions to be put under FDIC receivership, those financial institutions would still have the political clout to snag a bailout instead.

This may be true, but it seems to be a drawback in any financial reform bill that doesn’t call for the biggest financial institutions to be broken up into smaller ones that are not too big to fail, i.e., which can go bankrupt without significant systemic risk to the economy.  Koenig has spoken elsewhere on the need to break up the biggest banks.  It’s a position that finds favor among many liberal economists,including James Kwak of the Baseline Scenario (see previous link).  Rep. Paul Kanjorski of Scranton, PA has proposed an amendment to give the government power to preemptively break up any financial institution whose failure would impose giant costs on the U.S. economy, but the Senate Banking Committee apparently has nothing like that on the table yet.  Alas, the political clout of the big banks may well be enough to make bank size restrictions a non-starter in the Senate.  Simon Johnson of The Baseline Scenario says much the same thing here.

Hoenig says that another provision of the bill actually makes things worse by narrowing the Fed’s supervisory role to just the nation’s 12 largest banks, most of which are headquartered in NYC.  I do not know what the logic of this provision is, and Hoenig doesn’t say; maybe the idea is for the other banks to be supervised by the FDIC and/or other agencies instead.  Whatever it is, Hoenig thinks the Fed needs to give just as much attention to the other 6,700 as to the top 12.  As he points out, that would seem to be the whole point of having 11 regional Fed banks besides the one in New York.

UPDATE:  Simon Johnson puts it a lot more plainly right here.  For the record, Paul Krugman has his doubts that breaking up the banks would help much — see the last three paragraphs of this recent column.  I’m with Simon Johnson here.  By all means, crack down on fraudulent finance at institutions large and small, but I don’t see how you limit the power of the big banks without limiting their size, too.

Well, it’s a start

Two of the most odious contributors to the financial crisis were the government’s too-big-to-fail policy and the brazenness of many financial institutions, including the credit rating agencies, in helping to disguise and then market so many garbage securities.  So two of this week’s developments look like good news, however small:

(1) The federal government refused a second bailout for The CIT Group. (You can read about their first bailout, last December for $2.3 billion, here.)  CIT is expected to file for bankruptcy, which isn’t great news, as CIT is the largest lender to small businesses and some of that lending may stop, and as the government/taxpayers’ $2.3 billion stake gets wiped out. But it may be the lesser of two evils.  As the WSJ points out, CIT is only one-tenth the size of Lehman Brothers,and the systemic risk in refusing this request seems much less than the moral hazard risk of granting it.  (I must admit, the WSJ does seem to have the best conservative editorial page in the business. Not that that’s my highest compliment.)

(2) Calpers, the largest pension fund in California, is suing the three leading credit rating agencies for providing “wildly inaccurate” AAA ratings of structured investment vehicles (SIVs) of various dodgy assets including subprime mortage-backed securities. The amount of the suit wasn’t disclosed, but Calpers bought $1.3 billion of bad SIVs in 2006, so that’s a good lower-bound estimate. While market discipline would be preferable to billion-dollar lawsuits, that horse escaped from the barn a long time ago. This is the first I’ve heard of anyone holding these agencies accountable.

Still too big to fail

. . . and too big to regulate.  JP Morgan Chase, Goldman Sachs, Morgan Stanley, and seven other megabanks got permission from the Obama Administration to repay their combined $68 billion in TARP debt to the government.  The government made a profit on the loans, and the banks are now out from the under the thumb of the TARP restrictions on executive pay and hiring.  Win-win, right?

Well, no, not for the taxpayers who are still implicitly on the hook for these ten behemoths should anything go wrong.  They are no more regulated than they were before the crisis, and there is no FDIC-like resolution system in place that would allow for the orderly failure of these financial supermarkets should they become insolvent (again?).   It would be rational for their managers to conclude that the institutions are still “too big to fail” and to return to reckless decision-making a la “heads I win, tails the taxpayers lose.”  Today’s Financial Times has an excellent editorial on the matter.   Wish I’d written it myself; the next best thing is to cut and paste most of it here:

Stats of the day

64%

= percent of U.S. bank assets controlled by the four largest commercial banks (JPMorgan Chase, Citigroup, Bank of America, Wells Fargo; source: Martin Wolf in the FT).  That four-firm concentration ratio is up sharply from 39% in Feb. 2003 (source: Frederic Mishkin’s money and banking textbook, ~2004 edition).

$2.7 million

= money received by Obama chief economist Larry Summers for 40 speaking appearances before bailout-receiving Wall Street financial institutions in 2008.   Now, Summers is a brilliant man with lots of policy experience to share, but how likely is it that these cash-strapped firms were paying just for his insights and not even trying to buy access to Obama’s top economic adviser?  The White House would have us believe that access had nothing to do with it:

‘A White House spokesman, Ben LaBolt, said the compensation was not a conflict for Mr. Summers, adding it was not surprising because he was “widely recognized as one of the country’s most distinguished economists.”’

Some have already called for breaking up the biggest financial institutions, to the point where none of the ones remaining are “too big to fail,” and then letting market discipline or effective regulation keep them in line.  All well and good, but these stats, especially the last two, recall the original 19th century rationale for antitrust action:  The biggest firms just have too much political power.  Small is not only beautiful, but small firms are less likely to be writing the laws of the land.

Geithner 3.0: What a difference a day makes

This is the most sensible thing I’ve heard from him yet — a proposal for FDIC-type powers for the government to temporarily take over too-big-but-failing-anyway financial institutions like AIG, clean house, and sell off their remaining assets.   I once thought the FDIC already had those powers, but apparently that’s so only for regular commercial banks, not bank holding companies or other financial Goliaths.   (FDIC Chairperson Sheila Bair explains it here.)

The new proposal doesn’t necessarily conflict with anything in yesterday’s plan to subsidize the worst financial institutions by overpaying for their worst assets, but it does suggest that the Obama Administration really does have plans to regulate them and is not kidding itself (Pollyannish recent rhetoric  to the contrary) that all of them are fundamentally sound.

The agony of AIG: Time to educate myself

“Zombie insurance company” doesn’t exactly roll off the tongue, does it?  We shall work on a suitable epithet.

As usual, Joe Nocera of the NYT offers pith and insight into the AIG mess.

And Yves Smith at Naked Capitalism offers some sophisticated outrage.  I’m a big believer in the concept of the enlightened rant, which may be why NakedCapitalism.com is among my daily visits.

So far, my summary understanding of the AIG mess is something like this:  The company diligently acquired a AAA credit rating and then recklessly exploited it by selling “naked” (unhedged, no offsetting position) credit-default-swaps to anyone and everyone.  Unlike the failing banks, AIG wasn’t directly involved in the subprime securities business, but their problems became AIG’s problems when many of them began defaulting on their obligations — obligations which were insured by . . .  AIG.  So now AIG also has obligations that no honest financial institution can pay.  And because AIG is one of the world’s largest corporations, it accounts for huge chunks of many institutions’ stock and bond/loan portfolios.  “Too big to fail,” blah blah blah.

To be updated with more links . . .

Two disgraced but insightful peas in a pod?

I couldn’t resist posting these two items together:

Henry Blodget, the disgraced former equity analyst for Oppenheimer, busted by then-New York Attorney General Eliot Spitzer and the U.S. Securities and Exchange Commission for securities fraud, has a compelling, thought-provoking essay in the December 2008 Atlantic, titled “Why Wall Street Always Blows It.” To be sure, it’s often self-serving, especially his claim that we’re all guilty, not just financial professionals (shades of those great scenes on “The Simpsons” when Homer, after totally screwing everything up, says, “Now let’s not play the blame game”).  But it’s informative just the same, and a good read too.  I thought his point about a larger credit bubble was well taken:

“Why did the housing bubble follow the tech bubble so closely? Because both were really just parts of a larger credit bubble, which had been building since the late 1980s. That bubble didn’t deflate after the 2000 crash, in part thanks to Greenspan’s attempts to save the economy.”

Spitzer, the more recently disgraced former New York Attorney General-turned-Governor, has begun his rehabilitation just as Blodget did:  by writing a column for the online magazine Slate.  Spitzer’s first column is a critical look at the financial industry bailouts, which he sees as cascading from excessive consolidation in the industry, to the point where so many financial institutions become “too big to fail” that policymakers have almost no choice but to perform these lavish bailouts when things go bad.  It’s an interesting point, a bit different from the usual point about excessive deregulation, as the banking industry had been consolidating well before the Gramm-Leach-Bliley deregulation of 1998.  But I don’t buy Spitzer’s conclusion that antitrust action to break up the big banks is needed.  There do seem to be significant economies of scale in banking; I think it’s no coincidence that the banking industry is also highly concentrated, in fact more so, in the European social democracies.

(modified a bit on 18 December 2008 )