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Bill Black: Brown-Vitter Will Not and Cannot Work but it is Criminogenic

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Yves here. Like Black, I see Brown-Vitter as well-intended but seriously flawed. One of my big concerns is that it does not deal with the real driver of systemic risk, which is tight coupling. Per Richard Bookstaber, our financial system is “tightly coupled” and in tightly coupled systems, risk reduction measures (which too often look at risks in isolation) will typically have the perverse effect of increasing risks. As he explained:

Tight coupling is a term I have borrowed from systems engineering. A tightly coupled process progresses from one stage to the next with no opportunity to intervene. If things are moving out of control, you can’t pull an emergency lever and stop the process while a committee convenes to analyze the situation. Examples of tightly coupled processes include a space shuttle launch, a nuclear power plant moving toward criticality and even something as prosaic as bread baking.

In financial markets tight coupling comes from the feedback between mechanistic trading, price changes and subsequent trading based on the price changes. The mechanistic trading can result from a computer-based program or contractual requirements to reduce leverage when things turn bad.

Some of the biggest drivers of tight coupling in our financial system are over the counter derivatives and credit default swaps. No one would have deemed Bear to be a systemically important play in 2006, but its big credit default swap exposures meant the powers that be were afraid to let it fail.

And as Bookstaber warned, if you try to reduce risk in a tightly coupled system without reducing the overconnectedness first, you make matters worse. Unfortunately, this is the that Brown-Vitter and most “reform” measures to date have taken.

By Bill Black, the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. Cross posed from New Economic Perspectivesa>

Introduction

Senators Sherrod Brown (D-OH) and David Vitter (R-LA) have introduced a bill entitled “Terminating Bailouts for Taxpayer Fairness Act of 2013.” It is a miracle of modern staffing that Vitter, who loves polluters as much as his prostitutes, was able to pull himself away from demanding that President Obama’s nominee to run the EPA answer over 600 questions and join Brown in proposing the bill. Under Obama, bipartisan bills have a dismal fate because the Democrats negotiate away key elements necessary to create a good bill and add provisions that make parts of the bill harmful – just to pick up a few token co-sponsors – and then the Republicans kill good parts of the bill anyway and try to enact the bad parts.

Brown-Vitter (BV) exemplifies all three problems. It would fail to achieve its desirable goals even if it became law. It would help the largest fraudulent banks continue to cripple effective examination. The Republicans will kill the well-meaning parts of the bill and try to enact the bad parts of the bill that are so bad that they are criminogenic.

One of the most essential actions we need to take is to eliminate systemically dangerous institutions (SDIs) (the rough dividing line is any bank with > $50B in liabilities). Dodd-Frank did nothing effective to end SDIs. So BV could be a sensible, even vital reform if it were drafted to end SDIs and if it were enacted. It was not drafted to end SDIs and it will be weakened before it is killed.

BV’s harmful provisions, by contrast, will likely be made worse by amendments. Those harmful provisions may become law.

BV Enshrines Rather than Ends SDIs

The concept of SDIs is that their failures are likely to cause a global, systemic crisis. This is why the “too big to fail” (TBTF) concept developed. TBTF, however, was historically a misnomer. TBTF banks failed in America. The FDIC, however, ensured that when TBTF banks failed their general creditors did not suffer losses. The equity holders and subordinated debt holders were normally wiped out when a TBTF bank failed. The regulatory concern was that if general creditors of an SDI suffered losses when the SDI failed it could cause a “cascade” of bank failures because the SDIs’ largest general creditors are typically other banks.

SDIs create three disastrous problems, any one of which should have been sufficient decades ago to convince Congress to get rid of SDIs.

1. SDI’s make a mockery of the phrase “free markets.” The metaphor that a group of conservative NYU scholars use to describe the competitive advantage that the implicit subsidy that arises from bailing out the general creditors provides to SDIs is that it is like “bringing a gun to knife fight.”
2. SDI failures risk causing global financial crises.
3. SDIs create so much economic power that it inherently translates into dominant political power and cripples our democracy by creating crony capitalism

SDIs also create no desirable advantages. SDIs are so large that they are impossible to manage or regulate effectively. They are inefficient as well as dangerous. We have a classic win-win available. We can make banks more efficient and far less dangerous by getting rid of SDIs.

BV goes off track from the beginning because it does not try to get rid of SDIs. Brown and Vitter’s comments about their bill make clear that they agree about the first two disastrous problems caused by SDIs.

“The truth, according to the markets, is that ‘too big to fail’ is alive and well with the Wall Street megabanks,” Vitter said. “Our number one goal is to protect the taxpayers from financial risks and the best way to do this is by implementing a systemic solution, increasing the minimum amount of capital the mega banks are required to have.”

BV Does Not Get Rid of the SDIs

The first problem with BV is so obvious that the fact that it ignored by the media (and by Brown and Vitter) tells us that SDIs have so insinuated themselves into our psyches that even reformers cannot conceive of a world free of what Brown and Vitter describe as the scourge of SDIs. If their “number one goal” is protect us from SDIs, why don’t Brown and Vitter get rid of the SDIs?

This is how Brown and Vitter began the press release announcing the BV bill.

WASHINGTON, D.C. – U.S. Sens. Sherrod Brown (D-OH) and David Vitter (R-LA) announced a new plan that would prevent any one financial institution from becoming so large and overleveraged that it could put our economy on the brink of collapse or trigger the need for a federal bailout.

BV does not do any of things the sponsors claim in this sentence. The SDIs are already large enough that they pose a global systemic risk when they fail. BV does not limit the size of the SDIs or prevent them from growing. Fraudulent SDIs can be massively overleveraged under BV. BV does not eliminate the need for federal bailouts.

Higher Capital Requirements Could Not Make SDIs Safe

Higher capital requirements cannot protect us from the three disasters that SDIs cause. Brown and Vitter’s explanation for their bill contains this telling fact.

Prior to the crisis, Lehman Brothers ostensibly had a capital ratio of 11 percent, yet its assets were sold in bankruptcy for nine cents on the dollar.

Brown and Vitter do Not Understand “Capital,” Accounting, or Fraud

Brown and Vitter do not understand the import of the facts of Lehman’s failure. “Capital” is merely an accounting residual: assets – liabilities = capital. Accounting control frauds like Lehman (see my House testimony for details) massively overstate asset values. Frauds also use many scams to dramatically understate liabilities. (Lehman used an accounting scam to substantially understate its debt levels.) There are also scams that directly create fictional capital. See my description in earlier articles of the Icelandic banks’ scams in which they lent money to their shareholders to buy their shares.

Brown and Vitter do not understand the ephemeral nature of capital. “Capital requirements will focus on common equity and other pure, loss-absorbing forms of capital.” Brown and Vitter’s conception that capital can be something that is “pure” and can be counted on to be there when the bank fails to “absorb” “loss” is a dangerous delusion that demonstrates that Brown and Vitter do not understand the most basic and critical concepts of finance, accounting, and regulation. They seem to believe that there is some vault in a bank that holds “capital” and that there is “pure” capital that will remain in the “pure” “capital” vault even after the bank is looted. It is dangerous to believe in such absurd myths.

Brown and Vitter have forgotten recent history, when Congress successfully extorted the Financial Accounting Standards Board (FASB), demanding that they change generally accepted accounting principles (GAAP) so that the largest banks would not have to recognize their massive losses on their loans and toxic derivatives. That accounting travesty remains the rule today, which means that we have systematically overstated bank asset values – which means that we systematically overstate bank capital. Brown and Vitter propose no change to end this travesty. Instead they spread fantasies about “pure” capital.

Brown and Vitter Ignore the Real Problem: Accounting Control Fraud

Lehman provides a chilling example of how much fictional capital an accounting control fraud can create – and how much damage the controlling officers can do by looting “their” firms. George Akerlof and Paul Romer described these frauds in their 1993 article (“Looting: The Economic Underworld of Bankruptcy for Profit”). I assume for the purposes of analysis the accuracy of Vitter’s claim that Lehman’s asset valuations were overstated by 91 cents on the dollar. At the same time that it was reporting an 11% (positive) capital level its real capital level was in the range of a (negative) 85%.

Lehman could, easily, have reported that it met the 15% capital requirement that BV proposes for “megabanks.” It would have required a few more scam deals, and that would have increased Lehman’s losses. Brown and Vitter show no signs of understanding the basics of accounting control fraud. Here is the fraud “recipe” for officers controlling a lender.

1. Grow like crazy by
2. Making really crappy loans at a premium yield, while
3. Employing extreme leverage, and
4. Providing only grossly inadequate allowances for loan and lease losses (ALLL)

Akerlof and Romer agreed with the conclusion of regulators and criminologists that this recipe produces a series of “sure things.” The lender is guaranteed to report record (albeit fictional) profits in the short-run, the controlling officers will promptly be made wealthy by modern executive compensation, and the lender will eventually suffer catastrophic losses. The officers who control a bank and use it as a “weapon” to defraud can easily produce vast amounts of fictional profits that can (partially) be retained so that they produce very high levels of reported capital. A higher capital requirement can slow down a fraud by reducing growth and leverage, but it will not prevent catastrophic losses and, if many controlling officers follow the same strategy, a hyper-inflated bubble that can produce a systemic crisis.

Accounting control frauds are exceptionally adept at suborning the “independent” “professionals” who value assets and liabilities. The fraudulent controlling officers deliberately create a “Gresham’s dynamic” that drives good ethics out of key positions in the professions. Lehman had no difficulty getting a subset of appraisers to overstate home prices and auditors to “bless” even their massively over-valued assets and its preposterously inadequate ALLL. Again, anyone who thinks there is “pure” capital has to believe in “pure” asset and liability valuations. I had not thought, after this crisis, that anyone still believed such a myth, but then came BV. The bottom line conclusion is that BV will fail at precisely the banks where success is most essential – the accounting control frauds. As a group of conservative finance professors were recently forced to conclude as a result of their study, during the recent crisis fraud was “pervasive” at our “most reputable” banks.

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market. Tomasz Piskorski, Amit Seru & James Witkin (February 2013) (“PSW 2013”).

I have explained their results at some length in a prior article.

The national commission that investigated the causes of the S&L debacle reported that at the “typical large failure” “fraud was invariably present.” The S&L frauds were control frauds. No one doubts that the Enron-era scandals were control frauds. Even conservative scholars that have investigated the most recent crisis have concluded that the SDIs engaged in “pervasive” fraud. The key folks who have not gotten the message about the need to deal with accounting control fraud if we wish to avoid future financial crises are Brown and Vitter. This passage, from their description of the BV bill reveals that they have implicitly assumed fraud out of existence.

Requiring the largest banks to fund themselves with more equity will provide them with a simple choice: they can either ensure they can weather the next crisis without a bailout or they become smaller.

No, there is another choice – a choice that the officers controlling the SDIs have often decided was their superior option – accounting control fraud. Fraud is a “sure thing,” and the C suites are filled with officers who love sure things. Again, notice that Brown and Vitter do not understand the import of Lehman’s massive overstatement of assets (and, therefore, capital) that they used as purportedly supporting the desirability of their bill. No capital requirement can “ensure” that a bank will not fail and will not be bailed out.

BV’s Dream of a Regulatory Fusion with Private Market Discipline

Brown and Vitter’s description of their bill contains this dream sequence.

Regulators may increase capital ratios as banks increase in size. Setting capital levels for the largest megabanks at levels required by the private market, absent government support, will ensure that they have an adequate cushion of equity in the event that the FDIC must put a megabank through orderly liquidation under Title II of Dodd-Frank.

This passage is another demonstration is that Brown and Vitter do not comprehend the importance of the Lehman fraud and the result catastrophic losses. Once more, they claim that their bill will “ensure” that we will never again have any expense when a “megabank” fails. How can they conceivably say that after Lehman’s failure? We need to go back to basic facts about finance. Lehman was an investment bank so it had no FDIC deposit insurance. Lehman was not treated as TBTF by the markets or the government. It was allowed to fail and its general creditors were not bailed out by the government.

Lehman was not treated by the markets as immune to failure. As a result, it purported to maintain a higher capital level (11%) than did most FDIC insured banks. But that higher reported capital level was a lie – an enormous lie by a grotesquely insolvent investment bank. Its reported capital level was chosen by its management “at levels required by the private market, absent government support.” The twin problems were that the reported capital level was a fiction and that “the private market” failed to spot for years the fact that Lehman was actually deeply insolvent. Lehman proves that one has to be delusional to believe that they can “ensure that they have an adequate cushion of equity” by setting a higher capital requirement. Congress’ role in successfully extorting FASB to hide real losses in order to overstate reported assets and capital also explains one of the several reasons BV cannot “ensure” the attainment of any of its stated goals.

BV Does Not Eliminate the Implicit Federal Subsidy that the Sponsors Decry

I explained why the acronym TBTF was a misnomer. TBTF banks have failed. It actually refers to bailing out the general creditors. Brown and Vitter explicitly criticize the “implicit federal subsidy” enjoyed by the SDIs because they can borrow more cheaply than their competitors. But a close reading of their press release reveals that Brown and Vitter think that the SDIs can borrow more cheaply because the government never permits them to fail. Brown and Vitter do not understand that the implicit subsidy arises because the government ensures when an SDI fails that its general creditors are bailed out. This explains why BV does not ban bailing out a SDI’s general creditors. BV, therefore, would not remove the implicit federal subsidy that SDIs enjoy.

BV Does Not Significantly Increase Capital Requirements for Most SDIs

Note that Vitter did not promise significantly higher capital requirements for SDIs. BV would not substantially increase the capital requirements of most SDIs. Note that Vitter has conflated TBTF with “megabanks.” Megabanks are an important subset of SDIs because their assets are so massive, but most SDIs do not meet the BV definition of “megabank” (assets > $500B). Again, the media has largely ignored this incredible failure by BV to require most SDIs to have substantially greater capital. Even if we were to assume, contrary to fact, that higher capital requirements removed the three disastrous consequences of SDIs, BV leaves a massive loophole. BV only begins to increase a SDIs capital requirement substantially when it attains a size roughly 10 times larger than the ($50B) threshold to become an SDI. BV redefines most SDI’s as “mid-size” and “regional” banks, but calling them that is a pure fig leaf. They are so large that they pose a systemic risk when they fail. BV’s eight percent capital requirement is essentially a return to the status quo before Basel II.

The Only Effective Means to Make Reported Capital Real is Vigorous Examination

I have noted that the officers running accounting control frauds find it easy to create Gresham’s dynamics that allow them to suborn appraisers and auditors who will bless massively inflated asset values while hiding real losses. A lender that follows the fraud recipe has will produce record (fictional) income and can produce very large amounts of (fictional) capital. These results are “sure things” under the fraud recipe. Creditors do not “discipline” accounting control frauds – they fund their growth. Creditors love to loan to firms reporting record profits.

Regulators are the only controls that the fraudulent CEO cannot hire and fire. Only skilled, vigorous examiners backed by tough supervisors have any hope of ensuring that reported bank capital bears any relationship to reality. Brown and Vitter do not appear to understand the import of the Financial Crisis Inquiry Commission’s (FCIC) key finding that the regulators failed to act because of the competition in regulatory laxity, the creation of regulatory black holes, and the regulators’ experience that it was impossible to get the political appointees running their agencies to take action against banks that were reporting high profits (FCIC 2011: 307). The key is for examiners to order banks to recognize losses on bad assets as soon as those assets are impaired – not when the default happens (which can be years later).

In the S&L debacle, we sent shock waves through the frauds when we targeted the S&Ls reporting the highest profits and growth as our top priority for investigation because they were the most likely to be fraudulent. It is essential that we return to that strategy by appointing real regulators.

BV is Criminogenic: It Would Eviscerate Vigorous Examination

Many influential officials try to impair vigorous regulation, which always starts with vigorous examinations. In the S&L debacle, the Reagan administration tried to give the most notorious S&L CEO, Charles Keating (who ran Lincoln Savings), control of the federal agency regulating S&Ls. I blew the whistle on this effort, which led to the resignation in disgrace of one of our three presidential appointees running our agency. A majority of the House co-sponsored a resolution calling on us not to go forward with reregulating the industry. Speaker Wright held the bill to recapitalize the FSLIC insurance fund (so that we would have the funds to close more control frauds) hostage to extort favors for Texas control frauds. Senator Cranston put a secret hold on the same bill at Keating’s behest. Keating used Alan Greenspan as a lobbyist to help recruit the five U.S. Senators who would become known as the “Keating Five” when my notes of the meeting were made public.

OMB threatened to make a criminal referral against the head of our agency, Edwin Gray, on the grounds that he was closing too many insolvent S&Ls. Yes, you read that sentence correctly.

The top guy in Treasury for S&L policy testified against our agency in the challenge to the appointment of a receiver of an insolvent S&L. He opined that it was “arbitrary and capricious” to close S&Ls because they were insolvent. He also testified to Congress that we should simply run a Ponzi scheme by encouraging insolvent S&Ls to grow so that they could use the cash they obtained from deposit growth from new depositors to pay interest to existing depositors.

The Reagan administration and Speaker Wright made a cynical secret deal not to reappoint Gray to a new term. The administration appointed Danny Wall as Gray’s successor. Wall proceeded to meet Wright’s demand that we force out our top supervisor in Texas. Wright’s complaint was that he was gay, but everyone knew that Wright’s real complaint was that he was effective.

Wall immediately ordered an end to our examination and the enforcement investigation of Lincoln Savings. This was Keating’s primary demand because he knew that our examination and enforcement investigation had already discovered a number of his frauds and that his control over Lincoln Savings could not survive our continued examination and enforcement investigation. Wall then removed the jurisdiction of the agency’s San Francisco office over Lincoln Savings because we persisted in recommending a takeover of Lincoln Savings after the Keating Five tried to intervene to prevent us from taking action against Lincoln Savings’ massive violation of the law. This led to a disaster. Lincoln Savings became the most expensive S&L failure and defrauded thousands of widows.

The Texas state S&L commissioner was consorting with prostitutes provided by the Nation’s second worst financial fraud, Vernon Savings (known as “Vermin” to its regulators). The California state S&L commissioner was secretly in business with Keating. The Texas Attorney General announced he was investigating us for discrimination against Texas S&Ls, particularly in our examination process. A couple days later he announced we were guilty without any cumbersome investigation to slow him down.

The COO of one the S&L our San Francisco office regulated threatened our examiner-in-charge. The FBI informed us that organized crime controlled the S&L.

Keating hired private counsel who had recently left a senior position at the Department of Justice (DOJ). They contacted William Weld, one of the most senior DOJ officials. Within days, the FBI was investigating us (the San Francisco office of the federal regulatory agency), rather than Keating.

Keating twice hired private investigators to investigate me. He sued me and a number of regulators, for $400 million in our individual capacities (in a Bivens suit). Keating boasted of spending $50 million to attack our examination report of Lincoln Savings. Keating infamously put in writing his directive to his chief political fixer that his “highest priority” should be to “Get Black … Kill Him Dead.” Keating also created what became known as “the secret file” that supposedly had derogatory information on me and gave it to senior officials of our agency. They refused allow me to read and respond to the file. When I persisted, they gave the file back to Keating to prevent me from getting access to the file.

I note these things to explain several points that are essential to understand about BV. First, regulation can succeed. It is only now, with the experience of the current crisis where effective regulation and regulators were deliberately targeted for removal that we can see that Chairman Gray’s actions in promptly reregulating the industry saved many trillions of dollars by containing a surging epidemic of accounting control fraud in the 1980s. We can also see that our actions in driving liar’s loans out of the S&L industry in 1990-1991 prevented a crisis that also would have cost trillions of dollars to resolve absent effective regulation.

Second, the key is regulatory professionalism, knowledge of accounting control fraud techniques, vigor, and resoluteness. Pushback is inevitable and violent. The accounting control frauds cultivate powerful political allies.

Third, the examination process is the key value that a financial regulatory agency adds. Good examiners do not wait for the assets to blow up in massive defaults. They spot impaired loans early and they spot accounting control fraud schemes early. It is then incumbent on the agency’s leadership to back up the examiners with prompt, vigorous supervision, enforcement, receiverships, and criminal referrals. Akerlof and Romer examined a large amount of materials from our examiners and came to this key insight.

Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself. (George Akerlof & Paul Romer.1993: 60).

Fourth, the frauds recognize that the examinations are the key and their effort is always to impair the examination and the ability of supervisors to require prompt corrective action on the basis of the examinations. I mentioned Speaker Wright holding the FSLIC recapitalization bill hostage. The broader story is that the Texas control frauds hijacked the bill and festooned it with “forbearance” provisions designed to allow the frauds to stall the exams and vital supervisory actions.

Fifth, the destruction of effective examination as a result of some of these forbearance provisions and the regulatory race to the bottom proved disastrous during the most recent crisis. Restoring effective financial examination and supervision (and criminal prosecutions) should be a national priority.

Sixth, instead, BV, as introduced, is designed to further impair examination. The Senators’ description of this portion of the bill is disturbingly disingenuous.

Provide regulatory relief for community banks. By reducing regulatory burdens upon community banks, they can better compete with mega institutions. Because community institutions do not have large compliance departments like Wall Street institutions, this legislation provides commonsense measures to lessen the load on our local banks….

• Creates an independent bank examiner ombudsman that institutions can appeal to if they feel that they have been treated unfairly by their examiner.

This provision, however, is not limited to “community” (very small) banks. Creating an ombudsman for examination will be a godsend to fraudulent SDIs. Keating ran a $6 billion S&L – and spent $50 million attacking a single examination (roughly our entire budget for a region regulating hundreds of S&Ls). Wait till JP Morgan decides to fight an examination. It will be able to stall the examiners and supervisors for years. The SDIs will hire away the Ombudsman, assuming he sides with the industry, and give him a wonderful sinecure (“revolving door”). The SDIs will lobby to try to ensure that the person selected as Ombudsman is hostile to effective regulation.

Incredibly, BV recreates the worst of Keating’s abuses.

(e) CONFIDENTIALITY.—The Ombudsman shall keep confidential all meetings, discussions, and information provided by financial institutions.

Yes, Keating’s secret files will now become National policy. The bank gets to make ex parte presentations in person and writing with the Ombudsman – who is forbidden by statute from informing the regulatory agency of the charges and giving the examiner and the agency an opportunity to respond. Then, on the basis of ex parte smears, the Ombudsman can issue a report condemning the examiner or the agency.

BV’s Anti-Examination Provisions Will Get Far Worse via Amendment

The grave danger is that one portion of BV will become law – the provisions that will be drafted by the fraudulent SDIs’ lawyer/lobbyists that will expand the assault on any effort to restore what is already a crippled examination process. This is what happened when Speaker Wright was extorting us in 1986-1987. It was only a bit of clever amending by us with the invaluable aid of Representatives Jim Leach and Henry B. Gonzalez that saved the Nation from disaster. I mentioned the cynical deal that the Reagan administration reached with Speaker Wright. The administration promised two things as part of the deal. It would not reappoint Ed Gray as chairman of the regulatory agency and it would not opposed the “forbearance” provisions that the control frauds’ lawyers had drafted to make effective examination and supervision impossible.

Where Does the Obama Administration Stand?

Will the Obama administration oppose this travesty of a bill posing as a reform aimed at the SDIs that would actually be a great boon to the SDIs because they could use it to assure that examination remains impotent? Will the Obama administration support a clean bill with the three provisions below?

1. No SDI may grow
2. All SDIs must shrink within five years to below $50 billion ($2013) in assets
3. All SDIs will be subject to stringent examination and supervision during that five year divestment period

And will the Obama administration appoint regulatory leaders who will actually vigorously enforce the laws? I propose Michael Patriarca.

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45 comments

  1. Chris Engel

    A couple of thoughts and questions I had upon reading this:

    1. Brown-Vitter alternative — are there any sensible lobbyists or consultants (I don’t know if Dr. Black or others are involved in the private sector in this way?) that can help write a proper layout for reform? Maybe NC and NEP and others can “crowd source” a “people’s SDI/financial institution accounting control fraud reform bill” that would get down the key points and details of what we really need for regulatory overhaul (per experts like Dr. Black and others).

    1) Role of accounting standards in capital requirement — “capital” in the general sense is an accounting fiction that can be inflated by over-stating assets, but there are of course tiers of capital that can be separated off so it’s more than just the difference between assets and liabilities. BUT — what role do lax accounting standards play in this? I’m not well-versed enough on the topic, but Isn’t a big part of the problem that we don’t have consistent international accounting standards for how banks should be marking their asset values and how we can prevent this angle that enables the accounting control fraud by financial institutions? As Dr. Black says “it’s all about fraud”, I knew an actuary who said “it’s all about the accounting” and who actually blamed the entire financial crisis on bad accounting standards (I dont know how strong his thesis was or if it’s been explored in public).

    2) Arbitrary $50B cutoff — even if this is inflation-adjusted (and I am playing devil’s advocate a bit here) — won’t this reduce the competitiveness (again, sorry if this comes off as a bankster talking point, but it is somewhat of a legitimate concern) of American banks to finance major international deals (M&A, PE, LBO comes to mind as big notional loan business that could end up going to European…if not Chinese banks in the future). Has this “competitiveness” angle been explored? My first thought, and how I argue against this talking point with banker friends, is that hypothetically, couldn’t American banks work together to pool the loans to provide to a customer who needs serious juice? Say, if JPM and Citi wanted to finance a major Brazilian takeover of some Indian company but they were each limited with their current balance sheet to making $10 billion — but the client needs $20 billion — then the two American banks could still get the business by working together to finance it? To which they respond that it would be messy for US competitors to have to work together on deals and European competitors would be able to provide the $20 Bil on the spot and have a smoother transaction. So, how valid is the “competitiveness” talking point against limiting balance sheets of banks?

    1. financial matters

      These were some of the main points to me and mostly have to do with transparency and enforcement of the law. How can someone invest in a bank or most corporations now without a real full knowledge of their balance sheet? There is no effective advocate keeping senior management from these types of control frauds. Not to mention the lack of transparency on the huge derivative positions.

      “”Congress successfully extorted the Financial Accounting Standards Board (FASB), demanding that they change generally accepted accounting principles (GAAP) so that the largest banks would not have to recognize their massive losses on their loans and toxic derivatives. That accounting travesty remains the rule today, which means that we have systematically overstated bank asset values – which means that we systematically overstate bank capital.

      The officers who control a bank and use it as a “weapon” to defraud can easily produce vast amounts of fictional profits that can (partially) be retained so that they produce very high levels of reported capital.

      Regulators are the only controls that the fraudulent CEO cannot hire and fire.Only skilled, vigorous examiners backed by tough supervisors have any hope of ensuring that reported bank capital bears any relationship to reality.”"

  2. LucyLulu

    Dr. Black got it right in the beginning of his article. Neither the Democrats or the Republicans would pass legislation limiting the SDI’s to $50B in assets, or any other meaningful reform. What happened with background checks on gun control legislation should make it obvious to any doubters that money is the primary driver of legislation, not what voters want or what is most sensible. And now that the gun control money is beginning to overpower the NRA money, the legislation is being forecast to be revisited and possibly passed. The FIRE industry spent almost $500M in 2012 on lobbying. That doesn’t include campaign contributions. Can a citizens’ grassroots group be expected to compete with that kind of money?

    1. Chris Engel

      My mind is blown. That 500M figure is now burned into my psyche.

      Health and Energy are also roughly 500M each in lobbying efforts.

      Those kinds of general stats help put things in perspective. I sometimes read so deep into the issues that I forget how powerful the macro figures really frame it.

    2. profoundlogic

      Along the same lines, deluding ourselves into believing that tweaks to a broken system will cure the problem is an exercise in futility. It’s pretty obvious at this point that neither the Democratic or Republic parties give a rat’s ass about real democracy. They are both playing out the clock to the game’s undeniable outcome.

      1. Banger

        The deep tragedy that some of are unable to face is that you are right. As I keep repeating the tipping point has already passed some time ago. It is it late for reform. The totality of the political structure will not allow it. I wish that we’re not the case but it is. Efforts must be directed elsewhere if we want some kind of decent life. There are many great ideas out there and we can consider ourselves blessed that we still live in a richly creative culture–but the only way to create a scenario that would enable any sensible idea to be even considered is to fund and support alternative institutions and give up on wasting our time on any type of “reform” within the current political/economic structure. I am prepared to defend that contention against any argument anytime anyplace, in detail.

      2. Christina Marlowe

        There is one and only one solution to both the American and the entire Global problem of the thorough “financialization” of the Kleptocratic, Corporate-owned and Corporate-Run [Corporate Takeover] Fascist Dictatorships that have enthroned themselves to power. Though I have scant hope, here it is anyway:

        The CRIMINALS must be PROSECUTED for their CRIMES. Absolutely NOTHING will “change,” much LESS get “better” until and unless THAT happens. Indeed, if the CRIMINALS are ALLOWED to continue to PLUNDER, it will, in FACT, only get WORSE. MUCH WORSE.

        ALL criminals involved in these monstrous, reprehensible, PATHOLOGICAL financial CRIMES, which were clearly, totally and willfully collaborated as a gigantic Scheme to Defraud and totally BILK the very citizens of this, our country, the United States, and, um, the entire world, MUST PAY.

        Each one of these Criminals must be Indicted, Prosecuted to the fullest extent of THE NEW LAWS, (all of which will be made retroactive) and, finally, actually PUNISHED SEVERELY; Let me be perfectly clear: Each CRIMINAL that is found GUILTY in the Courts of Law, whether by a judicious Judge or by a Jury of his/her “peers,” shall be held fully accountable for their [blatant] CRIMES, and penalties will surely entail STIFF terms of imprisonment, along with the lawful SEIZURE of ALL ill-gotten gains.

        We all know, for example, that George Bush, Dick Cheney, OBAMA…that list goes on and on; And let’s not forget Ben Bernanke, Jamie Dimon, Lloyd Blankfein, Richard Fuld, Hank Paulson, Larry Sommers, Timothy Geithner, Alan Greenspan; And an astonishingly dizzying and countless number of all the other CRIMINALS; All should be on the TOP of the list for the vigorous investigations and thorough prosecutions.

        We MUST HOLD each of these Serial Predators/Criminals FULLY ACCOUNTABLE for their outrageous crimes of Fraud, Scheme to Defraud, Financial Elder Abuse, and countless other very serious Felonies.

        But that, of course, is my own pipe dream.

    3. Cynthia

      LucyLulu, you write,

      “the gun control money is beginning to overpower the NRA money.”

      Does this have anything to do with why the “sequestration” doesn’t cut back on the massive amount of ammo being purchased by the Department of Homeland Security?

    1. diptherio

      How about a guillotine that lops off anything bigger than $50B and some actual regulators. I suggest training some wrongfully foreclosed-upon homeowners in bank regulation…

      1. AbyNormal

        ” I suggest training some wrongfully foreclosed-upon homeowners in bank regulation…”

        wouldn’t that be RICH…i love the way you brainwaves swirl!

    2. Yves Smith Post author

      Grr, I wrote a long reply that got eaten.

      This bill focuses on banks qua banks. That’s really wrongheaded.

      1. So BofA spins off Merrill. Merrill and all the former major investment banks were TBTF and they became banks (either via acquisition, see Bear and Merrill, or having the Fed make them bank holding companies, see Goldman and Morgan Stanley). So breaking them up is insufficient as a solution. They are all critically linked to each other by counterparty exposures in the debt market (which has always been OTC) and the derivatives market (which was initially only exchange traded but the banks started pushing OTC products because they were more opaque and much more profitable; note swaps aren’t derivatives even though they are often lumped in with derivatives. CDS are really unregulated insurance contracts).

      2. Citi and JPM remain unresolvable. Citi has GTS (see here: http://www.nakedcapitalism.com/2011/01/sigtarp-on-citi-rescue-ignoring-a-bomb-that-has-yet-to-be-defused.html) and JPM clears tri-party repo. The Fed is not going to let any major clearing or custodial bank fail (that includes BoNY and State Street, BTW), They are too important to the financial infrastructure.

      3. A lot of the activity that BV intends to address can and likely will just migrate to insurers. BV does not provide for any capital charges on insurers. Oh, and Vitter was recently named Legislator of the Year by the mutual insurance industry.

      4. Black is right that without tough regulation, capital rules aren’t as meaningful as they seem because the banks have latitude in how they mark positions. Lehman is a classic example. They were so desperate to maintain the fiction that they had positive net worth that they had obvious monster overvaluations on stuff you could verify was way off, namely Archstone and SunCal. When firms are doing that, you know they’ve already pushed the valuations of the less visible stuff to the max and then some. Yet the financail media for the most part was taking the Lehman side in the heated debate over its financial health.

      5. This is US-based legislation. So it can’t cover foreign ops effectively (only holding co and US ops, that is why GTS is a problem). This does nothing to fix the problem of putting systemically disruptive activities in foreign subs (Citi booked its SIVs which were dollar products using US mortgage exposures in its London unit). Since banks have historically booked some dollar activity in foreign ops, I’m not certain the BV non-circumvention language would cover that (the banks could argue since they were doing that sort of thing pre BV, it’s not circumvention).

      6. The derivatives bills that just passed the House allow banks to put a 0 capital charge on inter-affiliate swaps. That would seem to conflict with BV.

      7. This does nothing about the real driver of systemic risk, tight coupling. One big reason is counterparties letting favored CPs get away with using too little collateral (Citi’s Phibro unit was an example) and the re-use of collateral (rehypothecation).

      BV will create the illusion that the systemic risk problem has been REALLY fixed, when even if it were implemented as written, it wouldn’t.

      1. Doug Terpstra

        David Vitter — banksters’ gigolo and patron of whores, is named [Prostitute] of the Year by the insurance industry. How apropos. That Sherrod Brown let Vitter put his scent on this says all we need to know about the intent of the bill, another insurance racket bailout.

  3. Banger

    The trouble with any reform bill is that if it is sensible it cannot be passed. Only bills that assure continue “money for nothing and chicks for free” of the most powerful interests can pass in this political situation. As Bill Black notes the bill we are discussing, as a practical matter, cannot be enforced. Black is very articulate in describing what regulators are up against. Though he doesn’t say this the mainstream is utterly complicit in presenting a totally false picture of reality–they do so knowingly and deliberately. Ther is today no chance that a career can be advanced in journalism by reporting the actual situation.

  4. Susan the other

    If we are going to have a banking system so critical to our survival as citizens then Professor Black is unquestionably correct about vigorous examination and regulation. But for decades now we have seen how they get away with it. His own argument here is telling us we need even more. Something there is that doesn’t like a regulation. In all seriousness, why do we even have any regulations at all? Because they cripple ordinary citizens, that’s why. Sounding like a libertarian here. So just think about Sheila Bair’s suggestion. She was being snarky but she was right. It would solve the whole “taxpayer” problem if every US citizen were entitled to a 10m line of credit at the Fed for .002% with which to invest or entrepreneur around. Let’s solve our own problem and let the banksters go take a flying leap. They’d all implode if every single regulation were suddenly pulled out from under them.

    1. profoundlogic

      Dramatic fail! Regulations don’t cripple ordinary people, but corruption and inequality in the application of regulation certainly do. And yes, this is one of the key failures of the Libertarian view. Markets are neither self-regulating or efficient when left unchecked. To argue otherwise is to ignore basic human nature.

      1. banger

        No markets must have regulations. But when regulations become complex beyond a certain point and are made by people who can and will profit from them they invite corruption which is exactly the situation we have today in all areas I know about–certainly in the federal gov’t which I know well. The regs are written to be gamed.

    2. banger

      I like what you say but, even more, the spirit of what you are saying. One of the chief faults of our time is a failure of the imagination–a notion that “there is no alternative” which is absurd. The path most people follow is the path of fear and, increasingly, loathing.

      I believe we have gone beyond the tipping point and that any regulation is probably worse than nothing. Everything has been thoroughly gamed and the more complex the regulation the more it can be gamed and will be gamed because those writing the regs are dominated by the very people they are regulating who, currently, are scofflaws in spirit if not in the letter.

      1. Susan the other

        Yes, Banger. It’s like nobody ever diagnoses the genesis of a problem, only the symptoms. Your arm has gangrene so let’s amputate it up to about here, OK?

  5. allcoppedout

    I not inclined to the coupling metaphor – more like a house of cards and system soft spots. The ideal of loose coupling and high cohesion always appeal in business process analysis but one has to remember flexibility in bridges can be a good thing but fatal for inventory costs in. Systems theories rely on one looking at like systems. We might do better with an ecology-based model – for some reason I associate banks with life-cycles that rely on hippos – or more to the point their dung.

    Bill’s long-made point that crooks will run a crooked system is well taken here. I’m watching ‘Kind Hearts and Coronets’ (1941?) and even that contains a line on banks supposedly supporting productive investment and not speculative gambling. The overdraft concerned is renewed because it really supports the banker’s mistress. Looking back at my own time in commercial fraud, I’d have to say the small fish I reeled in always claimed to be doing no more than the big city boys. I didn’t believe them then, but I do now – the regret not a single arrest.
    Criminal systems are often resilient – one can think of many – from the vile loan sharking in Indian farming (245,000 suicides in 10 years) to Ponzi schemes that have not gone critical, drug, child abuse and prostitution rings – one finds they build in all sorts of protections against failure. One classic is that the real books are never the published ones, but much criminality shifts historically – the current offshore financial looting system looks a lot like smuggling (tax evasion) and piracy funded by joint stock venture.
    Amongst thieves one often has to wait or engineer a falling out to create soft spots. What they legislators seem to want to build-in is the ability to lie about the organisation’s liquidity and solvency – many managers lie about this in attempts (often successful) to evade bankruptcy or equity dilution in hard parts of the business cycle.

    It’s hard to believe the UK will do anything other than maintain its place in the race to the bottom. I’m not sure Bill makes enough modelling sense of the criminality for me – I’m sure crimogenic modelling is appropriate and pretty sure we have a co-evolutionary arms race and complex life-cycle of a parasite at work. There are parallels to Soviet production planning and reporting too (no real product other than the target report).

    Most of us must be at least worrying by now that government has been bailing out the crooks and the system is so corrupt there seems no one left to trust. We have a police station like this at Killingbeck in West Yorkshire – probably a national crisis in police regulation. This situation has been achieved by light-touch regulation too (in a vicious spiral over many years of failing to allow civilian decision making on complaints).

    The building-in of criminal potential through self-regulation and false-accounting-made-legal runs through many different types of organisation. We should be able to model this accurately. When a tight-coupled system gets flexible it’s usually a sign to get the spanners out and tighten some nuts (hopeless advice if programming, good if maintaining a bridge). The human body and society, magnificently flexible in some situations, are tightly-coupled under contagious attack. Criminality can provide flexibility and be paralyzing corruption. Some diseases make you feel a bit better to start with before the misery takes over.

    As a true Brit (actually I’d rather be Norwegian) I should encourage the US to appoint Bill Black as the Serpico of Wall Street – and encourage City of London piracy to take advantage! One wonders how the Dons ever manage criminal territories in ‘peace’! It seems impossible for a country to come out of the closet and declare itself straight (other than in routine lying).

    I think the ultimate con may be deeper than we dare think (we have a chief constable here under suspicion of fencing stolen platinum wire, cops losing evidence against themselves everywhere – but dare we think the 43 police forces in England and Wales are fundamentally corrupt?). I think the con is making us believe we need banking at all. It could be a machine by now.

    1. Jackrabbit

      I think the con is making us believe we need banking at all.

      Yves has suggested making basic banking into a public utility.

  6. Jackrabbit

    It seems to me that Dodd-Frank has already enshrined TBTF.

    My sense is that we are beyond the event horizon with respect to political influence and regulatory control. It seems that Black fought against bad apples — some of which had political connections (like Keating). How do we (the public) and regulators tackle control fraudsters that make claims of ‘industry practice’ AND have substantial, pervasive political cover?

    Although I haven’t read BV, I was hopeful that it would help by pitting one set of powerful interests against another. The objections and attacks on BV from TBTF Banks seemed to support this view.

    ===

    Black’s descriptions of the maneuvering of politically connected fraudsters is gripping.

    I wish Black had discussed moral hazard.

  7. Johnny Fraudclosure

    If we conside the problem of regulation in the context of a misuse of information technology, solutions might seem clearer. Transparency, or a lack there of is described as a problem. By way of example – when users are “regulated” on Nak’ed Cap, a thoughtful system blocks problematic content, ideally while an operator is asleep….How difficult would it be to mandate the use of open systems to eliminate control fraud? Aside from industry screams of resistance to the idea, lawmakers might have an easier time of lawmaking if good design prevents abuse or fraud to begin with. This also reduces the problems with lawmakers who appear to be bought off.

  8. Gerard Pierce

    The article is OK, as far as it goes. But it fails to identify the US Congress as the most significant “systemically dangerous institution”.

    1. psychohistorian

      I beg to differ with your focus.

      The congress critters are puppets enshrined by the inherited rich plutocracy. Get rid of the current crew and more will be enshrined.

      It is time to put a lid on inheritance so folks can’t buy governments any more.

  9. traveler

    I’m not buying the ‘well-intentioned’ part. The authors of this bill aren’t idiots. They apparently lack the expertise to craft effective legislation in this area (understandable, forgiveable) but had ready access to those who do. Are they that blissfully unaware of their own limitations?

    1. traveler

      At best BV is diversionary and a waste of time and money. Sounds like it could have worse consequences, however.

  10. Paul Tioxon

    Transnational flows of capital represented by the SDIs, can not be ring fenced by national legislation. The nation state and its laws stop at the border. The Pentagon has achieved transnational status commensurate with its hegemonic mission per The National Security Act of 1947 and its subsequent amendments and ancillary empowering within The Black Budget. If there were any similar way to get rid of SDIs, the US economy would have institutions with the same hegemonic dominance possessed by its military. The US military goes almost anywhere, so that now, it is beyond the conception of any American used to the idea of being stationed outside the US on military assignment, to ever dream of the Chinese People’s Army doing likewise to us. A German military base on American soil with 10,000 soldiers in uniform? Not outside of a Hollywood right wing fantasy a-la RED DAWN.

    During the Cold War, the US/ N. Atlantic economic bloc dominated the world outside of the USSR and China. There may have a chance then to set up controls over transnational flows of capital, when the world they operated in was much smaller. But now, Moscow would be more than happy to welcome Wall St if it were kicked out of America.

    It is not going to come to pass that a global government with the power to shut down SDIs, where ever they may go, will be set up by a growing nation state authority based in the US. Or maybe any where. It may have to be a multi- national authority with global reach that in a multi-polar world will not come to pass. The mutual advantage of dealing with a Hegemon was that it brought stability. If there is only one final authority, SDIs could be brought to heel, not so in world of many, competing authorities. The crisis is a sign of weakening state power here and more than willing competitors offering anything to see the US weaken some more, even if there is not a relative advantage for them.

    1. financial matters

      From ‘Confessions of an Economic Hit Man’ by John Perkins re Omar Torrijos
      ‘I had been sure he knew that the process was based on the assumption that men in power are corruptible, and that his decision not to seek personal benefit – but rather to use foreign aid to truly help his people – would be seen as a threat that might eventually topple the entire system.’

  11. allcoppedout

    It’s almost impossible to think of British MPs even trying to put up legislation on financial or business regulation. What we do is put up and idea, let it be watered-down by vested interests, take out any effective bits and then say we must give the result time. On police corruption this is about a 20 year cycle – a relatively short one.
    I’d be amazed if Yves hadn’t mentioned primitive banking. It was a feature of Labour debate in the 60s and early 70s – we even had the National Giro Bank. I have tracts from 1820 cluttering the house that discuss the idea in much detail (Sue does a lot of work with archives). Our most primitive UK bank – The Cooperative – is in trouble. I was sort of blurting out that I think bankers so vile I’d like them high-teched out of my life. Our resistance to “the machine” is what lets the con work and this is connected with the way we are prevented from regulation through public scrutiny generally. There is no hard coupling but rather disjuncture to provide gatekeeping as virtual competitive advantage.
    The technology is not metal, plastic or even a circuit supervening an electronic circuit – but riddled with ideology, power effects, trauma – and the denial of regulation. Our knowledge of how dangerous money-lending is – how far does it extend? Police corruption? Yet continue to allow ‘regulation’ in self-interest, swallow arguments known wrong long ago and recently breached. What we aren’t allowing is public, democratic scrutiny, even equality before the law.
    I just think we should widen our scope from 101 SSADM or soft systems text. We could have had primitive banking 200 years ago (also a time of banking fraud and few convictions) and have to understand how such a sensible idea has been rebuffed.

  12. kevinearick

    ‘our financial system is “tightly coupled” and in tightly coupled systems, risk reduction measures (which too often look at risks in isolation) will typically have the perverse effect of increasing risks.’

    Civil Marriage in Civil Society

    The technology you are looking at has been around for many decades. The only difference is the increasingly arbitrary user interface, separating you from the means of production, yourself, with misdirection, driven by miniaturization, under capital control, and it has run its course, the fixed cost of which has completely consumed what capital defines as its labor. Capital has circled the wagons accordingly, and is shooting itself. Syria is just a transitional symptomatic focal point, where its divide and conquer oil economy is most irrational.

    Unless you want to be the best developer in your chosen field, your best (better) bet is civil marriage, the find ‘em, f- ‘em, and leave ‘em, but not in your own back yard, strategy. Socialism is simple; maximize extraction with minimum input, leveraged by layer. Real labor is always fully invested. The two don’t mix. It’s a quantum battery.

    Choose an occupation that matches whatever intellect you have, and marry a female with the property to match your income, to land in the empire event horizon of rewards and penalties you are willing to comply with to maintain your desired position for as long as possible, which will depend upon the class you are born in and how much stupidity you can withstand as you climb the ladder.

    Within the empire, females are pretty much locked into their future at birth, regardless of all the fantasies presented by its lottery economy. Males are disposable pieces, rotated to maintain the chosen fantasy, until one can be found to maintain the fantasy for as long as possible. Always have a scapegoat, ready for the occasion of economic downturns, artificial turnover of capital’s labor. The eunuchs that accept their role are positioned to surround the eunuchs that believe they are men.

    Civil marriage is quite simple; follow the social rules that exempt you from the laws governing others. All empire complexity comes from layering, built over thousands of years. Just change the name on the shingle after each bankruptcy.

    The empire is and always has been a ponzi of ponzis, rotated in and out as needed, which operates on simple calculus – get them before they get you. It pays you to ignore reality first and then to get as many others to do the same in succession. It’s a prison, employing many layers of masters and slaves to provide the necessary rewards and penalties.

    Marry, consume, be merry, and vote for more of the same. The only difference between parties is the nature of lies / assumptions / promises. If you can’t live with ‘em and you can’t live without ‘em, choosing the better bad outcome every time, you are in a ‘civil’ society, prisoners dilemma.

    There is nothing remotely unique about Bill and Hillary Clinton. They are actors acting for actors, paid with layer upon layer of other people’s debt. Bill Gates and Warren Buffet are sitting on piles of false promises, not cash, and the illusion only works if you train your children by example to participate.

    Civil marriage is a mercenary game for monkeys, and there is nothing wrong with being a monkey, dressed as the critter of your choice, if that’s what you want to do. Regardless of event horizon, you will be master to the one below and slave to the one above. It’s just a sh-show; make the best of it.

    If you don’t want to be a monkey, examine the false assumptions constraining you. The price of real estate is going to fall, and fall hard, relative to real money released as employment barriers fall, as trade routes are re-organized, explosively if necessary. Labor is the only entity capable of sacrificing the present for the future effectively, sometimes for decades, sometimes for centuries, sometimes for millennia, and sometimes for all of the above, which is why the marriage Microsoft and Boeing does not work.

    Homosexuality, feminism and chauvinism are not paths to the future. A battery is something else all together, which is why the observer is the prisoner, of bias feedback. The middle class of each empire iteration always sees itself in the mirror, assuming it is peering out a window, repeating its behavior and expecting a different outcome.

    The zoo critters can’t function beyond the zoo confines of empire rewards and penalties, so they define the zoo as global, and it is in all their interests to ignore all evidence to the contrary. Their world is flat and finite. That’s captive breeding for you.

    God sets you up to be prosperous, but you have to define prosperity for yourself, the changing definitions of which provide elastic demand, supply and price. Stable demographic compilation with feedback from nature, not central control, drives price stability.

    Decide for yourself, but experience says that the circuit between God, your brain, your body, and nature cannot be interrupted for long without reversion. Central control, whatever you want to call the flavor of agency interruption, does not work and has never worked. It’s just gravity, the return pole. From the perspective of agency, humans are disposable, and the objective is to avoid disposition, while subjecting others. Economic discharge is civil accordingly, until it isn’t.

    The rewards and penalties are interlaced and re-enforced by breeding rules, Family (banking) Law.

  13. Jackrabbit

    Despite its flaws, I might choose to support Brown-Vitter.

    I haven’t yet decided. What do you think?
    ===

    I don’t see any realistic way to control the FIRE Monster. So perhaps its best to just give the Monster enough (moral hazard) rope…

    Fight FIRE with FIRE?

    ===

    Sadly, it seems that a) we will burn every drop of oil and b) the FIRE will rage until it burns itself out.

    I wonder if these are related. If (b) happens would that make (a) more or less likely?

    1. charles sereno

      Jackrabbit, for the benefit of NC readers, I will try to phrase your final question in a more understandable form: If it happens that the FIRE rages until it burns itself out, would that make it more or less likely that we will burn every drop of oil? Do I have that right? Truly an awesome question. Oops. I think you’ve already given us an answer in the form of a question: “Fight FIRE with FIRE?” Pretty deep. Could you kindly expound on your thoughts? I’m not suggesting in any way that you are a troll.

      1. Jackrabbit

        Hi Charles, I guess you don’t remember me?

        Its simple really. There is much frustration expressed on NC and elsewhere regarding our powerlessness to “stop the madness” (both regarding TBTF and climate change).

        As I wrote in my first comment on this thread, I think that TBTF political influence has progressed beyond the event horizon. What doesn’t kill you makes you stronger and TBTF, and their grip on politics, has only strengthened after 2008.

        What MIGHT throw a monkey-wrench into TBTF planning is something like BV. And since the public has already lost – why not let the Insurance Companies and Smaller Banks join the ‘party’ – if it might hasten the end of the ‘party’ from rampant abuse and over-reach?

        Currently, the future looks bleak. Continuing consumerism, careerism, etc. that sustains a persistent, parasitical, plutocracy. Nobody cares (enough) to question or change this until/unless there is a crisis.

        With the 2008 crisis as backdrop and visible effects of climate change, maybe more people would be motivated for *real* change when the next crisis comes. Maybe BV would mean a crisis in 2020 rather than 2030. And an earlier crisis might be much more beneficial to the world due to 1) reduced consumption and 2) a ‘rethink’ of a leadership/system that has failed to tackle climate change.

        ===

        Yves is concerned that BV is driven by Insurance Companies – who are no better than the Banks. I have no such concern. They are all a$$holes. Let them at each other.

        Yves is concerned with ‘overconnectedness’. Guess what, they will not let anyone mess with their derivatives anyway. And you what? When the blow up comes, it is inevitably going to involve contagion.

        Black is concerned about furthering a criminogenic environment. But we are already there. And it seems unlikely that we return to the rigorous enforcement regime that he prescribes.

        ===

        I look forward to comments.

        1. Jackrabbit

          My biggest concern of a “FIRE fight FIRE” strategy is if BV were to wind up being just another give to the TBTF Banks. this concern is expressed by Black: that only the worst parts of BV may survive by the time it is passed.

          So I really need more research and a better understanding before saying that I would support BV.

          ===

          Corrupt political systems are hard to root out. Tammany Hall ran NYC for generations.

    2. Refus

      The fuel for fighting FIRE with FIRE is readily available…. Credit Default Swaps (CDS) all $62 trillion of it (the best guess by the ISDA). Naturally, FIRE is determined to avoid consuming that particular combustible for fear a massive explosion. Something, the rest of us need to be wary of too – such a FIRE explosion will not only ‘remove’ the oxygen feeding FIRE but, perhaps, all the oxygen feeding us.

  14. Jim

    Steve Keen has argued that there is a positive feedback loop between changes in debt and asset prices where the acceleration of debt is a component of the change in aggregate demand with a change in the first factor (debt) leading to a change in the second factor (asset prices) in the same direction, which then causes a change in debt once again. Keen believes that such a dynamic can lead to a breakdown in the financial/economic system.

    Richard Bookstaber has argued that in the financial markets, tight coupling comes from the feedback between mechanistic trading, price changes and subsequent trading based on the price changes. And this mechanist trading can result from a computer-based program or contractual requirements to reduce leverage when things turn bad. Bookstaber believes that such a dynamic can eventually lead to a breakdown in the financial system.

    Liah Greenfeld has provocatively argued in “Mind, Modernity, Madness” that there is also a tight coupling between the cultural phenomenon of nationalism (the consciousness which forms the cultural framework of our modern society based on the values of freedom, equality and choice) and the increasing psychiatric diseases of unknown etiology (schizophrenia, manic depression and major unipolar depressions) and she argues that if this culture is not cured( through a minimization of growing alienation and anomie) the chances of accelerating social breakdown will increase.

    Could it be that we are indeed in some kind of cultural as well as a financial/economic crisis and that any political vision out of this situation must speak directly to the apparently tight couplings of (culture, individual consciousness and identify, will and self) as well the tight couplings in finance and economics?

  15. Peter Pan

    I enjoyed 99.9% of this critical review of BV. There was only one sentence that caused some hesitation: “I propose Michael Patriarca.”

    Is this the same Michael Patriarca that works for Promontory Financial Group and used to work for Wells Fargo Bank as well as the OCC? Yikes !!

  16. ccrider27

    After reading this overly long article, with its overly wonky description of ‘tightly coupled systems,’ and with unnecessary dispersions cast on both Brown and Vitter, and very repetitive critiques of every possible detail of stuff that’s not even in the bill, in the end what Mr. Black is suggesting, bottom line, is to do nothing.

    The three suggestions he has at the end are never going to happen in the real world.

    So rather than support a bill that would at least raise reserves, he suggests breaking up JP Morgan and Goldman. Either that or NOTHING. C’mon!

    That’s dream land. Let’s get behind something that would at least help the situation – and if the megabanks pull another Libor/Whale then let them all fold.

    1. Yves Smith Post author

      1. It’s aspersions, not dispersions

      2. You have this backwards. Brown-Vitter has no odds of being passed. The Administration is opposed to it. The bank lobbyists aren’t even bothering to go after it in a serious way, they are so unconcerned about it.

      So the argument that what Black is wrong because he’s proposing what won’t happen is spurious. He is using this opportunity to message for what needs to happen, as opposed to a bill that even if it were to pass, goes only after banks, not insurers or investment banks, which would come back to life if someone sprinkled pixie dust so BV could pass. And if you were awake in the crisis just passed, it was investment banks and insurers, far more than banks, that were sources of systemic risk.

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