Attention Lloyd Blankfein: The Public Purpose of Banking

By Marshall Auerback, a fund manager and investment strategist who writes for New Deal 2.0.

It seems odd that days after we were told by Goldman Sachs’s CEO, Lloyd Blankfein, that bankers are doing “God’s work”, we are still having active debates about how to regulate these selfless apostles of capitalism.

The latest foray into financial reform comes from the Senate. Senator Christopher Dodd will propose creating a single U.S. regulator that would strip the Federal Reserve and Federal Deposit Insurance Corp. of bank- supervision authority, according to a report from Bloomberg. Dodd, according to the Bloomberg report, has faulted the U.S. bank regulation system, saying “it encourages charter shopping and a ‘race to the bottom’ by agencies to win oversight roles.” Bloomberg notes that “his proposal goes further than proposals by President Barack Obama and House Financial Services Committee Chairman Barney Frank to merge the OTS and OCC.”

Certainly, almost anything is an improvement over the abomination that came out of Barney Frank’s committee. But we feel that the ‘race to the regulatory bottom’ could easily be solved via a simple mechanism: If you don’t fall in line with our regulatory requirements, you’re simply denied a banking license to operate in this country. Problem solved. The United States is the biggest banking market in the world. Do you think any major bank would willingly vacate this market?

And even if the “too big to fail” behemoths decided to transplant a bunch of their operations elsewhere, the country would still be left with thousands of community banks which could fill the void and better fulfill the public purpose described by Mr Blankfein: namely, to “help companies to grow by helping them to raise capital”, rather than extracting their pound of flesh via grotesquely high financial intermediary fees, as is the case today.

We have argued before on New Deal 2.0 that the FDIC is best suited to carry on the role of chief systemic regulator, given its role as deposit insurer. That regulator has the best institutional incentives to be concerned with systemic risk and to be a vigorous regulator. It should be the least subject to regulatory capture (a pervasive problem at the Fed, which is full of quant economists who have virtually no interaction with other Fed examiners).

But WHO controls the banks is ultimately less important than HOW we control the banks’ activities. Oversight is all very nice, but at times it pays to get back to first principles. What on earth is the public purpose of these things?

Banks are set up and supported by government for the further benefit of the macro economy via providing a payments system and lending in a way that is specifically defined by regulators. Newsflash: the public purpose of banking is NOT to provide profits per se to shareholders. Rather, the provision of the ability to earn profits is only a tool used to support the attendant public purpose. Banks should only be allowed to lend directly to borrowers, and then service and keep those loans on their own balance sheets. There is no further public purpose served by selling loans or other financial assets to third parties, but there are substantial real costs to government in regulating and supervising those activities. There are severe consequences for failure to adequately regulate and supervise those secondary market activities as well.

Banks should be prohibited from engaging in any secondary market activity because it serves no public purpose and may result in severe social costs in the case of regulatory and supervisory lapses. Some argue that these areas might be profitable for the banks, but this is not a reason to extend government sponsored enterprises into those areas. Therefore, banks should not be allowed to buy (or sell) credit default insurance. The public purpose of banking as a public/private partnership is to allow the private sector to price risk, rather than have the public sector pricing risk through publicly owned banks.

If a bank instead relies on credit default insurance, then it is transferring that pricing of risk to a third party, which is counter to the public purpose of the current public/private banking system. Banks should not be allowed to engage in proprietary trading or any profit-making ventures beyond basic lending. If the public sector wants to venture out of banking for some presumed public purpose it can be done through other outlets.

If the activities of the banks are not facilitating the production and movement of real goods and services what public purpose do they serve? It is clear they have made a small number of people fabulously wealthy. It is also clear that they have damaged the prospects for disadvantaged workers in many parts of the world.

It’s more obvious to all of us now that when the system comes unstuck through the complexity of these transactions and the impossibility of correctly pricing risk, the real economies across the globe suffer. The consequences have been devastating in terms of lost employment and income and lost wealth.

All governments should sign an agreement which would make all financial transactions that cannot be shown to facilitate funding for real goods and services illegal. Simple as that. When we keep these principles at the front of the argument, we can see that what Senator Dodd and Congressman Frank are arguing about is akin to how to rearrange the deck chairs on the Titanic.

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50 comments

  1. attempter

    Everything in the post is clarity, simple common sense, and simple morality.

    It would be good politics too.

    These bank rackets create no value, they serve no purpose, they only bleed, destroy, corrupt.

    So it’s clear that the only obstacle to sound policy and America regaining its dignity and freedom are two corrupt parties.

    Even if some quixotic soul still wanted to try to argue that what was done last fall was necessary, there’s no way he could argue that it was done in good faith.

    That’s because not only have two administrations refused to take step one toward getting us out from under this extortion racket, eradicating its power over us once and for all; they’ve INCREASED that power, formally enshrined it, officially declared that their number one priority is the continued existence and megaprofits of giant insolvent banks.

    Cetainly nothing can happen until critical mass is reached for the realization that not only is Wall St the enemy of America, but these 2 parties are irredeemably corrupt and rotted to the core, and are now themselves nothing but enemies of the people.

    Maybe it doesn’t always seem helpful to just say that, but the more people realize it and say it and become educators about it, the closer we may come to achieving that critical mass.

  2. craazyman

    And it came to pass that as Don John sat in his house, which they called a john, and upon his pile, that the pile reacheth, yeah, unto the ceiling and his head protruded through the beams and up as it were unto heaven, and he gathered his disciples and said unto them, “Take ye each a portion of the pile, even gold and silver coins and storeth them in your cloak, and go ye out unto the multitude and find the sick and the poor and distributeth the coins unto them.”

    And the disciples were sore amazed and they said unto him, “Will not that reduce thy pile and find ye disfavor under the eyes of thy father?”

    And Don John said unto them, “Verily, verily I say into thee, extract ye not an eye for an eye, nor a tooth for a tooth, but for every one ye lendeth, ensure ye that ye receiveth two or three in return. For man doth not live for bread alone, but worketh the sweat onto his brow and laboreth hard beyond the setting of the sun. And take ye this script prepared by the scribes that numberth in letters even the number of hairs on your head and gain a signature for every one who receieveth, for that he may be known unto ye and may be found even unto the ends of the earth and even unto Babylon.”

    And the disciples did as they were instructed and the pile was shrunken, yeah, unto a half, and they were sorely amazed.

    And Don John said unto them, “Now taketh these papers signed by thee who have receiveth thy coins, yeah even these prepared by the scribes, and sell them at the market place for a portion of the promise written on them, for the time of retribution is known by no man, and the lord is no respector of persons. And bring ye back the coineth ye receive.”

    And the disciples took the scripts to the market and, behold, they receiveth twice the number of coins lent and the pile increaseth in stature, yeah, even beyond the beams and reacheth as up to a heaven.

    And the disciples said unto Don John, “Care ye not whether the poor and sick be whole, for a whole man can labor, but a broken man, yeah, lieth in his tent and is unable to serve the lord. And if the poor man not repayeth thee, will not thy pile shrink before the lord of hosts?”

    And Don John said unto them, “How can ye see and not understand? For the burden is upon the poor man and the tribute is to be paid not unto me, but unto those who are his masters, yeah even unto them who ye greeted in the marketplace and who receiveth the papers from thee.”

    And he picked up a coin from his pile and said “Who’s inscription is this?” And they said, it be Caeser’s. And he said, “And the burden too now be Caesar’s and the poor and sick, yeah, they will render unto Caesar what is Caesar’s, and have rendered unto ye what is yours.”

    -The Gospel According to Mammon, X, ix – xvii

  3. Kid Dynamite

    “There is no further public purpose served by selling loans or other financial assets to third parties”

    really? how about the fact that it frees up capital and allows the banks to make more loans?

    1. Skippy

      Kid I get your point, but when is enough, enough. Seems loans were the main reason for this little fracas to which more of said financial investments are some how the solution, further more the packaging of these loans in a blended cocktail of ratings to hide the bad stuff and still make alpha.

      It does not take a financial sophisticate to understand a bet on a bet on a bet on a bet ad infinity will end badly. Sooner or later a link will break and wipe-out the majority, although a few will massively benefit from it. Rinse and repeat long enough and you have Goldman Sachs and do you think they care about anyone_but themselves_till the last tree is cut down.

      Is that the world you wish for really?

      Skippy…finacial innovation or fraudulent innovation?

    2. Yves Smith Post author

      Kid,

      Where were you during the crisis? Strategies that “freed up capital” were a major cause of the crisis. It was a mechanism by which banks showed illusory profits, allowed executives to overpay themselves while draining their companies of capital.

      By the same logic, we should applaud when the owners of nuclear plants find ways to operate more efficiently by circumventing safety regulations.

      1. Kid Dynamite

        I haven’t torn through all the balance sheets lately, Yves, but i’m ALMOST CERTAIN that there is not a SINGLE bank who ended up in trouble because it sold off too many of its loans…

        the problem was not banks selling loans (and variations thereof). it was banks BUYING loans.

        yes – i understand how banks selling loans increases the critical mass of the “system” – what people seem to remember is that the system doesn’t blow up when people lose their own money – the system blows up when people lose OTHER PEOPLE”S MONEY.

        1. Yves Smith Post author

          Kid,

          You just demonstrated you do not know what you are talking about. Start with Citicorp. I can add more names, but you are clearly determined to show your manifest ignorance of this topic, and I have no interest in educating someone who claims to have knowledge and insight but is unwilling to do basic homework.

          1. Kid Dynamite

            no Yves – i’m sure you’re right again. After all, this is your house, so you’re always right.

            Is it your claim, then, that Citi attained a massively upside down balance sheet because it sold off TOO MANY bad loans that it had made? If only Citi had kept all those crappy neg-am mortgages with borrowers who couldn’t pay them back, then maybe, just maybe they wouldn’t be a ward of the state? Right…

          2. Yves Smith Post author

            No, I am arguing with you because you do not know what you are talking about on this topic. I give you some major clues as to where your ignorance lies, and instead of saying, “Whoa, I might be missing something important here,” you instead keep insisting you are right without bothering to investigate. You are simply dead wrong on this one, you do not understand the economics or motivations behind “loan sales.”

            I have no trouble with people overstepping the limits of their knowledge upon occasion, but most people, when that becomes obvious or it is pointed out to them, will go and try to become better informed before continuing.

            Persisting in being ignorant is not a sign of intelligence. If you want to continue to continue to put your foot in your mouth and chew, I have to tell you it is not a pretty or rewarding experience for readers.

          3. Kid Dynamite

            i noticed you ignored my question on Citi, yves, and resorted to attacking me again.

            Don’t worry – i don’t want you to have to chastise me again or block my IP. I’ll run off to bed like a good little boy now.

  4. Roberspiere

    Why is this not understood is beyond comprehension. The packaging and re-packaging while taking a slice of commissions on every iteration can only extract value of the underlying paper. Banking is an inter-mediation business like a toll road it can never create value for anyone but the toll operators and just like toll operator they should be regulated to the hilt.

  5. Marshall Auerback

    Kid Dynamite,

    Good point, but I would argue that you tackle the problem of demand via fiscal policy. I’ve made this point before, but the focus should be on improving aggregate demand and incomes and creditworthiness (and, hence, credit) will follow. Fearing what it might find if it actually examined the books of financial institutions in detail, the administration put a chosen handful of them through a wimpy “stress test” after announcing that none would fail. Rather than closing massively insolvent institutions, Washington continues to allow them to operate “business as usual” and to cook the books to show profits so that they can pay out big bonuses to the geniuses who created the toxic waste that brought on the crisis. As James Galbraith has argued, the problem is said to be no more serious than some clogged plumbing—a bit of Draino in the form of government handouts and guarantees should be sufficient to get credit flowing again. Second, most major banks are not insolvent but rather have a temporary liquidity problem induced by malfunctioning financial markets. Time will allow market mechanisms to restore the true, higher, value of “legacy” assets. Once the banks are healthy, the economy will recover.
    I disagree with both premises. And increased capital requirements simply respond reactively to the problems created by our current market based finance. Here is the reason why the shift to markets and away from banks matters. When a commercial bank makes a loan, the loan officer wonders “how will I get repaid”. Because the loan is illiquid and will be held to maturity, it is the ability to repay that matters—and it is most prudent to rely on income flows rather than potential seizure and forced sale of the asset at some time in the possibly distant future and in unknown market conditions. On the other hand, when an investment bank makes a loan, the loan officer wonders “how will I sell this asset”. The future matters only to the degree that it enters the value of the asset today because it will be sold immediately. Even the buyer of the asset need not worry about the distant future because the liquid asset can be unloaded quickly (Tymoigne 2010). Especially when confidence is high and euphoria reigns, it is easy to sell assets whose value is disproportionately determined by expected asset appreciation (and goodwill). The sky is the only limit to how much an asset’s value might rise, hence no euphoric expectation can be easily dismissed. And any debt ratio can be justified as sound because it will automatically fall as the asset appreciates. As late as spring 2007, Fed economists were still giving papers (at the Levy Institution’s annual Minsky conference) denying that real estate was over valued and that there was a credit bubble—the vast majority of economists were similarly in a perpetual state of denial—because real estate values would continue to rise, validating the debt. As Greenspan said during the dot-com boom, how can one argue with the wisdom of tens of millions of market players? Galbraith nicely captures the circularity of such group-think: “It is difficult not to marvel at the imagination which was implicit in this gargantuan insanity. If there must be madness something may be said for having it on a heroic scale.” (Galbraith 1997: 64)

    Indeed, this was a fundamental reason for the separation of commercial banking from investment banking in the aftermath of the 1930s collapse. Commercial banks would make and hold loans, issuing insured deposits to finance positions. As loans would be held to maturity, there was no need to mark to fleeting market values. Banks would not be able to count asset price appreciation during a bubble as a source of profits and equity, nor would they have to recognize losses if asset prices temporarily fall. Since the value of most of their liabilities (deposits) would not fluctuate in value, this practice of ignoring asset price fluctuation kept their balance sheets stable. By contrast, investment banks and other types of financial institutions would be subject to these market fluctuations—recognizing capital gains and rewarding traders with bonuses in good times, and taking losses and downsizing portfolios in a bust. The market-based institutions would be highly pro-cyclical, while commercial banks could be much less so. (Of course, they would still be somewhat pro-cyclical because the demand for loans as well as credit-worthiness moves with the cycle. But they would not be forced to sell off their loans simply because asset prices were falling; so long as firms and households would eventually recover sufficiently to service debt, the loans could be retained and marked to original value.)

    Unfortunately, we moved strongly in the opposite direction as we freed commercial banks to become brokers and dealers in marketed assets. We allowed them to leverage government money (insured deposits) with little supervision. We allowed them to use their own complex and proprietary models to value assets and to assess risk. When crisis came, we handed bank charters to the last remaining investment banks so that they, too, could use government money to speculate in asset markets. This represents an ironic completion of the circle because the main justification for deregulating commercial banks was that they had to be allowed to compete with the much more efficient shadow banking sector, and when the shadow banks collapsed in a spectacular manner we gave them access to insured deposits so that they could compete with the banks. We also promoted consolidation to create “too big to fail” and “too big to supervise” institutions so that management and owners have nothing to fear—only government money is at risk and government has neither the will nor competency to oversee the gambling.

    1. DownSouth

      Marshall,

      Unless your intent is to use Kid Dynamite’s comment as a mere hook upon which to hang your own comment, I think you’re pretty much wasting your breath.

      The heading to his web page pretty much says it all:

      KID DYNAMITE’S WORLD
      A COLLECTION OF STORIES ABOUT POKER, GAMBLING AND OTHER INTERESTING ADVENTURES

      In your post, for instance, you inquire: “If the activities of the banks are not facilitating the production and movement of real goods and services what public purpose do they serve?”

      Do you believe questions such as that will resonate with someone whose big thing in life is playing zero sums games?

      1. Siggy

        I don’t think Kid Dynamite said quite that much.

        The problem with the Federal Reserve System is that it is trying to deliever on two charges; the promotion of full employment (whatever constitutes full employment), and stable prices.

        It is my view that we would be better served if the Fed concentrated soley on the preservation of purchasing power. Instead of that we have the Fed attempting to manipulate the economy with false prices (interest rates) so as to achieve growing employment and GDP.

        Bear in mind that the money supply has two components, coin and currency; and, the availability of credit money which created out of a fractional reserve regime.

        When a loan is made there has been the initiation of a potential increase in the money supply. The actual increase occurs when the recipient of the loan spends the proceeds. Then, credit money becomes ordinary money.

        This crisis is a balance sheet crisis. A significant number of ‘primary dealer’ banks are insolvent and rightly should be undergoing dissolution. This circumstance has occurred because these banks bot paper that can nolonger be sold at any price that is sufficient to avert the complete loss of the bank’s tangible net equity. All of which is the result of allowing the combination of intermediation activities with speculative investment activities.

        As to Blankfein, he is a trader and the only thing that GS brings to the table is some degree of liquidity and for that service GS extracts a fee. Effectively, GS serves as an intermediary whose presence effects a reduction in profit margins.

        So long as the Fed and the Treasury insist on supporting these zombie banks, its not a zero sum game.

        The public purpose of banks is what we say it will be, either by direct action or by inaction. It is our inaction that has allowed these banks to become what they are. Net, the whole system needs to be dismantled and reconstituted.

      2. Dan Duncan

        DownSouth, the Kid Dynamite site is actually quite good. The guy is very smart and he’s a very good writer.

        Finally, you ask Marshall:

        “Do you believe questions such as that will resonate with someone whose big thing in life is playing zero sums games?”

        And then you follow it up with:

        “Also, please, please break your comments down into more paragraphs.

        Those long paragraphs are extremely difficult to read.”

        Seriously, DownSouth…

        If you lack the attention span to digest a paragraph that hold more than the emotionally charged, 3 sentence, buzzword-laden soundbite…

        then perhaps you should refrain from asking rhetorical questions—that ooze pretentiousness—about what resonates with another.

        Did you make it this far?

        1. DownSouth

          Well actually, Dan, playing poker is something that I just happen to know a little bit about. And I also know a little bit about the people who play the game.

          The first thing one needs to know about poker is that it is a zero sums game. It is an activity that produces nothing, so if one person wins, somebody else loses. That makes it entirely different from, let’s say, someone who cuts your hair and you give them twenty bucks in return. That’s a win-win situation. In poker, it’s always a win-lose.

          So with that in mind, let me talk a bit about the kind of people who play poker. Now granted, there are those who play purely for entertainment. They gamble occasionally and for modest amounts in relationship to their income. If they lose, it’s no big deal, and they shrug it off to a good night’s fun.

          But that’s where the prettiness ends, for there are two other types who play poker. One is the professional, who makes his living at it, and the other is what is typically referred to as the “mullet.”

          Now professional poker players tend to fall into two categories. First, there are the cheaters. These include the card mechanics who, if they’re good enough, can deal you any card they want; the team-players who gang up on you; and those who have an observer in the room to tip them off as to others’ hands. And secondly, there are those who are just superior card players. Their advantage comes from the fact that they are better trained and have greater mental discipline, intelligence and endurance than those they play against.

          The role the mullets play in all this is to provide the professionals with a steady source of income, and of course the professionals are always on the troll for new mullets. The mullet’s defining characteristic is that he suffers from some sort of emotional disorder. He loses consistently and continuously, week after week, month after month, year after year, and yet he continues to play. Fyodor Dostoevsky gives us the perfect portrait in The Gambler:

          Yes! It only takes being calculating and patient at least once in your life and—that’s all! It only takes being steadfast at least once, and in an hour I can change my whole destiny! The main thing is character. Only remember what happened to me of this sort seven months ago in Roulettenburg, before I lost definitely. Oh, it was a remarkable case of determination: I lost everything then, everything… I walk out of the Vauxhall, I look—one last gulden is stirring in my waistcoat pocket: “Ah, so I’ll have money for dinner!” I thought but after going a hundred steps, I changed my mind and went back. I staked that gulden on manqué (that time it was manqué), and, truly, there’s something peculiar in the feeling when, alone, in a foreign land, far from your own country and your friends, and not knowing what you’re going to eat that day, you stake your last gulden, you very, very last! I won, and twenty minutes later left the Vauxhall with a hundred and seventy guldens in my pocket. That’s a fact, sirs! There’s what your last gulden can sometimes mean! And what if I had lost heart then, what if I hadn’t dared to venture?…

          I find the similarity between the mullet and the Ayn Rand groupie to be quite striking. Here’s how Adam Kirsch describes the Rand sycophant:

          Rand’s particular intellectual contribution, the thing that makes her so popular and so American, is the way she managed to mass market elitism — to convince so many people, especially young people, that they could be geniuses without being in any concrete way distinguished. Or, rather, that they could distinguish themselves by the ardor of their commitment to Rand’s teaching. The very form of her novels makes the same point: they are as cartoonish and sexed-up as any best seller, yet they are constantly suggesting that the reader who appreciates them is one of the elect.
          http://www.nytimes.com/2009/11/01/books/review/Kirsch-t.html?hp

          So if Kid Dynamite is just some casual poker player who gambles for fun, I suppose that’s pretty benign.

          But the fact that he declares his web page to be about poker and gambling indicates it’s a little more serious for him than that. And if that’s true, then take your choice. A professional gambler or a mullet: neither is an appropriate choice of persons to look to for guidance on how to run a well-functioning economy or society.

          1. Skippy

            Unfortunately DownSouth some people only wish to chase the rainbow of *triumph of the individual* over the success of the community, and yes it does have allot to do with their inner core.

            In the military I witness the rectification of this disorder in numerous ways ie: two door wall locker exiting second story window with said individual inside, mummy sleeping bag with individual hanging upside down 3 story’s up tied to bed inside or the old whiskey locker treatment.

            Ayr Rand was a mediocre screenwriter that put a contemporary novelized feel good self indulgent blinkered view point on her own need to succeed and injected it straight into those that suffered the same defects.

            Skippy…life is all about me!

        2. DownSouth

          And by the way, Dan, I don’t believe my request to Marshall to write shorter paragraphs was at all out of line. Anybody who has studied writing, and especially writing for the internet, knows that what Marshall did was a no-no:

          4. Explain your points in short paragraphs. Short paragraphs are easier for the reader to follow. No one likes to look at a long block of solid text. Three, four or five sentences are usually enough for one paragraph.

          Read more: http://www.zeromillion.com/webmarketing/effective-internet-article-writing.html#ixzz0WatqjuPi

    2. DownSouth

      Also, please, please break your comments down into more paragraphs.

      Those long paragraphs are extremely difficult to read.

  6. Mannwich

    Call me crazy, but don’t we need to get back to the day when the banks’ primary purpose was to serve the community and businesses in the community and not the other way around? Everything has been flipped on hits head. Bizarro world indeed.

  7. Hugh

    Hey Kid, very funny. “Frees up capital”? Is that what creating bubbles is now being called?

    I have often asked what useful function Goldman serves. Marshall Auerback extends this to banking. It could be extended again to the paper economy generally. There is no wealth creation here, no market efficiency, no reason for the financial industry to do most of what it currently does. On the other hand, we have seen and experienced the great destructiveness of what this industry does and will continue to do so for years, even if real reform were at hand, which bought and paid for pols like Frank and Dodd make sure will not happen.

  8. craazyman

    It must have been a typo.

    Should have been “it creates free capital, and etc. etc.”

    But pity the poor savers — wink wink nudge nudge say no more . . . :)

  9. RichieRich

    I think you’re misconstruing what Dodd’s “race to the bottom” argument is. He is not concerned with regulatory shopping with respect to other nations, its between regulators (i.e. state banking regulators vs. Fed vs. OTS).

    The idea is with one regulator you forestall the race to the bottom that has allegedly occurred with corporate regulation. Each of the 50 states acts as a competing regulator to garner the business/listing fees of the highest number of corporations. This causes incentives for the regulators to lower their standards (more corporate friendly regime) so that they can expand their jurisdiction.

    Though race to the bottom theories are still hotly debated, my own research into this with respect to the insurance market finds these arguments to have a lot of merit. A single regulator will prevent banks from shopping around for the best regime domestically.

  10. Francois T

    Excellent post! By questioning the fundamental role of a bank, it is much easier to cut through the thick fog of spinmastery and skullfuckery that permeates the politico-financial discourse today.

    Alas, in order to return to more robust financial principles, we must consider what’s up in Washington DC. Sucks to no end to have to give such weight to purely political considerations, but it is necessary; after all, financial institutions are legal creations, and who talks legal must talk politics.

    This country would need a Legislative and Executive branch willing to forgo their personal and short-term political interests. In other words, destroy the incentives that makes politicians act the way they do. I can’t see that happening unless we have a true voters’ revolt at the polls and/or a deep-sixing of campaign finance laws actually on the books.

    The actual reality is that way too many senators and congresspersons are stuck in a “we do what is politically feasible” mindset, a.k.a. preserving the status quo as much as possible. A status quo that includes, of course, actual power and the promise of future wealth, personal or for the family. (Think Lieberman in Health Insurance or Diane Feinstein in Defense, for example) A very far cry of what we need to rebound as a nation.

    Hence, a powerful catalyst is needed. I believe the voters’ rebellion could well be such a catalyst. My take is that it is coming, and much sooner than anticipated.

    Why?

    Those who really go behind the headline unemployment numbers (Rosenberg, Rithloz, John Williams to name a few) paint a rather horrendous picture of what’s to come. A 13% headline numbers is very much in the realm of possibilities within the next 18-24 months. That would roughly translate into a 20%+ total unemployment. Yes! I’m alluding to long-term unemployment here, the “structural ” kind.

    What happens when one in five person is either out of work or can barely scrape by?

    Trouble…big trouble! Being mildly optimistic, I think this will translate into a tidal wave of “let’s throw the bums out of office” between 2010 and 2014.

    In this context, valuable and truly reform-minded candidates that would have been brushed aside by the establishments could end up being regarded as a valid option by the bases of both parties and carry the day. It has happened before, and the last time I checked, there is no physical impossibility prohibiting that to happen again.

    Of course, this is an optimistic scenario. Very powerful forces conspire against it, the prime culprit being the mainstream media, the financing of political parties being another one. A third problem is that Congress does not even have an independent Office of Financial Assessment that could impartially inform them of what’s going on in the financial universe.

    This, of course, is no accident. Why do you think the Republicans trashed the Office of Technology Assessment during the Bush years? To allow lobbyists to be the most powerful source of “information” on Capital Hill. The effects are plainly visible when one witness hearings where the colossal ignorance of lawmakers regarding Science and High Finance is on full display.

    In any case, I am deeply pessimistic that we’ll see any meaningful reform of the banking system if politics as usual is the only game in town.

    Note: Since I am all for equal opportunity, my scorn goes to both parties with equal abandon.

  11. timbo

    Legislate away. But why stop there?

    Require by law, peace and prosperity for all humanity. And outlaw murder too. No more disease. Thats should be illegal.

    You guys are asking the GOVT to outlaw something. They are feeding the beast.. Wishful thinking

  12. Marshall Auerback

    Down South,

    Always happy to debate anybody in a civilised manner. Kid Dynamite raised a point which I thought needed to be addressed, so I tried to do it. The tone of his comment wasn’t abusive and even though I probably haven’t persuaded him specifically, I tried to introduce an additional argument which might persuade others. None of us knows what may happen next. Nor do we have a monopoly on the truth. As I said to Yves the other day, all we can do is plant seeds for something better to arise and stay prepared for openings and venues to offer an alternative analysis and a more sensible path forward, even when things appear to be going retrograde all around us.

    Look, Fisher got completely wiped out and could have simply taken himself out, as most mere mortals would have done. He has to rent his house back from Yale and borrow money from his sister in law – this, one of the greatest economists of his time, a man Keynes declared was the great grandfather of his theoretical innovations. Instead, Fisher tried his damnedest to make sense of what happened, he changed his mind about previously held beliefs and analysis, and he left us some valuable clues. If that is all we can do for the next generation, so be it.

    1. DownSouth

      You’re of course right.

      Maybe I’m a little overwrought because I’m a reformed ex-professional poker player. And you know what they say about the zealousness of an ex-sinner who’s seen the light.

      But trust me, there’s nothing at all pretty about the underworld of gambling. And I was quite good at it. I remember I graduated college and went to work as a junior engineer for a major oil company making $1,000 per month, and I was averaging that much in winnings per week playing poker just on the weekends. To put that in perspective, I think recent petroleum engineering graduates now start for about $8,000 per month.

      But not all the mullets are Ayn Rand types who think they are God’s gift to the card table. One never minds taking their money away. Unfortunately there’s another kind of consistent loser that’s really nice people. They are always courteous and never rude or arrogant. And they’ve got a wife and kids. And here you are, taking the house payment away, or money for the kid’s tuition away. I never cheated, but given their poor card skills and playing ability, there’s no way they could have ever beat me. And I knew that. But if you’re going to play poker, and win consistently, you’ve got to be absolutely ruthless. It’s either win or lose, and taking prisoners is out of the question.

      So that’s why I gave it up, despite the fact that it was quite lucrative. I just couldn’t do it anymore. The guilt just became overwhelming.

      1. Kid Dynamite

        wow, boys, sorry i missed this thread today after my comment. I didn’t see any rapid replies, so I went on my merry way.

        Hey Downsouth – 1) poker isn’t a zero sum game – it’s a negative sum game for the players involved – don’t forget the rake. 2) the heading on my web page should have no influence on how you view my opinions – sorry I haven’t updated it in 3 years.

        NOW – here’s my point: our economy, in case it’s not clear, depends on growth. expansion. No one was complaining during the bubble that they were being given loans that they shouldn’t have been given – it’s what WE WANTED. It’s what Barney Frank wanted, even though he tried to deny that it was what he wanted when everything blew up.

        More importantly – the problem in our system – our bubble had very little to do with the fact that banks SOLD LOANS. The problem, and Marshall, this is the real key – IS THAT BANKS BOUGHT LOANS…. Banks getting risk (loans) off their balance sheets and onto the books of someone who wants that risk (like hedge funds) wasn’t the problem. Banks keeping that risk for themselves, and ADDING to it by buying loans (MBS) from OTHER BANKS was the problem.

        Also, Marshall – i don’t disagree at all with your assessment of bank solvency in the magnum opus comment reply you left me. The administration and the regulators are trying to hide the facts, which are generally, insolvency or variations of it. HOWEVER – again, that’s not caused by banks selling loans.

        The argument for banks being able to sell loans really isn’t hard, and it’s got nothing to do with zero sum games, free markets, cutthroat dog eat dog philosophies, or efficient markets adherence: if I, a non bank investor, wants to buy mortgages from my local SMallTownUSABank, why can’t I? WHO IS THAT HURTING? It’s not hurting anyone – in fact, it’s freeing up capital for SmallTownUSABank to make more loans so that some other American dreamer might have the opportunity to own a home or a business.

        Selling off loans and compromised lending standards are not equivocal. Don’t mis-assess the mistakes of our recent history (which wasn’t that loans were sold – it’s that loans were bought in massive amounts with massively mis-diagnosed risk, with massive LEVERAGE)

        after all – If i buy a loan from SmallTownUsaBank using MY money, not other people’s money, I can’t blow up the system.

        1. Yves Smith Post author

          Kid,

          You just contradicted yourself. You argued initially for selling loans as “using capital more efficiently.” That is tantamount to increasing leverage system wide. There is no point in engaging in this activity save for its leverage effects. When banks sell loans, the end destination is a securitization vehicle or a conduit, such as a credit card trust or a SIV. Those all increase systemic leverage. You pretend this is mere loan trading, It isn’t. The sale of the loan is economically attractive only if it is shifted to a party or entity that is more highly geared. If you understood banking, you would understand that very basic fact.

          I have noticed you tend to argue this way. You make statements in defending your argument that are not consistent with your initial position, then you adopt whichever line seems most convenient in dealing with someone who is trying to engage you. Frankly, this is not an up and up way to argue. It is discourteous to readers, at a minimum, and has the potential to confuse those members of the audience who are finance newbies and come to the site to get better informed.

          Moreover, this activity is damaging, despite your assertions to the contrary. The selling of loans reduces the original lender’s incentive to do borrower due diligence. Back in the 1980s, bank officers got extensive training in credit assessment and banks would get non-public information via direct interaction with the prospective borrower. We have seen that the proxies used (FICOs and credit ratings for securitiezed credits) are poor substitutes.

          Economists have remarked (see Gary Groton at Yale, among others) that never in the prior history of banking were loans sold. By contrast, almost all the other elements of modern markets, such as futures and options markets, debt syndications, private equity, have numerous historical precedents.

          I suggest you become better informed about banking before opining.

          1. Kid Dynamite

            please don’t misquote me, Yves. I can’t find anywhere in this thread where i argued about ““using capital more efficiently.””

            what i said was “frees up capital and allows the banks to make more loans”. I think that’s pretty much the goal of our American banking system – for banks to make loans.

            you are addressing the wrong symptom, AGAIN. If the symptom is that buyers of these loans use too much leverage to buy them (which is probably true!), that’s a problem to be addressed. The sellers of loans are not the problem. You may need to actually stop and think about this, before simply replying that I don’t know what i’m talking about again.

          2. Yves Smith Post author

            You are now engaging in the other tactic I warned you about, which is changing your argument to because winning is more important to you than consistency. If you recanted your earlier position, this might be valid, but you act as if you believe your running thread is consistent, which is isn’t.

            “Freeing up capital” is using capital more efficiently. That is the regulatory rationale used for this practice, regulators and banks used the terms interchangibily when talking about this practice. So I am not misrepresenting what you said. Moreover, making more loans with the same underlying capital base does increase system-wide leverage. So again you have contradicted yourself, you keep saying the problem is leverage, yet refusing to see the obvious and well known fact that selling loans was a major mechanism by which this was achieved.

            As I said before, and you chose to ignore, the only way the economics of loan sales worked was via the leverage effects. I addressed that before you made this comment.

        2. Skippy

          Damn you Kid and the people that informed your opinions.

          Do you not understand that people are going to their graves in order to facilitate your position on fiancé, to allow this construct to continue, to give you and many other here and every where the capacity to engage in this folly.

          Where is your geology, ecology, microbiology, social science, humanity’s et al, this is more than a discussion about making a buck, its about how we learn to live together with out putrefying our backyards (I live above your water rights by property law in the old vernacular).

          We must all be wide in our thinking and not just some product of people like Ayr Rand telling us the sum of *I* is more than the sum of *us*.

          Skippy…sorry to dump on you, but we are in the same basket in the end, amends.

          PS. it is hard, as we are, but a mixed bag of idealogical currency to date.

        3. Skippy

          Kid I have a case of defective land minds I’d like to sell, are you a buyer, its only 1 in 5 that are bad, if you off load quick enough it should be not a problem and you’ll get the % up the market till she blows.

          Skippy… you say the shat blew up carrying it to your van, mate once off the premises my insurance does not cover such events and if it did the govs got the tab, so go speck to the mouth piece.

          PS don’t know you from a bar of soap, but sales is sales or commonly called grifting of the uninformmed, so your sayin your cool with that?

        4. DownSouth

          Kid Dynamite,

          If one is playing poker in those games at a casino where they take a “rake,” then that definitely excludes one from the ranks of the professional poker players. Those games at casinos are set up for the benefit of the casino, and it is all but impossible for a player to win over the long haul.

          There were excellent books written back in the 50s and 60s that explain all this, so I will just briefly hit the high points.

          1) The “rake” is too significant for a good poker player, regardless of how good he is, to overcome. Most of the games in Vegas (when I was there) were low-stakes games with a $3 or $5 limit. The average pot size was only about $50. Those dealers in Vegas are extremely fast, and maybe they deal 20 games per hour. Now imagine the cumulative effect of them cutting each pot $2 or $3. In the period of an hour they siphon off an entire pot. Winning at poker entails managing one’s money well, and it’s impossible to do that when the house is raking off 5% every pot.

          2) In a low-limit game like those in Vegas, it’s impossible to control the relationship between the card odds and the money odds with your betting. You have to play in a pot limit or no limit game in order to do that.

          3) Poker is as much a game of psychology as anything else. You have to set out to psychologically disarm your opponents, and that takes time. That’s hard to do in a milieu like Vegas where players are constantly coming and going. The preferable poker session is a minimum of 12 hours up to 36, allayed against the same players.

          4) With the piddling stakes of those games they play in Vegas, it’s not possible to wear someone down psychologically. How are you going to, as we used to say, “make someone pucker up their asshole” by betting $5? It’s not possible. No, you’ve got to put people through the stress of calling a $500 or $1000 bet (in today’s terms that would be equivalent to something like $3000 to $8000)—the size of the entire pot–if they want to find out whether you’re bluffing or not.

          5) A professional gambler has to be able to extend credit to his mullets, and he has to be able to manage that credit. That means he has to know the people he is playing with and play with them on a regular basis. An environment like Vegas is not conducive to that sort of relationship. The mullet is captive to the casino, not you.

      2. Skippy

        DownSouth said…And you know what they say about the zealousness of an ex-sinner who’s seen the light.

        I’ve just gained a hole new respect for you. Your learning curve was money, mine was morta and see was my goddess, I thought see made me strong.

        Skippy…I lament my wrong doings, I swim up stream!!!

        1. DownSouth

          Thank you, Skippy.

          Things have realy changed over the decades. Gambling used to be considered to be a shady enterprise. Now people–like Greenspan, Bernanke, Summers and Geithner–think you can base a whole economy on zero sums games.

          It’s mind boggling.

  13. Phillip

    Anybody remember “capitalize on savings and expand on earnings?”

    The most knowledgable (to my thinking) proponent of credit as a public utility is Richard C. Cook, a Treasury analyst for 21 years and whistleblower on the Challanger disaster.

    His videos on the subject here:
    http://www.opednews.com/articles/-Credit-as-a-Public-Utilit-by-Richard-C-Cook-090329-936.html

    Articles here:
    http://www.globalresearch.ca/index.php?context=listByAuthor&authorFirst=Richard%20C&authorName=Cook

    The book Social Credit, available online at http://www.mondopolitico.com/library/socialcredit/socialcredit.htm
    is the founding document of the “social credit” economic movement of the 1930s. Robert Heinlein used much of For Us, the Living to espouse this theory, and it appeared as a major element in the later Beyond This Horizon as well.

    There is no reason to wait for the government to spend interest-free money into circulation. A person can do it themselves by obtaining new dollar coins from their bank/credit union. The US Mint will pay shipping on up to $500 of each Presidential dollar or $5000 Native American dollars when available.

  14. Doug Terpstra

    “…If you don’t fall in line with our regulatory requirements, you’re simply denied a banking license to operate in this country. Problem solved.”

    Self-evident wisdom that is, as are most prescriptions here, but I would put more far more emphasis on crime and punishment—on the consequences of fraud and malfeasance. Is the guillotine no longer an option?

    Sadly, all the pearls of wisdom here are cast before swine, because they all ignore the golden rule: “those with the gold rule.” The High Priests of finance, Blankfein, scoffs at all your analysis from his divine perch at Government Sachs. Until this system, including rampant campaign bribery, is crashed and burned by any means necessary, all efforts at regulation are useless Doddering.

    1. Yves Smith Post author

      Doug,

      I’m afraid you are missing the reason for that idea. The argument is often made, “oh we can’t impose tougher standards here, all sorts of stuff will just be done off shore.” Yanking the US banking license is a powerful threat. Conversely, the US cannot prosecute (in the criminal sense) activity that is not illegal in the home country (no one will extradite) even if they did violate the laws here.

      1. Doug Terpstra

        I think I understand the reason for it. It makes perfect sense; it is elegant intelligence.

        At the risk of being a wet blanket, however, this seems tantamount to calling for a revocation of corporate charters for serious violations or malfeasance. When corporations can legally purchase legislators like Dodd and even a president outright, about the highest enforcement we can possibly hope for are current cost-of-business fines tolerated by a collective of powerful corporations. No matter how sensible, equitable, and efficient, we seem to have reached a level of self-serving, corrupted power, crony fascism (so far velvet glove), that much of this seems like spitting into the wind.

        Sorry for the pessimism. I am still grateful for your faith and perseverance. When the current system freezes, siezes, or collapses, then your vision will be a bright searchlight. I can hardly wait. Meanwhile we should be as subversive as legally possible.

  15. mjiam

    Revoking bank licenses is impractical and inarticulate. Those TBTF institutions have way too much clout to deem that feasible.

    Seems to me a tax on asset size is much easier..Progressively higher tax rates on higher asset bases will drive de-consolidation and de-leveraging and offer a much more viable alternative. Introduced with an out-year onset, much like the latest Basel-III req’s, this seems too easy

    1. Yves Smith Post author

      mjiam,

      With all due respect, if we start from your premise, that the TBTF institutions have too much clout for the regulators to take tough measures, an asset-based tax is a non-starter too.

      An asset based tax requires global coordination, which means it would be years in coming. My dim recollection is it took 8 years to agree on Basel II (which the US has yet to adopt) and capital rules are less controversial than a tax.

      The big advantage of Auerback’s idea is that it can be used to enforce standards implemented locally and make them stick (ie forestall geographic arbitrage).

  16. Tim Solanic

    The idea:
    “Wall Street Execs should donate 100% of their bonuses to help Vets get health care”

    Demand any bank still on the dole from us, The Federal Govt, to re-route their bonuses to completely fund health care for all honorably discharged Vets.

  17. Marshall Auerback

    I’ll try to answer KD’s specific point about Citi, even though I think he mixes up cause and effect. Leverage is a beautiful thing on the way up, and disastrous on the way down.
    Most de-leveraging took place off the books of banks for two reasons—aside from the obvious fact that banks had declined in importance, holding only a quarter of financial system assets. First, it has always been very hard for banks to de-lever loans and deposits.

    Traditionally, loans are hard to sell because of their idiosyncratic nature (presumably, loans on the books of banks today are those that were more difficult to securitize); and they usually cannot be called-in because debtors do not have cash-on-hand for repayment. Thus, positions can only be slowly unwound as loans are repaid or credit losses progressively materialize, while a mark-to-market accounting system leads to the immediate recognition of huge and erratic market losses. Second, as highly leveraged institutions subject to at least some oversight, banks could not afford to recognize losses thus could not sell even marketable assets into declining markets.

    One of the supposed advantages of the securitisation model is that it made illiquid assets (such as home mortgages, credit card debt, and student loans) marketable and thus more liquid. Unfortunately, that was only in the boom—with the bursting of the bubble, they became hot potatoes that could be sold only into declining markets. And because they were largely held by institutions that do (and in many cases must) “mark to market”, falling prices trigger more sales to avoid even greater losses, pushing prices ever lower in what Irving Fisher and Minsky called a debt deflation process. The higher the leverage ratio, the greater the impact of a decision to get out of a toxic asset class.
    So the structure of Citi’s balance sheet clearly did contribute to financial instability.

  18. winterwarlock

    Take a 8 1/2 by 11 inch piece of paper. Use a pen to put a dot somewhere in the center. If you diligently pursue your own God / universe – given talents, that dot represents the bank’s scope of authority, and the bank will have no choice but to move toward your position, wherever else it may be on that piece of paper.

    Ultimately, that is the only way to effectively regulate the banks. Competing for an 800 credit score for the opportunity to take on more debt reverses the situation, and government regulation only confuses the issue.

  19. Eric Lindauer

    Selling the loans isn’t the problem. Selling the loans is like 5 steps removed from the real problem, something like this:

    – selling isn’t the problem, the problem is that the the buyers paid too much for them as they miscalculated the default risk
    – screwing up the default risk isn’t really the problem though, the problem is that the loans were then repackaged as derivative products and resold
    – making the loans into dervatives isn’t really the problem though, the problem is that people didn’t understand either the inherent risk of the correlation risk involved w/ the derivatives
    – default and correlation risk aren’t really the problem though, the problem is that people bought such a huge amount of these derivatives
    – buying a huge amount isn’t really a problem though, as long as you have the capital to cover your losses. The real problem is that nobody posted adequate collateral, so a failure by one bank meant massive losses to counter-parties, which spiraled through the economy in a somewhat self-reinforcing cycle

    Cure the root of the problem, and the rest is fine. Don’t allow institutions to get levered up any more then you would allow an individual person to get levered up. Don’t believe them when they quote crap like VAR to claim that they don’t need to post 100% of the potential loss on the product. These numbers are always spit out of fundamentally flawed models that end up missing some unusual once-in-a-decade type correlation that blows up in everyone’s face. It’s happened many times now, and we keep making the same mistake.

    Make people post adequate collateral and everything else takes care of itself. Nobody becomes too big to fail because nobody can take down anybody else by going broke.

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