The Kanjorski “We’re Tough on TBTF” Headfake

Dear God, if you read the media, you’d really think the Congressional huffing and puffing at the banking industry was going to solve the “too big to fail” problem, or even make much of a difference.

Folks, I hate to tell you, these remedies fall so far short of what it would take as to constitute a complete joke. And I am cynical enough to believe that the industry is secretly delighted, its bitter howls to the contrary (now it admittedly may be a shocker to them that they might have to be a wee bit inconvenienced in the interests of appeasing the public). Remember the lesson of the Barney Frank derivatives bill: even that weak offering was watered down to nothing. The Kanjorski salvo is the first round, and the banks are going to get this cut back, substantially. And Kanjorski has unwittingly played into their hands. But the theater certainly is impressive. From Bloomberg:

Seven Wall Street lobbyists trooped to Capitol Hill on Nov. 9, hoping to convince Representative Paul Kanjorski’s staff that his plan to dismantle large financial firms was a bad idea.

They walked out with a sobering conclusion, according to the accounts of two attendees who requested anonymity because the meeting was private. Not only was Kanjorski serious, he planned to offer the legislation as early as next week — and it just might pass.

Today marks a decade to the day that President Bill Clinton signed the repeal of the Depression-era Glass-Steagall Act that split investment-banking from lending and deposit-taking. The repeal allowed the creation of Citigroup Inc., the financial colossus now propped up by $45 billion in taxpayer rescue funds. Financial firms are scrambling to prevent Congress from re- imposing the act.

“We’re playing with live ammo,” said Sam Geduldig, a lobbyist at Clark Lytle & Geduldig who represents financial- services firms and wasn’t at the Nov. 9 meeting. “The banking community is rightfully concerned.”

Now admittedly, the Kanjorski proposal would reinstitute Glass Steagall by splitting commercial banking operations from investment banking and thus lead to some pretty dramatic surgery at JP Morgan (hiving off Chase Manhattan), Citigroup, and Bank of America. But while that would affect the scope of operations (and thus the pay packages for the CEOs, since top level pay is correlated with asset size of the entity) of the highest ranks, it would have comparatively little impact at the business unit level.

This is a 1930s remedy for 21st century banking. The Kanjorski proposal does remarkably little to reduce TBTF risk. The real problem is not size, and this approach puts the focus on completely the wrong issue. So if this solution does come to pass, Congress will have spent a huge amount of political capital on a largely ineffective solution.

A little quiz: what exactly got bailed out in the crisis? Yes, we had to resolve a few big sick banks, namely WaMu and Wachovia. But that happened pretty smoothly and was within traditional FDIC bounds.

The crisis bailed out the global capital markets. Look at where the Fed’s rescue the markets programs were directed. Once you got past the first, the Term Auction Facility, they were directed at credit markets that are the playground of a fairly small number of very influential capital markets firms (an indicative list: Goldman, JP Morgan, Citigroup, Morgan Stanley, the old Merrill part of BofA, plus the trading operations of major international banks like UBS, SocGen, Barclays, DeutscheBank). Simply splitting off capital markets businesses does absolutely nothing to reduce the risk they represent to taxpayers. A massive safety net has been thrown underneath them, and no one save Goldman’s PR department believes that they won’t be bailed out when one of them goes off a cliff again.

The Fed does require the granting of waivers for deposits to be used to support trading operations. I’ll confess I have not seen any data here, but my impression is that that is very limited (but one could argue that the big deposit base allows them to fund in the short-term borrowing markets more cheaply, which would benefit the trading operations. Eurobanks, by contrast, do permit deposits to be used to support the capital markets businesses, which does give them a funding advantage.

Remember, Bear Stearns, with a roughly $400 billion balance sheet, was too big to fail. We now have a comparatively small number of firms globally that are enmeshed via counterparty exposures in OTC trading markets. These products cannot be moved to exchanges (you need enough trading liquidity in the underlying instruments; there is a good reason that, for instance, corporate bonds, munis, and even Treasuries and FX are traded OTC). This is like pretending we are living in a world of mainframes, of isolated players, when the problem is an a network of distributed computers, where any one going down can and probably will bring the network down. And we can’t halt the network while we take it apart and rebuild it. You may not like my saying that, but these are design parameter problems.

How would you break up Bear Stearns? You can’t separate OTC derivatives from the related cash markets; that will cause havoc (you’d be putting the derivatives book in runoff mode while simultaneously making it monstrously difficult to hedge, and these books are dynamically hedged). The logical-looking ways of doing it (say having them separate equity markets businesses, which are exchange traded and did not require government support in the crisis, from the debt businesses) makes the firms smaller but still does not solve the TBTF problem, which is the OTC debt and related derivatives markets. Those have become crucial to credit intermediation.

Now there are a bunch of things the officialdom COULD do to reduce the size of the public’s exposure, and I see them nowhere on this list. One is to bar proprietary trading and monitor overnight positions to make sure banks don’t simply start taking significant (as opposed to short-term) directional bets on customer order flow desks. Second is to force any systemically important firm to get out of the commodities business. We have commodities exchanges that perform the socially useful function of commodities hedging for end users. There is no reason for governments to backstop that. Principal trading similarly not socially productive and should not be in firms that have recourse to the government checkbook. Capital markets players should also be prohibited from offering bridge loans to customers (that is consistent with the Glass Steagall idea).

So that is why the Kanjorski approach, despite the tough talk and possible disruption, is actually a win for the industry, even if a somewhat extreme version (remarkably) were to pass. It means no one is on the trail of the draconian measures needed to contain the risks the industry poses to the public at large.

The only viable solution to the misbranded TBTF problem is to require systemically important firms (one in the OTC debt businesses, which thanks to the development of “market based credit” is now essential to modern capitalism) to exit all activities that are not socially essential and therefore deserving of government support (pure fee businesses that pose no risk to the taxpayer would be allowed). The permitted activities are regulated intrusively, with tough rules on capital requirements, and product scope (new products would be subject to approval to make sure they were socially productive, that the regulators understood them, and they did not result in increased risk to taxpayers). In other words, an effective solution requires more extensive dismemberment than anyone plans right now, and still requires heavy regulation of the crucial bits that will inevitably be taxpayer backstopped.

Print Friendly, PDF & Email


  1. winterwarlock

    The intelligent, talented kids, globally, all abandoned this system (and took all the big hits), which is why it’s imploding, and they are being followed by more and more folks everyday, including prime mortgage holders. They pulled the plug.

    If you are in Goliath’s shadow, you might want to move.

    1. 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.

      There are no benevolent dictators, and, at some point soon, all individuals are going to have to take their share of the regulatory load. Government is going to shrink dramatically.

  2. fesno dan

    Does anyone have a good reference that actually explains how Goldman, Morgan, et al make money? I mean at a basic, basic level with definitions.
    Now I can understand hedging – although I think a lot of it is equivalent to buying those “warranties” on toasters that retail stores sell. Peple buy it, and it has “some” value – but it really doesn’t make economic sense for the purchaser. My point being the fact that someone buys something is alone not enough of a rationale for an action making economic sense.

    If these firms are making fees by trading all these financial instruments, there has to be an underlying “economic” value. But what is it??? For example, I can understand MBS (mortagage backed securities) – there is a mortgage and the income derived from making a loan – balanced by the default risk. It all went kablooey due to principle agent problems – but they can theoretically work. But my question is: are they really more EFFICIENT than the old school way of making loans, taking into account the expense and uncertainty of all the other players that have to be involved to make them work? (were they REALLY priced correctly???) The rationale I heard for them is that it transferred risk to those most sophisticated and able to bear it (I guess they weren’t as sophisticated as they thought). There is only so much credit that can be extended and credibly paid back. Insurance for actual physical events (fires, hurricances) is one thing, but insurance for human emotion (financial meltdowns) is quite another.

    My final example are casinos. No economically rational human should gamble, yet casinos rake in the dough. Are Goldman et al just big casinos and most business men marks who hedge, insure, or whatever you call it with the promise that you can win big or be protected from the most outrageous risk, and Goldman will make a forture just skimming a small percentage of the money flow? I have no problem with casinos and humans irrational love of gambling. But, at least up to this point, the casinos aren’t giving gamblers their money back to keep the illusion that the casinos make money and asking the Feds to take the losses of the gamblers.

  3. Percy

    Kanjorski does no more than correct an error that let banks do something that never should have been permitted in the first place. The real problem was and remains derivatives. Yves seems to assume that they can and should remain and that all sensible arguments about what to do share that assumption. It may be tiring to say so, but nevertheless it’s the wrong assumption. It’s like saying we have to learn to live with the bomb. That may be true in the case of the bomb, but not derivatives. Look at the OTC derivatives segment (about a zillion incomprehensible, exception-riven pages)in the Dodd bill and then tell me without breaking into howls of laughter that these instruments can be appropriately regulated. They are not and can’t be. So, now that we have learned how uncontrollably complicated and dangerous they are (no longer a speculative theory), and we have, they must be made illegal, unwound, cashed out, and disappeared. Whatever falls, falls. What remains will be sounder eventually. Unless this is done, everything else being talked about, all this elaborate floundering around by Congress and the regulators, is a deceptive canard told against a great sucking sound in the background. That noise is being made by our country going down the drain. Don’t tell me it isn’t feasible. That’s absurd, assuming people still wish to live and own property here. We just need someone to tell them don’t do it any more or I’ll lock you up and take away your toys. After this, and breaking up these huge banks and insurance companies (and tightening the straight jackets that they ought to be in given their public functions), as also needs to be done, we can deal with leverage — perhaps simply by making sure that no one left is big enough to again make a mistake of such a size that it assumes national importance.

    1. Yves Smith Post author


      I have written repeatedly about derivatives on other posts. The ones that are pernicious are credit default swaps. As much as I have said very clearly that they have no redeeming social value, moving them to exchanges is not a realistic solution (the jump to default risk of CDS cannot be adequately margined, with the result that the exchange/clearninghouse is a concentrated point of failure, another TBTF institution). And I am also now persuaded, based on conversations with experts who are similarly not fans of CDS, that trying to put them in runoff mode is not viable either, and is likely to produce bad outcomes. I have said repeatedly that the need to be strangled over time, by regulating them intrusively (I’ve offered specific suggestions repeatedly) and then it might possible to wind down a smaller market.

      I suggest you not attribute views to me that are not mine. A simple search on the blog would have shown what my position is.

      1. john bougearel

        I like this idea of strangling CDS by regulating them intrusively, so that over time it would be possible to shrink the market. What you are recommending, and it should be viable as their is political precedent from two superpower, is a sort of nuclear disarmament. A CDS disarmament that reduces or eliminates these financial weapons of mass destruction would lessen the probability of another systemic mutually-assured financial destruction occurring. Ideally, we’d eliminate these products altogether to create a CDS-free world.

        If the two superpowers could agree to reduce nuclear arms, then the Big 5 superpower banks could agree to reduce CDS. But of course, they would never initiate such an agreement on their own, it would have to come from Congress to reduce the use of CDS.

        Of course, the history of Nuclear Disarmament has a long history, and key treaties and accords did not come easily. The first major accord came into force in 1970, this was the nuclear non-proliferation treaty. Two of its main pillars was nonproliferation and disarmament.

        Fast forward to the Strategic Arms Reduction Treaty ratified in 1994 was intended to limit nuclear forces in the US and Soviet Union.

        And then again there was the Strategic Offensive Reductions Treaty whereby the US and Russia “loosely” agreed to reduce their nuclear warheads by 2012.

        The 40 yr long history has made some progress towards nonproliferation, and reduction, though disarmament has never occurred and hasn’t never really been the goal.

        Still, we could stand a few CDS non-proliferation and reduction laws on the books. If Kanjorski wanted to make a real difference that is.

  4. Jim in SC

    Does anyone have a rational explanation for how Goldman supposedly lost money trading only one day last quarter? Is it because they are actually market makers but calling themselves ‘traders’? I thought they had dialed back their exposure to their proprietary trading group.

  5. i on the ball patriot

    All of this theft through financial manipulation has come about as a result of political manipulations — finance has deceptively bought the government and eliminated the regulatory laws and curtailed the regulators that might control it.

    This is all one part of a more comprehensive policy initiative that began back in the early eighties that includes not only the capture of finance to consolidate global financial power, but also the creation of the ‘war on terror’, wars in the Middle East, manipulation in WTO and IMF, etc., so as to gain geopolitical power.

    Whether or not you agree that there is any directional plan, or insider conspiracy involved, it should be quite obvious that the government (aside from a few token politicians allowed to rave on and provide credibility to the claim that the people are represented) has been completely captured by the wealthy ruling elite.

    The only viable solution is not to continually suggest remedial measures that ultimately fall on deaf ears but rather to suggest remedial measures to regain control of government.

    Election boycotts are in order.

    Deception is the strongest political force on the planet.

  6. Siggy


    Why not pull the government checkbook. No guarantees, no cash infusions. Then the system implodes and at that juncture, repudiate all the unserviceable debt.

    Such legislation as might be considered ought to focus on proscribing any form of deposit taking from being under the same corporate umbrella with investment banking.

    This all points to the idea that the zombie banks should have been nationalized, broken up, and sold to new private ownership. With some pain, that can still be done.

    As regards TBTF, does it occur to anyone that once an institution becomes TBTF, it has, in fact, failed.

    This crisis is about balance sheet failure, the damm banks are bankrupt, the Fed and Treasury are trying to let them ‘earn’ their way to solvency. The public is mad as hell and the poltroons are pandering to an ill informed and largely ignorant public.

    Worse yet, what appears to have been massive fraud in the CDS space has yet to investigated and prosecuted.

    There is a certain cynicism in the Kanjorski proposal that reeks of theater with no substance and complete ignorance of the nature of the problem at hand.

    You are absolutely correct to observe that size isn’t the issue. It is conduct that matters and efficient markets won’t fix conduct, prosecution and law suits take time. Bankruptcy clears the air quickly and points to where the prosecutors should focusing.

    1. john bougearel

      Another problem with this Kanjorski theater: let’s say the legislation passes, along with the watered down Frank bill on derivatives. Combined, you know what this theater endorses the wrong-headed notion that these banks did not do anything illegal, that they just got out of control, too big too reckless, but nothing illegal.

      The only two people tried for securities fraud, Tannin and Cioffi, were found not guilty by jurors this week as prosecutors failed to make their case. Hell,Tannin proved beyond a reasonable doubt that he and Cioffi were guilty, but jurors did not see it that way.

      On April 22 2007 Tannin e-mailed Cioffi that the “subprime market looks pretty damn ugly and could be toast” and further suggested that they “should close down the funds immediately” if projections for the CDO Market were anywhere near accurate, adding that “If AAA bonds are systematically downgraded then there is simply no way for us to make money — ever.Caution would lead us to conclude the model is right — and we’re in bad shape.”

      So, what did Tannin tell investors on an April 25 2007 conference call three days later? “We’re very comfortable with exactly where we are.” And knowing the hedge fund was in trouble, Cioffi moved $2 million of his own money out of the fund in the month prior to this conference call.

      An effective risk management strategy to curbing the illegal activities of the past decade in the future would include prosecutions for violations of securities laws that leads to convictions. It is not helpful when a good defense lawyer is all you need to prevent a conviction.

  7. Blurtman

    Bailing out the global capital markets had to have some benefit besides protecting the bacon of the ultra rich, didn’t it?

  8. Ultimate Janitor

    It is a complete joke.

    Congress needs to be cleansed of the obstructionists that take bribes (should be about 80% in my estimate)

    Financial system regulation needs to be COMPLETELY OVERHAULED to reflect today’s risks. The “too big to fails” should be dismantled immediately.

    If this congress will not heed the will of the electorate they need to be gone. Where wrongdoing is proven, stiff jail terms nust be applied. It is the only way to clean up the sewer which is the US Congress.

  9. Hugh

    I still think to sort out all the OTC exposures, we will have to take over the financial industry and net out or nullify instruments until we get down to the level of the original risk. Only then will we know the full scope of the problem and be able to put the system back together in a restructured way.

    Alternately, I see re-imposing Glass-Steagall. Anti-trust actions and phasing out derivatives would be needed as well. Prosecutions for fraud would be an added stimulus to get around intransigent bank managements. Even with all these, there is still a high likelihood we would have to go the complete reconstruction route described above.

  10. Ed

    If the weak reform proposals keep getting stuffed, that doesn’t mean that they will go away. You will just get much stronger reform proposals. Because the underlying problem doesn’t go away and eventually it has to be addressed.

  11. Vinny G.

    I am on the Chicago subway now, and a guy is, as I type this, peddling to riders a series of new merchandise (jeans, sneakers, leather jackets) which I presume were stolen. Is this the type of “green shoots” signs of an economic recovery we should look for?…lol

    Vinny G.

    1. Vinny G.

      Yep, see my post in the unemployment thread about the Magnificent Mile.

      BTW, the other day I was having breakfast with the mayor, and when I asked what’s the deal with all the commercial vacancies on the Magnificent Mile, he suggested that although places like Borders Books is closing its 5-story store, joints like Walmart may be moving right in.

      Walmart on the Magnificent Mile — now, that’s a bad sign… unless they’ll catering to all the panhandlers and Elvis mimes that work and sleep (on the sidewalk) in the area but cannot quite afford Louis Vouiton…


      1. bob

        Louis Vouiton-

        The only person who could justify a $2000 bag is someone who is living out of it, funny how that works.

        1. Vinny G.

          Indeed! And I’m sure that Louis Vouiton bag/home would hold it’s value better than the average house or condo in America today… :)


  12. dd

    Oh please, duh Mayor at least lights things up (love the blue lights on State Street), plus Vinny’s on the subway and not walking. The real issue is that we can’t afford the NY bankers. MS is killing us in the parking deal, and the other once public parking venues are now hugely expensive private operations with poverty workers on patrol. Actually, it seems that contract workers with city revenuer ID’s on bicycles are the enforcers for the MS parking. Talk about a private/public partnership! But it matters not as anyone with a brain and a car drives to the burb malls (Free Parking and only 10% sales tax!) to shop.

    1. Vinny G.

      Yep, love the blue lights on State St too. Nice touch – almost makes up for the high crime, parking, and 6-month-long winter situations we have here… :)

      You know, I have not taken my car downtown ever since they kicked in this private parking deal. This way, not only do I save money, but I get free daily entertainment while riding the “EL” (for readers from other parts of the world, that’s what the subway is called around here… and trust me, this thing really is highly representative of the finest state-of-the-art technology that the 19th century had to offer).

      PS — the “breakfast with the mayor” situation was with another 150 people in the room, so if anybody here may want me to pass him a bribe from you, I regret to say that I really don’t know him that well… but I understand he also accepts bribes by mail, as long as they are sent to one of his cousins…LOL

  13. john bougearel

    Thank you for writing this post.

    Kanjorski is the same congressman back in March that THROTTLED the FASB to change the FV accounting rule to “mark to make believe.” Basically, the legislation served to legalize fraudulent reporting within the financial industry.

    Yes, this stroke of a pen back in April 09 to legalize fraudulent accounting went a long way to creating this secular bear market rally. But, knowing this is the same Kanjorski who saved the banks bacon back in March is the same Kanjorski who is now going to break them up. It’s such a joke that it’s not even funny.

    Big banks and TBTF entities can’t be broken up without shrinking the OTC debt and derivatives market, and dismantling the tight-coupling and interconnectedness created by these counterparty risks. As Rob Johnson pointed out, they aren’t TBTF so much as too difficult to resolve TDTR.

    So, I particularly like how you phrase the “only viable solution” being to require all systemically important TBTF firms “to exit all activities that are not socially essential” if they are to be deserving of taxpayer support.

Comments are closed.