It may seem perverse to use a particularly strong piece by Martin Wolf of the Financial Times, who even on his rare less than stellar days is reasoned and readable, to illustrate a deep rooted problem even for critical thinkers in the mainstream media, namely, that certain ways of framing issues are simply off limits. But those forbidden vantages are sometimes the most descriptive and potentially the most effective in galvanizing public opinion.
Wolf’s article today is a wonderful bit of high dudgeon, a shredding of Basel III, the latest incarnation of BIS rules on bank capital (our Richard Smith was similarly less than impressed and provided more detail on the shortcomings). Treasury Secretary Geithner, who tacitly admits that the so-called Dodd Frank bill fell short of the level of intervention needed to prevent another financial crisis, has taken to touting the idea that getting enough capital into the banking system will do the trick., which means he is effectively fobbing the problem off on Basel III.
Now narrowly speaking, the idea that enough bank capital would do a lot to prevent future crises isn’t wrong, but it begs the question of what “enough” is. Absent a lot of other coordinated measures (constraints on off balance sheet entities, much tougher accounting, limits on rehypothecation, securitization reform), “enough” would need to be a very big number. Steve Waldman, who wrote a definitive post on why bank equity figures are at best a conjecture, put the needed level of bank equity ex other measures at 30% of assets, a level that Wolf independently deems to be within the required range.
It’s great fun to see the Basel III rules, which for the most part been treated with undue reverence by the media and many commentators, get the drubbing they deserve. Per Wolf:
To celebrate the second anniversary of the fall of Lehman, the mountain of Basel has laboured mightily and brought forth a mouse. Needless to say, the banking industry will insist the mouse is a tiger about to gobble up the world economy. Such special pleading – of which this pampered industry is a master – should be ignored: withdrawing incentives for reckless behaviour is not a cost to society; it is costly to the beneficiaries. The latter must not be confused with the former. The world needs a smaller and safer banking industry. The defect of the new rules is that they will fail to deliver this.
Am I being too harsh? “Global banking regulators . . . sealed a deal to . . . triple the size of the capital reserves that the world’s banks must hold against losses,” says the FT. This sounds tough, but only if one fails to realise that tripling almost nothing does not give one very much…. the new standards are also to be implemented fully by 2019, by when the world will probably have seen another financial crisis or two.
This amount of equity is far below levels markets would impose if investors did not continue to expect governments to bail out creditors in a crisis, as historical experience shows (see chart). It would not take much of a disaster to bring such leveraged entities close enough to insolvency to panic uninsured creditors….. We might think of the new requirements as a “capital inadequacy ratio”.
Wolf then points out that the banking industry has managed to gin up analyses, using dubious assumptions, that endeavor to show that considerable cost to growth of higher bank capital levels. Funny, then, that the far from bank-unfriendly BIS did its own assessment and its estimate was 1/8 the level of the banking industry scaremongers.
Wolf then comes perilously close to making a fundamentally important observation, but pulls back (emphasis ours):
We cannot assess the costs of regulation without recognising a few facts: first, both the economy and the financial system have just survived a near death experience; second, the costs of the crisis include millions of unemployed and tens of trillions of dollars in lost output, as the Bank of England’s Andy Haldane has argued; third, governments rescued the financial system by socialising its risks; finally, the financial industry is the only one with limitless access to the public purse and is, as a result, by far the most subsidised in the world.
Read the boldfaced part again. Big finance has an unlimited credit line with governments around the globe. “Most subsidized industry in the world” is inadequate to describe this relationship. Banks are now in the permanent role of looters, as described in the classic Akerlof/Romer paper. They run highly leveraged operations, extract compensation based on questionable accounting and officially-subsidized risk-taking, and dump their losses on the public at large.
But the subsidies go beyond that. To list only a few examples: we have near zero interest rates, which allow bank to earn risk free profits simply by borrowing short and buying longer-dated Treasuries. We have the IRS refusing to look into violations of REMIC rules, which govern mortgage securitizations. We have massive intervention to prop up real estate prices, with the main objective to shore up banks; any impact on consumers is an afterthought.
The usual narrative, “privatized gains and socialized losses” is insufficient to describe the dynamic at work. The banking industry falsely depicts markets, and by extension, its incumbents as a bastion of capitalism. The blatant manipulations of the equity markets shows that financial activity, which used to be recognized as valuable because it supported commercial activity, is whenever possible being subverted to industry rent-seeking. And worse, these activities are state supported.
Consider Fannie and Freddie pre-conservatorship. They were at least branded more accurately as “government sponsored enterprises” and “agencies” making their public/private role explicit. Yet they were over time allowed more and more latitude to act as private enterprises, particularly as far as employee pay was concerned. We know how that movie ended.
Consider now the banking industry. Admittedly, banks do not fund at the tight spreads over Treasuries that Freddie and Fannie enjoyed pre-crisis, and regulators are trying to convince investors and the broader public that they will allow big banks to be resolved and are prepared to impose losses on bondholders, but does anyone believe this will happen? Winding down even a medium sized broker-dealer is a market-disrupting activity, and the “living wills” requirement looks like window dressing. But aside from the saber rattling of Pimco about why bondholders needed to be spared any pain, we also heard troubling rationalizations, such as bank bonds are held by pension funds. Well, yes, it’s risk capital. Investors are supposed to diversify holdings and losses are part of the game. And perhaps most important reason during the crisis for not cramming down bondholders was fear of contagion: imposing losses on bondholders of one bank would lead bondholders of other at-risk firms to run for the exits, raising their funding costs and potentially putting them in a death spiral.
So, the reality is that banks can no longer meaningfully be called private enterprises, yet no one in the media will challenge this fiction. And pointing out in a more direct manner that banks should not be considered capitalist ventures would also penetrate the dubious defenses of their need for lavish pay. Why should government-backed businesses run hedge funds or engage in high risk trading, or for that matter, be permitted to offer lucrative products that are valuable because they allow customers to engage in questionable activities, like regulatory arbitrage? The sort of markets that serve a public purpose should be reasonably efficient and transparent, which implies low margins for intermediaries.
A good post by Jay Rosen of NYU explains why this sort of observation don’t get traction with the press and why that is undermining its legitimacy:
In the age of mass media, the press was able to define the sphere of legitimate debate with relative ease because the people on the receiving end were atomized– connected “up” to Big Media but not across to each other. And now that authority is eroding….
1.) The sphere of legitimate debate is the one journalists recognize as real, normal, everyday terrain. They think of their work as taking place almost exclusively within this space. (It doesn’t, but they think so.) [Daniel] Hallin: “This is the region of electoral contests and legislative debates, of issues recognized as such by the major established actors of the American political process.”…
Perhaps the purest expression of this sphere is Washington Week on PBS, where journalists discuss what the two-party system defines as “the issues.” Objectivity and balance are “the supreme journalistic virtues” for the panelists on Washington Week because when there is legitimate debate it’s hard to know where the truth lies. There are risks in saying that truth lies with one faction in the debate, as against another— even when it does. He said, she said journalism is like the bad seed of this sphere, but also a logical outcome of it.
2. ) The sphere of consensus is the “motherhood and apple pie” of politics, the things on which everyone is thought to agree. Propositions that are seen as uncontroversial to the point of boring, true to the point of self-evident, or so widely-held that they’re almost universal lie within this sphere. Here, Hallin writes, “journalists do not feel compelled either to present opposing views or to remain disinterested observers.” (Which means that anyone whose basic views lie outside the sphere of consensus will experience the press not just as biased but savagely so.)….Whereas journalists equate ideology with the clash of programs and parties in the debate sphere, academics know that the consensus or background sphere is almost pure ideology: the American creed.
3.) In the sphere of deviance we find “political actors and views which journalists and the political mainstream of society reject as unworthy of being heard.” As in the sphere of consensus, neutrality isn’t the watchword here; journalists maintain order by either keeping the deviant out of the news entirely or identifying it within the news frame as unacceptable, radical, or just plain impossible. The press “plays the role of exposing, condemning, or excluding from the public agenda” the deviant view, says Hallin. It “marks out and defends the limits of acceptable political conduct.”
Anyone whose views lie within the sphere of deviance—as defined by journalists—will experience the press as an opponent in the struggle for recognition. If you don’t think separation of church and state is such a good idea; if you do think a single payer system is the way to go; if you dissent from the “lockstep behavior of both major American political parties when it comes to Israel” (Glenn Greenwald) chances are you will never find your views reflected in the news. It’s not that there’s a one-sided debate; there’s no debate.
Yves here. Ambrose Bierce, in The Devil’s Dictionary, described a partnership as “When two thieves have their hands so deeply plunged into each other’s pockets that they cannot separately plunder a third party.” Pointing out that banks are de facto partners of the state, enjoying substantial privileges (that unlimited checkwriting on official coffers when things go bad, the ongoing subsidies, the lavish private sector pay) without commensurate duties opens a huge can of worms. It goes beyond the usual, relatively anodyne “privatized gains and socialized losses” and opens up the terrain of “What do we mean by private enterprise?” Part of the American ideology is that there is a hard line between government and business. But entire industries suck off the state with far too few strings attached. The black/white distinction is illusory; what we instead have is a gradient.
But looking hard at the degree of looting and abuse of taxpayers, particularly in light of lavish CEO pay, not only raises uncomfortable questions, but calls for remedies that are politically unpalatable. Even though the state is deeply involved in enterprise, our ideology is that explicit industrial policy or other forms of involvement is a bad thing, the government will screw it up (when in fact some foreign governments do a decent job but we’d never deign to learn from them). So we’d rather limp along with a defective and increasingly costly model than challenge deeply held political beliefs.