Haldane Unto the Breach

We remarked before that attempts to nobble Mervyn King would soon bring other UK bank reformers out of the woodwork, and we have a confirming sighting today, via a puzzled tweet from @EconOfContempt:

Strange op-ed by Andrew Haldane in the FT. No one is really pushing the argument that he’s trying to shoot down

EoC means this FT piece; responding to the Merv crisis, BoE regulator Haldane is pushing his latest formulation of the idea that big banks need either to be broken up, or to carry a lot more capital. He’s just published a paper about this, at Nature, if you’re keen to part with $32:

In the run-up to the crisis, and in the pursuit of diversification, banks’ balance sheets and risk management systems became increasingly homogenous. For example, banks became increasingly reliant on wholesale funding on the liabilities side of the balance sheet; in structured credit on the assets side of their balance sheet; and managed the resulting risks using the same value-at-risk models. This desire for diversification was individually rational from a risk perspective. But it came at the expense of lower diversity across the system as whole, thereby increasing systemic risk.

In his paper, he uses a biological metaphor, or model, and expands on it some more in his new FT piece:

There is no evidence that failure probabilities are lower among big, complex banks than smaller ones. But even if there were, the case for big banks holding higher levels of loss-absorbing capital would not be weakened. That case rests not on the probability of large banks failing, but on their system-wide impact. What matters is not a bank’s closeness to the edge of the cliff; it is the extent of the fall. And this will depend on a bank’s size, complexity and numbers of market counterparties.

These basic principles have long been known in the study of infectious diseases. Optimal strategies for preventing disease spread focus on “super spreaders”: not those most likely to die, but those with the greatest capacity to infect counterparties. The same calculus applies to big, complex banks. These super-spreaders of the financial world have huge balance sheets and often comprise thousands of distinct legal entities. Their numbers of counterparties are often mind-boggling. When Lehman Brothers failed, it had more than 1m such relationships. These spread financial infection on a global scale.

In the new FT piece, doubtless mindful of the recent Merlin capitulation, he seems to be leaning quite a lot more towards the ‘more capital’ alternative, rather than advocating a bank break-up:

The present situation in banking is in many respects perverse. The magic of diversification, when assumed into banks’ risk models, means that large, complex banks often hold less capital than their smaller, simpler brethren. The rocket-scientists building models tell us this makes sense. But the rocket-scientists building rockets tell us it is nonsense. This error has cost the world dear. Through this year, the Financial Stability Board is leading the charge to boost loss-absorbing capital for the largest, systemically important institutions to correct this error. It is right to do so.

Disagreeing with EconomicsOfContempt about anything at all is a completely nervewracking ordeal, but it must be done sometimes. The idea Haldane is trying to shoot down is that universal banks benefit from risk diversification, and, contra EoC, this idea is not only embedded in risk models, as Haldane remarks above, but also in the thinking of many bankers (and in some criticism of the Basel accords, for that matter).

For instance, here’s Jamie Dimon’s FCIC testimony:

While some of our businesses have faced substantial headwinds over the course of the financial crisis, others have performed remarkably well. Our size and our diversity of businesses have helped us. Size matters in businesses where economies of scale can be critical to success, particularly in areas such as systems, operations, innovation and especially risk diversification. I believe our performance and the events of the last 18 months validate this.

Admittedly Lloyd Blankfein did make a more qualified pronouncement some time back:

Certain developments of recent decades, like changes in the structure of financial institutions post Glass-Steagall, have brought the risk of less frequent but more intense upheavals. The diverse income streams of mega financial conglomerates reduce the effects of the 10-year storm, but their size and ubiquity exacerbate the consequences of the 20- or 30-year storm.

But what does that mean? It strikes me as one of those concessions that just bogs down the debate. Which are we meant to care more about: frequent relatively mild events or somewhat more frequent bigger events that threaten global financial stability? Still the latter, I should think; so why bother with the nuance?

But I suppose the guy in Haldane’s sights is, most likely, Bob Diamond:

…speaking at the CBI conference in London, Diamond said: ‘There is no empirical evidence that big is bad – in fact, quite the opposite. Banks dependent on a single market or product can be a greater risk, as we saw with Northern Rock.

By contrast, the global universal banking model, which integrates retail, commercial and investment banking, is well diversified by business and geography, well diversified by clients and products. And it should carry less risk, by virtue of that diversification, if it’s well run.

Less risk implies less capital.

So what I take from@EconOfContempt’s alerting tweet is this: having steamrollered the Treasury Select Committee and the Treasury, and apparently brushed Mervyn King aside, Bob’s next date will be with Andrew Haldane.

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19 comments

  1. Richard

    I think Mr. Haldane is trying to preserve the idea, which is strongly supported inside the BoE, that the large, global banks need to retain more capital.

    This idea is under attack and is about to be cutoff at the knees in the US by the current round of stress tests.

    A goal of the current round of stress tests is to allow the TBTF to start paying dividends or buying back their stock again (we would not want Jamie Dimon to have to worry that the banking sector has too much capital).

    The TBTF with the lowest capital ratio that is allowed to start paying dividends will effectively set the global standard for capital adequacy.

    This level will be far below the 20% that BoE Deputy Governor Paul Tucker suggested was ‘ideal’.

  2. readerOfTeaLeaves

    So it appears to be a Battle of the Metaphors.
    Dimon and Diamond claim that economies of scale are better for banking; they refuse to address the metaphor offered by Haldane, which is a bold concept with a lot of explanatory power.

    Diamond cares about making money; he claims economies of scale do that in banking. What he misses are the ways those economies of scale fundamentally weaken the entity: by increasing risk, it weakens the bank’s ability to ‘fight off disease’ as overleveraged bets risk sudden, catastrophic collapse.

    Haldane’s metaphor seems quite apt, and a refreshingly new way to think about economics that IMVHO is long overdue.

    Diamond, having no adequate response, is stuck with his ‘but b-b-bigger is b-b-better’ mantra. Which would be fine if he were making widgets, or only responsible for shareholder dividends. But at this point, if the banks are going to claim their almighty importance on the globe, some basic fundamental Public Health metaphors are long overdue in rousting them to some far more responsible behavior as a means of respecting more viable metabolic parameters.

  3. Banks are on meth

    All the banks are like this nurse; this is a great focused example of the state of global banking today, an unregulated, out of control, drug addiction state, that is corrupt and dangerous!

    See: “Marguerite Irene Furgerson, 29, is accused of using patients’ names on forged prescriptions to obtain over 4,000 Vicodin and Hydrocodone tablets while working at Hospice and Palliative Care of Northern Colorado. Furgerson admits being addicted to painkillers, and in fact she was reported to the State Board of Nurses at her previous job at North Colorado Medical Center because she took a patient’s medication.

    You read right: Furgerson stole medication from a patient and was caught, yet she was rehired as a nurse and paid to handle the substances to which she was, by her own admission, “heavily addicted.” Furgerson faces identity theft charges; police describe her as an addict relying on up to 75 pain pills a day.

    Furgerson’s alleged crime comes soon after surgical technician Kristen Diane Parker, 26, was charged with injecting herself with painkiller syringes, then replacing the dirty needles with saline for patients’ use. According to the charges, not only did the patients get saline instead of the painkiller they were prescribed, but they were also exposed to Hepatitis C (Parker and the hospital knew she carried the virus before she was hired). As Westword reports, Parker’s public Myspace page, still accessible, contains comments such as “I have a crazy fascination with needles. . . I just like the way they feel!” So very comforting to the nearly 6,000 people who could have been infected with Hepatitis C due to her alleged actions.”

  4. F. Beard

    The bankers have a de facto government enforced monopoly on money creation via legal tender laws, a lender of last resort (the central bank), government deposit insurance, etc.

    How about we abolish that monopoly so as to allow other ideas on private money creation to compete?

    How long shall an incompetent money and banking system be privileged by government?

  5. BFWR

    Decentralization of the the current financial paradigm would do little in the way of reform or democratization of the economy. The anarchy of multiple currencies would simply result in increased fraud, theft and recentralization of the financial system in short order. It is what the Banks would allow as a fall back to any real assault on their money creation privilege. What we actually need is the direct distributive financial paradigm which will drive the stale through the heart of oligarchic control of our money forever. G. K. Chesterton, Hillaire Belloc and C. H. Douglas are the direction we must go or we will end up having a reactionary socialist revolution and even more tyranny than we have now.

    1. Mansoor H. Khan

      Exactly,

      Decentralization will lead back here to our current situation eventually!

      What is needed some simple, practical adjustments/refinements to our economic system:

      We need to put income in the hands of consumers to combat global wage arbitrage. Global wage arbitrage tends to be deflationary. The federal government simply needs to print newly created money and:

      a) create a massive jobs program
      b) greatly increase aid to states and municipalities
      c) greatly increase jobless benefits (amount of benefit and length of time) and extend COBRA benefits to 5 years
      d) issue a $500 per month per citizen national dividend

      And only if the above policies cause inflation, tax the rich.

      Mansoor

      http://aquinums-razor.blogspot.com/

      1. Paul Tioxon

        I never see the political dimension in any of these equations, but you seem to proposing one masquerading as a rational option for putting liquidity back into the economy without debt creation. I think there is the beginning of a theoretical framework for a cybernetic theory of money and the three day work week. Productivity gains and continued automation require less than forty hours a week necessary to be given to the wage economy. People really do not have that much productive work to do anymore and the inputs for agriculture and manufacturing and distribution require less than what is demanded of us in terms of time and real effort. The other four days can be relegated to whatever, mostly family obligations for many of us. This is the political meaning of under utilization. We just are not needed most of the time to get all of the work that needs to be done. This is a tremendous political problem that is coming to the fore with the accelerated automation brought on by IT and the internet. The fact that so many people do not work, and yet there is not mass starvation and homelessness is indicative of the wealth of America and the diminishing need for people to give 5 days a week and 8 hours a day to the corporate world. It has been barely 100 years that workers won the right to the 8 hour day and the week end in America. We are even more productive than then, so why are we forced to show up when not really needed? Apparently, there is less and less desire to keep so many people on the pay roll. Aside from capitalism needing more profits, that is their problem. Mine is why are we still working so hard when machines and computers are doing most of the work?

        1. Ian

          Paul- I live in the world of self-employed construction people. Excavators,masons,framers,roofers,electricians etc. New houses are one thing,remodelling is another. The people who build only new homes are one breed. They do not know how to dismantle an existing home and add on, rebuilt,restore etc. We all have work, it is tougher to get,we all pay our bills and raise our families. Nobody wants to do this kind of work any more. Spending a lifetime watching tv and thinking that one is going to succeed by sitting in a cubicle and entering data on a computer has let to this. Most of the work that most people do is busy work mandated by state or federal law or reporting requirements with no basis in production or value added. So we are all busy. We usually have 40 hrs in by late afternoon Wednesday, and have 3 more days to go. Do we make alot of money? No. Do we give value for money spent? Most of the time. Are all jobs suitable for inclusion in Architectural Digest? Definitely not. But we roll with the punches, and persevere. Cannot do this in a 3 day week. My farmer friends work 7 days. Some of them go on vacation once every 15 or 20 years. Work is work.

        2. Mansoor H. Khan

          What I am trying to do is slowly “turn” our economic system to a new way to thinking about money and work. Americans are very suspicious of new “grand economic theories”. But Americans will easily adopt small incremental steps to the world you are alluding to.

          Mansoor

          1. BFWR

            Yes, people have a hard time understanding new ways of doing things. But crises are a time when new and more radical ideas can take hold. We can linger in this crisis for many years if we are apathetic, and then have a very reactionary turn toward a rigid socialism. I would prefer that we get real about monetary reform before that happens so we can maintain a profit making system, but at the same time democratize the economy much more than it ever has been. We need a person who communicates well enough to break the images most people have in their heads about finance/money. An iconoclast.

  6. avatar singh

    basnk og englasnd is a pirate bank whichmust bemade bankrupt which england really is except for its economy being depodendent on british stooges bringin g stolen money from third world and parking that in london-thyat is how deindustraile ngland lives off-the stolen money be it from mussaraf, or mubarak or bhutto or unelelcted corrupt manmoahn singh the stooge of anglos in india.

    Allowing british journalists is very dangerous-they are the spies working to destabilise al countries not under them.
    10/02/2011, 00:08
    besides whenever the english journalists infiltrate the news media or forum the news become propaganda for the english interest only. The same happend with CNn and is happening with al jareeza where english journalists infiltrated.
    Another example is Russia today where the english journalists have hijacked the agenda of Russian tv.
    Just one example out of thousand as to how much the english journalists do the propaganda for england even in Russian tv.
    Today while interviewing an American about the money and corruption of Mubarak and his cronies with american support-the american lady was lashing out at american corruption and collaboration with dictatorial mubarak regime- then the newscaster of Russia today with name of some the some dudley guy(obviusly from england) said “but then such ally of usa in egypt like mubarak brings stablility and help to the west and thus is it not a good thing instead of bothering about corruption?”
    Here is the newscaster of Russian tv but is pimping for English (west is code word for anglosaxon) interest even when he admits that is corruption and against democracy for Egyptians!
    =======================================================================
    http://www.atimes.com/atimes/China_Business/MB17Cb01.html

    ===The Opium Wars do not belong to the glorious episodes of Western history. Rather, they were instances of shameful behavior the West still has not lived down.

    Mercantilist governments resented the perpetual drain of silver from West to East in payment for Oriental goods (tea, silk, porcelain) that were in high demand in the Occident, while facing low demand in the Orient for Occidental goods. From the mid-17th century, more than 9 billion Troy ounces, or 290 thousand tonnes, of silver was absorbed by China from European countries in exchange for Chinese goods.

    The British introduced opium along with tobacco as an export item to China in order to reduce the trade deficit. Under the

    disguise of free trade, the British, the Spanish and the French, with the tacit approval of the Americans, continued sending their contraband to China through legitimate as well as illegitimate trade channels even after the Chinese dynasty put an embargo on opium imports.

    Because of its strong appeal to the Chinese masses, and because of its highly addictive nature, opium appeared to be the ideal solution to the West’s trade problem. And, indeed, the flow of silver was first stopped, and then reversed. China was forced to pay silver for her addiction to opium smoking that was artificially induced by the pusher – the British==

    The present trade dispute between the US . and China is reminiscent of the background to the two Opium Wars. Once more, the issue is the humiliation and plunder of China as a “thank you” for China’s favor of having provided consumer goods for which the West was unable to pay in terms of Western goods suitable for Chinese consumption. The only difference is the absence of opium in the dispute.

    Oops, I take it back. The role of opium in the current dispute is played by paper. Paper dollars, to be precise.”

    1. Paul Tioxon

      The Sons of the Ancient Order of Hibernians stand in solidarity with your denouncement of the British Crown.

  7. Maybe this is it?

    As a distinguished thinker, the late Warren Weaver of the Rockefeller Foundation has pointed out, both in the biological and in the social sciences frequently we cannot rely on probabilities, or the law of large numbers, because unlike the positions which exist in the physical sciences, where statistical evidence of probabilities can be substituted for information on particular facts, we have to deal with what he calls organized complexity, where we cannot expect to find permanent constant relations between aggregates or averages.

    Indeed, this intermediate field between the simple phenomena of the physical sciences, where everything can be explained by theoretical formulae which contain no more than two or three unknowns, and the instances where a large enough number of events to be able to deal with true mass phenomena to rely on probability is our subject. In the social sciences we have to deal with something which Warren Weaver called organized complexity, phenomena which are not made up of sufficiently large numbers of similar events to enable us to ascertain the probabilities for their occurrence.

  8. Cedric Regula

    Yes,yes. I thought everyone covered this already. Starting with Volker, and on and on.

    So the Daliks say banks shouldn’t have money in them…they can get it from another bank, and they should diversify into countercycle things like quasi-insurance for their own good.

    And this makes sense because other industries may sell steak and beans.

    Ya. So? Why are we still listening to Daliks?

  9. nonclassical

    why not discuss what these “investment banks” are actually doing in international market place, flying in, monopolizing
    one commodity or another, driving the market, profiteering and leaving, causing massive failure in local markets..

    this is what has happened since TBTF has been codified, happened prior to 2007, by speculators…is this, or is it not acceptable?

    Now local markets are requiring 2-3 years in markets if players are to be allowed in..is this the cure?

    Too big to fail is the problem…no one in power wants to admit it, as they get bigger-we all know that reason…

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