This is by Yves Smith, cross-posted from the New York Times Room for Debate…
Preventing blow-ups like the JPMorgan “hedge” that bears no resemblance to any known hedge isn’t difficult. What makes preventing it difficult is that banks that exist only by virtue of state-granted charters — and more recently, huge transfers from the public — have persuaded public officials and regulators that they have a God-granted right not just to high levels of profit but also high levels of employee and executive compensation.
Banks enjoy state support because they provide essential services, like a payments system and a repository for deposits. One proposal to limit them to these vital services is “narrow banking,” or requiring that deposits be invested in only safe and liquid instruments. This idea was put forward by Irving Fisher and Henry Simons in the 1930s, and has been championed by the right (Milton Friedman), the left (James Tobin) and banking experts (Lowell Bryan of McKinsey).
A less radical idea would be to eliminate credit default swaps over time (they are too embedded in current practice to ban them; banks need to be weaned off them). There are no socially valuable uses for the product. Contrary to defenders’ claims, they aren’t a good way to short bonds (not only does it deal with only one attribute of bond risk, it does so badly: payouts in actual credit events on credit default swaps vary considerably, and are generally less than payouts to holders of real bonds). These swaps were the driver of the crisis. They were the mechanism that allowed real economy exposures to risky subprime bonds to be multiplied well beyond the number of actual borrowers and thus cause vastly more damage.
Another route would be to implement the Volcker Rule as Paul Volcker envisaged, meaning without the portfolio hedging exemption that JPMorgan relied on. Or officials could enforce Sarbanes Oxley, which has the chief executive officer certify the adequacy of internal controls, which for a major financial firm includes risk controls. Had any chief executives been targeted for Sarbanes Oxley violations for the massive risk management failures during the financial crisis, it’s pretty likely thatJamie Dimon, head of JPMorgan, would have thought twice before giving the chief investment officer both the mandate and the rope to enter into risky trades.
Maybe it’s time to recognize that these firms are too big and in too many complex businesses to be managed. Jamie Dimon was touted as a star who could supervise a sprawling firm running huge risks, and he fell short because no one can do the job adequately. A less disaster-prone financial system requires more simplicity and redundancy. Re-instituting Glass-Steagall or other variants on the narrow banking theme isn’t a full solution, but it would make for a good start.
Update by Yves: I’m not happy with the headline the Times put on this piece. The article did not say implementing Glass Steagall would have stopped Dimon’s losses but was an example of the sort of step that could help make the financial system less crash prone.
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Friends;
I liked the tagline one of the comments on the “Room For Debate” site threw out: “Smaller is Better.” This debate is making it to the MSM sites, see the Robert Reich piece at the same site, “Break Up the Banks.” People denigrate it, but I’m still a believer in “Moving the (Overtons) Window” as a sound strategy. Everything is worth trying before we have to resort to the final option. (See the Preamble to the U.S. Constitution.)
“Or officials could enforce Sarbanes Oxley”
President Obama can’t enforce rules like this, because then his friends on Wall Street wouldn’t donate to his campaign, and then he couldn’t get re-elected, and then he can’t enforce rules like this!
Well put Yves!
Down with complexity and fragility. Complexity is the hand-maiden of predatory finance. Fragility is gateway to taxpayers’ pocket.
Casinos make the most from the games that are ‘easiest’ to understand, which is a paradox of sorts. I do hate the whimpering appeals this late in the US Fraudclosure process:
“Maybe it’s time to recognize that these firms are too big and in too many complex businesses to be managed”
I think it’s time to seize data centers, and use our police state and military resources to full effect on the kleptocrats in the NY-DC nexus. Will the last crook on Wall Street denounce mammon from his delusional existence?
Re phasing out credit default swaps: what is to keep the London subsidiary writing as much as it pleased? This is what sank AIG as a real life example.
Threaten to revoke the charter of any bank, domestic or foreign, to do business in the US that uses them or has a subsidiary that uses them.
Banks enjoy state support because they provide essential services, like a payments system and a repository for deposits Yves Smith
The US Federal Government, as the monopoly issuer of its money, should provide a risk-free storage and transaction service for that money that makes no loans and pays no interest. It should be free up to certain limits. That would allow the repeal of government deposit insurance and all other privileges for the banks.
Of course the above would cause massive bank runs so it is important that new reserves be provided first so the banks would not run out. The just way to do that is a universal bailout ala Steve Keen that would payoff ALL private debt over time (to prevent price inflation) combined with a moratorium on new credit creation till the bailout is accomplished.
Banking, the business of borrowing short to lend long, is gambling and a form of counterfeiting. If not absolutely banned then at least all government privileges for it should be abolished.
Credit Default Swaps were created principally so that Banks would have a means of laying off credit risk of loans they made to corporations.
Selling the loans was expensive and sent the wrong message to the corporate client.
CDS allows both Banks and speculators to be more efficient. The market has grown to hundreds of trillions of notional exposure for a reason.
CDS does have the potential to be used badly. I think they should be registered and that regulators should collect trading info – then create appropriate rules or get them on an Exchange.
==============
I support Yves call for separating risk-taking Banks from Utility Banking.
Why is Goldman Sachs a Bank????
“CDS allows both Banks and speculators to be more efficient.” -Jackrabbit
If only CDS allowed both you and your informants to think more efficiently. Then you might be able to take into account the rather gross inefficiencies of the global financial crisis that your hallowed CDS engendered.
The only efficiency that CDS allows is more efficient transferring of risk onto other, less informed parties. I assume from your cheerleading that you are one of the beneficiaries of that asymmetrical transfer.
I object to the tone of your reply. I’m not “cheerleading” nor am I a “beneficiary” of financial schemimg.
Yves is being practical when she says that CDS shouldn’t be eliminated immediately. I am only going a step further (in practicality) by saying they should be registered and studied before they are regulated because they do seem to have some utility (judging by their success in the market).
For example, an outright ban implies that Hedge Funds and others who are neither systemicly important nor depository institutions would be barred from using CDS. That kind of over-reaching (even if unintended) only gives ammunition to those who oppose regulation altogether.
I disagree with Yves. Current CDS should be nullified and the practice banned.
The CFMA tellingly exempted CDS from both insurance and gambling regulation. They are underpriced insurance used to sweeten bad deals which otherwise should never have been entered into. And they allow third party betting on the results of transactions in which they are not involved, i.e. gambling. Any argument for why CDS should exist would have to give a social good that they fulfill. Making the lives easier for speculators does not qualify as one. CDS do not reduce risk. They both transfer and magnify it. We saw their devastating contribution to the 2008 meltdown. So we know they are immensely destructive. We know they facilitate the blowing of bubbles. And we have no evidence that they serve any useful social purpose. It is incredible that anyone would defend their use. Nor for that matter does Yves. We both advocate for their abolition. We just would go about it in different ways.
If you want another 2008 level of bailouts and related looting, banning CDS overnight is the way to do it. They are used in a very large scale way for hedging (not a very good hedge, but a hedge nevertheless) by banks. Take away the hedge and you’ll blow up a LOT of banks. I’ve spoken at some length to real experts who don’t like CDS (like Satyajit Das) and they maintain that banning CDS will blow up the system.
You have to wean financial players off them over time. You may not like that answer, but the alternatives are worse.
It seems to me that the problem is unregulated markets. Most people wouldn’t like the stock market very much if the SEC wasn’t regulating it, either (yes, they could do a better job …).
And, while CDS made 2008 worse (as it became a conduit for contagion), the cause of the calamity was the credit bubble, which in turn was caused by TBTF Banks(ters) essentially arbitraging public trust (which ‘The Powers That Be’ have undermined further by covering up for them).
Lastly, markets are not just a mechanism for taking/laying off risk but also an information source. That information is valuable to all credit market participants even if regulators decide that some of them can’t use CDS at all (utility banks, for example), or can do so only in specific circumstances/ways.
I _do_ have a concern as to whether the regulators can be trusted to do their job, however.
Other reforms are needed as well (political finance reform, corporate governance reform, etc.).
Maybe you mean that you want to ban synthetic CDS?
That might be understandable, as these are just ‘side bets’ with no hard and fast tie to any underlying instrument.
What about something like the following:
a) ban synthetic CDS altogether
b) force credit stripping (CDS creation) via a Clearinghouse
c) Exchange-traded swaptions (for CDS with active markets as replacement for synthetic CDS)
d) regulate CDS/Swaption use in specific cases (by institution or application)
No, I don’t expect this is ‘The Answer’ but just a stab at something that could be better than “banning CDS.”
Yves, I would simply declare CDS to be unenforceable and rebate the costs to the buyers on a pro-rated basis. I can’t help hedge funds for buying what they had to know was a defective, mispriced hedge. As for rendering CDS unenforceable, how does that blow up the banks unless they too were involved in buying these same defective instruments? And as for the banks, they blew themselves up back in 2008. What is left is their zombified remnants. So the resolution of the banking sector that should have been done in 2008 still needs to be done. In this regard, I would look at other swaps classes too. I think netting is BS, especially if another meltdown occurs. Netting looks good on paper but it doesn’t mean a thing if half your counterparties are dead. And as LTCM showed way back when even supposedly safe swaps like currency ones can blow up under the right conditions.
I do agree with JackRabbit about naked swaps. They’re just bets and should be nullified outright.
A lot of the problems with swaps could be taken care of if they were put back under traditional insurance and gambling regulations. If holders of CDS wanted to keep them, I would let them. I would just charge real insurance rates for them, effectively killing them.
“I am only going a step further (in practicality) by saying they should be registered and studied before they are regulated because they do seem to have some utility (judging by their success in the market).” -Jackrabbit
Why not say neo-Nazis should be studied before being regulated because they do seem to have some utility (judging by their success in politics)? Or that Kim Kardashian should be celebrated for her utility (judging by her success in media coverage).
I urge you to consider the logical fallacies you are operating under before regurgitating these discredited memes on the rest of us.
Your neo-Nazi and Kim Kardarsian strawmen are nonsensical. There is no equivalence.
1. I agree with separating banks (you already knew that)
2a. I agree with banning synthetic CDS, and
2b. even banning their use by certain institutions (like depository institutions)
3. I agree with establishing regulations to protect against abuses of CDS.
But that’s not enough for you. OK. I’m sure the 5 people on the planet that are as certain and ardent about the issue as you are will be able to get CDS banned in no time. (Yes, 5 people is an exaggeration – but one that is much less grating than your exaggerations.)
Banks, politics, regulation, etc. all need reform. I can’t wait to hear your colorful prescriptions for those.
He lives under a bridge.
[Lambert, I forgot that a certain word related to money creation lands my comments into moderation. Please delete that comment. Thanks.]
“Banks enjoy state support because they provide essential services, like a payments system and a repository for deposits.” Yves Smith
The US Federal Government, as the monopoly issuer of its money, should provide a risk-free storage and transaction service for that money that makes no loans and pays no interest. It should be free up to certain limits. That would allow the repeal of government deposit insurance and all other privileges for the banks.
Of course the above would cause massive bank runs so it is important that new reserves be provided first so the banks would not run out. The just way to do that is a universal bailout ala Steve Keen that would payoff ALL private debt over time (to prevent price inflation) combined with a moratorium on new credit creation till the bailout is accomplished.
Banking, the business of borrowing short to lend long, is gambling and a form of counterf**ting. If not absolutely banned then at least all government privileges for it should be abolished.
“Banks enjoy state support because they provide essential services, ” and if public, would provide these services without fraud, crime, waste, abuse, subversion of due process, constitutional rights and destruction of what should be a Democratic institution. In other words, stealing state support doesn’t mean they enjoy it, although they probably do. Too big to take responsibility for global warming too, so far.
I’ll go even further. “Banks enjoy state support because they provide essential services, like a payments system and a repository for deposits” The people have this power already, they truly do, but are chess pieces in a game of keep away so they are corralled and prevented and blogged into submission.
Obsolescence is guaranteed one way or the other. Bit coin your mortgage fraud, banksta!
I’ve been wondering what Yves thoughts on this might be as of late… since she has pointed out on more than one occasion that by the time Glass-Steagall was abolished much was already gone years before.
I don’t know. Advocation of fiddling around the edges (adjust Glass-Steagall here, Volker there etc.) in a time of systemic abrogation of rule of law, especially at these uppercrust levels seems to me to be wishful thinking. Were the 50’s thru 70’s that wonderful? Can we utilize GS and Volker etc… in a world without a giant MIC post cold war, an cheap oil, massive coal and nuke waste based economy/ecology? Should we be trying to go back there, this way?
Does restoration of Glass-Steagall further ensconce too many other areas of failed neoliberalisim such as free trade and continued rule by the aristocrats?
We need dramatic restructuring on so many systemic levels. We need to reestablish enforcement of law and regulation before we pretend penning new rules means a damn thing. I really think this should begin with an entirely new Constitution – Article V convention, an entirely new finance/money system, new political (public financed only) election/representative of the people system.
We’ve got to crush the beasts, redistribute the wealth… with a table of, by and for the people at large. Otherwise these ponzi-scheming criminals will just control all options at a table of their own…with no consequence.
For a brief, concise history of how the Glass-Steagall act was gradually dismembered see this posting by Barry Ritholtz. Barry thinks it has a lot to do with the fact that Corporations “live forever” and can lobby everyone else to death. The vampir squid concept lives on.
http://www.ritholtz.com/blog/2012/05/how-we-ended-glass-steagall/
It “took a village” to finally kill it near the end of Clinton’s reign — after decades of incessant nibbling by the financial wizards and their political fellow travellers.
He’s got a good outline of some of the key milestones but he’s missing the driver. It’s not about long lived corporations. All the investment banking partnerships of the 1970s and 1980s had been around for over 100 years.
It was about the deregulatory philosophy that was being marketed on all fronts thank to the orchestrated efforts of what was then the radical right, starting with the Powell memo of 1971. The big push started during the stagflation, under Carter.
Banks jumped on this bandwagon. They were jealous of investment banking profits and wanted a piece. I had Citi as a client in the early 1980s and had a ringside seat (Citi was the most aggressive in pushing the regulatory envelope in those days).
That’s an excellent point. It is seductive to imagine how the current system could be reformed. But reform requires a system whose foundations are still sound. In the kleptocracy we have, this is not the case. Kleptocracy as advanced as this one can not be reformed. It can only be overthrown and replaced. The same is true of the elites which run and serve it. They too can not be reformed and must be replaced, hopefully by non-elites, that is people with expertise but without the heredity privileges of the current elites.
The overthrow of kleptocracy means revolution. I advocate what I call a good old-fashioned American revolution. We still can have a Constitutional revolution, but the longer and more tenaciously the kleptocrats and the elites dig in, the probability that we will go in the direction of the Russian Revolution increases. This is why action now rather than action deferred is so important.
What would your revolution look like?
Isn’t it great how we can propose to rebuild the magic gardens of Babylon? I propse also that humans have wings (saves gas and improves cardio), everyone be slim and trim, poverty ebolished and Texas returned to its rightful owners: the Indian or may be its the Palestinians.
Seriously, the solutions of 20 years ago have to be reevaluated. Banks shouldn’t be in gambling business, but deposits and loans are not enough. Breaking up the banks will not happen, but chaneling them into narrower and less risky areas might. No one ever suggested to break up GE or GM.
Others may have more and better proposals that do make sense and are realistic.
Glass Steagall can’t bring the global bond market back from the dead. It can protect citizens and tax payers from direct theft (MF Global et. al.) but it can’t do anything about the exhausted practice of bonding debt based on growth speculation. The EU has just put out a statement that they are now looking for a way to create growth without throwing more money a moribund economies. Where is this going?
Yeah, by the time Glass-Steagall was repealed it was already a stale, rotted-out, worm-eaten piece of Swiss cheese, since the organization and practices of financial “markets” had evolved massively since the inception of the act, such the repeal was a mere formality. Calling for its re-instatement is a bit like calling for a renewed union movement, when the industrial mass production jobs and the pools of oligopoly rents they could target have long since been restructured and outsourced overseas: an exercize in earnest nostalgia.
No, something more radical is required, not just a few feeble amendations of regulatory rules. Raise bank capital requirements sharply, (and strip out the risk adjustment nonsense), forcing banks into insolvency and thus public receivership, fire top management and boards, convert bonds to equity, strip out all the bad “assets” and manage them in a bad bank owned by the former bond-holders, and publicly re-capitalize the banking system, while breaking it up, downsizing it, and tightly re-regulating it. No bank or financial organization should be allowed to have assets of more than $25 billion, all financial organizations should be restricted to a single functional specialty, regulations should be based on principles rather than detailed rules, and regulators should be given strong mandates with an explicit hold on licenses and the rents that accrue to them, while being well-paid permanent public service careers, with a “once you go black, you never go back” rule.
Only then will finance and banking be subordinated to the real productive investment it is supposed to serve and “intermediate” and the enormous financialized rent extractions that cripple the real economy be eliminated.
You’re not radical – nor prudent – enough.
Credit creation should be destroyed, not “reformed” but in a prudent manner:
1) Ban any further credit creation. This would be massively deflationary by itself as existing credit is paid off with no new credit to replace it.
2) Bailout the entire population equally, including non-debtors, with full legal tender fiat till ALL credit debt to the banks is paid off. To prevent changes in the size of the total money supply (reserves + credit) the bailout could be metered to just replace existing credit as it is paid off.
Or keep tolerating a system that will eventually destroy much of the world.
Austrian piffle. The basic role of credit to to build future improved production capacity without a deflationary collapse of current supply and demand. It’s true that some such real investment can be financed out of current profits/productive surpluses, but credit allows for accelerated investment. Any advanced production system, whether capitalist or not, would require a functional analog of credit. But what’s not true is the Austrian illusion that only savings lead to investment sine qua non. In real terms, it’s rather that investment in productive improvements produces savings.
Common stock as private money allows the necessary investment but without the theft of purchasing power inherent in credit creation in a government enforced monopoly money supply. Nor does common stock require usury since it can be spent into existence without borrowing someone else’s money.
BTW, the Austrians don’t much like the idea of common stock as money as they are devoted to usury for a monopoly money supply.
Can’t we all just agree that our money system should not require theft either by counterfeiting (credit) or by a private money monopoly?
But what’s not true is the Austrian illusion that only savings lead to investment sine qua non. john c. halasz
Agree. The use of real capital should not have to wait on the accumulation of mere money tokens. But the Austrians are terrified that their money hoards might be bypassed as indeed they are being bypassed by credit creation – which is a form of theft by counterf***ing.
It’s true that some such real investment can be financed out of current profits/productive surpluses, but credit allows for accelerated investment. john c. halasz
Of course, because credit creation is basically theft by money dilution from the less “credit-worthy”. But note that the workers have been dis-employed with their own stolen purchasing power so that using credit to finance accelerated investment is self defeating – the ex-workers can’t afford the new products of the investment!
@john c. halasz
Sure, your radical reforms are good (and obvious), but in case you haven’t noticed, every proposal made by leftists and progressives and reformers has gone nowhere. The System, the Establishment, TPTB, has rolled on relentlessly on its agenda. The 99% has lost everywhere. The public didn’t even get shares and shareholder control when it bailed out the banks and AIG in 2008, as the British government got. The “reforms” adopted by the System so far have all been Trojan Horses (Obamacare, bank settlements, mortgage writedowns, the Task Force). The only thing saving the middle and lower classes has been SS, Medicare, non-recourse mortgage rules, and some trickle down from the rich and government spending.
It’s obvious by now the the System will never adopt real reforms until the whole thing blows up (eg. stock market and housing declines 50%, unemployment hits 30-40%, banks blow up). And even if the System does explode, it might just be another parade of Shock Doctrine reforms that really clamp down on the 99%.
You have to start somewhere, with something doable, which I suppose is why Yves suggests thing like reinstating Glass-Steagall and getting an effective task force and some SEC/DOJ action and derivatives oversight.
(I would suggest something different, like banning the practice of corporations indemnifying officers and directors for misdeeds while employed by the corporations (right now, corp execs don’t care if they get sued because the corps pay the bills, and criminal prosecutions are not happening because the SEC thinks convictions are too difficult). Or allowing or encouraging class actions of various sorts.)
The point is that if you ask for the moon you will get nothing, but if you try to get something small you might get the ball rolling on larger reforms. In the current environment, what do you thing the chances are that JPM, GS, Citi or MS would be forced into reorganization and management fired, or even have their capital requirements raised? Zero chance.
The first order of business is to focus on real functional effectiveness, which means also to focus on the dysfunctions of a hypertrophied financial system and the financialized rent extractions that occur from overloading the economy with credit/debt, which amount to a private tax upon the real productive economy and impair and degenerate its efficiency. The collapses in “values” that you cited have already halfway occurred and only have been forestalled in full by futile bailouts, attempting to restore the status quo ante, at the expense of consigning the real economy to a decade or more of stagnation and spreading social misery, (while not meeting the challenges of rebuilding the productive economy in a more socially and environmentally sustainable way). Small half-measures, piecemeal reforms, are not a start, just putting band-aids on gaping wounds and sores, and will easily be circumvented or reversed. It’s either radical reforms or continuing decline, corruption and collapse. Those are the real odds, slim or none.
It’s either radical reforms or continuing decline, corruption and collapse. john c. halasz
You’re not radical enough. We could mostly do away with credit and even usury and still have a modern economy with the necessary economies of scale.
The key is ethical money creation.
Money is a functional matter, not directly an ethical one. And, its limits duly observed, has useful roles to play, (e.g. given that most production costs for most production organizations are indirect, it allows for the calculation of costs to determine the most efficient, cost-effective techniques of production under given conditions). But money itself is just a cypher, a semiotic instance, a representation of economic value without being that elusively real thing itself. Fetishizing money as if it ought to be the real itself is an instance of the fallacy of misplaced concreteness.
So those standard Austrian tropes about how the debasement of money is theft,- (dude, there’s a reason it’s called “currency”!),- of how a dollar today is worth just $.05 in 1900 dollars, (yeah, well, just try buying an antibiotic with a 1900 $),- and how credit is simply fraud,- (no, it depends on how well and for what purposes credit is underwritten, which is why the credit system needs to be tightly regulated and can’t depend on the alleged self-regulating properties of “free markets”),- are just so much pettifoggery, blind to its own defective and fallacious thinking, based on the pseudo-moralistic idea that ethical standards could be derived from a monetary basis.
Fetishizing money as if it ought to be the real itself is an instance of the fallacy of misplaced concreteness. john c. halasz
Common stock is very much real – it is part-ownership of all the unencumbered assets of the issuing common stock company.
The smarter Austrians, btw, realize the silliness of commodity monies which is why they seek a gold standard – to create fiat gold – backed by the taxation authority and power of government.
But you are dodging the issue. Between existing fiat (spent into existence ala MMT for government investments and operating costs) lent out for honest usury and common stock as private money what need is there for ethically problematic “credit” for private investment? I’d say there is none.
The Austrians are correct that credit creation is theft by inflation but they would replace it with theft by deflation which is even worse.
@beardo… “The Austrians are correct that credit creation is theft by inflation but they would replace it with theft by deflation which is even worse.”
Skip here… steady state value, really, is that what you pine for? Know wonder your ethics and morals are constantly at odds. Hint… there is and never will be ethical capitalism, the driving force of private capital accumulation forbade’s it. For you to even use such words, in conjuction with such activtys, shows how weak your historical understanding is.
Skippy… just another pidgion in a skinners box, willingly. Hows 5K years of debt coming along, challange any belifes lately?
steady state value, really, is that what you pine for? skippy
No, dummy. Even common stock money would vary in value as it was first diluted to buy new assets (including labor) and then increased in value as the new assets created additional demand for the common stock money. But the difference is that the common stock is an ethical private money form.
So you don’t want to share and you believe ethics are impossible?
Well, at least get out of the way.
You keep using metaphysical words like they are constant (or near) physical thing. Hence how do you steal, engage in theft of that which is by its very nature, unstable? Labor – Capital relationship thingy.
Like… “But the difference is that the common stock is an ethical private money form.”… beardo
Skip here… what’s ethical about it? WTF is private money form? And we could use about ten different terms for common stock, all of which are not very promotional. How about the lowest form of issuance a private identity could issue, having damn near zero contractual recourse. Save burning it in front of their faces.
Skippy… I could, as many big dogs do, just umbrella a hole bunch of small identities and play – pump – and skim. Like DIA airport. Do you have any idea what the actual enviroment is like out there?
what’s ethical about it ? Skippy
What’s not ethical about it? Common stock is democratic – at least per share. And if great wealth inequality exists, that’s a result of the current money system – usury for counterf**t money – which should be reduced with a universal bailout (which you also oppose).
You should not conflate the issuance of script with democratic action, there is nothing democratic about it.
Skippy… I oppose anything that would strengthens the miscreants that have pillaged a world for too long. Time for a new economic reality… methinks.
Well, even the stale old piece of Swiss cheese was enough to have made the Traveller’s – Citi merger illegal. Was before the repeal, but the crooks corrupted the cops. This “we won’t enforce laws, the 1% can do no wrong” idea is the deepest problem.
I want to see Yves’ or another competent analyst’s take on Felix Salmon’s discussion of Glass-Steagall today. It seems to me there is a giant hole in his argument. He asserts that Glass-Steagall would not have limited the damage done by speculation by investment banks in MBS’s and derivatives based on them. I assert that the demand for mortgages created by these banks’ activities were responsible for the housing bubble and the corruption bubble feeding it. The question is whether or not Glass-Steagall would have, in in the presence of effective regulatory action, have provided the firewall necessary to prevent investment bank demand for MBS their derivatives from contaminating the lending practices of bank banks.
A second, possibly more important, question is whether or not Glass-Steagall in the presence of effective regulation would have insulated the bank bank sector from investment banking well enough to have permitted us to let the investment banks to fail, without causing massive failure in the bank bank sector as a result.
I believe JPMorgan of 2012 was formed from the merger
of a pure investment bank (Old JP Morgan), and
Chase Bank (Chase-Manhattan), a pure bank bank.
It’s at Old JP Morgan that lots of derivative products
innovation happened.
In any case, the repeal of Glass-Steagall made possible
mergers into mixed-banks (utility banking and investment
banking).
No, the old J.P, Morgan was split into a commercial bank, J.P. Morgan, and an investment bank, Morgan Stanley, following the passage of Glass-Steagall in the 1930’s. J. P. Morgan merged with Guarantee Trust in 1959 and then, after the G-S repeal, with Chase Manhattan in 2000.
Credit Default Swaps would have been pretty much extinct, if AIG and others were allowed to fail in 2008. Instead we are living with a half quadrillion dollars mirage, which will greatly contribute to the next big financial crisis, coming shortly.
“It is no exaggeration to say that since the 1980s, much of the global financial sector has become criminalised, creating an industry culture that tolerates or even encourages systematic fraud. The behaviour that caused the mortgage bubble and financial crisis of 2008 was a natural outcome and continuation of this pattern, rather than some kind of economic accident…And yet none of this conduct has been punished in any significant way.” Charles Ferguson, Inside Job
Much?
The entire mess was the largest case of collateral fraud in history.
GS is a good start. Dimon in concrete overshoes in the East River is a better one….
The demise of Glass-Steagal did not cause the financial crisis. (Andrew Ross Sorkin and Dean Baker agree, links below.) It was however part of the zeitgeist of the times that did.
What the demise of Glass-Steagel did do however was to hopelessly (to our leaders, at least) complicate the recovery. Too many of the TBTF banks had FDIC insurance exposure (and those that didn’t, got it — that wasn’t particularly wrong, given the circumstances), and it was impossible for our leaders to determine whether or not a failure of one of them might sweep up all of them, taking with them the FDIC pool.
With that in mind, a return to Glass-Steagel is imperitive. There have to be firewalls in the event of catastophic failure, and Glass-Steagal is as good a place to put one of them as can be found.
Sorkin: http://dealbook.nytimes.com/2012/05/21/reinstating-an-old-rule-is-not-a-cure-for-crisis/
Baker: http://www.cepr.net/index.php/blogs/beat-the-press/glass-steagall-and-the-economic-crisis
The importance of Glass-Steagall is not the black letter law but the idea behind it, that banking (and insurance)should be plain, simple, and boring. I am a believer in plain vanilla banking. I don’t really care whether this is done through the government or the private sector. But it needs to be stripped down to the essentials and heavily regulated with the public through the government in control and not the banks and banksters. Anything outside this needs to be totally cut off from it and from the Fed.
JPMorgan Said to Hire Ex-SEC Enforcement Chief McLucas http://www.bloomberg.com/news/2012-05-22/jpmorgan-said-to-hire-ex-sec-enforcement-chief-mclucas.html
JPMorgan Chase & Co. (JPM), the biggest U.S. bank, has hired former U.S. Securities and Exchange Commission enforcement chief William McLucas to help respond to regulatory probes of the firm’s $2 billion trading loss, according to two people with knowledge of the assignment.
This post is similar to continuing theme I’ve been addressing with posts over the last couple of weeks.
There must be a ceiling to “economies of scale.” Beyond Glass-Steagall is the sheer size of the financial industry corporations. A more effective control to their destructive nature would be a vicious application of anti-trust law to break up the TBTF corporations into much smaller regional entities. No one entity could command enough leverage, capital, or market share to cause systemic failure if it crashed. Smaller regional entities would be more responsive to the market, and would not distort strict liability laws that would govern them in palce of flexible regulations. Their ability to influence governments would be diminished, especially if the governments ability to bestow competitive advantage through regulatory bodies was eliminated.
Competition leads to stability when there are many entrants in the market. No one entity has a leader advantage. As competition diminishes due to monopolization, distortions enter the system in ever larger waves that end up destabilizing and destroying the system. The pieces that are picked up become many new market entrants, and the cycle repeats.
Using strict laws to keep corporations under a ceiling size that scales with population or some other measure would prolong the healthy period, but will naturally never overcome the business cycle. Attempts to do so have lead us to our current situation.
@bluntobj. This sounds very reasonable to me.
Yes, we used to get into these arguments with Obots who contended that Obama was powerless due to Republican obstruction to effect the change he campaigned for. Our answer was to point out all the areas where Obama as President could execute policy on his own. Anti-trust was a prime example, both for breaking up TBTF and placing limits on anti-competitive mergers and acquisitions. That Obama put a corporate lawyer like Holder in as AG made it clear that Obama was there to serve the corps not hold them to account.
DEMOCRACY is two wolves and a lamb deciding what to have for dinner. LIBERTY is a well armed lamb contesting the vote. – Ben Franklin
** Take out your cash, your Lender/Broker and then their bottom feeding Attorneys ** – Enslaved Likeyou
Does anyone else notice the interesting dichotomy amongst those of us who at least marginally understand the problem. On the one hand, there are the true believers. They tend to believe that government in general and government intervention, both in the form of regulation and bailouts, is the culprit. If only those TBTF institutions had been allowed to fail, everything would turn out fine. I happen to have a bit of affinity for these folks, even though I think they are wrong. There is this image of bankers trying to fly out of their offices to the tune of Jump you ****ers!
This becomes a bit of a “what if” game. If only Hank hadn’t bailed them out and Bernanke had made borrowing tougher because, after all, the banks were not all that credit-worthy. Yes, we get the flying bankers imagery, but you know, a full on systemic collapse would likely have been pretty painful. Companies couldn’t make payroll, or buy ahead. I would assume that government would step in, create a bank out of whole cloth, and slowly knit the whole thing back together – but again, that is anathema to the true believers in capitalism.
Next comes the believers in government control, but not ownership. “Treat banks like utilities,” is the rallying cry. OK, Ms Smith, that is precisely what this country did in the 30s – and it worked, for a while. Then the effects of money on politics began to be felt. Little by little those safeguards were eviscerated to where we are right here and now. As the system Stoller describes in today’s post is a current inducement with a tomorrow pay-out, there is little hope of ending money in politics in this model, leading to its eventual demise.
I offer a third way. End private, for profit banking. Replace it with publicly owned public utility banks – or credit unions. I’ll stop here so as to not offend our host, but the belief that government regulation can chasten the enormous motivator of profit is simply self-delusion. Profit, and opportunity for self-enrichment will bring out the cleverness in humans. Ways around regulations, especially regulations designed to impress the public without really chastening the elite, will be found. Humans are remarkably clever. Being clever in one’s ability to cheat his fellow, is not a virtue, regardless of what some self-important Russian woman thinks.
But, as the socialist model I suggest is unlikely to become popular anytime soon, by all means, reinstate Glass-Steagall – its the least we could do. And by golly, change the building codes so those skyscraper windows could be opened.
Similar to the old canard – corporations must maximize shareholder profit. Seems like a particularly stupid thing to say when non-profit corporations exist.
Then again, if corporations have all the rights of individuals but also must maximize profits above all else, this would seem to make corporations either psychopaths or crooks. Throw the one in the mental health ward and the other in jail since it’s clear that’s Wall St’s ideal corporation is a terrorist organization.
The people ‘regulating’ the banks are the exact same people who are being ‘regulated’, to state the obvious once again. Game is rigged, to the streets!
I never quite understood why naked CDS should even exist. As I recall, during the first CDS crisis at Delphi, only a fraction of CDS holders could present the underlying asset, i.e. Delphi bonds. Would it be so disrupting to only allow CDS payouts upon presentation of the underlying bond? And if this was to be put in force say 3 years from now?
Another idea that sounds pretty darn reasonable.
Agree!
Abe – – –
Do you know how much underwriting and transaction commissions you would be taking away from the “job creators?”
Let’s try to close a circle of logic:
1. Banks are corporations.
2. Corporations are people (Citizen’s United).
3. People don’t have a right to health care (political position opposed by “liberals”).
4. Profits constitute the health measure of corporations.
5. Banks don’t have right to unregulated profits (political position opposed by “conservatives”).
6. Banks and people have the same rights because the SCOTUS says they are the same under the law.
7. Therefore “liberals” and conservatives” agree.
Something is wrong with this circle!