Yves here. Even though this post links to all three presentations made at the G20 on how bank regulation continues to fail, the one embedded at the end of the post, by Ed Kane, is short, cogent, and devastating. It includes a list of major banks with market value lower than the book value of their equity, with Deutsche Bank the bottom of the list. Kane points out that the market value reflects both their franchise value, which presumably is positive, offset by unrealized losses, which in these cases, Mr. Market clearly thinks are large.
By Thomas Ferguson, Director of Research for the Institute of New Economic Thinking; Professor Emeritus, University of Massachusetts, Boston. Originally published at the Institute of New Economic Thinking website
Talk about signal and noise: the outpouring of commentary that marked last fall’s tenth anniversary of the Lehman disaster sounded mostly like any other establishment celebration of itself. Current and former policy makers joined with political leaders and prominent bankers to tout how swift, decisive action by central banks and finance ministers had saved the world, while offering reassurance that financial markets were now much safer thanks to reforms overseen by vigilant regulators.
Just as in the run up to the original catastrophe, the press mostly played along. Its stories all but unanimously credited authorities’ claims to heroic status while sidestepping questions about how those same policymakers had allowed the situation to spiral so far out of control in the first place or why “single payer” insurance was OK for the financial sector but not anyone else.
Running in the background, though, was a new, darker theme: That the post-2008 reforms had gone too far in restricting policymakers’ discretion in crises. The trio most responsible for making the post-Lehman bailout revolution—Ben Bernanke, Timothy Geithner, and Henry Paulson—expressed their misgivings in a joint op-ed:
But in its post-crisis reforms, Congress also took away some of the most powerful tools used by the FDIC, the Fed and the Treasury…the FDIC can no longer issue blanket guarantees of bank debt as it did in the crisis, the Fed’s emergency lending powers have been constrained, and the Treasury would not be able to repeat its guarantee of the money market funds. These powers were critical in stopping the 2008 panic…The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater. We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration.
Sotto voce fears of this sort go back to the earliest reform discussions. But the question surfaced dramatically in Timothy Geithner’s 2016 Per Jacobsson Lecture, “Are We Safer? The Case for Strengthening the Bagehot Arsenal.” More recently, the Group of Thirty has advanced similar suggestions—not too surprisingly, since Geithner was co-project manager of the report, along with Guillermo Ortiz, the former Governor of the Mexican Central Bank, who introduced the former Treasury Secretary at the Per Jacobson lecture.
Aside from the financial collapse itself, probably nothing has so shaken public confidence in democratic institutions as the wave of bailouts in the aftermath of the collapse. The redistribution of wealth and opportunity that the bailouts wrought surely helped fuel the populist surges that have swept over Europe and the United States in the last decade. The spectacle of policymakers rubber stamping literally unlimited sums for financial institutions while preaching the importance of austerity for everyone else has been unbearable to millions of people.
Especially in money-driven political systems, affording policymakers unlimited discretion also plainly courts serious risks. Put simply, too big to fail banks enjoy a uniquely splendid situation of “heads I win, tails you lose” when they take risks. Scholars whose research INET has supported, notably Edward Kane, have shown how the certainty of government bailouts advantages large financial institutions, directly affecting prices of their bonds and stocks.
For these reasons INET convened a panel at a G20 preparatory meeting in Berlin on “Moral Hazard Issues in Extended Financial Safety Nets.” The Power Point presentations of the three panelists are presented in the order in which they gave them, since the latter ones sometimes comment on Edward Kane’s analysis of the European banks. Kane, who coined the term “zombie bank” and who famously raised early alarms about American savings and loans, analyzed European banks and how regulators, including the U.S. Federal Reserve, backstop them. Peter Bofinger, Professor of International and Monetary Economics at the University of Würzburg and an outgoing member of the German Economic Council, followed with a discussion of how the system has changed since 2008. Helene Schuberth, Head of the Foreign Research Division of the Austrian National Bank, analyzed changes in the global financial governance system since the collapse.
The panel took place as public discussion of a proposed merger between two giant German banks, the Deutsche Bank and Commerzbank, reached fever pitch. The panelists explored issues directly relevant to such fusions, without necessarily agreeing among themselves or with anyone at INET.
But the point Robert Johnson, INET’s President, and I made some years back, amid an earlier wave of talk about using public money to bail out European banks, remains on target:
We are only interested observers of the arm wrestling between the various EU countries over the costs of bank rescues, state expenditures, and such. But we do think there is a clear lesson from the long history of how governments have dealt with bank failures…. [If] the European Union needs to step in to save banks, there is no reason why they have to do it for free… best practice in banking rescues is to save banks, but not bankers. That is, prevent the system from melting down with all the many years of broad economic losses that would bring, but force out those responsible and make sure the public gets paid back for rescuing the financial system.
The simplest way to do that is to have the state take equity in the banks it rescues and write down the equity of bank shareholders in proportion. This can be done in several ways—direct equity as a condition for bailout, requiring warrants that can be exercised later, etc. The key points are for the state to take over the banks, get the bad loans rapidly out of those and into a “bad bank,” and hold the junk for a decent interval so the rest of the market does not crater. When the banks come back to profitability, you can cash in the warrants and sell the stock if you don’t like state ownership. That way the public gets its money back….at times states have even made a profit.
In 2019, another question, alas, is also piercing. In country after country, Social Democratic center-left parties have shrunk, in many instances almost to nothingness. In Germany the SPD gives every sign of following the French Socialist Party into oblivion. Would a government coalition in which the SPD holds the Finance Ministry even consider anything but guaranteeing the public a huge piece of any upside if they rescue two failing institutions?
00 Kane-Berlin-G20-banks run wild
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If I was a megabanker, I would be getting firmly behind any reform laws to bail out their worsening position as a matter of survival. But not necessarily just financial survival. Consider that as a result of the 2008 crash – either directly or indirectly – we have seen this play out in things like the election of Trump, Brexit, the arisal of far right parties throughout Europe, the Yellow Vest movement in France, the weakening of center-left parties in countries like Germany and France, etc. So I ask you. When the next big crash inevitably comes around and considering how this article talks about how policymakers have been hamstrung in what they can do, what will arise out of this second crash? If this starts to lead to a breakdown of law and order on an institutional level as there are neither the resources nor will to bail out the megabanks next time around, megabankers and the like may find themselves as physical targets with the State unwilling to step in lest they become the next targets.
> policymakers have been hamstrung in what they can do
I doubt this is actually true, but even if it is, policymakers will just rewrite the rules if it becomes necessary. They did this all the time on weekends during the GFC. (Yes, my memory extends that far back.)
This type of system, “saving the banking system via adhocracy during a crisis”, can break down in two ways. One is if you have meaningful opposition. That is not the case here. All policymakers and powermongers are fully on the side of banks. The only other possible way for it to break down is if you get personnel in there who somehow believe the rules have meaning. Which is to say, stupid people willing to follow regulations off a cliff. That’s quite possible, but rules can’t prevent stupid anyway.
What this means is that people arguing that policymakers are “hamstrung” are full of B.S. They are in reality arguing for weakening regulations, which will in the short term increase banking profits, and in the medium term cause another financial crisis, and in the long term lead to a revolution, almost certainly not the good kind.
Funny, I when I hear the argument that policy makers are hamstrung and cannot prevent banking crises, I take it to mean that bankers should be lamp-post strung.
Hanging bankers from lamp-posts before they cause any more trouble is an unmitigated good thing. If we do that first, then we don’t have to go through the stages of increasing banker profits, causing another financial crisis, and then having an unpleasant revolution.
I really like the line in Ferguson, “why “single payer” insurance was OK for the financial sector but not anyone else.”
Right in line with the above and a great summary one-liner.
This could be a good line to use in single payer health-care discussions.
megabankers and the like may find themselves as physical targets with the State unwilling to step in lest they become the next targets.
I don’t root for violence, but…
My snarky thought reading the headline: “Oh yes it can be. Can be and is.” Reading the article confirms my initial take. Love the Kane slides, too. Makes it very clear what’s going on: a protection racket.
“… force out those responsible and make sure the public gets paid back for rescuing the financial system….”
Thank you, Yves! It is really that simple.
The public gets paid back!
When, I ask, is that going to happen? So very much, on a truly mega-disastrous level, hangs from that simple sentence fragment above, that the mind reels.
I myself think that it will be a contest between a megabanker financial crisis and an environmental/climate change crisis. If they both occur at the same time, it won’t be a pretty sight: there will not be enough caves and bunkers in “safe” countries to keep the billionaires out of harm’s way in spite of all their massive scuttling about!!
Enforcement of financial laws is not our thing. Just ask Chuck Schumer of the #Non-Resistance:
https://theintercept.com/2019/03/28/sec-democratic-commissioner-chuck-schumer/
It waz the Russians wot did it!
The ones Russing around the WasNeBos corridor.
there needs to be an asset tax on/break up of the megas. End the hyper-agglomeration of deposits at the tail end.
not holding my breath though. (see NY state congressional delegation)
to be generous, tax starts at $300 billion. Even then it affects only a dozen or so US banks. But would be enough to clamp down on the hyper-scale of the largest US/world banks.
The world would be better off with lot more mid-sized regional players.
Anyone who mentions Timmy Geithner without spitting did not pay attention during the Obama reign of terror. He and Obama crowed about the Making Home Affordable Act, implying that it would save all homeowners in mortgage trouble, but conveniently neglected to mention that less than 100 banks had signed up. The thousands of non-signatories simply continued to foreclose. Not to mention Eric Holder’s intentional non-prosecution of banksters. For these and many other reasons, especially his “Islamic State is only the JV team” crack, Obama was one of our worst presidents.
Thank you Yves and Tom Ferguson.
Fergusons graph on DBK’s default probabilities coincides with the ECB’s ending its asset purchase programme and entering the “reinvestment phase of the asset purchase programme”.
https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html
The worst of the euro zombie banks appear to be getting tense and nervous.
https://www.youtube.com/watch?v=dKpzCCuHDVY
Maybe that is why Jerome Powell did his volte-face last month on gradually raising interest rates. Note that the Fed also reduced its automatic asset roll-off. I’m curious if the other euro-zombies in the “peers” return on equity chart are are experiencing volatility also.
Apparently the worst fate you can suffer as long as you don’t go Madoff is Fuld. According to wikipedia his company manages a hundred million which must be humiliating. It’s not as humiliating as locking the guy up in prison would be by a very long stretch.
Greenspan famously lamented that there isn’t anything the regulators can really do except make empty threats. This is dishonest. The regulations are not carved in stone like the ten commandments. In China they execute incorrigible financiers all the time.
Greenspan was never willing to counter any problem that might irritate powerful financial constituencies.
For example, during the internet stock bubble of the late 1990’s, Greenspan decried the “irrational exuberance” of the stock market.
The Greenspan Fed could have raised the margin requirement for stocks to buttress this view, but did not.
As I remembered reading, Greenspan was in poor financial shape when he got his Fed job.
His subsequent performance at the Fed apparently left him a wealthy man.
Real regulation by Greenspan may have adversely affected his wealth.
It may explain why Alan Greenspan would much rather let a financial bubble grow until it pops and then “fix it”.
Everybody forgets (or at least does not mention) that Greenspan was a member of the Class of ’43, the (mostly Canadian) earliest members of the Objectivist Cult with guru Ayn Rand. Expecting him to act rationally is foolish. It may happen accidentally (we do not know why he chose to let the economy expand unhindered in 1999), but you cannot count on it. In a world with information asymmetry expecting markets to be concerned about reputation is ridiculous. To expect them to police themselves for long term benefit is even more ridiculous.
Greenspan attempted to hide his predilections by removing traces of his PhD thesis. He admitted that his policies would result in asset bubbles. Those who got in early on the Maestro Train, and that of his acolytes, benefited handsomely, several times. What he promulgated was serial malfeasance, and he was aided and abetted by exceedingly self-interested bankers. The carnage wrought on the average person was unconscionable. Obama and his ilk let reckonings, reform and meaningful assistance slide.
History should not be kind to either one.
I think Finance is currently about 13% of the S&P 500, down from the peak of about 18% or so in 2007. I think we will have a healthy economy and improved political climate when Finance is about 8-10% of the S&P 500 which is about where I think finance plays a healthy, but not overwhelming rentier role in the economy.
I think things will be much better when finance is about ~3% of the S&P 500, but no more than that.
Everything about debt, money and banks is obfuscated to the nth degree.
Banks don’t take deposits or lend money and this is quite clear in the law. It is important for the legal system to know, but they don’t really want anyone else knowing.
You are not making a deposit; you are lending the bank your money to do with as they please.
They are not lending you money; they are purchasing the loan agreement off you with money they create out of nothing.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Richard Werner explains in 15 mins.
https://www.youtube.com/watch?v=EC0G7pY4wRE&t=3s
This is RT, but this is the most concise explanation available on YouTube.
Professor Werner, DPhil (Oxon) has been Professor of International Banking at the University of Southampton for a decade.
As he points out the Basel regulations are based on the assumption that banks are financial intermediaries, but they are not.
You can’t regulate the banks unless you know how they work. What they should be doing with the money they create out of nothing, and what they shouldn’t be doing with the money they create out of nothing.
https://cdn.opendemocracy.net/neweconomics/wp-content/uploads/sites/5/2017/04/Screen-Shot-2017-04-21-at-13.52.41.png
1929 – Inflating the US stock market with debt (margin lending)
2008 – Inflating the US real estate market with debt (mortgage lending)
Bankers inflating asset prices with the money they create from loans.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
The private debt-to-GDP ratio clearly shows when they are inflating asset prices with their lending and trouble lies ahead. Inflating asset prices doesn’t add to GDP and so you see the debt increase, but not GDP.
Steve Keen saw 2008 coming in 2005 by looking here.
The Chinese have also now worked this out, or got the idea from Steve Keen, one of the two. This is how they saw their own Minsky moment ahead, like 1929 and 2008 in the US.
The Chinese announced their discovery at Davos 2018
https://www.youtube.com/watch?v=1WOs6S0VrlA