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When you strip away the disinformation, false promises, and wishful thinking, this is where we are on really reining in the power of the country's largest—and most dangerous—banks.
Senators Sherrod Brown and Ted Kaufman have proposed the Safe, Accountable, Fair, and Efficient (SAFE) Banking Act, which is an entirely reasonable and responsible way of limiting the size of our largest banks. It should be adopted as an amendment to the main financial reform bill now before the Senate.
As the New York Times pointed out on May 6, there is growing support for this approach. But note that this article—while entirely accurate—was relegated to page B3; Sewell Chan's original piece on this topic was a front page story on April 20.
The opposition to Brown-Kaufman at the highest levels of government (legislature and executive branches) is so strong that it is increasingly unlikely the amendment will even get an up-or-down vote on the Senate floor.
The New York Times' editorial page has endorsed Brown-Kaufman, as have a growing number of organizations that want to see some meaningful financial reform.
But opposition to Brown-Kaufman (and actually any real reform) is deeply entrenched among prominent senators and even the White House. They fall back on increasingly specious arguments, completely unencumbered by the evidence or any real head-to-head debate.
These people may well be soon forgotten—or even as widely disparaged in a few years as the once-ascendant Robert Rubin and Alan Greenspan are today. But for the moment their power on Capitol Hill is almost unbreakable.
This is not about ideology any more—it is hard to find anyone who will argue in public that finance is always good, unfettered finance is better, and largely unregulated big banks are the best. This is a major and encouraging break from the history of the past 30 years—as told, for example, in 13 Bankers.
The revolving door between Washington and Wall Street is also playing less of a role than in the past (again, we review the recent decades of evidence in 13 Bankers). To be sure, there are still plenty of lobbyists with Capitol Hill experience, but it is no longer fashionable for a top senator or treasury official to go easy on big banks and then slip into a comfortable boardroom for well-remunerated slumber (talk to Robert Rubin or Phil Gramm). We may see some of this, of course, but any such individuals will be pilloried indefinitely and without mercy; their names will live in serious infamy.
The lack of debate over Brown-Kaufman—and its likely demise—is all about money. There is a tsunami of contributions from the financial sector washing over Congress right now. When the dust settles, the pattern will be clear: Wall Street (legally) bought off key senators.
There will be a reckoning, to be sure, at the polls. The supporters of big banks will go down hard in November and in 2012; there are no secrets over this kind of time frame. But by then it will be too late for this cycle of financial reform—and there is one guarantee that the backlash will bring stronger reformers to power (in fact, the White House and the biggest banks would be quite happy to see nonreformers prevail.)
Also posted on Simon Johnson's blog, Baseline Scenario. Previously posted:
Expect Nothing
May 5, 2010
After months of denial, the European policy elite finally begin to understand that something is seriously wrong in the eurozone.
But the prevailing definition of the problem is still too narrow—the consensus in France and, even more, in Germany is that "this is a Greek problem." Even the most negative still think that Portugal and Spain can easily escape serious damage.
This is a major misconception, as we pointed out last week—and as we have been emphasizing to anyone who would listen for more than a year.
If you want to call for a "rescheduling" of Greece's debts—a position that is becoming increasingly popular among leading north European intellectuals—that is fine. But you also need to recognize that the policy elite (central banks and ministries of finance) are completely unprepared to handle the consequences, which would be immediate and devastating for other weaker eurozone countries.
You simply cannot do a low-cost or small unilateral restructuring of government debt in this kind of situation; the market will at once take that as a signal that Portugal, Spain, Italy, and perhaps even Ireland will face difficulties (in fact, this is exactly what spreads in the two-year European government bond market are saying today). The French may smile upon such outcomes with a feeling of superiority, but they might also consider not throwing bricks in glass houses.
It is fine—even appropriate—to emphasize that big European banks have aided and abetted the irresponsible behavior of eurozone authorities. The profound stupidity of these banks-as-organizations is beyond belief, and it is deeply puzzling quite why leading figures in the US Senate would see them as a model for anything other than what we need to euthanize as soon as possible in the global financial system.
But do not fall into the trap of thinking just because "megabanks are bad" (undoubtedly true) that you can whack them with losses and not face the consequences—these people are powerful for a reason; they hold a knife to our throats. For all his hubris, missteps, and over-reliance on Goldman group think, Hank Paulson had a point in September 2008: If the choice is chaotic global collapse or unsavory financial rescue, which are you going to choose?
The Europeans will do nothing this week or for the foreseeable future. They have not planned for these events, they never gamed this scenario, and their decision-making structures are incapable of updating quickly enough. The incompetence at the level of top European institutions is profound and complete; do not let anyone fool you otherwise.
What we need is a new approach at the G-20 level; this can definitely include debt restructuring, but it has to be done in a systematic fashion (and even then there will be a considerable degree of total mess). Such a change in framework for dealing with these issues will not get broad support until after further chaos in Europe, but it now needs to be put into place.
The Europeans will not lift a constructive finger. The leading emerging markets are too busy battening down the hatches (and accumulating ever more massive chests of reserves). And the White House still seems determined to sleep through this crisis. Expect nothing.
Fake Debate: The Senate Will Not Vote on Big Banks
May 4, 2010
There is widespread agreement that the financial crisis that broke out in September 2008 was our most severe in over 50 years. There is also a consensus that, whatever other factors may have been involved, the excessive risk taking and general mismanagement of huge banks at the center of our economy played a significant role in what happened. (Yes, of course the largest banks themselves deny any responsibility— including most recently using insulting language.)
The financial reform package now on the Senate floor puts surprisingly little constraint on the activities of our largest banks going forward—preferring instead to defer to regulators to tweak the rules down the road (despite the fact that this approach has gone badly over the past 20 to 30 years).
A growing number of senators insist we should do more to reduce the size and limit the leverage of megabanks (i.e., the amount that banks can borrow), arguing that this would constitute an important additional failsafe—on top of all other efforts to establish "more effective regulation."
Senator Ted Kaufman (D-DE) has led the charge on this issue, pounding away for months and giving another powerful speech on the floor of the Senate yesterday.
Yet, astonishingly, it seems increasingly likely there will be no real Senate debate on this issue.
A real debate, in the modern American system, needs a vote on something specific—in this case, an amendment to the main legislation. And Senator Kaufman, with Senator Sherrod Brown (D-OH), to that end has proposed the SAFE Banking Act—with meaningful size and leverage caps—which is ideally suited as a way for senators to show whether or not they support the continued existence of our largest banks in their current (very dangerous) form.
Kaufman has directly taken on and rebutted all the arguments put forward by proponents of big banks—such as Larry Summers of the White House and Hal Scott of Harvard Law School. Kaufman has the facts and most sensible opinion on his side, including the literature summarized in our book ( 13 Bankers, which he cited yesterday), and other voices (also quoted in his speech yesterday):
- Mervyn King, governor of the Bank of England: "Banks who think they can do everything for everyone all over the world are a recipe for concentrating risk."
- Alan Greenspan, formerly chair of the Federal Reserve board: "For years the Federal Reserve had been concerned about the ever-larger size of our financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. A decade ago, citing such evidence, I noted that ‘megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.' Regrettably, we did little to address the problem."
With such strong arguments and powerful evidence on its side, you might think that the completely reasonable and responsible proposals in the SAFE Banking Act would get a vote. But you would be wrong.
The Senate leadership—on both sides of the aisle—has apparently decided that they do not want to give senators (and the public) the opportunity to focus their attention on this key issue. Instead, they would prefer to keep the "debate," in terms of votes, on issues less likely to infuriate powerful banks.
Our democracy allows great freedom of discussion—and it is encouraging that someone as prominent as Senator Kaufman can take on (and trounce) the biggest banks on the merits of the case.
But how much is this freedom worth if the political power of the megabanks—based on campaign contributions, lobbying efforts, and more general ideological control—can effectively prevent an up-or-down vote in the US Senate on the most pressing issue of financial reform?
This is, of course, partly about the political power of corporations. But corporations are, in this sense, merely a veil—this is really all about which people have what kind of power in our society. To what extent are we really still a democracy—and how far have we already slipped down the road to oligarchy?
"Most Observers" Do Not Agree with Larry Summers on Banking
May 3, 2010
What is the basis for major policy decisions in the United States? Is it years of careful study, using the concentration of knowledge and expertise for which this country is known and respected around the world? Or is it some unfounded assertions, backed by no data at all?
At least in terms of the White House policy toward megabanks, it is currently "no discussion of data or facts, please."
Speaking on the Lehrer NewsHour last week, Larry Summers said, with regard to the Brown-Kaufman SAFE Banking Act—which would restrict the size of our largest banks (putting them back to where they were a decade or so ago):
"Most observers who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies, and hurt the competitiveness of the United States."
"But that's not the important issue, they believe that it would actually make us less stable. Because the individual banks would be less diversified, and therefore at greater risk of failing because they wouldn't have profits in one area to turn to when a different area got in trouble."
"And most observers believe that dealing with the simultaneous failure of many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment."
I've looked into these claims carefully and really cannot find any hard evidence supporting Summers's position—and therefore US policy. To be sure, there have been assertions made along these lines by a few people.
But can the White House point to any published material or even publicly available analysis or data that is relevant to the questions at hand? How about work that has been presented to critical audiences, preferably with the entire discussion on the public record? I would be happy to be corrected on this—call me—but I can find nothing.
This is not about jumping through any kind of academic hoops—it is simply a question of whether this critical aspect of our public life is post-Enlightenment (i.e., we worry about the evidence) or stuck at the level of unfounded medieval assertion.
On the other side of the argument, I would submit the evidence reviewed in our book 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, which—among other things—surveys the available literature, from both academics and practitioners. Read it for yourself—we wrote it for this moment and this issue. (Or ignore the book if you prefer; this would put you in good company at the top rungs of our society.)
"Most observers" agree with 13 Bankers on the need to rein in (and constrain the size of) our largest banks. We've presented this book and its findings to top lawyers, finance people, both more academic and completely practitioner. We've talked about it at length on Capitol Hill and with very experienced people who work or have worked throughout the financial system. We have also argued in detail with anyone who is close to the big banks—although, unfortunately, top executives and their representatives will not come out to debate in the open. The experts are overwhelmingly on board—except for those who work for the big banks.
I would not have a problem with the administration's top officials saying, "We can't take on the biggest banks because: (1) they are too powerful in general; and (2) they would cut us off from the campaign contributions that we need for November." This would at least be honest—and then we could discuss whether it makes sense as a political tactic.
And if the most senior and experienced economic policymakers in the land wish to make their own assertions, unencumbered by the facts, then you can take a view regarding whether or not they have earned the right to be taken seriously. (By the way, "most observers" think we are very fair to Larry Summers in 13 Bankers; a significant minority think we are overly generous.)
But for the White House to make inaccurate claims regarding the views of "most observers" is the most obvious and cheapest sham.
Come out and have the discussion on its merits in public. Or just cut off debate in the Senate through some sleazy backroom deal and face the consequences.
Why Do Senators Corker and Dodd Really Think We Need Big Banks?
May 1, 2010
On Friday, Senator Bob Corker (R-TN) took to the Senate floor to rebut critics of big banks. His language was not entirely senatorial: "I hope we'll all come to our senses," while listing the reasons we need big banks. And Senator Chris Dodd (D-CT) rose to agree that (in Corker's words) reducing the size of our largest banks would be "cutting our nose off to spite our face" and that by taking on Wall Street, "we may be taking on the heartland."
Unfortunately, all of their arguments in favor of our largest banks remaining at or near (or above) their current scale are completely at odds with the facts (e.g., as documented in our book, 13 Bankers).
The senators led with the idea that our nonfinancial sector needs huge, complex, global banks in order to remain competitive internationally. But this is completely untrue—in fact, Senator Dodd conceded as much to Ezra Klein recently when he said that he had heard the arguments of 13 Bankers against big banks also from "CEOs" (presumably of nonfinancial companies).
Even the biggest nonfinancial companies do not, under any circumstances, want to buy all their financial services from one megabank. They like to spread the business around, to use different banks that are good at different things in different places—in part to prevent any one bank from having a hold over them. Playing your suppliers off against each other to some degree is always a good idea.
Senator Corker also argued that entrepreneurs need today's megabanks. Please find me a single entrepreneur who would agree with that statement—keeping in mind that I work with a lot of entrepreneurs in my day job (professor of entrepreneurship, among other things, at MIT, with a particular focus on entrepreneurs working globally). Of course entrepreneurs need access to capital and they need investors who are willing to back risk takers in the nonfinancial sector, but if you can find a link between that productive activity and what Goldman Sachs is accused of doing by the SEC, write it up.
Senator Corker also stressed that businesses need to be able to hedge risks, e.g., regarding their input prices. This is a fair point but it is completely unrelated to how large our biggest banks should be. This is instead an argument for allowing the existence of a derivatives market—like Gary Gensler of the Commodity Futures Trading Commission (CFTC), we take the view that requiring all derivatives to be traded on exchanges would not only reduce system risk, it would also be completely consistent with all legitimate and productive derivative-related transactions, and it would reduce the size of the largest broker-dealers (who currently have a great deal of market power when so much of derivatives trading is over the counter).
Both Senator Corker and Senator Dodd stressed that the biggest US banks are not the biggest banks in the world. But what does that have to do with anything? The largest European banks are again in seriously trouble this weekend because they piled on exposure to the eurozone periphery in an irresponsible and frankly dumb manner. The largest Chinese banks are a complete mess in terms of governance and ability to make a sensible loan. And the biggest Canadian banks are underwritten by government guarantees of a nature and scale that make Fannie Mae and Freddie Mac look respectable during the go-go years (which they were not)—we have taken these points up at the highest levels within the Bank of Canada and they get this. So why would anyone think that any of these global banks is an appealing model for the United States to follow?
Senator Corker is opposed to any "arbitrary limit" on bank size. Senator Dodd's support for Senator Corker on Friday is striking and surprising because, at least nominally, the Dodd financial reform bill as it came out of committee does cap bank size—see Section 620, "Concentration Limits on Large Financial Firms":
"Subject to recommendations from the Financial Stability Oversight Council, a financial company may not merge or consolidate with, acquire all or substantially all of the assets of, or otherwise acquire control of, another company, if the total consolidated liabilities of the acquiring financial company upon consummation of the transaction would exceed 10 percent of the aggregate consolidated liabilities of all financial companies at the end of the calendar year preceding the transaction. The council recommendations will be included in a study of the extent to which the concentration limit under section 620 would affect financial stability, moral hazard in the financial system, the efficiency and competitiveness of United States financial firms and financial markets, and the cost and availability of credit and other financial services to households and businesses in the United States. The intent is to have the council determine how to effectively implement the concentration limit, and not whether to do so. The council will have six months to write the study, and the Board of Governors of the Federal Reserve will have nine months in which to issue regulations that reflect the recommendations and modifications of the council.
This is obviously very weak, in part because at best it only applies to acquisitions. This is a significant watering down of the second Volcker Rule, which read in January:
"2. Limit the Size - The president also announced a new proposal to limit the consolidation of our financial sector. The president's proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms to supplement existing caps on the market share of deposits."
Unfortunately, for whatever reason, the White House appears to have completely folded on the substance. Larry Summers now claims (inaccurately) "most observers" think breaking up big banks would be a bad idea because:
"Most observers who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies, and hurt the competitiveness of the United States."
"But that's not the important issue, they believe that it would actually make us less stable. Because the individual banks would be less diversified, and therefore at greater risk of failing because they wouldn't have profits in one area to turn to when a different area got in trouble."
"And most observers believe that dealing with the simultaneous failure of many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment."
The Brown-Kaufman SAFE Banking Act would cap banks, as a practical matter, between about $100 billion and $450 billion in total assets—depending on their exact risk profile. What exactly is the diversification that you can do at $2 trillion that cannot be done at $100 billion?
The Corker-Dodd-Summers view follows closely the line from Hal Scott, a Harvard law school professor (and a director of Lazard) who strongly favors the big banks—for example, he testified against any form of the Volcker Rules when we both appeared before the Senate Banking Committee in February. Scott runs the Committee on Capital Markets Regulation, which recently stated:
"As with the Volcker Rules, the committee does not believe that size limitations will reduce systemic risk. An institution does not pose systemic risk because of its absolute size, but rather because of its debt, its derivatives positions, and the scope and complexity of its other financial relationships. Because the problem is not size but interconnectedness, reform should focus on reducing the interconnections so that firms can fail safely. Furthermore, even if size were the right issue, the Senate banking bill would not require any existing bank to shrink; it would only prevent further growth by consolidation or acquisition. Assuming size is the source of systemic risk, we should presumably be concerned about it whether it is the result of acquisition or organic growth."
Of course the issue is about system risk. Risk is about many things, including the ability of banks (at any size) to circumvent regulation. But risk is also partly a function of bank size—smaller banks are not too big to fail and this affects the incentives of management and directors (as well as traders, depending on the compensation system).
And if you don't think our largest banks have completely captured the hearts and minds of their regulators—both prior to September 2008 and perhaps even more subsequently—read 13 Bankers and tell us where we got that part of the story wrong.
If you still really don't want to cap bank size, take a long hard look at the United Kingdom, where Royal Bank of Scotland (RBS) had a balance sheet of roughly 1.5 times the UK economy when it failed. When it failed in fall 2008, Citigroup had total liabilities around $2.5 trillion. Would our problems now be better or worse if Citi had had $5 trillion in assets—or if it had been the size of RBS relative to the UK economy, i.e., roughly $20 trillion?
As for why exactly Senators Corker and Dodd really support big banks, it seems increasingly likely that this is all about campaign contributions.
