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Who Is Too Big to Fail? (Aug. 1)
In 2004, Brookings published "Too Big To Fail: The Hazards of Bank Bailouts" by Gary Stern and Ron Feldman (paperback edition 2009). There is a great deal of sensible thinking in this book, as well as much that now seems prescient— particularly asthey have been presenting and publicly debating these ideas at least since 2000.
Some of it also seems a bit dated, but in an interesting way that tells us a great deal about how far we have come.
On the basis of their qualitative assessment, reading of the regulatory tea leaves, and a deep understanding of the available data, Stern and Feldman construct several lists of banks that may be considered (in 2004) Too Big To Fail. The most interestingnames and numbers arein Box 4-1 (scroll to p.39 in this Google Books link)(update: or look at this pdf version), entitled Organizations Potentially Considered Large Complex Banking Organizations.
Here's this weekend's competition.
What strikes you about their list? Who do they miss and what can we infer from that? And should we, like them,also consider foreign banks active in the United States as potentially Too Big To Fail?
Also posted on Simon Johnson's blog, Baseline Scenario. Previously posted on Baseline Scenario:
What Is Josef Ackermann's Point (July 31)
Writing in the Financial Times yesterday, Josef Ackermann—CEO of Deutsche Bank—argued that larger banks are not more dangerous to the health of financial system (and thus to taxpayers) than smaller banks. According to him,system danger arises primarily from the degree to which banks are "interconnected."
Inadvertently, Mr. Ackermann makes a strong case for banking system reform. You can break this down into five parts.
- There is no "either/or" structure to the discussion of size vs. interconnectedness vs. leverage vs. herding behavior of management. "All of the above" is a completely plausible answer, and Mr. Ackermann helps to make the case that relatively small banks also need to be addressed.
- No doubt smaller banks will not be thrilled by his point—we should expect more Robert Wilmers-type diatribes, next time against Deutsche rather than Goldman. This, of course, is exactly the kind of division within bankers' ranks that you need to push for meaningful reform. Divide and re-regulate effectively, before they close ranks.
- Mr. Ackermann nowhere mentions that Deutsche Bank's leverage was, at its peak, judged by some market participants to be around 50:1, making it arguably the biggest hedge fund in world history. Deutsche's response in 2008was that such estimates were based on mismeasurement and its true leverage was "no higher than that of Citigroup." Ouch.
- Deutsche's experience, its effective bailout by the German government, and the current misery of European banking more broadly emphasize the need for much stronger capital requirements across the board as part of our eventual response. Of course, these can be higher in percentage terms based on size, interconnectedness or anything else you want to worry about; but all of banking has become too dangerous (to your fiscal health). European-type loopholes, such as "off-balance sheet" activities, must be removed and—as Mr. Ackermann implicitly acknowledges— only action at the level of the G20 can really ensure cross-border bite on such rules.
- Mr. Ackermann's endorsement of the current G20 action plan is further confirmation that this plan does not constitute serious progress. Unless and until you getagitatedpushback from the world's biggest bankers, your reform efforts are not real.
Interestingly and surprisingly, Ackermann also makes only a weak case for large banks (in his last paragraph, which seems tacked on awkwardly). If this is the best his staffcan do, the case for very big banks is in no way compelling.
Traditional Chicago Economics Under Pressure: Beyond the Thaler-Posner Debate (July 29)
Richard Posner is against the proposed new Consumer Financial Protection Agency(CFPA). This is, of course, not a surprise. Posner has always been an articulate advocate of the view most often associated with economics at the University of Chicago: market-based outcomes are invariably better than the alternatives, and anything that interferes with consumer choice is a bad idea.
Posner wraps this opposition to the CFPA into an odd attack (near the end of his WSJ op ed) on the personal decision-making abilities of Richard Thaler—a leading economist on consumer choice, misperceptions, and mistakes. (More on Thaler here.)
Thaler, also of the University of Chicago, hit back hard yesterday. He is right that Posner mischaracterizes the CFPA proposal, and points out that his agenda—and that of Cass Sunstein, formerly of Chicago and now a czar in the administration—is simply to provide consumers with a framework for better decisions. Heimplies thatPosner defends defective baby cribs and their equivalent.
I would go further.
Think of it this way. We've learned a great deal about how consumers make decisions, including when they get things right and wrong. Behavioral economics, marketing, and related social science have made big strides (e.g., follow the work of Dan Ariely).
But all of this research is also available to companies. Perhaps they knew some of this before from trial-and-error, but there is no question that many of the techniques corporate America uses—and we as consumers find ourselves "up against"—is cutting edge manipulation of our decisions.
We worry a great deal about how corporations lobby to shape their regulatory environment. This is a struggle that is at least 150 years old in its modern form (e.g., railroad concessions), and much older if we think about powerful people bribing their way into advantageous relationships with the state.
In addition, companies now havepowerful new tools to shape how we perceive our potential choices. Some of these tools might be good for us also—I'm open to argument on this. But within some particular spaces, including financial products, it's clear that many of these "innovations" are actually clever ways to extract value from consumers.
Traditional Chicago economics always had its weaknesses—particularly when you focus on the fact that the "rules of the game" are often shaped by the more powerful. Thaler and Sunstein (and others) are trying to modernize this view more generally, while keeping the element of consumer choice as central.
But if the balance of power has shifted—due to technological innovation in social science—further towards corporations and away from consumers, then the task ahead is much harder.
Unless companies are compelled to keep their offerings "simple enough to understand," we will face repeated rip-offs and crises—both macroeconomic and personal—arising from our financial sector.
Jeb Hensarling, George Orwell (July 28)
The debate over re-regulation of the financial sector has finally, and irreversibly, turned partisan. This helpsdefine issues in ways that may be more familiar and thus easier to understand.
In the blue corner we have Treasury Secretary Tim Geithner. Secretary Geithner's overall banking policy continues to be problematic, and his broader re-regulation effort is hampered by all the free passes he gave to bank CEOs earlier this year. But on consumer protection he has the right message and he delivered it forcefully to Congress last week: we need a Consumer Financial Protection Agency (CFPA) and we need it now.
In the red corner, Representative Jeb Hensarling is rapidly emerging as a leader. A member of the Congressional Oversight Panel and the senior republican on the House Financial Services subcommittee on Financial Institutions and Consumer Credit, he wrote last week in the Washington Times that the CFPA is "Orwellian", because it would strip consumers of their rightful choices.
Mr. Hensarling seems dangerouslyclose toslipping into double think.
He says that the House Republican "regulatory reform plan" will protect consumers. (This plan was not available for outside review when I enquired last week; if you have a copy that can be shared, please send it to me.) As far as I can see from his article—confirmed by what I heard before the House Financial Services Committee last week -the only tools they propose are those that have been tried and failed, repeatedly, in the recent past.
The key sentence in his op ed may be, "If we act responsibly, whether the mortgage blows up on us is largely within our control." This ignores all the evidence that consumers were duped, misled, or otherwise fooled into financial products that they did not understand and could not afford.
Mr. Hensarlingsays that financial products are completely different from toasters, which are regulated by the Consumer Product Safety Commission, because "No one wants a toaster that will blow up, and whether it does is largely out of our control." But regulation over consumer durables was introduced and tightened over the years precisely because the "free market" produced items that were unsafe (at any speed, or any toaster setting).
Mr. Hensarling claims that consumer protection will be very much against the interest of smaller companies. There is no evidence to support this assertion—and it seems implausible. Many smaller businesses have been scammed by Big Finance in the past few years—either directly, through the products they were sold, or indirectly, through the higher tax bill we all face as a result of bailing out the big banks.
And the bad behavior of big banks is closely connected to how the financial sectorhas been allowed—and is still allowed—to treat consumers.
Yesterday, at last, amajor commercialbank CEO broke ranks and articulately made the case against the actions and structure of Big Finance, specifically Goldman Sachs- see Robert Wilmers, head of M&T Bank, writing in the Washington Post. Hopefully, the finance lobby will more generally follow his lead—both in speaking out against the dangers of the biggest banks (and their "innovations") gone bad, as well as in favor of protecting valued consumers against outrageous scams.
If consumers don't trust financial services—and why should they, given all we've seen?—this will be a long and painful recovery. Given what we know and have learned painfully about how our financial system operates, saying that "the market will provide consumer safety" is essentially the same thing as saying "the market will not provide"—you're on your own, again.
