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Political Power of Just 6 Banks is the Problem

by NBBooks Fri Jan 30th, 2009 at 09:21:34 AM EST

Last week ago, Institutional Risk Analytics interviewed Josh Rosner of Graham Fisher & Co and David Kotok of Cumberland Advisors, and the discussion is one of the most direct and revealing of the true political nature of the financial collapse I have yet seen. As I have written before, using reports from the Fed, FDIC, and Comptroller of the Currency, the financial problems are very tightly concentrated in a handful of the largest banks, with over 8,000 plus smaller and regional banks having declined to participate in Wall Street’s derivatives madness.

But in this interview, the participants explain that there are only six large banks and financial firms that are the core of the problem – and the problem is not being addressed in the public’s best interest because of the huge political power these firms have. Citigroup, Bank of America, JPMorganChase, Wells Fargo, and to a lesser degree, Goldman Sachs, and Morgan Stanley are essentially dead.

from the diaries - afew


The enormity of their losses this year is going to force a break through the political obstacles these big banks have selfishly created to actually solving the financial and banking crises.

Since most of the toxicity in the banking system is concentrated among the larger banks, with perhaps US Bacorp (NYSE:USB) on down viable in the long run, perhaps we can rebuild the industry using the next round of TARP funds to bulk up these relatively smaller banks and thereby end up with 10-15 larger super regionals in the $300-$500 billion asset range.

Second, the Good Bank/Bad Bank debate is really a political battle between the large banks listed above plus Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) et al among the Sell Side survivors in NYC vs. the rest of the industry and the US economy. In preparing their plans for review by the White House, we hear that the Fed and OCC are supporting further bailouts for the larger banks, while the rest of the industry is being resolved and recapitalized a la Washington Mutual and Lehman Brothers.

Perhaps we ought to feed the "good bank" parts of the "too big to fail" crowd, a crowd prone to leverage and bad risk management, to the smaller and plain vanilla bankers that comprise the nominal majority of the industry. This would solve many things including reducing the lobbying power that Wall Street has in Washington. Come to think of it, President Obama should think about banning lobbying by any company participating in the TARP.

IRA also notes that Sheila Bair’s proposals have the same result: saving the big banks while sacrificing the rest of the banking system and the economy. It mentions that the rest of the banking industry about to burst into open revolt.

. . . you can understand why the smaller banks in the industry are SERIOUSLY PISSED OFF at the large banks and their minions in the Obama Administration like Tim Geithner and Robert Rubin. Oh, and don't forget Chairman Ben Bernanke and the entire Fed board of governors. These leading officials are increasingly taking the side of the large banks in the battle over limited financial resources, a fact that is causing the community bankers to rise in anger. Stay tuned.

Rosner flat out states, “I am hearing very clearly from within the regulatory community that it is their primary concern that whatever they are planning is predicated on the notion that we must keep the large banks alive.” Kotok confirms, and notes

The motivation of keeping big banks alive is driven by a desire to avoid another Lehman on the Obama watch. I hear people saying that we cannot have another Lehman, therefore we cannot permit a failure…

Kotok notes that Paul Volcker is pushing this “no more Lehmans” line. He also notes that of the 16 primary dealers of U.S. debt that remain, nine of them are foreign owned. This creates a big problem for the Fed, because it gives a foreign government final say in any decision about the failure of a primary dealer. This is essentially what happened in the case of Lehman Bros. British regulators and the Bank of England placed such requirements on the Barclays purchase of Lehman, that the Fed backed away. Importantly, Kotok nails Bernanke and Geithner for lying about this in testimony before Congress and Geithner’s conformation hearings.
 

IRA: Nobody in the Congress or the White House wants to acknowledge that the policy prescriptions coming from the Fed and Treasury are badly flawed when it comes to bank solvency. The market liquidity measures have had success, but the "save the big banks" approach by the Fed is just more of the same nonsense that cause the problem in the first place.


Rosner: Exactly. In operational terms, there are no longer institutions that are too big to be resolved. As we discussed with the tree analogy, that is different from 'failing'. Any risk of a run on C[itigroup] or the other banks is now ameliorated. The recently enacted changes to guarantees on deposits, non-interest bearing transactions accounts, etc, addressed that issue. The other systemic issue was counterparty risk, but with the qualified financial contract rule just put in place by the FDIC that risk is also largely gone and you can resolve a bank's counterparty exposures into a good bank/bad bank configuration with little problem and without creating larger systemic risk. If the a counterparty's financial contracts are adequately collateralized, then they can go with the good bank, but the FDIC must retain unilateral power as receiver to reject or accept contracts. The notion that we can't allow C[itigroup] to be wound down and broken up is a spurious argument. I think this argument has less to with Lehman and more to do with the fact that the Fed of New York and the Board have always benefited from the failure of small institutions and the absorption of those assets by the big banks. There is no way that they can stomach seeing their regulatory power dissipated by those institutions now being broken up and sold. Perhaps we have to go back to the question of whether it makes sense for the Fed to be a regulator as well as a central bank.


Rosner: If the FDIC determined C[itigroup] is sick enough, were it not politically blocked by the Fed and OCC, then the FDIC has the authority to resolve C[itigroup] tomorrow.


The IRA: We are reminded of one of the drafts of the TARP legislation where somebody inserted language that would have allowed the FDIC unilateral authority to declare an institution insolvent without first getting a declaration of same from the primary regulator. Needless to say, the provision was not included in the final bill, but this illustrates the civil war that rages between the Fed and OCC, on the one hand, and the FDIC and the state regulators on the other. This issue of resolving the larger banks has been a political issue going back to Paul Volcker's day.

They foretell the appointment of Bill Dudley to replace Geithner as President of the New York Fed, and discuss who is really running policy in Washington. Geithner is too wounded to actually lead, but the Republicans in Congress are afraid to oppose him because they “fear a socialist in the wings.” (I wrote about some of the problems with Geithner back in November.)

Kotok says this leaves Volcker and Summers running the show, but IRA argues that an internal battle between Volcker on one hand and Summers and Rubin on the other has yet to be decided.

. . . Paul Volcker and Robert Rubin, and Larry Summers, represent very different and ultimately incompatible world views. Volcker is all about public service, transparency and fairness. Rubin and also Summers represent political duplicity and malfeasance on a grand scale, especially when you look at their role in blocking regulation of OTC derivatives and structured finance.

I will conclude with a statement by Rosner:

Summers is just as capable of being misdirected by the same Wall Street inputs as caused this mess. We need to somehow communicate to Summers et al, though the media if necessary, that the managed breakup of the big New York banks does not necessarily mean a systemic failure and another crisis.

The Big Banks vs. America: A Roundtable with David Kotok and Josh Rosner


 

Cross posted from The Economic Populist

Display:
too big to fail = too big to exist.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Jan 28th, 2009 at 11:57:44 AM EST
or too big to be private owned...

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Wed Jan 28th, 2009 at 04:53:43 PM EST
[ Parent ]
... it is functionally necessary to be that size.

And it simply isn't. The reason for the size is to be a high roller to stay at the table and bet a portion of your chips when the other player has to go all in. At that size its not "economies of scale", just old fashioned monopoly and monopsony power.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Jan 28th, 2009 at 08:23:19 PM EST
[ Parent ]
... contact some pissed off small banks and run for one of the small-bank elected positions at the Cleveland Federal Reserve Bank.

Cash flow problems solved and insider access to boatloads of wonderful researchable data in one fell swoop.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Jan 28th, 2009 at 03:29:48 PM EST
What is actually the whole history of the political power of the big Wall Street banks?
by das monde on Fri Jan 30th, 2009 at 04:04:25 AM EST
... AFAIU, the big New York banks had a lot of power back in the day, which is to say in the days when the money center banks were integrated banks, before Glass-Steagall. In the late 1800's, they had a good number of Senators in their pockets, as the Western Railroads had a good number in theirs.

And they were always influential in the Republican party, but for quite a long time that was a blocking power rather than a power to enact.

The rise of their influence in the Democratic party ... well, it was certainly completed by the Clinton administration, so it may be the backwash from the aggressive and ongoing destruction of Glass-Steagall, and the wave of corporatization of the Investment Banks in the 1980's.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Jan 30th, 2009 at 09:04:57 AM EST
[ Parent ]
What can we tell about that history? Does the number of pocket senators measures the real influence?

There are also views like this:

Wall Street and the Rise of Hitler, by ANTONY C. SUTTON

This is the third and final volume of a trilogy describing the role of the American corporate socialists, otherwise known as the Wall Street financial elite or the Eastern Liberal Establishment, in three significant twentieth-century historical events: the 1917 Lenin-Trotsky Revolution in Russia, the 1933 election of Franklin D. Roosevelt in the United States, and the 1933 seizure of power by Adolf Hitler in Germany.

Each of these events introduced some variant of socialism into a major country -- i.e., Bolshevik socialism in Russia, New Deal socialism in the United States, and National socialism in Germany.

Contemporary academic histories, with perhaps the sole exception of Carroll Quigley's Tragedy And Hope, ignore this evidence. On the other hand, it is understandable that universities and research organizations, dependent on financial aid from foundations that are controlled by this same New York financial elite, would hardly want to support and to publish research on these aspects of international politics. The bravest of trustees is unlikely to bite the hand that feeds his organization.

It is also eminently clear from the evidence in this trilogy that "public-spirited businessmen" do not journey to Washington as lobbyists and administrators in order to serve the United States. They are in Washington to serve their own profit-maximizing interests. Their purpose is not to further a competitive, free-market economy, but to manipulate a politicized regime, call it what you will, to their own advantage. It is business manipulation of Hitler's accession to power in March 1933 that is the topic of Wall Street and the Rise of Hitler.

by das monde on Sun Feb 1st, 2009 at 11:23:02 PM EST
[ Parent ]
NBbooks, what's your take on possible indicators of an Obama plan to dump Geithner? It seems to me there should be some signs, like the grooming of a replacement, and/or the emergence of a new narrative emphasizing the failed regulation and the overwhelming influence of the big 6 and the pernicious combined results.
Are Rubin and Summers more easily disappeared?
Rubin is embalmed.
Rosner assumes that Summers is capable of discarding the central ideology of his life, and can admit that government CAN do something right.  
I see no evidence of that yet. Quite the contrary. He seems to fear a bolt of lightning from a vengeful market god will toast his world.
Too late for that. The toast is in--and burning.
Wish Paul Volker were --just 10 years younger.
 

Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Fri Jan 30th, 2009 at 10:53:14 AM EST
I've not heard anything of the sort.

I, unfortunately, fully subscribe to the dark, dark ruminations of Stirling Newberry:

O-phoria (this is long but well worth the time)
http://agonist.org/stirling_newberry/20090120

Memo to Paul: Because he is a Freepucking Uckpublican
http://agonist.org/stirling_newberry/20090130/memo_to_paul_because_he_is_a_freepucking_uckpublican

As for Paul Volcker - he's part of the problem. Remember, when he was Fed chairman, he had the choice of saving Chrysler or saving the banks that were caught in the cold on the Hunt brothers' silver corner. Volcker chose the banks. The U.S. economy has never really recovered since, but fallen deeper and deeper into the Anglo Disease.  Rubin is like tuberculosis; Volcker is like pneumonia. They're both a disease.

Look, my view is that all 300 million of my fellow countrymen have been driven insane by having their self-identity redefined from being producers to being consumers. Being a consumer involves action that reinforces a sense of self as a discrete individual. Being a producer involves action that reinforces a sense of self as member of a larger organization working toward a common goal. It is very instructive to read about how the U.S. Army and Marines have had to change their programs of basic training from World War Two, until today, in order to achieve unit cohesion.

But there are even larger problems. There is a massive, massive cultural problem. American christianity and judaism have been thoroughly corrupted by their acceptance of usury. Traditonal christianity emphasized the gospel of social justice, giving rise to the abolitionist movement and the struggle to preserve the Union in the 1850s and 1860s, the Populist reaction against growing concentration of economic and financial power in the 1890s to 1910s, and then the Civil Rights movement in the 1950s and 1960s. I've always thought that the big funding increase behind American movement conservatism after Goldwater's defeat in 1964 was in no small part a racist reaction against the Civil Rights movement; a reaction that can only be characterized as perniciously cunning cultural warfare, with the objective of getting the churches to turn their backs on social justice and focus instead on individual sin and "taking responsibility" for accepting individual salvation.

The whole idea of "the common welfare" has been under sustained assault for nearly half a century, and has been entirely eradicated from one third of Americans' minds. Actually, not just eradicated, but propagandized and transmogrified into something those miserable minds think is socialistic and evil.  

by NBBooks on Sat Jan 31st, 2009 at 01:31:45 AM EST
[ Parent ]
The role of the churches
Yes.
There is a bright side, I think.
 I think the churches' perverse trend to focus on an Ayn Rand-like theology of "individual responsibility", which is in reality an offshoot of the market theology (sorta your point) and atomizes and renders powerless the individual, is a force imposed on many of the churchgoers. I see it as an element of the incredibly convenient group of authoritarian personalities who make up the base.
BUT--
In country after country, crisis after crisis, I see the emergence of collective behavior based on a fundamental human need for the richness of social life based on empathy.

Good, strong example:
The revolutionary theologists such as Bishop Oscar Romero who acted so bravely, yet emerged from the Catholic Church- no bastion of leftist thought.

Wish you'd write more on this--it'd save me a lotta work.

Capitalism searches out the darkest corners of human potential, and mainlines them.

by geezer in Paris (risico at wanadoo(flypoop)fr) on Sat Jan 31st, 2009 at 10:05:04 AM EST
[ Parent ]
  1. Volcker is as much a product of the financial class as all the other players.  When he took over the Fed, his public task was to bring inflation down, but he also had the private task of enabling the conversion of the US economy from a blue collar base to a white collar base.  His choice of the banks was part of that.

  2. Of course the increase in funding for conservatism was racially motivated, with Lee Atwater writing the script.  When the Democrats stopped backing segregation, Atwater led the racists to the Promised Land of the GOP, ultimately leading to over a quarter-century of dominance.  But populism has always had a strong streak of racism here in the US.
by rifek on Tue Feb 3rd, 2009 at 04:33:22 PM EST
[ Parent ]
The thrust of your post, and of the interview, is mostly correct, but not for the reasons suggested in the interview.  At this point in the crisis, banks are no longer necessary to getting us out of it, therefore we mustn't be overly worried about another large bank failure -- it wouldn't worsen things much more than they already are, and might even improve it.  It's also true that political power has a lot to do with the bank bailout.  But it's not particularly newsworthy or scandalous that the executives of the world's mega-banks are politically powerful and are actually calling in their chits when they need them, is it?  The issue is whether they are getting in the way of recovery by wielding their influence or not.

The six banks listed, however, are simply not "bad" banks by any honest measurement, other than their size. (And regarding size, it's important to keep in mind that it is the dearth of small banks in Europe that European economists have always touted as the reason for superior European financial stability.  As recently as September European economists were hoping that this crisis would result in the accelerated absorbtion of America's 20,000 small banks by the same four large ones mentioned here.)  

The reason the big banks have solvency risk issues is because of only one thing: the disappearance of the market for securitized capital.  This means that banks that took lots of risks, such as Goldman Sachs, are in the same boat as banks that took very little leverage and hedging dependency such as Wells Fargo, which made conservative home loans and held most of them like a traditional bank does, rather than securitizing them.

The disappearance of securities markets is a bastard of many fathers, unfortunately, so it is both disengenuous and potentially bad policy to make shareholders of the largest banks liable for the best practice risk management policies they, and everyone else, employed and were agreed to by regulators, policymakers, and bankers worldwide, for better or for worse.  This is particularly true since the major shareholders include institutional investors such as pension and pension-like savings plans of working people, not just rich investors who we don't feel bad about.

However, going back to my original point, the interviewers do indicate a disconcerting belief on the part of Obama's major policy advisors that banks are so critical to an economic recovery.  They were potentially critical to preventing the disaster we are now in, but propping up the banks by injecting public capital didn't work.  Forget about that money now -- it's a sunk cost.  What we need now is to increase and maintain aggregate demand (and therefore production) of real goods and services by using government's unique ability to redistribute society's resources through political coercion, both from the rich to the poor, as well as from the future to the present.  Only when people have confidence in smooth future consumption of goods and services will they be willing to stop saving and start spending and investing again.

by santiago on Fri Jan 30th, 2009 at 02:49:37 PM EST
(And regarding size, it's important to keep in mind that it is the dearth of small banks in Europe that European economists have always touted as the reason for superior European financial stability.  As recently as September European economists were hoping that this crisis would result in the accelerated absorbtion of America's 20,000 small banks by the same four large ones mentioned here.)

Who are these "European economists" you cite?
In Germany for example around 60-70% of all banking accounts (according to German media) are with small local thrifts and credit unions. Dearth of small banks here?
And I can´t remember anyone in Germany who wants to get rid of them. Not to mention they were the major reason people stayed calm when the big banks developed "problems".

The disappearance of securities markets is a bastard of many fathers, unfortunately, so it is both disengenuous and potentially bad policy to make shareholders of the largest banks liable for the best practice risk management policies they, and everyone else, employed and were agreed to by regulators, policymakers, and bankers worldwide, for better or for worse.

Best practice risk management?
Are you kidding me?

Only slightly exaggerated scenario:
A US mortgage broker arranged a mortgage. He wasn´t interested if the borrower could pay it back. Once the loan was made he got his fee. The bank wasn´t interested in the borrower either because they sold the mortgage to an investment bank. The investment bank bundled hundreds of mortgages into asset-backed securities like MBOs, CDOs, CDOs-squared and CDO´s-cubed and whatever.
And then they went shopping around, asking rating agencies for the best rating.
Followed by selling these "securities" around the world. In short NOBODY was interested in any kind of risk management because they assumed they could sell the "loans" to someone else. NOBODY was responsible for ANYTHING.

Subprime Mortgage Crisis


The New York State Comptroller's Office has said that in 2006, Wall Street executives took home bonuses totaling $23.9 billion. "Wall Street traders were thinking of the bonus at the end of the year, not the long-term health of their firm. The whole system--from mortgage brokers to Wall Street risk managers--seemed tilted toward taking short-term risks while ignoring long-term obligations. The most damning evidence is that most of the people at the top of the banks didn't really understand how those [investments] worked."[39]

Investment banker incentive compensation was focused on fees generated from assembling financial products, rather than the performance of those products and profits generated over time. Their bonuses were heavily skewed towards cash rather than stock and not subject to "claw-back" (recovery of the bonus from the employee by the firm) in the event the MBS or CDO created did not perform. In addition, the increased risk (in the form of financial leverage) taken by the major investment banks was not adequately factored into the compensation of senior executives.[138]

Moody's, S&P Employees Doubted Ratings, E-Mails Say


 Oct. 22 (Bloomberg) -- Employees at Moody's Investors Service and Standard & Poor's privately questioned the value of some mortgage-backed securities that were given creditworthy ratings, saying they created a ``monster,'' according to e-mails released by a U.S. House panel.

``Let's hope we are all wealthy and retired by the time this house of cards falters,'' one e-mail from an S&P employee said.

It was obvious to anyone who wanted to know.
Back in 2005/2006 you could read economic blogs (Calculated Risk, The Housing Bubble Blog for example) questioning the idea of house prices rising forever. :)
Simply because they noticed that ordinary citizens couldn´t afford "regular" mortgages any longer.
Best practice risk management?

by Detlef (Detlef1961_at_yahoo_dot_de) on Fri Jan 30th, 2009 at 06:38:58 PM EST
[ Parent ]
But it's not particularly newsworthy or scandalous that the executives of the world's mega-banks are politically powerful and are actually calling in their chits when they need them, is it?

Newsworthy, no. Scandalous, yes.

Dog bites man may not be news, but the dog is still put down afterwards.

Democracy, in the common perception, means one man, one vote and government of the people, by the people, for the people, not one €, one vote or government of the oligarchs, by the oligarchs, for the oligarchs.

The reason the big banks have solvency risk issues is because of only one thing: the disappearance of the market for securitized capital.  This means that banks that took lots of risks, such as Goldman Sachs, are in the same boat as banks that took very little leverage and hedging dependency such as Wells Fargo, which made conservative home loans and held most of them like a traditional bank does, rather than securitizing them.

I still don't understand why you say this. The Fed has been playing lender of last resort since before the newsies realised that the shit had hit the fan. If these supposedly sound banks have a balance sheet of fundamentally sound assets - loans that will be paid off, loans with collateral that's actually worth the book value, hedges that are backed by people who are actually solvent, and so on and so forth - then why don't they just use those assets as collateral for bridging loans from the Fed?

If the assets are actually worth what the balance sheet claims that they are worth, how can the bank become insolvent due to a liquidity crisis, when the Fed is willing to extend bridging credits to prevent a firesale?

If these sound banks (assuming that any exist) are having trouble, it sounds like it's because the Fed has been bailing out the gamblers instead of providing liquidity like they said they were going to do.

it is both disengenuous and potentially bad policy to make shareholders of the largest banks liable for the best practice risk management policies they, and everyone else, employed and were agreed to by regulators, policymakers, and bankers worldwide, for better or for worse.

If I have a shipyard, and we build a ship that capsizes and sinks before it even leaves the dock, we have been incompetent, engaged in bad shipbuilding, not done our jobs right and certainly deserve to be held liable for the loss of the ship.

The fact that we may have been following "best practise" at the time of construction, that we obeyed every rule and regulation, that politicians everywhere praised us for our work, and so on is entirely irrelevant. If the ship sinks before it's even out of the harbour, we've not been doing our job: Building ships that will take people and/or cargo from point A to point B, assuming that points A and B are connected by waterways of sufficient depth.

Similarly, the banks that bought or originated mortgages to overvalued homes, extended credit to firms that were already overleveraged, who were themselves overleveraged, moved their risk off their balance sheet, mixed up investment banking, retail banking and outright gambling, traded in toxic OTC instruments, and so on and so forth and etc. were not doing their jobs, which is to facilitate the allocation of capital in the monetary production economy. What they were doing is bad banking. There's no two ways about it. And the fact that thirty years of deregulation insanity have first legalised and then actively encouraged what can only be described as clear-cut bad banking is simply not an excuse.

If the shipbuilder in the above example had told his customer "look, this is crazy, this design won't work; it'll capsize right out of the dry-dock, and here's the physics that demonstrate that it will," and the customer had replied "I don't care, I want the ship built to these specifications," then I might have been inclined to let the shipbuilder off the hook.

Similarly, if these big banks had dug in their heels at the time and argued that these were bad policies, that they would amplify systemic risk, that they were strongly pro-cyclical, that they were permitting and encouraging sloppy, unprofessional and downright unethical practises, then I might have some sympathy for the claim that their hands were forced. But they didn't, so I don't.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Jan 31st, 2009 at 04:31:37 AM EST
[ Parent ]
The author's inclusion of Wells Fargo in the list of big bad banks is what proves my point.  Wells Fargo is the bank that avoided the risky lending and kept its "skin in the game" by not securitizing its loans like the others did.  It did everything right not just by the standards of the day, but it went the extra mile to avoid even the risk that credit derivatives wouldn't fully insure their loans if they did go bad by just holding the mortgage loans they made themselves. But they're still in the same boat needed federal capital. Why?

It's because the only problem is that private markets for capital no longer exist, having been taken over by the US federal government, because private investors don't trust banks in general with the kind of money that big banks need to renew their debt and avoid calling in loans.  That means that good banks as well as bad are taken down, and it's a good reason for the government to provide the capital to those good banks that would have been provided by private investors had Great Depression II not happened.

To your shipyard point:  If the reason the ship sank is that a once in a lifetime hurricane happened at the same time as its maiden voyage, then, no, it's not the shipbuilder's fault, and he should be paid for the boat he built.  That's the real analogy here.

by santiago on Sun Feb 1st, 2009 at 05:04:06 PM EST
[ Parent ]
But if the assets they hold on their balance sheet are fundamentally sound, why do they need money from the Treasury? Why can't they borrow money from the Federal Reserve's liquidity program, and hold the assets to maturity or until they become liquid again, whichever comes first?

And the real story about the shipyard analogy is that a lot of shipyards have been getting rich by building military submarines for pirates, and now the ship either sank on its own or was destroyed by pirates using one of those military submarines. If the shipyard had been in the business of building military submarines for pirates, then it should not be paid for the ship that the pirates sank before it left the harbour.

This current shitstorm was entirely man-made, entirely predictable to anybody who had bothered to familiarise himself with the most rudimentary of economic history, and thus entirely somebody's fault. You can argue, on a case-by-case basis, that this or that bank didn't have a hand in creating the shitpile that's crashing down right now. But to equate this with a natural disaster like a hurricane is overly generous to the financiers and regulators who weren't doing their jobs for the past couple of decades.

I'll take your word that Wells Fargo is reasonably sound, by American standards. But that clearly does not apply to GoldmanSachs or MorganStanley.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Feb 1st, 2009 at 06:45:52 PM EST
[ Parent ]
They need money from the tresury because their assets, e.g.30-year mortgages, are offset on their balance sheet with debt in the form of securitized bonds, but these securities are always much shorter than 30 years, so they need to be renewed periodically, say six-months to 5 five years. (And the interest rates were fixed for the weighted 30 years by using interest rate swap derivatives of the kind that aren't available anymore either.) At the time Wells and other lenders put the 30-year mortgages on their books, it was inconceivable that there wouldn't be a capital market that could, at some price, allow them to continuously renew their debt, or at worst, sell it off to Fannie Mae, but that's what's occurred, nonetheless. That is why many banks with very strong balance sheets still need goverment-guaranteed money (the FDIC guarantees) in order to remain solvent. In the absence of a private market for capital, the US Federal government is simply supplying it instead.
by santiago on Mon Feb 2nd, 2009 at 10:43:59 AM EST
[ Parent ]
But isn't that precisely what the Fed has been doing since forever and a lunch break ago?

Why do they need the Treasury to start doing that?

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Feb 2nd, 2009 at 05:25:24 PM EST
[ Parent ]
No, the Fed does something different, which is that banks can put up collateral and the fed lends to them at a discount.  However, in the current environment, banks have two constraints -- their collateral is bad because there is no market for it, and they are also increasing the capital to cover for higher defaults due to the recession.  So they need to raise funds that require no collateral or capital set aside from their balance sheets, like they were always able to do until investors and governments stopped lending to them in order to buy US treasuries and recapitalize their own banks (in the case of governments).
by santiago on Wed Feb 4th, 2009 at 01:57:16 AM EST
[ Parent ]
But that's not what the Treasury has been doing under TARP I and II, is it? As I understood it, under TARP, Treasury has been buying Shitpile(TM) from the banks at face value, i.e. exchanging assets for cash.

And more fundamentally, when a bank makes a loan, shouldn't it be capitalised enough to cover the default risk over the entire business cycle? I mean, this whole "recession" thing isn't precisely a new and exciting development... it's kinda been around longer than most of the illiquid banks.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Feb 4th, 2009 at 06:37:06 AM EST
[ Parent ]
No, that was the original plan and the one intended by Congress, but, due to an almost universal outcry from economists in academia as well as Europe, that plan was canned, and the US treasury simply adopted a modified version of the European model by injecting capital into cash-strapped banks by buying non-voting shares and, later, by guaranteeing new debt securities.
by santiago on Wed Feb 11th, 2009 at 09:23:55 PM EST
[ Parent ]
If you look at the data for the many recessions since 1933, there is not a single one in which current (meaning pre-4Q08) capital reserves were insufficient to deal with the recession, even though capital reserve ratios have been almost zero for decades.  The Great Depression is, in fact, the only US recession since the establishment of the Federal Reserve System that also coincided with a financial sector crisis. Banks usually make money in recessions because businesses borrow in order to overcome their own solvency issues, so capital requirements hae never been considered anything but an individual-level problem, not an economy-wide problem.  It is only an issue when you have a calamity like the current one or the previous one which almost no one working today has a memory of. Up until now, banks have had no data on which to do stress tests of the kind proposed by the latest bailout package in the US.
by santiago on Wed Feb 11th, 2009 at 09:32:23 PM EST
[ Parent ]
A different point of view:
What cooked the world's economy

  Imagine that a person is terminally ill. He or she would not be able to buy a life insurance policy with a huge death benefit. Obviously, third parties could not purchase policies on the soon-to-be-dead person's life. Yet something like that occurred in the financial world.

    This was not caused by imprudent mortgage lending, though that was a piece of the puzzle. Yes, Fannie Mae and Freddie Mac were put on steroids during the '90s, and some people got into mortgages who shouldn't have. But the vast majority of homeowners paid their mortgages. Only about 5 to 10 percent of these loans failed - not enough to cause systemic financial failure. (The dollar amount of defaulted mortgages in the U.S. is about $1.2 trillion, which seems like a princely sum, but it's not nearly enough to drag down the entire civilized world.)

    Much more dangerous was the notorious bundling of mortgages. Investment banks gathered these loans into batches and turned them into securities called collateralized debt obligations (CDOs). Many included high-risk loans. These securities were then rated by Standard & Poor's, Fitch Ratings, or Moody's Investors Services, who were paid at premium rates and gave investment grades. This was like putting lipstick on pigs with the plague. Banks like Wachovia, National City, Washington Mutual, and Lehman Brothers loaded up on this financial trash, which soon proved to be practically worthless. Today, those banks are extinct. But even that was not enough to cause a worldwide financial crisis.

    What did cause the crisis was the writing of credit derivatives. In theory, they were insurance policies for investors; in practice, they became a guarantee of global financial collapse.

    As insurance, they were poised to pay off fabulously when these weak bundled securities failed. And who was waiting to collect? Well, every gambler is looking for a sure bet. Most never find it. But the hedge funds and their ilk did.

Read the whole thing--it's worth it.

Capitalism searches out the darkest corners of human potential, and mainlines them.

by geezer in Paris (risico at wanadoo(flypoop)fr) on Sat Jan 31st, 2009 at 10:13:51 AM EST
[ Parent ]
The link doesn't work...

"Dieu se rit des hommes qui se plaignent des conséquences alors qu'ils en chérissent les causes" Jacques-Bénigne Bossuet
by Melanchthon on Sat Jan 31st, 2009 at 10:28:42 AM EST
[ Parent ]
Sorry- here's a link to the original, instead of the Truthout version.
Truly a good summary, I think- and fun, breezy writing style.

Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Sun Feb 1st, 2009 at 02:03:21 AM EST
[ Parent ]
If I understand the author correctly, he points out that if all credit derivative OTC trades conducted through Bloomberg's software were aggregated in a central database - controlled by Bloomberg... and if the market information was then repackaged and sold by Bloomberg back to the market... without being regulated... then there was opportunity for a multi trillion dollar fraud through manipulation of the pricing information.

In theory this is true. Although the larger banks (the very ones that are bust) compile their own market data. I would assume that 'internal' market data and Bloomberg's market data would be roughly correlated - any longer term, statistically significant offset would have been visible, raising questions.

by vladimir on Sun Feb 1st, 2009 at 01:44:08 PM EST
[ Parent ]
See my comment to Jake above.  That story fits Merrill Lynch, not Wells Fargo. Just because you're big and need government money now because capital markets are non-existent for your needs doesn't mean that you were doing anything wrong and should be punished.
by santiago on Sun Feb 1st, 2009 at 05:07:04 PM EST
[ Parent ]


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