Banks … And All That Noise

There is an astonishing amount of verbiage floating around in cyberspace and the regular media about the banking industry right now. Much of it is hysterical nonsense and the creation of hyperactive minds with a conspiracy theoretical bent. And some of that strange stuff is actually flowing from the mouths of hitherto sensible folk. Which only goes to show that when people get lathered up over something they don’t fully grasp they can say odd things.

Some of the attacks on bankers are fully justified: they seem to have been supremely stupid. Not all. Some. They fell into a haze of ‘groupthink’ over the efficacy and profitability of certain kinds of financial assets. They have been shown to be spectacularly wrong. But that this should ignite a firestorm of populist hatred and venom is astonishing, and probably prevents the adoption of a cure. Public policy needs a considered environment, one in which solutions can be discussed calmly and credibly. At the moment we are far from such an environment. Instead we are the midst of a populist lynching of the bureaucrats who brought this mess upon us.

I suspect the venom would be reduced vastly were it not for the enormous cost to us taxpayers that will be required to fix the problem. We are still several hundred billion dollars from getting the numbers right. I doubt that we will arrive at the ‘right’ answer for a few months because of the almost irrational torrent of critiques, half baked proposals, and outright lunatic suggestions it is easy to find in print at the moment. This tsunami of silliness has to pass before we can get on with real problem solving because anything said at the moment will be engulfed in a vituperative counter attack of opinion, informed and otherwise. It is really difficult to pick out who is making sense currently.

Here’s a website you should all visit on a regular basis, not because of the validity of its content, which I think is mixed, but because it seems to be an example of the hyperbole and exaggerated tone that deafens us to sense: Baseline Scenario. The site is new and is clearly a reaction to the economic problems we are facing. The site’s authors are all highly regarded economists [at MIT], who are trying to stoke the flames of debate. One of the authors is Simon Johnson whose use of the word ‘oligarchs’ so annoyed me last week. If you read through the comments attached to the blog entry I linked to, you can get a picture of the heated nature of what is being said.

Now. Back to reality.

The banking system is huge and complex. It includes not just banks but a variety of other kinds of institutions. That’s why we should not use the words ‘banking industry’ as a proxy for the larger system which is properly called the ‘financial system’. Hedge funds, investment banks, bond dealers, rating agencies, accountants, lawyers, and other are all bundled under the rubric of this expanded phraseology. Nonetheless the big banks are the current central problem. I caution you about the phrasing only to call attention to the fact that much of the current crisis began within the non-bank parts of the system and only afterwards did it infect the big banks. For instance the explosion in trading of derivatives involves the old investment banks [see Bear Stearns and Lehmann Brothers as examples] just as much as it does Citibank or JPMorgan Chase.

Within this whole complex the closest approximation to an ‘oligarch’ would be found in the partners of Goldman Sachs or of one of the hedge funds. To call the CEO of Wells Fargo an ‘oligarch’, when he at best a vastly overpaid bureaucrat is stretching the word beyond its useful limits. Using provocative words to get attention, as I accuse Simon Johnson of doing, doesn’t help.

Next, the actions we need to take to solve the banking crisis are fairly obvious.

We need to establish a good price for the toxic assets. This is extremely difficult to do since there is no active market for them. Your guess is as good as mine. That is a rotten foundation for policy. So there has to be a method developed for valuing those assets. Inevitably it will be inaccurate. That exposes it to criticism. We will have to take the risk that taxpayers pay too much for the assets … if buying them is part of a solution.

Then we have to persuade the banks to sell. This may sound odd, but in fact it could be a major stumbling block. The reason is that a bank may decide to ‘tough it out’ and hang on to the rotten assets in the hope that an economic recovery in the near future increases the value of the assets and thus removes the potential capital loss implied by the current valuation [whatever that is]. So banks will have to be ‘induced’ to sell. That means either paying a premium or coercion. Either method will bring down an outpouring of criticism.

Finally we have to manage the assets we purchase, or the banks we nationalize. That means we need a pool of talent capable of doing that. The only possible such pool is the current one. We will have to staff the management form the ranks of the banks. That will be seen as a cave in to the ‘oligarchs’ also. Geithner’s appointment as Treasury Secretary was criticized exactly in this way. He was seen as ‘one of them’ and thus not a reliable custodian of the public interest. Personally I don’t see an alternative. Staffing the banks with a wave of economists like Simon Johnson, does not appeal to me. However tainted we need people who have actually done banking. Not a slew of armchair quarterbacks who now think they are experts on the minutiae of deal making. They are not, we need them to keep well away.

That’s it. A credible policy has to deal with those three steps. Valuation. Purchase. Management. Geithner’s much maligned plan started us down that road. He failed to arouse support or even hope because he recognized the difficulties buried in the details and consequently fudged. I think he is setting us up for nationalization: his proposed stress test is a way to force the first step in the process: getting a valuation. After that the policy options will flow more naturally.

Meanwhile the public debate will rage and we will have to listen to ever more ludicrous suggestions from all quarters.

Addendum:

I maintain my attack on the economists. Nowhere in Simon Johnson’s blog is there a reference to the development of the derivatives business and its basis in Nobel winning financial economic theory, much of which emanated from MIT. He asks for accountability and the fragmentation of the ‘corporate elite’. He should start in his own house. This does not imply, by the way, that Johnson’s policy analysis is incorrect. On the contrary he is right in demanding a housecleaning in our corporate boardrooms – presumably he is not in one of them. Where I fault him is in his blind spot: one look over his shoulder and he’d see a whole big mess of theory to fix as well. When he comes clean on that I’ll applaud. Simple.