Banking, Geithner, The Fed: Doomed to Repeat?

What a glorious day. I walked back up from the Strand bookstore and in so doing wandered past the citadels of more than one of our anti-social banking community. Spring may be the harbinger of warmer days, but I am now seriously wondering whether they will be better.

Why, you might ask, am I so downcast on such a beautiful day.

Banking is headed straight back to the crisis from which it just emerged. And in so doing is condemning us to a repeat of the economic crisis.

Ordinarily I would avoid being so certain about this prognosis, after all if there is one lesson we should all take from Keynes it is that economies are inherently uncertain. As I have explained before uncertainty and risk should not be confused, the one is intractable to analysis, the other is easily analyzed within the rubric of normal probability theory. So for me to assert that the banks are dooming us to a repeat is a contradiction of my own criticism of the banks themselves.

Enough of this philosophy, let me explain myself:

Allow me to present exhibit one.

The Fed. For some reason that eludes me right now, it appears that the fools in Congress are going to allow the Fed to continue as a major regulator of our large banks. This cannot be a decision based upon competency, since the Fed has amply displayed a remarkable lack of skill, foresight, and independence of mind when it comes to bank regulation. I would go further: if we were to compile a list of things not to do, the Fed would be a good place to start. Yet here we are, with the Fed getting its way, and the dolts who govern giving in to the inertia and fear mongering that supporters of the Fed have been relying upon. Let’s face it, the Fed is appalling at regulating. In any evidence-based decision process the events of the last few years would condemn the Fed to elimination from consideration. In a politically and crony driven process, nothing could be more natural than leaving the failed watchdog as the new watchdog. The sleepwalker is dead, long live the sleepwalker!

The fact of the matter is that the Fed is staffed to the rafters with wizard economists who want to leave a mark on macroeconomic policy. They run sophisticated models, they write brilliant papers, and they engage in learned to and fro with the biggest brains in academia. Great. And they leave the dirty work of regulation to the dullards down the hall. I sometimes get the feeling that the Fed has consigned its regulatory staff to some dusty basement room and told them not to say naughty things about all the important bankers who grace the upper floors, and attend hushed and vital monetary policy discussions. And it gets even worse when we think about the Fed’s abysmal record in its role as consumer protector. The word failure dignifies its record.

Anyone with ambition at the Fed does not get involved in regulation. While Bernanke may be correct in arguing that a good regulator needs to have an ear to the pulse of monetary policy, and that good policy makers need to deal directly with big bankers, he seems to fail to grasp the equality implied in that statement. Regulators and policy makers are equal partners in ensuring a smoothly operating banking system.

That’s why I want the two activities split apart. The Chairman of the Fed is a lifetime academic economist who is steeped in the follies of orthodox economics, and has absolutely no hands on grasp of the intricacies of day to day banking operations. A good regulator needs such a grasp. Besides, the staff of the Fed is indistinguishable intellectually from the bankers they are supposed to restrain from damaging the economy: they all attended the same schools, learned the same theories, and believe the same dogmas. This blurring of lines is called ‘regulatory capture’, and the Fed is the prime example of its toxic result.

So when I read that the Fed is retaining its central role in regulation, I naturally flinch. Obviously we learned nothing from the crisis.

On too exhibit two.

This one is a little obscure: the Icelandic bank controversy. You may have noticed that the good folks of Iceland went to the polls over the weekend to vote up or down on a referendum concerning the conditions for repayment of money lost by the governments of Britain and Holland. That money was lost because those governments felt obliged to underwrite the consumer deposits of an Icelandic bank with an extensive customer base abroad. When the bank failed the foreign governments stepped in to protect their domestic depositors – in the same manner that we would expect the FDIC to insure our deposits at American banks. The difference, of course, is that the failed bank fell under Icelandic jurisdiction and not UK or Dutch jurisdiction. So now those two governments want to be repaid for the cost of the bail-out and the Icelandic voters are balking. The issue boils down to this: why should Icelandic taxpayers cough up billions in order to cover the losses of a failed private bank? Especially when those losses are abroad.

Sound familiar?

The reason I raise this is simple: it illuminates the international nature of the banking system and the need, therefore, for international regulation.

It is all well and good building great regulatory bulwarks domestically, but they have little value when confronted by large complex and internationally intertwined behemoth banks. Our problem is that the level of international cooperation is terrible and basically reduced to marginal quasi independent groups based in places like Basel, who take decades to talk about the major issues of the last crisis, and have not a clue about the issues of the next. Plus, naturally, in the aftermath of the kind of crisis we have just endured, and are, perhaps, still enduring, legislators get very parochial in their approach. Each country has politicians who are ambitious and want to make their reputations as ‘fixers’ of great problems, in America that means getting the legislation named after you, but this often prevents true coordination across national boundaries.

The Icelandic case is an example of the bureaucratic gridlock that can occur in such circumstances, and the populist fervor that can get in the way of a solution.

A different example is the ongoing liquidation of Lehman. It may surprise you to learn that there are armies of lawyers still haggling over the proper disposition of the assets of that defunct organization, even after all this time. Then again it probably won’t surprise you – lawyers always perpetuate the fee opportunities in such cases.

The point is that no amount of huffing and puffing, and no amount of good intentions can substitute for detailed inter-government cooperation. Since we are nowhere near such cooperation, we are doomed to experience many more episodes like this Icelandic case. Nationalism gets in the way of good regulation when the industry is global. Without global oversight, global banks will run rings around us. That’s what they do. We would be foolish not to recognize and correct that.

So far we are fools.

Lastly, exhibit three.

Today’s article in New Yorker defending Geithner. What a farce. I am not a visceral Geithner basher, I need evidence for me to get riled up about him. The problem is that there is plenty of evidence. He seems totally incapable of a human touch, and is prone to statements that strike me as the height of elitism. The New Yorker article has him saying that the Obama administration won the war against the economic crisis, but that it lost the people. By which he means that, somewhere along the way, the administration forgot to explain itself in words that would resonate with the public.

Well, Tim, that’s because you were doing the talking.

You come across as an arrogant dweeb.

Plus you flat out lie. Maybe I should retract that: you exaggerate wildly. The re-regulation that you point to as the most sweeping in 75 years is a watered down, banker biased, and overly detailed mess. It will not accomplish what, to me, is the big goal of such legislation: the hobbling of a rogue industry. These people are shut away from the rest of us and occupy a privileged, safe zone within the economy. They can play with fire, and crash, knowing full well that they will be picked up at our cost. Their homes won’t get foreclosed and their private wealth will not be at risk, so they can continue to concoct an alphabet soup of dense, self-serving, and ultimately dangerous products layered in legalese in order to pay themselves vast bonuses. The rest of us merely pay for their mistakes.

You, Tim, set this last stage of the game up. Your ‘stress-tests’ of the failing banks last year were designed to signal to the world two things: one, was the fact that the banks were adequately capitalized, and two, was the bigger fact that the US Treasury was backstopping them. They could not fail. They were too big.

So having allowed the taxpayers to taken hostage by the big banks, we all expected comeuppance. For the banks not for us. Instead what we got was watered down legislation and surrender after surrender to the lobbying might of the banks. We lost over 8 million jobs and countless homes, they got bigger bonuses and an ability to continue to play with our money.

How, exactly, we are supposed to have misinterpreted the administration’s capitulation to the banks I am not sure. The signals have been very clear and I think the public’s reaction completely justified: all the talk and most of the action appears to have been to help the banks. The stimulus was anemic by comparison, and squeezing a jobs bill out of Congress has been a painful embarrassment. The size of the jobs bill that finally emerged – months after the bankers were helped – is an affront to common decency. At $15 billion it is dwarfed by the cash that flowed into the greedy maw of Wall Street. Dwarfed. So how are we supposed to have missed the emphasis?

I think the problem lies within the issues I raised when I discussed the Fed earlier. Geithner and his minions at Treasury are all from the same school. They see their ability to fend off a new Depression as a singular triumph of their technical and bureaucratic skills. That none of what they did makes much sense to the average voter is that voter’s problem. The public should be grateful that there were great and accomplished scions of finance available to save the day. We need no worry our little heads about the details, we should just rest assured that the big people were protecting the other big people and that we little folk won’t get hurt much more.

Ugh.

Tim’s problems are a microcosm of what’s wrong with Obama’s administration generally. There is no connection between the policy makers and the public. There is no common touch. There is plenty of haughty, well educated, self-congratulation, which comes across as disdain for Main Street.

Further, since Geithner and the others are drawn from the same circles as the bankers, they are incapable of the objectivity needed to make the changes in the regulatory regime to avoid a repeat of the crisis.

We still have banks way to large. We still cannot let them fail. We still have no international problem resolution ability. Our banks are still too complicated. They still indulge in anti-social financial structuring. They still have no discipline. worse, now they operate in a shrunken competitive pool. Their boards of directors are still supine. Only one of the CEO’s has been fired. They are already inventing new toxic products. They are obstructing consumer protection legislation. They are still the most powerful lobbying force in Washington – which considering the pharmaceutical industry is saying something. They still switch regulators to lessen our control. They still manipulate markets on the basis of inside information – Goldman’s ability to use customer information to make profits is legendary. And they still boss Geithner about.

To defend Geithner is to defend ineffectiveness. I refuse to do so.

So, as I was walking past the citadels of finance and saw the scurrying self-important folks running in and out of those buildings I was plunged into a worried reflection: we blew this opportunity to clean house. We blew it big time.

They are back to their old tricks.

Which means we are doomed to repeat.

Taxpayers of America: get your checkbooks ready! Goldman, Citi, JP Morgan, and the others will be needing your help in the not too distant future.

Thanks a lot Tim.