bank reform

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Republican Conundrum

One of the more delicious events in recent politics has been played out over the last few days. It was the complete undermining of the GOP’s Senate leadership by its own ranks.

Last week we went from one extreme to another as the GOP desperately tried to maintain any form of relevance in the face of the rapid public reaction to the Goldman scandal.

One day we had McConnell announcing the rock solid opposition of his caucus to any form of reform. Next we had the Goldman scandal break. Then we had Senator Grassley break ranks and support the Democrats in pressing for derivative regulation. After that the dam seems to have burst and the GOP leaders were swept away by events and public opinion firming against them. Even in these days of partisan divide, a full 61% of the public support strong bank regulation. With the tide turning so strongly the Democrats way, they have become more and more determined to avoid the farcical slow motion ‘negotiation’ that accompanied health care reform. Instead they are steadily walking back compromise proposals and taking a good look at amendments that would beef the law up.

Within this sudden turn of events the GOP appears totally lost and irrelevant.

That raises quite a conundrum.

The entire GOP strategy in the Obama presidency has been based on the idea that they can stall, obstruct, and maintain an uncooperative stance on all major legislation, the notion being to paint the Democrats as ‘big government’ social worker types intent on undermining ‘good old American values’ – whatever they are.

The plan worked well, and, in the absence of a solid Democratic rejoinder, nearly derailed health care reform, which was an issue easily painted as ‘big government’.

The problem with bank reform is that, while it is clearly an abandonment of Reagan style Republicanism, and implies the use of a heavy government hand in the economy, it is extremely popular with voters and appears to be getting more popular. The banks have done their utmost to solidify public opinion against them, and the public seems, at last, to be comprehending the catastrophic role the banks played in undermining our economy.

So, the GOP is faced with an awkward choice: does it keep up the implacable ‘no’ strategy? Or does it buckle in the face of public opinion and work alongside the very enemy it was just demonizing as anti-American?

I suppose this difficulty should stand as a warning to us all: if you want to oppose someone in politics, do so on the basis of a positive opinion about something – take a position – rather than simply hiding behind the word ‘no’.

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Support “SAFE” Banking

The Brown-Kaufman proposal probably has little chance of success, so in my long standing tradition of supporting the underdog I want to throw my support behind it.

The reason is very clear: our biggest banks are too big. Not just too-big-to-fail, but too big to do anything properly. They are unmanageable in any real sense. Even an army of regulators has no chance of uncovering all the sly tricks being used to hide the absurd risks being taken. Internal risk management is buried under layers of hot-shot sales oriented bonus driven executives. Auditors, lawyers, accountants, and the rating agencies all buzz around feeding off the flow of deals and doing everything they can to obscure the truth in order to keep that flow surging. Boards of directors see only extremely redacted versions of the activities being sanctioned every day. And shareholders don’t give a hoot since they can off load their shares at the first sign of trouble, and will get bailed out in any case if the worst happens.

In other words every single aspect of control is perverted in order to maintain the orgy of cash that funds the extravagant lifestyles of those within the perimeter of the banking system. Everyone inside the system is to blame, and because of that no one can be blamed – we would have to replace everyone, and we simply are incapable of doing so.

The game is rigged against the public.

Every aspect of innovation is designed not to benefit customers, but to create new ways to gamble within the system. It is no accident that, as the banks return to profitability, their recovery is driven by trading – gambling – and not by lending or funding the real economy. It is as if the banks have become so huge that they operate in an economy all their own and are disengaged from the world around them.

Except of course that they suck in our savings and deposits in order to create the currency needed for their gambling games.

And when it all goes awry they expect us to fund and support their lavish lifestyles.

The urgency of cauterizing the banking system, perhaps sanitizing is a better word, is so high that I regard it as the make-or-break issue for our economy. Until we restore a banking system that is socially productive, one that actually is engaged in banking and not in proprietary trading, our ability to generate jobs and to maximize our wealth will be severely curtailed, if not eliminated.

The administration is only now arriving at this realization. The Republicans are of in some distant land in denial of the problem. And the banks are pouring money into their resistance – Goldman Sachs alone handed out more cash to Senators in March than in all of 2009. M ost went to GOP Senators who were opposing any reform at all.

It is this ability to distort and subvert democracy that ought to energize us all against the banks.

They are simply too big.

So in addition to that list of problems that bank size creates we should add their ability and willingness to distort politics.

And lest you imagine this is a local issue, watch the way in which the biggest banks lavish entertainment and attention at this week’s IMF meetings. The problem is not just here: it is worldwide.

Which is why I support Brown-Kaufman.

Putting in place a ‘resolution authority’ to enable the orderly liquidation of our largest banks is insufficient. They are all international. Resolution will get bogged down in a maze of international jurisdictional dogfights in which only the bank shareholders win. By becoming so complex and internationally entangled the banks hope to have avoided the law of any jurisdiction. They move profits around to lower taxes to bilk everyone. They move assets to the nation with the most lax regulation. And they hide both profits and assets along the way by playing one bureaucracy of against another.

These games are all legal.

They are all unethical.

They are all tolerated by politicians and exploited by the banks.

We should not be surprised by any of this behavior: the banks are simply gaming the system as best they can.

So we should change the system.

Radically.

By which I mean carve the banks apart. We should employ anti-trust style tactics and cut them down to reduce their individual power and to encourage competition. Divide and conquer. It is not enough to have clever laws on the books that can be deployed to break Citibank when it goes bust – still a high likelihood at sometime in the future. Why? Because at crunch time the political and economic calculus favors capitulation and bail-out. To avoid that end, we need to be blunt in our attack on the banks. They have demonstrated – copiously – they are oblivious to their role in the recession. Their continuing lack of self-control and now their imperious hubris in the face of the Goldman scandal, should be sufficient to motivate anyone with an objective interest in the safety of the economy.

The big banks must be reduced. If they suffer so be it. They have shown no remorse. Instead they have returned, after having been revived by our infusion of cash, to exactly the same path that led to the disaster. For this alone they deserve no sympathy.

Brown-Kaufman, augments the Dodd bill by placing hard limits on the size of a bank. In my opinion even Brown-Kaufman is being too lenient, but we have to start somewhere. We have to destroy the bank’s ability to connive their way back to immunity. That means reducing them from their lofty status and putting them back underfoot.

Dodd gives us resolution authority and consumer protection. Brown-Kaufman gives us size limitation. The Agricultural committee gave us derivative regulation. Sum these up and we have a good start on the long road back towards banking stability. We still need international coordination, but that will be more easily attained once we appear to be serious in our efforts to fix the crisis in American capitalism.

There has been much talk of the need to re-esatblish America’s good name in the world. That talk is usually in the context of the damage wrought by the Bush foreign policy. But just as damaging has been the collapse of the respect for our business acumen. Our banks have been exposed and along with them the seamy side of our economic model. Outright greed motivated the crash. Untrammeled hunger for profit led the banks to forget how to be banks. We need to replace that ethic with a more durable one that is not so relentlessly exploitive of the American and worldwide public. We need to save American capitalism from itself. That requires drastic and painful action. It means imposing our will on the banks.

After all our banks caused the recession. They ought to pay for its clean up. We need to make our banks safe again.

Support “SAFE” banking.

Addendum:

For those of you keeping score, there is another amendment floating about that deserves to make it into the final legislation: the Merkley-Levin proposal to enshrine the Volcker rule into law. This would force the separation of main street style banking from the casino style pseudo-banking so beloved of Goldman and the others. In effect it would re-institute the old Glass-Steagall Act that helped keep banking relatively stable for about seventy years.

Also: the White House and representatives from the House are urging Dodd not to compromise. They see the political virtue in forcing the GOP to come clean and decide whether it wants to support Main Street or Wall Street. The downside to this hard nosed position is that it opens up the possibility of a filibuster. That eventuality is receding quickly, though, as more and more GOP Senators run away from publicly supporting Wall Street.

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Bank Reform Kick Off … Sort Of

Here we go again.

Let the partisan sniping begin.

Despite protestations to the contrary the Republicans blocked debate on bank reform today. The reason? “This is not something that should be rushed”.

Ummmm.

The two parties have been engaged in close quarters combat for at least two months. Senators Dodd and Shelby have been virtually living together as they seek to thrash out a bi-partisan deal.

And.

The financial crisis hit us full force two years ago. That’s tons of time to reflect and get a response ready. Frankly, if the GOP hasn’t got any ideas together in the time since Lehman imploded and AIG was bailed out, both of which happened on George Bush’s watch – yes it was that long ago – then I doubt they will ever get any ideas together.

The problem for the Republicans is simple. They are the party of deregulation and free markets at a time when deregulation and free market theory has been debased and disproven by the actions of the big banks. They are on the wrong side of history. It is the obverse of their position back in the early Reagan days when anyone advocating deregulation and freeing up markets was hip and cool. Now they are passe and reactionary.

Getting from their deregulation trench to a better position is tough when that better position is well occupied by the Democrats.

Hence the brickbats.

And the hissy fits.

Last week was a great illustration of the political bind the GOP finds itself in.

Mid-week Mitch McConnell yelped about how he will oppose bank reform all the way. He looked like a man on a mission: no more bail-outs he yelled.

Within two days he was overwhelmed by the Goldman scandal and the obvious trickery of the big banks he had set out to defend. Goldman may or may not have committed fraud, but it sure looked unethical. Plus it announced enormous profits and ever increasing bonus pools for its already overpaid staff. This is probably not an organization a politician wants to expend too much time defending this fall in the elections. All of a sudden the GOP found itself about to be stranded on an island along with Wall Street. Not a good place to be when the public looks at Wall Street with such a jaundiced and angry eye.

So McConnell had to walk back his stridency within two days.

So his next trick was to claim that he had won the argument, and that he had forced the White House to concede some points on the proposed legislation. Specifically he pointed to the administration’s willingness to bargain away the bail-out tax on banks. Except that no one ion the Senate had suggested that bargain, and the current legislation still includes the very tax McConnell says he successfully rid it of.

Oh well.

After the Goldman scandal broke, a variety of GOP senators broke ranks and made it clear that they would not support a filibuster against the legislation. That seemed to clear the decks for debate. The bill is sitting on everyone’s desks for their edification. Discussions are ongoing about the details. Dodd and Shelby still cling to each other. Compromise is in the air.

Until later today when the GOP decided to go back to being the party of ‘no’.

So here we go again.

Health care redux.

Except that the Democrats seem to have learned not to waste time waiting for the likes of senators Collins and Snowe to decide whether they like the legislation. Instead they have announced that the vote is imminent – probably Monday.

All this huffing and puffing will undoubtedly take a few wrong turns before we actually get a vote. But it now looks likely that we will have bank reform fairly soon.

Is that good?

Well … it’s better than nothing.

The proposed legislation is a vast improvement over where we are today. Particularly when the bill that came out of the Senate Agricultural Committee is combined with it – that bill beefs up regulation over derivatives and will cause intense pain to the traders who benefit from doing deals in the murkiness of non-public and opaque corners of the erstwhile market. Nonetheless, we should all contain our enthusiasm. This legislation, even if it isn’t watered down by the bargaining now underway, is not sufficient to prevent another financial melt down. It is the beginning, not the end, of what I think will be long series of legislative efforts to put the financial genie back in its pre-deregulatory bottle.

The simple goal is to get banking to be socially responsible again. That means draining it of profit. Containing its excesses. Reducing our subsidy of it. Limiting the damage each bank can do. Cutting it down to size with respect to the economy. And above all else, stopping it sucking capital away from the ‘real’ economy. Don’t forget: banks are supposed to channel capital towards the best opportunity for profit. Not just for the traders, but for all of us. That means the banks need to get back to being banks, and get away from being deal makers, traders, and gamblers.

The old watchword for Goldman Sachs was that it should be ‘long term greedy’. That is to say it should be willing to sacrifice short term gain in order to secure the best long term profit. But banking, including Goldman, has become ‘short term greedy’. Banking should about building those long term relationships that create symbiotic profit opportunities both for the bank and its clients. It should not be about a dog-eat-dog brawl in which the only goal is today’s best deal. I realize this takes the macho gloss off Wall Street, but, hey, who said banking should be fun? It isn’t.

Bank reform needs to re-draw the financial map so that the industry is forced back to doing banking, and is severely – very severely – limited. The current legislation does too little to accomplish that. But at least we appear to be setting off on the journey.

It will be interesting to watch the Republicans as they adapt to this new world.

I hope they do. We need all the help we can get if we are to prevent another banking melt down.

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The GOP Opposes Bank Reform?

Well sort of.

What they oppose is the currently proposed bank reform bill that Senator Dodd has introduced.

If this seems a lot like health care reform … you are correct. So far the GOP had studiously avoided saying what it thinks is good reform. All we know is that the Senate Republicans will say no to whatever is in front of them now.

Wow. That’s constructive.

The key issue is that the GOP argues the Dodd proposal makes future bail-outs more likely. To use Senator Mitch McConnell’s words: ‘it institutionalizes bail-outs’.

And dare I say it? He’s right.

That’s why the Dodd bill needs to be fixed.

The problem is this: as long as the government extends guarantees of various sorts to the big banks, there will be the probability of a future bail-out. Actually, given the evident incompetence of the big banks, this is not a mere probability, but an outright certainty.

Dodd realizes this and tries to mitigate the damage the banks do to society by establishing an up-front fund sufficient to pay for any such future bail-outs. The cash in the fund will come from the banks via a levy on their income.

My problem with this approach is that we have no idea whether the fund, at $50 billion, will be enough. Given the enormous size of the big banks, and their voracious growth, I doubt it.

Of course the GOP is being disingenuous. They know full well that we will always have to bail out the big banks: they are too central to the workings of the economy for us not to. Which is why I am waiting to hear the Republican alternative. Presumably they have one. But, given their approach to health care reform, I doubt we will be treated to it any time soon.

So McConnell is simply being an obstructionist rather than a legislator.

Typical.

Meanwhile: bank reform is getting more, not less, urgent.

I read with great interest a speech given by Andrew Haldane, a UK regulator, who has emerged as one of the leading thinkers on the bank reform problem. His wording is provocative but accurate: banks should be treated in the same way as a polluter.

Basically a polluter is someone, or a business, who has an economic impact borne by society rather than by that person or business itself. GE is a classic example. GE denied for thirty years that it had dumped toxic waste into the Hudson river, despite all the vast evidence amassed that contradicted that statement. Eventually it was forced to pay for a clean up, but not before the shareholders of GE had benefitted from decades of earnings unencumbered by the full cost of the company’s operations. Pollution is a way that private entities try to avoid the cost of what they do by passing a part of the cost on to society at large.

Cars are another such example. The cost of driving a car should, in a proper economic sense, include the cost of the pollution spewed into the atmosphere. Instead the taxpayers, even non-drivers, end up paying for the clean up.

These two examples also give us insight into the two main ways in which society can recoup the cost from the private sector.

It can prohibit certain activities – dumping toxic waste into public rivers. Or it can tax the activity to raise funds to offset the pollution – taxes on gasoline achieve that aim. A slight variation on the taxation method is to force a private entity to incur a cost they would not normally or willingly incur without coercion. In the case of a car such taxation comes in the form of mileage goals that auto manufacturers have to hit. Such goals raise the cost of owning a car, so it acts as if it is a tax.

Haldane uses these arguments to look at banking.

We should both tax, i.e. artificially raise the cost of certain activities; and we should prohibit other activities.

The current discussion about bank reform should focus on what mix of the two strategies we need to deploy to minimize the damage the banks will inevitably try to offload onto society at large.

But before we can get into that phase we need to recognize the fact that banks are, in fact, polluters. They impose huge social costs on us and reap the benefit of all sorts of subsidies. In one calculation Haldane estimates that the value of the subsidy we give the banks exceeds their annual income. In other words, were it not for the taxpayer propping them up, the banks would be losing money consistently for their shareholders.

The biggest subsidy we give the banks is the implied bail-out that McConnell so objects to.

This bail-out subsidy affects the banks by lowering the cost at which investors are willing to lend to them. Because the investor community is aware of the subsidy, they perceive less risk in lending, and therefore charge a lower interest rate. Haldane measures this subsidy by looking at the different bond ratings the rating agencies establish for the banks, with and without the subsidy.

Crucially, for bank reform, the larger the bank, the greater the difference between the subsidized and non-subsidized cost of funding. In other words the bigger the bank the more it costs us to subsidize it. That’s where ‘too-big-to-fail’ becomes an issue for all of us.

Not only are smaller banks easier to regulate and eliminate when they screw up, but they cost us less to prop up.

The challenge then becomes how to get rid of this subsidy and force the banks to earn their own money and not live off of our largesse.That’s an argument the big banks don’t want us to have since they are addicted to the subsidized way of life.

So, perhaps, we can use the GOP obstructionism as a way of opening up a wider discussion. If they want to eliminate the need for future bail-outs, we should discuss exactly what that implies for reform.

Massive capital requirements?

Intense oversight?

Smaller banks?

Highly restricted activities?

New bankruptcy codes so that bank creditors and shareholders are wiped out before public money is available?

I am waiting for answers …

This could be a long wait!

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Bank Reform: Contingency Planning

A couple of days ago I gave the thumbs down to the Dodd bank reform proposal, but in the past couple of days it has become clear I wasn’t sufficiently open about why.

One reason: bank behavior is not our only problem. Bank size is too.

Maybe one way to get at why this is so important is simply yo return to aspects of the crisis. There was no explicit taxpayer guarantee of AIG, but we bailed it out anyway. We allowed Bear Stearns to be pushed into a merger, yet we allowed Lehman to go out of business altogether. In short there was muddle and confusion everywhere, with ad hoc decisions being the order of the day rather than the execution of a well known and well rehearsed rescues plan.

Plus, and this is where I am most adamant, the crisis revealed the extraordinary size of the contingent liability the government has.

I find it odd, no positively annoying, that people who decry the use of off balance sheet accounting by the banks would then condone off balance sheet accounting by the government. Yet that is exactly what our continued guarantee of the banks amounts to. The way I see it is that the extension of a taxpayer safety net is a liability that taxpayers take on, and so should be added to the sovereign debt burden of the country. When a government bails out a bank it is converting a private debt into a public debt. Naturally it only does this in the event of a bank crisis, so the obligation is contingent. It is a real debt nonetheless.

Setting aside for the moment the efficacy of such a conversion – and the moral hazard it involves – the existence of a huge potential debt obligation needs to be factored into the risk profile of the national debt.

Why does this matter?

Because we are piling up liabilities at a prodigious rate. The national debt is growing rapidly as the result of our need to prime the economy, and our need to fund entitlement payments even while government revenues suffer a cyclical decline. This growth is causing consternation in the more right wing elements of the financial media because there is a fear we may eventually be charged more for the debt we issue. So far there is no sign of that happening: the government seems to have easy access to a large enough flow of funds, which indicates that the debt fear argument is more ideological than economic. Nonetheless it goes on.

My point then becomes this: our debt burden is growing and is making fiscal policy difficult over the medium term. We will no doubt have to resort to a combination of tax increases and spending cuts to get the budget back in line. Crucially: this adjustment period will be a highly sensitive one. We will have little room for maneuver should another crisis erupt. This lack of wiggle room is the basis for my continued criticism of the Reagan/Bush strategy of starving the government of revenues. No one is seriously going to slash spending on entitlements in the midst of a crisis – cutting them would exacerbate the drop in demand, and the existence of entitlements adds a huge ballast to the economy offsetting the volatility of the private sector. One overlooked aspect of the crisis is the value social programs play in keeping cash flowing in the face of a freeze up of private spending.

But the lack of wiggle room is made much worse by the continued contingent liability we have to bail out the banks. The implied addition to our debt load overhangs any ‘on the books’ policy decisions. Put another way: the bank bail out liability could serve as pressure to cut social spending in order to free up debt room for the banks.

In that light I wanted to see strong measures in the reform that would cut back the contingency.

One way, which is included in the proposal, is to force the banks to pay an up front fee that is set aside as a ‘rainy day’ fund for the government to dip into when it needs bail out cash. I am skeptical about this fund, not because it will not exist, but because it looks insufficient at $50 billion. This insufficiency stems from two weaknesses in the reform proposal: the sheer size of the industry dwarfs $50 billion so a systemic failure would flow straight into our debt burden; and even if the problems were contained to individual banks, those banks are still behemoths, each quite capable of absorbing $50 billion – the cost of saving AIG was much more than that.

And this is my central criticism of the proposal. It leaves the banks too large. It contains fine words about establishing a process to dissolve big banks, and to suggest limits on them. But this puts the burden of change on the shoulders of the regulators, a group prone to capture and intimidation by the industry.

Proper reform, in my view, would have included some form of cap on bank size, backed by the Volcker rule to eliminate over-entanglement and unmanageable complexity.

The contingent liability implied by ongoing taxpayer support should have provided a rallying point for fiscal conservatives to support the establishment of size limits – one way to reduce future budget deficits and limit the fiscal risk of the country is to limit the size of our banks.

Such is the power and importance of the banking industry that we need to take both its instability and incompetence into account as we manage our way out of the hole it dug for us in this crisis. Which is why any reform has to have a harder edge than the Dodd proposal has. So far at least.

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