bank reform

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Round Up, and Returns

I’ve been off line for a few days, so I ought to catch up with the news.

Which, it turns out, isn’t really news at all. The economy is right where we left it. Chugging along at an unspectacular pace, adding jobs at a modest rate, growing, but too quickly, and exposed to the exact same risks that beset it before. Our banks are still way too large relative to our economy, Europe still is dithering about in self-inflicted recession, and the Middle East is simmering back to one of its regular boils thus threatening oil supplies.

The more things change, the more they stay the same. Or something like that.

Stateside, things are going reasonably well for an economy hobbled by awful policy leadership and gluttonous banks. Sales of homes are showing signs of life, which by itself is a relief, but is probably more important as an indicator the households are growing in confidence. Both new homes and existing homes are selling at rates above their crisis bottom dwelling levels. But neither are bubbling along at unsustainable rates either. I have mentioned before, but here I go again, that construction has now fallen behind long term demand. We have a growing housing shortage in some areas. Especially multi-unit housing. I suspect that sometime in the next year or so we will see a small blip – and I hope it is only a small blip – in construction as this shortfall is erased.

The long slow debt reduction process has evidently had an impact on household expectations: purchases of big ticket items has picked up. Unfortunately wages are lagging still – they have for decades – so any acceleration in these kinds of products will inevitably involve a run up in debt as well. The key will be reaching a sustainable level of debt and avoiding the excesses of the Bush era bubble.

Which brings me to the banks.

They remain a dagger pointed directly at the heart of our economy. They have failed us mightily for a very long time. During the past two decades they have misdirected capital throughout the economy with spectacular abandon. The dot-com and housing bubbles stand in permanent testimony the the ineptitude of our banker’s ability to spot a good investment opportunity. The one thing we know bankers are good at is generating, on paper at least, profits that justify big bonuses. They are less adept at ensuring a reliable and stable flow of capital into the real – non-financial – economy where the economy would benefit from long lasting increases in its productive capacity. And they are certainly not very good at credit analysis.

This latter point is being hammered home heavily at the moment by the squirming over sovereign debt. The steady right-offs of sovereign debt by our large banks is horrific to watch. Even worse is the craven attempt to get taxpayers to offset such losses in one way or another. Bankers are supposed to be skilled at risk management. Apart from managing our payments systems that’s what they are paid to do. Yet they seem all to want to be relieved of that duty every time they make a mistake. Making mistakes is an essential part of the training of every good risk manager. They are supposed to learn and get more capable as they go along. Ours just want to be bailed out so they can get back to making a quick buck. Where, oh where, are our regulators?

Which bring up the scuffle going on over the Volcker Rule.

This, as you all know, is a rule that iS supposed to be appended to the infamous – and frankly incredibly dense and not at all good – Dodd Frank reform of banking. You would have thought that within a document of over 800 pages someone would have find room to write in a rule to deal with proprietary trading. This is the kind of trading that banks do for themselves and not on behalf of a client. It is the locus of the most egregious casino mindset that sent us careening off the cliff, and is the least useful of all the things banks do. I have nothing against proprietary trading along as taxpayers are not deployed to clean up the losses. If traders want to have fun gambling, sop be it. Not on our dime. Not at all. The Volcker rule is supposed to force banks to carve out proprietary harding and thus eliminate taxpayer support for gambling. The banks are aghast. They are crying and pouting because it looks like their toys are being taken away. Which they are. Justifiably so. You don’t give fireworks to children. You don’t allow traders to trade on the taxpayer’s dime. Things get blown up otherwise. Nonetheless they banks are marshaling a formidable array of lobbyists to attack Congress in order to keep the subsidy they rely on to boost their margins. Keeping the Volcker rule off the books is one way to avoid having to be good at banking – playing with free money is so easy any juvenile can succeed. Look around the yahoos on Wall Street to see just how stupid one can be and still make a fortune if you are playing with someone else’s money.

This brings me to the inimicable effects of returns. Particularly the return on equity in whose name all sorts of evils are wrought on a daily basis. ROE is the driver of modern business. Everyone tries to ‘maximize’ ROE. As if maximization is possible in an uncertain world – just how do you determine what a maximum is in the face of uncertainty? No one knows, but all sorts of experts opine about maximization as if it is possible. It isn’t. So business leaders use a proxy: they seek to attain the ROE the ‘market expects’. This is a measure admittedly plucked from thin air. Or, more precisely, the air between the ears of sundry Wall Street analysts who opine constantly about the required return on equity in various industries. It is very subject to whim and rises and falls rather like skirt lengths on Parisian fashion runways. The problem recently has been that everyone is reaching for ever higher levels of ROE. Hence the urge to cut costs, deploy more capital at the expense of labor, off-shore production, otherwise outsource, and – this is the killer – to take more risk.

Just last week Proctor and Gamble announced a slew of lay-offs in order to ‘align’ its ROE with market expectations. P&G’s problem is that too much of its business is here in the US where ROE is hard to squeeze – the underlying sluggish growth of the economy is a major block to higher ROE, growth is much more attainable in emerging economies where consumption is still a novelty. Thus P&G needs to downscale its operations in the US – hence the layoffs – while boosting its operations abroad. This, by the way, is the same company that has abandoned much of its marketing to the US middle class on the basis that said class no longer has sufficient purchasing power to justify the expense. P&G’s shareholders, no doubt, will be happy to hear about the move to boost ROE. American workers probably less so.

Likewise, much of the banking objection to reform is that it will limit ROE. Poor dears, perhaps this means less of a bonus. Here’s my response: tough. Banking is not supposed to be a high ROE business. And if your bank is so large that it is a good cross section of the US economy – which all the big banks are – then your ROE will mimic, or track closely to, the economy’s overall performance. Trying to squeeze an abnormal rate of return from a mature economy is likely to drive you to do reckless things. And we know where that leads. Safe banking is low ROE banking. Get used to it. The lunatics on Wall Street who constantly demand higher rates of return than are sustainable should be silenced or ignored. If they really want those rates of return they ought to invest in boutique style banks that have portfolios small enough and select enough not to be samples of the entire economy. Size matters in banking. Just don’t tell those traders. They’re juvenile enough as it is.

So. There we are. There’s lots going on, but not a lot of change. Which is probably a good thing in an election year fraught with awful candidates and practically no sharp criticism. But that’s another story.

Oh, and one last thing: does anyone really care anymore about the Oscars? If there’s one totem to the past it is an awards ceremony in an era of instant review. Social networking, downloading, streaming and all the other properties of an internet economy have made the movie industry look increasingly out of touch. It still knows how to lull an audience in order to make a living, but its business model is looking extraordinarily musty. The Oscars belong in the 1950’s. It’s time to move on.

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Volcker and Banks

We have reached a crucial point in our attempt to bottle up the banks. It looks as if they will win. That means the economy will lose, and the likelihood of a new crisis immediately jumps. Read your Minsky. And weep.

There is a looming deadline in the Dodd-Frank regulations that requires rules to go into effect to govern proprietary trading. As you all know by now I am ardently opposed to banks being allowed to speculate. I refuse to call speculation ‘banking’, which is a term I like to reserve for the very dull and prosaic process of credit extension based upon sober analysis. It was yahoo trading that launched us into this crisis as banks sought short term profit at the expense of any semblance of banking rectitude – the creation of all those unnecessary derivatives in order to meet insatiable trading desk demand for commodities to move about was the ultimate reason the mortgage market mutated into a cancerous mess. Bankers still have not paid the price – personal price – for their role in casting us all over the cliff. Yes, we aided and abetted with our debt splurge, but sound credit analysis would have mitigated against our ways. We rely on banks to be measured, and not to be at the forefront of folly.

So, in my mind, it is essential to eradicate – totally – any temptation to indulge in such self destructive trading. This will not overcome the ever present dangers of credit extension. Banking will always be fraught with uncertainty, and so will never be cleansed of cyclical losses. But there is no need at all to accelerate the conflagration by adding speculation to an already combustible mix.

Banking is too important to the proper and socially beneficial workings of an economy to be left to bankers. They have amply demonstrated that they cannot, and should not, be left to regulate themselves. I say this as someone who spent more than a little time in the mid to late 1980’s writing position papers for bank lobbyists dedicated to the abolition of the twin regulations of the Glass-Steagall and the MacFadden Acts. How naive I was.

The problem bankers face is that traditional banking is pedestrian. It moves slowly. It is riven through with bureaucracy. It resembles a tedious department of the government in its red tape, rules, and other restrictions. It produces a clodden return for its shareholders. And it is hardly a stage on which a go-getter post grad business school ace wants to act.

Trading is a lot more fun. So is playing with fireworks. It is exhilarating. Dangerous. Filled will thrills and spills. And very profitable. Sometimes. The rest of the time the losses will wipe out all those gains. Over any decent span of time speculation ends up being a lot less attractive. The losses and profits tend to offset each other. The problem is that when trading gets jumbled in with banking – where margins are wafer thin most of the time – a single error can destroy years of steady progress. Capital can get swallowed up quickly. Liquidity evaporates. And bankruptcy beckons even though large swathes of the bank’s assets are sound. More importantly, such a disaster freezes the banking system, produces a credit crunch, precipitates a recession and thus swallows regular people, jobs, households and a lot else besides. We just lived through such an event. It is hardly a fictional creation.

As I said – banking matters. We need sound banks. Which means we need to reform our current banks because they are not sound. Or, at least, sound enough.

This is why trading should never, ever, co-mingle with banking.

Which is why a hard and fast ban on proprietary harding is essential as we re-build our banking system.

At the moment the bankers are pressing back against the implementation of the so-called ‘Volcker Rule’, named after Paul Volcker the former Fed chief. His rule would carve out trading from banking in a manner similar to the old Glass-Steagall Act. The banks are throwing up all sorts of dust in order to distract politicians, and are getting serious help from big business and foreign governments all of whom seem to fear a loss of market access.

Those fears are palpably nonsense.

I don’t recall big business and foreign governments having a hard time getting access to US money markets back in the Glass-Steagall era. Indeed I recall all too vividly some banks regretting being involved in sovereign lending. Nor do I recall big business being hamstrung by a lack of credit. On the contrary big business was a center of financial innovation as it developed all sorts of new funding devices to expand its way into direct market access. It was the banks fearing losing market share, not big business fearing tight credit, that drove, in part, the fight against Glass-Steagall.

This debate over the Volcker Rule is emblematic of the power struggle that sits at the heart of our economic recovery. This is a fight that we cannot lose. To do so condemns us to continued subsidy of the banking system, and to heightened risk of economic collapse in the near future. The big banks are preposterously sized with respect to even the US economy. They are grotesque giants capable of sinking us with one incorrect derivative decision. Their power has not been eroded sufficiently to rein them in. Only breaking them up will accomplish that task. Even with a full implementation of the Volcker Rule, behemoths like JP Morgan Chase, Bank of America, and Citibank will continue to lurch about the economic landscape supported by our subsidy which enables them top raise money much more cheaply and in much larger quantities than they could were they truly private organizations. Their quasi-public status allows them to make poor decisions – which they do with alarming frequency – and offload the consequences onto us. All while their managers benefit from rotten bonus incentives and lead the continued march towards greater income inequality.

This anti-social behavior has to stop. It is undermining democracy. It is ruining our economy.

Full application of the Volcker rule is urgently needed. But it is only a first step. Our bureaucrats may think they can devise subtle plans to deal with future bank failures. They cannot. All their clever plans will dissolve at first contact with a ‘too-big-to-fail’ event. The panic will force accommodation. The bankers will re-surface to pillage us again. Only breaking the banks into smaller chunks will prevent them from being the danger they became after deregulation.

The Volcker Rule is a beginning. It is not an end.

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Break Up The Banks

Before they break us up. Again.

I have stayed away from discussing the banks in recent months largely because I consider the solution to our banking problems to be self evident. They’re too big. Make them smaller. Arcane debates over capital ratios, naked CDS prohibitions and other bureaucratic responses are all small fry and akin to re-arranging deck chairs. The chairs are just fine. It’s the Titanic we need to worry about.

For instance, I look at the current Euro crisis through the prism of banking. The Europeans have allowed their banks to grow so large that they fear for their economies were one or more of those behemoths to collapse under the weight of toxic sovereign debt. So, central to the overall Euro crisis, is bank stability. Indeed that is the most pressing issue even if the inept leaders of various European nations don’t care to admit it.

With that said I will re-state my position: despite the reams of paper dedicated to bank reform here since the crisis began we have not taken strong or sufficient action to prevent a repeat. We are still susceptible to a banking crisis. Perhaps even more so given that the largest banks are all now much larger than they were when the original crisis erupted. The banks still are being heavily subsidized. There are insufficient incentives on the banks to limit their activities. And, they still exert undue influence on our political process. In short they remain anti-social and not focused on those aspects of their business that adds value to society at large.

There’s just no polite way to say this: the banks are nasty. They can do immense damage far, far, out of proportion to any value they represent. We need to do radical surgery not a facelift.

Since I have heard little substantive discussion of possible action to break up the banks into more manageable chunks – by which I mean pieces small enough to allow to fail – I have ignored banking regulatory discussions generally.

That changed today.

Jon Huntsman, the most marginal of a host of marginal Republican candidates for President, has written an op-ed for the Wall Street Journal arguing that the banks are too big.

It makes sense that a right winger would take up the challenge, though Huntsman is hardly a extremist. Smaller banks would not live off the largesse of taxpayer subsidy the way are largest banks currently do. I would have thought that any right winger worth their salt would want to reduce subsidies. The implicit guarantees of “too big to fail” are a humdinger of a subsidy. So cutting the big banks down in size should be a top agenda item for any red blooded capitalist. Forgive me if I am wrong, but I imagine any Austrian or classical economist, Ayn Rand fan, or sundry libertarian would salivate at the prospect of cutting our big banks down, fostering true competition, and letting the devil take the hindmost. Even Gene Fama, whose laughableEfficient Markets Hypothesis I hold in utter contempt, is on board with our cutting the big banks down in size. It is a strange day indeed when I agree with a hard core University of Chicago person.

Huntsman is right when he argues the Dodd-Frank resolution authority method for eliminating “too big to fail” is a skimpy fig leaf at best. No right minded politician would allow one of our big banks to collapse, so the guarantee remains in force no matter what Dodd-Frank says. In the next crisis – which we will assuredly get one day – we will be treated to a repeat of the Lehmann/Bear Stearns mess where frightened politicians run around trying to shore up goliath organizations each of which is capable of destroying the economy. All the innocent sworn forbearance in the world will vaporize the instant one of the dinosaurs of Wall Street starts to implode. We simply cannot afford the disruption, uncertainty, and outright panic that would ensue. Smaller banks we close and lose every day. Big banks are too large to swallow so easily.

Surely we learned this.

Apparently not.

Our weak kneed politicians gave in to the assault of bank bought lobbyists and avoided the issue of size. Instead they produced the reams of Dodd-Frank. Full of nice details. Beautifully crafted. And demolished whenever a big bank crumbles.

In the annuls of our cautious response to the crisis the bank reform effort stands out as one of the least bold, ineffectual, and industry bought. And the competition for that title is stiff.

The greatest obstacle to progress, by which I mean getting smaller banks, has been the inordinate political clout they can muster to defend their privileges. So it is pleasant, to say the least, to see a Republican entering the fray. In the Wall Street Journal, no less.

Perhaps there’s hope.

Break up the banks!

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The Outlook

I read today that Moody’s suggests a new recession has about a 40% chance of occurring in the foreseeable future. I think that’s a bit high. The problem we have at the moment is that our elite is doing everything in its power to diminish growth. Moody’s says that policies will chip about 1.7% off of GDP growth next year. That I agree with.

Nothing in the recent spate of numbers suggests great strength. I cannot detect anything lurking in the weeds capable of jump starting robust growth. The great dead hand of low demand coupled with continued debt pay down by households dominates any countervailing positive movement. The lack of a coherent job creating policy, and the very real prospect that bitter politics will preclude such a policy anyway, will stop the recovery in its tracks.

Businesses are flush with cash, but are not expanding because they see no demand for their products.

Wages have been pummeled by the recession and were weak going into it anyway. Workers have been the butt end of productivity growth and have watched profits soar while being told they are at constant risk of dismissal. Consumers are fearful of the future and are holding back.

The housing crash exposed the growth – what growth there was – of the past few years as a total illusion. Debt is only a justifiable long term support for growth as long as wages keep its repayment within decent limits. Beyond such limits it becomes a time bomb that will eviscerate swathes of the economy and will create lingering after effects that take years, if not decades, to mop up.

The banks are still weak. They are now laden with sovereign debt. No one seriously believes that they are stable. Their dependence on gambling profits remains high. Their capital is stronger, but they resist true reform.

Europe is gripped by a fever of incompetent politics. The peripheral nations like Spain and Portugal are being asked to bear the brunt of poor decision making and improper policy by the central nations like Germany and France. The flood of cheap money – the core of the current crisis – perverted relative productivity within the Euro zone. No one cared until the crisis erupted. Now the obnoxious moralizing from the center diverts attention away from the culpability: the system was rigged. The failure to solve the problems is epic. It could lap across the Atlantic and erode our banks.

European failure means that trade will not be an elixir either. Indeed the world economy is slowing down as the emerging nations are all entering rougher patches.

So there is nothing to provide sufficient power to lift America out of stagnation.

Thus the economy looks stuck in a growth pattern of around 2%. Maybe 2.5% next year. With the majority of the variance from that level likely on the downside. Not a 40% chance of a new recession. But not a negligible chance either. We are well and truly stuck and thus vulnerable to any storm that crops up.

That is not a happy place to be. But it is where we are.

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Occupy Wall Street

Will it work?

Who knows?

When the normal method of influencing policy is disrupted by its co-option by an interested minority, and when political leadership limits itself to serving the interests, primarily, of that minority, a new direction or channel must be found. It will, of necessity, be outside the norm. It will thus be criticized by those invested in the norm as unusual, threatening, or irrelevant.

New channels are a feature of nature. It is how even the largest of rivers is formed. Somehow, somewhere, an original trickle in a new channel began the path that later became the Amazon. What appears later as irresistible was first insignificant. This is simply the way of change. No one can predict what will happen since the past is not a perfect template for the future. Is it this trickle? Or that small stream that will become the Amazon? I do not know. Nor can I.

So Occupy Wall Street may be the beginning of something larger. Or it may evaporate and leave no trace.

My suspicion, though, is favor of it having an impact.

If so Wall Street deserves the damnation. Its hubris needs to be contradicted and tamed. Its influence over policy and its constant, pathetic, self referential aggrandizement disregarded.

We need banks. They serve a social function. They are integral to the successful operation of a complex economy. They help us bridge the gap between the present and the future. Building that bridge implies the existence of risk. Bankers accept that risk in return for a reward. But the bridge does not exist in and of itself. It is merely a bridge. Investment and savings flow across it in order to serve society’s larger needs. That is how we match opportunity in the future with availability of capital today. It is how we allow ourselves to postpone consumption in the present to construct a chance for greater consumption down the road.

The profound uncertainty that dominates the unfolding of our economic future demands that such bridges be built, and that we encourage rather than disparage those who dare build them.

But.

Problems arise when the builders forget that bridges connect things. Such forgetfulness leads them to build bridges for their own sake rather than to make such connections. When this happens the investment that is supposed to flow across is diverted towards embellishing the bridges themselves. Social opportunity is reduced and we end up with useless, but elegant, bridges.

Our banks fell into this trap.

They realized that they could earn more money for their shareholders by staunching the flow of capital into future projects that expanded the general opportunity of society as a whole, and by deploying that capital into games they invented for themselves.So the money stayed within the banking system rather than flowing into the enhancement of production goods or services we all benefit from.

These games went under many names. Each more obscure than the last. Each designed carefully to enrich bankers at the expense of others. Each another block slowing the flow of capital into other activities.

The end result was that our bridges were no longer effective access points into the future, but that they were traps – ever larger traps – blocking the way forward in order to profit the present.

Our banks became anti-social. They built elaborate, and as it turns out, highly unsafe bridges. They gloried in their architectural magnificence. They were astonished at their constant innovation in design. That the bridges went nowhere was not a consideration. Bridge building was now not about connections, but about suspension and engineering. Bridges were not a way point on a path into the future, but an end point here and now.

The banks became a social problem. A big problem.

The people who comprise Occupy Wall Street seem to understand this, although I am not so sure they understand our need for banks. The money that Wall Street hoarded has contributed to the corruption of American politics and our elite. Wall Street is not the sole reason our economy is stagnant, but its money has surely prevented open discourse about how to break free of that stagnation. Wall Street was certainly at the fore of the crisis that brought the economy to its knees, but much of the weakness that the crisis exposed was well established ahead of its onset.

If Occupy Wall Street can accomplish anything I would want it to be the highlighting of that corruption and the take over of our democracy by the few. Everything else flows from that.

The rallying cry on the right will always be the protection of rights for the individual. In every day action this translates into protection of privilege. The rallying cry on the left thus must be protection of rights for all. This means we must question privilege.

Wall Street carved out a privileged position. Instead of being socially useful it became anti-social and counter productive. It abused its privilege. It abused us all.

Perhaps Occupy Wall Street can point out that abuse sufficiently that its current small stream becomes a river to break the dam of complacency that prevents the reform required to restore our democracy. Only after that reform can we re-balance our economy so that both wages and profits are privileged, not just the latter.

Will it work?

Who knows?

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