B. of A.

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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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The Art of Bankers and Economists

The big question, and one I have been asked several times this morning already, is this: does the good jobs report last week signal a major shift in the economy?

No.

Clearly the tone of things has changed, but there are still large reservoirs of under-used resources to be brought back on line before we can talk about a healthy economy. This entire recovery has been one characterized by baby steps. Our economy seems nowadays to be akin to a supertanker, lumbering, slow, making very long turgid moves, unable to make quick transitions. The days of fast recovery are a distant memory.

This, of course, is partly due to the nature of our recent crisis. The financial sector and the run up in household debt combined to undermine everything. Digging out from the catastrophe that our banks wrought is necessarily difficult. Particularly since they remain unchastened, under-capitalized, and way too large for our own good. Beware: the banks will be the cause of our next downturn.

Which leads me to a beef of mine, something that has dogged me throughout the crisis. I wish we could stop calling the yahoos who destroyed our economy ‘bankers’. In my day we referred to them as ‘traders’. Its a better description of what they do. They sit at desks and move mountains of money about. They do not do banking. They trade. Their incentives are built around rapid movement of bulk capital and cash in order to turn wafer thin spreads into huge profits. It is a volume business. It is largely self-contained. It has very little to do with banking.

Bankers take positions. They own the assets they create when they lend. They husband those assets when necessary. They are in contact with customers. They assist when credit weakens. They build reserves to offset losses. They stay very far away from speculative capital flows. They are the epitome of dull and boring.

We need bankers. We don’t need traders.

Our problem, which was emerging during my tenure in banking, is that our major banks are all run by traders. They have extremely short term decision horizons, and they believe they can fudge risk away by offloading it on other banks or by insuring against it. Every single bank seems to think it can accomplish this risk immunization. Hedging is everywhere. Structured finance sits precariously on top of a narrow foundation of basic assets that are not at all altered by the fun and games erected up above. The risk still exists, only it is masked behind accounting conventions and tricky book entries designed to fool regulators and shareholders into believing a 30:1 leverage ratio is not just sensible but is sound to boot.

I would laugh at this were it not so damn dangerous to you and I. These indescribably ignorant fools have the ability to ruin our economy. They will do so again. Soon.

Why?

Because we didn’t punish them. Nor did we have the courage to rid our politics of their influence. Their money still flows. So their games still continue. Until JP Morgan Chase, Citicorp, Wells Fargo, Bank of America, and the others are broken into little pieces, and until we have re-established a separation between banking and trading, our economy is not safe. It is as simple as that.

And we are not there yet.

So, while the economy may be turning around in its pondering way, we cannot be assured this recovery will last.

Further: we are now being treated to an object lesson in the irrelevancy of economics.

The good jobs news has brought to the fore the great divisions within economics. Those of you who are new to the subject might be forgiven if you imagine it to be a scientific pursuit laden with sage insights and bursting with solid advice. Not at all. It is an art. It is an adjunct to politics. It is full of ideological axiomatically driven bias. Its object is to discuss its own artifacts not those of a real economy. Thus it expends derisory amounts of time on a general equilibrium that no one, not once, has actually witnessed. It stylizes consumers as being automatons with inhuman cognitive capacities. And it flattens business firms into a ludicrous other wordily construct that no business person I know would recognize, let alone dignify as a grown up interpretation of what goes on. This is all done in order to pursue the holy grail of determining, definitively, that markets are more efficient than any other form of allocating mechanism – like the government for instance. At the end of all this its more honest adherents will admit the entire enterprise is disconnected from the real economy, while its more ardent defenders will argue this paraphernalia actually helps interpret the real world.

Quite how, I am at a loss to say. But there we are.

Meanwhile the more politically connected representatives of this melange of arts get involved in the debate about the jobs news.

One side, represented by the infamous Glenn Hubbard – of ‘Inside Job’ notoriety – says that the pick up in employment is despite Obama’s policies. The other side, represented ably by Larry Summers – the leader of bank deregulation amongst other oddities – says that the gain is entirely due to those self same policies.

Nothing could articulate for you the irrelevancy of economics more clearly. Which is it? Did those policies help or hinder? A scientist could answer that question. An artist can always paint a picture or tell a tale to defend whatever side needs a good story. Some people like abstract art. Some people find orthodox economic theory appealing. Whatever pleases your eye. And whatever plays into your preconceived views. Capitalism is great. Or it is an abomination. Economists have no idea which. But they can sure as heck talk about it. As artists they are unsurpassed. The stories they tell are riveting. The pictures are full of color and texture. Our walls and libraries are copiously equipped with the product of economic artistry.

The connection between bankers and economists, beyond their artistry, is that they have the power to be really dangerous. They both believe themselves in possession of magic that allows them to defy uncertainty. They have concocted recipes for brews and potions that addle the rest of us into thinking that we, too, are free from the ravages of uncertainty. Since that is so alluring, we were in their thrall.

Then they trashed the place.

Only to emerge as the people we turn to fix things. Now the bankers are called creditors. They’re the ones calling for wisdom and sacrifice on the part of the devastated economies. And the economists are the ones we turn for the wisdom and to organize the sacrifice in order that we all may return to our happy ways. So the economists negotiate with the bankers on our behalf in order to right the wrongs they wrote.

How did that happen?

I don’t know.

But it goes to show how relevant irrelevancy can be.

Alice in Wonderland?

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Foreclosure Mess – Update

Given this morning’s disappointing report of existing home sales it is worth recalling that one factor weighing down heavily on real estate is the ongoing foreclosure mess. By this I mean the growing chaos within the foreclosure process, and the steady and increasing stream of revelations that indicate that the banks have a slew of documentation problems. Lest we forget: foreclosure is a process that hinges on proper documentation. Getting a clear view of property rights and thus title is a vital component of a healthy real estate market. We all tend to overlook this simple fact because we have assumed for decades that the American system is a well oiled machine with title clear and thus borrowers and lenders rights well established. Finally we should also recall that real estate is an extraordinarily well established body of law at the state level.

So, with that said, what is going on?

Well, there is an interesting ongoing foreclosure case in New Jersey that threatens to destabilize everything. The basic facts do not concern us. What we need to focus on is that during the court hearing a representative of Bank of America stated, under oath, that it was customary for Countrywide, that bete noir of the bubble and now part of BoA, to retain documents pertaining to securitized loans. They were retained for ease of reference and out of fear they would be lost.

This is an extraordinary admission. It contradicts what BoA had said previously and completely calls into question the validity of any securitized loans BoA contributes assets to.

Why?

Because the law is simple: for a trust associated with a securitized loan to be securitized the trustee has to take possession of all the relevant paperwork. To the extent that Countrywide kept documents relating to mortgages it sent forward for inclusion in such a trust, then those loans are not properly securitized. If this is held to be the case, and after the court testimony it would be hard to roll this one back, then it is equally clear that there are a few, possibly very many, securitized loans sitting on third party balance sheets that are not correctly securitized. They are unsecured loans no different from a credit card. Since this would undermine their valuation anyone holding such an asset would be looking at a substantial loss. They would almost certainly sue to reclaim that loss. That means they would end up suing BoA, as it now is the owner of all that Countrywide paper. The potential damage to BoA is huge, and I doubt that its current stock price reflects this properly.

So why has the stock price not sunk?

I can suggest a number of issues.

One is that the market doesn’t believe the court testimony has a generalized impact and that it may be only a localized problem. In which case the loss is restricted to this one case – BoA would not be able to complete the foreclosure on the home of the litigant in question.

Another, far more dangerous reason for market indifference, is the belief that the government will stop the damage from spreading. This is, I fear more likely. Our government, under both Bush and Obama, has been supine in the face of bank incompetence and misconduct. At every turn the government has seen fit to “save the system” rather than enforce economic punishment for anti-social behavior. The banks are well aware of this and so indulge in all sorts of corner cutting in their activities. They are under no pressure to behave well or even obey well established law. They have the ultimate get out of jail card: government complicity.

Unfortunately for all concerned this game of complicit behavior could run afoul of state law, where armies of real estate lawyers are challenging the veracity of Wall Street’s slick legal teams who botched the securitization process. The consequence of this confrontation is a sudden and massive slowdown in the foreclosure process. This, in turn, is stopping the healing of real estate values – until the backlog of foreclosures are dealt with it is very difficult to place a good valuation on property. More to the point: the bank’s apparent disregard for paperwork is starting to gum up the entire real estate transaction process. Title searches, new mortgages, liens,and other aspects of the conveyance of property are all now suspect. It will take a while for confidence to return and for long established processes to be trusted again.

Yes, the banks really were that stupid.

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Fix Wall Street … Please

I apologize to those of you who are sick and tired of the flood of Wall Street news. You want to know more about the ‘real’ economy, and less about finance.

Well, blame the banks.

They have co-opted our economy, and are abusing it for fun and profit.

They have to be stopped.

There is no credible story within the domestic affairs of America larger, or of more importance, than the state of our banking system. I mean this not just as a comment about the economic sphere but about the political sphere.

The financial crisis of the past two years has exposed the incredible choke hold the big banks have on our democracy. They can, and they did, expect taxpayer assistance to defray the cost of the compound and manifold errors of judgement that they made. They expected us to pay them for their mistakes. They expect us now to go back to being compliant as they pile up vast profits and pay themselves massive bonuses even as the millions of workers who suffered as a result of their errors still wallow in fear and poverty.

I say no.

I hope you do as well.

It is time to rebalance the economy and cut back the stifling weed that Wall Street has become.

A banking system, like the oil in your car’s engine, should be effective and anonymous. It should enable other sectors of the economy to generate wealth. It should be constructed on trust and relationships. It should enhance and supplement industry. It should be responsible with, and respectful of, your money. In short should be a supportive and essential cog in the overall economic machine. It should never become the be all and end all of the economy it is supposed to support.

Unfortunately our system outgrew that proper role. It became a rapacious, short term, deal oriented cesspool where it is expected that your banker is trying to take advantage of you. Relationships be damned. Short term profit be praised.

As Blankfein of Goldman Sachs says repeatedly – sophisticated investors should know what they are getting into when they trade with his firm. Absolutely: they are trading with a business whose word cannot be trusted.

In the ‘anything goes’ vision of the marketplace that infuses and informs the Goldman Sachs culture anyone can and should do anything. Anything. Get the deal done. Pocket the profit. Move on. No remorse. No looking back. No consideration. And, above all else, no ethical qualms. The presumption is that all players in the market are equally capable of stabbing all others in the back. So Goldman simply does it first.

This is a recipe for failure.

But only in the long run.

In biology we have learned that the most survival effective strategy is that called ‘tit for tat’. This means that when you defraud me, I will defraud you. In other words we all apply the golden rule. As Confucious first wrote, and as Kant famously argued, we should all act towards others the way we would want to be acted towards.

The crucial aspect that makes ‘tit-for’tat’ effective is that all the actors in the game know that they will cross paths again and that the playing field is level at each meeting. Plus all players will remember the way in which they were treated in the past. So an actor who cheats will be cheated upon in turn, and learn, eventually, not to cheat.

Goldman evidently disagrees.

They have abandoned the time honored banking principle of protecting and nurturing clients, and adopted a deal driven ‘attack at all costs strategy’. In their game, there are no clients, just sources of information. There is no confidentiality other than that needed to shroud the next deal. Because the deal flow is so large, and because Goldman’s size enables it to cast a wide net into that flow, it no longer fears the repercussions of cheating on a client. Tit-for-tat is useless when there are no opportunities to get even. And it is especially useless when one or two players get to be so big that even past victims have to continue to deal with them.

This is the state of Wall Street.

What was already a very restricted choice of players to partner with, is now even more narrow. The game has been tilted even more Goldman’s way. The failure of Lehman and Bear Stearns has handed more power to the remaining players. Now even more they can ignore any pretense and go for the jugular. That this is so is evidenced by the 91% jump in Goldman’s first quarter profits.

The economy, you and I, may languish, but Wall Street is back to its trading, raging, best. Those profits, and those at Citi, JP Morgan Chase, or Bank of America were driven, not by good old fashioned banking – lending so the economy can grow – but by trading exotic made-up products back and forth between each other. No value was injected into the economy other than the ability of the traders to go and spend those big bonuses.

To make matters worse, Jamie Dimon, CEO of JP Morgan Chase bemoaned just yesterday that he and his fellow bankers lacked access to the political process. This lack of access, Dimon suggested, is leading legislators to wrong conclusions: the banks need to be left alone to do their business – ‘God’s work’ to quote Blankfein – and not fettered by silly little things like new regulations.

This is, frankly, absurd. The banks employ approximately 1,500 lobbyists, and contribute millions, if not billions, to the coffers of politicians. Plus the records of Tim Geithner’s telephone calls show that he spoke to Dimon more often that he spoke to his boss, Obama. Bankers crawl all over Washington. They dictate legislation. Literally in the case of the changes to the bankruptcy code enacted under George Bush.

Dimon does not need more access, he needs less.

Or at least the rest of us need a voice in what goes on in Wall Street.

Ultimately we all need to realize that the financial crisis was also a political one. It showed just how deeply the banks have managed to burrow into the center of our economy. By discarding the regulation that had served society well for 70 years we unleashed not only an economic whirlwind, but a distorting force in our national politics. No one can talk of economic policy without negotiating with the banking system. The banks, and their attitude and power, intrude into every single conversation we have about how to fix the economy. The way in which we structure solutions, and even the way in which we allocate our wealth, all have to pass muster with Wall Street. The traders there can disrupt policies they don’t like. Which would be fine if those traders knew anything about long term finance. But as we now all know: they don’t care beyond the next deal. Anything with a maturity beyond the next bonus cycle is irrelevant to their thinking.

So bank reform is not just about putting the banking genie back into its old bottle, but it is about ridding ourselves of an unwanted voice at the political decision making table.

We need a banking system that is quiet and humble, not one filled to the rafters with hubris and that thinks the economy dances to its every whimsical tune.

Our bankers have outgrown their social value. They are now a malevolent force in society. They forgot what banking is.

We need to teach them.

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A Mockery of It All: Wall Street, The Joke’s On Us

Here I am, late at night reading accounts of the implosion on Wall Street. We are sufficiently past the peak of the crisis that we now have a few good books that explore or describe in detail what went on. They penetrate deep into conversations and exchanges that took place at the epicenter of the disaster.

And I am stunned by the arrogance, stupidity, cluelessness, and outright willful lack of ethics.

More to the point I am overwhelmed by the total abrogation of economic theory. Everything we know as standard economics is wrong. Totally and completely.

And I must admit, I love the idea of having to start over. There is nothing more exhilarating than learning. And boy do we all have a lot to learn.

Wall Street, hallowed as it is to market magic theorists was a demented fools game, rigged and self-serving, and completely beyond anything resembling what we read in economics text books. It was a colossal failure as a market. It was inhabited by people who had no idea what they were doing: bankers, lawyers, and accountants who were so incompetent that they genuinely believed in the inanity. They misled each other. They lied. They spoke in jargon in order to cover up the fact they didn’t understand even that most basic of banking rules: get your money back. They fell prey to the laudatory sewage published in the financial media, whose depth of analysis was so shallow that I doubt that even today, with the benefit of hindsight, that the commentators we see there actually have a clue as to what happened.

What we have just witnessed, folks, is a collapse of an entire elite. Wall Street has been exposed as an intellectual fraud of epic proportions.

Deals were made with the full knowledge that the paper being exchanged had no value. banks with sterling names and reputations were inhabited by idiots and dolts who sold assets they knew were valueless and yet swore up and down that those same assets had enormous value were they still on their own balance sheets.

We witnessed CEOs who knew little or nothing about the details of deals sufficiently large to sink their banks.

We saw risk management systems replete with elaborate math and sophisticated models, whose sole purpose was to obfuscate and hide the lie long enough for it to be traded to some other sucker.

We watched as traders larded their own bank accounts while not caring a jot about the bank where they worked. And we watched as the supporting cast of ‘professionals’ sliced and diced the legalese so finely that no one knew anything about reality.

The deal became the driver and be all of life. Anything more substantial, sensible underwriting for instance, became seen as retro and passe. Risk was something to be traded away not managed. Everything, absolutely everything, revolved around the next bonus. And since the next deal was the source of that next bonus, the deal became the reason for being. Shareholders, responsibility, longer time frames, and even the truth itself were tossed overboard in pursuit if the next deal. Quantity of effort dominated quality of effort. Mediocrity could masquerade as brilliance as long as it put in the hours.

The mockery this makes of standard economic theory is difficult to describe to anyone who isn’t familiar with the details of that theory.

It destroys it.

It is a total repudiation of everything we learn in introductory economics.

The market, and remember the money market is always held up as the closest approximation we have to a text book market, was a shambles. It was so far from the perfection we read about that it seems almost surreal when people who still advocate market magic theory try to defend it. I have to pinch myself when I hear anyone mouth a defense of free market economics. Exactly what about the implosion do they not understand? Markets, it turns out, are riven through with inconsistencies, errors, and foibles. They are not the perfectly smooth all knowing, infinitely adjustable, and hyper sensitive mechanisms for exposing the ultimate truths of an economy. On the contrary they are murky, dark, and dingy places full of mistakes and misalignments.

Free market economics has always been more an ideology than a science. To make the models work in order to defend the notion that markets are better at asset allocation than anything else they have to be so perverted as to be utopian and almost mystical.

The greatest of the free market advocates: Hayek, Friedman, and others worked very hard in order to avoid taking into account the real world. They cut away vast swathes of reality from their modeling in order to distill the ‘essence’ and explore the efficacy of the unreal world of their ‘perfect markets’.

Generations of students have been taught free market economics subsequently, but few have been told the exact nature of the sham it represents. The American population at large has been persuaded that markets work magically in ways that other forces – usually the government – cannot. Somehow the market achieved mythical status, and to attack it was to expose your ignorance or lack of sophistication.

And always Wall Street and its heroic denizens, those multi-millionaire whiz kids and their super suave managers, were held up as the epitome of the truths embodied in free market economics.

Well no more.

They are incompetent fools with very limited ability and even more limited ethical standards. They may make fortunes, but they make those fortunes by rigging and twisting the market not because they inhabit or understand the market’s magical forces.

There never were any magical forces.

It was all an illusion.

An illusion inside people like Hayek’s and Friedman’s minds. An illusion they forced into existence in order to justify their political views rather than to provide a scientific explanation of reality.

The big banks would not make a penny were it not for our subsidy of them. None of them. Not Goldman, not Citi, not JP Morgan Chase, not Wells Fargo, not Morgan Stanley, and not Bank of America. They all rely on us, and in particular our guarantee that they will not fail.

Don’t believe the hype: none of these organizations is well run or sophisticated. They are all a sham. They would all crumble back to a much more humble level were it not for our constant support.

The sad part, the truly sad part, is that most of them don’t realize the mockery they have made, not just of decades of economic theory – that is way too abstract for them anyway – but of themselves.

They have become a caricature. Like the grotesque figures of Hogarth’s satires, they are exposed as deluded, corrupt, and venal. They are cartoons to laugh at as they continue their incompetent ways.

Even worse, they continue. And this is, perhaps the biggest mockery of all: their ability to continue and make fortunes as they wallow in blissful ignorance, safe in the knowledge that we will bail them all out again, mocks our intelligence. It is a slight to all those who try to do the right thing, or who try to work honestly. It is an insult to those who seek to learn and apply knowledge diligently in the hope of a fair reward. And it is a total mockery of the notion that the American economy rewards those with the most merit or those who work the hardest. they are the exact opposite of the story book reward for hard work. They are being rewarded despite their continuing incompetence.

Wall Street, as we now know it, is a ship of fools.

They mock us. They mock economics. They mock themselves.

Truly: they made a mockery of it all.

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