Banking on the Backroom Deal

While, GM’s bankruptcy and Chrysler’s emergence from bankruptcy grab front page headlines, yesterday’s banks with issues are positioning themselves at the table to discuss future financial regulation. This comes as some of the premier researchers in financial economics look for systemic solutions. As you know, I’m a huge advocate for finding new regulations that promote transparency of process and recognize the importance of fiduciary responsibility when the financial industry takes on risk. Harvard’s Oliver Hart and University of Chicago’s Luigi Zingales, both NBER researchers, have just produced A New Capital Regulation For Large Financial Institutions. I want to review some of their findings and suggestions in conjunction with two more mundane articles.

The first of these articles is an astounding piece on Alternet that finds information suggesting Larry Summers has been taking kickbacks from big troubled banks. Another article is in today’s NY Times that shows how the banks have been spending a good year–even as they took TARP funds and cheap money from them FED–girding for a fight on forthcoming regulations.

I would think that the big lesson from the last few years is this is not time to go back to business as usual. However, the mindset of those making major decisions in the White House (Treasury Secretary Geithner and CEA head Summers) is this is just a glitch and there’s no chance anything like this could happen again. In other words, we don’t need to look for systemic problems, we just need to send the patients home with some aspirin and they can call back in the morning. This aspirin prescription has been particularly expensive. It is either utterly naive or completely disingenuous to think that pouring money into financial institutions and waiting this out is going to prevent any future occurrence of financial meltdowns. We need to be prepared to offset what may be an elaborate hoax to convince that nothing really needs to change systematically and a major congressional influence- and administration influence- buying spree by the big banks. Even as we see Dow de-list Citibank, we see evidence that Citibank possibly manipulated its stress tests results through Summers.

If the Alternet article is correct, Summers should be in trouble and the trustworthiness of the large institutions should be questioned by a congressional committee. This sure looks like pay-to-play to me. (HT to Dr. BB for the link.) The post by Mark Ames is a must read.

Last month, a little-known company where Summers served on the board of directors received a $42 million investment from a group of investors, including three banks that Summers, Obama’s effective “economy czar,” has been doling out billions in bailout money to: Goldman Sachs, Citigroup, and Morgan Stanley. The banks invested into the small startup company, Revolution Money, right at the time when Summers was administering the “stress test” to these same banks.

A month after they invested in Summers’ former company, all three banks came out of the stress test much better than anyone expected — thanks to the fact that the banks themselves were allowed to help decide how bad their problems were (Citigroup “negotiated” down its financial hole from $35 billion to $5.5 billion.)

The fact that the banks invested in the company just a few months after Summers resigned suggests the appearance of corruption, because it suggests to other firms that if you hire Larry Summers onto your board, large banks will want to invest as a favor to a politically-connected director.

Last month, it was revealed that Summers, whom President Obama appointed to essentially run the economy from his perch in the National Economic Council, earned nearly $8 million in 2008 from Wall Street banks, some of which, like Goldman Sachs and Citigroup, were now receiving tens of billions of taxpayer funds from the same Larry Summers. It turns out now that those two banks have continued paying into Summers-related businesses.

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