Former Fed Chair Paul Volcker (appointed by Jimmy Carter and reluctantly reappointed by Ronald Reagan) is the person most responsible for a horrible recession in the 1980s that put to bed our high rates of inflation. My first house loan in 1980 was for a whopping 16.8% at the time. I was also getting raises twice a year that usually fell somewhere between 15-20% (yes, in banking). It was a whole different world back then.
Volcker is an imposing man both intellectually and in appearance. He towers over nearly every one in a room. He also has the ear of President Obama who placed him in charge of the analysis and planning for policy to rid the country of the systemic risk that characterizes our financial system today. The Glass-Steagall Act (GSA) of 1933 set the regime for the post-depression banking system. The Gramm-Leach Bliley Act (GLBA) of 1999-2001 removed that regime. The Volcker Rule seeks to remove the excesses of the GLBA. It is not quite GSA, but its goal is to return to separation of commercial banking from investment banking and hedge fund speculation, tighter capital controls, and a less concentrated industry.
The first details of Volcker’s suggestions are being made public. The Banker Pinata picture came from The Economist which is running a series of articles on The Volcker Rule. Right now, they’re interested in the Wall Street Reaction. I also woke up to an Op-Ed in the NYT by the man himself on How to Reform Our Financial System. Dodd is already showing signs of caving to the FIRE Lobby and is considering removing some of the language and the agency that would most protect consumers. This doesn’t surprise me because I expect him to be in the FIRE lobby by a year from now and he’s undoubtedly already beefing up his post-Senate credentials. We’ve seen Obama’s leadership method which is basically to give the right wing everything they want without doing a thing. He retreats at the mention of challenge. Volcker will not retreat. However, he’s in the process but outside the system so how truly effective can he be?
Volcker’s op ed is a concise call to action to stop the excesses of regulation capture, monopoly formation, and extraordinary profits and bonuses that resulted from the removal of transparency and oversight.
A large concern is the residue of moral hazard from the extensive and successful efforts of central banks and governments to rescue large failing and potentially failing financial institutions. The long-established “safety net” undergirding the stability of commercial banks — deposit insurance and lender of last resort facilities — has been both reinforced and extended in a series of ad hoc decisions to support investment banks, mortgage providers and the world’s largest insurance company. In the process, managements, creditors and to some extent stockholders of these non-banks have been protected.
The phrase “too big to fail” has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.
As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.
There are substantial differences–and I’ve said this a million times in this forum–between the roles of commercial banks and the roles of investment banks in a modern economy. Commercial banking should be boring and operate on a very slim margin. It consists of pooling the funds of households and businesses and placing them into loans for mundane things like inventory and cars. Just because the government now insures those deposits doesn’t mean the banks should be allowed to gamble with them. If you want to play high stakes financial engineer, got to an investment bank and go to one that doesn’t have an implicit guarantee not to fail when you screw up royally which you eventually will because the role of randomness in the financial markets is huge. You’ll get more of a sure thing in Las Vegas where the population of cards and the distribution of aces, tens, and sevens is known. The Volcker rule recognizes and respects these differences. It codifies it once more in a way not unlike the GSA but not exactly the same.
The article referenced from The Economist is the one that looks at the banks’ reaction and it is as expected. I lifted the table for your reference and the article describing the political dance around the Volcker law is referenced within the quote. (I have to tell you, there is a lot I would give up before I gave up my subscription to The Economist.) You can see exactly who the vampire squid in the room is in the graph. No wonder they own the Treasury and the White House lock, stock and FIRE bought barrel.
Though widely characterised as a return to the Glass-Steagall act, the plan falls far short of the Depression-era law that separated commercial banking and investment banking (and was repealed in 1999). Banks can continue to offer investment-banking services to clients, such as underwriting securities and making markets. The plan’s aim, say officials, is narrow: to stop Wall Street from gambling in capital markets with subsidised deposits.
The timing of the proposal—two days after Mr Obama’s party suffered a thumping Senate-election loss in Massachusetts—looks nakedly political. But it was not dreamed up overnight. Last year the president’s economic lieutenants had seemed content to shackle the banks with tougher regulation and higher capital ratios, rather than limiting their activities. In recent months, though, they warmed to the ideas of Paul Volcker, a former chairman of the Federal Reserve, who was advocating more drastic action—and after whom the new rule is named (see article).
Banks have been scrambling to estimate the potential damage. Despite the lack of detail, for most the impact looks manageable. Officials admit that new limits on non-deposit funding are designed to prevent further growth rather than to force firms to shrink. Banks were already scaling back their proprietary-trading activity sharply as a result of the crisis: some say its contribution to revenue has fallen by more than half in the past three years. Prop trading now typically accounts for a mere percentage point or two of firms’ revenues (see table)—if it is defined narrowly to exclude risk-taking related to client business. Drawing a line between the two will be horribly difficult, but that will be the regulators’ problem.
This article from the Economist on Obama’s Economic Team goes more into depth about the relative coziness of Geithner and Summers to the Wall Street Bonus class and the one thing Obama can ride back to above 50%: hatred of bankers. There may be a growing disconnect here that bodes well for the Volcker Rule. While it’s unlikely we’ll see capped bonuses, it is possible for a rework of the GSA and the so called firewall in a less intense sense. Oddly enough, Biden is a friend of Volcker’s and is playing a role in pushing the spine-challenged Obama in the direction of the Volcker Rule. There are some really odd political dynamics to this game.
I know how hard it is to get folks interested in economics and finance as I’ve now chosen this as my occupation rather than sitting inside these institutions doing the strategic planning and the overall asset-liability alignment that I used to do back in the days when my house loan was nearly 17% instead of the 7% I’ve got today. I have no idea why I find it a fascinating game of detective. Perhaps it’s something I inherited from my central banker grandfather. Perhaps it’s just one of the many quirks I’ve developed over the years. I do know, however, that now is not the time for you to go all glassy-eyed over complex derivatives. What this suggests is a way to make commercial banking boring again so that almost any one could do it and still have time for that ABA game of golf on a Wednesday afternoon.
Watch what happens to the proposed Volcker Rule. It could very well be the difference between real change and chump change. Lobby your senator and congressman because you know the FIRE lobby will be doing so vigorously and with a lot more money than you and I will ever have.
I frequently listen to the Reading radio for the Blind and Print Handicapped station here in Southeastern Louisiana(WRBH88.3 FM) on my way home from work. I had the absolute pleasure yesterday to listen to an article on the FIRE lobby and the huge amount of power it wields in the beltway from the last issue of Mother Jones. I did a little Google research on the topic since both the Davos World Economic Forum and the meaningless rhetoric delivered last night in the last SOTU have some hint of a call for financial market regulation. Of course, you know, as an ex banker, ex central banker, and a financial economist, I’ve got more than a passing interest in what used to be the boring little business of taking in small savings accounts and making loans for houses, businesses, and cars. It used to be funding the American dream. Since the 1980s, they’ve been financial engineering an American nightmare and making a tidy profit to do so. It’s just one big game of passing the trash to a higher bidder in a fixed game of who can leverage themselves into the highest arbitrage profits by creating false momentum now.
The chart here (you know me and my love of nifty graphs) shows a most interesting modern trend that fits in easily with the time line when politicians and regulators completely left financial institutions to police themselves. You can also see the 2008 crash and the current return to business-as-usual for extraordinary profits of Financial Institutions vs. the rest of the industries in the U.S. economy. Lenin would love this. It shows a complete siphoning of money from everything else to banks. It also shows that they damn near brought the U.S. and global economy to their knees and they’re happily doing it again. Now, this graph is from the Financial Times. As usual, I have to go to European sources these days to find worthwhile journalism. The numbers themselves and the analysis actually comes from the Deutsche Bank. The graph was first introduced in an article back in 2008 but was just recently updated. The bottom line of the analysis (based on the statistical technique called mean reversion or regression toward the mean) was astounding then but is appalling now given everything we’ve been suffering.
The US Financial sector has made around 1.2 Trillion ($1,200bn) of “excess” profits in the last decade relative to nominal GDP.
So mean reversion would suggest that $1.2 trillion of profits need to be wiped out before the US financial sector can be cleansed of the excesses of the last decade.
Basically, the article concluded that the banks were getting extraordinary profits on a historical basis starting around 1991 up until the financial crisis. It’s particularly interesting because it compares banking profits to profits from doing business in any other industry. They were unique. They made money like successful bandits and thieves.
So that article concluded that perhaps we’d seen the correction needed to bring the financial institution profits back to their historical trend. No such luck. The new graph just shows they’ve been able to go right back at it again. So, why should we believe that the incredible amount of leverage and risk-taking it took to create this giant bubble of profits isn’t going to repeat itself? At the moment, nothing really, because we’ve yet to see the changes in legislation that we need to remove the sources of systemic risk. These essentially are the risk from market concentration (i.e. several players going under brings down the entire industry because the top 10 players or so make up the majority of the market) and from being able to leverage themselves beyond reason (i.e. removal of strict capital requirements in the early 2000s) and also there’s the fact nearly all of them are out there running giant speculative hedge funds; even the ones with fiduciary responsibility. The only difference now is that they are using tax payer funds and low interest money compliments of the Federal Reserve Bank.
So this brings me back to the series of articles in Mother Jones and rent seeking. There was a concerted effort on the part of the FIRE lobby (financial institutions and real estate) to ease their way out of strict regulations that resulted from the last time they brought the U.S. and world economy to a grinding halt. That would be, of course, the period of the Great Depression. That is also where their rent-seeking activities paid off handsomely in the profits generated as illustrated by that nifty graph. That’s a terrific ROE illustrated up there in that graph. The U.S. Congress, the SEC and the FED, Fannie and Freddie and the lot of politicians who write state and local banking laws were very good investments.
I listened to Kevin Drum’s “Capital City” read aloud and was appalled at the flagrant examples influence peddling. He takes the story of the crash of 2008 and puts it purely into the world of political lobbying and investing in politicians. I’m now convinced nothing will really change until we rid the world of Senators like Chuck Schumer. Chuck Schumer is on the top of my list. Thankfully, Dodd’s gone and Biden is carefully tucked into a job where he can do no real harm. Please read the article and be prepared to be appalled.
THIS STORY IS NOT ABOUT THE origins of 2008’s financial meltdown. You’ve probably read more than enough of those already. To make a long story short, it was a perfect storm. Reckless lending enabled a historic housing bubble; an overseas savings glut and an unprecedented Fed policy of easy money enabled skyrocketing debt; excessive leverage made the global banking system so fragile that it couldn’t withstand a tremor, let alone the Big One; the financial system squirreled away trainloads of risk via byzantine credit derivatives and other devices; and banks grew so towering and so interconnected that they became too big to be allowed to fail. With all that in place, it took only a small nudge to bring the entire house of cards crashing to the ground.
But that’s a story about finance and economics. This is a story about politics. It’s about how Congress and the president and the Federal Reserve were persuaded to let all this happen in the first place. In other words, it’s about the finance lobby—the people who, as Sen. Dick Durbin (D-Ill.) put it last April, even after nearly destroying the world are “still the most powerful lobby on Capitol Hill. And they frankly own the place.”
But it’s also about something even bigger. It’s about the way that lobby—with the eager support of a resurgent conservative movement and a handful of powerful backers—was able to fundamentally change the way we think about the world. Call it a virus. Call it a meme. Call it the power of a big idea. Whatever you call it, for three decades they had us convinced that the success of the financial sector should be measured not by how well it provides financial services to actual consumers and corporations, but by how effectively financial firms make money for themselves. It sounds crazy when you put it that way, but stripped to its bones, that’s what they pulled off.
Kevin Drum’s article is a must read for ANYONE that lives in the shadow of the U.S. financial industry. It is both a historical narrative as well as a cautionary tale. Much of our national treasure is no longer going to actually producing goods and services. (I had to laugh when I read the SOTU speech and the promise of the return to an export economy. What are we going to sell other than our natural resources and people?) The high rates of return are based on loan shark returns from things like overdraft protection and making arbitrage profits when big players with enough clout force small enough moves in market momentum–that when leveraged to incredible levels–create incredible bonuses and profits.
There are some high profile people–including Paul Volcker one of my personal heros–trying to prevent a repeat of this catastrophe. (See the Volcker Rule.) However, the depressing thing is that it appears that the FIRE lobby owns so much of the Congress and Executive Branch– and possibly SCOTUS given that damnable ruling last week–that it will be hard to pull them back to size. Perhaps the international community will be able to do it on a global basis and the Davos forum could lead to a new Basel Accord. That still leaves us here in the United States hopelessly indentured to the banking system.
Now, I could be a good researcher and run a really great little econometrics model specifying something to the effect like dollars spent on lobbying by FIRE = f(bank profits, decreased capital requirements, exotic unregulated derivatives, regulator capture, market concentration) and a huge amount of other variables that are basically not in the public interest but in the bankers’ interest but low and behold, I found one done by the IMF just recently released. Surprise, surprise–the primary investigators were WOMEN economists. Here’s a link to Lobbying and the Financial Crisis at VOX EU. Notice again, I’m having to go to European sources since the media industry here is financed by the US banking industry, they certainly don’t want their financiers to turn off their cash spigots and access to seasoned equity offers.
If regulatory action would have been an effective response to deteriorating lending standards, why didn’t the political process result in such an outcome? Questions about the political process, through which financial reforms are adopted, are very timely now that the US Congress is considering financial regulatory reform bills.
A recent study by Mian, Sufi and Trebbi (forthcoming) shows, for example, that constituent and special interests theories explain voting on key bills, such as the American Housing Rescue and Foreclosure Prevention Act of 2008 and the Emergency Economic Stabilization Act of 2008, that were passed as policy responses to the crisis.
A number of news articles have reported anecdotal evidence that, in the run up to the crisis, large financial institutions were strongly lobbying against certain proposed legal changes and prevented a tightening of regulations that might have contained reckless lending practices. For example, the Wall Street Journal reported on 31 December 2007 that Ameriquest Mortgage and Countrywide Financial spent millions of dollars in political donations, campaign contributions, and lobbying activities from 2002 through 2006 to defeat anti-predatory-lending legislation.
There has, however, been no careful statistical analysis backing claims that lobbying practices may have been related to lending standards. In a recent paper (Igan, Mishra and Tressel, 2009), we provide the first empirical analysis of the relationship between lobbying by US financial institutions and their lending behaviour in the run up to the crisis.
The striking picture is that financial institutions lobbying on specific issues related to mortgage lending and securitisation adopted significantly riskier mortgage lending strategies in the run-up to the crisis.
We considered three measures of ex-ante loan characteristics: the loan-to-income ratio of mortgages, the proportion of mortgages securitised, and the growth rate of loans originated. The loan-to-income ratio measures whether a borrower can afford repaying a loan; as mortgage payments increase in proportion of income, servicing the loan becomes more difficult, and the probability of default increases. Recourse to securitisation is often considered to weaken monitoring incentives; hence, a higher proportion of mortgages securitised can be associated with lower credit standards. Fast expansion of credit could be associated with low lending standards if, for example, competitive pressures compel lenders to loosen lending standards in order to preserve market shares.
We find that, between 2000 and 2006, the lenders that lobbied most intensively to prevent a tightening of laws and regulations related to mortgage lending also:
- originated mortgages with higher loan-to-income ratios,
- increased their recourse to securitisation more rapidly than other lenders, and
- had faster-growing mortgage-loan portfolios.
These findings suggest that lobbying by financial institutions was a factor contributing to the deterioration in credit quality and contributed to the build-up of risks prior to the crisis.
How does it feel to know that you’re an indentured servant and that all the businesses you work for or do business with are dependent on entirely legal group of thieves and extortionists?
GET YOUR MONEY out of BIG BANKS now. You’re helping to finance your own contract with the devil. They’re throttling democracy and making a huge buck off of it in the process. Try to primary and remove ANY politician who has been heavily financed by FIRE. Spread this message far and wide.
So the so-called conservatives are having their so-called freedom event with so-called commentators and news anchors from so-called news stations. It’s all a side show to the real problems of the country. It’s easy to misplace anger in an environment where misinformants rule the airwaves.
So, let me show you where the real theft is happening, in case you may have missed it.
First, the FDIC released yet another move towards creating a financial banking cartel. Another one bites the dust.
Corus Bank, National Association, Chicago, Illinois, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with MB Financial Bank, National Association, Chicago, Illinois, to assume all of the deposits of Corus Bank, N.A.
But you know there’s really nothing to see here at the NY Times: A Year After a Cataclysm, Little Change on Wall St. Much more important to focus on creeping socialism and taking our government back from imagined enemies.
One year after the collapse of Lehman Brothers, the surprise is not how much has changed in the financial industry, but how little.
Backstopped by huge federal guarantees, the biggest banks have restructured only around the edges. Employment in the industry has fallen just 8 percent since last September. Only a handful of big hedge funds have closed. Pay is already returning to precrash levels, topped by the 30,000 employees of Goldman Sachs, who are on track to earn an average of $700,000 this year. Nor are major pay cuts likely, according to a report last week from J.P. Morgan Securities. Executives at most big banks have kept their jobs. Financial stocks have soared since their winter lows.
No nothing to see here. Wait, a minute. Maybe we should listen to people with some expertise instead of Glenn Beck or Rush Limbaugh who couldn’t even get one college degree or a freshman’s worth of credits between them . Maybe we shouldn’t focus on sycophants like Chris Matthews or Keith Olbermann who just want to hear themselves talk and hump each others legs until they tingle.
In fact, though, regulators and lawmakers have spent most of the last year trying to save the financial industry, rather than transform it. In the short run, their efforts have succeeded. Citigroup and other wounded banks have avoided bankruptcy, and the economy has sidestepped a depression. But the same investors and economists who predicted, and in some cases profited from, the collapse last fall say the rescue has come at an extraordinary cost. They warn that if the industry’s systemic risks are not addressed, they could cause an even bigger crisis — in years, not decades. Next time, they say, the credit of the United States government may be at risk.
Yup, what have we been talking about here for month after month after month, while we get named called every imaginable insult from one end of the political spectrum to another. I must defy definition if one day I can be called a racist republican ratfucker then be called a greenie and a leftie the next.
Oh, meanwhile …
If the U.S. economy was a patient, I’m sure we all would be talking medical malpractice by now. After having 8 years of nothing to lecture on during the Clinton years other than, yes Keynesian economics works, we are now on our 9th year of wtf? (Feel sorry for my poor undergrads.) We’re still dealing with the spinning of the complete failure of Voodoo Economics, Trickle-down economics, Reaganomics or Supply Side economics from the free spending, tax dollar giveaway as success story with no real point other than supporting faith based economic hypotheses and the rights of the ultrarich to stay that way in to something it was not. I simply cannot believe that any REAL democratic administration with some roots in the Clinton years could possibly be choosing to continue the failed policies of the right.
So, since I’ve been on a populist rant over Wall Street Bonuses, let me just fuel the fire some more with this little piece in the Washington Post website today with the unsurprising title “Bailout Overseer Says Banks Misused TARP Funds”. No kidding cupcake. Why do you suppose the same risk happy folks that got their bonuses last year are getting big ones this year? We might as well funded a national road trip to Vegas.
Many of the banks that got federal aid to support increased lending have instead used some of the money to make investments, repay debts or buy other banks, according to a new report from the special inspector general overseeing the government’s financial rescue program.
The report, which will be published Monday, surveyed 360 banks that got money through the end of January and found that 110 had invested at least some of it, that 52 had repaid debts and that 15 had used funds to buy other banks.
So, we’re basically funding a real time game of monopoly. Okay, Republicans, let me just explain this to you ONE more time. MONOPOLY is the antithesis of market capitalism. It isn’t Socialism. Socialism is NOT an economic concept any more than GOD is a Buddhist one. It’s the difference between, I buy houses in Houston and I buy All the houses in Houston. We actually prove markets are efficiently working by comparing competitive markets to centrally planned ones and find the same result when they are. However, that’s IFF (if and only if) things in both circumstances are perfect (which they NEVER are). We live in a land of frictions and 30 years of research shows that we’ve just about got as much chance of having the Pure Capitalist dream as we do the Pure Marxist dream. Zip, Zilch, nada, no way! Our lives our lived in imperfect markets where government sometimes steps in to make things worse, and some times steps in to make things better. We’re basically in the search for the middle path.
Right now, we’re funding and sustaining a financial market structure that perpetuates extraordinary profits for the capital owners, less products available to the market, and higher prices for every one. It is also well-researched that bigger institutions do not bring efficiencies of scale to the market so how is this a good thing? Just pick up any basic microeconomics book and study market structures. The bottom line is a welfare loss for the market as resources will be inefficiently used, quantities will be reduced, prices will be higher, and the demand side of the market will experience a loss of welfare. (Sorry, I keep having to remind myself I have the summer away from theory, but I’m an old dog and that’s a new trick for me.) The empirics on this have supported these theories for hundreds of years!