Posts Tagged ‘too big to fail’

Knights Who Say…

October 19, 2009

Since the scariest part of the financial crisis abated — without any meaningful reform happening, I might add — we don’t hear much about the banks, anymore; therefore, there hasn’t been a new Knight since July.  Here’s a good one, though.

Over the weekend, former Fed chairman and supposed “Maestro” of the financial system Alan Greenspan caught up with me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, Kwak, Marshall, Wolf, A New Way Forward, and the Wall Street Journal:

If they’re too big to fail, they’re too big.

Took you long enough, Al, but welcome to the club.

Know what this means?  Every living Fed chairman says too big to fail means too big. All of them.  Even the current one.  All the way back to the Carter administration’s first appointee, William Miller, who died 3 years ago.

Every single person who’s been responsible for running our entire banking system over the past 30 years says the banks have to be downsized; there cannot be a financial institution that’s “too big to fail.”

Not that what I think makes any difference, but it seems to me a thing like that ought to set the media and the policymakers on their ear.

Knights Who Say…

July 16, 2009

Some of the Knights have made the news again, lately.

First, there’s the Wall Street Journal, which proposed taxing big banks for their bigness.  Then, FDIC honcho Sheila Bair and Fed potentate Ben “Boom-Boom” Bernanke came out with a proposal to do just that.

You probably thought “too big to fail” was dead.  Oh, no.  Heavens, no.

Too Big to Fail: rex quondam, rexque futurus.

Knights Who Say…

June 19, 2009

Paul Krugman, sadly, declines to join me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, Kwak, Marshall, Wolf, A New Way Forward, and the Wall Street Journal.  He says preventing banks from getting too big to fail just isn’t possible.

Knights Who Say…

May 28, 2009

Financial Times columnist Martin Wolf catches up with meBernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, Kwak, Marshall, A New Way Forward, and the Wall Street Journal.

Wolf, writing about the UK, says the financial sector has become a dangerously large piece of the nation’s economy, and must be shrunk.  It imposes too many negative externalities on the rest of society.  He offers an interesting conceptual framework for thinking about the problem:

So how should one manage a sector that produces such “bads”? The answer is: in the same way as any polluting activity.

Pollution is, in economic terms, exactly the same as taxpayer bailouts: a large negative externality; a cost created by an industry that isn’t borne by that industry, but instead imposed on someone or something outside.  As Wolf points out, if the financial sector’s negative externalities were internalized — that is, born by the financial sector that created them — the whole industry would probably be insolvent.

That puts us in a bind.  Nobody likes externalities.  They’re economically inefficient, distort  incentives, and are unjust.  When we find them, it’s best to fix them.  But we do need a financial sector of some kind, to move capital around efficiently; we don’t want them reduced to insolvency.

What do we do when we want to discourage pollution?  Yes, we write regulations and put regulatory agencies in place to enforce them, but gradually and inevitably, the regulators fall behind the regulatees and the externalities return.

What to do?

Well, often, we tax them.  If we can’t maintain a regulatory system that effectively limits the externalities, we put a tax in place to recover at least some of the social costs of those externalities.  A tax usually also has the effect of keeping the industry from getting very large.

And that’s what Wolf proposes for the financial sector.  A tax to recover the cost of their externalities, and to shrink the industry so that it can no longer create such enormous externalities in the first place.

No more too big to fail.

h/t Ezra Klein

Knights Who Say…

April 24, 2009

An update on a couple of the Knights.  First, Simon Johnson, who today testified before congress that the government should use modified anti-trust legislation to prevent banks from becoming too big to fail.  Sound familiar?  Go, Simon, go!

And Ezra Klein, in posting about Johnson’s testimony, made the argument even familiarer:

The basic principle, after all, should hold for both spheres. Antitrust law is concerned with the dangers that size poses to markets. It offers regulators a usable mechanism for breaking up corporations that grow too large and thus threaten continued competition — which is to say, threaten the market’s continued capacity to function. This crisis has taught us that size can endanger the very survival of the market through means that have nothing to do with noncompetitive behavior. But we’re still dealing with the problems that result from too much “bigness,” and that’s fundamentally the sort of problem that antitrust laws were designed to address.

I’ll just add, since I seem to be on something of a populist kick today: the bigger the bank, the smaller you and your money look to them.

Knights Who Say…

April 15, 2009

Stop the presses.  The Wall Street Journal editoral page — I repeat, the Wall Street Journal editorial page — catches up with me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, Kwak, Marshall, and A New Way Forward.  After taking Goldman Sachs to task for complaining about the wispy strings attached to its federal bailout money (I repeat, the Wall Street Journal editorial page), they end thus:

The larger issue going forward is whether Goldman is “too big to fail,” which means that everyone knows the feds will ride to the rescue if it gets into trouble again. Before Bear Stearns, investment banks were allowed to fail, a la Drexel Burnham. But after last autumn, no one will believe it. And Goldman will hardly mind if that’s what the marketplace believes, because such an implicit taxpayer guarantee will let it borrow more cheaply and thus make more money. Think Fannie Mae again. Even now on the taxpayer dime, Goldman is still trading on its own equity account — risky banking behavior.

The point is that Goldman and other banks can’t have it both ways. If they want taxpayers to save them, then they have to take fewer risks and become smaller. Either that, or we need a new financial resolution or bankruptcy process that lets these companies fail while protecting the larger banking system. We’re glad Goldman wants to flee Barney Frank’s embrace, but it’s still only half way back to the promised land of capitalism — which includes the freedom to fail.

The whole editorial is worth reading, as it does as good a job as I’ve seen of concisely demonstrating the flaws in the argument now being flaunted by the banks and many on the right that the banks are lining up to give back their bailout money because the gummint is so darn oppressive.

I need to dash out and get some teabags, but I have to catch my breath, first, though.  I mean, the Wall Street Journal?  What’s up with that?

Knights Who Say…

March 30, 2009

TPM’s Josh Marshall catches up with me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, Kwak, and A New Way Forward:

When do we downsize these banks? A key part of the crisis, perhaps the key part of the crisis is that these banks were so big that we could not let them endure the normal fate of failed businesses, which is to fail. So when do we break them up into more smaller entities? Yes, we’ve got our hands full now. But companies always fight being broken up. So it’ll be much harder if and when these companies struggle back to some level of health. So when does that happen?

Knights Who Say… (Twofer Edition)

March 27, 2009

James Kwak, highly respected economics blogger, catches up with me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, and A New Way Forward.  First he rues the fact, as I did, that the Obama administration seems fixated on the “to fail” part instead of the “too big” part:

Given the existence of “systemically important firms,” I agree they need careful regulation. But why does Geithner assume that they have to exist at all?

Then he provides a longish and quite detailed argument, including:

Clearly some financial institutions reached a level of scale and complexity where they simply could not even understand what they were doing, let alone manage their risks appropriately; they were too big, looked at just from their own perspective (and excluding the implicit Too Big To Fail subsidy). To this equation, we now need to add the social costs (negative externalities) of being Too Big To Fail: moral hazard, socialized losses, and so on . . .

When you are designing regulation, you have to bear in mind that the world will change. But this is another reason why simpler is better, and the simplest solution is simply to prevent firms from becoming Too Big To Fail in the first place. First, you have to expect that no matter how clever your regulatory scheme, some firms will be even more clever in finding ways to evade the system and blow themselves up. You are far better off if they are small when they blow up than if they are big.

And Sir Yglesias catches up with my analogy to anti-trust legislation.

And that’s why the Greeks invented hubris.

March 26, 2009

When VH1 does its nostalgia show for the decade of the Twentysies (which will cover the years 1998-2008, sorta like “the Sixties” actually means roughly 1967-1975), its theme will be hubris.  Lotsa people getting too big for their britches, thinking they know something nobody else knows, and that that knowledge means the normal rules don’t apply to them; in the end, they flame out, sometimes destroying themselves in the process, but always destroying lots of innocent by-standers.

It starts off in the late Clinton years, when Sen. Phil Gramm and a guy in the White House named Lawrence Summers (I wonder what ever happened to that dude . . . hmmmm) decided they and their Wall Street confreres suddenly understood America’s financial system better than anybody else ever had.  This special knowledge informed them that the usual rules didn’t apply anymore; that huge, multifarious financial institutions no longer presented a threat to the American economy, and the 70-year-old rules preventing banks and insurance companies from spreading into each others’ industries were no longer needed.  Pres. Clinton agreed, and bye-bye Glass-Steagall Act.

Next comes Enron.  That was basically a case of some guys who thought they had a deeper understanding of energy markets than anybody else.  Ever.  First they convinced their peers that their nonsense was real, but too complex for anybody but “the smartest guys in the room” to understand.  Next they used that social leverage to build a wall of secrecy around what they were doing.  And last they ran their company straight into the ground, in the process throwing hundreds of people out of work and causing rolling blackouts all up and down the West Coast.

The next example is Dick Cheney.  First he convinced himself that he and his inner circle were the only ones who really knew how the world worked, the only ones who really knew what Saddam Hussein was up to, the only ones who really understood what was necessary to interrogate terrorism suspects, the only ones who really knew how to keep the country safe.  Next he built a wall of secrecy around what he was doing.  And last he ran the country into the ground in Iraq.  He walks away with a limp, but for the rest of us it cost trillions of dollars, thousands of American lives, tens of thousands of Iraqi lives, millions of Iraqi refugees, and lost ground in our other war (the one where the people who attacked us actually are) and in America’s global influence.

Then there’s Karl Rove, another big fan of secrecy who thought he knew more than anybody else, thought he understood America better than anybody else, thought there was such a thing in America as a “permanent majority” and he knew how to build it.  That I-have-special-secret-knowledge attitude is how he drove his party into the ground.  As he famously said the night before the 2006 elections, all those polling companies had “their math,” but he had “THE math.”  Oops.  He walked away relatively unscathed, though with his reputation for brilliance diminished.  The rest of us have to deal with the mess he created — a fouled Justice Department and a two-party political system with only one functioning party.

Now, at the end of the Decade of Hubris (we hope), we have pretty much everybody in the financial industry, who all convinced themselves they alone had special insight into how securities markets worked, insight that seemed to lift the normal rules of supply and demand and no free lunches.  They’ve all made out like bandits, but pretty well sunk the rest of us.

That’s a nice bookend to the beginning of the Decade of Hubris, and . . . hey! there’s that Larry Summers guy in the White House again!  Seems he walked away unscathed.  So did Phil Gramm, who left the senate and became vice chairman of UBS, a huge Swiss bank.  He was in charge of . . . wait for it . . . lobbying the U.S. government on mortgage issues.  And, of course, Bill Clinton walked away from this unharmed, too, and now is worth millions.

So here are a few lessons I’ve learned from America’s last 10 years:

  1. If you find yourself thinking, “Nobody gets this but me,” you’re the one who doesn’t get it.
  2. Secret knowledge is not knowledge.  It’s cultivated ignorance.
  3. If you screw up, make it huge.  That way, everybody has to pay but you.
  4. Taking regulatory advice from Larry Summers or Phil Gramm is right up there with getting involved in a land war in Asia.  (A perfectly symmetrical irony, since a) Summers is Obama’s lead economic adviser and Gramm was John McCain’s; and b) we’re currently involved in 2 land wars in Asia.)

Knights Who Say…

March 21, 2009

The Knights are getting organized up in here.  The new political organization A New Way Forward has as one of its 3 central principles:

DECENTRALIZE: Banks must be broken up and sold back to the private market with new antitrust rules in place– new banks, managed by new people. Any bank that’s “too big to fail” means that it’s too big for a free market to function.

Preach it!  Your efforts are very welcome to me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Simon Johnson, and Sheila Bair.

(Their other 2 principles are almost as good: Nationalize and Reorganize.)