Other Voices – January 5, 2009

IMF study links lobbying by US banks to high-risk lending, guardian.co.uk (Jan 4). Three IMF economists conclude that extensive lobbying and political contributions by financial institutions were highly correlated with naughty behavior in the mortgage markets:

The paper, written by a trio of high-profile IMF economists, established that firms who spend more on buying access to politicians are more likely to engage in risky securitisation of their loan books, have faster-growing mortgage loan portfolios as well as poorer share performance and larger loan defaults.

The landmark paper will increase pressure on US politicians to regulate the mortgage industry, which Washington insiders say has so far been immune from meaningful financial reform in the aftermath of the bank crisis.

Highlighting 33 pieces of federal legislation that would have tamed predatory lending or introduced more responsible banking but were the target of intense lobbying, the IMF found that the efforts by banks to resist the legislation overwhelmingly succeeded.

"Our analysis suggests that the political influence of the financial industry can be a source of systemic risk," Deniz Igan, Prachi Mishra and Thierry Tressel wrote in their conclusion. "Therefore, it provides some support to the view that the prevention of future crises might require weakening political influence of the financial industry or closer monitoring of lobbying activities to understand better the incentives behind it."

More evidence from the archives of the Department for the Obvious Department on the capacity of directed influence and money to piss in the policy well. Is it time to reevaluate campaign contributions and directed lobbying as "protected speech" yet?

Fannie, Freddie, and the New Red and Blue, Matt Taibbi (Jan 4). The scourge of vampire squiditude and plutocracy everywhere sets his frame a little wider. In it, he comes to the conclusion, inter alia, that: 1) everyone was to blame for the financial crisis; 2) our entire socioeconomic system is endemically if not irretrievably corrupt; and 3) the mainstream media is incapable of interpreting these events and problems outside the lens of Red State–Blue State politics.

To me all of these people were equally guilty of making bad decisions to benefit themselves in the here and now at the expense of the whole in the future. When it comes to bubbles, It Takes a Village ...

My prediction? Taibbi will rapidly tire of a fight in which there are so many combatants—many of whom, unlike Goldman Sachs, will have no compunction about fighting back without restraint. He will retire to the country and write clever hatchet jobs about despicable people and institutions who, because they do not gaze back when you look in the mirror, are much easier and far more entertaining for his readers to hate.

“Wake Up, Gentlemen”

[This post originally appeared at The Baseline Scenario on December 15, 2009. It is reproduced here in its entirety with the kind permission of the author.]

The guiding myth underpinning the reconstruction of our dangerous banking system is: Financial innovation as-we-know-it is valuable and must be preserved. Anyone opposed to this approach is a populist, with or without a pitchfork.

Single-handedly, Paul Volcker has exploded this myth. Responding to a Wall Street insiders‘ Future of Finance “report“, he was quoted in the WSJ yesterday as saying: “Wake up gentlemen. I can only say that your response is inadequate.”

Volcker has three main points, with which we whole-heartedly agree:

1. “[Financial engineering] moves around the rents in the financial system, but not only this, as it seems to have vastly increased them.”
2. “I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy”

and most important:

3. “I am probably going to win in the end”.

Volcker wants tough constraints on banks and their activities, separating the payments system – which must be protected and therefore tightly regulated – from other “extraneous” functions, which includes trading and managing money.

This is entirely reasonable – although we can surely argue about details, including whether a very large “regulated” bank would be able to escape the limits placed on its behavior and whether a very large “trading” bank could (without running the payments system) still cause massive damage.

But how can Mr. Volcker possibly prevail? Even President Obama was reduced, yesterday, to asking the banks nicely to lend more to small business – against which Jamie Dimon will presumably respond that such firms either (a) are not creditworthy (so give us a subsidy if you want such loans) or (b) don’t want to borrow (so give them a subsidy). (Some of the bankers, it seems, didn’t even try hard to attend – they just called it in.)

The reason for Volcker’s confidence in his victory is simple - he is moving the consensus. It’s not radicals against reasonable bankers. It’s the dean of American banking, with a bigger and better reputation than any other economic policymaker alive – and with a lot of people at his back – saying, very simply: Enough.

He says it plainly, he increasingly says it publicly, and he now says it often. He waited, on the sidelines, for his moment. And this is it.

Paul Volcker wants to stop the financial system before it blows up again. And when he persuades you – and people like you – he will win. You can help – tell everyone you know to read what Paul Volcker is saying and to pass it on.

By Simon Johnson

Finreg I: Bank capital and original sin

[This post originally appeared at interfluidity on December 11, 2009. It is reproduced here in its entirety.]

I have always flattered myself that I would someday die either in prison or with a rope around my neck. So I was excited when The Epicurean Dealmaker invited me to write about financial regulation and crosspost at a site called The New Decembrists. But my views on the topic have grown both more vehement and more distant from the terms of the current debate (such as it is), and I'm having a hard time expressing myself. So I'll ask readers' indulgence, go slowly, and start from the beginning. This will be the first long post of a series.

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Banks are not financial intermediaries. Their role is not, as the storybooks pretend, to serve as a nexus between savers with capital and entrepreneurs in need of capital for economically valuable projects. Savers do transfer funds to banks, and banks do transfer funds to borrowers. But transfers of funds are related to the provision of capital like nightfall is related to lovemaking. Passion and moonlight are often found together, yes, and there are reasons for that. But the two are very distinct phenomena. They are connected more by coincidence than essence.

The essence of capital provision is bearing economic risk. The flow of funds is like the flow of urine: important, even essential, as one learns when the prostate malfunctions. But "liquidity", as they say, takes care of itself when the body is healthy. In financial arrangements, whenever capital is amply provided — whenever there is a party clearly both willing and able to bear the risks of an enterprise — there is no trouble getting cash from people who can be certain of its repayment. Always when people claim there is a dearth of "liquidity", they are really pointing to an absence of capital and expressing disagreement with potential funders about the risks of a venture. Before the Fed swooped in to provide, 2007-vintage CDOs were "illiquid" because the private parties asked to make markets in them or lend against them perceived those activities as horribly risky at the prices their owners desired. There was never an absence of money. There was an absence of willingness to bear risk, an absence of capital for very questionable projects.

No economic risk is borne by insured bank depositors. We have recently learned that very little economic risk is borne by the allegedly uninsured creditors of large banks, and even equityholders — preferred and common — have much of the risk of ownership blunted for them in a crisis by terrified governments. The vast, vast majority of bank capital is therefore provided by the state. Prior to last September, uninsured creditors of US banks were providing some capital. Though they relied upon and profited from a "too big to fail" option when buying bonds of megabanks, there was some uncertainty about whether the government would come ultimately come through. So creditors bore some risk. During the crisis, private creditors wanted out of bearing any of the risk of large banks. Banks were illiquid because private parties viewed them as very probably insolvent, and were unsure that the state would save them.

For Every Action ...

[This post originally appeared at The Epicurean Dealmaker on December 10, 2009. It is reproduced here in its entirety.]

Christopher Columbus: "Hello there, hello there. Heh, heh. Ahh ... We white men. Other side of ocean. My name ... Chris-to-pher Co-lum-bus."
Indian chief: "Oh? You over here on a Fulbright?"
Christopher Columbus: "Hah? Uh, no, no. I'm over here on an Isabella, as a matter of fact. Which reminds me: I wanna take a few of you guys back with me in the boat to prove I discovered you."
Indian chief: "What you mean, discover us? We discover you."
Christopher Columbus: "You discovered us?"
Indian chief: "Certainly. We discover you on beach here. Is all how you look at it."
Christopher Columbus: "Ah, I never thought of that."

— "Columbus Discovers America," Stan Freberg Presents the United States of America, Vol. 1: The Early Years

It looks like Alistair Darling is going to have a quiet Christmas.

The UK finance minister unveiled a nasty Christmas surprise for bankers in the City yesterday: a 50%, non-deductible tax on discretionary bonuses in excess of £25,000 (or $41,000), to be levied against their employers' net income. This scurrilous government attack against chalk stripe suits, Soho strip clubs, and London property values landed with a sickening thud in Old Blighty. Many a banker's wife summarily cancelled their holiday plans and started contacting real estate agents in Geneva.

Today, Nicolas Sarkozy of France had the unmitigated gall (Unmitigated Gaul?) to pile on with a parallel policy proposal for his country's budget and an editorial in The Wall Street Journal, co-authored with famously dyspeptic Scot Gordon Brown. The fact that France agrees with the UK and is proposing a similar policy is proof positive that either La Republique has been secretly taken over by a stunted Englishman pretending to be French or the UK's Labour government is so desperate to retain power that it's turning Gaullist. Probably both.

In any event, the policy—as do all new tax policies at the end of the day—has triggered a desperate surge of scurrying about by bankers and banks, as they attempt to discover ways out of the trap. Their prospects do not look good.

London contacts report senior investment bankers stacked three deep on the pavement outside advisory boutiques' offices this morning, banging on the custom paneled mahogany doors to get entrance for interviews. One Vice President remarked he hadn't seen that many bespoke suits in one place since he stumbled into Gieves and Hawkes' basement storeroom on Saville Row by mistake. I predict independent UK advisors will quintuple their headcount by Christmas.

Revolution and Reform

[This post originally appeared at The Baseline Scenario on December 7, 2009. It is reproduced here in its entirety with the kind permission of the author.]

Many of us bloggers are better at criticizing than at proposing anything — especially when the world makes it so easy to be a critic. The Epicurean Dealmaker, who has sent the occasional volley of criticism my way (I’m not linking to examples because my ego is too fragile), recently decided to deal with this head-on and wrote a “reformist manifesto,” complete with an epigraph from The Communist Manifesto, with a list of specific proposals.

Basically these include cleaning up the regulatory structure, expanding the scope of regulation (consumer protection, hedge funds), moving “virtually all” OTC derivatives onto exchanges or clearinghouses (I believe that “virtually all” means the currently-proposed exemption for “end-user” hedges would be drastically reduced), and increasing Fed transparency. There is also this one: “Ban political campaign contributions by the financial industry.” I think that would be great, although there is at least one constitutional problem and possibly two there.

There’s nothing on the list that I disagree with.

Cap This!

Lest we forget that the recent financial crisis has imposed real costs on the real economy, Simon Johnson of The Baseline Scenario reminds us, at length.

He claims that bailing out financial institutions considered too big or too connected to fail was the principal vector in the recent contagion, and he asserts we will have fixed nothing if we do not fix this:

9) At the heart of every crisis is a political problem – powerful people, and the firms they control, have gotten out of hand. Unless this is dealt with as part of the stabilization program, all the government has done is provide an unconditional bailout. That may be consistent with a short-term recovery, but it creates major problems for the sustainability of the recovery and for the medium-term. Again, this is the problem in the U.S. looking forward.

And in Europe, too, a point which Mr. Johnson makes as well.

His solution? Explicitly limit the size of financial institutions through the imposition of hard caps: