Self-deception is a remarkably useful form of mental disturbance. Calculated liars have to keep their stories straight, while the deluded are sincere and often unshakable in their misguided beliefs.
The Powers That Be insist that a magic bullet called a special resolution authority will solve many of the problems with the “heads I win, tails you lose” taxpayer backstopped financial system with inadequate oversight. The prospect of taking terminally sick banks out and shooting them will supposedly reintroduce moral hazard and make banks behave responsibly again.
The problem is that there isn’t much evidence to support this optimistic belief. Investment banks were seen as normal enterprises, at risk of bankruptcy, before the meltdown, yet that did not prevent Bear, Lehman, and Merrill from getting themselves into trouble that ultimately proved fatal. And the leaders of these enterprises did not take meaningful financial hits (oh yes, they were less rich than they would have been otherwise, but none of them is at risk of spending his waning years subsisting on dog food), a lesson surely not lost on other bank CEOs.
Then we have the wee problem that the idea of a special resolution authority looks not credible. We’ve harped more than once that as long as the firms crucial to debt markets remain deeply connected to each other, the idea that one can be taken out gracefully without impacting the others is a fairy tale. We’ll believe this comforting story only if we see measures to cut back counterparty exposures, most importantly in the repo and credit default swaps markets.
Bob Teitelman, editor of The Deal, gives a more detailed evisceration of the problems with the idea (I’m jealous that I didn’t write this myself):
The absence of resolution authority has become as handy an excuse for the mess as any, like the lack of a League of Nations after World War I…..Resolution authority, in short, is the Maltese Falcon of regulatory reform. What is this strange bird? Simply put (though nothing here is simple), it’s the legislative authority to wind down a financial firm. In fact, this definition is about as far as anyone ever gets on the subject….In its grandiose form (as if its normal form isn’t ambitious enough), the mere presence of resolution authority will scare the crap out of stockholders, creditors and counterparties and make them do their job, which is insuring that banks don’t go all suicidal, blow themselves up and force regulators to do their jobs….
But something about resolution authority feels too good to be true. Resolution authority is modeled after the Federal Deposit Insurance Corp.’s power to deal with failing banks. That’s fine, but when was the last time the FDIC tackled a promiscuously interconnected, global, highly leveraged giant? Given that we seem to have no idea how finance is wired, how can we be sure that we can halt contagion from spreading from a firm rotting faster than a day-old corpse?….Resolution authority might even trigger self-fulfilling prophecies — setting off an early scramble for the exits, while regulators are still watching the feature. And what about overseas assets?….
Who believes that if Goldman, Sachs & Co. was flaming out, the feds would not flinch? Answer: no one with a measurable IQ. Resolution authority resembles proactive bubble defense: The optimal time to use it is before the anticipated corpse turns blue. But if Paulson had shuttered Lehman right after Bear collapsed, would he be praised, pilloried or prosecuted like a dog? Lehman would have howled, Congress would have whined, so try door No. 3. Resolution authority demands, well, resolution in the face of a spitting mob. And yeah, money; no free lunch here. To make it fly requires a hero — Volcker played that role once on inflation — willing to lose everything. Alas, such lunatics are rare, making resolution authority just a dusty prop from an old movie.
Yves here. Aside from pointing out the obvious, glaring operational issues, Teitelman points out that there is a massive political problem: for resolution authority to prevent contagion, the sick financial firm probably has to be taken out and shot relatively early. Look how quickly Bear went into a death spiral, a mere ten days. Paulson, who was famously aggressive (like it or not, it did take nerve to put Fannie and Freddie into conservatorship) stepped back on Lehman (this seems to have been in part collective frustration of the officialdom team when the Barclays rescue was blocked by the FSA, of having not been prepared for that deal to fail, but it was also clear at the time that Lehman was not going to be rescued, that the bad press on Bear meant the next firm that foundered would not be helped).
Remarkably, the often-sound Epicurean Dealmaker defends the fantasy resolution authority. And his choice of metaphor undermines his argument. He uses both a “break glass” emergency image and the same expression in the article. Surely he must recall the Neal Kashkari “break the glass” memo mentioned in Sorkin’s Too Big Too Fail. It was well received by the higher-ups and was totally useless in practice.
ED offers two defenses, that the vagueness give regulators flexibility and discretion. Ahem, regulators always have those available to them. And the powers that be had that in spades during the crisis. They went around and did rescues that were widely criticized for their inconsistency and ad-hoc-ness. Why were Bear’s shareholders given anything at all? Why were WaMu’s sub bond holders crammed down (and worse, as John Hempton bitterly argues, a bank that he believes was not insolvent taken out and shot?). In fact, that very “flexibilty” meant that the authorities seemed to be constantly overcorrecting in response to whatever criticism they had gotten on their most recent salvage operation.
“Flexibility and discretion” is merely putting a happy face on “we’re going to have to improvise our way through this one yet again.” Now a certain amount of improvisation is necessary (an old saying has it that no plan survives first contact with the enemy). But for an completely untested and untrusted regime, the authorities need to convey the ground rules and key mechanisms in advance, both to prepare investors and counterparties, and more important, to debug the plan on paper as much as possible in advance.
Another ED argument in favor of flexibility amounts to, “markets evolve too quickly, you can’t really plan.” I don’t buy that in the strong form version he presents. The Bank of England prepares a Financial Stability Report twice a year, and it very clearly identified the dangers that large complex financial institutions posed pre crisis, as well as the risks posed by key markets. Unfortunately, that analysis did not translate into the kind of preventive measures that might have been warranted (but the UK also has the problem of large domestic banks with large international exposures, which means that many of the risks were beyond the authorities’ ability to contain). This means that regulators need to be vigilant about the evolution of markets, monitor exposures aggressively, and update emergency plans frequently (at least annually, and in a fundamental rather than superficial manner).
Or it points to another approach. I am very skeptical that the financial system can be made less dangerous and costly to society as a whole absent root and branch reform, which means much more aggressive oversight, with the objective of regulating activities that are critical to advanced capitalist economies (namely, the credit markets infrastructure) like utilities (I discuss how to go about doing that longer-form in ECONNED). We clearly lack the political will to do so now. In the meantime we will be subjected to various reform proposals which leave the system which has enabled the financiers to loot taxpayers on an unheard-of scale intact.
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It’s obvious that anyone who really wanted to solve these problems would advocate breaking up the rackets now, and turning whatever financial activities really were necessary into utilities.
It’s long been obvious that “resolution authority” is just another misdirection scam run by those who don’t want a real solution.
They already have resolution authority, and indeed a mandate, under the PCA law. It went right out the window. Meanwhile, as Yves said, their supposed exposure to capitalist reality didn’t prevent the investment banks from behaving recklessly, nor did it prevent GS and MS from being made permanent wards of the state. They all assumed they’d be bailed out. Eveyone will always assume that.
So that right there proves no pre-existing structure of understanding and legality will hold up when the crisis hits. Nor would any ever do so in the future.
Any prefabricated resolution authority would simply be a “social myth” to fool the gullible. Then in the crisis they’d improvise whatever disaster capitalist bailout was most beneficial to the banks.
And if the justification is supposed to be, in defiance of all reality, “THIS time they’ll take it seriously, THIS time they’ll abide by it”, the refutation of that is that if the government were truly serious about resolution authority, it would be serious about pre-emptively dismantling the rackets and turning the remains into utilities.
(It also couldn’t work on a practical level anyway. I think this piece has previously been linked at Nak Cap:
http://www.creditslips.org/creditslips/2009/10/toobigtofail-resolution-why-one-size-cant-fit-all.html )
The basic rule is always the same: If it’s politically possible to enact “regulation” which would truly be enforced, then it’s politically possible to enact the real structural changes necessary to permanently solve the problem.
If the latter isn’t possible, then neither is the former. The enemy will always fight any significant level of public interest change just as hard. So there’s never any reason to demand anything less than the full reformation, and never any reason, other than cowardice or betrayal, to lower one’s demands.
This past year that’s been proven true with health insurance “reform”, finance “reform”, greenhouse gas “reform”. It will always be true for as long as this system exists.
“If the latter isn’t possible, then neither is the former. The enemy will always fight any significant level of public interest change just as hard. So there’s never any reason to demand anything less than the full reformation, and never any reason, other than cowardice or betrayal, to lower one’s demands.”
Good comment if you mean ‘full reformation’ of the system in total, anything else is a waste of time. A systemic problem (as you point out its not limited to finance) requires a systemic solution.
Deception is the strongest political force on the planet.
It sure does, and I do.
► “Who believes that if Goldman, Sachs & Co. was flaming out, the feds would not flinch? Answer: no one with a measurable IQ.”
Well that leaves out about 90% of economists and 95% of politicians. Right?
Well actually no. The reality is that it’s just so profitable to be stupid.
Yep. Economists and politicians are dumb all right. Dumb like a fox!
► “I am very skeptical that the financial system can be made less dangerous and costly to society as a whole absent root and branch reform, which means much more aggressive oversight, with the objective of regulating activities that are critical to advanced capitalist economies (namely, the credit markets infrastructure) like utilities (I discuss how to go about doing that longer-form in ECONNED). We clearly lack the political will to do so now. In the meantime we will be subjected to various reform proposals which leave the system which has enabled the financiers to loot taxpayers on an unheard-of scale intact.”
This same pattern has played out time and time again in Latin America. These guys come to loot the place, not save it. Being “made less dangerous” isn’t even on the program.
Crises are used to impose succesively purer forms of neoliberalism, until the whole thing comes crashing down upon itself. We’re talking social chaos here.
Americans think they’re smarter than the average bear. They, after all, couldn’t be like those brown people, could they?
It’s this sort of arrogance that precludes them from learning from the experiences of others, and enables the looting and plunder.
DS says — “Well actually no. The reality is that it’s just so profitable to be stupid.”
Playing stupid, deflecting with complexity, blaming the other guy, looking the other way, good cop bad cop demonizing, etc. — the whole gamut of burden shifting bullshit — has been taken to a new level by the present ruling elite neo-con inspired regime. Scamericans, believing their own insipid propaganda of supremacy, are not fully on to the depth of the new, fast building now, societal structure that is being imposed on them.
It HAS BEEN profitable in the past, in the old VANILLA GREED game, for scamericans to use those deceptive burden shifting deceptions to insure one’s individual crumb supply as the rest of the world took the hit of exploitation. But the newer, neo-con inspired, PERNICIOUS GREED, now has a new role for the scamerican public, indeed the entire global middle class and its management overseers. That new role is to be a participant in the intentionally created, devastatingly divisive, ‘perpetual conflict’ in the lower ruled class of a simple two tier ruler and ruled world.
The new societal structure worships control over profit. You will no longer get profits, and, stripped of your resources and crumb supply, you will be self controlled and eliminated, at very small cost to the ruling elite, by virtue of participating in the dog eat dog perpetual conflict at the bottom.
And all of you old vanilla greed bankers who think you are in just another down turn and will come out of this on the other side are grossly mistaken. Your red ink will match the blood in your streets and the blood will be yours. Unless of course you suddenly wake up and see clearly how the neo-con inspired wealthy ruling elite are so slickly fucking you up the ass and eliminating you from the picture.
No balls! No brains! No freedom!
Deception is the strongest political force on the planet.
I’m very much in agreement with your sentiment. It is also my opinion that being a politician as a career choice reveals a venal propensity that needs to be throttled.
I’m struck by the fact that we do have a resolution process, it’s called the bankruptcy court. That process, however, is deemed to be inadequate to the task of restructuring a large number of institutions, several of whom are ‘primary dealer’ banks. Similarly, the Swedish solution is considered unworkable because . . . well, because this isn’t Sweden. I consider those arguments to be out of hand. You have a mess, and now you want to clean it up; BUT, the clean-up can’t be messy?
Paulson’s mea culpa relies on the premise that he didn’t have the authority to act. Geithner joins in that assertion and apparently so does Summers. Curious in deed that. So, lets reenforce our collective mea culpa and call for a new resolution authority. That will surely create a dust up and when the dust finally settles and everyone stops sneezing, will the body politic remember why it all began? Worse, will the body politic care?
Head fake? Hell, it’s a conspiracy by default to preserve the status quo.
DS . . . Here is where we need one of your sets of citations to the point that it is the tendency of professional politicians to not seek office to serve; rather, their pursuit of election is for the purpose of acquiring power and power alone. Moreover, in that pursuit they willingly prostitute themselves to whoever will give them money in support of their quest for election.
You hit both of the points I noted. Goldman is just the most obvious manifestation of out of control casino capitalism. We can’t fix Goldman in isolation. The casino system is the problem. We would have to take it over and restructure it. The “We clearly lack the political will to do so now” is a little vague. Companies like Goldman are looting the system because they paid our political elites not to have such a political will. This was fairly easy to do because the lines between our various elites are blurred to the point of non-existence. It is more like our elites told themselves not to have the political will to act and they proceeded not to.
A view from Europe:
– The Dutch newspaper Volkskrant had an article about the American regulators ( whoever that is ) having come to take a look at the dual regulatory system in the Netherlands: AFM ( monitoring the financial markets ) and Nederlande Bank, the Central Bank, the article putting the emphasis
on collaboration between the two entities, post the DSB bankruptcy
– The British Tories intend to ‘cage’ the FSA within the
Bank of England, a line in the sand now pursued by Chris Dodd, for obvious reasons, corporate cunning shall we say,
neither the FED nor the Treasury having properly acted in
their regulatory statutory functions
– Curiously, as I consider the FSA to be doing a fairly good job except for not opening an investigation on the shady swap deals the London-based G.S.I conducted with Greece and, at least, another major European country-maybe the UK itself, which would explain why the lid remains closed-( in my recalling of Sorkin’s book, the denial of a Barclay bail-out comes more from Alistair Darling and above ) although from what I read, H.Paulson blames it on the British regulators, a story we will never get in its whole-though one remark: although Barclays was involved in early 2008 in a failed taking-over of ABN-AMRO, Barclays is about the only British bank not to have received ‘bailout funds’ and they got just what they wanted from Lehman post-bankruptcy..
They all assumed they’d be bailed out. Eveyone will always assume that.
They didn’t used to assume it before various measures (including some of the Depression-era banking reforms) attempted to remove the possibility of bank failures. The choices are really:
1.) The current debacle of private profits and public losses, OR
2.) Turn the banks into regulated utilities, probably still with some form of public guarantees, concentrate the task of overseeing the banking system into a single regulatory body, and hope the regulators never get captured or caught up in a new bull market again, OR
3.) Start letting failed banks actually go bankrupt again, until unsecured bondholders and equity holders get the message and start reining in out-of-control management again.
Personally I think 3.) is the only solution likely to be decently effective over the very long run. Even it will fail at times, but it will fail less spectacularly than 1.) and 2.)
I would also add trading counterparties and even secured depositors to the list of people who need to be expected to pay some attention to how risky their bank is again. Let people go reaching for yield in 5% Corus CDs or Icelandic banks, and suffer the consequences if it doesn’t work out.
The special resolution authority will be staffed with “former” Vampire Squid executives. You figure out what it will do.
Good point. All the laws and authority in the world won’t help if the regulators are industry lackeys. There is, unfortunately, no substitute for having good people at the Fed, Treasury, White House, etc. Insert standard rant about Bush, Obama, Paulson, Geithner, Bernanke, Summers, et al here, as the standard complaints are true. Banal means being consistently and obviously right.
‘attempter’ above channels William K. Black and mentions the PCA (Prompt Corrective Action) law, which has been on the books since the S&L crisis, and has been consistently ignored. What’s the matter, that law was for the old crisis, ignore it now? Laws are meaningless if they’re unenforced.
The financial services industry is laughing its way to the bank while TED, you and others write copious amounts of copy about this intractable subject. To rescue (aka bailout) any major private sector financial corporation now would be political suicide, apart from the fact that the US (and UK) economies simply couldn’t afford it. Meanwhile hundreds of billions of dollars are NOT being extracted by taxing the activities of the institutions that are the subject of such concern. Taxing derivatives (stamp duty) is very cheap to enact and collect relative to most forms of taxation. VAT which should also be introduced in the US will take much longer to introduce but is the only sane way forward to pay for future obligations. Devising such taxes would reveal all that regulators would need to know about what and how to regulate. Who does it seems to be further down the list to me. Dodging the tax revenue (or lack thereof) issue in order to talk endlessly about regulations is dumb in the extreme. But, as most politicians couldn’t run a piss-up in a brothel I guess they’ll try every other useless avenue before reality checks in.
Yves: “Why were WaMu’s sub bond holders crammed down (and worse, as John Hempton bitterly argues, a bank that he believes was not insolvent taken out and shot?).”
Yves or anyone else have insight (possibly links) about this allegation? I’ve heard it before but the versions I hear never seem very authoritative, just a lot of “he said, she said”. Shooting a sufficiently healthy bank is either a serious screwup and/or a serious abuse of power (depending on how conspiratorially one thinks about the JPM connection).
I know that most of my friends here in California were ready to stage personal runs on their WaMu accounts before it was seized. Generally not the hallmark of a strong, healthy, solvent bank.
The pressure put on the regulatory body/figure that actually pulls the trigger on the wind-down would be astonishing:
“Why would you destroy a company–a piece of America–and eliminate thousands hard-working Americans’ jobs and throw the market into chaos by attempting an unproven wind-down system?”
“It’s just a temporary liquidity issue caused by the greedy hedge funds shorting a strong corporation.”
“Why not just provide some short term government funds and let them get back to the business of serving mainstreet?”
“Shooting a sufficiently healthy bank”
Who precisely is defining sufficiently? Remember, Professor Black was personally threatened multiple times because he “shot” savings&loan organizations that were, at the time, perceived to be sufficiently healthy. Except, of course, they weren’t.
We’ve always had the power to do everything that “would have” forestalled the crisis.. except the US has never had regulators willing to actually exercise their authority pre-crisis. Again, aside from Prof Black, who IMHO should be chief-regulator-for-life in the US. But we can be sure that won’t happen — he’s competent.
There’s nothing wrong with TED’s position.. except that we need to find AND EMPOWER competent regulators who are willing to stand against the wind of Wall Street. You know what happened to the last one.. his name is Spitzer.
“ED offers two defenses, that the vagueness give regulators flexibility and discretion. Ahem, regulators always have those available to them. And the powers that be had that in spades during the crisis. They went around and did rescues that were widely criticized for their inconsistency and ad-hoc-ness. Why were Bear’s shareholders given anything at all? Why were WaMu’s sub bond holders crammed down (and worse, as John Hempton bitterly argues, a bank that he believes was not insolvent taken out and shot?).”
Sure you jest, Yves. Regulators didn’t have the authority to resolve non-bank financial institutions during the financial crisis. This is an indisputable fact.
Why were Bear’s shareholders not wiped out while WaMu’s sub bond holders were forced to take a haircut? Because Bear was an investment bank, for which regulators had no resolution authority, and WaMu was a thrift, for which regulators did have a resolution authority (i.e., the FDIC’s resolution authority). Done and done.
“Sure you jest, Yves. Regulators didn’t have the authority to resolve non-bank financial institutions during the financial crisis. This is an indisputable fact.”
I can’t see where Yves is disputing this indisputable fact.
“Why were Bear’s shareholders not wiped out while WaMu’s sub bond holders were forced to take a haircut? Because Bear was an investment bank, for which regulators had no resolution authority, and WaMu was a thrift, for which regulators did have a resolution authority (i.e., the FDIC’s resolution authority). Done and done.”
With Bear, JPM got such a soft deal on the Fed guarantees for Bear’s toxic assets ($27Bn IIRC) that they could afford to toss in a few extra bucks when the Bear shareholders jibbed at $2/share.
With WaMu, if you believe Hempton, and he is plausible, JPM got another soft deal (~$20Bn in capital). So between the two we are up to $47Bn of discretion.
The economic effect of that $47Bn seems to have ended up in JPM’s lap, irrespective of whether a resolution authority existed or not. At least that part’s consistent, eh?
EoC,
The issue here is latitude within existing frameworks. The FDIC has very clearly defined resolution authority and well established procedures, yet has discretion as to when/how they use it.
The resolution authority is not credible ex further specification of details. The worst is we have an exact parallel to Lehman: one firm is allowed to fail because it is politically necessary to do so (with presumably a better form of BK filing, but as Harvey Miller pointed out, even the failure of a mid-sized, strictly domestic broker-dealer has proven to be disruptive) with hugely disruptive consequences, others are bailed out in an ad- hoc fashion.
I don’t see why a rules-based resolution authority could not be fully operable if it provided that financial institutions’ long term debt and equity stood at risk in front of all other claimants, and financial institutions were required to maintain sufficient long term debt and equity. That would seem to deal with the interconnectedness problem (e.g., swaps, repos, overseas cash management). I raise this as a technical question, since having a truly operable resolution authority would seem to be a highly desirable component of any solution to the “too big/interconnected to fail” problem.
I don’t disagree. My main beef is the lack of specificity of any sort, this makes it look more like PR than anything that could be operational.
Yes, capture of the government by moneyed interests seems to be the root problem preventing reform. I suppose it will continue until the public insists on campaign finance changes.
Income and wealth inequality is the root cause of financial instability. Capital, and the need for capital must be balanced for an economy to function stably.
If the accumulation of capital exceeds the need for capital to fund growth, the taxes on wealth and capital gains must be increased, and taxes on consumption and consumer income decreased .
If consumer demand, and the attendant need for capital, outpace capital accumulation, the reverse is required. Taxes then should be shifted from wealth and capital gains to consumption and consumer income.
Over the past several decades capital accumulation has outpaced the demand for capital, largely due to reductions in top bracket tax rates and stagnation of middle class incomes. The discussion that follows shows what happens when this occurs.
Enterprises need capital to expand and take advantage of new opportunities. This allows economies to grow to accommodate increases in population and the attendant need for new jobs.
If too little capital is accumulated, growth will be curtailed. If the effect is severe enough, sufficient growth will not be achieved to accommodate population increases and the need for additional jobs, and the standard of living will fall.
If too much capital is accumulated, rates of return on capital drop. As rates of return drop, capitalists seek ways to improve them through the use of leverage or the use of techniques to increase the demand for credit.
If leverage is used, risk increases, necessitating even larger rates of return. This leads to a potentially unstable situation. So there is a limit to the amount of leverage that can be used.
As the limits of leverage are reached, investment banks and hedge funds will look for ways to stimulate demand for credit. This can be done by relaxing the standards for issuing credit, and compensating by using techniques that hide risk.
By collateralizing debt and issuing insurance on debt capitalists can be made to feel more comfortable with less secure investments. Debt issued with relaxed credit standards can be mixed with more secure debt making it harder for rating agencies to correctly assess risks. If regulation does not keep up with these measures, or decreases, the value of the collateralized assets and insurance instruments will be jeopardized.
Excess capital can also result in additional risky speculation. When returns on productive investments are low and approaching inflation levels, capitalists will be willing to take larger risks in short term speculation on valuable assets and commodities, causing prices to rise. In turn, the rise in prices creates an upward momentum in asset prices that attracts even more speculation. Such price bubbles tend to be self sustaining as more and more capitalists are willing to take advantage of the upward momentum in prices, until eventually that trend cannot be sustained and the bubbles burst.
All of these measures are driven by the need to increase returns on capital, when there is just too much capital for the real investment needs of the country. This is the situation that has developed over the last few decades largely because returns have been going more and more to capitalists while workers wages have stagnated. With stagnating wages, the demand for goods and services has not kept up with the accumulation of capital.
The stagnation of wages has been caused largely by shrinkage in the manufacturing sector, causing consumers to seek returns in the financial sector and to tap available credit to sustain consumption. This is evidenced by the excessive growth of the financial sector. At the same time, high income and capital gains tax rates have been reduced, accelerating the income and wealth gap between capitalists and middle class consumers. Election laws have allowed capitalists to be the primary funders of elections, allowing them access to politicians, who then water down laws regulating capital and reduce taxes on capital formation.
Unless taxes are shifted to wealth and capital gains from consumption and consumer incomes, this increasing spread in income and wealth will continue to cause instability and the kind of financial crises we are now experiencing.
Great post, Elwood, a sound rationale for transparent, purposeful economic planning toward sustained commonwealth and optimal wealth creation. Taxing unearned and ill-earned wealth is a good start. It sure beats the “invisible hand” rigging levers behind the black curtain. Thay have strangled the goose and it won’t lay those shiny yellow eggs anymore.
I, too, possess a pit-bull who will be the most tender animal I’ve ever owned. Quickly, a new dog breed will occur together for that media to blast, because they have done rotties and dobies in prior years. Unfortunate that media sensationalism breeds so much inaccurate details.
“I, too, possess a pit-bull who will be the most tender animal I’ve ever owned.”
Huh??
sorry, I I don’t get it