Banks Take Themselves Hostage

Yves Smith comments on the further weakening of banking regulation:

The notion that makes this guaranteed-to-continue-to-be-weak oversight OK is that the big banks will be permitted to fail. While that may be credible for some of the really big banks (Fifth Third, for instance, is large but not systemically important) any large capital markets player is an integral part of crucial debt market operations. Those large firms in turn are deeply enmeshed via counterparty relationships, most notably repos and credit default swaps. How, pray tell, do you shut down a trading firm in an orderly fashion? You can’t freeze positions, which is what you need to do in an unwind, and not create pain and inconvenience for the counterparties. Are we going to have a firm in default (presumably with emergency credit lines) continue trading? I haven’t heard a credible solution to this rather major conundrum from the officialdom.

There isn't a credible solution, and every time you hear a politician claim that the new regulations will allow for an orderly winding down of any of these institutions you should remember that. Unilateral regulations can never work in the age of globalization; it is essential that the G20 work together to come up with some method of dealing with cross-border resolution issues-as Simon Johnson has pointed out repeatedly, this just isn't going to happen anytime soon. And since it isn't, we need to break these big banks up, because if we don't we will have to bail them out in a couple years when they fail again, and it will only be worse next time.

Also, notice the perverse incentives created by this government guarantee. Fifth Third is not systemically important enough to get saved, therefore it probably won't. What does this tell the CEO of Fifth Third? If it's me, I'm going to get out there and try to make myself systemically important. I'm going to make my bank dangerous so that it won't be allowed to fail. I am essentially going to strap a bomb to my chest and walk around Wall Street daring taxpayers to let me fail.

These are not good incentives.

Simon Johnson On Goldman Bonuses

Simon Johnson says that Goldman will announce more massive bonuses soon:

For critics of the company and its fellow travelers, the timing could not be better.

He goes on to list some reasons why Goldman will go ahead and announce these bonuses, even as it gets more and more obvious how much it is angering the public who saved their asses. Here's reason number three:

The most important reason is also Goldman’s greatest weakness: throughout the organization, people really think they are worth the money.  But remember these facts and keep track of how many times you hear them repeated: Goldman Sachs essentially failed in September 2008; it was saved by extraordinary and unprecedented government efforts at the end of September and subsequently (particularly through its conversion to a bank holding company, which gave access to the Fed’s discount window); partly this treatment was shaped by the special favor with which Hank Paulson viewed Goldman (documented in nauseating detail in Andrew Ross Sorkin’s Too Big To Fail); and the strategy of allowing Goldman to recapitalize through taking huge risk with an unconditional government guarantee in 2009 only makes sense if they use the proceeds to boost their capital – not if they pay out massive bonuses.  In any reasonable economic analysis, the entire bonus pool at Goldman should be paid – with gracious thanks – to the government.

Read the rest of it to see why Johnson thinks this will never happen, and how these bonus announcements could become the rallying point for real reform in 2010. 


This will become big news right after the story about Geithner ordering AIG to cover up to the money trail blows up.

Innovation

Simon Johnson and James Kwaak have a great article at Democracy Journal. Choice quotes:

...The presumption should be that innovation in financial products is costly—it increases transaction costs, the cost of effective oversight, and the risk of unanticipated consequences—and should have to justify itself against those costs.

...

Though it is not often thought about in these terms, reforming health insurance—to make it universally accessible and stable in its premiums—would be another financial innovation that would accrue both social and economic benefits. Because individual households’ economic fortunes are volatile, insurance is one of their core financial needs. It is generally possible to buy adequate auto, home, and life insurance, but for most people true long-term health insurance is simply not available. While a majority of Americans get health insurance through their jobs, many would be unable to remain insured should they become unemployed. What they have is subsidized health care during their term of employment; they don’t have true insurance. While there are several ways to do it, making individual health care policies available to everyone (and not subject to an accident of fate like a layoff or divorce) would allow consumers to better plan their economic lives. There could be no better embodiment of positive financial innovation.