Does anyone really believe this:
At an otherwise docile gathering Monday, New York Fed President William Dudley and Fed Gov. Daniel Tarullo delivered a message to high-ranking Wall Street executives that bad behavior won’t be tolerated. Dudley in particular said big financial institutions operate under a cloud of suspicion and have continued bad behavior even after suffering more than $100 billion in fines and triggering a multitrillion-dollar bailout after the financial crisis.
[…]
“In conclusion, if those of you here today as stewards of these large financial institutions do not do your part in pushing forcefully for change across the industry, then bad behavior will undoubtedly persist,” Dudley said. “If that were to occur, the inevitable conclusion will be reached that your firms are too big and complex to manage effectively. In that case, financial stability concerns would dictate that your firms need to be dramatically downsized and simplified so they can be managed effectively.”
The bankers at the big banks know, with a confidence rooted in experience, that in a crisis the Fed will bail them out. It doesn’t really matter what they do. If, on the other hand, we had nationalized, say, Bank of America five years ago, I think we’d be amazed at the change of behavior at the other banks. As Voltaire said of the execution of John Byng, it is wise to hang an admiral from time to time to encourage the others.
Here are two ways of looking at that $100 billion in fines, number.
First, it would represent what poker players call the rake. If you play in a public card room, you are playing other players, not the house, unlike in black jack or roulette. The house makes its money by taking a certain amount of every pot, which is called the rake. If you’re a winning player, you take this into account but still figure you’ll come out ahead, as it isn’t that much if you’re good.
So a hundred billion in fines is just another part of the rake, taxes being the big one.
The second way of thinking about it is this: the government took $100B but gave them back trillions. WTF were they expecting would happen? That’s like giving out a $200 speeding ticket and then giving the offender $2,000 as an incentive to “never do this again.” Instead of never doing it again, the offender is going to be LOOKING for speed traps! Even if he gets popped for $200 again, he’s still ahead, and if he gets another $2,000 incentive, he’s going to keep speeding.
Hell, it’s all there in one sentence! I’d askhow they don’t realize this, but as everyone here knows, I think they know damned well what they’re saying, and this is just a sop for the public.
Where’s The Comedian when you need him?
I just returned from two weeks in Spain. The other big story over there concerned the very large Spanish bank, Caja Madrid-Bankia, which had to be bailed out to the tune of 22 billion euros. During the time the bank was going down, the president of the bank and other higher-up were running up huge credit card bills — millions of euros in the aggregate — (safaris, vacations, expensive dinners, stocking of wine cellars — the usual bullshit) on what the Spanish call “tarjetas negras” — black credit cards: Cards used outside the normal channels of corporate accounting. The Spanish people — suffering under a 27% unemployment rate — are not amused.
The difference is that these guys are all being hauled in front of a judge on fraud charges.
Well. So we have the Fed tsk-tasking the banks. No doubt deserved. However, who criticizes the Fed for destroying savers and benefitting spenders and stock market speculators?
And in a move that will vindicate steve, we see that the 20% down mortgage rule is being eased, and that Fannie and Freddie are going to up their exposure to these loans……..wait a second, that’s not the banks and GWB, that’s Obama’s federal regulators!! WTF?!?! It’s déjà vu all over again…..
At least the auto industry has been saved, with no propping up by a third of purchase financed sub-prime. Wait, hold on again…..
They will also need to eventually lower borrower standards for approving loans. The credit rating agencies will need to lower their standards when rating instruments including these loans. The regulators will need to lower their standards when assessing the financial institution’s books.
Luckily, Sen. Dodd and Rep. Frank have assured that it will be different this time.
We’d have nationalized BofA except it would have been a racist act committed by stupid republicans. Oh, wait. Sorry, was just at OTB reading some comments and saw MRs usual comments through his pathetic prism.
Looking back through the records of the time I can find no evidence that converting Lehman or any other investment bank to a commercial bank, firing the senior executives and winding the company down was ever seriously considered. Our brilliant leaders in government seemed incapable of any thought process other than “bailout” or “allow to explode”.
It does beg the question: what the fuck is all that authority at the Fed for if it isn’t used when needed most?
@Ben, according to Geithner’s book, Summers proposed nationalizing BOA and Citi, but I didn’t follow closely enough to know how seriously. I’ve never seen a clear explanation of what legal authority existed for nationalization; though I believe proponents believe that if we changed the rules in how housing equity was valued, then these banks would be insolvent and could be seized to protect the investors. That would mean the government was intervening to protect the investors by fairly liquidating the underlying equity, which sounds a lot like my home and maybe yours.
“Looking back through the records of the time I can find no evidence that converting Lehman or any other investment bank to a commercial bank,”
What? With what balance sheet?
PD
I think you would find an orderly liquidation of assets would have been a less ham-fisted approach, but still result in equity being fully wiped out, which is fine, at least in my world. They opted for taxpayer subsidy. Those who complain about corporate welfare, income inequality and such should be violently opposed to what was done.
Just one mans opinion.
PD,
The Fed has authority to seize commercial, or chartered, banks. So for the Wall Street firms they would have had to force a conversion but it could have been done. Like Drew says the shareholders would likely have lost their shirts (there would be a shit-storm of litigation afterward to claw back a few pennies on the dollar) which I would have been fine with; the only legitimate reason to take these steps (in my opinion) would have been to prevent the kind of cascade failure that resulted from Lehman’s implosion. Our geniuses in the federal government seemed unaware the financial industry’s infrastructure was so intertwined that negative effects could not be limited to a single firm.
” Our geniuses in the federal government seemed unaware the financial industry’s infrastructure was so intertwined that negative effects could not be limited to a single firm”
Wasn’t that the rationale for the whole of the gimcrackery?
@Ben, if you can point me to a discussion of legal authority to seize a bank, I would be interested. But bank seizures require insolvency (under one of the various tests for undercapitalization), and the banks were not insolvent under these tests, perhaps they would be in time. Most discussions in this direction involve changing the valuation of bank assets to force the banks to realize losses from “toxic assets” at an arbitrary point in time. Also, these banks were partly holding companies that are not subject to banking regulation and were sources of capital infusion that would slow any regulatory efforts to force the banks under.
Who in Government will regulate who in the banking sector when they are the same persons. Geithner who came from Goldman Sachs to Treasury then back to Goldman Sachs as an example.
@sam
Wasn’t that the rationale for the whole of the gimcrackery?
No, but if you know how money laundering works, you would recognize how a low rated loan is cleaned-up.
The financial system, especially lending, does not work the way you think it does or the way you may have been taught. @Ben Wolf’s point is that neither does the Fed, but none of this is difficult.
The term banks covers many different types of financial institutions, and these are regulated by various overlapping agencies. Some of them have access to borrowing from the Fed, but others do not.
I am going to get into trouble, but here it goes. Banks do not lend money that they have. Banks are required to have capital, and that capital is a fraction of how much they can lend. Or, they can lend a multiple of their capital. When they create loans, they create money, but it is on a balance sheet. They borrow from the Fed and each other using their assets, and the loans are one asset.
This glosses over a lot. It is more complicated, but the point is that banks do n0t lend money they have. Banks lend money they do not have, and then, they borrow money to cover those loans.
The loans are assets, and they can also be sold. Assuming a positive sale price, this would keep their books balanced, and these loans would enter the financial system as “free agents”. They would not be tied to a specific bank. These can be bundled into Mortgage Backed Securities (MBS), and these become assets. Because MBS’s are assets, they can be used as collateral for further borrowing.
In addition, there are Credit Default Swaps (CDS) which are like insurance for the MBS, but there is a market for non-primary purchasers of CDS’s. The non-primary CDS’s are also assets.
Sidebar:
The non-primary purchase of CDS’s is gambling, and Wall Street is a bookie. Wall Street was not betting against any MBS. They were laying off the other side of the bet. A bookie makes money from the 10% cut of the winnings. He wants the winners and losers to be even. This is the purpose for adjusting the odds.
In addition, MBS’s were used to create Collateralized Debt Obligation (CDO), and these were what a lot of banks owned. These were similar to MBS’s.
All of these instruments had legitimate purposes, and with the exception of CDO’s had been around for at least a decade. They were developed when Glass-Steagall was still in place. They were investment instruments by investors for investors, and I mean hedge fund level investors.
There was nothing sinister. This was their ballpark. This was their field, and this was their rules. There was some regulation, but as long as they left the public alone, they were free to do what they wanted to each other. If I recall correctly, there were regulations about minimum level of investment to enter, and a lot of mom & pop types were bitching.
When G-S was repealed, people began warning about these various products, and the problems they would cause. This was as early as the end of the 1990’s with CDS’s, but nobody would listen. The financial collapse was forecast based upon an understanding of how things were tied together.
A first loan is used as collateral for a second loan. A non-primary CDS is taken out on the first loan used as collateral for a third loan, and a non-primary CDS is taken out on the second loan used as collateral for a fourth loan. The second loan is used as collateral for a fifth loan, and a CDS a non-primary CDS is taken out on the fifth loan is used as a sixth loan.
This is an oversimplified version, but everybody should begin to see what is going to happen when a few of these loans begin to go bad. The loans they were supporting as collateral will collapse because there is no more collateral, and the CDS (insurance policy) will need to be paid out (AIG anybody).
The financial system is a lot more complicated than this, and these assets move around. It is this movement that allows the economy to operate and expand. It is a game of musical chairs. The Fed should understand all of this.
What happened was that many of the loans were “not worth the paper they were written on”, but they were still performing. People were still paying their monthly payment, and if they continued, the loan would be paid off as if it were worth the actual value. At some point, the loan will be paid down enough to equal the value of the asset (house) securing (important word) it. It will no longer be under water, and the asset owner (homeowner) can sell the asset (house).
The banks are in a similar situation. Many of them are sitting on performing assets, but they cannot move those assets. Because they cannot move those assets, they cannot create new assets. Because they cannot create new assets, the economy flounders. In addition, many of these assets could not withstand a thorough assessment. Many banks are insolvent.
This does not mean that there is no way to untangle the financial system, but if you do not or will not understand how it works, you will never be able to do it.
You have FDIC depositors, and you have money market funds or other retirement and 401k funds. These are the people that you want to save. The process is to unwind a bank is to setup a good bank and a bad bank. The depositors and the good assets go into the good bank, and the trash goes into the bad bank.
The good bank is sold to a stable institution, and the bad bank is sold or liquidated. For the FDIC, they will need to make up any difference to the purchaser, and it would be the same for whatever body regulated the transaction.
Enforcement could be voluntary, or it could be through audits, raising capital requirements, raising asset standards, etc. These institutions are only able to lend because of the government and the Fed not in spite of it. In a free market without government intrusion, there would no Fed to create money for them to borrow. They would have a set of books with loans, but there would no way to obtain currency to hand out.
To keep depositors safe, you need to backstop the loans that are underwater. As I understood it, this is what TARP was for. It would be an insurance fund that would payout the difference if any asset had to be sold at a loss. This would allow that asset to continue to be considered a AAA rated asset. I do not know the details of TARP, but a program like this should have carried provisions for the homeowners.
The remaining financial system would have collapsed, and it would have been steep. Because much of the wealth is financial wealth, the wealth gap would have plummeted. Instead of an increasing income inequality gap, President Obama would have ushered in a decreasing income inequality gap.
Unfortunately, I will not have a lot of time to defend this, and I expect to get beat up. There are gaps large enough to “drive a truck through”, and some of the phrasing is probably bad. I should go back and proofread it, but I have gone way past where I intended.
@TastyBits, I think that’s a good summary. I’ll just use a few of your statements to make my own points:
“The good bank is sold to a stable institution, and the bad bank is sold or liquidated.”
This is the receivership model, and I’m not sure it is what people think of when they are talking about nationalization. The government protects the asset class by taking them out of a failing institution and place them with a more successful, usually larger, institution. BoA gets sold to JP Morgan, and there end up being fewer, larger banks, all in private hands.
“I do not know the details of TARP, but a program like this should have carried provisions for the homeowners.”
I think this is an outgrowth of the receivership model; the government is taking over a failing bank for the benefit of the creditors and depositors. The homeowners, a/k/a debtors, are ultimately the source of the problem — an adverse interest. Not that the government couldn’t help homeowners, but I think that’s an entirely different program.
@PD Shaw
The CDS’s were the gasoline or nuclear bombs. Allowing the homeowners to bear his/her responsibility would cause the CDS’s to kick in, and this would require assets to be sold to cover the losses. If the asset was a loan, the collateral supporting the loan would need to be of equal or greater value.
If the collateral could not support the loan, the loan could not be used, and it was probably technically in default. Calling the loan would cause another CDS to kick-in, and the process would start again.
There would be a failure cascade causing the entire financial system to collapse. The people who want to hold the homeowners accountable do not have any idea of how the system works. They want to “cut off their nose to spite their face.” There were/are ways to make the homeowners accountable without throwing them out on the streets, but you need to understand how things work.
Speaking of work …
I was talking about the argument that the financial system was so intertwined, so interlocked, that the destruction of one of the big banks would result in a domino effect and the whole system would come down. I recall that that was the rationale for the bailouts. [Please note that I am not endorsing the argument, merely stating it.]
@sam
Yes, but … It is true, but it is not the whole truth. It is a hustle, and they stacked the deck. There is a goat behind door 1, 2, & 3, and they have Bruno in the alley with a baseball bat to take any money you might win.
In simple terms, the financial system is a pyramid type scheme, and as one brick crumbles, the remaining bricks must support the pyramid. This adds more weight to each brick which increases the impact if it crumbles.
During the crisis, the bricks at the top were threatening to crush more of the lower bricks unless the entire structure was shored up. The top bricks said they would hate to do it, but they would use sledgehammers on the lower bricks.
The bailouts were necessary for the wealthy to remain wealthy. They used the homeowners and depositors (money market and 401k type funds) as hostages.
There were ways to install shims, splints, and bridges. The government could have purchased assets at firesale prices. As the prices begin to drop, they would fall faster and faster. The investors could either hold out and foreclose on “deadbeat” homeowners getting pennies on the dollar, or they could play ball with the government and recoup a larger portion of their investment.
Republicans may be idiots, but Wall Street is not. Wall Street knows that they had far more to lose. Instead of cowering, they began sowing FUD. Wall Street is full of hustlers, and they know that a scared rube will believe anything if you say it with confidence.
Once you understand how things work, you can see through the bullshit. It may be legal, but it is still a hustle. This will happen again. This must happen again. When you tear down the backyard fence, spread raw meat around the yard, and let the kids play with wild animals, you should expect they will get eaten.
To the best of my knowledge, we have never one through with nationalizing or bankruptcy with a large international. I am not sure we know how to do it.
“And in a move that will vindicate steve, we see that the 20% down mortgage rule is being eased, and that Fannie and Freddie are going to up their exposure to these loans”
As I have said, I would favor easing the GSEs out of business. I think this is not a good idea. However, low downpayment loans generally did ok. The big losers were the liar’s loans (an idea generated entirely by the finance industry, not coming from some regulation), exploding ARMs, 120% mortgages and second mortgages. Banks are really supposed to assess risk and allocate capital. They stopped assessing risk.
Steve
Sam,
Lehman playes with its leverage via a tasty little scam it called “repo 105” a Tobashi scheme. Basically it woild periodically borrow money to pay off debt on the books without reporting the loan. This made the company appear to be less leveraged (therefore requiring less capital) than it actually was. Lehman was already insolvent by the time it collapsed: bad enough by itself but this also meant it couldn’t service its liabililities to other highly leveraged banks which suddenly lost the income streams and assets from the loans that just went bust.
That triggered the credit default swaps (unregulated insurance contracts) those banks had taken out against just such an eventuality, many of which were issued by AIG (which issued more than it could actually cover. So banks which had made loans to Lehman lost those assets, their CDS were being effectively defaulted on and panic set in. Banks stopped lending to each other entirely and the risk was total collapse of the payments system. That’s when the Fed swooped in and seized control of AIG to assure the banks they wouldn’t be left holding the bag (Greenberg actually has a good case the Fed overstepped its authority).
That’s just an example of the cascade effect, whole books have been written on this aspect.
I do not have all the particulars at this moment, but there was one woman who was pushing to have CDS’s regulated with the futures markets. This was back in 1998 or 1999. (post G-S) Who could have seen it coming?
Brooksley Born. Summers kneecapped her and Clinton turned his back while it happened.
To the best of my knowledge, we have never one through with nationalizing or bankruptcy with a large international. I am not sure we know how to do it.
So long as it never happens, companies know that if they grow large enough they can act with a certain impunity. Time to hang and admiral and bankrupt a multinational.
When an oil company is nationalized, their drilling rigs, production platforms, pipelines, refineries, and anything that is used to produce oil is seized.
If banks were like oil companies, they would set up a headquarters and issue stock. The amount of capital would determine how much oil they could produce.
They would have an oil production facility on government land, and they would build this facility using government resources. They would use this facility to generate more capital to create more oil.
The oil they produced would not come from the ground. It would be barrels marked “US Oil”. It would be graded, and it would receive a certificate of authenticity from the US government.
These barrels would be sold and traded the same as oil from Exxon, but the liquid in them would not be the same. As long as none of these barrels were actually used in a refinery, there would be no problem.
The banks only exist because of the US government. They are chartered institutions, and therefore, they cannot be nationalized the way Hugo Chavez nationalized the oil companies in Venezuela. If their charter is revoked, they cease to exist. (not quite, but close enough)
Conservatives should learn the differences between manufacturing real goods and non-existent goods. They do a disservice to real manufactures to pretend that financial companies are no different than oil companies, steel mills, or bakeries.
The same lament applies to healthcare. In the healthcare sector the consumers want health and the producers sell care. There’s a knowledge problem. The consumers must take the word of the producers that the care being provided will afford them health. A consumer walks into a bakery to buy a cake. The baker sells the consumer a cake.