Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 4 January 2015

The war with the banks has to be fought on two fronts

Trying to prevent another financial crisis was always going to require fighting on two fronts. The first, which gets most of the attention, is to change the rules and framework of regulation. That involves imposing higher capital ratios and leverage ratios, as well as restricting the activities that banks can engage in. Some progress has been made on that front. The second involves political change, and here I’m not sure any progress has been made. 

The banking sectors in most countries were responsible for the financial crisis. Increases in leverage on the scale shown here were just courting disaster. Big mistakes were made by regulators in allowing this, but the source of the problem was the actions of those in the financial sector. That crisis showed us that ‘too important to fail’ creates a huge market distortion, which mainly benefits those working in banks. The battle to change the status quo is therefore of huge importance.

I’m not an expert in these matters, but my impression is that some progress is being made on the first front. Banks have of course resisted much of this, saying that it would discourage lending and therefore hurt the recovery. Stephen Cecchetti argues that this has not happened. What has been hit is bank profitability, which indicates changes are having the desired effect. Cecchetti suggests as a result that more could be done, and this seems an understatement. Recent work by the IMF suggests that big banks continue to attract large implicit subsidies, while Admati and Hellwig present a well thought out case for much higher capital ratios. Until this happens, our money will continue to help fund bank bonuses.

So on the first front, some progress has been made but much more needs to be done.[1] However the recent case of Citigroup and the US congress illustrates all too clearly why we need a second, more political battle. [2] The story is very simple. The Dodds-Frank act that became part of US law in 2010 prevents US banks from using deposits to undertake certain ‘speculative’ activities. That was one of the victories on the first front discussed above. One of these speculative activities, and possibly the most dangerous in scale, is derivatives trading. On the 11th of December last year, as part of the last minute deal to prevent another US government shutdown, congress passed a provision that exempted derivatives from Dodds-Frank. The provision was based on drafting by the US bank Citigroup.

Why would Congress undo its own legislation in this way? The answer is not hard to find. US banks contribute huge amounts of money to fund the campaigns of those that run for congress, be they Democrat or Republican. It spends huge amounts on lobbying. Members of government often have or will work for these banks. Of course regulators can also be captured by those they are supposed to regulate. This could all be described as institutionalised corruption.

The only big difference between the US and the UK or Europe is that these things are a little more open in the US. City contributions make up a large proportion of Conservative party donations in the UK, and the other parties are hardly indifferent to wealthy donors who made their money in the financial industry. Lobbying is extensive and there are plenty of legislators with links to the financial sector. As Tamasin Cave notes, the UK comes second only to Switzerland for the number of people moving through the “revolving door” between the finance sector and officialdom. Whether Europe’s attempts to put a cap on bankers’ bonuses made economic sense or not, the fact that the UK Chancellor and Treasury were prepared to try so hard to prevent it happening shows who calls the shots in the UK government. Similar points can be made about the extent of lobbying and industry links in Europe.      

The Citigroup case shows how any immediate gains achieved on the first front can be steadily eroded by the political influence of the banks as the memories of the financial crisis fade. Now it might have been prudent from the US banks’ point of view to wait a bit before doing this so openly. Simon Johnson rather optimistically suggests that Citigroup’s blatant move may end up with its breakup. Alternatively Citigroup may just know they have the political upper hand. In the UK, it is difficult to know where an effective challenge to banks' political power will come from, and good reasons to think that any challenge would not be successful. [3] Such a challenge would be hugely popular, but more than popularity is required to counter the influence of money and power.

[1] In particular, the importance of simple regulation that cannot be gamed seems not to have been sufficiently appreciated.

[2] The case is unfortunately not an isolated example.

[3] An example of what UK governments can try and get away with in the interests of large corporations is provided by the case of Jeremy Hunt and News Corp. In November 2010 Culture Secretary Hunt sent a memo to the Prime Minister which began “James Murdoch is pretty furious at Vince’s referral to Ofcom.” That was Vince Cable’s referral of News Corp’s proposed takeover of BSkyB. The memo argued News Corp’s case. As Stuart Weir documents, Hunt was hardly a disinterested party in this. When Vince Cable was subsequently forced to relinquish his role in the affair because of comments he made to constituents, it fell to Cameron to appoint someone who was seen as more impartial. He appointed Hunt to take over. When civil servant Gus O’Donnell was asked to oversee the propriety of the appointment, Hunt’s memo was not disclosed to him. 


44 comments:

  1. If you were to look for the one reason why voter turnout at elections is down, and the feeling that all political parties are the same (not quite true but too near a truth to be ignored), Davos-man funding would be it.

    I see, ominously, Robert Shiller is about to publish his third edition of Irrational Exuberance. I started to read the puff for it, but decided to hide instead.

    ReplyDelete
    Replies
    1. This comment has been removed by the author.

      Delete
  2. Didn't Karl Polanyi argue that the "market" was indistinguishable from government? That the government largely existed to enforce market conditions on labour? The capture of the regulators and the policy makers cannot be a surprise to anyone, how can progress be made when, as you point out, the very people it will hurt are those in power...turkeys, Christmas and voting.

    Capital constraints are useless when it is the capitalists who get to say what their "risk weighted" value is, risk being something they are incapable and dis-incentivised to calculate with anybody's interests in mind other than their own. Aided and abetted by the very people (ostensibly) there to regulate and control them.

    ReplyDelete
  3. More regulation==>lower profits==>greater risk of bank failure.

    ReplyDelete
    Replies
    1. More regulation==>lower profits==>LESS chance of bank failure
      ...since if the regulation is effective they would be forced to engage far less in the more speculative, higher risk casino style banking activities which lead to much greater losses when things go wrong, compared to the losses they might make if they run a far more prudent (but less profitable) operation exposed to less risk and volatility.

      Delete
    2. Except when those regulations include:
      1. Forcing banks to lend to low income borrowers, who then default.
      2. Forcing banks to locate in low income areas, where they are more likely to be robbed.
      3. Imposing billions in fines on those banks for knowingly lending to people who couldn't repay.
      4. Imposing deposit insurance that puts banks in a "heads I win, tails the taxpayer bails me out" position.
      5. Forcing banks to hold idle cash reserves that sit as dead stock.

      Delete
    3. Lehman was subject to none of the above.

      Delete
    4. Perhaps rather than lots of regulation we need very concise but transformational regulation, such as:
      -No lending (or holding any assets other than reserves or T-bills) by any company administering the payment system.
      -All lending funded with liabilities at least as long term as the loans.
      -All lending kept on the balance sheet of the lender.

      We'd never need another bail-out and our economy would not need to bear the burden of a bloated banking sector. We would just have a very low cost utility style financial system and all the rocket scientists would be making rockets not zero-sum financial engineering.

      Delete
    5. Stone, I agree with your first bullet point. I may be teaching grandmothers to suck eggs, but that point is incorporated in full reserve banking (a system advocated by Irving Fisher, Milton Friedman, and more recently by Prof. Richard Werner (Southampton), Positive Money and many others).

      Re your second point, full reserve banking involves having shares rather than debt fund loans. That’s compatible with your 2nd point, I think.

      Delete
    6. Ralph, positive money weirdly don't eliminate maturity transformation in their proposal though. Their plan involves continuously rolling over illiquid but short term savings accounts as a way to fund even 30 year mortgages or such like. I fear that it would be a system very prone to bank runs. Andrew Jackson from Positive Money joined in on the comments of Nick Edmonds' post:
      http://monetaryreflections.blogspot.co.uk/2014/04/cohrane-and-wolf-on-full-reserve-banking.html

      Delete
    7. Stone, You're right. And for that reason I prefer Laurence Kotlikoff and Milton Freidman's systems to Positive Money's. PM could answer by saying that given much higher capital ratios (say 30% or 50%), the chance of bank failures is vanishingly small. But my answer to that is that taking the ratio right up to 100% gives a finite improvement in safety, plus there are no costs involved, because as Modigliani and Miller explained, the costs of funding a corporation are not influenced by the WAY the funding is done.

      Delete
    8. Lehman was an investment banker, not a commercial bank.

      Stone and Ralph: How about a banking system that was developed by practicing bankers over centuries of experience, which bankers followed in their own best interest, without being forced at the point of a gun: Banks issue money in exchange for short term real bills of adequate value.

      Delete
    9. Mike Sproul: Yes, Lehman wasn't subject to the commercial bank regulations that you describe, but it nonetheless took big risks with razor-thin capital and drove itself into failure, with damaging consequences ... That was precisely my point. Is there some reason to think that commercial banks wouldn't do the same under laissez faire? In other words, how can one be sure that the net effect of existing bank regulation is to increase the incidence of bank failures (which I take to be your point)?

      Actually, none of the regulations you describe above existed from 1929-1933 for US nonmember banks (and for member banks the only one that applied was reserve requirements) -- yet they failed in droves, with damaging consequences. Doesn't this cast some doubt on the argument for laissez faire?

      Delete
    10. Mike Sproul, correct me if I'm wrong but weren't the days of unregulated free banking also the days of unlimited liability and debtors prisions? So if a bank pushed the envelope, then the bank owners (and their families) would end up languishing in a horrendous prision. That was how then ensured prudent lending and substantial capital buffers in the bad old days I guess.

      Delete
    11. Anonymous and Stone:

      Do you trust government officials more than you trust bankers? My transactions with banks are voluntary, but the government can imprison or kill me. If I don't trust a bank, I don't have to do business with them. Not so with the government.

      "they failed in droves, with damaging consequences. Doesn't this cast some doubt on the argument for laissez faire?"

      No damaging consequences? Except the great depression? Government regulations prevented banks from suspending convertibility in the 1930's, so they failed in droves with horrendous consequences. In contrast, banks in the 1830's did suspend, and the 1830's recession was much milder than the one in the 1930's.

      And free banking/laissez faire are to blame for debtors prisons? I had no idea.

      Delete
    12. Mike Sproul, I wasn't meaning that free banking was to blame for debtors' prisions.
      Mike Sproul, what I was meaning was that unless we also had very draconian punishments (such as unlimited liability and debtors' prisions) then free banking might end up like legalising Madoff style ponzi schemes.
      Don't get me wrong, I think our current system stinks. I just don't think the 1830s provide that great a template either.

      Delete
  4. If you design a non-financial product and sell it, knowing it will never work; and, will be a total waste of money, you would have committed criminal fraud and would likely be convicted by a Jury.

    If you design a financial product in the Spiv City of London, claiming it to be an investment banking "innovation"; knowing it will never work (and taking bets on the side that it won't work), then you will never be put before a Jury, but you will be given a large bonus by your masters, for committing fraud.

    The Spiv City of London is fundamentally the largest Casino on the planet. Less than 5% of its activity is to service international trade in goods and services. The rest is is pure gambling the same as any Bookmaker in the High Street or in some off-shore tax haven. The Foreign Exchange casino is the largest betting pit. In four days, enough foreign exchange swaps will occur to finance a whole year's worth of trade. The rest of the year is pure gambling; one currency chasing another in a two horse race.

    The nations on this planet use sovereign fiat currency units of account to operate their economies. Most allow their fiat currencies to be freely exchangeable with other fiat currencies. There are no financial markets that are essential to the international operation of this planet. All "financial markets" are parasitic and secondary to socio-economic operations between peoples. Countries that peg to, or use a foreign currency (like the Eurozone), have only themselves to blame when it goes wrong.

    We need to stop commercial banks becoming casinos and license them to lend money and and take insured deposits and that's all, no proprietary trading. Central banks must take in house ALL payment; clearing and settlement activity world wide. They will provide trade credit particularly for SMEs that suffer from slow payers at home and abroad.

    Everything else is a casino, you place a bet and take your chance. Just like any other Bookmaker. No bail-outs; no Central Bank or Treasury guarantees.

    PS. Just a little bit of bile. If you are a financial corporation that employs; has employed, or, has implied that employment will be provided to a person that is/was a sometime elected to the Palace of Westminster or employed by the Civil Service, then you are barred from any contract directly or as a sub-contractor, that may be issued by any UK public Sector financed entity. Additionally, any financial activity such corporation may be involved in, shall not be availed of any public sector protection, financial or non-financial.

    ReplyDelete
  5. I question whether the core concept of banking is worthwhile. For a start it would be possible to have a payments system that had no link to lending institutions. In 2008 we were told that we had to pay for bank bailouts because we needed the payment system. If the payment system was no more than something like paypal or m-pesa (in Kenya) then it would be a low cost, totally safe utility. The banks use the payment system as a hostage to get bailouts IMO.
    I also don't see that good comes from allowing lending institutions (eg banks) to conduct maturity transformation. IMO lending should only be funded with maturity matched liabilities (such as funding circle does). Maturity transformation leads to mispricing of debt lending so disfavoring equity financing. Maturity transformation is also at the heart of financial panics and bubbles.
    Let's face it 80% of lending is for pushing up the price of pre-existing housing stock. We are told the lie that bank lending is all about supporting industry and enterprise.

    ReplyDelete
  6. From a purely British perspective, it really should be noted that the "derivatives trading" to which Prof W-L refers, really wasn't a major factor in the financial crisis. A glance at the long list of failed UK financial institutions circa 2008 would show that only RBS was affected to any real extent by this activity.

    ReplyDelete
    Replies
    1. "only RBS" ! LOL

      RBS was huge. The RBS collapse gutted us.

      Anyway isn't it true that many US financial institutions use the London arms of their operations to conduct their worst derivative excesses (eg the "London Whale" ).

      Delete
    2. Stone, You querie the logic of combining deposit taking with lending. Good question. James Tobin said “The linking of deposit money and commercial banking is an accident of history..”. And Richard Werner questioned that combination in a recent paper (though that isn't the central question he addresses in the paper):

      http://www.sciencedirect.com/science/article/pii/S1057521914001434

      Re your criticisms of maturity transformation, I quite agree. The apparent merit of maturity transformation is that it creates liquidity / money. But it can’t do so without at the same time incurring the risk of bank failures, credit crunches, etc. As Douglas Diamond and Raghuram Rajan put it in the abstract of a paper of theirs, and in reference to the liquidity producing services of commercial banks, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.” See:

      http://www.nber.org/papers/w7430

      Now given that the state can issue whatever amount of money is needed to keep the economy ticking over at full employment, and without risking bank failures, I’m baffled as to what the point is of having private banks issue money as well.

      Delete
    3. Apparently after the takeover of ABN Amro, RBS was the largest bank in the world, by assets. It was ludicrously highly leveraged by that point, echoing the point made in Prof W-L's second paragraph. Conventional wisdom has always been to blame 'light-touch' regulation. There was plenty of evidence of considerable stress within financial markets by the autumn of 2007. I think it was just totally incompetent regulation.
      A cynic might observe that in a typically British way we stumbled upon a rather interesting business model. It's true all the racier trading by US/European financial institutions is done in London. The capital's' economy undoubtedly benefits from their presence. None of the leading trading houses was British, so US and Swiss banks suffered most from their derivatives positions going awry

      Delete
  7. You mention the links between the Tories and the banking lobby. I think we also need to remember just how deeply corrupted the Labour Party is. Tony Blair is cashing in big time from JP Morgan after New Labour pandered to the banks when they were in power.

    ReplyDelete
  8. I guess a big part of the problem is that the banks based in the UK gather money in from the whole world and pay employees and taxes here with that globally sourced rent stream. So the UK has become dependent on the banks, perhaps like Somalia is dependent on the takings by Somali pirates.

    ReplyDelete
  9. For a nice cartoon that encapsulates the banker / politician nexus, see:

    http://www.ritholtz.com/blog/2010/05/too-pig-to-fail/

    ReplyDelete
  10. I agree with much of what you say about the banks, and their lack of or poor regulation, but you go too far and thus miss the wood for the trees.

    Banking leverage is not the whole story of the GFC, or even the main part. Your earlier 2012 post with the chart on UK banks' leverage is all well and good, but oh so parochial. US banks did not have huge increases in their leverage, modest increases, but not huge.
    http://www.newyorkfed.org/research/banking_research/QuarterlyTrends2014Q1.pdf
    (charts on page 15 and 16)

    Other countries were similar to the US, but all were hit by the GFC. You really do need to add in monetary policy mismanagement to the story.

    Obession with inflation targeting, especially headline inflation hit by a temporary oil price shock, meant that central banks ether tightened deliberately, or didn't loosen monetary policy, just as cyclical economic downturn in 2007 had begun to hit. Nominal GDP growth, and especially expectations about Nominal GDP growth, were weakening throughout the 2h07/1h08 period. Targeting NGDP forecasts would have prevented the worst of the GFC and much of the subsquent unemployment, and lost income generally.

    ReplyDelete
  11. Whether Europe’s attempts to put a cap on bankers’ bonuses made economic sense or not
    Not only does it not make sense, it is completely counter-productive, because it has forced banks to increase the fixed element of compensation at the expense of variable bonuses. This transfers risk from employees to shareholders, and by extention the state, which is daft even if you think that bankers are vastly overpaid.
    More broadly the importance of 'casino banking' in general and derivatives trading in particular is usually vastly overstated in analysis of the current crisis. They had a central role in the liquidity crisis that killed Lehman but they were and remain peripheral in the solvency crisis that is still afflicting the banking system in Europe in particular. The biggest problems facing European banks today are rather more old-fashioned: loans made against over-valued real estate and holdings of the sovereign debts of over-indebted European countries.

    ReplyDelete
    Replies
    1. "This transfers risk from employees to shareholders, and by extention the state, which is daft even if you think that bankers are vastly overpaid."

      Shareholders are SUPPOSED to bear risk. That's the whole point of a stock ownership system.

      Delete
    2. You ignored the second part of my statement. Of course shareholders should bear the risk, but unlike normal companies banks can't go bust, so when the shareholders are wiped out the state has to step in. The EU's bonus regulations accentuate this risk.

      These new regulations don't even address the issue of bankers' incentives. The right way to do that would be to increase the variable component of their income, but to link it to the long-term health (or at least survival) of their employer. The threat of losing five years of bonuses might have led to different behaviour amongst bank executives. Or at least made us all feel a bit better about bailing them out.

      Delete
  12. A commercial bank should be a commercial bank. An investment bank should be an investment bank. One should be completely safe and act as a clearing house, there should never be a need to stress test it.
    The second should be a private firm that does whatever the hell it wants (within the law) and the consequences should be kept in the private sector. Loans between commercial banks and investment banks should be limited so as not to indirectly transfer risk between the two.
    Unless this is done, banks like Goldman will always be able to wield a sword over everyones head, with terms like "systemic risk"..."contagion"... etc..

    ReplyDelete
    Replies
    1. How would you propose to make a commercial bank 'completely safe'? Banks are perfectly capable of going bust without resort to investment banking: see most of the European banking sector for further detail.

      Delete
  13. "Banks are perfectly capable of going bust without resort to investment banking"

    You are correct. But I don't think the argument is correct as "since there is already risk, let us really pile it on".

    I'd start somewhere around Glass-Steagall as originally interpreted. I just think it is essential to protect the system primarily responsible for clearing the transactions of a countries currency. If Bank X wants to write an option assuming Coca Colas $ risk vs. cold temperature on July 4th weekend, go right ahead, but not with John Smith backing it. Particularly since John Smith doesn't see much of the upside. Then the more of this that occurs, the more this forced one bank to hedge with another, therefore, creating counterparty credit risk with one another (now making it 'systemic risk') based on operations that they should not even be doing, in my opinion, in the first place.

    ReplyDelete
    Replies
    1. You misunderstand my point, which is that even if you separate investment banking from 'normal' deposit taking and lending, you do not create a 'completely safe' bank. Remember that most banks in Europe today are insolvent because of traditional lending activities (mostly against real estate), not investment banking. So you don't really solve the problem.

      I'd make two related points here:
      1. It is not as easy as you might think to separate commercial and investment banking. Commercial banks (like all companies) use derivatives extensively to hedge their positions. This is a normal and vital activity for banks, and to do it effectively they need a trading desk. So 'John Smith' will always to a certain extent be 'backing' this kind of activity.
      2. Even if you do separate proprietry derivatives trading from normal commercial derivatives use (assuming you can actually make this distinction, which is far from obvious), you are solving a non-existent problem without addressing the real one. One of the effects of derivatives trading is that the network of interrelationships between counterparties is extremely complex and opaque. This means that in a crisis, no-one really knows who owns what, which can have a catastrophic effect on confidence and therefore liquidity. This is what killed Lehman, and in these markets the death of even a relatively small participant like Lehman turns a crisis of confidence into panic (see also LTCM).

      So separating 'normal' banking from investment banking poses all sorts of practical problems for the operation of banks, doesn't make 'normal' banking safe, and does nothing to address the risk of a liquidity crisis. 2008 was a liquidity crisis. We are still living through the effects of a banking solvency crisis that has nothing to do with derivatives trading.

      Delete
    2. "assuming you can actually make this distinction, which is far from obvious"

      I've run massive physical next to massive prop and never had a difficulty knowing which was for which.

      "One of the effects of derivatives trading is that the network of interrelationships between counterparties is extremely complex and opaque."

      Yes, I said that, so I agree, with the exception of the word complex.

      "This means that in a crisis, no-one really knows who owns what, which can have a catastrophic effect on confidence and therefore liquidity."

      Having you believe that is highly beneficial, but I have never not known my position, or my traders, nor groups, nor companies position. If that ever happened I would have had to have committed Hara-Kiri in disgrace. If anyone working for me, or working for anyone I know, ever said that, they would be fired. Any of my peers told a story of that occurring, they would become the focus of ridicule for days. Now lawyers on a bankruptcy commitee, involving derivatives, they love to propagate that belief. "This might take 20 years, to figure out, at $800 an hour"

      Delete
    3. 'Massive prop' isn't really the issue. The issue is distinguishing a hedge from a proprietary position, which you can only do perfectly if you directly hedge individual positions against one another. You know better then me that's not how it works. But that was only an aside really and of course it can be done.

      I'm not sure what you mean by 'beneficial'. I don't doubt for a second that you know all your positions and counterparty exposures. The problem for me if I'm trading with you is that I don't.

      Delete
    4. And just to add to my last point: in 2008 you might have thought you had nicely diversified counterparty risk in your CDS portfolio but actually all of it led back to AIG.

      Delete
    5. “I'm not sure what you mean by 'beneficial'. I don't doubt for a second that you know all your positions and counter party exposures. The problem for me if I'm trading with you is that I don't. “

      No, I would not expect you to, but I would expect it of whoever is running a sizable trading desk. What I mean by 'beneficial' was to a lesser extent referring to my final comment about bankruptcy committee lawyers, but entertainingly enough was said with AIG-Goldman in mind. My original comment about why they should not be allowed to a lot of business they conduct and create the risk they do comes from that example.
      I remember in 2002-2003 when all roads led to Enron. First Dynegy, then Aquilla, then AES, then Enron, after Enron all the dominoes fell. And the response was to do nothing, which was correct, because it might bother people to hear this, as it does not suit the common narrative, but the net risk of all derivative trades, is 0. So the dominoes fell and the pain was taken where it should have been taken. The market learned, NYMEX created a swap and cleared OTC trades, and less than 2 years after, record volumes.
      Same could have been done for AIG, had not the systemic risk, that time, been so interconnected into the banking system. (Which it should not have been) Those contracts weren't between AIG and farmer Bob, they were between professional traders, people who fought to make sure those contracts were off a clearing house. Let the losses fall were they should, net still must be zero. Of course, I think Paulson protecting his best buddies and his own net worth was the driving force behind the bail out.
      Think of it in another way, if you and I are an entire system, and we make a bet for a billion dollars, and tonight you win, I can't pay, so why should a 3rd party then inject a billion dollars into a system where the billion dollars did not previously exist? I could actually see someone laughing about pulling that off, over a few very nice bottles of wine.

      Delete
    6. Are you saying that you would expect someone running a sizeable trading desk to know all the positions and counterparty exposures of all their counterparties? Because the point I'm making is that you wouldn't, which is what creates the loss of confidence.

      On the rest of it:
      1. On the basis of what I said above I don't think you can disentangle banks from this systemic risk. They need to be big users of financial derivatives so they will be exposed to losses and (most critically) a loss confidence if the whole system implodes.
      2. The 2008 crisis was not fundamentally a crisis of losses, or solvency. It was a crisis of liquidity. If derivatives (or more narrowly sub-prime and sub-prime-linked CDS) had been the only problem then the banking sector would have been back on its feet and (speaking from a UK perspective) the government would have had its money back years ago. The real issue was (and remains) that the credit crunch uncovered a more fundamental solvency issue.
      So if, in 2008, the banking system had been as disentangled as much as possible from 'casino banking', would it have escaped unscathed? I don't know, it's possible. The system as it was survived LTCM and Enron, and in both cases the banking system was linked: from what I remember a lot of banks pre-Enron used to trade at least as much energy as they ever did CDS. Whether a more segregated system would have survived a crisis on the scale of 2008 we will never know. But we do know that the system would not have survived the ensuing solvency crisis, because that was basically caused by massively overgeared banks lending at 90% LTV (or 125% LTV in the retail mortgage market) against real estate whose value subsequently fell by 30%+ (in Spain that was if you were lucky).
      But to go back to the beginning, I'm not sure how I've been dragged into an argument about whether we should separate standard banking from the casino. I've nothing against it really. It's complicated but it's been done before and without it the investment banking arm of J.P. Morgan is using John Smith's deposits to give it a competitive advantage in the form of a lower cost of capital and underwriting capability. I get all that. My original and basic point is that doing this would not have solved the main problem. The European banking system would still be insolvent. A system that seeks to avoid this, even segregated from the casino, would need to be run differently (much lower leverage and tighter control over what banks can do) and would still need stress testing. And a system like this unsegregated from the casino might have survived 2008 wiithout a bailout, and even if it hadn't would have returned to solvency quite quickly.

      Delete
    7. P.S. I'm not a lawyer so none of this is beneficial to me!

      Delete
  14. To win the political battles over banking you first need to win a moral battle about the basis of the financial system:
    http://www.democracymatters.org.uk/the-daily-mail-and-the-battle-for-responsible-banking/
    And alongside that the intellectual battle to replace the economic model which tragically failed.

    ReplyDelete
  15. "Are you saying that you would expect someone running a sizeable trading desk to know all the positions and counterparty exposures of all their counterparties?"

    YES! A very close approximation in real time. This becomes even easier on a default event where all optionality is removed from a derivative and the value becomes fixed at that time, never to move again. Then it becomes REAL easy.

    But my benefit is to make you think there is an incalculable mess that will result in the world imploding if you do not give me Billions of dollars. Markets are moving, so you better decide quickly. No time to think, write the check!! Trust me, I'm doing Gods work!

    What you said in point 2, I agree with, this was not THE problem. Unscathed would not have been a possibility either. It would have been a mess, but one that would have resolved itself. Where there is money to be made, someone eventually comes in to fill the gaps. Often the same people as before, under a different name, some new rules, and hopefully wiser.

    ReplyDelete
  16. If that is true (and I find it very hard to believe) why did everything freeze in 2008? What was everyone afraid of if?
    As you can tell, I'm not a trader. My world is private equity and leveraged finance, and my abiding memory of 2007 is of people at UK banks running around underwriting anything that moved. They knew what they were doing was crap (a senior executive at one of these banks said to a colleague of mine in 2007 "we're writing bad debts"!) but they were paid on the basis of fees for writing new business so that's what they did. They syndicated some of it where they could (to even more stupid banks, or CLOs) but if they couldn't they just stuck it on the balance sheet (i.e. let John Smith and Farmer Bob take the risk) and moved onto the next one. Even at the time it was obviously insane, and I know that in the (much larger) Property departments it was even worse. None of this had anything to do with derivatives.

    ReplyDelete
  17. You actually make it seem so easy with your presentation but I find this matter to be really something which I think I would never understand.
    It seems too complex and extremely broad for me. I am looking forward for your next post, I’ll try to get the hang of it!
    Obat Herbal Filariasis | Obat Herbal Kanker Usus | Tips Mencegah Kanker | Makanan Yang Baik Selama Kehamilan | Makanan Pemicu Kolesterol Tinggi

    Thanks for sharing this information brother :D

    ReplyDelete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.