Relevant and even prescient commentary on news, politics and the economy.

Neel Kashkari and the Minneapolis Plan to End Too Big to Fail

Neel Kashkari has been President of the Federal Reserve Bank of Minneapolis since January 1, 2016. Prior to that, he was brought over from Goldman Sachs to be Assistant Secretary of the Treasury for Stability from October 2008 to May 2009. His job was to hand out money to the banks as bailout.

I believe the first time first time he was mentioned at this blog was right after he was appointed to give away our money:

The bail-out will succeed only, repeat, only in the sense that the US succeeded in Iraq in 2003 and 2004 when Simone Ledeen and the rest of the Heritage interns were running around the country handing out trash bags full of money and giving Halliburton money for services it would never begin to render. There will be less yabbering of silly catchphrases like “but what about all the schools that were painted?” this time around, though, because the schools will be exploding when GW is no longer in office. To be extremely precise, this is what I think the success will look like: shady, undeserving characters will be enriched, young versions of the idiots who got us into the mess will launch successful careers (can you say “Kashkari”?), and the promised benefits to the American public, the schmucks footing the bill, will never materialize.

From memory, not only is that the first time I mentioned Mr. Kashkari, it is also the most complementary I have been toward him yet. But now, Mr. Kashkari is back with a new scheme to reduce the likelihood of a meltdown.

Kashkari provides this slide as a summary of his plan:

Figure 1 - The Minneapolis Plan

Figure 1  (click on the slide to embiggen)

Accompanying the slide is this platitude which also functions as a fly in the ointment:

We cannot make the risk zero, and safety isn’t free. Regulations can make the financial system safer, but they come with costs of potentially slower economic growth. Ultimately, the public has to decide how much safety they want in order to protect society from future financial crises and what price they are willing to pay for that safety.

Because Kashkari is a political creature who won’t speak clearly, to get an understanding of what the vegetables he wants us to eat taste like we go to the full plan:

We measure the cost of higher capital requirements in terms of lost GDP due to tighter lending conditions. This calculation requires a number of steps. We trace the impact of higher capital requirements to lower bank return on equity (ROE) and then to higher loan rates. Higher loan rates slow economic growth by restricting borrowing. As noted above, this approach closely follows the BIS.

And the banks agree:

The Financial Services Forum that represents U.S. financial services companies cautioned that implementing the recommendations would stymie the economy. “For those looking to accelerate economic growth and job creation, tripling bank capital levels — already double from pre-crisis levels — will make it much harder to meet those goals,” the forum’s spokeswoman, Laena Fallon, said by e-mail.

So, to summarize the negative side of this proposal: more stringent regulatory requirements –> higher interest rates –> less borrowing –> slower growth in GDP.

I recognize that this is gospel in the banking and regulatory community, and its been many moons since I thought of myself as an economist, but this seems pretty daft to me. Or rather, it seems like regulatory capture speaking. Consider for a moment this seemingly unrelated graph:

Figure 2 - The Fed Funds Rate and the Bank Prime Rate

Figure 2.

Note that the bank prime rate (orange line on the graph) is almost perfectly correlated with the fed funds rate (blue line on the graph) which is set by the Federal Reserve Bank. The difference between the two lines is shown in the gray bars. Do you see the large, sustained increase in that difference between the pre-Crisis period and the present that is due to the large increase in capital requirements we’ve already seen? No? Well, that’s because it didn’t happen. This notion that increased capital requirements raises the interest rates that banks charge their customers makes perfect sense in theory, but it stubbornly refuses to actually be true in the real world.

However, let’s assume this time things will be different. Let’s assume that unlike what we’ve seen so far, this time increased capital requirements do lead to a big sustained increase in the bank prime rate. Say for the sake of this post that the requirements effectively doubles the difference between the fed funds rate and the bank prime rate, permanently. What changes?

Well, if the Fed decided, at that point, that it wanted to raise or lower the interest rates charged by banks, it would do what it currently does in the same situation, namely change the federal funds rate. If anything changes at all, maybe, just maybe it will do so at the lower bound. And if there were some evidence that the Fed knows what its doing when the Fed Funds rate is near the lower bound, I admit that would be a concern.

So there’s no downside to this plan, at least as far as I can see.  Of course, the plan is just the tame one we’ve already enacted, but with a bit more in the way of a bite and, courtesy of Mr. Kashkari, a more extravagant soundtrack.  The Federal Reserve Bank of Minneapolis has a good sized research team. Kashkari could have asked any of them of to explain how the Fed Funds rate works, or about the relationship between the Fed Funds rate and the rates charged by banks. But failing upwards requires ignorance.  The higher up you are, the more ignorance is required. It is clear Mr. Kashkari has further to rise.

Tags: , , , , Comments (9) | |

Paul Krugman Retracts a Key Part of Last Friday’s ‘Sanders Over the Edge’ Op-ed: That Sanders, rather than the New York Daily News editorial board members, don’t know what Dodd-Frank authorizes the federal government to do concerning ‘systemically important’ (a.k.a., too-big-to-fail) financial institutions. Good for him.

Which brings us to Snoopy, who has, for reasons I don’t fully understand, long been the emblem of the insurance giant MetLife.

“At the end of 2014 the regulators designated MetLife, whose business extends far beyond individual life insurance, a systemically important financial institution. Other firms faced with this designation have tried to get out by changing their business models. For example, General Electric, which had become more about finance than about manufacturing, has sold off much of its finance business. But MetLife went to court. And it has won a favorable ruling from Rosemary Collyer, a Federal District Court judge.

It was a peculiar ruling. Judge Collyer repeatedly complained that the regulators had failed to do a cost­benefit analysis, which the law doesn’t say they should do, and for good reason. Financial crises are, after all, rare but drastic events; it’s unreasonable to expect regulators to game out in advance just how likely the next crisis is, or how it might play out, before imposing prudential standards. To demand that officials quantify the unquantifiable would, in effect, establish a strong presumption against any kind of protective measures.

Of course, that’s what financial firms want. Conservatives like to pretend that the “systemically important” designation is actually a privilege, a guarantee that firms will be bailed out. Back in 2012 Mitt Romney described this part of reform as “a kiss that’s been given to New York banks” (they never miss an opportunity to sneer at this city, do they?), an “enormous boon for them.” Strange to say, however, firms are doing all they can to dodge this “boon” — and MetLife’s stock rose sharply when the ruling came down.

The federal government will appeal the MetLife ruling, but even if it wins the ruling may open the floodgates to a wave of challenges to financial reform. And that’s the sense in which Snoopy may be setting us up for future disaster.

It doesn’t have to happen. As with so much else, this year’s election is crucial. A Democrat in the White House would enforce the spirit as well as the letter of reform — and would also appoint judges sympathetic to that endeavor. A Republican, any Republican, would make every effort to undermine reform, even if he didn’t manage an explicit repeal.

Just to be clear, I’m not saying that the 2010 financial reform was enough. The next crisis might come even if it remains intact. But the odds of crisis will be a lot higher if it falls apart.

Snoopy the Destroyer, Paul Krugman, New York Times, today

I posted here twice in the last few days about the stunningly bungled political commentary about the New York Daily News editorial board interview of Sanders, a transcript of which that paper released last Tuesday.  The second of my two posts was titled:

Why did Paul Krugman and the Washington Post editorial board—both of whom know better—misrepresent that it was Sanders rather than the New York Daily News editorial board that was wrong about what Dodd-Frank provides, and about whether it would be Treasury or instead the financial institutions themselves that would determine the method of paring down?

In today’s op-ed Krugman has retracted that allegation against Sanders in his op-ed from last Friday.  But what prompted the retraction—and especially the timing of it—is itself important: The federal judge’s opinion in the MetLife case was issued on March 30, the news reports about it were published mostly on March 31, and the New York Times published a critical editorial on it on Apr. 4, the day of the New York Daily News editorial board’s interview of Sanders.

A significant part of the media-criticism frenzy of Sanders for saying that he was unsure about the extent to which Dodd-Frank authorizes the federal government to determine that a financial institution is systemically so important because of its size that it must be pared down concerned questions about that opinion, by that one federal judge, issued less than a week earlier and containing some strange and unexpected—and inaccurate—statements about the relevant part of that statute.

Apparently on the ground that Sanders by then should have read the opinion and discussed it in detail with legal and finance-industry experts, the New York Daily News editorial board and most of the mainstream political analysts and pundits who opted to weigh in on it did so with the verdict that Sanders does not know much about this signature issue of his.  Or maybe it was just on the ground that no politician should ever, regardless of the circumstances, say he or she does not know something, does not know enough yet about a new development or about an obscure fact, point or event, or hasn’t thought through something in particular—or maybe everything in particular—and that any politician is, according to the prevalent assembly-line political-journalist guidelines, is toast.

And Hillary Clinton, who at a televised debate two months earlier had said the very opposite of what the New York Daily News editorial board and its journalist parrots were saying about that exchange between the editorial board and Sanders, and emphasized that she had made the same point earlier in the campaign—specifically, about Dodd-Frank, what it authorizes, and how clear those provisions and their breadth are—herself parroted that take.  With no indication of irony.

The first of my two posts on that interview and its aftermath was titled:

Clinton admits she failed to do her homework, and therefore misunderstood, when she stated at the February debate that Dodd-Frank already authorizes the Treasury Dept. to force too-big-to-fail banks to pare down and that therefore no further legislation authorizing it is necessary.  That’s quite an admission by her, and the New York Daily News editorial board (and the Washington Post’s Chris Cillizza) should take note.

This will be my last post on that editorial board interview and the punditry’s reaction to it.  Gratefully.

____

CORRECTION: The second-last paragraph in the excerpt from Krugman’s column that opens this post somehow ended up with a really big cut-and-paste error in it as I posted it there. Someone I don’t know emailed me and told me about the error.  I’m very grateful.  Apologies to Paul Krugman.  I didn’t do that on purpose.  Although next time he writes something nasty about Bernie, I might.

Added 4/11 at 8:41 p.m. 

Tags: , , , , , , , Comments (3) | |

Is ‘overbanked’ going to be a common household word?

Via The Big Picture and Ritholz comes Nervousness in over banked Europe

Go no further than the following two charts to understand why markets freaked out over Dijsselbloem’s comments.    Europe is way overbanked and vulnerable to financial sector shocks.
Even in the so-called “safe haven” Switzerland the banking system is outsized relative to the country’s GDP.  Compare the relative size of UBS, for example,  to the largest bank in the U.S.,  JP Morgan.  Nuff said.

Tags: , , , Comments (2) | |

Expounding on To Big To Fail, SEC Policy, DOJ prosecution action

Linda posted here on To Big To Fail and made suggestions as to how to fix it. I want to just add some more background information to the discussion.
Via Bob Swern at Daily Kos who linked to a post by Pam Martens at Wall Street on Parade comes a bit of transcript from the confirmation hearing for Mary Jo White for the SEC. 
Senator Brown: When you were U.S. Attorney, my understanding is you consulted Bob Rubin and Larry Summers when considering whether to bring charges against financial firms. Is that correct?

White: I actually consulted the Deputy Attorney General who had Mr. Summers call me back. I was asking a factual question.

Senator Brown: Did they reject the argument that institutions could not be prosecuted to the fullest extent of the law?

White: I’d like to answer that yes or no but I can’t. Essentially, I was seeking information based on an argument that had been made by the lawyers for the institution that I ultimately indicted, as to whether an indictment of that institution would result in great damage to either the Japanese economy or the world economy. And the answer I got back is that I should proceed to make my own decision; which I took to mean that it would likely not have that impact.
Pam then notes:
There actually is an official policy but its finer points have certainly not been expanded upon by either Attorney General Holder or SEC nominee Mary Jo White. The policy is called Title 9, Chapter 9-28.000: Principles of Federal Prosecution of Business Organizations.* The policy thoroughly advocates the prosecution of corporations — especially when there is a serial history of fraud as in the case of Wall Street.
She quotes from the policy:
“…Virtually every conviction of a corporation, like virtually every conviction of an individual, will have an impact on innocent third parties, and the mere existence of such an effect is not sufficient to preclude prosecution of the corporation.”
Just saying.
*The link for the actual policy is in Pam’s article.

Tags: , , , , Comments (9) | |

Addressing TBTF with tax and other policy: because "Big Banks Go Wrong, Pay Little Price"

by Linda Beale

Addressing TBTF with tax and other policy: because “Big Banks Go Wrong, Pay Little Price”

The New York Times today reiterated what many Americans lament–Big Banks went uncharged for serving as the main engine of the Great Recession that cost ordinary Americans jobs, homes and futures.  See Andrew Ross Sorkin, Big Banks Go Wrong, but Pay a Little Price, New York Times, at B1 (March 12, 2013).

Big Banks (and especially their managers), however, made out like bandits through the socialisation of losses and privatisation of gains.  The aftermath of the crisis provided  lower cost of funds from the perceived government TBTF subsidy.  Big Bank managers made big bucks leading their institutions into disaster and “staying on” after the disaster because their “expertise” was essential.  The stock market, but not ordinary Americans’ pocketbooks or paychecks,  has recovered from the recession, forging a return of lucrative M&A activity and, of course, the management of wealthy people’s assets.  No Big Bank has faced criminal indictment for “the damage caused to the economy and millions of Americans” by their  sloppy mortgage financing, sloppy foreclosure procedures, and casino capitalism “bets” with credit default swaps and other derivatives.

The reason–the lesson from Enron and Arthur Andersen, where thousands of lower-level employees who had no control over corporate actions lost their jobs when the firms collapsed after wrongdoing and charges.  Any Big Corp can be TBTF.  “[S]imply charging a company with a crime reaises the possibility of putting the firm out of business.”  Id. at B5.  Collateral damage is therefore a major hurdle to bringing a criminal case against a corporation.

The takeaway, according to the Times article, is that “prosecutors should focus on the individuals responsible for the misconduct” rather than indict corporations, which can result in “condemnation of one person [many employees] for the actions of another [boards and managers or ‘rogue’ employees]” (quoting, in the latter case, Elizabeth Ainslie’s paper on indicting corporatrions).

While protecting employees of rogue firms (where management and directors have pursued aggrandisement of their own status and riches at the cost of society’s well-being) is important, it is not clear that the takeway outlined above is a complete answer.  Several additional components should be addressed, by a combination of Congressional and state legislative action and regulating agencies.  And actions to limit the size of corporations would have another advantage–acting as a deterrent to their power in dictating the well-being of ordinary employees, and thus helping to deflect the growth of corporatism in our society.

  • First,  boards that make irresponsible judgements that allow CEOs and managers to engage in reckless bets with their companies should be able to be held personally responsible more easily, without corporate protection for the ultimate costs. 
  • Second, anti-trust needs to be expanded to limit the interwoven boards and contractual relationships that permit a few TBTF institutions in an industry to dominate the market and set the “Wall Street Rule” for what is acceptable behavior.  ULtimately we need forced split-up of TBTF institutions, through anti-trust or new means, as necessary.
  • Third (and most relevant for this blog, of course), tax policies encouraging corporate consolidation should be strictly limited.  The section 368 reorganization provisions should be tightened to require a much higher percentage of continued shareholder interest: the current requirement for a tax free reorg of only 40% (under an example in the reorg regulations) should be tighted to at least 70%.  The opportunities for loss recognition in reorgs provided by the Bush Treasury under regulations should be eliminated.  Spins of parts of mega corporations to existing shareholders should remain tax-free, but spins that amount to initial steps in acquisitions should be more limited.

Will Congress (or state legislators) take any of these actions?  It is highly dubious.  The left is too often too cowardly to act and mostly funded by wealthy interests.  Most on the right–disproportionately represented in Congress because of gerrymandering in the House and the disproportionate Senator-to-population ratios in the Senate–dogmatically favor market fundamentalism no matter the evil it causes when it comes to advantages for business to make more profits, even if it comes at the expense of ordinary people through market power to defeat unions, defeat reasonable pay requests, etc.  (Of course, when it comes to exploiting government , the right tends to favor government subsidies–look at Wisconsin’s recent move to remove pesky environmental regulations protecting wetlands to support a mine owner, in the purported interest in supporting job creation, even when the mine is likely to cause long-term environmental damage and potentially devastating water pollution and destruction of wetlands.)

cross posted with ataxingmatter

Tags: , , Comments (2) | |

Warren questions Benanke on ‘too big to fail’

Via Bloomberg comes this snippet from testimony between Senator Warren and Ben Bernanke.  Follow the link as the embed does not seem to work.

Partial Transcript via Global Economic Trends

Warren: These big financial institutions are getting cheaper borrowing to the tune of $83 billion in a single year, simply because people believe government would step in and bail them out. And, I’m just saying, if they’re getting it, why aren’t they paying for it?

Bernanke: I think we should get rid of it.

Warren: Alright. I’ll ask the other question. You were here in July, and you said you commended Dodd-Frank for providing a blueprint to get rid of “Too Big to Fail”. We’ve now understood this problem for nearly five years, so when are we going to get rid of “Too Big to Fail”?

Bernanke: Well, some of the you know uh as we’ve been discussing, some of these rules take time to develop. Uh, uh. ….”

Tags: , , , Comments (0) | |

Are banks too big to jail?

Update:  Dealbook at the NYT interviews the producers of ‘The Untouchables’.

Yves Smith at Naked Capitalism comments begin:

Lanny Breuer, former Covington & Burling partner and more recently head of the criminal division at the Department of Justice, resigned abruptly today. The proximate cause may be a Frontline show that ran two nights ago, part of a series on the financial crisis…

and ends

But sadly, Breuer’s resignation is unlikely to be a bellwether that lying does not pay. He simply didn’t lie well enough and that made him an embarrassment.

David Sirota at Salon discusses the significance of:

PBS Frontline’s stunning report last night on why the Obama administration has refused to prosecute any Wall Streeter involved in the financial meltdown doesn’t just implicitly indict a political and financial press that utterly abdicated its responsibility to cover such questions. It also — and as importantly — exposes the genuinely radical jurisprudential ideology that Wall Street campaign contributors have baked into America’s “justice” system. Indeed, after watching the piece, you will understand that the word “justice” belongs in quotes thanks to an Obama administration that has made a mockery of the name of a once hallowed executive department.

The Frontline report is titled “The Untouchables,”

As this excerpt from Breuer’s 2012 speech to the New York City Bar Association shows, that characterization of Breuer’s declarations is not an overstatement (emphasis added):

To be clear, the decision of whether to indict a corporation, defer prosecution, or decline altogether is not one that I, or anyone in the Criminal Division, take lightly. We are frequently on the receiving end of presentations from defense counsel, CEOs, and economists who argue that the collateral consequences of an indictment would be devastating for their client. In my conference room, over the years, I have heard sober predictions that a company or bank might fail if we indict, that innocent employees could lose their jobs, that entire industries may be affected, and even that global markets will feel the effects.

In reaching every charging decision, we must take into account the effect of an indictment on innocent employees and shareholders, just as we must take into account the nature of the crimes committed and the pervasiveness of the misconduct.

I personally feel that it’s my duty to consider whether individual employees with no responsibility for, or knowledge of, misconduct committed by others in the same company are going to lose their livelihood if we indict the corporation. In large multi-national companies, the jobs of tens of thousands of employees can be at stake. And, in some cases, the health of an industry or the markets are a real factor. Those are the kinds of considerations in white collar crime cases that literally keep me up at night, and which must play a role in responsible enforcement.

Save for the intrepid Marcy Wheeler and now Frontline, this speech received almost no news media attention despite being arguably one of the most important statements to come from a top law enforcement official in recent history.

The highlighted parts of that speech are what is so significant. In them, Breuer is saying that enforcing the law should not be — and no longer is, in the Department of Justice — prosecutors’ chief priority. Rather, he says listening to Wall Street’s economic arguments about the alleged cost of stopping and/or punishing lawbreaking should be.

… After all, it was Breuer who sculpted the Obama administration’s settlement with megabank HSBC after the bank admitted laundering money for drug cartels and terrorist organizations.
In that decision not to criminally prosecute any HSBC executive who had enabled such laundering, Breuer explicitly cited the same radical Too Big to Jail principle aired in the PBS Frontline report. He said: “Our goal here is not to bring HSBC down, it’s not to cause a systemic effect on the economy, it’s not for people to lose thousands of jobs.”

For pure adversarial and investigative journalism horsepower, the PBS Frontline piece rivals Bill Moyers’ epic PBS indictment of those charlatans who enabled the Bush administration’s march into the Iraq War. It is a must-watch in the truest sense of the overused term because it so powerfully explains how Obama’s campaign motto of “change” meant something entirely different than what many thought. In the case of financial crime, it meant the embrace of a radical Too Big to Jail ideology, one that creates a moral hazard, encourages exactly the same kind of crimes and therefore makes it more likely that another financial meltdown will happen.

UPDATE: A mere hours after the PBS Frontline piece aired, Lanny Breuer just announced he is resigning his post at the Justice Department. Meanwhile, PBS reporter Martin Smith just reported that in response to his report, the Obama White House has decided to block access to Frontline reporters in their future reporting.

Tags: , Comments (6) | |

If too big then, what are they now?

Jon Ogden at Switch Your Bank offers a graphic picture of too big to fail.  Lifted from an e-mail response to me…:

The units on the left axis are total assets in billions. So, yes, the total domestic assets of these 4 US megabanks grew from nearly $4.5T in 2007 to nearly $6T in 2012, or about 30%.
The data comes from the FDIC database, where I looked up each individual megabank’s assets each year since 1995.

And we also have too big to prosecute” added to the titles via HSBC.

Deal book reports two recent examples of trend:

GOLDMAN PROFIT ROSE TO $2.89 BILLION IN 4TH QUARTER Goldman Sachs on Wednesday reported a fourth-quarter profit of $2.89 billion, or $5.60 a share, well above the results a year earlier and handily beating analysts’ expectations of $3.78 a share. The results were buoyed by strong trading and investment banking results. The firm’s conference call is at 10:30 a.m.

JPMORGAN PROFIT JUMPS 53% JPMorgan Chase reported a record profit of $5.7 billion for the fourth quarter, up 53 percent from the period a year earlier. Revenues were also strong, rising 10 percent to $23.7 billion. The results were bolstered by a surge in mortgage lending.

Tags: , Comments (1) | |