We have previously argued that the approach to dealing with our problems by adding a layer of regulation is a mistake. The political, financial and academic communities are enamored of this approach. If only we could watch these guys more closely!
Most recently, NYU's Stern School of Business has put out a series of 2-page discussions and recommendations called "Restoring Financial Stability: How to Repair a Failed System".
This is a good read. I would like to take exception to Chapter 5, "Enhanced Regulation of Large Complex Financial Institutions (LCFIs)".
A key part of that Chapter reads:
"We believe that regulation by function is not enough in the case of LCFIs. For these institutions, we advocate a third option - a special, dedicated regulator for LCFIs. (authors' emphasis)
Au contraire. We have had enough foxes guarding enough henhouses. The regulator comes from the same milieu as the regulated and can't wait to join the institutions he regulated, especially a "LCFI" that has lots of money to pay rather than the parsimonious regulatory agency.
The simpler solution is to prohibit any LCFI from coming into existence that has governmental subsidy or poses a systemic risk to society/government.
The Internet provides a conceptual solution. The 'Net was developed to deal with a nuclear attack on the U.S. It allowed data and communications to take a meandering path through whatever nodes for data switching happened to survive the proposed attack. When you read this blog over the Internet, the packets of information get to you not through a dedicated pathway such as a traditional phone call, but rather through whatever communications path is open at the time. The system is redundant and can survive the loss of lots of interchanges. It takes a lot to destroy all Internet potential paths.
The same should be true of a modern financial system. LCFIs have proven that the purported benefits to society they offered were really licenses to gamble with what turned out to be our money when things went really, really bad. The posturing by politicians that now they really mean to stop the big bonuses etc. are for show. The truth lies in the apparent resuscitation of the TARP 1 plan by the Obama Administration for taxpayers to buy up the bad assets on these institutions' balance sheets. Why bother doing it unless it's a massive subsidy?
If, however, the financial system had a modern series of single-state, interstate or national banks, each one small, the failure of none would be systemically important. The benefits to businesses, travelers, North-South snowbirds, etc. would be present as it is now with BofA.
In order for the financial institutions to be small, they would have to have simple functions. They should little other than take deposits and make loans. And all their assets would have to be liquid. "Tier 3 assets" is an abomination as a concept.
Regarding complex financial instruments, leveraged pools of money would in my proposal be banned from borrowing from these banks. Let various people and entities lend to one another with private, risk capital. Thus, subject to whatever regulation and/or reporting is truly necessary, let them do what they want, but essentially stay out of regulating them. It's their money, after all.
One of the underlying points comes from my background as a physician. Anything a trusted physician is associated with gets some or all of the trust the patient has in the doctor, even if it is independent of the doctor's control. Similarly, once a "bank" gets into other lines of business, the average person and even a sophisticated investor associates the presumed safety and government guarantee of a bank deposit with the other functions that the holding company that owns the bank provides. One can put forth all the disclaimers one wants, but people will both misunderstand or forget those disclaimers, or at least will be subconsciously swayed to underestimate the risks. Let's not kid ourselves. How many average people understand to this day the difference between Citigroup, the holding company, and Citibank, the depository institution?
(In fact, if you Google "Citibank", your first click will be to a web page promoting Citi, presumably meaning Citigroup, rather than Citibank, which also gets mentioned now and then on the page but less prominently.)
"Prudential regulation" of large complex financial institutions is little more than putting more and more doctors on the case of a complex diabetic patient with high blood pressure who is prone to nicotine or alcohol addiction. Keeping this patient in balance is a constant struggle. And if the doctor is a friend of the patient and is also prone to sweet foods and nicotine or alcohol himself, fuggedaboutit. And if such a patient is a systemically important person, such as the Pope or President of the U.S., then what a burden on the doctor!
Keep your vices few and simple.
Let's also keep our banks simple as well; interconnected and properly regulated; but never too big to fail.
Showing posts with label Banking reform. Show all posts
Showing posts with label Banking reform. Show all posts
Saturday, January 24, 2009
Friday, January 23, 2009
Principles for Banking Reform: Small Is Beautiful
On "fixing" the banks:
The Swedish solution, the Soros solution, the upcoming Obama solution, perhaps a different Reid and/or Pelosi solution, perhaps a "why-bother" Republican solution- all may be or will be under discussion by the same inept politicians who whooped through the TARP bill last year - enhanced in the Senate to waste more of your money - after sleepwalking through the same financial crisis that set yours truly to essentially dump all of his stocks in the summer of 2007.
The Swedish solution suffers from a number of problems. For one, the Swedes protected the bond-holders. Our current problems stem from the repeal of Glass-Steagall and the non-banking businesses of the "banks" as well as the banking businesses of the "non-bank banks".
There is no reason why bondholders should receive one penny of taxpayer money (except those who bought recently under Federal guarantee, of course). They can take their lumps like everyone else. At least, unlike the great unwashed who bought and may still own NASDAQ stocks in the bubble, they have been getting paid interest regularly. In addition, Sweden's banks were likely not run by as greedy people as ran ours.
The Soros solution calls for injecting equity, again, into these financial companies. Why- the taxpayer cries- why? Let the bondholders try to salvage their investment. Let current or prior management try to avoid Sarbanes-Oxley and other prosecution for fraudulent financial practices, misleading public statements, and the like by putting their money back into the banks- in real quantity; not the pitiful $1 M that Ken Lewis threw back into the pot at BofA.
All solutions seem to revolve against getting lending going again. But there is too much debt now. America grew via land grants and the like: owndership. Let's get to a culture and an economy based not on debt but on equity. So there is a fundamental flaw in all these plans. A more practical flaw is that the same bankers would still be in charge. And they have repeatedly proven that they don't know what they're doing. Let the functionaries at your local Department of Motor Vehicles give out home loans. They can't do worse than Countrywide or Fannie/Freddie did. And they would charge a lot less.
The G30 proposes better risk management of systemically important financial institutions. That current report is sponsored by RiskMetrics. 'Nuff said.
Here are some practical and simple principles for bank reform:
1. Ban all systemically important, "too big to fail" financial institutions. The giant banks and non-bank banks have proven they are too big, slow, stupid and/or greedy to succeed. Never allow them to get bigness back. Not ever. Put it in the Constitution.
2. Allow interstate banking, but keep the banks small. Let a thousand interstate banks bloom, all bite-sized.
3. Bring back a bill that reconstitutes the principles of Glass-Steagall. Require depository institutions to stick to their knitting. Consider mandating the 3-6-3 rule (borrow at 3%, lend at 6%, and get on the golf course at 3 PM) (that's a joke). In any case, banking can be simple. Keep it that way.
4. Do NOT give blanket, gigantic FDIC coverage such as $250,000 per depositor beyond 2009. Restrict FDIC to the little guy and get rid of all the loopholes such as different titles of accounts being considered different for FDIC purposes. Australia did without governmental bank insurance until this crisis, when they had to keep up with Ireland etc., and their banks functioned tres prudently. Depositors kept an eye on their banks and lost no money.
5. America is over-housed relative to its need for international export competitiveness. Withdraw Federal tax support for homeowners in favor of other things, such as health care, environmental initiatives, high-tech industries, export industries, etc. Let people rich and poor decide if they want a better home, better health care, a better or safer car, piano lessons for the kids, etc. It's the health and wellbeing of people who count, not the number of their bathrooms. This means letting the mortgage industry, Fannie and Freddie, the FHA, etc., shrink or go away.
6. Stop manipulating short-term interest rates to levels that penalize saving. It is borrowing that should be discouraged, not saving. The same Fed that messed up in 1929-32 messed up again and continues to mess up. Hold hearings and determine if the country really needs a Fed, and if so whether its "quasi-independence" really works.
7. Do NOT listen to the RiskMetrics crowd re risk management. Listen instead to Nassim Taleb. We can't even conceive of all the risks out there. Let private entities take whatever risks they want, but structure matters so if they lose, it's their loss, not ours.
8. Follow the rule that banking and finance should be a small part of the economy. They should for the most part function like the gears in a clock: unseen and unheard; or like WD-40, lubricating the moving parts of commerce.
9. Sweeping reform of the personal finance/credit industry are required. The current Congressional bill is a minor start. Consider limiting the amount of credit anyone can have extant absent truly exigent circumstances. Place a surcharge on all credit card solicitations. Do all that can be done to fight the Merchants of Debt.
10. Inculcate knowledge of financial literacy in all public schools, starting at young grades. Children handle money at very young ages. They should learn that a penny saved grows, whereas a penny borrowed puts one in a dependent position. As a penalty for its misdeeds, the financial industry should pay for a variety of consumer education programs.
11. Get toxic financial names with bad connotations out of use. Who needs the name, "Citi" and its various permutations? The world is surviving w/o the Bear, Stearns and Lehman Bros. names. It is doing fine w/o Wachovia. It will do fine w/o Bank of America if it truly is insolvent. What's in a name? These weeds stink. They are not roses.
12. The point of #11 is that nationalization is a ruse. It is propounded by those who are part of/wedded to/joined at the hip with the current institutions. Let the companies die if they are terminal.
Where oh where is Dr. Kevorkian now that we really need him?
Copyright (C) Long Lake LLC 2009
The Swedish solution, the Soros solution, the upcoming Obama solution, perhaps a different Reid and/or Pelosi solution, perhaps a "why-bother" Republican solution- all may be or will be under discussion by the same inept politicians who whooped through the TARP bill last year - enhanced in the Senate to waste more of your money - after sleepwalking through the same financial crisis that set yours truly to essentially dump all of his stocks in the summer of 2007.
The Swedish solution suffers from a number of problems. For one, the Swedes protected the bond-holders. Our current problems stem from the repeal of Glass-Steagall and the non-banking businesses of the "banks" as well as the banking businesses of the "non-bank banks".
There is no reason why bondholders should receive one penny of taxpayer money (except those who bought recently under Federal guarantee, of course). They can take their lumps like everyone else. At least, unlike the great unwashed who bought and may still own NASDAQ stocks in the bubble, they have been getting paid interest regularly. In addition, Sweden's banks were likely not run by as greedy people as ran ours.
The Soros solution calls for injecting equity, again, into these financial companies. Why- the taxpayer cries- why? Let the bondholders try to salvage their investment. Let current or prior management try to avoid Sarbanes-Oxley and other prosecution for fraudulent financial practices, misleading public statements, and the like by putting their money back into the banks- in real quantity; not the pitiful $1 M that Ken Lewis threw back into the pot at BofA.
All solutions seem to revolve against getting lending going again. But there is too much debt now. America grew via land grants and the like: owndership. Let's get to a culture and an economy based not on debt but on equity. So there is a fundamental flaw in all these plans. A more practical flaw is that the same bankers would still be in charge. And they have repeatedly proven that they don't know what they're doing. Let the functionaries at your local Department of Motor Vehicles give out home loans. They can't do worse than Countrywide or Fannie/Freddie did. And they would charge a lot less.
The G30 proposes better risk management of systemically important financial institutions. That current report is sponsored by RiskMetrics. 'Nuff said.
Here are some practical and simple principles for bank reform:
1. Ban all systemically important, "too big to fail" financial institutions. The giant banks and non-bank banks have proven they are too big, slow, stupid and/or greedy to succeed. Never allow them to get bigness back. Not ever. Put it in the Constitution.
2. Allow interstate banking, but keep the banks small. Let a thousand interstate banks bloom, all bite-sized.
3. Bring back a bill that reconstitutes the principles of Glass-Steagall. Require depository institutions to stick to their knitting. Consider mandating the 3-6-3 rule (borrow at 3%, lend at 6%, and get on the golf course at 3 PM) (that's a joke). In any case, banking can be simple. Keep it that way.
4. Do NOT give blanket, gigantic FDIC coverage such as $250,000 per depositor beyond 2009. Restrict FDIC to the little guy and get rid of all the loopholes such as different titles of accounts being considered different for FDIC purposes. Australia did without governmental bank insurance until this crisis, when they had to keep up with Ireland etc., and their banks functioned tres prudently. Depositors kept an eye on their banks and lost no money.
5. America is over-housed relative to its need for international export competitiveness. Withdraw Federal tax support for homeowners in favor of other things, such as health care, environmental initiatives, high-tech industries, export industries, etc. Let people rich and poor decide if they want a better home, better health care, a better or safer car, piano lessons for the kids, etc. It's the health and wellbeing of people who count, not the number of their bathrooms. This means letting the mortgage industry, Fannie and Freddie, the FHA, etc., shrink or go away.
6. Stop manipulating short-term interest rates to levels that penalize saving. It is borrowing that should be discouraged, not saving. The same Fed that messed up in 1929-32 messed up again and continues to mess up. Hold hearings and determine if the country really needs a Fed, and if so whether its "quasi-independence" really works.
7. Do NOT listen to the RiskMetrics crowd re risk management. Listen instead to Nassim Taleb. We can't even conceive of all the risks out there. Let private entities take whatever risks they want, but structure matters so if they lose, it's their loss, not ours.
8. Follow the rule that banking and finance should be a small part of the economy. They should for the most part function like the gears in a clock: unseen and unheard; or like WD-40, lubricating the moving parts of commerce.
9. Sweeping reform of the personal finance/credit industry are required. The current Congressional bill is a minor start. Consider limiting the amount of credit anyone can have extant absent truly exigent circumstances. Place a surcharge on all credit card solicitations. Do all that can be done to fight the Merchants of Debt.
10. Inculcate knowledge of financial literacy in all public schools, starting at young grades. Children handle money at very young ages. They should learn that a penny saved grows, whereas a penny borrowed puts one in a dependent position. As a penalty for its misdeeds, the financial industry should pay for a variety of consumer education programs.
11. Get toxic financial names with bad connotations out of use. Who needs the name, "Citi" and its various permutations? The world is surviving w/o the Bear, Stearns and Lehman Bros. names. It is doing fine w/o Wachovia. It will do fine w/o Bank of America if it truly is insolvent. What's in a name? These weeds stink. They are not roses.
12. The point of #11 is that nationalization is a ruse. It is propounded by those who are part of/wedded to/joined at the hip with the current institutions. Let the companies die if they are terminal.
Where oh where is Dr. Kevorkian now that we really need him?
Copyright (C) Long Lake LLC 2009
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