The Absurdity of Sandy Weill

I’m suggesting the big banks be broken up so that the taxpayer will never be at risk, the depositors won’t be at risk and the leverage will be something reasonable.

This from the guy who provided the impetus and the funds to end Glass-Steagall? Totally absurd — akin to Joe Stalin renouncing Marxism-Leninism and the gulag archipelago on his deathbed.

Glass-Steagall’s separation between depository and speculative institutions — especially during the Bretton Woods period — was a relatively robust system; there was never a large-scale banking calamity of the nature of 2008 or 1929 under its regime. Certainly, it had its imperfections — above all else that it never prevented bankers like Weill from chipping away at it up to the point of repeal — but the proof of the pudding is in the eating, and Glass-Steagall presided over a period of growth and stability.

While the data tends to show that the end of Bretton Woods in 1971 was the real catalyst of the financialisation, globalisation, deindustrialisation and debt buildup that ultimately flung the US into a depressionary deleveraging trap, the end of Glass-Steagall was profound.

Depositors’ funds became a medium for the creation of the huge and sprawling shadow banking and derivatives webs.

The blowout growth in shadow banking was presaged by the end of Glass-Steagall in 1999:

And the slow contractionary deleveraging of shadow banking has been a significant force in keeping the economy depressed since 2008. Any contrition on the part of Weill for his role in repealing Glass-Steagall might as well be an attempt to close the stable door after the horse has bolted. It’s like trying to uninvent the atom bomb after Hiroshima. Weill was the guy who — above anyone else — was responsible for the damage done.

Coming out and claiming that reimposing Glass-Steagall would fix the problem is inadequate. If he wants to be taken seriously he should match every dollar he spent trying to get Glass-Steagall repealed with new lobbying funds to reimpose a separation between banks that accept deposits and the shadow banking and derivatives casinos.

Beyond that, I think that this is very telling. The financial institutions will do anything to avoid the ultimate free market solution — the disorderly liquidation of the system they created via default cascade. If high-ranking members of the financial elite are willing to talk about reimposing Glass-Steagall, they must be seriously concerned that the system they built is getting dangerously close to self-destruction.

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Can Banking Regulation Prevent Stupidity?

In the wake of J.P. Morgan’s epic speculatory fail a whole lot of commentators are talking about regulation. And yes — this was speculation — if Dimon gets to call these activities “hedging portfolio risk“, then I have the right to go to Vegas, play the Martingale roulette system, and happily call it “hedging portfolio risk” too, because hey — the Martingale system always wins in theory.

From Bloomberg:

The Volcker rule, part of the Dodd-Frank financial reform law, was inspired by former Federal Reserve Chairman Paul Volcker. It’s supposed to stop federally insured banks from making speculative bets for their own profit — leaving taxpayers to bail them out when things go wrong.

As we have said, banks have both explicit and implicit federal guarantees, so the market doesn’t impose the same discipline on them as, say, hedge funds. For this reason, the Volcker rule should be as airtight as possible.

Proponents of regulation point to the period of relative financial stability between the enactment of Glass-Steagall and its repeal. But let’s not confuse Glass-Steagall with what’s on the table today. It’s a totally different ball game.

To be honest, I think the Volcker rule is extremely unlikely to be effective, mostly because megabanks can bullshit their way around the definitional divide between proprietary trading and hedging. If anything, I think the last few days have proven the ineffectiveness, as opposed to the necessity of the Volcker rule. Definitions are fuzzy enough for this to continue. And whatever is put in place will be loopholed through by teams of Ivy League lawyers. What is the difference between hedging and speculation, for example? In my mind it’s very clear — hedging is betting to counterbalance specific and explicit risks, for example buying puts on a held equity. In the mind of Jamie Dimon, hedging is a fuzzy form of speculative betting to guard against more general externalities. I know that I am technically right, and Dimon is technically wrong, but I am also fairly certain that Dimon and his ilk can bend regulators into accepting his definition.

What we really need is a system that enforced the Volcker principle:

As Matt Yglesias notes:

Once bank lawyers finish finding loopholes in the detailed provisions, whatever they prove to be, the rule will probably have little meaningful impact.

The problem with principles-based regulation in this context is that you might fear that banks will use their political influence to get regulators to engage in a lot of forebearance. The problem with rules-based regulation in this context is that it’s really hard to turn a principle into a rule.

And I fear that nothing short of a return to Glass-Steagall — the explicit and categorical separation of investment and retail banking — will even come close to enforcing the Volcker principle.

Going even further, I am not even sure that Glass-Steagall will assure an end to this kind of hyper-risky activities that lead to crashes and bailouts.

The benefits of the Glass-Steagall era (particularly the high-growth 1950s and 1960s) were not solely derived from banking regulation. America was a very different place. There was a gold exchange standard that limited credit creation beyond the economy’s productive capacity (which as a Bank of England study recently found is correlated with financial and banking stability). But beyond that, America was creditor to the world, and an industrial powerhouse. And I’m sure Paul Krugman would hastily point out that tax revenues on the richest were as high as 90% (although it must be noted that this made no difference whatever for tax revenues). And we should not forget that it was that world that give birth to this one.

Anyone who worked in finance in the decade before Glass-Steagall was repealed knows that prior to Gramm-Leach-Bliley the megabanks just took their hyper-leveraged activities offshore (primarily to London where no such regulations existed). The big problem (at least in my mind) with Glass-Steagall is that it didn’t prevent the financial-industrial complex from gaining the power to loophole and lobby Glass-Steagall out of existence, and incorporate a new regime of hyper-leverage, convoluted shadow banking intermediation, and a multi-quadrillion-dollar derivatives web (and more importantly a taxpayer-funded safety net for when it all goes wrong: heads I win, tails you lose).

I fear that the only answer to the dastardly combination of hyper-risk and huge bailouts is to let the junkies eat dirt the next time the system comes crashing down. You can’t keep bailing out hyper-fragile systems and expect them to just fix themselves. The answer to stupidity is not the moral hazard of bailouts, it is the educational lesson of failure. You screw up, you take more care next time. If you’re bailed out, you just don’t care. Corzine affirms it; Iksil affrims it; Adoboli affirms it. And there will be more names. Which chump is next? If you’re trading for a TBTF bank right now — especially if your trading pattern involves making large bets for small profits (picking up nickels in front of steamrollers) — it could be you. 

I fear that the only effective regulation was that advocated way back before Gramm-Leach-Blilely by Warren G and Nate Dogg:

We regulate any stealing off this property. And we’re damn good too. But you can’t be any geek off [Wall] street, gotta be handy with the steel, if you know what I mean, earn your keep.

In other words, the next time the fragilista algos and arbitrageurs come clawing to the taxpayer looking for a bailout, the taxpayer must kick them off the teat.

UPDATE:

Some commenters on Zero Hedge have made the point that this is not a matter of stupidity so much as it is one of systemic and purposeful looting. Although I see lots of evidence of real stupidity (as I described yesterday), even if I am wrong, I know that to get access to the bailout stream banks have to blow up and put themselves into a liquidity crisis, and even if they think that is an easy way to free cash it’s still pretty stupid because eventually — if not this time then next time — they will end up in bankruptcy court. It would be like someone with diabetes stopping their medication to get attention…

Britain Separates Retail and Investment Banking — But Will it Work?

A government-commissioned report led by John Vickers into Britain’s financial system has been published — and its chief recommendation is a separating wall between retail and investment banking. This is a very similar system to what prevailed in America until 1996 under the Glass-Steagall Act of 1933. The chief intent is to prevent the endangerment of customers’ savings, mortgages and pensions through banks’ much riskier and more free-wheeling investment arms. This means that the risky but profitable investment banking sector would no longer be considered infrastructural, and — in theory — would be no longer be eligible for bailouts.

From the BBC:

There has been widespread support for a government-backed commission that has recommended UK banks ring-fence retail from investment banking.

The Independent Commission on Banking, led by Sir John Vickers, said it would “make it easier and less costly to resolve banks that get into trouble”.

The ICB called for the changes to be implemented by the start of 2019.

Chancellor George Osborne said the report would mean UK banks could remain competitive.

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