A review of 13 Bankers

When you talk with Conservatives about regulation, they will generally tell you that government regulation is too pervasive and ineffective; additional regulation is out of the question, and existing regulation should be simplified.   Those same conservatives often blame the financial crisis and the Great Recession on government involvement, and claim that if only the markets were free of government interference, rational actors would allow the markets to regulate themselves.  However, deregulation during the last three decades eliminated most of the protections put in place after the Great Depression, and put us in a hole we have yet to dig ourselves out of.

Simon Johnson and James Kwak, creator of The Baseline Scenario blog and authors of 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, examine the long history of financial regulation and deregulation in their recent book.  They show that, without question, the Wall Street banks continue to hold inordinate power over our government and the U.S. economy.  They carefully trace the bipartisan financial deregulation that began under Ronald Reagan but continued through each successive administration, leading to the near collapse of the Global economy:

“Never before has so much taxpayer money been dedicated to save an industry from the consequences of its own mistakes.  In the ultimate irony, it went to an industry that had insisted for decades that it had no use for government and would be better off regulating itself – and it was overseen by a group of policymakers who agreed that government should play little role in the financial sector.”

For example, Johnson and Kwak explain the SEC agreement of April 28, 2004 that allowed the five large investment banks (Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Sterns) to calculate their own net capital based on internal models, rather than using standard models, allowing them to expand their leverage extensively for the next three years.  In fact, the regulation put in place by FDR after the Great Depression was systemically dismantled, and 13 Bankers shows how that dismantlement created massive financial institutions that were not only Too Big to Fail, but too powerful to control:

“The fact that their failure could entail the loss of millions of jobs gave the banks the power to dictate the terms of their rescue.  If the government insisted on paying market prices for the toxic assets, or insisted on taking majority control, the banks could simply refuse to go along, secure in the knowledge that the government would have to come back to the table.”

13 Bankers examines many common assumptions about the financial crisis; for example, conservatives tend to blame the entire crisis on Fannie Mae, Freddie Mac, and the Democratic Party.  However, Johnson and Kwak artfully disarm that claim:

“The riskiest mortgages, however – the ones that pushed the housing bubble to dizzying heights – were simply off-limits to Fannie and Freddie.  The [Government Sponsored Enterprses] could not buy many subprime mortgages (or securitize them) because they did not meet the conforming mortgage standards… ultimately regulatory constraints prevented them from plunging too far into subprime lending.  As housing expert Doris Dungey wrote, ‘the immovable objects of the conforming loan limits and the charter limitation of taking only loans with a maximum [loan-to-value] ratio of 80%… plus all their other regulatory strictures, managed fairly well against the irresistible force of innovation.’”

In short, the banks lobbied for years to remove the regulations that limited their size and scope; they developed complex financial instruments that were impossible to understand without a PhD from M.I.T.; they used those instruments to hide risk inside AAA rated securities that ultimately plummeted in value, and to move debt off their books; and finally, they had the nerve to complain about government interference after taxpayers backed up those risky bets.

Last summer, the Financial Reform Law was finally passed by Congress and signed by the President.  On The Baseline Scenario, Simon Johnson quickly identified the missing ingredient in the new regulation: it does nothing to reduce the size of institutions that are Too Big To Fail.  In 13 Bankers, Johnson and Kwak examine some common arguments about large banks, that they supposedly gain economies of scale, and that our large corporations require large, multi-national banks.   In fact, those claims “suffer from a shortage of empirical evidence.”  Johnson and Kwak provide good evidence to the contrary; for example, Johnson & Johnson used 11 different banks in their 2008 debt offering, and 13 different banks in their 2007 debt offering.

13 Bankers clearly identifies the systemic risk that TBTF banks offer, and warns of an even more dangerous crisis to come in the next financial cycle.  One of the main reasons is that TBTF institutions are effectively subsidized by the government, getting money for lower interest rates than smaller competitors; this occurs because investors know the government will always bail out TBTF institutions; this competitive advantage will provide the TBTF institutions a strong incentive to take excess risk.  Ultimately, until TBTF institutions are reduced in size, they will remain dangerous to long-term economic health.  Johnson and Kwak propose that commercial banks be limited to 4% of GDP and investment banks to 2% of GDP.  This would affect only six institutions: Bank of America (currently at 16% of GDP, JP Morgan Chase (14% GDP), Citigroup (13% GDP), Wells Fargo (9% GDP), Goldman Sachs (6% GDP), and Morgan Stanley (5% GDP). The goal would be to allow these banks to fail without taking down the entire economy with them.

13 Bankers will give you a good understanding of how bankers and the government have navigated the regulatory question over America’s history, and what caused the financial crisis.  The book also provides an excellent prescription for tackling the TBTF problem.  The Baseline Scenario is also an excellent resource, updated daily.


Are evangelicals becoming liberals?

Don’t look now, but the Southern Baptist Convention is turning into a bunch of liberals.  At least that is how hyper-partisans like Glen Beck and Sarah Palin would describe them.  Recently, the SBC has come out in favor of environmental regulation and comprehensive immigration reform, two issues that put them at odds with conventional right-wing ideology.

First of all the SBC passed the following resolution in the wake of the ongoing oil spill in the Gulf of Mexico:

“The Convention called on the government “to act determinatively and with undeterred resolve to end this crisis … to ensure full corporate accountability for damages, clean-up and restoration … and to ensure that government and private industry are not again caught without planning for such possibilities.”

Dr. Russell Moore, the dean of the School of Theology at Southern Baptist Theological Seminary and preacher at Highview Baptist Church near Louisville, Ky., helped pass the resolution.  He believes that conservatives should not, as Milton Friedman preached, have a lassez-faire view of government regulation:

“We, as Christians, believe in sin. That means if people are sinful, if all of us are sinful, then all of us have to have accountability — and that includes corporations.  Simply trusting corporations to go about their business without polluting the water streams and without destroying ecosystems is really a naive and utopian view of human nature. It’s not a Christian view of human nature… Human flourishing means a healthy natural environment, and it simply isn’t good for ourselves or for our neighbors to live in a world that is completely paved over and in which every piece of green land is replaced with a Bed, Bath, and Beyond,” he says. “That’s not how God designed human beings to live.”

In addition to that resolution, leaders in the SBC are coming out in favor of comprehensive immigration reform that includes both border security and a path to citizenship for undocumented workers.  Richard Land, head of SBC’s Public Policy Arm, is trying to convince Conservatives that compromise makes political sense:

“I’ve had some of them appeal to me. They say, ‘Richard, you’re going to divide the conservative coalition.’ And I said, ‘Well, I may divide the old conservative coalition, but I’m not going to divide the new one.’ If the new conservative coalition is going to be a governing coalition, it’s going to have to have a significant number of Hispanics in it, that’s dictated by demographics, and you don’t get large numbers of Hispanics to support you when you’re engaged in anti-Hispanic immigration rhetoric.”

Land believes that the fight over the Hispanic vote is being won by the Democrats, which could put Republicans in a bind for years to come:

“The people who have been anti-immigration have lost every one of these arguments,” he says. “They lost it with the Irish in the 1830s and ’40s and turned them into Democrats for three generations. They lost it with the Italians in the 1890s and the early part of the 20th century and turned the Italians into Democrats for three generations. I mean, you know, do they want to do it with the Hispanics too?”

It is surprising for me to discover that I agree with the Southern Baptist Convention on two major issues.  It would be a big coup if Conservatives could make the shift the SBC is advocating.  I am confident, however, that Sarah Palin’s opposition to environmental regulation will win the day.  I am also confident that Republicans will continue to look only at the short term on immigration, as their base gets older and older.  In other words, despite their best efforts, I don’t think the SBC will be able to save the Republican Party.


The Surprising Truth About What Motivates Us

Kudos to Brian Hull at RI Future for finding this great animation created by the RSA.  Monetary incentives aren’t always the best motivators, according to Economists from the University of Chicago, M.I.T, and Carnegie Mellon, bastions of conservative, capitalist economics.  Of course, market-driven decisions dominate the business world’s preferred risk management and regulation mindset.


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