Thursday, May 31, 2012

Weekly Standard: Yes, Time To Break Up The Banks

Emmanuel Dunand / AFP/GettyImages
Originally published on Tue May 29, 2012 9:00 am
James Pethokoukis is a columnist and blogger at the American Enterprise Institute and a contributor to CNBC.
America needs to break up its biggest banks, but not for reasons likely to give a tingle to Occupy Wall Street's remnant rabble (or its Great Everywhere Spirit, Senate candidate Elizabeth Warren of Massachusetts). This isn't about some political exercise in election-year demonization. Bankers, as a class, aren't villains. They're not "banksters" grifting money from middle-income pockets. And they're certainly not vampire squids on the collective face of humanity, asRolling Stone writer Matt Taibbi has infamously described Goldman Sachs. And while it might be rhetorical overkill to say they're "doing God's work," as Goldman boss Lloyd Blankfein has put it, bankers do fulfill a critical economic function. Bankers, not bureaucrats, are supposed to be the efficient allocators of capital in America's market-based economy. They connect people who have spare dough to those who need a bit of spare dough, such as entrepreneurs looking to start a business or companies looking to grow one. We need lots of successful banks, and we need smart folks to run them.
But America doesn't need 20 banks with combined assets equal to nearly 90 percent of the U.S. economy, or five mega-banks — JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs — with combined assets equal to almost 60 percent of national output, three times what they were in the 1990s. That amount of complexity and financial concentration — which has grown worse since the passage of Dodd-Frank — is a current and continuing threat to the health of the U.S. economy. Now don't blame market failure or unintended results of deregulation. Banks that big and complex and interconnected are both the unsurprising outcome of Washington's 30-year expansion of the federal safety net and the cause of its ongoing existence. When you combine a "too big to fail" guarantee from Uncle Sam with the natural human tendency toward irrational exuberance, you have the key elements in place for another unaffordable financial crisis.
Bubbles are nothing new. And the root cause of the financial crisis of 2008-2009 may have been no different than what drove manias for Dutch tulips in 17th-century Holland, shares of the South Sea Company in 18th-century England, or dot-com stocksin 1990s America. This time around, the vehicle for the market's mania was an outbreak of cockeyed optimism about housing prices — among both lenders and borrowers — and their inability to ever decline. A new study from the Federal Reserve banks of Atlanta and Boston, "Why Did So Many People Make So Many Ex Post Bad Decisions: The Causes of the Foreclosure Crisis," explains it this way: "Bubbles do not need securitization, government involvement or nontraditional lending products to get started. . . . If the problem was some collective, self-fulfilling mania, [a new round of regulations] will not work."
The supporters of the Dodd-Frank financial reform law, the study suggests, diagnosed and treated the financial crisis like it was an outbreak of malaria, a preventable disaster caused by a disease whose pathologies are well understood. Change this or that incentive via this or that financial regulation and the problem is far less likely to repeat.
But that approach is as much a case of mass delusion as the one that afflicted all those owners in 2007 of sure-thing mortgage-backed securities or mini-mansions in reclaimed Nevada desert. MIT economist Andrew Lo reviewed 21 books about the financial crisis and concluded that "like the characters in Rashomon, we may never settle on a single narrative that explains all the facts; such a 'super-narrative' may not even exist."
Lo finds the empirical evidence for many so-called facts that influenced Dodd-Frank to be unclear at best. We all know, of course, that Wall Street compensation was too focused on making a quick buck from short-term trading profits. Yet Lo inconveniently points out that big bank CEOs' aggregate stock and option holdings were more than eight times the value of their annual compensation, making it "improbable that a rational CEO knew in advance of an impending financial crash, or knowingly engaged in excessively risky behavior."
And a rational CEO of a key Wall Street player also knew that if he did make some cataclysmic mistake, Uncle Sam was there to cushion the landing. Indeed, the bigger the firm and the more enmeshed it was in the financial system, the more likely the government backstop would be there. The riskier banks were, paradoxically, the safer they were — at least for bondholders. So why wouldn't "rational CEOs" try to increase their return on equity by lowering capital levels, increasing leverage, and finding new, profitable lines of business? They might be violating their duty to bank shareholders if they didn't. "The consequence of expanding the safety net to an ever-increasing range of activities is to invite a repeat of our most recent crisis," said Thomas Hoenig, vice chairman of FDIC and former president of the Kansas City Fed, in a speech last year.
But treating the financial crisis like a malaria outbreak uses the wrong model. Better, say the authors of that Fed bank study, to view the meltdown as a different sort of noneconomic catastrophe: "Science has a theory of why earthquakes occur, but quakes strike without warning, and there is nothing we can do to prevent them. Even so, policymakers can mitigate their consequences." Or as Hayek might have put it, not only is government unable to predict the future, the world is too complicated for it to really have much useful understanding of what's going on right now. Regulators are always a day late and a dollar short. Indeed, despite Dodd-Frank, the biggest banks still have a sizable funding edge over their smaller rivals. Markets still perceive them as too big to fail.
So how do you (a) make the financial system more shockproof when the next economic earthquake hits, (b) reduce the likelihood of expensive taxpayer bailouts, and (c) ensure the banks themselves don't cause the next crisis? Hoenig, for one, would only allow banks to engage in traditional activities that are well understood and are based on long-term customer relationships so borrowers and lenders are on the same page: commercial banking, underwriting securities, and asset management services. Banks would be barred from broker-dealer activities, making markets in derivatives or securities, trading securities or derivatives for their own accounts or for customers, and sponsoring hedge funds or private equity funds. The result would be banks that are smaller, simpler, safer. Not only would they be less likely to spark financial crisis because management would know government might let them fail, the cost of failure to taxpayers would be less.
Of course, some will argue that we need large, complex financial institutions and that their very existence is proof of that. Who are the know-it-all breaker-uppers to say we don't? But that size and complexity is itself more a result of crony capitalism than of market forces. It's little wonder, then, that the preponderance of the evidence is that all the supposed benefits from supersized banks and their economies of scale are outweighed by the risks of disaster they generate. Take this 2011 study from the University of Minnesota: "Our calculations indicate that the cost to the economy as a whole due to increased systemic risk is of an order of magnitude larger than the potential benefits due to any economies of scale when banks are allowed to be large. . . . This suggests that the link between TBTF banks and financial crises needs to be broken. One way to achieve that is to break the largest banks into much smaller pieces."
There are other options, of course. We could just put a hard cap on bank size. But there's no clear evidence what that size limit should be. Besides, while the failure of a big bank creates a big economic impact, it's not necessarily size that makes a bank potentially dangerous as much as what a bank does. Others want to treat systemic risk as an externality like pollution and tax it. Nothing wrong with that in theory. Former presidential candidate Jon Huntsman proposed just such a plan and would have used the revenue to cut corporate taxes. The riskier the activities the bank engages in, the higher the tax. But this again requires too much knowledge on the part of regulators to precisely gauge the riskiness of activities or assets and levy an appropriate tax. Again, Hayek. A risk tax also creates new opportunities for Wall Street lobbying.
What about just getting Washington out of the banking business entirely? No deposit insurance for investors. No Federal Reserve as a lender of last resort. Lenders would be more vigilant, bank execs more scared, moral hazard eliminated. But explaining to the American public the need to do away with these two longtime features of both the American economy and advanced economies globally would take time, time we may not have. And if a crisis should occur, politicians would still be strongly tempted to start cutting checks. And America cannot afford another economy-crushing financial crisis, not now and probably not for years. In 2007, publicly held federal debt as a share of national economic output was 36 percent. In 2012, it will be roughly double that level, 73 percent, and likely heading even higher. And once you add what Uncle Sam owes in social insurance entitlements, total U.S. debt is bigger than the entire economy, 103 percent of GDP. That amount of indebtedness is well past the 90 percent level identified by economists Carmen Reinhart and Kenneth Rogoff as a serious drag on long-term growth. And like the debt, unemployment is also already at an intolerable level and likely to remain historically high for years to come given the slow pace of recovery.
Also unlike those ideas on libertarian wish lists, breaking up the banks has some actual legislative momentum thanks to JPMorgan's huge trading losses on its botched hedging strategy. Banking analyst Jaret Seiberg of Guggenheim Securities' Washington Research Group calls a bipartisan bank breakup movement along the lines Hoenig outlines both a "serious threat" and the top issue facing the sector for the rest of the year. "The Republican response to Dodd-Frank's overkill is to break up the banks. The far left also wants to break up the big banks. The issue with the JPMorgan hedging mess is that it empowers the far left and the far right to pursue their agendas while the silent majority in the middle ducks for political cover." In fact, what banking analysts call a "serious threat" should strike those outside the management of big banks — left, right, and center — as a "serious opportunity."
Breaking up the biggest banks would allow markets to work better, by cutting down on crony capitalist rent-seeking by big money from big government. It would also reduce the moral hazard created by Washington's too big to fail policy. Ending too big to fail isn't a policy conservatives should shy away from — even if some on the left support it too.

Copyright 2012 The Weekly Standard. To see more, visit

Wednesday, May 30, 2012

Clock running on foreclosure reviews

If you lost your house to foreclosure, the last thing you might want to do is relive the pain.
But if you suspect that something was wrong during the foreclosure process, you need to take advantage of an independent review mandated by federal banking regulators.
Related Stories

We can all hear you, and it’s annoying

We can all hear you, and it’s annoying
The train used to be my happy place — until rude people’s inane conversations ruined it.

Student loans require homework

Student loans require homework
Parents and students heading off to college should pay attention to the horror stories about excessive debt.

Used cars: Not a clunker choice

Used cars: Not a clunker choice
Paying cash for an older vehicle can be more advantageous than borrowing for a newer one.
Last year, 14 large residential mortgage servicers were required by the Federal Reserve, the Office of the Comptroller of the Currency and the Office of Thrift Supervision to retain independent consultants to review their foreclosure actions. This was the result of widespread complaints by consumer advocates and borrowers about deceitful and improper foreclosure practices by some mortgage servicers.
If consultants find fault during the review, then borrowers who suffered financial injury because of errors, misrepresentations or other problems in the foreclosure process may get money or some other remedy.
At the end of last year, a consulting firm acting on behalf of federal bank regulators sent 4.3 million letters to individuals who might be eligible to have their foreclosuresreviewed. Through May 17, more than 194,000 people responded, asking for a review. Another 142,000 people have been selected for review because their foreclosures were related to a bankruptcy or the foreclosure might have violated the Servicemembers Civil Relief Act, which provides certain rights to members of the military.
“If people believe they were wrongfully injured by a foreclosure error in 2009 and 2010, they should request a review,” said Bryan Hubbard, a spokesman for the OCC. “They give up no rights by requesting a review.”
To also qualify, the foreclosure had to be on the person’s primary residence and the mortgage servicer had to come from one of 14 participating companies.
If you received a letter, you might have thought, “Why bother?” You might be skeptical that anything will come of it. But don’t lose out on the chance to get some redemption if it turns out that your mortgage servicer did something wrong.
“The review can take several months, and they are very detailed,” Hubbard said.
There’s another bonus to finding out whether you qualify for a review. Requests from eligible borrowers in which a foreclosure sale is imminent will receive priority attention, the OCC has said. But don’t expect too much. You still need to work with your mortgage servicer to determine whether the foreclosure can be prevented. Although asking for a review won’t automatically postpone or stop a foreclosure, at least the extra attention might help.
The review isn’t just for folks whose homes were sold through foreclosure. Consultants will be looking at cases in which homes were slated for foreclosure but the process stopped because payments were brought up to date, the borrower entered a payment plan or modification program, or the home was sold in a short sale or given back to the lender.
But you have to act soon. The deadline for requests to get a review by an independent consultant is July 31.
Additional letters will be sent out early in June, Hubbard said. And to increase awareness of eligibility, the Federal Reserve has put together a short video that can be found on YouTube by searching for “Independent Foreclosure Review PSA.”
Here are some additional things that might have gone wrong in your foreclosure that consultants will examine:
●The mortgage balance was listed incorrectly.
●The foreclosure occurred while someone was waiting for a modification although the person submitted all of the paperwork on time.
●A borrower thinks the mortgage payment and/or the fees that the servicer charged were inaccurate.
The review is free, and there is just one review process. Go to the Web site www.
 for a list of the 14 mortgage servicers and for information about the review and claim process. You can mail your request form or submit it online. To get the form online, you have to click on the link for your servicer. The company you sent your monthly mortgage payments to is your mortgage servicer. If you need help completing the form or if you have questions, call 888-952-9105.
Put your request in. You really have nothing to lose and possibly something to gain.
Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071, or singletarym@ Personal responses may not be possible, and comments or questions may be used in a future column, with the writer’s name, unless otherwise requested. For previous Color of Money columns, go to

Friday, May 25, 2012

Egos and Immorality

In the wake of a devastating financial crisis, President Obama has enacted some modest and obviously needed regulation; he has proposed closing a few outrageous tax loopholes; and he has suggested that Mitt Romney’s history of buying and selling companies, often firing workers and gutting their pensions along the way, doesn’t make him the right man to run America’s economy.
Fred R. Conrad/The New York Times
Paul Krugman
Opinion Twitter Logo.

Connect With Us on Twitter

For Op-Ed, follow@nytopinion and to hear from the editorial page editor, Andrew Rosenthal, follow@andyrNYT.

Readers’ Comments

Readers shared their thoughts on this article.
Wall Street has responded — predictably, I suppose — by whining and throwing temper tantrums. And it has, in a way, been funny to see how childish and thin-skinned the Masters of the Universe turn out to be. Remember when Stephen Schwarzman of the Blackstone Group compared a proposal to limit his tax breaks to Hitler’s invasion of Poland? Remember when Jamie Dimon of JPMorgan Chase characterized any discussion of income inequality as an attack on the very notion of success?
But here’s the thing: If Wall Streeters are spoiled brats, they are spoiled brats with immense power and wealth at their disposal. And what they’re trying to do with that power and wealth right now is buy themselves not just policies that serve their interests, but immunity from criticism.
Actually, before I get to that, let me take a moment to debunk a fairy tale that we’ve been hearing a lot from Wall Street and its reliable defenders — a tale in which the incredible damage runaway finance inflicted on the U.S. economy gets flushed down the memory hole, and financiers instead become the heroes who saved America.
Once upon a time, this fairy tale tells us, America was a land of lazy managers and slacker workers. Productivity languished, and American industry was fading away in the face of foreign competition.
Then square-jawed, tough-minded buyout kings like Mitt Romney and the fictional Gordon Gekko came to the rescue, imposing financial and work discipline. Sure, some people didn’t like it, and, sure, they made a lot of money for themselves along the way. But the result was a great economic revival, whose benefits trickled down to everyone.
You can see why Wall Street likes this story. But none of it — except the bit about the Gekkos and the Romneys making lots of money — is true.
For the alleged productivity surge never actually happened. In fact, overall business productivity in America grew faster in the postwar generation, an era in which banks were tightly regulated and private equity barely existed, than it has since our political system decided that greed was good.
What about international competition? We now think of America as a nation doomed to perpetual trade deficits, but it was not always thus. From the 1950s through the 1970s, we generally had more or less balanced trade, exporting about as much as we imported. The big trade deficits only started in the Reagan years, that is, during the era of runaway finance.
And what about that trickle-down? It never took place. There have been significant productivity gains these past three decades, although not on the scale that Wall Street’s self-serving legend would have you believe. However, only a small part of those gains got passed on to American workers.
So, no, financial wheeling and dealing did not do wonders for the American economy, and there are real questions about why, exactly, the wheeler-dealers have made so much money while generating such dubious results.
Those are, however, questions that the wheeler-dealers don’t want asked — and not, I think, just because they want to defend their tax breaks and other privileges. It’s also an ego thing. Vast wealth isn’t enough; they want deference, too, and they’re doing their best to buy it. It has been amazing to read about erstwhile Democrats on Wall Street going all in for Mitt Romney, not because they believe that he has good policy ideas, but because they’re taking President Obama’s very mild criticism of financial excesses as a personal insult.
And it has been especially sad to see some Democratic politicians with ties to Wall Street, like Newark’s mayor, Cory Booker, dutifully rise to the defense of their friends’ surprisingly fragile egos.
As I said at the beginning, in a way Wall Street’s self-centered, self-absorbed behavior has been kind of funny. But while this behavior may be funny, it is also deeply immoral.
Think about where we are right now, in the fifth year of a slump brought on by irresponsible bankers. The bankers themselves have been bailed out, but the rest of the nation continues to suffer terribly, with long-term unemployment still at levels not seen since the Great Depression, with a whole cohort of young Americans graduating into an abysmal job market.
And in the midst of this national nightmare, all too many members of the economic elite seem mainly concerned with the way the president apparently hurt their feelings. That isn’t funny. It’s shameful.

Thursday, May 24, 2012

JPMorgan, the Volcker Rule, and the Extreme Brevity of Financial Memory

Posted: 05/24/2012 11:16 am

Financial crises are a lot like childbirth -- they both involve a lot of pain and end up costing you a lot ofmoney. But, after a while, you forget about all the negatives and are ready to do it again. Of course, with childbirth you at least get something positive out of it. In my own case, I'd forgotten enough about the downside of having a baby to do it again two years later -- without an epidural. (My older daughter just graduated from college this week -- time flies!) This propensity to forget, so useful when it comes to having babies, is incredibly destructive when it comes to our economy. So why do we do it?
In 1990, John Kenneth Galbraith tried to answer this vexing question in his bookA Short History of Financial Euphoria. Using the 1987 market crash as his launch pad, Galbraith looks at the history of financial bubbles -- and the subsequent and inevitable crashes -- and at why the lessons that would prevent boom and bust cycles from happening with devastating regularity are never learned. To Galbraith it's a combination of "the extreme brevity of the financial memory" and a general ignorance of history.
"There can be few fields of human endeavor in which history counts for so little as in the world offinance," he writes. "Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."
And not only is the boom and bust cycle repeated endlessly, so is the response. See if this sounds familiar: When the initial wave of public anger at a financial bubble bursting is at its highest, there are pledges from politicians to get tough and "never let this happen again." Some reforms are proposed but, as the public's anger -- and memory -- weakens, so does the "reform." By the time reform measures are passed (if they even are), lobbying has weakened them enough to make another crisis inevitable. In fact, that's how these measures are designed -- not with the intent of creating a fresh crisis per se, but by providing loopholes that explicitly allow the activities that will make the next crisis inevitable.
Exhibit A: The renewed battle over the so-called Volcker Rule in response to JPMorgan Chase'srecent trading loss -- which might reach $5 billion. How did such a massive misstep happen? We want to think there must be some extraordinary reason for such an extraordinary loss. Was it because of a change in JPMorgan's risk model, which hid the true extent of risk the bank was taking on? Was it because of the personnel conflicts brought on by the vacuum created when Ina Drew, head of JPMorgan's chief investment office, came down with Lyme disease in 2010? Or was it, in fact, inevitable because "of a loophole in the reform legislation that Obama signed"?
In any case, it was no doubt helped along by the "extreme brevity of the financial memory." Right now the question is whether the small-bore outrage over the JPMorgan debacle will help the small-bore reform -- in the form of the Volcker Rule -- inch across the finish line in some more-than-meaningless form. But it's also useful to go back a bit, into Galbraith's "primitive refuge" of "past experience." Let's go back to 2008. It's not that long ago, but it has the feel of a distant memory when you recall the level of outrage directed at big banks at the time, and the kind of real reform that, for a minute or two, seemed possible. There were serious proposals to transform the way big banks do business, and to ensure that taxpayers would never again have to step in to pay the tab after another Wall Street bender. There was a lot of tough talk from the new Obama administration, which, if it was willing to do more than talk, had the public's will -- and outrage -- behind it.
But as the banks and their lobbyists surely knew, the devil is in the details. So, as the public began to forget its outrage, the lobbyists began to get to work. First, the most meaningful proposals, like bringing back Glass-Steagall, or getting rid of too-big-to-fail banks by breaking them up, were tossed aside. What was left became the Dodd-Frank bill, passed in the summer of 2010. In the year following the bill's passage, over two-dozen pieces of legislation were put into the mix to weaken it.
According to Public Citizen, members of Congress who support a weakened version of the rule raked in 35 times more in contributions from the financial industry than those who support a strong version -- $66.7 million to $1.9 million. And as lobbying intensified this spring, lawmakers were, as Bloomberg News put it, "signaling they're receptive" to revising the rule. Sounds like something out of a nature documentary -- modern democracy's equivalent of wild animals signaling they're receptive by lifting their behinds.
And now comes the JPMorgan trading loss -- exactly the kind of thing the Volcker Rule is supposed to prevent. "JPMorgan Chase has a big hedge fund inside a commercial bank," said Boston University economics professor Mark Williams. "They should be taking in deposits and making loans, not taking large speculative bets." Or, as Felix Salmon put it, the bank was "using its Chief Investment Office to gamble with taxpayer-backstopped funds." Once again, the taxpayer is the ATM at the Wall Street casino -- exactly what all the politicians, responding to our outrage in 2008 and 2009, were never going to let happen again.
And, once again, we're hearing the tough talk. "We are very confident that we will be able to make sure [the new rules] come out as tough and effective as they need to be and I think this episode helps to make that case," said Treasury Secretary Tim Geithner.
"Without Wall Street reform, we could have found ourselves with the taxpayers once again on the hook for Wall Street's mistakes," said President Obama. "We've got to finish the job of implementing this reform and putting these rules in place."
Could have? And finish the job? It's not like the loophole-ridden Volcker Rule will end too-big-to-fail -- and as long as that's the case, the banks know they have us right where they want us. And the president didn't mention anything about finishing the job a few days earlier when he appeared onThe View and declared that "JPMorgan is one of the best-managed banks there is." Peter Boyer and Peter Schweizer say this is evidence of Obama's "passive-aggressive relationship with Big Finance," but when someone is passive-aggressive, they're expressing aggression in the guise of passivity. This is passivity in the guise of aggression.
As for finishing the job, even when the Volcker Rule is implemented in July, the banks have two years to comply -- and to further water it down. Or, if Mitt Romney wins, repeal the Dodd-Frank bill altogether, as he's pledged to do.
Hearings were held Tuesday in the Senate Banking Committee on finalizing the derivatives rules. Before the JPMorgan debacle the leading Democrats, Chairman Tim Johnson and Chuck Schumer, wanted to lighten protections. Now, Johnson says the JPMorgan case illustrates "why opponents of Wall Street reform must not be allowed to gut important protections for the financial system and taxpayers." But where was that tough talk before? After all, what happened with JPMorgan was inevitable under the looser rules Johnson and Schumer seemed to support as of a few weeks ago.
The Times editorializes that "JPMorgan's fiasco should be a teachable -- even a transformational moment." Well, don't hold your breath.
It's clear the solution to the destructive effects of the financial euphoria-driven boom and bust cycle will not be found in Washington. The banks will always win on that front -- they own the lobbyists, and the lobbyists have a stranglehold on the legislative process. When piecemeal rules are written, the banks will hide behind complexity and loopholes.
So we all need to stop forgetting. We need to tap back into the outrage we felt when the financial crisis erupted in 2008. And maybe there could be some sort of Clockwork Orange-like aversion therapy for those inside the banks. Just imagine what would happen if any time a dazzling new financial transaction is mentioned, an electric shock follows -- strong enough to make us question the wonders of financial "innovation." It's sometimes said that humans have natural aversions to snakes and cannibalism. Maybe with the right kind of training we can eventually add to that list financial trades in which complexity has somehow magically removed all the risk.
Would this aversion therapy work? I'm not sure, but I know it's got a better chance of stopping the next nobody-saw-that-one-coming crisis than a watered-down Volcker Rule. Otherwise, a few years down the road, we're going to once again find ourselves in a lot of pain, wondering, "How could I ever have forgotten just how horrible this is?"
Add your voice to the conversation on Twitter: