bail ’em out then break ’em up

Posted on Wednesday 28 October 2009

Fool me once, shame on you. Fool me twice, shame on me.
           not George W. Bush
Greenspan Says U.S. Should Consider Breaking Up Large Banks
Bloomberg

By Michael McKee and Scott Lanman
October 15, 2009

U.S. regulators should consider breaking up large financial institutions considered “too big to fail,” former Federal Reserve Chairman Alan Greenspan said. Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations. That squeezes out competition and creates a danger to the financial system, Greenspan told the Council on Foreign Relations in New York.

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil – so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.” At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc.

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said. Fed officials have suggested imposing a tax or requiring higher capital ratios on larger banks to ensure the firms’ safety and reduce some of the competitive advantage from the implied subsidy. Greenspan said that won’t work. “I don’t think merely raising the fees or capital on large institutions or taxing them is enough,” Greenspan said. “I think they’ll absorb that, they’ll work with that, and it’s totally inefficient and they’ll still be using the savings.”

Really Arbitrarily
The former Fed chairman said while “just really arbitrarily breaking down organizations into various different sizes” goes against his philosophical leanings, something must be done to solve the too-big-to-fail issue. “If you don’t neutralize that, you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society,” he said. “Failure is an integral part, a necessary part of a market system,” he said. “If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.”
There’s a many-fold problem in listening to Alan Greenspan. First, he had a big part to play in leading us down this path to the Financial Crisis 0f 2008 – a really big part. Second, like the newly sober alcoholic or the recently born-again christian, it’s hard to trust his intuition. What must it be like to be Alan Greenspan and know from the inside how wrong he really was in a number of areas where he was directly involved in leading us to ruin. He is, himself, a player in why we have these mega  banks   financial institutions  whatever-they-are.

But we have a problem too. Alan Greenspan is an unlikely celebrity. He looks like he evolved along the amphibian branch of our developmental line, yet we treated him as if he were a wing-footed Mercury bringing us the message from the gods. And it took us a bit to realize that he was a big part of the problem from the start. Both our former idealization and subsequent disillusionment color our ability to trust his formulations.

My own biases interfere too. When it comes to money, I err on the side of safety. The repeal of Glass-Stegall, the Derivatives Market [particularly unregulated], Hedge Funds, and mega  banks   financial institutions  whatever-they-are’s are all frightening to me – unsafe, risky. I don’t stand near the edge of overlooks, ride motorcycles [anymore], hang-glide, collect guns, things like that. So, I’m reflexly opposed to any of these financial methodologies that have the argument – "it’s good for business" or "without it, we can’t compete in foreign markets." Things that have names like "exotic financial instruments" are particularly suspect to me. But I like it when things are good and investments are paying off. I just don’t have a felt sense of when a risk is a justifiable risk versus folly. In the financial arena, most risk feels like folly to me.

I do have some financial intuition I trust. I immediately knew Reaganomics would bring us to ruin. I didn’t have any knowledge of "financial bubbles," but when we decided to sell our big house in town, I was a nervous wreck until it sold, being sure the house values would crash. And a year before the crash, I wanted to get out of the Stock Market altogether, but was over-ruled by my wife and financial planner [and do I ever enjoy reminding them!]. So I’m not a dunce in these matters. One area where that intuition was the loudest has been about the Banks. Back in the 1980’s when the Banks all started merging and buying each other, I balked. Whenever I got the notice that my Bank had changed names, I cringed. I kept changing my accounts to locally owned Banks, only to see in the paper that they’d been "acquired" by somebody else.

So my hunches agree with Greenspan. But there’s something else. I’m currently in love with Paul Volcker. He doesn’t trust these people and focuses on their obvious profit motives. Volcker’s track record is stellar. He says break up the Banks, so that’s something I trust. But Greenspan is not to be ignored here even though he helped create these monsters. When he says, "Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations," it sounds to me like he’s thinking clearly. And this, "… you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society. Failure is an integral part, a necessary part of a market system. If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.” I really like the "Failure" part.

So when Volcker and Greenspan agree, I question why Obama doesn’t jump on the bandwagon. But wait! Krugman doesn’t agree:

Too big to fail FAIL
New York Times
by Paul Krugman
June 18, 2009

I’m a big advocate of much strengthened financial regulation. One argument I don’t buy, however, is that we should try to shrink financial institutions down to the point where nobody is too big to fail. Basically, it’s just not possible. The point is that finance is deeply interconnected, so that even a moderately large player can take down the system if it implodes. Remember, it was Lehman — not Citi or B of A — that brought the world to the brink. And as far as I know, there never was a time when policymakers could have viewed the collapse of a major money center bank with equanimity.

They certainly were worried about systemic risk in 1982, when I had something of a front-row seat. There were fears that the Latin debt crisis would take down one or more money center banks — Citi, or Chase, say. And policy was shaped in part by the desire to make sure that didn’t happen. Bear in mind that this was in the days before the repeal of Glass-Steagal, before finance got so big and wild; the New Deal regulations were mostly still in place. Yet even then major banks were too big to fail. So I think of the pursuit of a world in which everyone is small enough to fail as the pursuit of a golden age that never was. Regulate and supervise, then rescue if necessary; there’s no way to make this automatic.
There is, as always, merit in what Krugman says. He earned his Nobel Prize fair and square. He’s saying that it’s a naive way to regulate things. If you want regulations, regulate. I agree with that. So I’ll modify my proposal. If a Bank uses its "too big to fail" status, break it up. That would take care of most of the existing megas. The easy way to pick them is "break up any Bank that required rescuing." I like that idea. Seems intuitive. They already failed

  1.  
    October 28, 2009 | 3:40 PM
     

    “He looks like he evolved along the amphibian branch of our developmental line, yet we treated him as if he were a wing-footed Mercury bringing us the message from the gods”

    I love that line, Mickey. Not only is Greenspan uglier than Yoda, he’s a chameleon in character. He picks himself up from being part of the problem, dusts himself off, and makes pronouncements about what was wrong and what we ought to do.

    There’s the tendency to say: what credibility do you have? I guess he still knows a lot, and if you get him thinking the right way, he has something to add. But it’s his hubris that galls me.

  2.  
    October 28, 2009 | 3:41 PM
     

    P.S. It’s HIS hubris, to be sure; but I guess we “aided and abetted,” as they say, by treatment him as if he were that wing-footed messenger for so many years.

  3.  
    October 28, 2009 | 6:52 PM
     

    Yeah. Talk about feet of clay. I guess I’m saying that he can’t be written off just because he destroyed Western Civilization as we know it. Now that I reflect, maybe we should write him off. But I really liked hearing him say, “Failure is an integral part, a necessary part of a market system.”

    Like they say, If you can’t do the time, don’t do the crime…

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