Felix Salmon

Why did Jamie Dimon fire Bill Winters as head of JP Morgan’s investment bank? According to Bloomberg, it’s because he felt Winters shouldn’t be CEO of the bank as a whole. And so, by the inexorable up-or-out logic of Wall Street, Winters was out.

Winters is one of the best risk managers on the street, and saved JP Morgan countless billions of dollars when he refused to let his group join the structured-product gold rush. But there’s much more to being a CEO than risk management, especially today, when you need to be able to charm not only institutional investors but also Washington regulators.

In a way it’s sad that no role could be found for Winters at JP Morgan — but he’s had a long and hugely successful run at the bank, and he’s surely happier dreaming of being CEO elsewhere than being stuck in JP Morgan without any hope of achieving the top job. This is how succession planning should work. For an example of how it shouldn’t work, of course, you just need to look at Bank of America.

If Winters had worked for Ken Lewis, not only would he never have been in line for the CEO job, but he would also have been fired years ago for being altogether too competent. Lewis didn’t like promoting potential rivals; Dimon, by contrast, loves surrounding himself by the smartest and best-qualified professionals he can find.

Paul Krugman gave a pleasingly wonkish talk at the World Business Forum today: the attendees with their Speaker Workbooks will have found it difficult to fill out the Paul Krugman Summary Sheet on page 95, complete with blanks where they are meant to write in their Action Plans and associated Due Date. Instead, he gave a smart and detailed disquisition on the past, present, and future state of international trade.

First, though, Krugman gave a quick overview of the crisis, and there was essentially nothing there I took any issue with. He was rude about financial innovation, saying that most of it is about regulatory evasion and arbitrage; he also worries that due to the fast action of the Fed,” we stepped back from the edge of the abyss too soon, quickly enough that there wasn’t a thoroughgoing appreciation of the need for reform”.

Bernanke “has averted disaster” by putting the Fed into the lending business, he said:

Around the turn of the year, it looked as though it might be the apocalypse, but apocalypse now has turned into apocalypse put on hold, and the risk of a second Great Depression seems to have evaporated.

He also had a good line about economic forecasters, who have us returning to full employment in about five years just because all forecasts tend to bake in a return to “normal” in five years. Krugman’s more pessimistic than that, however: “We almost certainly have a long, long haul before we’re fully recovered,” he said. A good part of the reason for that is what has happened to international trade — it “has fallen through the floor in a way that it literally never has before, including in the Great Depression”. And building it back up is going to be very hard indeed.

Krugman noted that economies like Spain and the US, with overleveraged housing bubbles and financial problems, have actually outperformed relatively sober manufacturing exporters like Germany and Japan:

World trade acted as a transmission mechanism. The vector of disease spread even to those economies with relatively healthy financial systems and little speculative excess.

The reason, said Krugman, was the big spike in trade intensity (essentially the trade-to-production ratio) between 1990 and 2007, much of which can be put down to containerization and the rise in IT logistics, which allow products to be have touched dozens of different countries before reaching the final consumer. This is a good thing: “goods are a lot cheaper and our purchasing power is much greater because of this globalization,” he said. But it has also, now, come to an end.

World trade growth might not be as buoyant as it has been: this looks like a long siege for the world economy. When you recover from a crisis, you almost always rely on a large trade surplus. But the world as a whole can’t move into trade surplus, so this may be a really prolonged slump.

So the growth in world trade is going to stop, or at least slow down dramatically, even without any kind of spike in protectionism. And in fact Krugman was sanguine on that front: he sees no such spike happening, and says that once international trade rules are put into place, they tend to be pretty strongly observed. “It’s very hard to have the cascading protectionism that you had in the 1930s,” he said. “When I was in the government and someone said ‘that’s GATT illegal’, that was pretty much the end of the discussion.”

But the trade-related gains in global living standards that we’ve seen since the shipping container was invented might not be easily replicable going forwards. Krugman wasn’t specific on what he thought that meant for global GDP growth going forwards, but the clear indication was that we might be moving to a much more zero-sum world than we’ve been used to. It’s a powerful and sobering conclusion, and one which, wonderfully, said absolutely nothing about Greatness or Leadership or Success.

Paul Krugman has a good response to Jenny Anderson’s piece today on the woeful state of the securitization markets: isn’t that a good thing?

Here’s my question: why does it have to be a return to shadow banking? The banks don’t need to sell securitized debt to make loans — they could start lending out of all those excess reserves they currently hold. Or to put it differently, by the numbers there’s no obvious reason we shouldn’t be seeking a return to traditional banking, with banks making and holding loans, as the way to restart credit markets. Yet the assumption at the Fed seems to be that this isn’t an option — that the only way to go is back to the securitized debt market of the years just before the crisis.

Why? Are we still convinced that securitization is a far superior system to conventional banking, and if so why?

Another way to look at this is to ask what’s happening at the big institutional investors who drove the securitization market. If they’re insisting on underwriting loans all of a sudden, and actually wanting to understand who they’re lending to, that’s a good thing too. Here’s James Kwak:

The boom in securitization was based on investors’ willingness to believe what investment banks and credit rating agencies said about these securities. Buying a mortgage-backed security is making a loan. Ordinarily you don’t loan money to someone without proving to yourself that he is going to pay you back (or that the interest rate you are getting will compensate you for the risk that he won’t pay you back). The securitization bubble happened because investors were willing to outsource that decision to other people — banks and credit rating agencies — who had different incentives from them.

What’s more, it turned out during the crisis that a lot of the investors in the securitization market were banks — specifically, they were European banks and SIVs who, in a feat of regulatory arbitrage, managed to discover that it didn’t matter how much credit you were exposed to, just so long as it carried a triple-A rating. I think we can all agree that insofar as banks are lending, they should be lending directly to borrowers, rather than outsourcing what’s meant to be their core competency to investment banks in the modeling-and-repackaging business.

The stubborn refusal of the securitization market to participate in the current credit boom is one of the few chinks of light I’m seeing these days. It shows there’s still some common sense in the world; long may it stay that way.

Remember the desperate lawsuit launched by Adaptive Marketing, Ben Stein’s sleazy paymasters, trying to uncover the identity of a critical blogger? The good news is that it’s been dropped:

Plaintiff Adaptive Marketing LLC (“Adaptive”) gives notice that this action appears to have become moot and, accordingly, it is hereby withdrawing this action as to all parties without costs to any party. The clerk may mark this matter “withdrawn.”

The better news is that Adaptive seem to be disappearing down a crazy rabbit hole:

Adaptive believes that it has discovered the name and address of the person in question, thereby mooting this action… The name and address discovered by Adaptive are as follows:

Franklin Seegers
1266 Morse Street, N.E.
Apt. #306
Washington, D.C. 20002

Franklin Seegers, as a minute’s Googling will reveal, is an inmate of Butner Federal Correctional Complex in North Carolina, having been given a 40-year sentence in 2006 for his role in a violent drug gang known as Murder Inc. I don’t know who “flâneur de fraude” is, but I’m quite sure that it’s not Seegers. Still, I hope that Adaptive spend lots of time and money trying to serve a lawsuit on Seegers claiming defamation. This could be very funny indeed.

Financial News has a quote from John Thain, at “a speech this month”:

“To model correctly one tranche of one CDO took about three hours on one of the fastest computers in the United States. There is no chance that pretty much anybody understood what they were doing with these securities. Creating things that you don’t understand is really not a good idea no matter who owns it.”

This is the same man, of course, who, during his tenure as CEO of Merrill Lynch, would repeatedly take a large writedown, raise capital, and say that his marks were conservative and that there would be no further writedowns or capital-raisings. And then of course he’d be back with more a couple of weeks later. Certainly Thain tried his darndest as CEO to give the impression that he knew exactly what his CDO holdings were worth, and that Merrill understood them very well. So I guess he’s now saying that he was lying?

Still, I’d like a bit more color on the “correct model” that Thain is talking about. Which computer does he have in mind? And how much faith does he have in the results? It’s hilarious to me that even after everything he’s been through, Thain thinks that if only we had more computing power, we might not have been in this mess. More likely, we’d be in an even bigger mess.

Update: The Q&A session at Wharton from which the quote was taken can be found in PDF form here. (Thanks, Cardiff!)

Update 2: John Carney points out that in January 2008, Thain seemed a bit less sure of himself when it came to how much all those CDOs were worth. But that call, on January 17, came in between a statement on January 15 saying that he was “certain that Merrill is well-capitalized”, and a statement on January 18 that he was “very confident that we have the capital base now that we need”. (Of course, any further writedowns in the CDO book would directly hit Merrill’s capital base, so statements that Merrill’s capital was safe were tantamount to statements that there wouldn’t be any further CDO writedowns.)

Later on in the year, Thain continued in this vein:

“…Today I can say that we will not need additional funds. These problems are behind us. We will not return to the market.” (March 8 )

“We have more capital than we need, so we can say to the market that we don’t need more injections. (March 16)

“We have plenty of capital going forward, and we don’t need to come back into the equity market… No more capital raising; I’m sure we have enough capital.” (April 4)

“We deliberately raised more capital than we lost last year … we believe that will allow us to not have to go back to the equity market.” (April 8 )

“We are well-capitalized. We’re comfortable with our capital position.” (June 11)

“We are in a very comfortable spot in terms of our capital.” (July 17)

How could he be so sure, if no one had a clue what Merrill’s enormous CDO book was really worth?

Given the size of Merrill’s CDO exposure, and the degree of uncertainty which Thain now claims was endemic to that exposure, it seems incredible that Thain could have been so certain about the amount of capital that Merrill needed. Of course, in retrospect all his claims about needing no more capital were wrong: the losses would never end, even after Merrill was taken over by Bank of America. As he now admits, the CDO book was so opaque that Thain had no grounds for being so cocky.

Commonfund releases its 2009 higher education price index. The cost of running a university is +2.3% this year. — Commonfund (PDF)

Ralph Lauren picks a copyright fight with the wrong gang — BoingBoing

Can we call this the last word on the subject? Kid Dynamite on Taibbi — Kid Dynamite

The radical incoherence at Brandeis continues. How embarrassing. — Justice

Rewriting God: “This quotation is a favorite of liberals but should not appear in a conservative Bible.” — Conservapedia

The astonishingly short life of a bagel — Serious Eats

Tim Phillips says nice things about me. We anti-anti-counterfeiting types have to stick together! — Research Live

I hate to say it, but Tina really does get it. — Daily Beast

In 2004, Gourmet commissioned David Foster Wallace to write 7600 words on lobsters. Now they’re both dead. — Gourmet

WTF is a “premium reading experience”? — Poynter

Many thanks to Bill, who read my blog entry on derivatives exposure and who is much better at navigating the OCC’s quarterly reports than I am. And it turns out that they’re rather misleading.

Consider this, from the executive summary:

Five large commercial banks represent 97% of the total banking industry notional amounts and 88% of industry net current credit exposure.

What are those five large banks? According to the OCC, they’re JP Morgan Chase, Goldman Sachs, Bank of America, Citibank, and Wells Fargo. Add up their “total derivatives” numbers in Table 1 of the latest OCC report, and you get $197 trillion, which is indeed 97% of the $203 trillion in total notionals.

But never mind that, and take a look at Table 2 instead. That shows the notional amounts at bank holding companies, rather than banks themselves. Suddenly, the size of Bank of America’s derivatives holdings spikes from $39 trillion to $75 trillion, while Morgan Stanley appears from nowhere to reveal itself as holding a more-than-healthy $41 trillion in derivatives. It seems that at Merrill Lynch and Morgan Stanley, the derivatives are generally held by the holdco rather than the bank, which allows the OCC to ignore them for the purposes of its headline calculations.

Add up the derivatives books at the holdcos, and the total isn’t $203 trillion any more: it’s $291 trillion — an increase of $88 trillion which is very hard to find in the OCC report unless you’re specifically looking for it. And never mind Wells Fargo, which was also something of an also-ran in the top five banks. The top five now comprise JP Morgan, Bank of America, Goldman Sachs, Morgan Stanley, and Citigroup, with derivatives holdings between them of $278 trillion. That’s 95% of the true total, or 137% of what the OCC would have you believe was the total.

Why does the OCC make the rather legalistic distinction between commercial banks and holding companies, and then concentrate on the former rather than the latter? If the object of the exercise is to add up total derivatives exposure, that doesn’t make any sense. Someone there should really start asking themselves why they’re publishing this report, and how they could make it most helpful to the people reading it.

Chris Swann reports that, yes, men have suffered 75% of the job losses in this recession. But look at the last recession: they suffered 86% of the job losses in that one. And the recession before that? More than 98% of the job losses. He concludes:

As the slide in manufacturing and production tails off, male workers can expect some relief. The problems of many women in the workforce are far more ingrained and harder to deal with. Man-cession aside, it’s still a man’s world.

The worlds where I live my professional life — both finance and the blogosphere/punditocracy — are massively overweight men; that’s an unambiguously bad thing. Women are more sensible than men, and less likely to take extreme risks. If we’d had more women in charge of the global financial system, I suspect that the most egregious excesses of the past decade would never have occurred. So if we must have a recession, then a man-cession is exactly what we need.

Luc Renneboog and Christophe Spaenjers of Tilburg University have done their own analysis of the art market, and conclude:

Our art index has underperformed stocks since 1951 and bonds over the last quarter of a century (but at a higher risk). Moreover, there are high transaction costs associated with trading art, which reduce the reported returns. When considering the low profitability and the high riskiness of art investments, one can only conclude that art should primarily be bought for its beauty.

This study shows art returning 4.03% between 1951 and the top of the market in 2007. That’s low, in comparison to other findings in the literature:

The returns on art calculated in this study are lower than the outcomes in the often-cited studies by Goetzmann (1993) and Mei and Moses (2002), even though our time frame includes an extra boom period. We argue that this can be explained by the fact that our dataset has a much broader coverage than the ones used in earlier papers, and therefore not only captures the (re)sales by top artists at big auction houses.

I think this works more generally: if you could somehow include in the survey all the art that anybody ever buys, the aggregate returns would certainly be negative. Most art is bought in the primary market and is never sold, mainly because it never can be sold. To all intents and purposes, it has zero monetary value the minute that it leaves the gallery or artist’s studio.

The greatest investors in art never bought art as an investment. If you take the set of all art collectors, statistically speaking some small proportion of them will see their collections grow substantially in value. Those collectors are deemed in retrospect to have had a “great eye”. But people who buy art as an investment are almost certainly going to be disappointed — and even more disappointed if they get someone else to buy art for them.

The only time it makes sense to think in such terms is in terms of asset allocation and risk profile: if a large proportion of your net worth is tied up in art, that should be taken into account when constructing the rest of your investments and your estate planning strategy. But don’t think that art has any real chance of growing substantially in value.

Sheila Bair, in Turkey, came out with a provocative and very interesting idea which few people seem to have picked up on: when a bank fails, its secured creditors should be limited to getting only 80% of their money back:

She said curbing claims would encourage secured creditors, who are protected from losses when a bank fails, to more closely monitor the risks a bank is taking and could speed up the process when an institution needs to be wound down…

“A major advantage is that all general creditors could receive substantially greater advance payments to stem any systemic risks without the extensive delays typically characteristic of the bankruptcy process,” she said.

“Obviously, the advantages and disadvantages need to be thoroughly vetted. In any event, there is a serious question about whether the current claims priority for secured claims encourages more risky behavior,” Bair added.

I like this idea, if only because secured funding at banks is invidious, especially from the point of view of someone like Bair, who exists to protect deposits. Depositors are senior to unsecured creditors, so lenders love to jump the queue, as it were, and become secured creditors instead, thereby becoming senior even to depositors. It’s an easy way of being lazy, and not feeling the need to underwrite billions of dollars in loans.

One wrinkle might be the difficulty in separating secured lenders, on the one hand, from simple trading counterparties, on the other; Bair is surely right that any mechanism along these lines should be implemented very carefully. But the bones are good, and global regulators trying to piece together a new regulatory architecture would do well to take this idea very seriously.

This time last year, I attended the World Business Forum at Radio City. I came away with a slight ringing in my ears and a blog entry entitled “The Parallel Universe of Leadership Events”, in which I attempted to skewer the content-free nature and general mindlessness of such things. My prize was an invite to come back this year, as part of their “Bloggers Hub“, so I could repeat the whole experience. I’m not there now, but I might pop along once or twice: it’ll be interesting to see how Paul Krugman, for one, approaches such a crowd.

It’s worth asking how Krugman felt himself allowed to take this gig. This is, after all, the man who wrote this:

I do very little paid speaking now, and no consulting, because the New York Times has quite strict rules: basically I can only get paid for speaking to nonprofits that have no possible interest in influencing the content of the column. It’s a good rule – read Eric Alterman’s book “Sound and Fury” to see how speaking fees can corrupt pundits – though it meant that I took a substantial income cut to work for the Times.

The World Business Forum is emphatically not a nonprofit, and it pays its speakers very large sums of money. (That’s how it gets the likes of Jack Welch, Tony Blair, and Bill Clinton to turn up.) So what’s Krugman doing there?

In any case, this annual boondoggle — an event with zero news value, which large companies give to their middle managers so that they can feel important and have a fun couple of days in New York without really working — has managed, incredibly, to get itself an entire dedicated blog at the WSJ. This is probably a function of the fact that the Journal — along with BusinessWeek, Fox Business, and something called ExecuNet — is a “media sponsor” of the Forum. (Those middle managers are exactly the audience that the WSJ wants to reach.)

I don’t for a minute blame the business side of the WSJ for sponsoring the WBF — it’s their job to do such deals. But there’s no indication on the WSJ’s WBF blog that it’s anything other than an editorial-side effort, put together by “reporters and editors at The Wall Street Journal”.

Which leaves just two possibilities, neither of which reflect very well on the WSJ. Either the business side bullied the editorial side into putting together this dedicated blog — which would imply that the wall between the two is porous indeed. Or else the editorial side really believes that the World Business Forum is so inherently newsworthy that it should be blogged by multiple staffers over two days. In which case someone at the WSJ really needs their news judgment examined.

The WSJ’s Eleanor Laise finds that the market in bond ETFs is rather messy, to say the least:

State Street Corp.’s SPDR Barclays Capital High Yield Bond ETF fell nearly 1% in the 12 months ending Aug. 31, even while its benchmark gained 6%. Part of the problem: The index contained some lower-quality bonds that the ETF couldn’t get, and when those bonds rallied, the fund got left behind, says Jim Ross, senior managing director at State Street.

The benchmark in question, it’s worth noting, is the Barclays Capital High Yield Very Liquid Index. That’s evidently “Very Liquid” as in “can’t find these bonds to buy no matter how hard we try”.

The lesson of this story is that ETFs don’t work when they’re investing in instruments which aren’t exchange-traded:

Keeping ETF returns in line with the indexes has proven to be tough in the murky bond market. For most bonds, there is no centralized exchange matching bond buyers and sellers, and different market players can assign very different prices to the same bonds. Many bonds don’t trade for days at a time, and when they do, they can be costly to buy and sell.

It’ll be interesting to see whether anybody tries to launch an ETF based on a liquid, exchange-traded CDS index. That might solve most of these problems, but I know a lot of people who would be dead-set against such a product, since its very existence would imply the dreaded “naked shorting” of CDS by dastardly speculators. Is a failed investment product better than a liquid derivatives market?

Clay Risen says Goldman Sachs will never be able to get to grips with the realities of the blogosphere — Faster Times

Olympic voting was “a win for prediction markets, not a failure” — Sabernomics

Surowiecki on the “palpable longing among pundits for Americans to become more frugal” — TNY

Backwardation in tin! — Telegraph

Hempton unleashes his analysis of BBVA’s US subsidiary, on the grounds that it might give an insight into BBVA — Bronte Capital

This is what you pay McKinsey for: the decision to axe Gourmet rather than Bon Appetit. — NYT

“You may already be drinking box wine and not know it”: wine is shipped in bladders in containers, then bottled — Wine Economist

The Center for Responsible Lending has a new report on overdraft fees, which has some startling numbers on the degree to which these things have increased in recent years:

Overdraft fee income for banks and credit unions rose 35 percent between 2006 and 2008, going from $17.5 billion to $23.7 billion. Add in non-sufficient fund fees, and the totals rise to $25.3 billion and $34.3 billion, respectively. (The difference between an overdraft fee and an NSF fee is that an overdraft fee is charged when the payment is made; an NSF fee, or bounced-check fee, is charged when the payment is not made.)

The Center also notes that “as recently as 2004, 80 percent of all institutions denied debit card overdrafts” — it’s astonishing how quickly such charges went from the exception to the rule.

Overdraft fees now dwarf the actual overdrafts themselves:

For 2008, we estimate that checking account holders receive only $21.3 billion in credit for the $23.7 billion they pay in overdraft loan fees. Put another way, consumers were obligated to repay $45 billion for $21.3 billion in extremely short-term credit.

The Center has some good recommendations, including this one:

Require that overdraft fees be reasonable and proportional to the actual cost to the financial institution of covering the overdraft. On average, overdraft fees exceed the amount of credit extended, which is particularly troubling given the short time period until repayment—usually only a few days. Since banks are able to repay themselves out of the accountholder’s next deposit, these loans carry a low default risk relative to their high cost. Overdraft fees should be proportional to the actual cost to the institution of covering the overdraft, taking into account the cost of funds, default risk, and a reasonable profit margin. Indeed, a product designed to be proportional to the cost to the institution of covering the overdraft already exists—an overdraft line of credit at a reasonable interest rate.

In fact, the status quo is even worse than the Center here implies. Yes, it’s true that banks are able to repay themselves out of the accountholder’s next deposit. But they never do.

Where I come from (England), an overdraft is simply a negative balance on your checking account. You pay interest so long as the balance is negative, and if you put in enough money to bring the balance back into the black, you stop paying interest. Not here. In the US, there’s normally no such thing as a negative balance on your checking account: instead, when you go into overdraft, you not only pay the usurious overdraft fees, but you also start running up a debit balance on your overdraft account. If you then deposit money into your checking account, it’s entirely possible (and indeed common) to have a positive balance in your checking account and an overdraft, all at the same time. In order to get rid of the overdraft, you need to actively transfer money from your checking account to pay off your overdraft — which of course you’re never going to do unless and until you find out that you’re overdrawn in the first place. Which might not happen until you get your next month’s bank statement.

If I may, then, I’d like to make one addition to the Center’s recommendations: that all deposits into checking accounts be put first towards any overdraft, and only then towards a new positive balance. But that of course would be consumer-friendly, so it’s probably never going to happen.

Ryan Chittum applauds Gretchen Morgenson and Dean Baker for trying to calculate what they all refer to as the “costs” of having a too-big-to-fail “policy”. But I don’t like this lens at all.

For one thing, what Baker is totting up here aren’t costs at all, they’re benefits to the banks concerned. At no point is the key logical step spelled out: if a big bank benefits by being too big to fail to the tune of say $1 billion a year, then there must be an equal and opposite $1 billion a year cost to taxpayers. What’s more, Morgenson implies, that cost can be compared directly to other government spending:

If Mr. Baker is correct about the estimated size of the subsidy, the costs of too-big-to-fail are substantial when compared with other government programs. At $34.1 billion a year, the subsidy is more than twice the grant given under Temporary Assistance to Needy Families, a $16.5 billion program that helps recipients move from welfare to work. A $6.3 billion subsidy would be roughly what the government spent in 2008 on the Global Health and Child Survival program, an initiative aimed at preventing malaria, AIDS and tuberculosis.

What Morgenson’s talking about here aren’t contingent liabilities, they’re cash outlays. The government isn’t giving that level of cash to the banks; there’s not even an explicit government guarantee on the banks’ unsecured debt. Instead, there’s an implicit government guarantee, which, being implicit, can’t really be charged for. Instead, the government is seeking to increase large banks’ minimum capital ratios so as to reduce their profits by at least as much money as the extra profits that Baker is calculating.

Conceptually, then, I don’t like the idea of painting this benefit to the banks as a cost to the government, because it really isn’t. After all, if the government were forced to bail out any of these banks’ bondholders, the sums involved would be vastly greater than the numbers that Baker is throwing about. In that sense, the cost to the government is either zero, or it’s in the hundreds of billions of dollars. It’s not somewhere in between.

I also don’t like the idea of painting too-big-to-fail as a “policy”, as though it was a decision implemented by some technocrat somewhere down the line. It’s not. Pretty much every major economy in the history of capitalism has had too-big-to-fail banks. It’s a natural state, which governments can try to manage, but doing so carries its own costs. Morgenson quotes Baker:

“There is a subsidy here, and we either have to say we are going to break up the banks and get rid of the subsidy, or if we don’t do that, then we have to be confident that we have put in enough regulation to offset the subsidy.”

Breaking up too-big-to-fail banks is, in the best-case scenario, an extremely costly and disruptive thing to do. That doesn’t mean it shouldn’t be done, of course. But there is absolutely a cost-benefit tradeoff here. What’s more, it might not even be possible: if you break a trillion-dollar bank into two $300 billion parts and one $400 billion part, all three parts are still too big to fail, especially in a time of crisis. How big is small-enough-to-fail? And is it possible to grind America’s largest banks into chunks that small? These are non-trivial questions, especially when you’re dealing with broker-dealers which need large balance sheets just to be able to make liquid markets.

Baker’s alternative involves offsetting subsidy with regulation — how is that supposed to work? Can you calculate regulatory costs and debit them from too-big-to-fail benefits? Goldman Sachs currently has a tier-1 capital ratio around 16%; if the government increases its minimum capital ratio from 8% to 12%, what is the associated cost to Goldman? Yes, it loses a certain amount of option value — the ability, if times turn tough, to reduce its capital ratio sharply while still remaining in regulatory compliance. But how would you even begin to calculate that option value?

I think that Baker’s exercise is a useful one, especially when he comes to the conclusion that in the case of a bank like Capital One, all of its profits and then some might be a function of the implicit government guarantee. (Although, is Capital One really too big to fail? When WaMu and Lehman were not?) But let’s not pretend that we could, at a stroke, take the benefits that accrue to banks when they get too big to fail, and spend that money on something entirely different. We can’t.