Comments on: How smaller banks would have helped shrink the CDO market http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: najdorf http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10087 Wed, 16 Dec 2009 03:48:54 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10087 jian1312: Why should we discourage risk-taking in the tax code? Risk-takers have been very, very good to the IRS with their tendency to generate growth, profitability, and corporate income/capital gains taxes. I would rather work on modifying our social contract so that no one expects that the government will save risk-takers when downside materializes. Size has been addressed. I agree with you on the other two.

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By: jian1312 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10052 Tue, 15 Dec 2009 01:48:35 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10052 It seems more than one factor matters and financial reform should look into ALL of them:

– size of the balance sheet
– debt to capital ratio/mandatory cash reserve level
– the type of financial institutions that are allowed to do any kinds of “financial alchemy” as opposed to plain old lending (re-institute Glass Steagall or at least some form of it)
– change tax code to encourage risk-aversion and discourage excessive risk-taking

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By: Sandrew http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10038 Mon, 14 Dec 2009 19:09:04 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10038 I agree with the other commenters that a cap on bank balance sheets would not have unambiguously prevented these risks from being distributed through this chain. Furthermore, it’s not clear to me why the chain itself is a bad thing. I suppose there are extra transaction costs (intermediary profit) at each step that could have been avoided had a few steps been short-circuited. Note that what we ended up with was dodgy loans originated by Countrywide, funded by European banks, and insured by AIGFP (who, it turns out, was back-stopped by US taxpayers). I take it your bigger gripe is with find that end state, not how we got there. That is, even if we arrived at this particular risk distribution more efficiently (with fewer steps and less intermediary profit), the risks still would have been borne by taxpayers.

I’m not sure I agree that capping the balance sheets of financial firms would help anyone. By what mechanism would this curb systemic risk and/or the need for taxpayers to bear it? (Or is that not the idea?) I’ve yet to hear this spelled out clearly. The only thing I can come up with is that if we shrink all the banks, then no one bank will be TBTF. Well, maybe; but so what? How is the bankruptcy of one big bank materially different from the simultaneous bankruptcy of a bunch of little banks? What makes you think that the balance sheets of a bunch of little banks wouldn’t be just as correlated as the combined balance sheet of one big bank?

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By: GingerYellow http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10015 Mon, 14 Dec 2009 00:19:12 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10015 I don’t see how a cap on absolute size would have done anything. A lot of the banks bought the CDOs, directly or through SIVs, were pretty small with balance sheets in the tens, rather than the hundreds of billions – IKB, HSH, SachsenLB. A gross leverage ratio which took into account off balance sheet vehicles might well have done something to slow it, however.

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By: jte http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10011 Sun, 13 Dec 2009 21:40:08 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10011 I’ll second OnTheTimes. For me, the key sentence is this: “Eventually, the bonds ended up with big European and Canadian banks, who were attracted by their triple-A credit ratings.” How did all this risk not get factored into the bond ratings? And the recently passed House financial industry reforms did bupkiss to address any of this.

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By: OnTheTimes http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10010 Sun, 13 Dec 2009 21:08:56 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10010 Was the problem the size of the balance sheets, as you say, or rather the ratios the banks were allowed to maintain because of the flawed ratings? What if there were 5x as many banks, each with 20% of the size of CDOs? More banks would have been in trouble then, and with the same amount of bad loans. That doesn’t sounds any better.

If the ratings can not be trusted, then the debt to capital ratios must be lowered. This would have a better effect on reducing risk than just limiting the size of banks. I don’t want to have to bail out any bank, regardless of their size, and only regulating size wouldn’t have prevented the collapse we experienced.

www.onthetimes.com

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By: najdorf http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/comment-page-1/#comment-10006 Sun, 13 Dec 2009 18:39:13 +0000 http://blogs.reuters.com/felix-salmon/2009/12/13/how-smaller-banks-would-have-helped-shrink-the-cdo-market/#comment-10006 Smaller banks are one of the least relevant proposed solutions to this crisis. Note that the U.S. has an enormous number of banks and that the little ones are failing all over the place (over 130 this year). The same was true in the S&L crisis and the Depression. The same would be true in Japan if Japan let banks fail. The losses of 100 bad banks with $1 billion each in bad assets are going to look pretty similar to the losses of 1 bad bank with $100 billion in bad assets. Talk about underwriting, talk about leverage, talk about regulatory arbitrage, talk about incentives for irrational risk-taking, talk about executive over-compensation, talk about bailouts – these topics all make sense – but why would we think that having more/smaller banks would have any bearing on these other problems?

The real problem with all the transactions in this CDO chain is that every participant thought that they were being paid real money to take a non-existent risk, and therefore they took as much of this “risk” (which they didn’t really believe in) as possible. While this may be feasable on very small scales (e.g. for 5 minutes there is a risk-free arb that you can put a few million into to make a tiny spread), it’s unlikely that our financial system is such that people can earn spreads over Treasuries for years on billions of assets without taking any risk. The smarter players eventually recognized the risk and did everything they could to get rid of it. The rest got bailed out. I would have much preferred that my government teach people the valuable lesson that there’s no free spread by putting a haircut on every bit of debt they bailed out, but some people still think they’re geniuses for buying agency mortgages and Merill Lynch bonds last year. Everyone who bought Lehman bonds was an idiot though. What’s the difference between Merill and Lehman? About two additional weeks of independent solvency and a cooler logo.

I have no problem with leverage and size for financial speculators – I just don’t want to bail them out. If someone wants to bet at the bucket shop or play foreign exchange levered 100-1, it’s fine with me – they add liquidity to the market and maybe their speculative excess provides me with a nice entry point.The problem is that our government has bailed out so many speculative entities, which means that people will continue to underestimate risk and provide easy capital to insufficently-skilled speculators while pretending that what they’re doing is investing. Without bailouts and the continued faith of the sheeple that they create, a company like GS would have a significantly higher cost of capital and cost of leverage (see Buffett’s investment). Then we wouldn’t have to whine about their traders being overpaid because they wouldn’t have the money with which to overpay them. It’s only because people are willing to hold GS equity and debt at pitiful returns that they can do what they do. If you invest in index funds you’re an enabler :)

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