Comments on: Another idea for breaking up the banks A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: najdorf Mon, 08 Feb 2010 22:34:37 +0000 In fact the names appear quite German, which I supposes makes sense given that the British monarchs are as well. Ah, nationalism! So rational and stable!

I’ve been reading “Other People’s Money” which is a good reminder of how much we all hated banks after the tech bubble/telecom bankruptcies/analyst scandals/Enron/California utility crisis. Just a few years later on the banks and corporate media do a great job pretending that none of these things ever happened, probably because all of the reporters with decent jobs at that time have been fired, have quit in disgust, or have been bought by the corporations they once skewered. It’s pretty hilarious to see people act like it was inconceivable that banks could systematically ignore lending standards, pay themselves huge bonuses for transactions no one understood which later blew up, and use absurd amounts of leverage and derivatives to create shady off-balance-sheet vehicles, when they did LITERALLY THE EXACT SAME THINGS to disastrous effect WITHIN THE CURRENT GENERATION.

I-banks have no interest whatsoever in minimizing information asymmetry. In fact, the opposite is true: they have a direct and persistent interest in maximizing information asymmetry, so as to create larger margins for themselves. Their only alternative to exploiting asymmetries is to act as strict intermediaries between informed parties like the world’s most boring commercial bank. Anyone can do this and competition drives the margins down to pitiful levels, leading either to weak profitability or taking on massive leverage in order to get the margins up to the huge-bonus-paying level.

The reason this is all relevant is that the underlying cause of our current problems is too much debt and not enough transparency, which create volatility and the possibility of panic which the government feels obligated to step in and control. The reason we have so much debt is that large financial institutions (now I’m getting close to riding on your hobby-horse) have enjoyed the power to create debt with an implicit (and then explicit)government backing. The reason we have so little transparency is that our government regulators, corporate boards, and major investors have been asleep at the switch in terms of understanding and controlling new forms of debt. Universal investment banks absolutely thrive in this environment as they can propose lots of complicated transactions to supine boards with supine investors and supine regulators and get what they want (fees). The government allows them to have the balance sheet to back all these deals by allowing the moral hazard trade to succeed and prosper (bought C or AIG debt yielding 10%? You win! Invested prudently in something that made sense? You lose!).

The way to deal with this is first of all to get rid of moral hazard. Let everyone who does bad transactions fail – it’s the only way to disincentivize them. Bail out the depositors or the insurance customers who got clear government promises up-front, not the holding company, its security-holders, and its gambling counterparties, all of whom knew they were taking risk. This process will be painful, but so is the process of building huge debts for decades and then raising taxes/cutting services to pay for them.

Once you deal with moral hazard, it no longer becomes cheap to run a speculative underwriting business because no one wants to supply 1% debt to a company whose model is “We buy huge chunks of mostly-unknown, highly speculative companies/debts, pump them up with dubious analysis, issue obfuscatory reports that no one can understand, restructure them to generate some fees for ourselves, and then distribute them to greater fools before anyone figures out what’s going on”. People only want to supply 1% debt to UBS and GS because they believe (correctly) that current government will not permit them to default.

Unfortunately, politicians can’t just pronounce that no one gets bailed out anymore, nor can they deregulate the whole banking system. They have to play off public anger at bankers to eliminate some of the worst excesses of the current model and provide stricter regulation of some of the fields most susceptible to moral hazard. When you have a type of bank that is strictly trading-focused, it’s very easy to say: “Gee, you hired some pretty dumb traders. You fail.” Likewise, when you have a bank that takes deposits and issues cheap mortgages to society’s benefit, it’s easier and cheaper to provide an up-front government guarantee, strict regulation, and a bailout if something unforeseen happens. When you have a corporation that strictly provides financial advice to other corporations and you regulate out some of the worst “Lever up with deceptive marketing/pay yourself a huge bonus out of other people’s money/flee and leave someone else holding the bag” practices, the market can probably handle most of the regulation. When all these banking functions and more are intertwined in one institution, everyone gets confused and nothing works. You get banks saying on the one hand “We provide valuable lending to stimulate the economy – give us a bailout” and “We’re self-interested private actors – don’t try to regulate our bonuses”. I don’t care in the least how big banking institutions are (short of anti-competitive monopolistic conditions), nor do I care if private actors want to engage in extremely risky, extremely complex financial deals at their own risk based on their own understanding. But if institutions are riddled with conflicts of interest and are structured such that no one (including their own management) understands them, it’s unlikely that the market is going to get the requisite information to create optimal outcomes.

By: Mega Mon, 08 Feb 2010 20:24:49 +0000 “… Rothschilds and Schroders and Kleinworts and Warburgs …”

Those “British” names aren’t Hogwartsy in the least.