Opinion

Felix Salmon

Dimon or Geithner?

By Felix Salmon
June 10, 2011

I’ve just noticed that Jamie Dimon’s little speech to Ben Bernanke last Tuesday recapitulated many of the points that Tim Geithner made in his own speech the previous day. Let’s play Dimon or Geithner:

  1. “We have a very complicated regulatory structure with multiple agencies, with closely related and sometimes overlapping missions and roles.”
  2. “It has been more than three years since the start of the financial crisis that led to those reforms.  And we are now in the midst of a fundamental reshaping of the financial system.”
  3. “Most of the bad actors are gone. They were thrifts, all the mortgage brokers, and some banks.”
  4. “The firms that took the most risk – no longer exist or have been significantly restructured.  That list includes Lehman Brothers, Bear Stearns, Merrill Lynch, Washington Mutual, Wachovia, GMAC, Countrywide, and AIG.”
  5. “We had a crisis, and it entailed need to do a lot of things to fix it and reduce risk.”
  6. “Higher capital and liquidity are already in the marketplace, we estimate more than double what it was before.”
  7. “19 firms have together increased common equity by more than $300 billion since 2008. The average level of common equity to risk weighted assets across these institutions is now 10 percent, much higher than before the crisis.”
  8. “Debt maturing in one year or less, as a share of total liabilities, has declined dramatically to roughly 40 percent of the pre-crisis level.”
  9. “Regulators are tougher in every way possible.”
  10. “It’s a good thing that there’s no more subprime.”
  11. “There’s far more transparent accounting.”
  12. “The US banking system today is less concentrated than that of any other major economy.”
  13. “Central banks and supervisors need a balance between setting capital requirements high enough to provide strong cushions against loss but not so high to drive the re-emergence of a risky shadow banking system.”
  14. “Capital requirements cannot bear the full burden of protecting the system against risk, and they should be considered in the context of the reinforcement provided by these other reforms.”
  15. “We need to improve the chances of promoting a uniform global approach that does not damage US firms.”

Simon Johnson has responded to these arguments with a post entitled “The Banking Emperor Has No Clothes”:

Big banks in almost all other major countries have run into serious trouble, including the UK and Switzerland – where policymakers are now open about the scope for further potential disaster…

Mr. Geithner’s thinking is completely flawed on bank size. The right lesson should be: big banks have gotten themselves into trouble almost everywhere; U.S. banks are very big; these banks have an incentive to become even bigger; one or more of these banks will reach the brink of failure soon.

But the fact is that Geithner won’t think that way, not least because of the fact that he arrived at Treasury from the New York Fed, an institution which is literally owned by the big banks such as JP Morgan.

Dimon will always push as hard as he can to have as little regulation as possible and to have no restraints at all on the size of his bank. That’s his job — you can’t really blame him for it. What’s more worrying is that Geithner seems to be very close to Dimon’s way of thinking.

(The answers, by the way: 1, 2, 4, 7, 8, 12, 13, 14, 15 are Geithner; 3, 5, 6, 9, 10, 11 are Dimon.)

Comments
18 comments so far | RSS Comments RSS

Next time, just to be explicit: Edgar (father of Candace) Bergen or Charlie McCarthy?

Posted by klhoughton | Report as abusive
 

Sir, I knew Charlie McCarthy, and Timmy Geithner is no Charlie McCarthy.

Posted by fresnodan | Report as abusive
 

“Higher capital and liquidity are already in the marketplace, we estimate more than double what it was before.”

Someone tell me if this is wrong, but aren’t the higher capital and liquidity levels due to banks basically borrowing a lot more money from the Fed, for virtually zero interest? And then lending it back to the government through other vehicles, where they not only make their books look stronger, but make money for free?

Why are banks allowed to borrow from the quasi-government for next to nothing, and lend it back to the government at a profit, and then reward themselves with huge bonuses?

Posted by KenG_CA | Report as abusive
 

There is of course an alternative view, perhaps a little radical, but it is quite possible that the 2008 crash was caused by increased capital requirements, not by requirements that were too small. I can point a finger directly at the 2004 Basel II as the beginning of this process.

As capital requirements increased, the need for banks to hold larger and larger “safe assets” increased in direct proportion. With their risk capital reducing, their potential returns reduced (perhaps necessitating they take more risk to achieve the same results). In order to continue to grow share price and make bonuses, there was a new imperative to maximise the returns attributable to the capital reserves.

This created a new market for high yielding, low risk products, hence the birth of sub-prime and the scandal of high yielding CDOs and other packaged products.

The UK and Switzerland perhaps suffered most because they are probably the two countries in Europe with the strongest US influences driving their markets. UBS is in effect a half US company after it’s merger with Payne Webber. In the UK, many old, well established UK banks are US owned or led, and in any case for some strange reason more Brits seem to feel closer to the US than they do to Europe – perhaps just because of language skills.

All the post event activity seems to have centred around minimising the costs to future governments of another failure, rather than concentrating on removing the motivation for dealing in such things as sub-prime based structured products.

It’s time to fix the disease, not the symptoms.

Posted by FifthDecade | Report as abusive
 

@KenG_CA, you weren’t supposed to notice. Bad boy for not being distracted.

@Really? I can point a finger at repealing Glass-Steagall for CDOs and such schemes and lack of ethics as the disease.

Posted by hsvkitty | Report as abusive
 

why do some want to excuse what the banks did? they cost the tax payers trillions (in bail outs, lost revenue, and other favors!). they cost investors trillions (lost money in the stock market and bonds). they cost home owners in lost value in the multi trillions (and more to come). they cost millions of jobs because their mess they created. and we aren’t done yet . this was a repeat of the financial debacle from the great depression. only this time we tried to fix it. and this time the bankers are taking responsibility for their actions.

Posted by willid3 | Report as abusive
 

“and this time the bankers are taking responsibility for their actions.”

Where did you get that impression? Goldman Sachs denies, denies, denies any wrongdoing. They keep whining about not knowing what regulations they have to pay attention to. Maybe they should just act ethically and with empathy and they shouldn’t have any trouble doing the right thing.

Posted by JEHR | Report as abusive
 

FifthDecade:

I missed the point of your comment.

What exactly was the cause of the issuance of fraudulently bad sub-prime and other mortgage securities?

I was under the impression it was greed and incompetence. You appear to be arguing that increased margin requirements necessitates the fabrication of lousy securities in order to keep the system going.

Posted by ErnieD | Report as abusive
 

JEHR, that was a typo
should have read
5:45 pm EDT

“and this time the bankers aren’t taking responsibility for their actions.”

Posted by willid3 | Report as abusive
 

ErnieD

The only way you can get the same returns from 90% equity, 10% safety as you get from 95% equity, 5% safety is to take more risk.

There are only so many vehicles that offer real safety, and to get higher returns new products were needed. Some financial marketing department decided mixing mortgages for poor people with mortgages for rich people reduced the risk so they could be labelled as “safe”.

Before the margins were increased, people could get the returns they needed without looking for new ways to make money “safely”. Even if the sub-prime products were out there, there just weren’t enough buyers to make them a big thing. But when Basel II introduced higher margins, the numbers of buyers searching for “safe”, and the amount of “safe” they were looking for increased substantially.

To supply the demand, mortgage backed securities grew from straightforward to extremely complex until nobody understood them anymore, but nobody complained because they were passed down an ever expanding client pyramid and everyone made money so nobody asked. They were sold worldwide and the rest is history.

Get it?

Posted by FifthDecade | Report as abusive
 

Got it, FifthDecade, though I would perhaps phrase this differently: “people could get the returns they needed”.

Not sure why bankers “need” ridiculous returns. The business ought to respond to economic reality, not the other way around.

Posted by TFF | Report as abusive
 

If the bankers hadn’t changed how they worked, they may not have got the bonuses the trigger points in their contracts stipulated, and the share prices of the banks may have fallen, thus reducing the bonuses of the CEOs as well. They may have had to survive on as little as a half million salary – how awful!

But it isn’t the money per se, it’s the standard components of Maslows hierarchy of needs: kudos and peer group pressure. It’s all about respect and status for the testosterone laden market traders. They’re usually young and don’t remember the last bear market, and if they do they survived it so think they’re immune and invulnerable. So long as they only hold these toxic assets for a fraction of time, who cares if they pass on junk to others?

What needs to change is the methodology of giving bonuses when companies make less money or even lose some – and this includes non-performing CEOs who should lose any Golden Handshake’s if the company does badly. Being rewarded for failure is a bad example to set.

Posted by FifthDecade | Report as abusive
 

FifthDecade, I don’t know how you can describe sub-prime mortgages as low risk. They were extremely risky, and when packaged with other loans, they were still risky, but the ratings agencies hid the risk. They weren’t so complex that nobody understood it, it’s just that nobody wanted to understand it, they (the buyers of the MBS’s) wanted to believe they were AAA, so they could justify buying them. If they failed they could say it wasn’t their fault because they were were AAA. The only people who actually looked at those bonds ended up shorting them and their buyers and their insurers.

It’s not fair to blame higher margins for the resulting crisis, as it would have happened without it. The CDOs were not created to address the need for higher quality debt, they were created solely to generate profits for their packagers and the sub-prime originators, and of course, middle men like Goldman Sachs.

You also can’t blame the actions of the bankers just on young people who had never been through a bear market, as those deals were all approved by veteran bankers, all of whom were greedy and ignored the risks that should have been obvious.

Increased capital requirements did not cause the crisis; chalk it up to delusion, incompetence, and greed. If risk was fairly and accurately assigned, we’re not having this conversation. But risk was anything but accurately assigned, because people wanted to believe that 1+1=3, and that extra one would go in their pockets.

Posted by KenG_CA | Report as abusive
 

The problems didn’t occur because greedy, stupid people around the world bought shedloads of high risk sub-prime mortgages; it was the sheer quantity of such products post-packaging (camouflaged) that were bought that caused the problem. And the quantity that were required increased because the margins were increased. No wonder marketing invented new ones.

If you were an ecologist you’d see this straight away. You have to look at the entire ecosystem, not just tiny bits of it, because everything affects everything else. It’s all butterflies and tornados.

Posted by FifthDecade | Report as abusive
 

Thanks, Felix.

Posted by Laster | Report as abusive
 

So, FifthDecade, you believe in that supply side fairy tale? That people buy stuff just because it’s available? It has been disproven in every market that it has been tried.

I get the ecosystem analogy, but I don’t agree with you on cause and effect. There’s no doubt that the risk of the junk bonds was understated by their marketeers, but I still think that greed was the driver for the creation of the toxic assets, not demand for low risk products. If capital requirements were lower, they just would have sold more of these bonds, and the losses would have been higher.

Posted by KenG_CA | Report as abusive
 

KenG_CA
You’re forgetting that where regulation is concerned, certain things *have* to be bought. When a regulation change requires an increase in “safe” assets, banks simply had to have more of them. It wasn’t a choice thing.

If it had solely been greed they would have bought more speculative investments that were not dressed up as AAA safe instruments. Don’t forget many of these bonds were giving returns only as high as 6% a year – most equities beat that.

However, there was some choice involved when choosing which AAA vehicles they had to buy, but that wasn’t the main motivator. As I said, with no regulatory change they’d have stuck with higher return instruments.

You seem to forget that these bonds were not Junk bonds when sold – they had AAA ratings. Junk Bonds are rated BB.

Posted by FifthDecade | Report as abusive
 

I don’t believe banks are allowed to buy equities at all to meet their capital requirements, otherwise they would just be a hedge fund. They were buying these bonds because they were profitable for them – all part of their record profits and the record bonuses for the execs who signed off on buying the bonds. I think they would have bought the bonds regardless of the capital requirements, because they were too lazy to investigate what they were buying. With lower capital requirements, they would have bought other, lower rated, higher yielding bonds, which also suffered similar fates as the sub-prime securities.

I have a problem with placing blame on capital ratios when the real culprit is mislabeling of products. You are saying the demand for low risk products drove the creation of high risk bonds that were sold as low risk, and therefore we shouldn’t set capital ratios high – and that’s just another argument for not regulating banks at all, as low capital ratios offer no protection against gabling with assets. That is fine, as along as the FDIC doesn’t insure them, and the Federal Reserve doesn’t lend money to them every night, and other banks don’t lend to them if they are part of either system.

Capital ratios are a much better tool for managing growth than setting interest rates, which can be inflationary and often don’t yield the desired results (low interest rates don’t always create growth, as we are seeing now, and high interest rates will not always stop bubbles, for if the expected profits exceed the cost of capital, people will still borrow money, but the higher interest rates will drive up prices). They shouldn’t be discarded because they are undone by incompetence and malfeasance, that combination will always result in failure, regardless of your protections.

Posted by KenG_CA | Report as abusive
 

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