http://krebscycle.tumblr.com/post/378446 00416/a-modest-proposal-for-free-market- bank-reform

That said, I differ substantially about the S&L’s. There were instances of fraud, but fraud was a small part of what happened. In terms of the monetary cost of the S&L’s, I feel confident saying that outright fraud was less than 10% of the issue. The bigger problems were a mix of incompetence (by both S&L’s and their regulators), excessive optimism, and bad economic conditions (everything from the oil bust to the 1986 Tax Reform Act, though you could argue that unsound real estate lending was going to catch up to the S&L’s sooner or later).

More broadly than just S&L’s, that to me is one of the bigger problems with journalist coverage in general. Journalists by nature are opposed to Hanlon’s razor – “Never attribute to malice that which is adequately explained by stupidity” – because malice is a far more interesting story than stupidity. That becomes a big problem in the coverage of something like the S&L crisis, because the specific instances of fraud get more coverage than the generalized incompetence, so the story ends up being that malice was the cause when it was really stupidity.

It was not risk based (all counterparts were equally able to repay the loans), it did not recognize market risk (!) and operational risk (!!). It was a main reason for many of the problems in the banking sector. It was a huge regulatory arbitrage challenge (and opportunity).

Banks are in the business of taking risks, and we cannot describe these risks and the necessary steps to mitigate these risks in 30 pages.

George Lekatis
Basel iii Compliance Professionals Association (BiiiCPA)

Capitalism can’t work if losses are not taken but absorbed by governments. Capitalism can’t work if people who make loans don’t understand that they have to be paid back. Capitalism can’t work if fraud and stealing is equated with earning…

Felix, nothing in this long post gives any comfort to the reader that Basel III represents any ‘clear improvement’ over its predecessor.

First, a rear view summary:

Basel 1: mortgage lending only requires 50% risk weighted capital. RESULT: Euro banks pile into this by way of dodgy US mortgage backed securities. OUTCOME: see 2008.
Basel 2: sovereign debt requires only 50% risk weighted capital. RESULT: Euro banks pile into this by way of PIIGS sovereign exposure. PREDICTED OUTCOME: see 2008.

In both cases, European banks were happy to ‘comply’ with Basel guidelines on capital-so they could game it. In fact, we should feel lucky that the US banks did NOT comply with Basel II-they were better capitalised in ’08 than their UK and EU stablemates.

From der Bloomberg today: “The first Basel agreement on global banking regulation, adopted in 1988, was 30 pages long and relied on simple arithmetic. The latest update, known as Basel III, runs to 509 pages and includes 78 calculus equations.”

Felix: Basel III isn’t perfect, but it’s as good as we’re going to get, and is actually significantly better than most people dared hope when it first started being negotiated. And the technocrats who put Basel III together are not some group of knaves, deluding themselves that they’ve magically fixed all the problems with the banking system. They’re smart and well-intentioned regulators………”

Right-who know differential equations.

The killer for me was seeing an excerpt from the Atlantic article (quoted by Levine) where Eisinger and Partnoy seize on the fact that Wells Fargo describes its market making activities as including “taking positions to facilitate expected customer order flow”. They go into hysterics over the term “expected” versus responding to what customers actually have done.

I am not going to make a categorical claim that Basel III is perfect, or that it can’t be improved upon. I’m sure there are ways it could be better. I will categorically state, however, that I’m not going to read 9,500 words on financial regulation written by authors who don’t seem to grasp that market making (i) requires holding an inventory of securities, (ii) entails taking on positions and risks that don’t always net to zero, and (iii) like all business, is a forward looking rather than backward looking activity.

Remember the S&L’s getting into trouble after high short-term interest rates up-ended their whole business model, and they therefore decided to get into other types of lending that they didn’t understand very well?

Remember almost every sizable institution in Texas failing in the 1980′s after the Texas oil and property bust, because they were regionally focused institutions in a region whose economy was crushed?

Remember Continental Illinois, which popularized the term “too big to fail” in 1984?

Remember the emerging markets loan crisis of the 1980′s, which nearly took down Citibank? (Citi, across different names and business scopes, has had an illustrious history of getting itself into trouble pursuing the trend du jour).

Bubble bursts – particularly ones than involve real estate – have pretty much always resulted in a banking crisis, regardless of the regulatory regime in effect at the time.

They’re not the same thing–though both may be true.

Or was the problem that the financial center banks were and are filled with hydrocephalic greedmonkeys whose main business was and is to enrich themselves while beggaring all of us? In which case, an effective Basel III WOULD look much like a return to Basel I, boring banking, Toronto, New Delhi?

And–by the by–if even India’s banking system proved robust and stable–India, whose tradition of public and private corruption is unmatched among great nations–than doesn’t that maybe say something important about the structure and efficacy of Basel I-style banking when set alongside the New York/London mess?

Simply saying “we can’t go back” doesn’t make it so. We actually could, if enough of us wanted to force the issue.

Oh, but Felix’s lunches would get boring …

Obtaining bank stability via oligopoly-based high pricing shouldn’t surprise anyone, as there’s a natural tension between wanting stable banks and wanting for bank customers to obtain the lowest possible fees and interest rates on borrowings (or alternately, for bank depositors to receive the highest possible interest rates). As with any business, there’s always the possibility that a truly competitive marketplace drives someone out of business. So we need to accept that either (i) we allow for somewhat higher than “competitive market” pricing on financial products and services as part of our regulatory regime as part of the price of financial stability or (ii) we need to allow financial institutions to fail and to prepare for that to happen.

I don’t think it’s regulatory incompetence or ineptitude as much as deliberate forbearance that encourages banks to do whatever they want for as long as they want and then pay relatively minimal penalties for breaking the rules. We’ve heard over and over again that nothing or very little was done by regulators during the crisis on both sides of the Atlantic – and auditors who took their cues from politicians rather than investors – because the “financial system” may break otherwise.

Investors – and taxpayers – must demand a financial system that serves the public not the bankers. Citizens must demand solutions to meeting specific goals like furthering growth for everyone not lofty ones like “stability” or we’ll perpetuate the current system that only profits insiders.

The problem isn’t that we get nostalgic for Bailey; it’s that the Potters of today have n/o/ c/l/o/t/h/e/s/ not enough capital, and complain when that is pointed out.

Investors didn’t worry when the black box was a small part of the plane. Now, when it’s all that’s still there, Whaling away, is when we look and say (to borrow the old joke), “Yeah, that thing will fly. Like me grandmother.”