Banking spins destruction myth: Hoocoodanode?

By J Saft
December 5, 2008

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Just as every society has a creation myth, banking is now busily writing a destruction myth that seeks to explain and soothe in a world torn to its foundations.

The myth, as expounded by regulators, bankers and their various service providers, is that we were hit by a perfect storm, a 1,000-year flood so unpredictable that we can’t possibly be held accountable for it. An act of god, rather than the folly of man.

Or as the excellent financial blog Calculated Risk puts it: “Hoocoodanode?”

The implication of course is that now banks know these sorts of things can happen, banks will behave sensibly because it is their best interests to do so. It’s just that the data we put into the models only covered the boom years. Now that we are getting good data on a downturn, well, problem solved. No need for overly heavy-handed regulation, that will only stifle growth and recovery.

No need for intrusive compensation controls; this will simply drive risk takers out of banking and into less regulated areas, or will prompt a brain drain in which the best minds might go into, god forbid, industry.

There is a pronounced unwillingness to take responsibility and to recognize that many of the factors that went into creating and sustaining the bubble weren’t so much unknowable but more likely, for those in a position to do something about it at the time, either unprofitable, unpleasant or politically inconvenient to know.

Take, for example, Robert Rubin, former U.S. Treasury Secretary and current board member at Citigroup.

“Nobody was prepared for this,” Rubin told the Wall Street Journal. He has been paid $115 million, excluding stock options, since 1999 and was advising Citigroup when it decided to mimic its peers and take on more risk.

“… What came together was not only a cyclical undervaluing of risk (but also) a housing bubble, and triple-A ratings were misguided,” said Rubin, who believes he along with Alan Greenspan has taken an unwarranted knock to his reputation. “There was virtually nobody who saw that low-probability event as a possibility.”

There is simply no doubt that a number of people were raising red flags about risk, about the use of ratings, about issues around securitization, and most certainly about an emerging real estate bubble. But it proved impossible for those risks to get a proper hearing within a system that was throwing off so much life-changing money.

WHOSE MONEY, WHOSE RISK?

Rubin, when queried on his pay, answered that he could have make more elsewhere. True enough, no doubt.

But while everyone is free to take money that is on offer, that is different from saying that you have earned it, or that, in a system in which pensioners and taxpayers are the ultimate bag-holders, it is appropriate and should not be subject to regulation.

There is a similar argument on pay making the rounds: that since so many senior managers lost so much of their fortunes in the failure of companies such as Lehman Brothers and Bear Stearns, this demonstrates that there was not a misalignment of risks between employees, shareholders and the governments that ultimately must pick up the pieces when things go wrong.

It is very sad that so many people lost so much, but this is not even close to being an argument for continued light touch regulation. The issue is not so much that people in banking and finance have skin in the game, but that they are far from alone in having it, and that their ultimate cost of capital is in part a function of the fact that it is and has been understood that the state will step in if things
come to grief.

That argues, in my view, for stricter regulation of bank capital and of bank compensation so as to decrease the risks. That means tying compensation more closely to risks, including the risk that things that look good today go bad in three years’ time. The UBS scheme, under which bankers can “lose” money they “earn” based on various performance factors in subsequent years, is not a bad start.

Those who argue against more stringent regulation have one thing right: it is going to cost, and requiring banks to hold more capital will impose a ceiling on the speed at which the economy can easily grow. Of course, we are always regulating the last war out of existence.

One idea worth consideration is proposed by Paul Miller of FBR Capital Markets and would involve regulating assets and how they are funded, rather than just the institutions.

That would help to guard against the next shadow banking system and another highly levered and ultimately government-insured bout of speculation.

–  At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here. –

76 comments

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Dear Sir,

2 years ago during summer holliday I made an error and left my bank account with HBOS in UK short of 2GBP£ which resulted 2 attempts for direct debit to be decliend and a penallty of 2 times 39 = 78GBP£ was charged to me.

I was away and on return I went to the bank and asked for explanation.

In shortest I was told, Mr Dimovski our bank has millions of clients and imagine if we allow unauthorised overdrfat for every second one even for 2 GBP£ it will add to our bank balanceshit negative ammounts.

In that respect we have implemented most sofisticated programs to monitor our balances. At the same time the bank regulators are monitoring our accounts and if we go in red for a 1Mil GBP£ we will be penalised and somebody at the bank will be fired.

Never the less we have witnessed that the very same bank with very same regulations and regulators in place was allowed to go billions in red and nobody was ever fired for their action.

Bankers have been infected with the most dangerous illnes of all time spread evenly arorund the politicians globally and that is the ignorance of the reallity .

Additionally they think that if they come on TV and read a text given to them by some speach wrighter that the people will listen and believe them.

People vote for government with believe that they are taking the oath to prevent such a colapses by monitoring what the so called big guys and blue chip companies are doing and to act quickly on even smallest of illegal action they take.

For them to come forward now with some sort of rescue packages making themself some sort of heroes is most pathetic situation ever occured in modern day life.

If a one dollar can go out uncontroled so it can 1 billion as same regulations apply.

Regards

Toni Dimovski

What a bunch of obsfucation. If you lie on a loan application you should go to jail. If you are so STUPID that you loan $500K to a person with a gross of $30K a year You should either lose that money if yours or you go to jail if it was given to you in trust for investment. If you package a number of these phony loans and sell them you should go to jail. Where is the problem in understanding or determining what to do in the current financial mess? John

Posted by ginsengjohn | Report as abusive

Mr. Saft does not seem to recognize the one true force behind the current monetary crises. This is the Federal Reserve Corporation, a private bank that has monopoly power over the manufacturing of the nation’s currency and entrusted with the regulation of its value. Without addressing the problems with the US Dollar and the owners of the Federal Reserve system strangling the US government and America’s citizenry with debt, it is hardly worth engaging in this discussion. Is this really as far as he can dig? If you want to talk about regulation then maybe we should audit the Federal Reserve System which is the only corporation in the United States that is not regulated by the US government!

Posted by Jay | Report as abusive

An ounce of sweat is worth an ocean of tears.

Posted by kelly p | Report as abusive

Well done.

Posted by Andrew McKay | Report as abusive

Absolutely, staggeringly, mind-numbingly unbelievable. This FIRE sector fiasco is a complete outrage. This kind of exploitation of the citizenry is exactly the reasons socialism and communism began. To see this kind of blatant Victorian Era thievery being floated on the public as if it was borrower’s fault and simply nature taking it’s course (i.e. piss down my back and tell me it’s raining!) should result in a Medieval response- line Wall Street with heads on pikes. I think no further regulation would be required…

Posted by J | Report as abusive

Common denominator to previous postings: short term self interest outweighs long term responsibility. The US is a democratic republic by brilliant design. Shame on businesses that skirt best business practices within legal boundaries and shame on the government overseers who do not in the minimum report to the citizens those very stupid business practices.

Posted by Andrew McKay | Report as abusive

meanwhile they will not bail out the automotive industry that did not cause this downfall of a world economy
we then give them 300 billion to start why are they not
grilled as they hunt for partridges-get upscale furniture and still go to the top steak houses

Posted by J Jones | Report as abusive

There’s plenty of blame to be spread, but it neither starts nor ends with the banking industry. The culture of this country has been one of excess far too long, resulting in an economy that is completely dependent upon consumers purchasing more than they can afford, most aptly exemplified by the $700B bailout intended to bolster investor confidence that Washington hoped would result in a resurgence of lending to an already over-indebted population. Where’s the logic? Corporate interests, including banks, have pilfered the citizen’s treasury, aided and abed by the prostitutes we refer to as politicians. I agree with “ginsengjohn(’s)” comment: its time to start rounding up these criminal bankers, their brokers and agents (including those they’ve successfully positioned in Congress and the Fed) and make them accountable for the damage that they’ve willfully caused. Certainly the writing was on the wall at least three years ago when already inflated and aggressively increasing housing prices almost instantly flat-lined and began to recede before our eyes. At the latest, that would have been the time to take action. At this point, economic stimulus can only serve to bandage the gapping wound, but does nothing for the infection that continues to spread.

Posted by Corey | Report as abusive

Evoking the image of a 1000-year flood represents an attempt to lessen the appearance of risk, the implication being that it will not reoccur for about 1000 years. Such an assertion is based almost purely on faith in cycles. We can extend the concept however, noting how civilizations collapse on a cyclical basis. I would say that there are some shades of truth to such comments from the banking industry.

Posted by Don | Report as abusive

I believe that the remedy must include regulation, but it also must include powerful disincentives, like confiscation of ill-gotten gains and prison time for the most egregious cases of self-serving corruption.

Although many of these institutions have gone down in flames so that the taxpayer is left holding the bag, many of the individuals involved in this piracy have been skimming vast sums for years and are extremely wealthy.

I have nothing against wealth, but I have something against wealth at the expense of society gained by “faulty intelligence” as our culpable leader and his henchmen are now trying to claim. If we don’t root out this kind of thing it will happen over and over again.

When the leaders are crooks, it destroys the nation. These are the true weapons of mass destruction that were hidden by the sleight of hand of a corrupt government serving its corporatist paymasters. On the other hand they say we get the government we deserve which does not speak well for our country.

Posted by Jonathan Cole | Report as abusive

Absolutely correct. First task is to do away with the Federal Reserve private corporation. It is an abomination not to be regulated by the government — and who exactly are the members who control our collective global destiny? Doesn’t seem to be the people we elected. Second, the comment by ginsengjohn is dead-on. Gross negligence, and reckless lending deserve jail terms for breach of trust. That goes for lender Boards of Directors and Executives, as well as politicians who now expect us blue collar stiffs to bail them out with our tax money. Is it just me, or is something wrong with this picture???

Posted by turismo | Report as abusive

I am a hedge fund manager. What is a bank?

Posted by John Blodbrett | Report as abusive

Dear Ginsengjohn,
The guy who loans that 500 K is not at all STUPID, because it is someone else’s money he is loaning. As for risk, the financial elite has been taking too little risk, not too much. If you pay me to gamble with your money at the casino, I am not taking any risk. You are!
As for jails, there are already 2 million Americans in them. It wouldn’t be a profitable way of using taxpayers’ money to put another million in new jails.

Posted by Ben | Report as abusive

Mr. Cole, For what it is worth, I agree with the your remedy except that I think public execution would set a better example. Also agree that as a whole, we probably deserve this, just not you and I. The only way to root it out is to let nature take its course, and it will. Those darned old cycles.

Posted by kelly p | Report as abusive

CalculatedRisk also noted this back in Mar 2008 – JPMorgan Chase memo titled “Zippy Cheats & Tricks” – The document recommends three “handy steps” to loan approval:

- Do not break out a borrower’s compensation by income, commissions, bonus and tips, as is typically done in a loan application. Instead, lump all compensation as the applicant’s base income.

- If your borrower is getting some or all of a down payment from someone else, don’t disclose anything about it. “Remove any mention of gift funds,” the document states, even though most mortgage applications specifically require borrowers to disclose such gifts.

- If all else fails, the document states, simply inflate the applicant’s income. “Inch it up $500 to see if you can get the findings you want,” the document says. “Do the same for assets.”

So basically Chase “intentionally engaged in fraudulent loan approval” and they ARE supposed to be Regulated by the Federal Reserve, FDIC, etc. So Why Isn’t Anyone from Chase in Jail Yet????

Posted by ap | Report as abusive

Bull s_ _ _! Blaming flawed computer models, you’ve gotta be kidding! The bankers and the regulators knew the dangers. Who relies on a computer model without profound knowledge of the subject matter and an understanding of the model itself. Bottom line is, the regulators didn’t regulate. They had the tools, they didn’t use them. And as everyone from bankers to buyers got greedy, those who should have and could have seen the problem in making loans predicated solely on an unsustainable rate of appreciation in housing prices, chose to ignore the problem rather than take on the Bush/Cheney administrations biggest financial supporters. We don’t necessarily need more regulation,to prevent a shadow banking system or unsafe practices but we most definitely need common sense enforcement of existing regulations. This economic disaster was both foreseeable and avoidable, but it would have required knowing the difference between a free market and a free-for-all. Phil C.

Posted by Phillip J. Cornacchia, Jr. | Report as abusive

According to John Ginseng, the US better start building many jails. The number of people whom took out loans knowing they couldn’t afford it and those giving it where in the millions. Many groups(ACORN) forced the banks to look the other way, John. This was done in the name of Fair and equal housing opportunities. Listen, when the loan officer made the loans that caused the problem, majority of them explained what had to be done. ITS THE CLIENTS(BORROWERS) FAULT FOR not changing their financial situation: Most all loan officers told their clients you are going to have to refinance within 2 years and in the meantime you need to improve your credit and secure a better income. I took out a loan but I had a plan, I refinanced in a year after paying off 20% of the balance and knocked off $500 a month, unlike most of the idiots, John I knew I could afford the home with the extra $500 payment or my current payment. The government needs to run classes as part of the $700 Billion program on “HOW TO MANAGE YOUR MONEY, NOT SPEND WASTEFULLY, USE CREDIT WISELY and LEARN TO PLAN FOR THE FUTURE.”

Posted by R Shah | Report as abusive

Greed, lies, deception, dishonesty. From the borrowers, to the banks, to the government. The underlying theme and lesson to be learned here is Biblical folks: “YOU REAP WHAT YOU SO”.

Posted by MJ | Report as abusive

Mr. Shah, you’re saying that most loan officers suggested to borrowers that “once you get this loan you need to refinance within 2 years and in the meantime you need to improve your credit and secure a better income” Doesnt that indicate that the loan officer was aware that the borrower couldnt afford the loan that they lending??

Posted by Jerri | Report as abusive