– 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. –
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.
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It’s funny how when people are comfortable with something they will latch onto any shred of logic that supports that comfort. the sad, plain reality is:
fractional reserve banking as it is, and its best friend debt, which has even the U.S. government in its grasp, is completely unsustainable.
for now, as in the depression, the rich are getting richer and the poor are left to suffer. the rich mostly being involved in banking, the poor being involved in the actual goods and services that run the country.
the middle class is disappearing.
this is not capitalism, it is not even excusable.
it is a cancer upon the very idea of democracy and freedom, because it has consumed them alive. a federal banking system that is privately held by so few has been an invite to outright debt slavery and manipulation.
any logic and reason that attempts to justify this is not only a colossal failure of the imagination, but of the human soul.
“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world. No longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.”
~ Woodrow Wilson ~
(after creating the Federal Reserve)
This period is simply the calm before the storm. It’s the begining of the end of our relationship with ‘Capitalism’. The trust is gone. What’s next?
this article hits it right on the money and wall street is poised to continue on course. the US government gave OUR money to one man with no strings and HE doles it out with no strings. then the banks say they wont even LOAN our money back to us. Many many people tried to tell it like it was, but it was the emperors clothes story. And now the banks ideas of “fixing” things is to let CEOS keep their bonuses, even it they have to be renamed, and tighten credit so much that the recession and layoffs are doomed to worsen. The inmates truly are running the asylum - with OUR money
Trillions of dollars and millions of jobs, and still the New York elite write about the ‘perfect storm’ and quibble over their bonuses. Not one bad guy…when in fact there are not prisons enough to hold you clowns…including what passes for a journalist/commentator/yakking head/analyst these troubled days.
seems to me that the cocaine mentality made this bubble even bigger. This will go down as the ‘great coke bubble’ of the modern era. Any market player could engineer investment vehicles in a roaring bull market- the question would always be ‘how much euphoria do you price into assets?’… amswer. always as much as the market will take. And a roaring bull market will take a lot. The amswer to me is simple. Return to a moderately conservative baseline regulated bank system. And then in bear markets let the failures burn. And never revamp the model when all debt skews to AAA in a bull market…
ugh… ouch…is this America? why do we have soldiers in the streets pointing the eay to the ration lines? time for an emergency and emergency power granted to central government..the ones saying this will last till 2010 are the same ones a year ago were saying the fundmentals of the economy are sound and we are not in a recession. do you believe them now? How low will we go? I think the once in 10,000 year bottom is what we are approaching..for every creation myth there is an appocolyptic myth too, are you sure these are just m
To think that this is not an orchestrated event is laughable. We now see the consolidation of power within a handful of banks. Institutions are allowed to fail while others are assisted. Changes in policy and tax code are adjusted after the give away of Bear Stearns and Wachovia to J.P. Morgan. Wells Fargo sees the adjusted tax codes and fights J.P. for the spoils of Wachovia. B of A picks up the largest mortgage servicer in the nation as well as Morgan Stanley for a song and a dance. Years of lost market share is reversed within 1 year. What will emerge is a stronger banking sector with stronger pricing power with tighter regulatory controls to eliminate new start ups. Read “The Creature from Jeckyl Island” and see how well the Federal Reserve looks after it’s own.
An article in the New York Times in 1999 said, in regard to “liars loans” and zero-down payment home loans, and a higher level of mortgage owners defaulting, that this could be sustained as long as the market was growing, but if mortgage holders began to default, then it would result in a financial crisis at least as large as the 1930s depression. They knew, they certainly knew. GW Bush even allowed the investment banks to widen their reserve requirements from 10-to-1 to 30-to-1. The bond rating organizations (Moody, Standard & Poor) also stamped out high ratings on bonds despite evidence they were losing value and not adequately backed. This sounds like no accident. If not by chance, then what is their hidden agenda?
Obviously the bankers and financiers will ride the storm head held high and they’ll come out on top with more of our savings AND tax follars in their pockets. We had this coming and everyone in the finance sector knew this would occur, every single one as even a child can do the sums. There are no excuses other than greed and blackmailing bankers are holding us to ransom right now.
Something similar, “tulipmania,”hit Holland, circa 1637. See: Extraordinary Popular Delusions and the Madness of Crowds, written by British journalist Charles Mackay around 1830.
Plenty of people saw it coming from top to bottom in our society. Even Greenspan admits now that he had a few advisors waving red-flags. But how can the financial wizards riding the dragon that pays them hundreds of millions of $ not believe in its power? It was not greed first that intoxicated them, but power. The power to milk sovereign funds and play with leveraged trillions.
It was spectacular. Either way, we now know it was madness, and just like after Enron and we had to have Sarbannes-Oxley, now we will have to restore respectability to the disheveled drunk in the gutter, ie., investment banking after its decade of Bacchus.
Love is blind.
And so it seems is Greed
That explains not seeing this “Low Probability”
Then PoP goes the Bubble(s)
A common human ailment be it:
Banker,Baker or Candlestick Maker
Owen (Hereford - Wales)
To which creation myth are you referring, Biblical, or Evolution. Such pontificating comments lessen your credibility and imply that you think you are somehow privy to universal knowledge.
Otherwise, your comments do make some sense.
These thousand year floods are coming too often. The solutions, new deal, resolution trust corp. and TARP,are cool names for policies. Policies to cure the problems that result from fleecing the sheep of their retirements, savings, and new worth. It’ deja vu all over again.
This is the very reason that regulation is needed (they did not see this coming?) I am a graphic designer - know nothing about money - and I saw it coming. Greed makes one blind, that is why regulation is needed
[...] Banking spins destruction myth: Hoocoodanode? [...]
Ok Wall Streeters, Time to break out the old hard hat, we are gonna build bridges and roads! Please do not forget a good pair of gloves to protect your manicure.
regarding Mr. Hart’s comment about the phrase “creation myth” - would someone who believes evolution to be true take offense at calling it a myth? I think they would. Neither can be proven in any case.
I think the financial industry needs to follow the advice of the CEO of Samsung, who in the early 90s and in an effort to improve performance, told his managers, “I want you to change everything except your wives and children!”
for anyone interested in unbiased economics and explanation of depresions etc. I recommend Hayek - Nobel price winner or Rothbard, both Austrian School econmists, http://www.mises.org, … Peter Schiif was able to forsee this crises thanks to Austrians …
I’m sorry, didn’t the same sort of thing happen with real estate valuation back in the 1930s and in Japan about a decade ago? So much for a 1000-year flood.
It’s not regulation that is needed, but restraint during over-optimism.