Opinion

The Great Debate

Lowering risks from large, complex financial institutions

– Robert R. Bench, a former deputy Comptroller of the Currency, is a senior fellow at the Boston University School of Law Morin Center for Banking and Financial Law. The views expressed are his own. –

Financial institutions inherently are fragile.

As intermediaries, they are exposed to both exogenous and endogenous threats. The 2007-2008 financial crisis was caused by endogenous forces.  Simply, financial institutions were poorly governed, taking-on extreme liabilities and gambling them into high risk activities.  The meltdown of the financial system fed contractionary forces into the real economy, causing our “great recession,” creating negative exogenous loops back into financial institutions.

The roots of the financial crisis were poor underwriting of credit.  However, the crisis happened because that credit risk was amplified through abusive underwriting, distributing, and trading of debt-backed financial instruments.  The abuse was driven by “heads I win, tails you lose” compensation schemes.  Wall Street won, Main Street lost.

Reform of the financial system requires restoring the social utility of deposit-taking institutions while eliminating the casinos within them.  The Volcker-Obama proposals move in that direction, by limiting the degree of gambling at deposit-taking companies.  In essence, Volcker-Obama addresses the very basic question: What do we want the financial institutions to do for society?  We do not want them focused on fast profits through proprietary trading.  We do want them focused on how to finance the needs of households, commerce, and governments.

We need to separate the “financial markets industry” from the “financial services industry.”  The former complicates and confuses the latter when both are located in one financial services company.  Market trading makes for an active balance sheet and exponentially increases counterparty interconnectedness.  Unless walled-off or spun-off, regulating and supervising financial holding companies is difficult.  The financial services industry culturally  is a public utility, essential to our modern way of life, which is why we rescue it when trouble appears.  Unless we separate proprietary trading from the public utility, the high-roller financiers continue to free-ride the taxpayer.

Welcome to the Teenies, sorry about those returns

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-James Saft is a Reuters columnist. The opinions expressed are his own-

As we say goodbye to a decade so abysmal it never even earned a nickname, it is time to take bets on how the coming 10 years will shape up in economics and financial markets.

Welcome, then, to the Teenies, a word that will describe the decade as well as the small returns in financial markets and the shrinking financial sector it will bring.

So, let’s run through some themes for the 2010s:

Banking – The decade will end with meaningful reform of banking in place, but what is not clear is if this happens soon or only after a new banking crisis brought on by an unwillingness to take tough steps now. The likelihood is that regulation limits leverage and causes the share of the economy captured by financial services to shrink. It will be a lousy decade to be a shareholder, but given the government backing, perhaps not a bad one to be a bondholder.

from Commentaries:

Banking? Keep it simple stupid

In 1873, Walter Bagehot wrote that "the business of banking ought to be simple; if it is hard it is wrong." He would have struggled to recognize today's banking system.

It is not just ever more ornate derivatives that bend the mind. Financial firms themselves have become fabulously complicated. Citigroup lists 2,061 subsidiaries and affiliates while the institutional chart of JPMorgan Chase is 267 pages long.

Complexity -- as Bagehot predicted -- has become a curse. If nobody can understand financial firms, they will become ever more accident prone.

Bank rally ready to be marked-to-market

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

U.S. bank operating earnings are going to have a hard time outrunning credit losses, making the massive rally in bank shares look ready to be marked-to-market.

A series of positive statements about profitability in the early part of the year from major U.S. banks, notably Bank of America, Citigroup and JP Morgan helped to spring a rally in the beaten down sector, as investors bet that with government assistance they could earn their way out of their troubles.

Accounting change won’t save banking

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

By all means reform accounting, but for pity’s sake take your time and keep your expectations low.

Suspending mark-to-market accounting immediately as a means of levitating banks out of peril simply won’t work. While transparency may or may not be the foundation of banking, trust undoubtedly is.

“Adjusting” or suspending fair value accounting, even if you swear up and down that this time it’s even more fair will erode rather than build trust and repel rather than attract capital.

A middle ground in the banking crisis

pauldanos– Paul Danos is the dean of the Tuck School of Business at Dartmouth College. The views expressed are his own. –

A major question in the government response to the banking crisis is choosing between the “evils” of nationalization of banks that would however provide stability, versus the “benefits” of saving of the private banks that would innovate and compete in a market system.

As the dean of the Tuck School of Business I’m privileged to speak with a wide range of economists, bankers, Wall Street executives and our own students, and what I’m interested in is finding an answer somewhere in the middle ground:

Bankers can’t kick the sporting habit

Alex Smith– Alexander Smith is a Reuters columnist. The opinions expressed are his own –

People are up in arms about bankers receiving bonuses when the banks they worked for have gone down the pan. But isn’t it just as shocking that so many state-backed financial firms still subsidize the eye-popping wages of sporting superstars through rich sponsorship deals?

It’s the same story on both sides of the Atlantic. Citigroup, which received $45 billion from the U.S. government, is sticking with a $400 million marketing deal from 2006 which includes the naming rights for the new home of the New York Mets baseball team, which will be called Citi Field.

from James Saft:

Save capitalism from the banks – Nassim Taleb

Black Swan

Nassim Nicholas Taleb,  the author of  "The Black Swan: The Impact of the Highly Improbable", has a simple proposal to as he puts it, "save capitalism and free markets from the banks."

Nationalise the banks, limit the rewards to those who work in what he calls the "utility" part of the system and have a completely uninsured second leg that can take all the risks it wants and lose its shirt, he said in an interview in Davos at the World Economic Forum.

"They rigged the game. We pay them for their profits, there is no clawback so their incentive is to hide the risk they are taking."

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