The Great Debate

Big banks aren’t bad banks

— Mark T. Williams, a former Federal Reserve Bank examiner who teaches finance at Boston University School of Management, is the author of the soon to be published “Uncontrolled Risk” about the fall of Lehman Brothers. The views expressed are his own. –

Too big to fail has become nothing more than a political sound bite and the title of a best-selling book. Unfortunately, in the process big banks have gotten a bad rap. The proposed Obama administration plan to limit bank size is just another example of big-bank bashing by high-level politicians.

Policy that simply focuses on downsizing big banks overlooks an important point. The problem is not that banks are too big; it is that banks are taking excessive risk. This includes big and small banks. Since 2008, more than 170 banks have failed, including big banks such as Lehman Brothers, Wachovia, and IndyMac. But most on this list – such as Citizens State Bank, Republic Federal Bank, and First State Bank — are smallish. They didn’t make big headlines. No books were written about them or movies made.

The fact that a bank is big should not automatically mean they are a threat to the financial system. It’s true that Citigroup, once our nation’s biggest bank, needed a massive government bailout. But this singular sample size is not large enough on which to base far-reaching policy changes.

Big banks offer many advantages over smaller ones. They provide consumers with a greater array of desired services and economies of scale allow them to deliver more for less, and they tend to have greater capital to protect them against unexpected losses. In many countries in Europe and elsewhere, the universal banking system (another phrase for big banks) dominates the market. In these countries, a universal big-bank system works.

In Canada, the top five banks represent 90 percent of the market. During the Great Credit Crisis of 2008, not a single bank failed in Canada (nor did any fall during the Great Depression). A decade ago, no Canadian bank made the North American top-ten list. Today, four are Canadian. The lesson from our northern neighbors is simply that they had tighter lending standards, lower leverage ratios, and better regulatory oversight. They also taught us that slow and steady is a better risk strategy than fast and wobbly.

Using Canada as an example, the real concern should not be bank size but the level of risk taking. Banks make money only three ways — providing loans, proprietary trading, and/or charging fees for services. The main driver of the recent financial crisis was neither proprietary trading nor fee charges, but risky lending practices.

There’s no way to hedge politics

James Saft

Jan 26, 2010 13:22 EST

Ben Bernanke in peril and the Volcker crackdown on proprietary trading by banks show two truths of the current dispensation: there is no effective hedge against politics and the reflation trade rests on fragile foundations.

Neither of these realities is particularly good for financial markets and neither is going away any time soon.

Both, too, are utterly related not just to each other, but to the Senate election in Massachusetts which installed a Republican into what had been a Kennedy seat, in the process terrifying Democrats who fear they will be sunk by association with a set of policies perceived to be favoring Wall Street.

In the aftermath, President Obama unveiled a policy authored by former Fed chief Paul Volcker, which is intended to make financial firms get out of the business of using government insurance to underwrite speculative bets; well, er, not all speculative bets, but the bad kind.

At the same time the confirmation of Bernanke is under threat, and he and the institution he works for had to endure the humiliation of seeing Senator Harry Reid issue a statement endorsing him but implying that he’d extracted some sort of undertaking from the central banker to “redouble” his efforts to help those struggling in the recovery.

Whether all of this is good or bad, or even if it has much of an impact, the fact is that both are the result of a financially struggling electorate which is going to strive to control things that they’ve previously been convinced to more or less let alone.

That’s quite a change from a few years ago, when most of us sat around stroking our chins and praising Alan Greenspan, banks and market forces as if they were one and the same. Everyone still agrees that you need banks, a market and a Federal Reserve Chairman, but there is a lot less agreement about how much freedom the three should be given.

from The Great Debate UK:

Glass-Steagall Lite, brewed by Volcker, served by Obama

Laurence Copeland

Jan 25, 2010 11:42 EST

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

Let me say at the outset that I am far from enthusiastic about either of President Barack Obama’s major policy initiatives: healthcare reform and the banking reform plan announced on Thursday.

But both cases are truly momentous, because both are tests of whether America is an imperfect democracy (like all the others) where government by the people eventually works, more or less, or a totally dysfunctional oligarchy.

Each initiative involves a confrontation with powerful vested economic interests whose lobbyists will no doubt fight long and hard in public and even longer and harder behind closed doors to block the changes.

The only difference between the two cases is that, while there may always have been significant popular opposition to the healthcare reforms, the need to “do something” about Wall Street is almost universally accepted on Main Street.

So if Congress blocks bank reform, it will represent a signal triumph of the lobbyists over the popular will.

from Rolfe Winkler:

Money market funds aren’t cash!

Rolfe Winkler

Aug 26, 2009 12:56 EDT

Paul Volcker wants to kill money market funds. He says that investors don’t understand them and that the funds could crash the financial system. He’s right.

The root of the problem is that money market funds are sold as “cash equivalents,” when really they’re anything but.

Investors allocating a percentage of their assets to “cash” are typically looking for a “riskless” place to park money. They want their principal protected, but they would  also like a few extra points of interest thank you very much. Free checks ? Even better.

Money market funds can offer all of the above, so naturally investors gravitate to them.

What they don’t realize is that their principal is at risk. The $1 net asset value that money funds market is just an accounting gimmick, a milder version of the same gimmick banks use to avoid writing down bad loans.

Because money market funds hold their assets to maturity, they’re allowed to use so-called “amortized cost” accounting instead of mark-to-market. If the value of securities in the portfolio rises or falls, investors don’t see that because it isn’t reflected in the fund’s share price. So they sleep soundly thinking their principal is perfectly protected.

To be fair, their principal is pretty safe. Most money market funds invest only in high quality ultra-short term paper. If the NAV did reflect the fluctuating value of holdings, it would still be very stable, probably never moving more than a penny or two.