Banks 1, nation states nil

April 12, 2011

The battle between the banks and nation states is shaping up as something that lies between a phony war and a rout.

The bald facts are that three years after the crisis in which banking almost brought down the global economy, the biggest banks are bigger, more global and more entrenched in their positions courtesy of a now all-but-explicit government guarantee.

All three factors make large banks harder for individual nations to control, even the U.S., and even if the U.S. manifested the desire to pull out of its heads-you-win-tails-we-lose bargain.

“Too big to fail (banks) really creates a capture problem … They are now larger than single nations,” Andrew Sheng, chief adviser to the China Banking Regulatory Commission said on Saturday at a conference at Bretton Woods sponsored by the Institute for New Economic Thinking.

“The top 25 banks comprise 73 of global GDP and 45 percent of total assets of the banking system … They are so powerful they are essentially Godzillas.”

Sheng argues, rightly, that the creation of momentum upwards in asset prices by financial engineering combines dangerously with lax and co-opted regulation and an incentive scheme at banks that encourages risk taking.

The result: repeated and ever-larger crises that begin in the banking system but the costs of which are borne by taxpayers.

The global nature of banking makes single-nation regulation largely impotent. The Dodd-Frank legislation recently enacted has a resolution program that, though intended to combat the risks of a large bank failing, can do very little due to the global nature of such institutions’ assets, liabilities and networks.

Even if this starts as a regulatory problem, it almost inevitably ends as a political one, as a glance at Iceland shows. Voters in Iceland rejected by a 59-41 percent vote an accord that would have allowed for the repayment of $5 billion to Britain and the Netherlands, the second time voters have refused to pay to make good the debts of their formerly out-sized banking system.

Iceland, you will remember, was the host nation to a group of global banks which borrowed and lent unwisely and when they collapsed left the nation of 320,000 with a staggering liability.

The most recent “No” may be foolish, as it will shut Iceland out of international capital markets and may be reversed by international courts anyway, but it is a good example of how people react to debts which may be legal but are certainly not just.

The mechanics and merits of Iceland’s situation are not fundamentally different from those of the U.S. or Britain; the chief difference is scale.

CAN GOLDMAN FAIL?
As the scale of losses rises, it is possible that the politics of TBTF banks change in the world outside of Iceland, but it looks as if that will wait until a further crisis breaks.

For now banks have bested the nation states. Compared to 2007 there exists the same incentives to take risks, largely, while the funding and trading positions of the largest banks are, relative to their smaller peers, now better because the world has had an object lesson in their special government guaranteed status.

Simon Johnson, the MIT professor and former chief economist at the IMF, conducted a thought experiment with the audience at the Bretton Woods conference, asking who believed that Goldman Sachs would be allowed to fail if, for whatever reason, it found itself on the brink.

No one, it appeared, in the audience thought Goldman would be allowed to follow Lehman Brothers into history, and Johnson reports that having tried that question on several audiences he has thus far only found one person who does, an evidently somewhat overenthusiastic Goldman short seller in New York.

Of course Goldman cannot be allowed to fail, at least in their current form and in the current state of play.

Of the ideas for righting this few have much chance of working, and those have little chance of coming to reality. Higher capital, especially on a sliding scale linked to size, might work, but at levels perhaps well above those currently being debated.

Resolution authorities would have to be international, making an agreement out of reach for the foreseeable future. The same can probably be said of a financial transactions tax, which again would only truly be effective if global.

That is even before we consider the fact that both regulators and elites in much of the world have largely been captured by finance. Where do you think people go to work when their days as public servants are through?

So, it is on to the next banking crisis. Whenever it sees fit to come it will be larger and may finally make the rest of the world a bit more like Iceland.

(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. Email: jamessaft@jamessaft.com)

4 comments

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ALways enlightening James.

I chuckle when I listen to the politicians squabbling over $30,000,000,000.00 in spending as the Federal Reserve pumps about $100,000,000,000.00 into the money supply every month via “quantitative easing 2″.

It seems to me that socialism is bad if you need health care but good if you’re a bank and need almost free money. (Since Citizens United I can refer to a bank as “you”.)

I think that our young people will awaken one day and realize that they have to deal with this. They’re just not paying attention yet.

They WILL awaken.

Posted by Missinginaction | Report as abusive

Very good article. Too big to fail = monopoly in any private business sector. These megabanks need broken up as they weild way too much power over the American, and world economy.

Posted by Trooth | Report as abusive

Do you think if left up to the voters of the US, the outcome of a confidence vote in the politicians and the banking system would be much different than Iceland? I severely doubt it. The thing that has people pissed off here is that we’re stuck with Bernanke and Geithner no matter who is in the White House or the US Senate. In other words the financial system is shoving Bernanke and Geithner down our throats. Anybody who thinks otherwise is delusional.

Posted by Woltmann | Report as abusive

That is most interesting. The big banks amount to non-geographic nations. They have owners and employees, but no citizens.

Maybe a coalition of huge banks could do some debt restructuring to soothe the world’s current confusion and anxiety. They could do us all a great favor by taming the scary balance sheets of many actual geographic entities, the countries, provinces, cities and towns that are all so broke on paper.

Posted by Ralphooo | Report as abusive