What Should the President Say?
On Thursday President Obama will give one of the defining speeches of his presidency. Most presidents are remembered for only two or three policies or events during their tenure. The Securities and Exchange Commission (SEC) case against Goldman Sachs means, like it or not, the legacy of this administration is wrapped up with the outcome of this and related cases.
The president is apparently lining up to give a fairly conventional "support the Dodd bill" speech. This would be major miscalculation.
The Democrats are afraid that if they truly take on the big banks, they will lose campaign contributions and be placed a major disadvantage for November 2010 and 2012—"don't push it too far" is the message from the White House to the Senate. But this just shows the White House has not fully comprehended the modern nature of banking.
The banks are already coming after the Democrats. A pro–big bank group launched advertising yesterday against Harry Reid in Nevada, as well as in Missouri and Virginia; the media spend is eye popping. Neal Wolin (deputy Treasury secretary) already declared war on the Chamber of Commerce over consumer protection; the people behind the chamber are very angry about what they think will hurt their interests.
If you want to rally the country against oversized banks that serve no productive purpose, you need to really end the too big to fail problem—half measures simply will not convince people or rally sufficient support. And what we have so far are half measures, as understood from left and right—see today's New York Times—because the "resolution authority" simply cannot work for large complex cross-border financial institutions.
It will help manage the failure—and avoid bailouts—at purely domestic US financial institutions, but it does not help for cross-border institutions because there is no international agreement on how to handle such failures and—I can assure you—there is no prospect for such an agreement in at least the next 20 years. The Dodd bill will help for resolving bank holding companies and for nonbank financial companies, but not for the megabanks.
How can you take on the banks—whose executives are out for revenge because of the consumer protection measures, because of what seems likely to happen on derivatives, and just to show they are still the top dog (e.g., Goldman)—with one hand tied behind your back in November?
What you would like to do is say: Look, we had an up-or-down vote on whether to break up the biggest banks and my opponent (or his/her party) was steadfastly opposed. You would want the president to state, in his clearest and loudest voice: There is no social value to having banks above $100 billion in total assets and we all now understand the danger of allowing banks to become 10 times that size—let alone entering the $2 trillion to $3 trillion range; we will gradually and responsibly force our biggest banks to become smaller. This worked for Standard Oil—no one can claim it hurt the oil industry. And who would really want to go back to having AT&T run a monopoly in any part of telecommunications?
What about the campaign contributions? If confronted on these terms, the top executives of the six megabanks, without question, would spend more money defeating Democrats. But that is exactly the issue you should take to the country. And it's only six banks.
Show people, in gruesome detail, the money being spent by this part of big finance. Go to the nonfinancial sector, to other parts of the financial system, and directly to individuals—asking most clearly for contributions that would replace what the banks have withdrawn and offset what the banks are spending to defeat the president's reform agenda.
Of course, people may choose not to support this effort. They are busy—and everyone has many distractions. Perhaps even the president cannot break through the daily clutter of information and ideas on this issue. But at least he should make a clear and determined effort—by putting the bank size issues accurately in stark and simple terms.
And if people still refuse to come on board, that's fine. But then they shouldn't complain so loudly as the big banks propel us all toward a Second Great Depression.
Also posted on Simon Johnson's blog, Baseline Scenario. The following were previously posted.
Break up the Banks
April 20, 2010
The biggest banks in the United States have become too big—from a social perspective. There are obviously private benefits to running banks with between $1 trillion and $2.5 trillion in total assets (as reflected in today's earnings report), but there are three major social costs that the case of Goldman Sachs now makes quite clear.
- The megabanks have little incentive to behave well, in terms of obeying the law. There is fraud at the heart of Wall Street, but these banks have deep pockets and suing them is a daunting task—as the SEC is about to find out. The complexity of their transactions serves as an effective shield; good luck explaining to a jury exactly how fraud was perpetrated. These banks have powerful friends in high places—including President Obama who still apparently thinks Lloyd Blankfein is a "savvy businessman"; and Treasury Secretary Geithner, who is ever deferential.
- The people who run big banks brutally crush regular people and their families on a routine basis. You can see this in two dimensions.
- They are not inclined to treat their customers properly. They have market power in particular segments (e.g., new issues or specific over-the-counter derivatives) and there are significant barriers to entry, so while behaving badly undermines the value of the franchise, it does not destroy the business.
- Small investors also lose out. Who do you think really bears the losses when John Paulson is allowed to (secretly, according to the SEC) design securities that will fail—and then pocket the gains?
- Underpinning all this power is the ultimate threat: too big to fail. If a big bank is pushed too hard, its failure can bring down the financial system. This usually means protection when the system looks shaky, but it can also protect big banks from serious prosecution—if their defenders, like Jamie Dimon, can make the case that this would undermine system stability and slow the creation of credit. (This is startlingly parallel to the arguments made by Nicolas Biddle against Andrew Jackson during the 1830s; see chapter 1 of 13 Bankers).
In turn, this puts competitors at a major disadvantage, because the bigger banks can borrow on better terms. The extent of protection provided to management and boards in 2008–09 was excessive, but what really matters is the protection perceived and expected by creditors going forward. And this is all about whether you can credibly threaten the creditors with losses. This, in turn, is about a simple calculus—if a firm is in trouble, will it be saved?
There are simply no social benefits to having banks with over $100 billion in total assets. Think clearly about this—and if you dispute this point, read 13 Bankers; it was written for you.
Goldman Sachs: Too Big to Be Held Accountable?
April 19, 2010
On a short-term tactical basis, Goldman Sachs clearly has little to fear. It has relatively deep pockets and will fight the securities "Fab" allegations tooth and nail; resolving that case, through all the appeals stages, will take many years. Friday's announcement had a significant negative impact on the market perception of Goldman's franchise value—partly because what they are accused of doing to unsuspecting customers is so disgusting. But, as a Bank of America analyst (Guy Moszkowski) points out this morning, the dollar amount of this specific allegation is small relative to Goldman's overall business and—frankly—Goldman's market position is so strong that most customers feel a lack of plausible alternatives.
The main action, obviously, is in the potential widening of the investigation (good articles in the Wall Street Journal today, but behind their paywall). This is likely to include more Goldman deals as well as other major banks, most of which are generally presumed to have engaged in at least roughly parallel activities—although the precise degree of nondisclosure for adverse material information presumably varied. Two congressmen have reasonably already drawn the link to the AIG bailout (how much of that was made necessary by fundamentally fraudulent transactions?), Gordon Brown is piling on (a regulatory sheep trying to squeeze into wolf's clothing for election day on May 6), and the German government would dearly love to blame the governance problems in its own banks (e.g., IKB) on someone else.
But as the White House surveys the battlefield this morning and considers how best to press home the advantage, one major fact dominates. Any pursuit of Goldman and others through our legal system increases uncertainty and could even cause a political run on the bank—through politicians and class action lawsuits piling on.
And, as no doubt Jamie Dimon (the articulate and very well-connected head of JPMorgan Chase) already told Treasury Secretary Tim Geithner over the weekend, if we "demonize" our big banks in this fashion, it will undermine our economic recovery and could weaken financial stability around the world.
Dimon's points are valid, given our financial structure—this is exactly what makes him so very dangerous. Our biggest banks, in effect, have become too big to be held accountable before the law.
On a more positive note, the administration continues to wake from its deep slumber on banking matters, at least at some level. As Michael Barr said recently to the New York Times,
"The intensity, ferocity and the ugliness of the lobbying in the financial sector — it's gotten worse. It's more intense."
This is exactly in line with what we say in 13 Bankers—just take a look at the introduction (free), and you'll see why our concerns about "The Wall Street Takeover and the Next Financial Meltdown" have grabbed attention in Mr. Barr's part of official Washington.
But at the very top of the White House there is still a remaining illusion—or there was in the middle of last week—that big banks are not overly powerful politically. "Savvy businessmen" is President Obama's most unfortunate recent phrase—he was talking about Dimon and Lloyd Blankfein (head of Goldman). After all, auto dealers are at least as powerful as auto makers—so if we break up our largest banks, the resulting financial lobby could be even stronger.
But this misses the key point, which Senator Kaufman will no doubt be hammering home this week: There is fraud at the heart of Wall Street.
And we can only hold firms accountable, in both political and legal terms, if they are not too big.
It is much harder to sue a big bank and win; ask your favorite lawyer about this. Big banks can more easily hold onto their customers despite so obviously treating them as cannon fodder (take this up with the people who manage your retirement funds). Big banks spend crazy amounts on political lobbying—even right after being saved by the government (chapter and verse on this in 13 Bankers).
When you really do want to take on megabanks through the courts—and have found the right legal theory and compelling lines of enquiry—they will threaten to collapse or just contract credit.
No auto dealer has this power. No savings and loan (S&L) could ultimately stand against the force of law—roughly 2,000 S&Ls went out of business and around 1,000 people ended up in jail after the rampant financial fraud of the 1980s.
We should not exaggerate the extent to which we really have equality before the law in the United States. Still, the behavior and de facto immunity of the biggest banks is out of control.
These huge banks will behave better only when and if their executives face credible criminal penalties. This simply cannot happen while these banks are anywhere near their current size.
Fortunately there is precisely zero evidence that we need banks anywhere near their current size—we document this at length in 13 Bankers (in fact, this was a major motivation for writing the book).
Break up the big banks before they do even more damage.
The Few: Sensible Republican Senators on Financial Reform
April 15, 2010
There are three kinds of Republicans in the Senate today. First, there are those willing to follow the lead of Senator Mitch McConnell—whose approach to financial sector reform apparently amounts to little more than, "Don't worry, be happy." If Senator McConnell has a reform plan he would like to lay out for review, now would be a good time to put some credible details on the table.
Based on what we have seen so far, Senator McConnell proposes to do nothing regarding the systemic risks posed by today's megabanks and just "let ‘em fail" when necessary. This is a dangerous and irresponsible position and it should be opposed tooth and nail by anyone who actually cares whether or not we run ourselves into a Second Great Depression.
The second group has remained silent so far, waiting to see which way popular opinion and their leadership will go. Most likely, almost all will cast their lot in with Senator McConnell.
And if Senator McConnell brings 40 Senators with him, they will defeat the Dodd bill—and then smash themselves into the rocks of November 2010 as the "too big to fail" party. Perhaps we should welcome that.
But there is also a third group, not yet numerous, that is more inclined to be sensible or—as Senator Corker aptly put it—to "act like adults."
These Senators (so far I have a list with precisely three names; tell me if you have more) begin to understand that allowing our megabanks to continue in their current form makes no sense. The power of this idea is starting to get through (also at BusinessWeek).
Saying we should do nothing about these megabanks makes no sense. And trying to turn the argument on its head to claim that, "a greater number of smaller banks would pose an even bigger risk of taxpayer bailouts" is truly not a powerful idea.
So what are the prospects for Senator Dodd's financial reform bill, which is expected on the floor soon?
Could it even be strengthened, for example in the direction that key Democratic Senators are already pushing?
The prospects for this are not as bleak as you might think. There are three elements that make this a potentially productive moment:
- The American people are legitimately and completely outraged by how big banks continue to behave. In such circumstances, you may think you have a backroom deal, but when it surfaces and people begin to do the math, the backlash can move things in an unpredictable direction.
- Senate Democrats are only now beginning to understand what the bill-as-drafted would and would not do.
- Almost all Senate Republicans are likely against the bill, but that "almost" may matter.
In short, anything can happen.