Category: Financial Institutions

Zombie Banks and the Need for a Public Option in Finance

I recently heard Thomas Ferguson discuss his work in political economy with Chris Hayes. He mentioned this paper, which does a pretty remarkable job summarizing what’s happened in finance since the bailout:

[Banks have successfully lobbied] for free or low cost money: the euphemism is the need to “get a new balance sheet into the game.” . . . Along with bank creditors, which in the U.S. include giant bond funds like Pimco and BlackRock, bankers also form a phalanx against making bank creditors share any costs of bailouts by converting debt into equity – which, of course, is exactly what states concerned about their taxpayers should do.

Financiers also hate the idea – important for reasons of moral hazard – of losing their jobs, or limits on their salaries and bonuses[, or clawbacks]. Not surprisingly, wolves are artful specialists in crying wolf: Moves by states to make banks pay the costs of cleaning up are greeted by what we like to call the “immaculate deception”: that such steps amount to “socialism” and will choke off recovery and drive “talent” out of the banks.

Where bad banks or other schemes for warehousing assets are set up, the price at which those assets are eventually resold often generates another mare’s nest of problems. And finally, there is the issue, widely overlooked in the literature, of how impaired banks treat customers. In the current U.S. case and, we suspect, many others, “zombie” banks gouge clients by raising fees and other charges. More generally, in a financial equivalent of the Night of the Living Dead, they try to raise margins everywhere they can. All too often, they can almost everywhere, thanks to the waves of consolidation that financial crises bring in their wake.

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Roger Lowenstein, Meet Bill Black

In an essay in Bloomberg Businessweek, financial journalist Roger Lowenstein compares those calling for more criminal investigation of Wall Street to 9/11 truthers and conspiracy theorists. He also distinguishes the current crisis from the S&L debacle by claiming that “The bankers convicted in the savings and loan scandal who dealt sweetheart loans to friends were fraudulent. These people had their hands, willfully, in the till—and knew it.”

You would think that anyone making that argument would want to engage with the work of William K. Black, who has repeatedly compared the finance practices of 2003-2008 to those which led to the S&L crisis. But no, Lowenstein appears too detached to confront Black’s ideas, which have been published in articles and finance sites, and repeatedly debated in televised programs. Praised for his prior work by Paul Volcker, George A. Akerlof, and many other luminaries, Black is off Lowenstein’s radar.

Lowenstein also fails to address the structural foundations of the recent lack of prosecutions; namely, the lack of referrals from financial regulators to law enforcers:

[D]ata supplied by the Justice Department and compiled by a group at Syracuse University show that over the last decade, regulators have referred substantially fewer cases to criminal investigators than previously. The university’s Transactional Records Access Clearinghouse indicates that in 1995, bank regulators referred 1,837 cases to the Justice Department. In 2006, that number had fallen to 75. In the four subsequent years, a period encompassing the worst of the crisis, an average of only 72 a year have been referred for criminal prosecution.

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From Truth to Trust

In my last post, I praised Hernando de Soto’s proposal to improve business recordkeeping, or “economic facts.” Commenter A.J. Sutter responded that de Soto’s “notion of ‘economic facts’ itself represents a fallacious reification. Those ‘facts’ are constructed by social actors.” Sutter emphasizes the inevitably subjective, contingent aspects of accounting practices. He concludes that “rolling back some [accounting] innovations might be a good idea,” but “the recovery of some sort of ‘objectivity’ is not likely to be the result.”

He is in good company; consider, for instance, this dismissal of de Soto’s ideas from Annelise Riles’s profound and original book Collateral Knowledge: Legal Reasoning in the Global Financial Markets:

Contrary to De Soto’s simplistic claim that the very existence of registered property rights produces clarity and certainty about the delineation of powers and obligations (and hence that the only necessary reform of the financial markets is the creation of an adequate registration system for property in derivatives), most of property law is in fact about the enormous ambiguities that surround what powers and obligations flow from titled property ownership. If I own a piece of land, does that mean I have a right to build a factory on it that billows smoke onto neighboring property? If I own a shopping mall, does that mean I have the right to exclude protesters from demonstrating there? . . . As Duncan Kennedy and Frank Michelman pointed out . . . [in 1980], formal property law increases certainty for some that reduces it for others; it increases certainty about some expectations but decreases certainty about others. The real issue is whose certainty do you want to maximize, and about what. (164-65)

Both Sutter and Riles are right to criticize anyone who thinks the only, or even the major, “necessary reform of the financial markets is the creation of an adequate registration system for property in derivatives.” It is naive to think that, if only we had more information, the crisis could have been avoided. To take but one of many possible examples: even if the analysts at the rating agencies had done far more due diligence on the quality of the loans behind the residential mortgage-backed securities that were sliced and bundled into collateralized debt obligations, they still could have come up with some rationale for a AAA rating. Many understood what was going on, but “danced while the music was playing.” To the willfully blind, the naive, or the dense, virtually any arrangement can seem opaque.
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Invisible Hand or Hidden Fist?

In his press conference last week, Ben Bernanke concluded on an upbeat note. He had high hopes for a US recovery, since he believed that the Great Financial Crisis (GFC) of 2008 hadn’t taken from the US any of its basic productive capacity.

Whatever the merits of that view, the GFC did highlight debilitating trends in US finance infrastructure that have been intensifying for years. In this week’s Businessweek, Hernando de Soto (with Karen Weise) highlights one of the most important: the opacity of key markets and relationships. With scant exaggeration, de Soto warns that the US is on its way to levels of uncertainty more common in developing and communist countries:

During the second half of the 19th century, the world’s biggest economies endured a series of brutal recessions. At the time, most forms of reliable economic knowledge were organized within feudal, patrimonial, and tribal relationships. . . . The result was a huge rift between the old, fragmented social order and the needs of a rising, globalizing market economy.

To prevent the breakdown of industrial and commercial progress, hundreds of creative reformers concluded that the world needed a shared set of facts. . . . The result was the invention of the first massive “public memory systems” to record and classify—in rule-bound, certified, and publicly accessible registries, titles, balance sheets, and statements of account—all the relevant knowledge available, whether intangible (stocks, commercial paper, [etc]), or tangible (land, buildings, boats, machines, etc.). Knowing who owned and owed, and fixing that information in public records, made it possible for investors to infer value, take risks, and track results. The final product was a revolutionary form of knowledge: “economic facts.”

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“Politics is the shadow cast on society by big business”

In the run-up to passage of financial reform, internal tensions among Democrats were frequently on display. (The GOP political landscape appears much simpler: whatever can be labelled as “anti-regulation” gets approval from both the leadership and the Tea Party freshmen.) Now the grand guignol over interchange fees has exposed growing faultlines among Senate Democrats. The future of the party lies either with Chuck “Wall Street” Schumer, or Dick “Austerity” Durbin. Their struggle illuminates a great deal about the modern legislative process.

Ryan Grim and Zach Carter lay out the contours of the battle:

Delivery surcharge. Paper charge. Equipment charge. There’s an additional fee for using cards from banks outside his contract, but [retailer Charlie] Chung says he has no way of knowing until he’s gotten his bill how much of that pricier plastic has been swiped. The fees Chung pays are a tiny fraction of Wall Street’s swipe fee windfall; banks take in a combined $48 billion a year from these “interchange” fees on debit and credit cards, according to analysts at The Nilson Report. That money comes out of the pockets of consumers as well as merchants, as stores pass on whatever costs they can to their customers.

Last year’s financial reform bill ordered the Federal Reserve to crack down on debit card swipe fees, a $16 billion pool of money from which $8 billion flows to just 10 banks. As a concession to Wall Street, credit card fees were left unscathed. But the clock never ticks down to zero in Washington: one year’s law is the next year’s repeal target.

Mike Konczal and Adam Levitin have exhaustively analyzed the interchange battles; suffice it to say, it’s hard to read their work (and compare fees internationally) without getting the sense that banks are getting a massive windfall here. Usually that kind of extractive industry can use its profits to buy endless favors in DC. But the extremely high rates started irking retailers, who had enough leverage to push for legislation that required the Fed to reduce the swipe fees. Now Chuck Schumer (and his surrogate, Jon Tester) want to delay that reduction; Illinois Senator Dick Durbin, who sponsored it, is fighting back. According to Carter & Grim, “118 ex-government officials and aides are currently registered to lobby on behalf of banks in the fee fight,” and retailers “have signed up at least 124 revolving-door lobbyists.”

In phrasing a bit less poetic than the Dewey quote I titled this post with, a “frustrated moderate Democratic senator” described the battle as emblematic of the broader tone in Washington:
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Congratulations to ProPublica on its Pulitzer

Though executive branch officials have disappointed many with their investigations of the financial crisis, some journalists have done an outstanding job. Over the past year, I’ve frequently linked to stories from The Wall Street Money Machine, an exceptional series by reporters at ProPublica. Today, the Pulitzer Committee recognized their efforts, giving the first award in its storied history to a series that never appeared in print:

ProPublica reporters Jesse Eisinger and Jake Bernstein have been awarded a Pulitzer Prize for National Reporting for their stories on how some Wall Street bankers, seeking to enrich themselves at the expense of their clients and sometimes even their own firms, at first delayed but then worsened the financial crisis.

The Eisinger and Bernstein series was essential because it helped challenge the idea that all “banks” or “hedge funds” are stable, self-preserving entities that would guard against bad behavior to preserve their reputations. Anyone familiar with the work of Karen Ho or Satyajit Das would take a darker and more realistic view: that is often in the interest of individuals in the industry to be part of shadowy and unstable ensembles of desks and divisions whose main goal is slipping by whatever bonus-maximizing scheme won’t set off alarms among risk managers and regulators. In a piece called “The Subsidy,” Eisinger and Bernstein explained how payments of a few million in “bonuses” to employees running one division of Merrill Lynch helped those running another division “offload” billions of dollars in toxic assets to their own firm:
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From “Qui Pro Domina Justitia Sequitur” to “Elite Frauds Go Free”

Should they change the motto at the Department of Justice? John Ashcroft modestly covered a statue of lady justice during his tenure as AG. But a series of reports suggests that, at least when it comes to financial heavyweights, Domina Justitia has left the building.

Consider first Morgenson & Story’s article, “In Financial Crisis, No Prosecutions of Top Figures:”

As the crisis was starting to deepen in the spring of 2008, the Federal Bureau of Investigation scaled back a plan to assign more field agents to investigate mortgage fraud. That summer, the Justice Department also rejected calls to create a task force devoted to mortgage-related investigations, leaving these complex cases understaffed and poorly funded, and only much later established a more general financial crimes task force.

To be sure, the DOJ has talked a good game here, unleashing Operation Broken Trust to catch the small fry. But even in December of last year, Andrew Ross Sorkin was ringing alarm bells:

To hear Eric H. Holder Jr. tell it, the Justice Department is aggressively cracking down on financial fraud. . . . But after you get past the pandering sound bites, a question comes to mind: is anyone in the corner offices of Wall Street’s biggest firms or corporate America’s biggest companies paying any attention to Mr. Holder’s “strong message”? Of course not. (I actually called some chief executives after Mr. Holder’s news conference, and not one had heard of Operation Broken Trust.)

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Finance’s Revolving Door: Perfected or Passe?

Washington’s revolving door is legendary. Everyone knows the connections between lobbyists, members of Congress, staffers, and favored firms. They’ve been mapped in health care, oil, agriculture, and many other industries. Finance journalists chronicle a superclass shuttling from beltway to bourse and back. Yves Smith and Matt Taibbi post on “sleazewatches” and $2,200-a-ticket conferences where the regulated schmooze with the regulators.

But what if the revolving door is the wrong metaphor? What if, instead, there has been a fusion of state and corporate authority in the banking sector? What if Peter Orszag never left the government when he dropped the OMB Directorship to make at least ten times as much as a vice chairman at Citibank? Gabriel Sherman suggests as much when he describes a lucrative cursus honorum for DC elites:

The close alliance among Wall Street and the economics departments of the major universities and the West Wing of the White House is the military-industrial complex of our time. That it has an effect on our governance is beyond question. How pernicious and distorting these effects are, how cynical many of its participants might be, and what might be done to change the system are being fiercely debated in Washington. In fact, to the layperson, the most surprising thing might be the degree to which people like Peter Orszag see the government and Wall Street as, essentially, parts of the same industry.

Conservative Kansas City Fed President Thomas Hoenig has already argued that “big banks like Bank of America Corp and Citigroup Inc should be reclassified as government-sponsored entities.” Texas Republican Randy Neugebauer has called eight banks “TSEs,” or taxpayer-supported entities. And at a recent conference on macroeconomics, Steve Randy Waldman made a legal point fundamental to all the economic dilemmas discussed.
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ClassCrits Conference Call for Papers

The ClassCrits blog has a number of interesting posts up recently. The group has announced a call for papers for a September conference; here is the notice:

ClassCrits IV, “Criminalizing Economic Inequality”

This workshop, the fourth meeting of ClassCrits, takes as its theme the criminalization of economic inequality. The dominance of “free market” economic theory and policy has been accompanied in the U.S. by increasing reliance on the criminal justice system to make and enforce economic policy. The criminal justice system is increasingly used to control persons and groups whose participation in formal markets is marginal at best. Many aspects of traditional immigration law have morphed into “crimmigration”, appropriating domestic criminal law enforcement tools and redefining whole communities of workers and their families as “illegal people.” States and municipalities have criminalized the lives of homeless people, including those who are mentally ill.

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