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Guest Post: Systemic Risk is All About Innovation and Incentives: Ed Kane

Tyler Durden's picture




 

Guest post by Chris Whalen of Institutional Risk Analytics

 

"My dear sir, the Treasury order is popular with the people
everywhere I have passed. But all the speculators, and those largely indebted,
want more paper. The more it depreciates the easier they can pay their debts…
Check the paper mania and the republic is safe and your administration must end
in triumph."


President Andrew Jackson writing to President
Martin Van
Buren regarding the Specie Circular


1837

 

Last week the financial markets received a wake-up call courtesy of our former
PruSec colleague Mike Mayo, now of Caylon, who appropriately suggested that Citigroup
(NYSE:C) may be required to start recognizing the impairment of
some $10 billion in deferred tax assets in its Q4 earnings. The good folks at C
responded as only bank IR flaks can, saying that they did not know where Mayo came up
with his estimate.


Well, duh!

Unlike most of the inhabitants of
Wall Street, who barely read the first page of earnings press releases,
Mike actually reads Ks and Qs. For example, on Page 10 on the most
recent Form 10-Q filed by
C,
you will see a fascinating discussion of the "TAX
BENEFITS PRESERVATION PLAN" implemented by C managers to prevent a
write-down of these icky intangibles, an accounting event that
would seriously impair the capital of the Queen of the Zombie Dance
Party.

Likewise on Page 21 of the last Form
10-K for C,
you will see a very concise
discussion of the composition of C deferred tax assets and also a good
discussion of the IRS rules regarding the longevity of same.
Just be glad that you are not the audit partner who must sign-off on
C's 2009 annual report. Can't wait to read that document.


As IRA co-founder Chris Whalen told Gretchen Morgenson of the
New York Times
on Sunday regarding C: "They are hoping
that a combination of bank assistance and maximizing revenue and buying time
will let them survive. When I look at the whole picture, Citigroup is in
the process of resolution. I continue to believe the equity is worth zero and
that the company will have to go to bondholders for some kind of money to make
the bank stable."


Just in case you missed our
well-deserved kudos for Mike Mayo on CNBC's Fast Money on
Friday, click hear.  The segments starts about 4:00 into the show.


And now to our feature. In this issue of
The IRA,
we present the views of our friend and mentor Ed Kane of Boston College, who argues that the problem with the financial regulatory framework
is not the law, regulation nor even the regulators, but rather the confluence
of poorly aligned incentives and financial innovation.


THE IMPORTANCE OF MONITORING AND MITIGATING THE
SAFETY-NET CONSEQUENCES OF REGULATION-INDUCED INNOVATION


Edward J. Kane
James F. Cleary Professor in Finance
Boston College
October 29, 2009


With respect to any crisis, accountability for top government
officials is a negative function of their "ability" to sell their own particular
"account" of the time line of crisis and recovery. To a greater or lesser
extent, official narratives are self-serving cover stories designed to heap
credit on their authors and the institutions they lead, while shifting the blame
for financial and macroeconomic turmoil into someone else's territory.


The plausibility of the key elements in a cover story is
sustained by a combination of mischaracterization, distortion, and distraction.
A particularly useful tool is post hoc ergo propter hoc argumentation. This kind
of argument starts by associating the absence of crisis in the past with
something or someone that departed the scene shortly before the crisis emerged.
For example, one might argue: first, that the US didn't experience a
full-fledged financial crisis until after Alan Greenspan or Paul Volcker had
left the Fed; and second, that the absence of one or the other's seasoned
leadership explains why the turmoil developed and why it degenerated into a
disaster.


Obviously, that particular narrative would not serve
the purposes of officials whose handling of financial turmoil is being
questioned today. By casting them as overmatched rookies, this story offers them no
credit and considerable blame. What incumbent officials want is a story that
portrays them as overcoming odds as fearful as those faced by Horatius (and his
brave colleagues Lartius and Herminius) at a bridge whose crossing would have
allowed the most important country in the world (in their time, Rome) to be invaded by
a deep depression. To avoid invidious comparisons with their predecessors,
the story officials might choose could attribute the turmoil to weaknesses in
the policy environment that previous officials (perhaps even Greenspan
himself) might have mistakenly embraced.

The cover story that I perceive to be making the rounds in
DC today concerns how large financial institutions made themselves too difficult
to fail and unwind (TDFU). To evaluate this story, I propose to answer
two questions. Is it reasonable to pin the blame for the crisis on
the Gramm-Leach-Bliley Financial Modernization Act of 1999 (GLBA), which
abandoned the longstanding regulatory strategy of trying to keep banking, securities,
and insurance firms from offering one another's signature products? Would
repealing GLBA and breaking up TDFU firms in the US help to mitigate the frequency
or depth of future crises? My answer to both questions is no.

The financial crisis of 2007-2009 is the product of
a regulation-induced short-cutting and near elimination of private
counterparty incentives to perform adequate due diligence along the chain of
transactions traversed in securitizing and re-securitizing risky loans (Kane, 2009a).
The GLBA did make it easier for institutions to make themselves more difficult
to fail and unwind. But it did not cause due-diligence incentives to break down
in lending and securitization, nor did it cause borrowers and lenders
to overleverage themselves. Still, the three phenomena share a common
cause. Excessive risk-taking, regulation-induced innovation, and the lobbying
pressure that led to the GLBA trace to subsidies to risk-taking that are protected by
the political and economic challenges of monitoring and policing the
safety-net consequences of regulation-induced innovation. These challenges and the
limited liability that their stockholders and counterparties enjoy make it easy
for clever managers of large institutions to extract implicit subsidies to
leveraged risk-taking from national safety nets (Kane, 2009b). The trick is to
probe exogenous advances in information, communications, and
financial-contracting technologies for opportunities to fashion products and organizational
structures that book traditional business in innovative and nontransparent ways.

In the US, the de jure barriers between the
banking, securities, and insurance industries that the GLBA finally eliminated had
by 1999 become loophole-riddled remnants of their original selves. They provided
no more protection for contemporary citizens than the scattered fragments
of ancient city walls that tourists admire in ancient European cities today.
In Europe, city fathers stopped maintaining these walls for good
reason. Technological innovations in weaponry and ordinance prevented the benefits
of repairing them from covering the costs. In a similar manner, blasts from
the ever-improving artillery and munitions of regulation-induced
innovation destroyed the effectiveness of Glass-Steagall and Bank Holding Company
Act barriers to cross-industry operation. Fresh blasts will destroy them again
if Congress decides to resurrect them.

In a world of gargantuan and footloose financial institutions,
re-erecting federal barriers to cross-industry competition in the US will change
the country or state in which particular risk exposures are booked, but it will
not lower the danger of future crises. What it would do is to distract Congress,
regulatory personnel, and the news media from addressing the need to repair the
defects in supervisory incentives that fostered the short-cutting and
outsourcing of due diligence at every stage of the derivatives creation and
securitization process.


To fix defects in supervision, securitization systems need
doses of better ethics and better incentives all along the transactions chain.
This requires that financial institutions be discouraged from abusing the
benefits of safety-net support and that government supervisors be made
specifically accountable for delivering and pricing safety-net benefits fairly
and efficiently. This can be done through changes in top officials' oaths of
office, changes in the ways that they are required to measure their performance,
changes in financial-institution reporting responsibilities, changes in
compensation structures, and changes in the kinds of securities institutions
have to issue.


I. Original Purposes and Declining
Effectiveness of Exclusionary Laws


The Glass-Steagall and Bank Holding Company Acts are
exclusionary laws. Their purpose is to compartmentalize the activities of
differently chartered firms so as to avoid potentially crippling concentrations
of risk in individual financial firms and to constrain opportunities for
multiproduct firms to take advantage of naïve customers. Intuitively, the GLBA
may be characterized as lowering and regularizing the cost of cross-industry
operations. It removed the need to spend resources on getting around
restrictions on what banks may do and on what kinds of differently chartered
(i.e., "nonbanking") corporations may own a bank. Proponents of traditional
compartmentalization policies had supposed that carefully restricting reciprocal
entry into bank and nonbank financial activities could protect society from
three kinds of potential harm (Saunders and Walter, 1994, pp. 134-135).
Microeconomically, proponents sought to assure a wider range of
financial-services competition by lessening opportunities for banks to engage in
the practice of coercively tying sales of financial products that might be
purchased from a nonbank (such as securities underwriting) to sales of a product
(such as loans) in which a bank might enjoy a degree of monopoly power.
Macroeconomically, proponents sought to limit opportunities for banks to expand
their risk taking into activities that might destabilize their earnings
sufficiently to disrupt financial markets by increasing the risk of widespread
bank failures. Distributionally, proponents sought to protect taxpayers from the
possibility of suddenly being handed a large bill for resolving bank
insolvencies. The current crisis amply demonstrates that outsized costs can be
shifted to taxpayers when institutional risk taking is effectively subsidized by
mispricing and undersupervising loss exposures booked by institutions able to
count on safety-net support.

The stubborn survival of compartmentalization strategies in the
U.S. traced far more to the workings of money politics than to the pursuit of
these societywide benefits. The GLBA passed because, as loopholes expanded and
proliferated in piecemeal fashion, the political contributions that supported
the compartmentalized regulatory regime dwindled and finally fell below the
threshold value that opponents were prepared to offer to eliminate what was left
of the scheme.


Regulatory Competition and Regulation-Induced Competition


Regulation-induced innovation accepts rules, but attacks
mechanisms for enforcing them. The loopholes it opened in compartmentalization
laws not only reduced their value to the sectoral interests that sponsored them,
it increased the number and complexity of definitional issues that supervisory
authorities had to investigate and defend. As distance-related communications
and transportation costs moved closer and closer to zero, jurisdiction-changing
innovations in financial contracting and organizational form rendered laws
designed to compartmentalize the banking, securities and insurance industries
increasingly irrelevant and difficult to enforce. In the years leading up to the
passage of the GLBA, US courts became clogged with cases requiring judges to
rule on whether or not an innovative contract, corporate structure, or
cross-institutional delivery system had successfully moved a bank, securities
firm, or insurance company beyond the prescribed reach of a particular law or
regulator (see, for example, Anderson, 1993; Sivon, 1992; Turner, 1993).

As national markets became highly connected and products
developed more and more potential substitutes, compartmentalization strategies
quickly became riddled with loopholes. Regulators and legislatures in different
jurisdictions competed eagerly with one another for regulatory domain and seemed
all too willing to accept as tribute a mere fraction of the incremental value
that the loopholes they create generate for the firms that use them.


Banking practices and market environments differ markedly over
time and space. Much of this variation is driven by an irreconcilable tension
between adjustments in regulation or supervision and loophole-seeking avoidance
activity undertaken to make regulatory interference less burdensome. Regulation
begets avoidance activity, and avoidance eventually begets some form of
re-regulation. Regulatory adjustments, problems, and market events unfold and
mutate as part of alternating sequences in which either regulation spawns new
forms of avoidance (RA sequences) or the growing effectiveness of particular
avoidance activities calls for innovative re-regulation (AR sequences). Adapting
regulatory protocols to innovative avoidance activity is an endless task. Each
and every piece of regulatory re-engineering kicks off a series of RA
sequences. Inevitably, the range, size, and speed of regulation-induced
innovation outpaces the vision and disciplinary powers that regulatory
authorities can bring to bear. The current crisis tells us that, in recent years
across the chain of adjustments by regulators and regulated institutions,
risk-taking incentives became more and more dangerously misaligned with societal
interests. But this process began long before GLBA was enacted.

In the face of foreign (especially European Union) regulatory
competition, the ease of locating viable loopholes and the resource costs of
adjudicating the permissibility of creative product-line and organizational
transformations make it foolish to try to roll back the clock. A strategy of
formally walling off the parts of a complex financial firm that formally enjoy
safety-net support is unenforceable today. Realistically, the societal benefits
compartmentalization could achieve in the 1930s have for years had to be pursued
in other ways. Most other developed countries acted far earlier than the US to
allow domestic and foreign banks to sell insurance and securities products and
permitted either direct or indirect cross-industry ownership of bank,
securities, and insurance organizations (Borio and Filosa, 1994; Hough, 1991;
Posner, 2009). Rebuilding cross-industry barriers in the US will make safety-net
exposures less transparent and serve foreign interest by intensifying incentives
for TDFU firms to undertake activities in these countries through foreign
subsidiaries.

II. Strategies That Might Reduce
Safety-Net Subsidies To TDFU Institutions


It pays multinational financial conglomerates and national
champion banks to make themselves harder and harder to supervise. This means
that policymakers' root problem is not how to make TDFU firms smaller or less
complicated, or even how to make them more transparent and easier to fail and
unwind (although that would be helpful). The root problem is how to design and
manage national safety nets so that they do not deliver subsidies to firms when
they expand their political clout, organizational complexity, and risk taking in
clever ways. This means not only improving the operation of the US safety net,
but also improving the ways that the US net links up with nets operated by other
countries.


Large US financial firms operate in a regime of multiple
regulators. The absence of cross-country agreements for sharing resolution costs
in the event of a multinational firm's insolvency encourages
incentive-conflicted regulatory competition. Ambiguity about which country's
taxpayers can be saddled with the bill for safety-net losses reduces
accountability for supervisory and regulatory mistakes. It incentivizes
regulators in different countries to compete aggressively for footloose
financial-institution capital and employment. It also encourages officials to
blame not themselves but foreign regulators if and when the risky business they
have competed for falls into distress.


To be effective, programs of regulatory reform must address the
sources of the agency costs that intensified problems in industry risk taking
and in government insolvency detection and crisis management. To confront these
issues squarely, Congress and the Administration must focus beyond mere
adjustments in form and bureaucratic structure to force a re-evaluation of the
information produced and the particular contracts under which private financial
managers and government officials operate. A mitigatable source of incentive
conflict in industry risk taking and loss generation is the limited liability
that stockholders enjoy. The less capital they have invested in the firm, the
more valuable safety-net support becomes to them and their counterparties.

Incentive conflict in government is rooted in two
circumstances. First, top government officials have horizons much shorter than
the taxpayers they formally serve. Second, taxpayers are not their only
principals. Different principals differ in at least four important ways: in
their understanding of the duties officials owe them; in their ability to
influence policy decisions as they are being made; in their ability to
appreciate the consequences of alternative policy decisions; and in their
ability to offer rewards for bending policy in the directions they prefer. The
result is that officials feel disproportionately accountable to residents of
sectors that make themselves particularly well-informed and politically
powerful.


Improving Incentives in the Private Sector


If they want to help safety-net managers to serve taxpayers
better, Congress must task large institutions with making safety-net loss
exposures in their firms easier to detect and cheaper to resolve. Detection can
be improved by developing explicit metrics for measuring the value of safety-net
support at individual institutions and requiring safety-net beneficiaries to use
these metrics to estimate the value of their safety-net support and report this
value at regular intervals to their principal supervisor.


Although still provisional, researchers have developed a number
of metrics for the value of safety-net support. Carbo, Kane, and Rodriguez
(2009) estimate the value of safety-net support from data on a banking
organization's stock price. Baker and McArthur (2009) extract estimates from a
firm's credit spread. Hart and Zingales (2009) focus on the price of credit
default swaps. Huang, Zhou, and Zhu (2009) use stock price, credit spreads, and
credit default swap data simultaneously. If the analytical resources of the
world's central banks and largest institutions can be incentivized to attack
this estimation problem on a massive scale, the confidence intervals that
practitioners have to build around the various point estimates should decline
rapidly in the future.


It would also be helpful to require financial firms to plan for
the downside. To my knowledge, Richard Herring and Jacopo Carmassi (2009) were
the first to propose that managers be required to prepare and file with their
principal regulator a standby plan with which to handle their firm's bankruptcy
and be obliged to test, update, and refile this plan on a regular basis. The
existence of an up-to-date corporate "living will" would make the threat of
putting an insolvent institution into receivership or conservatorship more
credible because it would lower the costs of executing the threat. Having a
benchmark winding-up scheme in place would also make it much easier for
authorities both to wipe out the claims of stockholders and to negotiate
haircuts for uninsured creditors as the moment of takeover approached.

Explicitly planning for liquidation or break-up is one way of
making insolvencies cheaper to handle. Another way is to re-establish some form
of extended liability for owners of financial-institution stock. Extended
stockholder liability makes stockholders of a liquidating firm responsible for
covering a layer of corporate losses beyond the value of the capital previously
accumulated at the corporate level. Several now-industrialized countries
(including the UK, the US and Canada) imposed extended liability on bank shares
when their safety nets and private contacting environments were less
well-developed.


Extended liability increases transparency, counterparty
disciplinary rights, and regulatory accountability at the same time. It
increases transparency by transforming movements in the stock price of publicly
traded banks into a clearer signal of institutional strength or weakness.
Extended liability means that a supervisor's right to liquidate an insolvent
commercial or investment bank would carry with it a right to collect specified
amounts of additional funds from the personal or corporate assets of every
stockholder. As compared to limited-liability shareholding, deterrency is
enhanced by stockholders' duty to pony up additional funds if (but only if)
managers and regulators allow the bank to become so insolvent that it passes
into liquidation. Stock markets would imbed the value of this contingency into
the price of each TDFU firm's shares and traders could fashion derivative
instruments that capture various tranches of the loss exposure it entails. The
value of the contingency would be negligible for institutions that were
performing well and adequately supporting their risk with paid-in corporate
capital. However, the insurer's claim on off-balance-sheet stockholder resources
would become increasingly valuable whenever a TDFU firm began to take poorly
supported risks or to slide into financial distress. By increasing the
sensitivity of TDFU stock prices to changes in earning power and earnings
volatility, extended liability would encourage information-revealing stockholder
doubt about the viability of troubled institutions in advance of their final
slide into complete economic insolvency. Because doubts would emerge gradually,
these "runs" on an institution's stock would be far less catastrophic than the
sudden meltdowns that inattentive regulators allowed Bear Stearns, Fannie Mae,
Freddie Mac, and Lehman Brothers to experience in 2008.

A sustained sell-off by worried stockholders would increase the
quality of counterparty and regulatory supervision by helping safety-net
managers to identify institutions that deserve increased supervisory attention
long before the enterprise-contributed capital of these institutions could
become exhausted. The idea is to create a pool of contingent private capital
that would be drawn inescapably onto an institution's balance sheet when and as
it firsts falls into distress. Mark Flannery's proposal for contingent capital
certificates (2009) would do this very well if an appropriate market-based
trigger for forcing the debt-to-equity conversions can be found. Sharp declines
in the price of a financial institution's stock could reinforce
regulator-initiated triggers if large financial firms were required to issue
extended-liability stock.


Improving Incentives in Government


Requiring private institutions to prepare a regulator-certified
unwinding plan and to estimate the value of their safety-net support would
sharpen the missions of micro- and macro-prudential regulators. Besides
verifying estimates of the value of safety-net support supplied by institutions
under their purview, regulators could be further tasked with establishing,
publicizing, and testing periodically a benchmark market-mimicking scheme for
insolvency management.


While authorities would be free to deviate from their benchmark
plan in an actual crisis, they would be obliged to explain why they are doing
so. To help them to put crisis-management plans into operation more promptly, I
would also require them to aggregate the estimates of safety-net subsidies that
individual institutions produce. Each micro-prudential regulator would
consolidate these estimates in ways that would track over time the aggregate
value of safety-net benefits for firms they supervise. I would ask the Treasury,
the Fed, the Office of the Comptroller, the Securities and Exchange Commission,
the FDIC, credit-union regulators, and the Office of Thrift Supervision (if it
survives) to use these estimates and other relevant data to construct
independent estimates of the evolving value of safety-net subsidies to the
financial sector as a whole.

Obviously, these reforms would make the jobs of top regulators
more difficult. For this reason, Congress would be well advised to raise the
salaries of these officials. However, to lengthen the horizons of safety-net
managers, the raise should be as deferred compensation that would have to be
forfeited if a crisis occurred within three or five years of their leaving
office. This would have the further benefit of making new appointees more
cognizant of unresolved problems that his or her predecessor might be leaving
behind. To discourage elected officials from trying to win special treatment for
firms that contribute money to their campaigns, it would be useful to require
that regulatory personnel report promptly and fully on interactions with elected
officials that occur outside the public eye.


Congress could further sharpen monitoring and loss-control
responsibilities by establishing schemes in which private and governmental
monitors could hold one another financially responsible for the quality of their
work. For example, Congress has proposed that safety-net managers be required to
move trading in over-the-counter derivatives and other securities to
clearinghouses or exchanges when and as their volume becomes large enough to
pose material safety-net consequences. This duty would be strengthened if
deposit insurers were made to reinsure with private parties the coverage they
provide to OTC market makers in derivative instruments. This could be done
either by writing credit default swaps or by transacting directly in reinsurance
markets.


III. Summary Implications


It is important to recognize that the current financial crisis
is rooted in the economic and political difficulties of monitoring and
controlling the production and distribution of safety-net subsidies.
Regulation-induced innovation by financial firms seeks relentlessly to outstrip
the monitoring technology and the administrative focus that supervisory
personnel use in controlling institutional risk-taking. Exclusionary laws and
rigid capital regulation encourage rather than control regulatory arbitrage over
time.


To reduce the threat of future crises, the pressing task is not
to rework bureaucratic patterns of financial regulation, but to repair defects
in the incentive structure under which private and government supervisors manage
a nation's financial safety net. The mission of these managers is to balance the
costs and benefits generated by: (1) protecting financial-institution customers
from being blindsided by insolvencies; (2) limiting aggressive risk-taking by
financial firms; (3) preventing and controlling damage from runs; (4) detecting
and resolving insolvent institutions; and (5) allocating across society whatever
losses occur when an insolvent institution is closed (Kane, 2001). Unless the
safety net is backed up by solid crisis planning, cumulative extensions of the
safety net are apt to result in less frequent but more devastating crises. The
more effective a nation's safety net becomes, the less likely it is that
regulatory personnel will have prior hands-on experience in coping with the
severity of crisis pressures.

Redesigning regulatory schemes and relocating bureaucratic
responsibilities for different features of the safety net will not by itself do
much to slow processes of regulatory arbitrage. This can only be done by making
financial-institution managers and federal regulators accountable for estimating
and controlling in a timely manner the safety-net consequences of transformative
financial contracts and institutional structures.


REFERENCES

Anderson, William R., 1993. "The Struggle Between Federal
Banking and State Insurance Laws," Life Association News, 88 (December), pp.
124-127.


Baker, Dean, and Travis McArthur, 2009. "The Value of the "Too
Big to Fail" Big Bank Subsidy." Washington: Center for Economic and Policy
Research Issue Brief (September).


Borio, Claudio, and Renato Filosa, 1994. The Changing Borders
of Banking. Basle: Bank for International Settlements Monetary and Economic
Department (October).


Carbo-Valverde, Santiago, Edward Kane, and Francisco
Rodriguez-Fernandez, 2009. "Evidence of Regulatory Arbitrage in Cross-Border
Mergers of Banks in the EU." National Bureau of Economic Research Working Paper
No. 15447.


Flannery, Mark J., 2009. "Stabilizing Large Financial
Institutions with Contingent Capital Certificates." Unpublished University of
Florida Working Paper (Sept. 18).


Hart, Oliver, and Luigi Zingales, 2009. "A New Capital
Regulation for Large Financial Institutions," Chicago Booth Research Paper No.
09-36 (Oct. 2).


Carmassi, Jacopo, and Richard Herring. "The Corporate Structure
of International Financial Conglomerates: Complexity and Its Implications for
Safety and Soundness," Oxford Handbook of Banking (Allen N. Berger et al. eds.,
forthcoming 2009).


Hough, Vince, 1991. "Banks and Insurance: The Lesson from
Abroad," Best's Review (March), pp. 25-26, 28, 30.


Huang, Xin, Hao Zhou, and Haibin Zhu, 2009. "A Framework for
Assessing the Systemic Risk of Major Financial Institutions." Working Paper,
University of Oklahoma (May).


Kane, Edward J., 2001. "Financial Safety Nets: Reconstructing
and Modeling a Policymaking Metaphor." Journal of International Trade and
Development, 3, 237-273.


_____________, 2009a. "Incentive Roots of the Securitization
Crisis and Its Early Mismanagement," Yale Journal on Regulation, 26 (Summer)
405-416.


_____________, 2009b. "Extracting Nontransparent Safety Net
Subsidies by Strategically Expanding and Contracting a Financial Institution's
Accounting Balance Sheet," Journal of Financial Services Research, 35
(December).


_____________, 2009c. "Discussion of 'An Industrial
Organization Approach to the Too Big to Fail Problem' by Jean-Charles Rochet."
Prepared for Federal Reserve Bank of Boston 54th Economic Conference in Chatham,
MA (October).


Posner, Elliot, 2009. The Origins of Europe's New Stock
Markets. Cambridge, MA: Harvard University Press.


Saunders, Anthony, and Ingo Walter, 1994. Universal Banking in
the United States, New York: Oxford University Press.


Sivon, James C., 1992. "Insurance Activities Permissible for
Banks and Bank Holding Companies," Washington: American Bankers Association
(April).


Turner, Bob, 1993. "Bank Sale of Life Insurance: The Ideal
Solution," Banks in Insurance Report, pp. 11-13.


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Mon, 11/02/2009 - 22:47 | 117901 Bear
Bear's picture

Haven't you heard ... In the spirit of transparency and efficiency, Obama Administration has suspended all 10-k and 10-q filings for financial institutions making the problem go away ... this Administration is dedicated to subterfuge.

Mon, 11/02/2009 - 23:05 | 117913 Anonymous
Anonymous's picture

Regulation should be entirely designed to prevent entities, particularly banks, from hiding their troubles and keeping secrets from their investors, debtors and depositors.

If banks were required to continually report (like hourly) their deposit to capital ratio, and the specific nature of the risks they are exposed to some kind of free market effects might be possible - lower capital ratio = higher interest. The market might even find a equilibrium of what the proper ratio is at any time.

But somehow our entire generation has been duped into believing that freedom is the only key element for successful market dynamics, and little details like 'full knowledge' are not important.

As long as banks get to operate in secret it will always be a constant battle with regulators to view the secrets and ensure the bank is not too fraudulent. Of course the bankers have the upper hand since they get to set their own rules via the bought and paid for government. It is hard to see how this can ever be resolved..

Mon, 11/02/2009 - 23:50 | 117958 Intuition
Intuition's picture

Good points. Freedom is purely illusory without full disclosure and knowledge on the part of each party to any cooperative agreement. Without such openness, the tyranny of information asymmetry reigns supreme and we know that simply allows the den of thieves to run amok.

Mon, 11/02/2009 - 23:51 | 117955 agrotera
agrotera's picture

Sorry Tyler, but this Edward J. Kane must have written this paper in order to impress the owners of the privately held federal reserve.   He actually said that there was no good reason to reinstate the Glass Steagall Act because banks would just take continue to do this one stop shop business overseas.  And he is completely stepping over the idea of legalized criminality by trying to write the whole bankheist mess of with the idea that the makers of the mess are just looking to have a cover story, but what the real problem is is...(he details it in his ridiculous paper).

I have really liked some of what they publish at institutional risk analytics, but this is groupthinkthinktank fed propaganda...sorry.

Chris Whalen's  little note and the Andrew Jackson quote was a jewel but i would choose nail scratching on a chalk board over reading his guest's post again.

Mon, 11/02/2009 - 23:48 | 117956 Intuition
Intuition's picture

The underpinnings of this most interesting post remind me of a talk I watched recently (can't remember who or from where) that discussed how the black market responded to increasing regulatory pressures. Basically, the idea is that the more you regulate (or enforce regulations) a particular segment of the black market supply chain, the more you increase the profit margin involved in pushing the product through that highly regulated point.

 

Combined with the fact that moral hazard is impossible to separate from regulation, I really believe that anarcho-capitalism is the only realistic way to deal with the issues at hand. By trying to stop the profits found in financial engineering, we only increase the profit margins of those who can successfully navigate the regulatory structure (read: execute within the loopholes), while giving the public a false sense of security that the sovereign has everything under control.

Mon, 11/02/2009 - 23:58 | 117968 Anonymous
Anonymous's picture

Horseshit.

Tue, 11/03/2009 - 00:04 | 117976 Bubby BankenStein
Bubby BankenStein's picture

I have the highest regard for Chris Whalen.

Ed Kane's epistle is one of the most outrageous purveyance's of commie speak apologetiks imaginable from a professor in finance.  Oh I forgot, who taught the beneficiaries of the TDFU how to be businessmen?

This is a collection of high class mumbo jumbo assembeled to obfuscate financial reform.

Repeated reference to safety-net support and it's implications are stunning.

Tue, 11/03/2009 - 00:12 | 117980 agrotera
agrotera's picture

That is what i was trying to say, thanks Bubby BankenStein!  I thought i might have a stroke over the repeated references to safety-net support and that is why i think he probably published this pack of lies to have as his top listing on his CV in an application package to the fed.

Tue, 11/03/2009 - 00:45 | 117999 DaveyJones
DaveyJones's picture

Agree. The ex-prosecutor in me is wondering why this fool is saying don't reinstate the rules because the criminals will just figure out more ways to break the law. At the same time, he uses this same logic to avoid any discussion of punishing those who already did. Finally, he concludes that it is all our fault for encouraging the criminals by passing laws that forbid their crimes:

"Regulation-induced innovation by financial firms seeks relentlessly to outstrip the monitoring technology and the administrative focus that supervisory personnel use in controlling institutional risk-taking. Exclusionary laws and rigid capital regulation encourage rather than control regulatory arbitrage over time."  

 

Tue, 11/03/2009 - 00:24 | 117991 Cistercian
Cistercian's picture

 It could be summed up thus: regulation is futile, we will game the system anyway.

 

I think it is intellectually dishonest at best, and propaganda from a lower level of hell at worst.The truth is probably between those, on the hellish side I suspect.

 

 

 

Tue, 11/03/2009 - 01:13 | 118027 Anonymous
Anonymous's picture

Cistercian said : It could be summed up thus: regulation is futile, we will game the system anyway.

I agree fully but I would say they are "the system" and the government is just a tool, a branch of their system not the other way around.
Reminds me of how "the military industrial complex" that kept the Vietnam war going to fuel the military and manufacturing contracts. There was way too much money to be made off that skirmish. How many years and how much did that cost us big bad Americans to try squash a few Asian ants? A lot of people got rich off that war. Lets not talk about that though, the system knows whats best.

Tue, 11/03/2009 - 01:54 | 118053 tom a taxpayer
tom a taxpayer's picture

Ed Kane throws a heaping bucket of sand in everyone's eyes. But he can not hide the greatest financial crimes in U.S. history. The financial crimes of the century demand the prosecutions of the century. 

We need coast-to-coast arrests, from Countrywide to Goldman Sachs and every one in between. We need Racketeer Influenced and Corrupt Organizations Act (RICO) prosecutions and mass trials in style of the Maxiprocesso (Maxi Trial) of the Mafia in Sicily during the mid-1980s that resulted in hundreds of defendants convicted. We need RICO confiscations of the hundreds of billions in illegal "profits" from the criminal enterprises of the banks, mortgage industry, and Wall Street Mafia.

 

It takes only one prosecutor to investigate just one crime, and follow the money and the connected crimes, and bring down the overlapping criminal enterprises using RICO prosecutions. This is a target rich environment, and the criminal activities (fraud, Ponzi schemes, extortion, looting of treasury, cover-ups, etc.) are continuing today. So the investigation and prosecution can begin anywhere and follow the trail, with Countrywide, the mortgage industry and the appraisers or Freddie and Fannie or Citi and the big banksters or with Goldman Sachs and other Wall Street investment banks and brokerages or the rating agencies or AIG or with the federal co-conspirators at U.S. Treasury, SEC, OTS, and the Federal Reserve or with Hank "the mole" Paulson, Ben "the bag man" Bernanke, Tim "the patsy" Geithner, or the members of Congress who took money to facilitate the criminal enterprise.

 

To get a recap of the rampant criminality that begs for prosecution, see William Black's "Great American Bank Robbery":

http://hammer.ucla.edu/watchlisten/watchlisten/show_id/129363

 

Once a tough prosecutor applies the pressure, the white-collar softies on Wall Street will crumble like feta cheese. Once a tough prosecutor drops the first weak link, the rats will trample over each other to be witnesses in hopes of leniency. 

 

When a prosecutor takes off the kid gloves, and hits the criminals with the iron fist of justice, the prosecutor will become a national hero.

Tue, 11/03/2009 - 03:55 | 118102 faustian bargain
faustian bargain's picture

sure, prosecute fraud...but start with the source of the fraud in government and the Fed. They set the playing field and the rules. Without this fertile ground of moral hazard and inflationary monetary policy, the business of harvesting middle-class wealth will dry up on its own. (to mix a few metaphors.)

One thing is true - all the regulations and regulators in the world will not solve the problems caused by leaving bad monetary policy in place.

 

edit: unless that whole "iron fist" thing is the vision of the future. That might solve *everything*.

Tue, 11/03/2009 - 01:57 | 118054 Anonymous
Anonymous's picture

Wall Street is complaining because they don't like the flavor and quantity of their carrots.

Perhaps it is time to skip the carrots and serve up a heaping helping of 'stick.'

Tue, 11/03/2009 - 07:54 | 118132 blindfaith
blindfaith's picture

ENOUGH!!!!!!

Break the damn banks UP!  Why all this bandaid crap and trying to figure out some answer to PLEASE the bankers, or keep jerks like this author employed.  F*&K them, as the have our nation. The have destroyed 50 years of building by Good Citizens of this country.   THEY ARE TRAITORS, a threat our military would have stomped on if the name Talaban was attached. 

THERE IS NO justice, you all know this...hope springs eternal, it that it.  What? maybe 3 years at some Fed Golf Club for a billion dollar pay scam...please.

Tue, 11/03/2009 - 08:15 | 118135 blindfaith
blindfaith's picture

"Systemic Risk is All About Innovation and Incentives"...yea, that is what the Nazis thought too.  That is how they got everyday Germans to go along with their confiscation of money, property and rights.

Like the jews, Americans have been slowly stripped of their weath one by one and rounded up and barbwired into a concentration camp.  We acquiesced.  Watched these bumbs in finance and government steal us blind...and it was OK as long as those 401K statements kept looking so fine.  YOU invested in these monsters to make a buck, didn't you?  You watched as they took your neighbors house, right?  YOU watched as they sent your neighbors job to china, so you could have a nice fat 401K to look at.  Well, You are next to the camps, and unlike the Allied troups, there is no hero to cut the barbed wire from the camps being built for you as I write.  They own the ball , the statum, the seats, the team, and the town...and your 401K too.

Tue, 11/03/2009 - 08:19 | 118136 Anonymous
Anonymous's picture

so phil gramm is writing under the pseudonym of ed kane now....well isn't that speeeecial....

kane/gramm is a quack which the rockefeller / rothschild terrorists sent to confuse folks with such winners as increasing regulator compensation (so that the salary differential between gs and governnment sachs is not so great when they rotate between positions), taking an oath (so that the terrorists can fool cnbc anchors), extending risk (so that shell cames of unimaginable complexity can be played), and filing contingency bankruptcy plans (so that meaningless make work can be created).....

kane can go back to his rockefeller overlord and fuck himself....

the crisis occurred in part due to glass steagal rescission, in part to regulatory avoidance and obese regulators, and entirely to loss of moral and financial hazard....

the financial terrorists are 40-70 year old frat boys who know that whatever damage they do will be paid for by dad and the community because the punks are too cute to hold accoubtable....

fuck the fed, whelan, kane, gs, jpm, and the rockefellers.....

Tue, 11/03/2009 - 12:49 | 118331 Anonymous
Anonymous's picture

Stunning, this version of the argument that regulation begets innovation, as if to say laws beget crimes.

But it is true that the Wall Street types who were walled off by Glass-Steagall have waged a successful 40-year siege on markets formerly protected by high walls of bank regulation. The simultaneous rise of money market funds and securitization in the post Vietnam War era of "stagflation" eventually moved nearly half of the action out of the banks and into unregulated markets where trading, arbitrage, hedging prevail.

It is a mistake to think of the counterparties in this system as banks, yet bank seems to be the only word we have for it. This confusion causes us to imagine that regulating banks will matter. Indeed, everything we are seeing today comes down to an effort to protect the system, even if that means artificially supporting insolvent counterparties.

Mr. Kane argues that safety nets promote innovations in regulatory avoidance, but a more straightforward economic view would say that innovations in regulatory avoidance were motivated by the attraction of the lucrative fields controlled by the castle and the gold within those walls. What we are experiencing is not a banking crisis so much as it is the capture of the money creating mechanism at the heart of the system.

Wed, 11/04/2009 - 02:32 | 119384 Anonymous
Anonymous's picture

You know I read the TDFU at first as "too dumb to fail", or once I got the letters right, "too dumb, f*ck u".

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