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More Government in the Financial Sector to Save Capitalism
I am a Capitalist Pig, and proud of it, thus you would not expect me to support government interference and more strenuous regulation of financial institutions – after all, capitalism (free markets) and tight regulation don't mix well. Well, at the risk of been kicked out of the Capitalistic Pig Party, I am in support of tighter regulation of too-big-to-fail (TBTF) institutions – the likes of Citigroup, JPMorgan, Bank America, and (God forbid; after all, they are doing “God’s work” – their CEO’s words, not mine) Goldman Sachs.
Lack of tight regulation in the TBTF space leads to the worst economic system of all: asymmetric socialism. The enormous gains are reaped by employees and shareholders, but losses are socialized and paid by taxpayers. That is simply immoral.
Letting companies fail is at the core of capitalism's DNA, and I still stand by that. However, what we've discovered over the last few years is that if we let TBTF banks go bankrupt, their failure may take down other healthy (interlinked) financial institutions and derail the real (nonfinancial) economy. We saw glimpses of that about to happen when Lehman went bankrupt. If the government hadn’t stepped in to guarantee money-market funds (and almost everything else on earth), the real economy would have stopped in a few days, with massive withdrawals of funds from money markets and a shutdown of the commercial paper market, which in turn would cut off healthy companies like IBM from regular day-to-day activities like financing their inventories and paying their employees.
Our financial system operates on the assumption of continuity: we assume tomorrow will arrive and that we'll be able to get our money out of the banks if we want to. A failure of large financial institutions is akin to an earthquake of magnitude 9 on the Richter scale taking place in NY, but with aftershocks of 7 magnitude ripping throughout the country; and at the end of the day (or the week) the whole country ends up in ruin.
I could be wrong, and the failure of a large bank might end up being not such a significant event, but we will NEVER find out, as the cost of being wrong is too high. So we end up with the imperfect world we live in – the big banks will not be allowed to fail.
This imperfect world leads us to two realistic solutions: (a) create incredibly strenuous regulations that will require significantly higher equity-to-debt ratios than for smaller banks and severely restrict the activities of TBTF institutions. Basically, they need to be turned into regulated utilities, like your local gas and water companies. Permit their “God’s work” to be limited to only very transparent traditional banking activities – so they cannot fail. Separate the leveraged hedge fund (the proprietary trading operation) and the bank (the institution that takes deposits and makes loans). In other words, bring back a more sophisticated version of Glass Steagall act.
Or we have option (b): break them up, either by making their lives unbearable through the strenuous regulation described in option (a), or simply by legislating it, as was done with AT&T in the 1980s.
There are upsides and downsides with each solution. I personally believe regulations of complex systems often fails, as Wall Street always figures out how to game the system. Fannie and Freddie had a single regulator, OFHEO, whose sole job was to insure their viability. That didn’t work out well. Of course Fannie and Freddie also had a conflicting goal: they had to report to HUD that they were providing enough financing to low-income households. (Canada, on the other hand, is dominated by just a handful of very large banks that are strenuously regulated and were almost unscathed by the recent financial crisis.)
Breaking them up is what makes the most sense to me. Break them into small enough pieces that their failure becomes a non-event for the economy as a whole. That way failure will not be socialized, but borne by those who were to reap the rewards, rather than your regular Joe and Jane Six-Pack having to fork over a chunk of their paychecks to “bail out” the TBTFs so they can keep their jobs.
Intense regulation of TBTF institutions will slow economic growth, but to its natural, sustainable level. As we have learned, the other type of growth, though fun for a while, has a price tag that only increases with time.
Regulation may even stiffen innovation. I love innovation; I buy anything that has an “i” in front of it – I may even buy Apple’s iPad. But Wall Street and our economy as a whole would have been better off if, over the last decade, Wall Street was less “innovative” and employed fewer mathematicians with PhDs. Their latest & greatest innovations – the financial products that through sophisticated, ingenious, mind-boggling formulas (that often lacked common sense) showed their bosses how to create higher financial leverage on top of already high financial leverage – were responsible for the bombs that were at the heart of many recent blowups.
Breaking up TBTF will face the criticism that smaller banks will be less efficient and thus borrowing costs will be higher for consumers and corporations. This would be true if TBTF banks did not come with marble conference rooms, million-dollar executive offices, fleets of corporate jets, and $100-million compensation packages. The bottom line, if you compare the financial metrics: smaller banks are not any less efficient than the large ones.
A greater government involvement in the financial sector is not something I thought I’d ever ask for, but it has turned into a necessity in order to preserve, not destroy, capitalism.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).
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Allowing failure is just as important as hoping for success. Governments are by their political nature unable to create success or pick winners. The greatest threat to the future of our system is government interference. To Big to Fail has failed - a quick painful end is better than pain without end.
Vitality-- Seems like you have a good handle on what regulations do, so then you're saying a little regulation is good. If a little is good, then wouldn't you agree that more would be better. The fact of the matter is that regulations are only as good as the regulators. So, who is going to regulate the regulators? The best regulator in the world is the free market. Let me ask you, who is loosing in all of the government intervention? That would be the person who has saved. They could have the buying opportunity of a life time. The message that the government is sending is that saving is foolish. This is the message they have been saving for the last 35 years. Government intervention in trillions of "invisible" dollars that we call wealth is only "kicking the can down the road." There are no free lunches and someone has to pay...
As someone once said capitalism without failure is akin to religion without sin. The reason we are in the mess was because too many investors thought that Fannie/Freddie had government guarantees. Too many people thought they were in positions that could "never lose".
Having additional government bailouts is no better than giving a heroin addict more heroin to prevent him from going into cold turkey. We have to take our medicine and do what's right.
For years the IMF has advised third world nations that it's ultimately destructive to have the state systematically support failing economic sectors. I think it would be absurd and extraordinarily hypocritical of the West not to heed it's own advice.
When these banking conglomerates profit I certainly don't get a check. Conversely if they fail I'm not going to write them one either. They succeed and fail upon their own merits or inadequecies.
Let nature take it's course and let the dead banks stay dead,instead of wasting our resources bringing the banks back into a senseless life without life and death without death.
Vitaliy: I don't consider you a capitalist. What you're advocating is the core of the arguments presented by Paulson, Bernanke, Geithner, Bush, etc. It's the stupidity of conservatism! It forms a justification for more QE, more secrecy, more of what a growing percentage of the country is sick of!
Get the government out of financial management and let the bad banks go under. The world will not end.
Nope. Not buying the argument. History shows government involvement of this nature never ends well for free markets.
I had the problem on and off all day. We do our personal and business banking online with B of A. I wondered if it was the big one.
Bank of America’s site is down currently, leaving customers grown reliant on online banking unable to manage their money through the BoA website.
The bank that’s too big to fail when it comes to taking taxpayer dollars apparently is fine with failing their customers, with the site down since morning and no word from BoA on why they’re not operational online. Reports indicate that Bank of America apps for the iPhone and Blackberry are loading fine, but the website- where one would imagine most actual transactions occur- is still unavailable as of 4:15pm EST. That’s a lot of time to be offline, particularly with the weekend coming up. (Update: the site loaded for me after 15 minutes of trying to connect, can any current BoA customers confirm functionality in the comments?)
Speculation is that the Bank of America website is down due to a cyber attack, but with a reaction from the bank that’s the opposite of proactive, it’s up to a bunch of angry customers to connect the dots until the bank explains their outage. (And hopefully profusely apologizes.)
fascism does not work. capitalism could work, if the fascists got out of the way. damn nazis.
(Blues Brothers Movie)
Officer: Ah, those bums on Wall Street won their court case so they're back manipulating the market today.
Jake: What bums?
Officer: The f--king Nazi HFT and Insider Trading Party.
Elwood: JP Morgan and Goldman Sachs Nazis!
Jake: I hate Nazis.
"I hate Illinois Nazis."
Undt vat about zee Illinois Kazis?
Great ideas, but the cold, cruel reality is that the financial sector lets government insinuate themselves in the way that the financial sector wants them to insinuate. As long as politicians are driven by their egos, and bankers give them campaign funding to support their narcissism, none of this will ever end.
So, none of this will ever end.
We just have to figure out how to make a buck amidst all this.
"shutdown of the commercial paper market, which in turn would cut off healthy companies like IBM from regular day-to-day activities like financing their inventories and paying their employees."
How is running your operation and paying your employee's entirely on debt "healthy"?
that seem's to imply that you are either too big, or well just too big. Like an insanely fat person who can't get out of bed without the help of a crane.
Large corporates cash / treasury management operations constantly roll over CP and other MM positions to fund daily liquidity needs.
To massively oversimplify, if your customers pay you on the 30th of the month, and your employees get paid semiweekly, you're paying your employees on debt. It's AP/AR float, and using commercial paper or a credit line for this purpose is neither new nor controversial.
WHY is the Bank of AMerica website completely DOWN??
Apparently, this has gone on ALL DAYYYYYYYYY!
I cannot access my account or touch my money!!!!!!!!!!!!
Can someone please report on this??!!!
Saving capitalism? Is it in danger?
I agree but what if they had done it in another way ? Give Those trillions... $30,000 to every citizen there would'nt be a recession. Hell GM would be backed up with orders, the people would have saved the country and an IPOD on every table.
I like your comments about innovation, check this innovation out:
http://www.theonion.com/content/video/sony_releases_new_stupid_piece_of
You are right in a fashion , If you gave $30,000 to each citizen there would be no deflation - you would have inflation.
But wage deflation and consumer inflation are essentially the same thing
The median income of families has remained stagnant for years and is now declining
This is only partially due to banks taking a larger proportion of wealth which is highlighted through lack of economic growth
The main reason why we are in such a shit storm is that the debt/money created is not creating sufficient revenue and this problem will not be solved by simple wealth transfer from one group to another.
The capital markets will have to be revolutionized and transformed before they can again be sustainable over the medium to long term.
You mean "Trickle Up" economics?
Something like that was tried in the mid 20th century through the labor movement. It's main drawback is that it is a much less efficient system of transferring wealth to the politically connected...