>The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accumulate in the financial system and become a catalyst for disaster.
I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary.
This is true, but the downside is capped: a bonus can't go below zero. Thus traders may become insensitive to the amount of money they lose and thus increase risk.
Edit: To clarify (since someone downvoted me), you are making a true statement, but I don't see how it is in conflict with anything I'm saying, or what other point it supports.
What Taleb is saying is still true. If I have a 400k market salary and I give up 200k of it for the right to 1% of the profits I generate, then I still maximize the expected value of my compensation that year by maximizing the size of my bets. I could bet a billion dollars on a coin flip, get 9.8 million (after recouping foregone salary) on heads and lose 200k on tails. Moreover, there is a well established history of traders that lost large amounts of money finding gainful employment regardless. See Boaz Weinstein, for example.
Based on those figures, earning a profit worth a bonus of 400,000 and losing far more the following year breaks even with respect to salary, so there's hardly an incentive to ensure consistent trading success to average well above market salary. If you can adopt worse trading strategies than martingaling a roulette wheel and still come out far ahead on salary, the incentive scheme isn't well designed.
I agree. The real problem he's describing is the bonuses reward short term success regardless of the long term risks. Bank shareholders who are long term investors should demand bonuses that incent long term success, rather than short term.
Wow yeah traders should really be the first thing we think about when we want to save the world economy because traders are improtend, I mean what would we do without traders?
You miss the point. It's possible to make huge returns on risky investments and get paid huge bonuses for several years until the investment fails. The the worst that happens is that you don't collect your bonus that year.
there are lots of bonus structures that mitigate this risk. some things you can do:
1. clawback clauses. when investments underperform, you take back bonus money. this goes well with:
2. long term vesting. you don't collect the entire bonus up front. you get it spread out over an extended period of time (say, 10 years), contingent on continued success / your bank still existing.
in fact, many banks and hedge funds already implement these ideas. of course, if you're writing a newspaper article, you can get a lot more pageviews by papering over this fact and saying the most populist thing you can think of.
Suppose there is a bet that has an 80% chance of success (a payout of 100), but a 20% chance of catastrophic failure (a loss of 500, which results in a bail-out). On average, this bet loses 20; it should not be made at all.
But suppose you make a bonus of 20% of your gains, and no bonus for losses. Would you make this bet? Is opportunity cost a sufficient disincentive, or is that an elementary mistake, since the expected return seems to be 16?
>I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary
Say my bonus is, I dunno, 2% of profits.
I go put 100 billion dollars on a single hand of blackjack. If I win, I make 2 billion. If I lose, I'm out 400k. Easy choice. Do it!
The Black Swan is an interesting book. You might disagree with Taleb's claims, but he's not making elementary mistakes.
In a Ponzi scheme, you give money to the Ponzi operator, the operator does "complicated" things with it, those who withdraw early do well but at some point there is no money.
How is this different from the bailed-out banks, or an over leveraged banking system in general?
If you don't participate in the global economy you can't get burned by it. People who subsistence farm are largely immune to problems in the global economy.
Another option is for banking (of the high risk investment banking kind) to be conducted by partnerships, with only natural persons as members, rather than corporations. One's ownership would be long-term, and actions could claw back previous upside.
Goldman Sachs was a partnership until its IPO in 1999. A lot of finance houses were closely held partnerships until the late 20th century.
That would work if we wanted to stop banks from transferring losses to shareholders - the real problem is that they transfer losses to taxpayers. Pre-IPO Goldman Sachs was probably considered "systemically important" enough for their losses to have been covered in the event of a large trading loss.
Yeah, there needs to be a clear distinction in advance between entities which can be bailed out (and thus must be highly regulated) and entities which can experiment/innovate freely (but which can't socialize their losses).
LTCM would have clearly been "not bailed out", except it was. Admittedly not directly by the USG/FR, but at the direction of the Federal Reserve.
And even then it's tricky, because a non-regulated entity can make a bet with a regulated one and end up getting bail-out money by virtue of that bet. That seems undesirable, but you also can't really stiff the non-regulated entity, because then nobody will ever want to bet with the regulated one again, thereby destroying its ability to hedge.
I wonder what the costs to the economy would be if we had Canadian levels of regulation of the financial industry, or even greater (something like how utilities themselves are regulated).
Canada believes in allowing only a few, highly regulated banks. Since there are only a handful of banks, it makes it very easy to regulate them.
But this model does hurt the little guys. Since Canadian banks form an oligopoly, they charge you for lending them money; account maintenance fees are standard. This hurts the smallest savers the most. Similarly, there is minimal competition in setting interest rates. Finally, financial innovation, done right, does help people---think Vanguard, index funds, ETFs, etc. All much more limited and much more expensive in Canada (I think).
In contrast to Canada, I think we would be better off with many small institutions, lightly regulated. Then they can compete for your business and do not need taxpayer support when they fail. When they become too big, break them up.
The banking system in Canada is not significantly different than the United States, except that it is just a banking industry. The U.S. has a banking/gambling industry. Actually it's more of a gambling industry with a small banking sideline.
IMHO they would also have been considered "politically important" enough to have their losses covered, given their long history of private => public => private employment.
I think a better solution for "too big to fail" banks would be to require bonuses are paid in restricted stock. That way if the bank needs a bailout, then bonuses would be automatically clawed back. The bigger the bank, the larger the portion that is required to be RSUs. This would give a recruitment advantage to smaller banks, thus serve as an automatic limiter to bank size.
An even better solution would be to just allow the market to take its course. Thinking up ways to allow to big too fail institutions to keep existing is counterproductive. Just allow it to fail and people will stop doing those things. If your bank doesn't exist you can't very well collect a bonus from it.
I bet you if the big money families started losing big chunks of their fortunes that there would be serious reform. Same with retirees and their pensions.
How do you think the prosecution of bankers would go if bankers put the DOJ pension at risk?
Well, the market successfully lobbied against regulation on CDO and CDS. It was the market that pushed the Gramm–Leach–Bliley Act. It was the market which gave AAA ratings to junk investments.
I see your point, but I think that if the whole deregulation (and thus free market) hadn't happened, a lot of the damage could have been avoided.
A partially deregulated market is not a free market. Also, if you read anything about the SEC you'll know that they don't enforce the current regulation so any point about extra regulations helping anything is largely moot.
Also, regarding the 'regulated market' look at the massive frauds that took place at Fannie and Freddy which are essentially arms of the gov't. Look at how the Social Security System is administered if any corporate pension plan was run the same way they'd be thrown in jail (if the SEC cared to enforce the law).
Look at the pressure on those institutions to create subprime loans under the federal housing laws. Look at the Fed Reserve chief talking about how great ARM loans were. Regulators, market participants, law makers all conspired to create a toxic environment that was not stable in the long term.
Yes, a lot of damage could be avoided if the gov't, regulators and market participants weren't going around telling everyone that they had guaranteed investments.
To think that after passage of GLB we had a free market is incredibly naive.
Gov regulations did little to promote sub prime lending. The simple fact was once investors started to buy loans banks where free to make loans as fast as they could repackage and sell those loans. This inundated the housing market with cheap loans and drove up prices creating the bubble in the first place. Computer models built in the middle of a housing bubble without much historical data where easy to trick into thinking housing loans where overly safe investment which let people churn loans until the only people left where those least able to afford them.
Toss in late night infomercials promoting get rich quick house flipping and the pump was primed with people willing to fudge the paper work. And loan servicing companies willing to look the other flip crap loans with little downside. The only thing that really hurt many of these company's is they ended up with to large a loan inventory, if they been a little leaner far fewer companies would have been at risk.
"At President Clinton's direction, no fewer than 10 federal agencies issued a chilling ultimatum to banks and mortgage lenders to ease credit for lower-income minorities or face investigations for lending discrimination and suffer the related adverse publicity. They also were threatened with denial of access to the all-important secondary mortgage market and stiff fines, along with other penalties."
"The threat was codified in a 20-page "Policy Statement on Discrimination in Lending" and entered into the Federal Register on April 15, 1994, by the Interagency Task Force on Fair Lending. Clinton set up the little-known body to coordinate an unprecedented crackdown on alleged bank redlining."
That's a stretch, if you look at the history of sub prime lending Clinton was out of office long before it took off. Most people would argue that subprime was a fairly healthy part of the overall loan / risk landscape until 2000. So, I think you need to look for slightly more recent causes. If you want to look for mis regulation the fed's stimulus to deal with .bust was a significant contributing factor.
Ugh, this tired idea. Ask yourself this: if the law was created in 1994, why didn't the bubble take off then? The CRA had nothing to do with the crisis as most of the subprime loans were made by non-CRA governed companies.
The housing bubble could have been avoided entirely if the Fed had just placed tighter restrictions on the loans that could be made. Greenspan famously decided that he didn't want to do that - which lead to companies like Countrywide creating the loans for packaging by Wall Street, allowing them to offload all risk immediately.
My true disappointment with Obama has been his lack of real, strong re-regulation of Wall Street and a pursuit of criminal charges against many on Wall Street, but at least, immediately after he came into office, added the simple language of requiring lenders to confirm income as part of the lending process. That simple language, which would seem obvious to anyone who would lend money, could have stopped the whole thing in its tracks in my opinion.
> Ask yourself this: if the law was created in 1994, why didn't the bubble take off then?
We were running another bubble then.
Note that W also encouraged home ownership, so I'm not blaming Clinton alone.
> The CRA had nothing to do with the crisis as most of the subprime loans were made by non-CRA governed companies.
The posted link wasn't the CRA, but a policy that applied to every company that made/makes home loans.
Also, you're ignoring the role of Fannie/Freddie. A large fraction of loans are made to be sold. As the largest buyer, Fannie/Freddie have a huge effect.
Doesn't follow - if the banks were forced, as you say, to make loans, the bubble should have started then.
>The posted link wasn't the CRA, but a policy that applied to every company that made/makes home loans.
That's fine, but there is no indication, in the actual mortgage data, that banks were being forced to issue subprime mortgages. The data shows that it was mainly mortgage companies were issuing subprimes, then offloading them for packaging into CDOs by Wall Street. If you want to make that argument, it isn't enough to produce a document - the data has to support the argument and it doesn't.
>Also, you're ignoring the role of Fannie/Freddie. A large fraction of loans are made to be sold. As the largest buyer, Fannie/Freddie have a huge effect.
Not true - Fannie/Freddie were late to the subprime game and had lost marketshare. In 2006, they got started buying subprimes. Bottom line, Fannie/Freddie had an impact, but they were not the driving force behind the housing bubble.
"Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.
During those same explosive three years, private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data."
> Doesn't follow - if the banks were forced, as you say, to make loans, the bubble should have started then.
The housing price data shows a run-up then.
Like I said, there were other factors, but without the "encouragment" to issue subprime, things would likely have been different.
> That's fine, but there is no indication, in the actual mortgage data, that banks were being forced to issue subprime mortgages. The data shows that it was mainly mortgage companies were issuing subprimes,
"banks" in this context is shorthand for anyone offering mortgages, which includes, by definition, mortgage companies. (It doesn't include banks that didn't do mortgages.) The policy cited explicitly said that.
Price data isn't what we're looking at here - we're looking at subprime mortgage origination.
>Like I said, there were other factors, but without the "encouragment" to issue subprime, things would likely have been different.
It is a bit laughable that you think companies like Countrywide had to be forced or encouraged into issuing subprime. Nothing could further from the truth - they were issuing the loans hand over fist, and constantly pushing the boundaries of acceptable loan documentation (such as giving loans to illegal immigrants). No one forced these guys to give loans - they did it because they were making a ton of money.
But let's say what your saying is true - show me documentation that shows banks actually being forced to give loans where they didn't want to. What you have is a document outlining a policy, but no data or evidence showing that it actually happened.
It's interesting that you think that the fed isn't part of govt and that repealing Glass-Steagall isn't either. Also, the ratings monopoly is also a govt creation. (Yes, folks could consider other things, but their ratings determine what counts for "assets" for regulated entities.)
Most items in the list in that article have govt's fingerprints all over it, and it's hardly complete. For example, it ignores fannie and freddie, the various efforts to encourage home ownership, and the like.
> What you have is a document outlining a policy, but no data or evidence showing that it actually happened.
Are you really arguing that regulated entities don't follow the rules?
If so, you don't get to argue that different rules would have made a difference.
>It's interesting that you think that the fed isn't part of
>govt and that repealing Glass-Steagall isn't either. Also,
>the ratings monopoly is also a govt creation. (Yes, folks
>could consider other things, but their ratings determine
>what counts for "assets" for regulated entities.)
When did I ever say that the Fed isn't part of the government or that repealing G-S doesn't matter? And the rating agencies were definitely part of the problem. But here's the problem - your basic argument is that the government promoted subprime mortgages. For evidence, you cite a document which purports to say that banks and mortgage companies were forced to lend, thus causing the subprime bubble.
This idea, of course, isn't backed up by the data (as I've shown). Now if you want to move the goal posts and talk about G-S, or the Fed, I'm all ears - they definitely contributed to the subprime bubble. But the idea that the government forced banks and mortgage companies to make loans is just crap.
In fact, it is the lack of government regulation that really caused the bubble. If the Fed had just required confirmation of income, then the bubble would have been stopped in its tracks - but Greenspan refused to make the modifications. When Obama came in, it was among the first regulations put into place.
>Most items in the list in that article have govt's
>fingerprints all over it, and it's hardly complete. For
>example, it ignores fannie and freddie, the various
>efforts to encourage home ownership, and the like.
Again, you have not presented evidence that Fannie and Freddie caused the subprime bubble. They were, in fact, losing marketshare during the bubble, while Wall Street took over the function of securitization. Are Fannie and Freddie messed up? Yes, but they didn't cause the subprime bubble.
>Are you really arguing that regulated entities don't
>follow the rules?
>If so, you don't get to argue that different rules would
>have made a difference.
Of course I can - it's called enforcement. Some laws are enforced, other are effectively ignored. So it's a combination of both rules + enforcement. Witness the SEC not enforcing rules on Wall Street banks. Just today, a judge rejected the settlement offer from the SEC to Citibank, while pointing out that Citibank has repeatedly broken the law, and yet the SEC had not done anything about it - even though they knew Citibank had broken the law. Under Bush, the SEC become a toothless entity - it's gotten somewhat better under Obama, but it is still a captured agency in my mind.
Are you seriously claiming that mortgage lenders ignored the nondiscrimination enforcement threats? You remember them - there was an offered safe harbor for making subprime loans. There were also demonstrations against lenders that weren't offering enough minority loans - do you really think that they had no effect on enforcement?
Note - I didn't say that there was one cause, so it's unreasonable to suggest otherwise. I'm pointing out that the subprime aspect is directly traceable to a series of govt policies.
No I'm saying that the lenders needed no government encouragement at all - they were making the loans because they were making money hand over fist. Simple. The government didn't force them, greed did.
Are you arguing that Countrywide made all of their so-called liar-loans based on the threat of government sanction? If yes, what percentage of loans were forced, by the government, under enforcement threat? Where's your data?
Govt had a big part in making things so that so that subprime loans made money.
The standards for regulated assets, which is what banks really need, are established by govt. Those standards favored Fannie and Freddie. Those standards also rely on govt-chosen rating agencies.
As to the "encouragement", W was the "ownership" president, so he was looking for ways to encourage lending.
>Govt had a big part in making things so that so that subprime loans made money.
So you're no longer arguing that the government forced banks and mortgage companies to lend?
>The standards for regulated assets, which is what banks really need, are established by govt. Those standards favored Fannie and Freddie. Those standards also rely on govt-chosen rating agencies.
Yes, they are set, but it was a lack of regulation that caused the problems, not too much regulation. Those standards had nothing to do with Fannie and Freddie. The government rating agencies is completely separate issue.
>As to the "encouragement", W was the "ownership" president, so he was looking for ways to encourage lending.
Again, are you no longer saying that the government forced lenders to lend?
Very different assertion from saying that the government forced them to lend via a policy which used discrimination as its basis. I'll take it that you've given up on that point?
So if it had such a big impact, it should be easy to show data to support such a claim. Where is your data?
And you're attempting to move the goal posts once again here - by merging the two categories. Face it, you have zero evidence to back up the idea that the government actually EVER forced a bank or mortgage company to make loans. Trying to now say "the govt then tried to make these loans make economic sense" is just a junk argument.
That's a very naive perspective. The big money families, retirees etc. are precisely the people who won't let big organizations fail; it is those people that politicians are looking after when they spend taxpayers' money bailing them out, because those people are reliable sources of donations or votes.
So you have to take a step back, and look at political incentives. How are you going to convince these people to support putting their capital at risk?
The correct solution is to let corrupt and reckless institutions fail.
Just because the deck is stacked against the actual implementation of the correct solution because of 'big money families' and so on doesn't nullify the correctness of the solution.
Exactly, which is why any non-free market solution will eventually accrue capital (or other benefits) to those in power, rather than to those who produce.
See regulatory capture and moral hazard for why our system is screwed.
Ok, but who has the power to enforce this mythical free market against the powerful people who benefit from the current system?
Power means never having to say you're sorry. If you're not part of the elite, your only realistic options are to become part of the elite, or to change the game (i.e. create a new elite including you and those you care about) in some way not easily anticipated / countered by the current elite.
Well, free markets don't accrue capital to "those who produce" either; there's a lot of problems in completely free markets. Efficiency can't be achieved without complete information; since nobody is omniscient (never mind everybody), there will be plenty of inefficient allocation of capital not in proportion to production.
Moreover, free markets have no moral content. Quite apart from unrestricted transactions creating injustice, free markets reward scarce resources in high demand. But something being in high demand does not make it virtuous - fashions change with the wind - and nor is there necessarily virtue in rewarding the owners of those scarce resources, which may be sheer luck. As a collective, we only want markets that are free to the degree that they are not also unjust; and that's a much harder problem.
Doesn't that assume that a free market solution won't eventually accrue capital to those in power? I fail see the connection - what stops someone, via the free market, from making a lot of money and then using it to promote what they want via the influence that money can buy?
Your point actually illustrates the argument against free markets quite well. When you don't consider the whole of what gravity actually does it sounds like it would be a lot simpler to build an airplane. The unfortunate reality of the situation is that the fantasy land doesn't actually work because of the many unintended consequences of eliminating gravity. Like the many unintended consequences that happen when you let people lend risk free.
For your example just considering the airplane, the air would have no reason to stay near the earth, nor would there be any reason for the matter in the earth to coalesce.
The sun would also almost immediately explode because of the immense pressures required to produce nuclear fusion.
Please study a little public choice theory. You're arguing from a perspective of incomplete information, as I see it.
You can't have free markets in the way you advocate in the presence of democracy as we know it. To argue for what you want, you need to describe how we would change our governmental structure to make it work. Perhaps an authoritarian rule by a benevolent AI?
The fundamental problem with this argument is that it's an adversarial problem space.
I.e. we could say "let corrupt institutions fail", but there's another powerful team that doesn't want them to fail, and can thwart our efforts. If we don't take that into account when designing the solution, we're doomed to fail.
Here's an idea for a country: everybody does legal things, so we don't need police. Crime problem solved!
Does that sound naive to you? Because that, to my ears, is exactly what you are advocating. You're completely ignoring institutional mechanics with a mere handwave of "correctness".
No, it is the dumbest solution picked out of a menu of solutions. If we accept there are "too big to fail" institutions, one way to get rid of them is to wait for them to fail. Much like if we have 8 unsafe airplanes, one solution is to wait for them to crash. The other solution is to enact policies that make these institutions smaller (like I originally proposed).
Capitalism works like this if you fail you fail that means you lose. It works very well in almost any sector in the econemy but not for banks and banks are allready very regulated.
We already tried this in the 1930s and that didn't go so well. Banks are different than other business because they act like a heart to pump cash through our economy. Allowing banks to fail would only make it harder for new businesses to find cash and for people to trust saving their money.
Actually in the 30s we did exactly what we're doing now, deflating our currency, passing a bunch of legislation to prevent competition, disallowing people from holding solid investments, paying people to be unproductive, a massive expansion of government predicated upon a weird interpretation of the commerce clause, and surprise surprise, it's having the same effect it did in the 30s.
Keep in mind that the economy 'failed' in 28, but it wasn't until FDR that things really got bad.
Actually, we tried this in the depression of 1920-21. We recovered so quickly that the depression is hardly notable enough to make it into a history class.
In 1907, there was a financial panic leading to widespread bank runs. To quell the panic, J. P. Morgan brokered arrangements among other wealthy financiers to redirect capital to the banks that they considered weak but salvageable. After the dust cleared, Congress (and, for that matter, bank executives) decided that they would rather not have the stability of the American financial system depend on one rich man’s charisma. Thus the Federal Reserve was born.
That's already very common practice, and unfortunately it's not very effective. Bear Stearns was 30% employee owned [1], and Lehman was 25% employee owned [2]. All that stock became worthless when the firms blew up.
Trying to use compensation to reduce the risk that a bank can fail is a fools errand. What we want to prevent is "too big", failure is healthy. My plan would reduce the amount of government intervention required during a failure (clawback), and it would also provide incentive to not be too big.
I have a pet theory that this solution might work if the restricted stock was very long-term--say it vested quickly but you couldn't sell it for a mean time of 15 years. The idea is to get the stock to be longer lived than the bank's liabilities. To my knowledge this has never been tried, and you'd probably need to pay significantly larger amounts of stock to get people to go along, and anyway this is pure speculation from a non-expert.
If investors could make accurate predictions of what securities would be worth 15 years out, then we wouldn’t be seeing financial blowouts every 15 years.
Sure. I never said they'd be accurate; the point is simply that if you want someone to give you money for bank stock that can't actually be sold for 15 years, you'd be unlikely to get a particularly good price for that, especially if it were in a climate where there's a high likelihood that the bank is quite likely to go bust long before that.
This sounds like we're tackling a symptom not the disease. Instead of figuring out how to stop bankers from being paid so much in bonuses, we should answer ask why a few times.
"Why can banks pay their employees so much?" - because they make so much money, and have so few employees.
"Why can banks make so much money?" - I'm not sure but it seems like banks can take risks, but pass off the real risk to others.
"Why can banks take risks, but not have to worry about the downside of those risks" - ...
I think if you follow that train of thinking you'll get to some structural problem in our current system. It doesn't seem like there is an easy fix here.
It sounds like you're responding to the headline and not the article. Taleb didn't say anything about bankers being paid too much (or "so much"). His argument was that bonuses encourage risk taking and that having bank compensation be less variable (i.e. base salary would go up, but not fluctuate) would lead to less risk taking.
Did you read the article? Taleb was arguing against bonuses as incentives to take risk, without corresponding downsides. He was not arguing against bankers being paid lots of money.
Because it currently is thus, therefore it must be efficient and optimal, and any attempt to change it is delusional... you sound like an economist! But I think a lot of HN is about challenging incumbents and the status quo...
The problem is what we are attempting to regulate culture wise does not view at as a problem..to change that culture requires some heavy duty court convictions and jail time...if Obama get his 2nd term some of those court cases in fact come to trial via the DOJ and SEC, etc.
The real solution is to either disintermediate the banks or eat away at their profits. LendingClub, Covestor, SecondMarket, Simple, Square, WePay, and Mint come to mind.
agreed. it's simple and it only requires direct action on the part of the "little guys", and doesn't require Congress. also, shift more money into credit unions rather than traditional banks. generally, if we as a society make less money available for the Wall Street types to play with, they'll have less to play with, and the chance/magnitude of them fucking with the normal/base/productive part of the economy will be lessened in the future.
I do like this idea, but I'm a bit skeptical that a relic of the 1930s would work in our modern economy. Thus, I suspect the answer is a bit more complex than "Bring back Glass-Steagall".
I think the economics is pretty timeless, actually. A lot of the regulation was aimed at preventing catastrophic bank failures, before the idea of Too Big To Fail was invented. Glass-Steagall contains the idea that a commercial bank, which gets major regulatory freebies by virtue of being a commercial bank (FDIC, Fed access, &c), shouldn't have access to unfettered financial markets. And so on.
Go and read J.K. Galbraith's The Great Crash: 1929. It's a short book, an easy read, and quite informative. Particularly interesting is his examination of causes and ramifications. If you buy a recent edition, these have been updated through the 1960s and 70s, with a foreward by his son in 2009 (the book was first published in 1955).
Though the situation of the 2008-2011+ crash/depression isn't an exact reflection of 1929, there are very strong rhymes.
There's a problem with the "go back in time" policy proposals. If the banks beat the regulations we had in place before, what makes us think they won't beat them again?
This is why Taleb is proposing a simpler solution - it might be hard to get around.
I am skeptical of all proposals, but I think it's important to understand that going back to the previous set of regs might not work since the banks busted through those.
Banks did not beat the regulation directly. They spent ~50 years chipping away until the regulations changed then another ~15 before things got really crazy. Personally if we can put the next crash off for ~65+ years before the next crash I think we will have done a great job.
For the most part the banks didn't find loopholes in the regs, they bribed the legislature to repeal them and to cut the budgets of the regulatory agencies.
Actually, if we move all our money from big banks to credit unions and small local banks, the end result will be the same as re-introducing Glass-Steagall act.
> Another similarity will be the lack of online banking. Many credit unions and small banks lack the scale to support that...
Huh? There are folks who sell the relevant software. My little credit union has had this stuff for years.
Yes, including bill pay and so on. I got it before big banks started advertising similar services.
I haven't seen any mention of by-phone money transfer or check cashing yet, but since I don't have a smart phone, that's may be me.
> See also: ATM access.
Credit unions banded together to solve that problem years ago. Some also pay fees for "out of network" use. (Non-banks like Schwab take that approach.)
Majority of credit unions outsource their online banking to companies like orcc. My credit union has better online banking than Wells Fargo (not hard to beat).
The ATM access do require small changes in behavior (i.e., don't forget to get cash back in Safeway), but it is quite possible to achieve.
I don't know if you've kept up with where things are at with credit unions, but my credit union's online banking is quite nice, and there's a credit union co-op network that means that ATM's which are fee-free and can take deposits are never very far away.
It would be nice to have more physical branches (maybe that's another thing a co-op network of credit unions could handle), but really, switching to a credit union was way easier than I had ever imagined.
So you think that, for instance, cherry-picking something specific you don't like and trying to make it a general counterargument to something many people do like, is a good idea?
Although RyanMcGreal didn't refer specifically to Glass-Steagall, it's a good bet that "re-regulating" (i.e. re-introducing measures from that law) might be a bad idea in several cases, Regulation Q being one of them.
Megan McArdle is a terrible journalist. I would suggest double-checking all of her claims.
For instance, she recently wrote that wealth inequality was probably worse in the 90s than it is now. In fact, it's now much worse than it was then. She didn't bother to check her own assumption.
Unfortunately, long experience has shown me that it's not worth trusting McArdle unless you have all of her sources right out in front of you; I believe the polite way to put it is that she "massages the facts" a bit :)
I suspect many people who want to "simply re-regulate financial institutions the way [the US] did during the period from the 1930s through the 1990s" are not fully aware of what those regulations entailed, or why they were repealed. The example I cited might be a motivating factor for such people to get more informed before they decide what they "like". I would further add that counting "like"s is probably not the best way to figure out how to reduce systematic risk in the financial system.
"are not fully aware of what those regulations entailed, or why they were repealed. "
But they are fully aware that the system worked pretty well, and was pretty stable, for decades, although it wasn't quite as profitable for the financial industry.
I think Regulation Q is a vary good idea. 'Checking' accounts that pay significant amounts of interest have long been the source of instability in the banking sector. And with FDIC inshurance covering the depositor's risks there is a significant moral hazard for banks to do ever more shady things. Just think about it for a second as a depositor your covered by FDIC and some bank is offering you 6% ROI why do any sort of due diligence just take it and let the tax payer bail you out if anything bad happens. And now your a competitor, you know that it's risky to compete but your also losing all your customers so you might as well take stupid risks vs just plain going out of business.
I don't think your story holds up. Checking accounts pay nowhere near 6% interest. Mine is currently paying 0.10%. Savings accounts are FDIC insured and Regulation Q did not forbid them to pay interest, it was just harder to get your money out. I don't think any professional economist believes that interest on demand deposit accounts has ever caused a crisis or been a significant cause of systemic risk. It was an anti-consumer regulation, plain and simple.
Taleb is an excellent writer and not (as someone here has stated) someone completely delusional. He, in fact, worked in the financial industry for many years and I thoroughly enjoyed reading his book "The Black Swan"[1] about how we've basically all been duped by large banks that expose us to risk and keep the profits for themselves.
>> I HAVE a solution for the problem of bankers who take risks that threaten the general public: Eliminate bonuses.
I'm sorry but that's not the solution.
The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail."
There are some incredibly elegant natural laws built into the fabric of the universe, one of which is expressed through economic systems in which corrupt, reckless institutions are eliminated because they go broke.
The only way corrupt, reckless institutions are allowed to persist are when they are propped up by taxpayer money.
And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations, well, "externality" is just a fairy-tale idea thought up by ivory tower economists?
I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".
>> I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".
But there is a "simple" difference between philosophies of how to address corruption in financial markets.
>> And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations
There is no way to avoid the day of reckoning.
Don't pretend that any crises that were avoided in 2008 won't be that much larger when they eventually materialize.
That would be true if it weren't for the fact that a good bit of our economy relies on confidence and trust. Confidence that there isn't a huge recession or depression in the near future, and trust that others will remain in business if you deposit/lend them money/invest.
So in a very real sense, a panic, even if it isn't based on anything fundamental, can set you back very significantly.
The only reason the money marked freezed up is because everybody thought the fed would bail out all banks (greenspan put). When Lehman-Brother failed they all went creazy because the knew alot of banks war acctually bad.
I don't think so - the money market froze up because everyone was worried about a failure of the overall system and therefore was not willing to loan money - they wanted all money to be at home. Thus, the Fed stepped in as the lender of last resort.
1) Why didn't it happen after the Bear stearns bust then? The banks had simular balance sheets, the only diffrence is the saving.
2) Ok lets asume your right:
Im against a fed in general but acting as a lender of last resort is the one of the few valid things the should do (sometimes). The problem is that the lender of last reserve thing is for banks that still are liquid and just need some cash now. A lot of banks like Lehman and other weren't liquid anymore and in that case its not really lending its more saving them. Banks that violate the golden rule of banking (lending long, borrowing short) should not get these kinds of lendings. The plaid at there own risk with ful knowlage what the do. Capitalism puniches this kind of stuff and acts as a filter. If no bank ever goes bust the banking sector will be much bigger then it normaly would (missalocation of resources).
Little extra note: Lending as last reserve should be done with high rates (if a bank really only needs it to guard agains the run the can afford it) the fed just floded the banking sector with cheap money. Thats quite diffrent then beeing lender of last reserve.
1. It didn't happen with Bear Sterns because the street didn't believe, yet, that Bear going down would take down the entire financial system. That changed after that.
2. That is a fine argument - I agree with you that banks should not be saved. Unfortunately, when they get too big, then they threaten the system itself and that was the worry. But I agree that the proper approach would have been a pre-packaged bankruptcy aka the Swedish approach.
Moreover, we should reinstate the laws that separated commercial banking from investment banking. And we should regulate the CDS market - a huge component of the system failure worry wasn't that an individual bank was going to fail - it was that all these different banks had CDSs to protect themselves. That created a stronger interconnection between the banks. Regulate the CDS market via a central marketplace with a clearing mechanism.
On your last point, if the goal is to provide liquidity, lending at a high interest rate won't do it. The point is to keep the market being a market - if you have the high interest rates people won't borrow and the banks will just hold onto that capital, and the market will continue to be frozen. Runs on the bank are stopped by the FDIC which secures depositor money - so you're mixing up why a bank might need the money. Also, I'm really not talking about the individual depositors - I'm talking about the commercial paper market which serves business, not individuals.
Did you read the article? In the third paragraph, he says it's impossible for a government to promise not to bail out banks. The banks will outmaneuver everyone when the time comes.
Another way of making the same point:
- We can't guarantee that future governments won't bail out banks.
- We can discourage one-sided risk-taking by banning bonuses in institutions that likely would manage to convince the government to bail them out.
Corruption exists. Power exists. When faced with this reality, what do you do to shift towards a reality with less corruption and power imbalance?
Saying to the powerful, and corrupt: "Don't do that -- what you're doing is wrong." is useless. If they had to listen to you they would be de facto not powerful.
>> what do you do to shift towards a reality with less corruption and power imbalance?
Absolute power corrupts absolutely.
Governments have absolute power. Businesses don't.
Governments have the ability to point their guns at the populace and say, "You have to pay for these failing businesses or some very bad things will happen."
>> If you think Taleb's idea to limit bonuses is bad, then say so. But don't attack an argument he didn't make.
Yes, I think any arbitrary interventions like 'limit bonuses' are not effective and costly. Banks will find loopholes and taxpayers have to pay for the new regulatory staff that enforce the regulations.
The only 'regulation' that is needed is the elegant self-regulation of a free, fair market: broke businesses fail.
I'm not talking about permitting fraud. People who commit fraud should go to jail.
> The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail."
We tried that by letting Lehman go bankrupt. While your "solution" has a ton of populist appeal, it seems lack an understanding of the events of the past few years. Let's accept the fact that banks are going to fail, and ask the government work on the "too big" part. Denying that it is even possible to be "too big to fail" is only compounding the problem.
The problem that Taleb unfortunately doesn't address is that the bankers have captured the political system. For this reason his solution unlikely to transpire.
The fundamental problem is that when a corporation has so much money they can throw tons of it at the upper management and executive, and not go out of business because they are undercut by a competitor that doesn't waste money like that, then something is wrong with capitalism at that point. That is the problem you try to fix, you don't just throw more regulation on the banks that will backfire like software patents.
I like the decimation idea. Before they can be bailed out, capital punishment should be randomly applied to one-tenth of the bankers of the failed institution. The lottery can be weighted based on bonus size, to ensure that the big wigs are fairly represented in the sample.
I like the general idea of linking the consequences of some actions to the actors involved to prevent cheating and bad behavior. The examples from Babylon and Rome were probably much more effective in this than cutting the bonus of a banker (ie they paid with their lives).
I had a similar thought when I started reading about fracking (http://www.propublica.org/series/fracking). A simple solution there for the pollution caused by the wastewater is to force the executives and their families from the companies doing fracking to live in the communities they affect and use/drink the water they claim is safe.
You cannot control payment to employees like that, companies just find a way around those kinds of laws.
Better to regulate the institutions themselves so that they dont get 'to big to fail', don't get to combine access to cheap money with access to the financial markets, don't get to insure themselves and so forth.
Instead, it’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed should not get a bonus, ever. In fact, all pay at systemically important financial institutions — big banks, but also some insurance companies and even huge hedge funds — should be strictly regulated.
I'd really like to see someone attempt to express such a condition in the type of legalese that appears in legislation.
How do you ban something based on a hypothetical possibility? How do you write this condition down?
This is absurd. Regulating private companies' compensation? Instead, the government should either make sure companies don't get "too big to fail", or make it very clear that banks don't have the Geithner Put option.
Right, you need to combine saving the financial system with systemic change. Letting them fail is equivalent to letting the system crash and the doing nothing.
I just dont understand why people talk about the "financial system". Its a bunch of banks and some of them fail. The only banks that failed are those who are bad.
A financial panic is not an avenging angel that slays the wicked and leaves the righteous untouched.
Without the possibility of a bailout, if, say, Citbank went under, this would not only screw Citibank’s depositors—most of whom were hardly in a position to audit Citibank’s books before opening their accounts—but also every bank that had loaned money to Citibank. If a bunch of people who deposited money with Citbank owe money to Wells Fargo, then Citibank’s failure hurts Wells Fargo. And if Citibank’s failure led the depositors at Bank of America to get nervous and withdraw their money, then BoA would be at risk even if it had been prudently managed up until the crisis. And then BoA’s and Wells Fargo’s creditors... etc., etc., etc.
Well yes some banks can be hurt in the process that are not acctully bad but history shows that in most cases bank runs happen on banks that are really bad. If you are a conservative bank you will acctully get a lot of cash (this happend in switzerland) witch you can then lend at high rates to banks that need it (if there wouldn't be the fed pushing the intrest rate down). Witch banks acctully are in a bad place and witch are not will be the task of bankers and private investors. The banks that are acctully good will probebly get survive.
So yes there will be some collateral damage but that just cant be avoided in a cycle. It would be much better then the mess we are in know.
That all beeing said in a system where you have fractional reserve banking (witch is a bad idea anyway) there is a case (not one that I totally agree with) to be made that we need a "lender of last resort". But beeing a "lender of last resort" is quite diffrent then what the fed did. They literly flooded the hole bankingsystem with cash, knowbody knew what was going on, how will be saved who want, witch banks acctully are still liquid and witch will bust when the flow of cash stops. Why should banks lend to each other if the get free money. If I would get free money, I too would just sit around and wait until the worst is over. If every body does that we acctully have a bigger problem a long rescession instead of a short crash.
Uh, no. Read up on counterparty risk, credit default swaps, and the crazy interdependencies of financial institutions.
If bank A goes bad, institution B might have sold lots of CDS on bank A, requiring it to pay out more than it is able, so it goes under. Institutions C and D might have sold CDS on institution B, etc.
All the banks deal with and depend on each other. Also, in a bubble most banks are invested in the same scheme. When the bubble finally pops, all the banks get in trouble. So "financial system" is exactly the right term.
There are alot of banks and even Hedgefonds that did not invest into realestate (because the could not actully figure out what that stuff was worth and didn't buy them just because it was what "The cool kids where doing") and where not in trouble. An yes you are right the hole system has "trouble" but the system wont just crash. Everybody that is "bad" will go done and maybe some others will go down but if a bank had enough reservse and had not a shitlode of bad asseds the could survive the storm. The remaining good asseds of the banks that go bust will be liquidateted. The conservative banks can now make the money that the did not get in the boom years.
Should we always bail them out, even after they begin to predicate their practices on the fact that we will hand them more stolen money when they screw up?
Why would you bail them out? The banking sector is much bigger then it should be and its natural that the sector shrinks again after a bust. The the economy crumbels when banks fail is just wrong, the world would have much less problems if the bad banks just failed.
I love that you link to a wiki article that basically says "it's a theory" - and that's exactly my point. You can't prove that we would have been fine if the banks had failed because we didn't let it happen. Ask yourself this - what if the theory is wrong?
A lot of what our governments do is based on theories and in this case they obviously decided to step in to protect their citizens. Just the same way, you cannot prove the opposite.
De facto you can decide to trust the government you were voting for or against - and me being from Euroland, I rather trust that they don't fuck up too big for important decisions like that. I know this is different in the USA.
But, the point isn't so much whether it was all right or wrong, the more important (and frustrating) point is that WHAT they did wasn't done very diligently because at the end of the day, bailout billions were passed out practically for free and nothing changed.
The question whether it was right or wrong to intervene is more a philosophical question and how much it has compromised the very foundations of our value system and economy: free market and capitalism.
>But, the point isn't so much whether it was all right or wrong, the more important (and frustrating) point is that WHAT they did wasn't done very diligently because at the end of the day, bailout billions were passed out practically for free and nothing changed.
>The question whether it was right or wrong to intervene is more a philosophical question and how much it has compromised the very foundations of our value system and economy: free market and capitalism.
That's all great - and I agree with your points, but the original point was "It wouldn't have destroyed the economy for everyone."
We simply do not know that - maybe, if the bailout hadn't happened, the economy would have plunged into a severe depression.
The problem is that once banks get big enough, they will get bailed out when they fail due to all the vested interest by affluent parties that they shouldn't fail.
So the only way to get in a situation where it is an option to never bail them out? It is to keep the sizes small.
This is absurd. Regulating private companies' compensation?
Corporations exist due to government enforced contracts, so I find no problem with government deciding to regulate certain markets in order to prevent total collapse of the economy.
If a company would get bailed out with public money upon failure, then it would seem dishonest to call it a private company, since it is effectively gambling with public money.
I don't mean to target just you, and a lot of people apparently don't know what it is, but before responding to my comment in any way, you should probably look up what a Geithner Put it. Then you'd find that your response looks a little foolish.
I didn't call names, but I'd be happy to elucidate. Krugman's article (the first hit) seems to explain it pretty clearly, but I'll do what I can.
A Geithner Put essentially means the banks could take enormous risk because they, simply put, bought a put option the government (with Geithner as analogical proxy) wrote on their bets going south. That is to say, the downside of taking a huge risk was covered by taxpayers with the bailout (= exercise price of a put), and the upside (that compelled the banks to take such risks) was even more appealing with limited losses the put option ensured.
It's kind of a tongue-in-cheek way of saying that the banks were insured against collapse via TARP.
On the other hand, you could argue that the more arbitrary restrictions there are on institutions that are FDIC insured the closer the market is to laissez faire in practice. Just as long as people follow Taleb's advice and don't extend this to institutions like hedge funds that eat their own risk.
I think strict regulation is the way to go. Banking in a modern economy is really a utility like gas, electric, and water.
Another solution that is more long term oriented and market based: create rival capital-formation pools outside of Wall and Broad, say in the Midwest, South, and West Coast. That way if one pool blows up, we can let them fail and it won't take out the whole economy. It also removes single points of failure from the system. I think the crowdsourcing bill floating in Congress is a great start as it decentralizes capital-raising.
Bonuses are incentives. What they are giving bonuses for is wrong. Not the bonus concept itself. Eliminate the bailouts, require a certain percentage liquidity, force assets to be marked to market on a certain interval. Suddenly the bank's finance sheet to it's investors won't be so rosy, investors will demand change, change will happen.
Not everyone who works at a bank is a "banker" -- going after bonus structure holistically without regard to station/role seems impractical bordering on impossible.
Beyond even that, one might imagine that if US banking regulations get extremely prohibitive, banks will just move offshore. (And still be too big to fail with regard to the US economy)
I think that a little divide-and-conquer is needed to fix some of the smaller sub problems...
Part of the issue you're highlighting has to do with banks being able to engage in risky behavior - the traders that argued, after the collapse of, say, AIG, argued that they still deserved their bonuses. End the mixing of risky and non-risky behavior and you put most of that problem to bed.
Banks moving offshore isn't really realistic - you can't avoid, at the moment, having America as part of your bank - too much of a market. So even if, like UBS, the bank isn't in the US, it doesn't mean that they wouldn't be subject to regulation.
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[ 3.1 ms ] story [ 308 ms ] threadI think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary.
Edit: To clarify (since someone downvoted me), you are making a true statement, but I don't see how it is in conflict with anything I'm saying, or what other point it supports.
They're already doing that.
1. clawback clauses. when investments underperform, you take back bonus money. this goes well with:
2. long term vesting. you don't collect the entire bonus up front. you get it spread out over an extended period of time (say, 10 years), contingent on continued success / your bank still existing.
in fact, many banks and hedge funds already implement these ideas. of course, if you're writing a newspaper article, you can get a lot more pageviews by papering over this fact and saying the most populist thing you can think of.
But suppose you make a bonus of 20% of your gains, and no bonus for losses. Would you make this bet? Is opportunity cost a sufficient disincentive, or is that an elementary mistake, since the expected return seems to be 16?
Say my bonus is, I dunno, 2% of profits.
I go put 100 billion dollars on a single hand of blackjack. If I win, I make 2 billion. If I lose, I'm out 400k. Easy choice. Do it!
The Black Swan is an interesting book. You might disagree with Taleb's claims, but he's not making elementary mistakes.
How is this different from the bailed-out banks, or an over leveraged banking system in general?
Goldman Sachs was a partnership until its IPO in 1999. A lot of finance houses were closely held partnerships until the late 20th century.
LTCM would have clearly been "not bailed out", except it was. Admittedly not directly by the USG/FR, but at the direction of the Federal Reserve.
But this model does hurt the little guys. Since Canadian banks form an oligopoly, they charge you for lending them money; account maintenance fees are standard. This hurts the smallest savers the most. Similarly, there is minimal competition in setting interest rates. Finally, financial innovation, done right, does help people---think Vanguard, index funds, ETFs, etc. All much more limited and much more expensive in Canada (I think).
In contrast to Canada, I think we would be better off with many small institutions, lightly regulated. Then they can compete for your business and do not need taxpayer support when they fail. When they become too big, break them up.
I bet you if the big money families started losing big chunks of their fortunes that there would be serious reform. Same with retirees and their pensions.
How do you think the prosecution of bankers would go if bankers put the DOJ pension at risk?
I see your point, but I think that if the whole deregulation (and thus free market) hadn't happened, a lot of the damage could have been avoided.
Also, regarding the 'regulated market' look at the massive frauds that took place at Fannie and Freddy which are essentially arms of the gov't. Look at how the Social Security System is administered if any corporate pension plan was run the same way they'd be thrown in jail (if the SEC cared to enforce the law).
Look at the pressure on those institutions to create subprime loans under the federal housing laws. Look at the Fed Reserve chief talking about how great ARM loans were. Regulators, market participants, law makers all conspired to create a toxic environment that was not stable in the long term.
Yes, a lot of damage could be avoided if the gov't, regulators and market participants weren't going around telling everyone that they had guaranteed investments.
To think that after passage of GLB we had a free market is incredibly naive.
Toss in late night infomercials promoting get rich quick house flipping and the pump was primed with people willing to fudge the paper work. And loan servicing companies willing to look the other flip crap loans with little downside. The only thing that really hurt many of these company's is they ended up with to large a loan inventory, if they been a little leaner far fewer companies would have been at risk.
Actually, they did.
See http://news.investors.com/Article/589858/201110311638/Housin... .
"At President Clinton's direction, no fewer than 10 federal agencies issued a chilling ultimatum to banks and mortgage lenders to ease credit for lower-income minorities or face investigations for lending discrimination and suffer the related adverse publicity. They also were threatened with denial of access to the all-important secondary mortgage market and stiff fines, along with other penalties."
"The threat was codified in a 20-page "Policy Statement on Discrimination in Lending" and entered into the Federal Register on April 15, 1994, by the Interagency Task Force on Fair Lending. Clinton set up the little-known body to coordinate an unprecedented crackdown on alleged bank redlining."
http://www.ots.treas.gov/_files/25022.pdf
Then there's Fannie and Freddie lying about the composition of the loans they were buying, which threw off everyone's risk evaluation.
http://dallasfed.org/research/eclett/2007/el0711.html
The housing bubble could have been avoided entirely if the Fed had just placed tighter restrictions on the loans that could be made. Greenspan famously decided that he didn't want to do that - which lead to companies like Countrywide creating the loans for packaging by Wall Street, allowing them to offload all risk immediately.
My true disappointment with Obama has been his lack of real, strong re-regulation of Wall Street and a pursuit of criminal charges against many on Wall Street, but at least, immediately after he came into office, added the simple language of requiring lenders to confirm income as part of the lending process. That simple language, which would seem obvious to anyone who would lend money, could have stopped the whole thing in its tracks in my opinion.
We were running another bubble then.
Note that W also encouraged home ownership, so I'm not blaming Clinton alone.
> The CRA had nothing to do with the crisis as most of the subprime loans were made by non-CRA governed companies.
The posted link wasn't the CRA, but a policy that applied to every company that made/makes home loans.
Also, you're ignoring the role of Fannie/Freddie. A large fraction of loans are made to be sold. As the largest buyer, Fannie/Freddie have a huge effect.
Doesn't follow - if the banks were forced, as you say, to make loans, the bubble should have started then.
>The posted link wasn't the CRA, but a policy that applied to every company that made/makes home loans.
That's fine, but there is no indication, in the actual mortgage data, that banks were being forced to issue subprime mortgages. The data shows that it was mainly mortgage companies were issuing subprimes, then offloading them for packaging into CDOs by Wall Street. If you want to make that argument, it isn't enough to produce a document - the data has to support the argument and it doesn't.
>Also, you're ignoring the role of Fannie/Freddie. A large fraction of loans are made to be sold. As the largest buyer, Fannie/Freddie have a huge effect.
Not true - Fannie/Freddie were late to the subprime game and had lost marketshare. In 2006, they got started buying subprimes. Bottom line, Fannie/Freddie had an impact, but they were not the driving force behind the housing bubble.
"Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.
During those same explosive three years, private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data."
http://www.mcclatchydc.com/2008/10/12/53802/private-sector-l...
The housing price data shows a run-up then.
Like I said, there were other factors, but without the "encouragment" to issue subprime, things would likely have been different.
> That's fine, but there is no indication, in the actual mortgage data, that banks were being forced to issue subprime mortgages. The data shows that it was mainly mortgage companies were issuing subprimes,
"banks" in this context is shorthand for anyone offering mortgages, which includes, by definition, mortgage companies. (It doesn't include banks that didn't do mortgages.) The policy cited explicitly said that.
Price data isn't what we're looking at here - we're looking at subprime mortgage origination.
>Like I said, there were other factors, but without the "encouragment" to issue subprime, things would likely have been different.
It is a bit laughable that you think companies like Countrywide had to be forced or encouraged into issuing subprime. Nothing could further from the truth - they were issuing the loans hand over fist, and constantly pushing the boundaries of acceptable loan documentation (such as giving loans to illegal immigrants). No one forced these guys to give loans - they did it because they were making a ton of money.
But let's say what your saying is true - show me documentation that shows banks actually being forced to give loans where they didn't want to. What you have is a document outlining a policy, but no data or evidence showing that it actually happened.
You really need to read this:
http://www.washingtonpost.com/business/what-caused-the-finan...
It's interesting that you think that the fed isn't part of govt and that repealing Glass-Steagall isn't either. Also, the ratings monopoly is also a govt creation. (Yes, folks could consider other things, but their ratings determine what counts for "assets" for regulated entities.)
Most items in the list in that article have govt's fingerprints all over it, and it's hardly complete. For example, it ignores fannie and freddie, the various efforts to encourage home ownership, and the like.
> What you have is a document outlining a policy, but no data or evidence showing that it actually happened.
Are you really arguing that regulated entities don't follow the rules?
If so, you don't get to argue that different rules would have made a difference.
Yes.
>It's interesting that you think that the fed isn't part of >govt and that repealing Glass-Steagall isn't either. Also, >the ratings monopoly is also a govt creation. (Yes, folks >could consider other things, but their ratings determine >what counts for "assets" for regulated entities.)
When did I ever say that the Fed isn't part of the government or that repealing G-S doesn't matter? And the rating agencies were definitely part of the problem. But here's the problem - your basic argument is that the government promoted subprime mortgages. For evidence, you cite a document which purports to say that banks and mortgage companies were forced to lend, thus causing the subprime bubble.
This idea, of course, isn't backed up by the data (as I've shown). Now if you want to move the goal posts and talk about G-S, or the Fed, I'm all ears - they definitely contributed to the subprime bubble. But the idea that the government forced banks and mortgage companies to make loans is just crap.
In fact, it is the lack of government regulation that really caused the bubble. If the Fed had just required confirmation of income, then the bubble would have been stopped in its tracks - but Greenspan refused to make the modifications. When Obama came in, it was among the first regulations put into place.
>Most items in the list in that article have govt's >fingerprints all over it, and it's hardly complete. For >example, it ignores fannie and freddie, the various >efforts to encourage home ownership, and the like.
Again, you have not presented evidence that Fannie and Freddie caused the subprime bubble. They were, in fact, losing marketshare during the bubble, while Wall Street took over the function of securitization. Are Fannie and Freddie messed up? Yes, but they didn't cause the subprime bubble.
>Are you really arguing that regulated entities don't >follow the rules? >If so, you don't get to argue that different rules would >have made a difference.
Of course I can - it's called enforcement. Some laws are enforced, other are effectively ignored. So it's a combination of both rules + enforcement. Witness the SEC not enforcing rules on Wall Street banks. Just today, a judge rejected the settlement offer from the SEC to Citibank, while pointing out that Citibank has repeatedly broken the law, and yet the SEC had not done anything about it - even though they knew Citibank had broken the law. Under Bush, the SEC become a toothless entity - it's gotten somewhat better under Obama, but it is still a captured agency in my mind.
Note - I didn't say that there was one cause, so it's unreasonable to suggest otherwise. I'm pointing out that the subprime aspect is directly traceable to a series of govt policies.
Are you arguing that Countrywide made all of their so-called liar-loans based on the threat of government sanction? If yes, what percentage of loans were forced, by the government, under enforcement threat? Where's your data?
The standards for regulated assets, which is what banks really need, are established by govt. Those standards favored Fannie and Freddie. Those standards also rely on govt-chosen rating agencies.
As to the "encouragement", W was the "ownership" president, so he was looking for ways to encourage lending.
>Govt had a big part in making things so that so that subprime loans made money.
So you're no longer arguing that the government forced banks and mortgage companies to lend?
>The standards for regulated assets, which is what banks really need, are established by govt. Those standards favored Fannie and Freddie. Those standards also rely on govt-chosen rating agencies.
Yes, they are set, but it was a lack of regulation that caused the problems, not too much regulation. Those standards had nothing to do with Fannie and Freddie. The government rating agencies is completely separate issue.
>As to the "encouragement", W was the "ownership" president, so he was looking for ways to encourage lending.
Again, are you no longer saying that the government forced lenders to lend?
Not at all.
The govt actions to make subprime profitable merely meant that there wasn't as much reason to say "i'm not sure that this makes sense".
Govt said that if your loan portfolio doesn't contain enough loans to certain people, you'll be shut down.
Govt then tried to make those loans make economic sense.
Yes, some folks arguably would have made those loans otherwise, but some wouldn't.
And you're attempting to move the goal posts once again here - by merging the two categories. Face it, you have zero evidence to back up the idea that the government actually EVER forced a bank or mortgage company to make loans. Trying to now say "the govt then tried to make these loans make economic sense" is just a junk argument.
http://en.wikipedia.org/wiki/Northern_Rock
So you have to take a step back, and look at political incentives. How are you going to convince these people to support putting their capital at risk?
It's still the correct solution.
The correct solution is to let corrupt and reckless institutions fail.
Just because the deck is stacked against the actual implementation of the correct solution because of 'big money families' and so on doesn't nullify the correctness of the solution.
See regulatory capture and moral hazard for why our system is screwed.
Power means never having to say you're sorry. If you're not part of the elite, your only realistic options are to become part of the elite, or to change the game (i.e. create a new elite including you and those you care about) in some way not easily anticipated / countered by the current elite.
Moreover, free markets have no moral content. Quite apart from unrestricted transactions creating injustice, free markets reward scarce resources in high demand. But something being in high demand does not make it virtuous - fashions change with the wind - and nor is there necessarily virtue in rewarding the owners of those scarce resources, which may be sheer luck. As a collective, we only want markets that are free to the degree that they are not also unjust; and that's a much harder problem.
And wouldn't it be great to design airplanes in a world without gravity? It would make things so much easier!
For your example just considering the airplane, the air would have no reason to stay near the earth, nor would there be any reason for the matter in the earth to coalesce.
The sun would also almost immediately explode because of the immense pressures required to produce nuclear fusion.
You can't have free markets in the way you advocate in the presence of democracy as we know it. To argue for what you want, you need to describe how we would change our governmental structure to make it work. Perhaps an authoritarian rule by a benevolent AI?
I.e. we could say "let corrupt institutions fail", but there's another powerful team that doesn't want them to fail, and can thwart our efforts. If we don't take that into account when designing the solution, we're doomed to fail.
> It's still the correct solution.
Well, no, that's what we're debating.
Does that sound naive to you? Because that, to my ears, is exactly what you are advocating. You're completely ignoring institutional mechanics with a mere handwave of "correctness".
No, it is the dumbest solution picked out of a menu of solutions. If we accept there are "too big to fail" institutions, one way to get rid of them is to wait for them to fail. Much like if we have 8 unsafe airplanes, one solution is to wait for them to crash. The other solution is to enact policies that make these institutions smaller (like I originally proposed).
Look up Free Banking on Wikipedia for Example.
Keep in mind that the economy 'failed' in 28, but it wasn't until FDR that things really got bad.
I just pulled up the a graph of US GDP from Google: http://www.housingbubblebust.com/GDP/Depression.html
FDR took office in March of 1933, which looks like when things got better.
[1] http://www.nceo.org/main/column.php/id/282 [2] http://online.wsj.com/article/SB122117966831526067.html
"Why can banks pay their employees so much?" - because they make so much money, and have so few employees.
"Why can banks make so much money?" - I'm not sure but it seems like banks can take risks, but pass off the real risk to others.
"Why can banks take risks, but not have to worry about the downside of those risks" - ...
I think if you follow that train of thinking you'll get to some structural problem in our current system. It doesn't seem like there is an easy fix here.
http://en.wikipedia.org/wiki/Panic_of_1907
1) Don't save them and make sure the understand that.
2) Take them you of the money creation process.
3) Stable Money (Gold is an example or something like bitcoin (an algorithem))
They had more (electoral) incentive to prosecute in the first term... They have no reason in their 2nd term.
Though the situation of the 2008-2011+ crash/depression isn't an exact reflection of 1929, there are very strong rhymes.
This is why Taleb is proposing a simpler solution - it might be hard to get around.
I am skeptical of all proposals, but I think it's important to understand that going back to the previous set of regs might not work since the banks busted through those.
In other words, wouldn't it be just as easy to defeat as simply "going back in time"?
See also: ATM access.
Huh? There are folks who sell the relevant software. My little credit union has had this stuff for years.
Yes, including bill pay and so on. I got it before big banks started advertising similar services.
I haven't seen any mention of by-phone money transfer or check cashing yet, but since I don't have a smart phone, that's may be me.
> See also: ATM access.
Credit unions banded together to solve that problem years ago. Some also pay fees for "out of network" use. (Non-banks like Schwab take that approach.)
The ATM access do require small changes in behavior (i.e., don't forget to get cash back in Safeway), but it is quite possible to achieve.
It would be nice to have more physical branches (maybe that's another thing a co-op network of credit unions could handle), but really, switching to a credit union was way easier than I had ever imagined.
Although RyanMcGreal didn't refer specifically to Glass-Steagall, it's a good bet that "re-regulating" (i.e. re-introducing measures from that law) might be a bad idea in several cases, Regulation Q being one of them.
For instance, she recently wrote that wealth inequality was probably worse in the 90s than it is now. In fact, it's now much worse than it was then. She didn't bother to check her own assumption.
But they are fully aware that the system worked pretty well, and was pretty stable, for decades, although it wasn't quite as profitable for the financial industry.
For a recent US example just look at savings accounts: http://www.bargaineering.com/articles/historical-online-savi... 3/05 HSBC 2.75% ING Direct 2.53% 2/06 HSBC 4.80% ING Direct 4.75% And guess what HSBC got bailout money.
[1]http://www.fooledbyrandomness.com/imbeciles.htm
Michael Lewis - Liar's Poker
http://www.amazon.com/Liars-Poker-Michael-Lewis/dp/039333869...
I'm sorry but that's not the solution.
The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail."
There are some incredibly elegant natural laws built into the fabric of the universe, one of which is expressed through economic systems in which corrupt, reckless institutions are eliminated because they go broke.
The only way corrupt, reckless institutions are allowed to persist are when they are propped up by taxpayer money.
I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".
But there is a "simple" difference between philosophies of how to address corruption in financial markets.
>> And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations
There is no way to avoid the day of reckoning.
Don't pretend that any crises that were avoided in 2008 won't be that much larger when they eventually materialize.
That would be true if it weren't for the fact that a good bit of our economy relies on confidence and trust. Confidence that there isn't a huge recession or depression in the near future, and trust that others will remain in business if you deposit/lend them money/invest.
So in a very real sense, a panic, even if it isn't based on anything fundamental, can set you back very significantly.
2) Ok lets asume your right:
Im against a fed in general but acting as a lender of last resort is the one of the few valid things the should do (sometimes). The problem is that the lender of last reserve thing is for banks that still are liquid and just need some cash now. A lot of banks like Lehman and other weren't liquid anymore and in that case its not really lending its more saving them. Banks that violate the golden rule of banking (lending long, borrowing short) should not get these kinds of lendings. The plaid at there own risk with ful knowlage what the do. Capitalism puniches this kind of stuff and acts as a filter. If no bank ever goes bust the banking sector will be much bigger then it normaly would (missalocation of resources).
Little extra note: Lending as last reserve should be done with high rates (if a bank really only needs it to guard agains the run the can afford it) the fed just floded the banking sector with cheap money. Thats quite diffrent then beeing lender of last reserve.
2. That is a fine argument - I agree with you that banks should not be saved. Unfortunately, when they get too big, then they threaten the system itself and that was the worry. But I agree that the proper approach would have been a pre-packaged bankruptcy aka the Swedish approach.
Moreover, we should reinstate the laws that separated commercial banking from investment banking. And we should regulate the CDS market - a huge component of the system failure worry wasn't that an individual bank was going to fail - it was that all these different banks had CDSs to protect themselves. That created a stronger interconnection between the banks. Regulate the CDS market via a central marketplace with a clearing mechanism.
On your last point, if the goal is to provide liquidity, lending at a high interest rate won't do it. The point is to keep the market being a market - if you have the high interest rates people won't borrow and the banks will just hold onto that capital, and the market will continue to be frozen. Runs on the bank are stopped by the FDIC which secures depositor money - so you're mixing up why a bank might need the money. Also, I'm really not talking about the individual depositors - I'm talking about the commercial paper market which serves business, not individuals.
Another way of making the same point:
- We can't guarantee that future governments won't bail out banks. - We can discourage one-sided risk-taking by banning bonuses in institutions that likely would manage to convince the government to bail them out.
Why not do the thing we can do?
I read the article.
The solution is still to not bail out corrupt and reckless private institutions.
This idea should not be obscured by concerns about what is politically viable.
I'm not talking about what is politically viable. I'm talking about right versus wrong.
Corruption exists. Power exists. When faced with this reality, what do you do to shift towards a reality with less corruption and power imbalance?
Saying to the powerful, and corrupt: "Don't do that -- what you're doing is wrong." is useless. If they had to listen to you they would be de facto not powerful.
Absolute power corrupts absolutely.
Governments have absolute power. Businesses don't.
Governments have the ability to point their guns at the populace and say, "You have to pay for these failing businesses or some very bad things will happen."
Stop mixing government with business.
We also agree that murder is bad. But saying "murder is bad" doesn't stop murder.
Likewise, saying "bailouts are bad" won't stop a future bailout.
If you think Taleb's idea to limit bonuses is bad, then say so. But don't attack an argument he didn't make.
Yes, I think any arbitrary interventions like 'limit bonuses' are not effective and costly. Banks will find loopholes and taxpayers have to pay for the new regulatory staff that enforce the regulations.
The only 'regulation' that is needed is the elegant self-regulation of a free, fair market: broke businesses fail.
I'm not talking about permitting fraud. People who commit fraud should go to jail.
We tried that by letting Lehman go bankrupt. While your "solution" has a ton of populist appeal, it seems lack an understanding of the events of the past few years. Let's accept the fact that banks are going to fail, and ask the government work on the "too big" part. Denying that it is even possible to be "too big to fail" is only compounding the problem.
I had a similar thought when I started reading about fracking (http://www.propublica.org/series/fracking). A simple solution there for the pollution caused by the wastewater is to force the executives and their families from the companies doing fracking to live in the communities they affect and use/drink the water they claim is safe.
Better to regulate the institutions themselves so that they dont get 'to big to fail', don't get to combine access to cheap money with access to the financial markets, don't get to insure themselves and so forth.
I'd really like to see someone attempt to express such a condition in the type of legalese that appears in legislation.
How do you ban something based on a hypothetical possibility? How do you write this condition down?
Simple and unobtrusive.
Exactly. And the best way to do that? Never bail them out.
Even if it destroys the economy for everyone?
Never bail them out.
The problem isn't a temporary, transitory state - it's a systemic design flaw in a system filled with rogue actors.
Without the possibility of a bailout, if, say, Citbank went under, this would not only screw Citibank’s depositors—most of whom were hardly in a position to audit Citibank’s books before opening their accounts—but also every bank that had loaned money to Citibank. If a bunch of people who deposited money with Citbank owe money to Wells Fargo, then Citibank’s failure hurts Wells Fargo. And if Citibank’s failure led the depositors at Bank of America to get nervous and withdraw their money, then BoA would be at risk even if it had been prudently managed up until the crisis. And then BoA’s and Wells Fargo’s creditors... etc., etc., etc.
That all beeing said in a system where you have fractional reserve banking (witch is a bad idea anyway) there is a case (not one that I totally agree with) to be made that we need a "lender of last resort". But beeing a "lender of last resort" is quite diffrent then what the fed did. They literly flooded the hole bankingsystem with cash, knowbody knew what was going on, how will be saved who want, witch banks acctully are still liquid and witch will bust when the flow of cash stops. Why should banks lend to each other if the get free money. If I would get free money, I too would just sit around and wait until the worst is over. If every body does that we acctully have a bigger problem a long rescession instead of a short crash.
If bank A goes bad, institution B might have sold lots of CDS on bank A, requiring it to pay out more than it is able, so it goes under. Institutions C and D might have sold CDS on institution B, etc.
We should bail them out and then imposse serious penalties and regulations. Sadly we didn't do that.
De facto you can decide to trust the government you were voting for or against - and me being from Euroland, I rather trust that they don't fuck up too big for important decisions like that. I know this is different in the USA.
But, the point isn't so much whether it was all right or wrong, the more important (and frustrating) point is that WHAT they did wasn't done very diligently because at the end of the day, bailout billions were passed out practically for free and nothing changed.
The question whether it was right or wrong to intervene is more a philosophical question and how much it has compromised the very foundations of our value system and economy: free market and capitalism.
>The question whether it was right or wrong to intervene is more a philosophical question and how much it has compromised the very foundations of our value system and economy: free market and capitalism.
That's all great - and I agree with your points, but the original point was "It wouldn't have destroyed the economy for everyone."
We simply do not know that - maybe, if the bailout hadn't happened, the economy would have plunged into a severe depression.
Why is this?
Do people assume we are Republicans?
I am not a Republican.
I am not a fan of Fox News.
I am a fan of fairness, and after exhaustive study of economics it seems plain to me that the road to fairness is through free markets.
So the only way to get in a situation where it is an option to never bail them out? It is to keep the sizes small.
That sounds obtrusive. Not that it's wrong, but it is obtrusive.
Corporations exist due to government enforced contracts, so I find no problem with government deciding to regulate certain markets in order to prevent total collapse of the economy.
A Geithner Put essentially means the banks could take enormous risk because they, simply put, bought a put option the government (with Geithner as analogical proxy) wrote on their bets going south. That is to say, the downside of taking a huge risk was covered by taxpayers with the bailout (= exercise price of a put), and the upside (that compelled the banks to take such risks) was even more appealing with limited losses the put option ensured.
It's kind of a tongue-in-cheek way of saying that the banks were insured against collapse via TARP.
Another solution that is more long term oriented and market based: create rival capital-formation pools outside of Wall and Broad, say in the Midwest, South, and West Coast. That way if one pool blows up, we can let them fail and it won't take out the whole economy. It also removes single points of failure from the system. I think the crowdsourcing bill floating in Congress is a great start as it decentralizes capital-raising.
Beyond even that, one might imagine that if US banking regulations get extremely prohibitive, banks will just move offshore. (And still be too big to fail with regard to the US economy)
I think that a little divide-and-conquer is needed to fix some of the smaller sub problems...
Banks moving offshore isn't really realistic - you can't avoid, at the moment, having America as part of your bank - too much of a market. So even if, like UBS, the bank isn't in the US, it doesn't mean that they wouldn't be subject to regulation.