Sunday, March 17, 2013

Banks - Too Big to Fail? Policy Choices.

More and more information is coming out about the JP Morgan London Whale debacle.  As always, the wonderful Gretchen Morgenson illuminates it with opinion and bite in today’s NYT.

(Of course, I have to admit, since I am not a financial professional and insider, I could always be wrong in my Gretchen Morgenson opinion.  I have great faith in the media.  As far as I can see, they are almost always right.  The only exception appears to be in things that I know a whole lot about.  In those cases, the media often gets it wrong.  But with that small exception, I think they are very reliable.)

Anyway, the gist of the argument is summed up by Morgenson at the end:

“We already know that banks of JPMorgan’s size are also too big to be allowed to fail and too big to prosecute. Such banks are too big to regulate and apparently too big to manage. So how much more evidence do we need that banks like JPMorgan are simply too big a risk for taxpayers to bear?”

Very, very interestingly, the WSJ editorial page comes to … the same conclusion!  They start from a different place – they say, banks are a private business, why is the government poking its nose into the workings of a private enterprise?  Why is the Senate concerned with JP Morgan, and why hold those awful hearings? 

(Morgenson’s take is: “…let’s congratulate the Permanent Subcommittee on Investigations, led by Senator Carl Levin, a Michigan Democrat. This is the second time in recent history that this subcommittee and its staff have served the public by illuminating the dark corners of the financial world — the first being the riveting hearings and reports on the causes of the 2008 financial crisis, which dove deep on Washington Mutual, Goldman Sachs and the credit ratings agencies.”)

But then the WSJ takes a left turn, blessedly.  They say, the Senate is concerned because of the potential of bailouts.  It happened once and it sure could happen again.  So the Senate is right to be concerned.

Therefore – and here is where the WSJ takes a surprising plunge, if I remember correctly – the banks are too big to fail, and consequently, they should be broken up!  Only then can the government not worry about the state of any individual company, and not micromanage, and not fear that the economy is at risk.

Of course, and the WSJ doesn’t go here, a whole industry can go down the wrong track – see mortgages, and Countrywide and friends – and there is ample reason for government to survey and regulate at the industry level.  But let’s leave that alone for now.  Enough to say, it seems that when the “best” bank, JP Morgan, is shown to be completely derelict, the argument for bigness in banks seems to go out the window.

On the other hand, even though the London Whale and his overlords went awry, overall there was really no cause for panic.  Even in the time period in question with $6 billion down the drain (and let’s not forget, what JPM lost, others gained), JPM still made a profit.  So you could say that bigness actually was a blessing.  You could say that the market could and should and actually did exert its pressure on the stock, and the market will work its magic – aided by the revelations of the government investigation, which shows also how poor JPM’s internal investigation was.  You could say that the biggest lesson, actually, is that pusillanimous regulators are the problem, and as long as there is very big money on the bank side, and very small wages on the government side, the risk-adverse and under-intellected (or maybe just under-cajonied) feds will always be captured by the industry. 

Where are we then?  If we can’t regulate, and the bank can’t self-regulate well, should we enforce the Buffet Rule, so banks can’t bet with their own money?  Also, a separate question, should we go with bigness, or smallness?

My own opinion is that we should look closely at societal gains.  Does society gain by allocating resources well, as banks can do by betting money on emerging industries, say?  Yes.  Does society benefit by betting on derivatives, as an example of pure trading risks?  Probably not, I’d say.  It seems pretty clear that there is a lot more betting going on, and a lot less hedging of bets than advocates will admit.  That being the case, I think we have to deemphasize trading as a major source of profits, and that will take governmental regulation – not micromanagement, but just a prohibition of certain courses of business.  That would be, the Buffet Rule.  You can’t just indulge in betting.

But what about size?  Should we regulate size?  If we mandate a limit to size, would that inhibit the ambition of banks, and make them less effective?  The reward for good bets on industries and other allocation decisions, after all, is profit and thus increased size.  Would a limit on size inhibit a single institution’s having enough resources to take good business risks in allocating capital?  That is, if you want to bet on an industry, but if you’re wrong you don’t want to have the whole firm go down the drain, you have to have large resources to withstand a bet gone wrong.  This is precisely the situation that JPM faced – they were able to withstand the London Whale debacle because they were very big.  Think not trading risk, but capital allocation risk, and being big takes on a completely different complexion.

So, although I hate the idea of big size, and I hate the model of Wall Street where these guys make so much money just because they are handling lots of money, I’m going to come down on the side of not regulating size.  But I’m also coming down on the side of implementing the Buffet Rule, hard as it may be to accomplish.

Now that I have made my decision, let’s see how the markets react….

Budd Shenkin

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