Blog Archives

Goldman’s Big Guns Fire Dud in Defense of Megabanks


108280_600

The six very large U.S. bank holding companies — JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup (C) Inc., Wells Fargo & Co. (WFC), Goldman Sachs (GS) Group Inc. and Morgan Stanley (MS) — share a pressing intellectual problem: They need to explain why they should be allowed to continue with their dangerous business model.

So far their justifications have been weak, and the latest analysis on this topic from Goldman Sachs may even help make the case for breaking up the financial institutions and making them safer.

egislative proposals from two senators, Democrat Sherrod Brown of Ohio and Republican David Vitter of Louisiana, have grabbed attention and could move the consensus against the modern megabanks. Under intense pressure from Democratic Senator Elizabeth Warren of Massachusetts, Federal Reserve Chairman Ben S. Bernanke conceded recently that the U.S. still has a problem with financial institutions that are seen as too big to fail. Pressed by Republican Senator Chuck Grassley of Iowa, among others, Attorney General Eric Holder is sticking to his story that these companies are too big to prosecute. Cyprus offers another vivid reminder of what happens when banks (S5FINL) become too big to save.

Goldman Report

In this context, it is no surprise to see the financial sector wheel out its own intellectual big guns. A frisson no doubt rippled through the financial-lobbying community last week with the release of a report from Goldman Sachs’s equity research team, “Brown-Vitter bill: The impact of potential new capital rules.” This is the A-team at bat, presumably with clearance from the highest levels of management.

Yet instead of providing any kind of rebuttal to the proposals in Brown-Vitter, the report may strengthen the case for breaking up the six megabanks, while also requiring that they and any successors protect themselves with more equity relative to levels of debt. Read the report with five main points in mind.

First, notice the lack of sophistication about bank capital itself. The authors write of banks being required to “hold” capital, as if it were on the asset side of the balance sheet. They go on to construct a mechanistic link that implies that “holding” capital prevents lending.

Banks don’t hold capital. The proposals are concerned with the liability side of the balance sheet — specifically, the extent to which banks fund themselves with debt relative to equity (a synonym for capital in this context). Higher capital requirements push companies to increase their relative reliance on equity funding, thus increasing their ability to absorb losses without becoming distressed or failing. If the transition is properly handled, there is no reason that more equity funding would translate into lower lending.

Second, the Goldman Sachs analysts seem completely unaware of the recent book by Anat Admati and Martin Hellwig, “The Bankers’ New Clothes,” in which those authors — who are top finance professors — debunk the way many bank representatives (including the authors of the Goldman Sachs note) look at issues around capital.

More equity relative to debt on a bank’s balance sheet means that equity and debt become safer: The bigger buffer against losses helps both.

Goldman Sachs makes much of the implications for return on equity, without mentioning any adjustment for risk. Bankers are generally paid based on return on equity without proper risk adjustment. Naturally, they like a great deal of leverage, but the reasoning they use to justify this is fallacious (see Chapter 8 in Admati and Hellwig).

Safety Measures

Admati and Hellwig make the broader case that we can run our system much more safely. Goldman Sachs made a big mistake by refusing to take them on directly.

The bank is correct in its assessment that bank equity is higher than it was before the 2007-08 crisis, but this is the natural reaction to a near-death experience. Over the cycle, big banks will again become more leveraged (meaning they will have less equity relative to debt). As a result, Goldman is far too optimistic in its projection of the capital levels that will be needed when the next crisis hits. Current — and likely future – – levels of equity capital are insufficient for our intensely interconnected financial system.

Contrast Goldman Sachs’s note with this excellent speech last week by Tom Hoenig, vice chairman at the Federal Deposit Insurance Corp., on the illusion of the Basel III rules in particular and the right way to think about capital more generally.

Third, while the Goldman Sachs analysts get some points for stating the obvious about Brown-Vitter — “In our view such a bill would incent the largest banks to break up” — they fail to explain why this would be a bad thing.

They do, however, have a line about how banks could only be broken up along existing divisional lines, though they fail to make clear why they believe this is the case or how it would be the best deal for shareholders. Also, once the too-big-to-fail subsidies fade, these new companies would probably be smaller than projected by Goldman Sachs. Less complex, easier to govern and more transparent to supervisors sounds pretty attractive, to officials and investors. (Any client can request a copy of Goldman’s May 2010 report, “U.S. Banks: Regulation.” See Page 32, where it explains how JPMorgan and Bank of America would be worth more if broken up. Richard Ramsden is the lead author of both this report and the one cited above.)

Fourth, the analysts express concern that these smaller companies will be less diversified and therefore more fragile than the megabanks. Delusions of diversification are precisely what brought us to the brink of catastrophe in September 2008. Have the smartest people on Wall Street really learned so little?

Diversification Imperative

From a social perspective, we want a system in which some companies can fail while others prosper, more like the conditions under which hedge funds operate. For macroeconomic purposes, we want diversity within the financial sector, not diversification within Citigroup (which has come close to failing three times since 1982 precisely because of this misperception).

Fifth, on supposed progress to eliminate too big to fail, Goldman’s arguments fall under the heading of what Winston Churchill called terminological inexactitude. The Orderly Liquidation Authority under the Dodd-Frank financial reform law won’t work for complex cross-border banks, such as Goldman, because there is no cross-border resolution authority. Living wills have so far proved to be a joke, and annual stress tests show every sign of becoming a meaningless ritual that undermines serious supervision.

What will move forward the debate? Will it be another money-laundering scandal, another disaster in the European financial system, or further revelations about the London Whale and Libor?

Or will it be thoughtful people sitting down to evaluate the best in-depth arguments for both sides? If it’s Admati and Hellwig v. Goldman Sachs in the court of informed public opinion, reformers win in a landslide.

(Simon Johnson, a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics, is co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.” The opinions expressed are his own.)

To contact the writer of this article: Simon Johnson at sjohnson@mit.edu.

To contact the editor responsible for this article: Max Berley at mberley@bloomberg.net.

via Goldman’s Big Guns Fire Dud in Defense of Megabanks – Bloomberg.

via Goldman’s Big Guns Fire Dud in Defense of Megabanks – Bloomberg.

Jim Himes, Former Goldman Sachs Executive, Introduces Bill To Roll Back Key Element Of Dodd-Frank


 A bill to roll back a bill that has not yet been fully implemented- Talk about being ahead of the times.

Rep. Jim Himes (D-Conn.), a former Wall Street executive, is joining Rep. Randy Hultgren (R-Ill.) to introduce legislation that would undercut one of the most meaningful elements of the 2010 Dodd-Frank Wall Street Reform Act.

The bill would “allow banks to keep commodity and equity derivatives in federally insured units,” Politico reported on Wednesday, meaning that banks would no longer be forced to spin off their trading desks. It would weaken Dodd-Frank’s “push out” provision, otherwise known as the Prohibition Against Federal Government Bailouts of Swaps Entities, which bars federal assistance from being provided to any swaps entity.

Derivatives — which Warren Buffett has referred to as “financial weapons of mass destruction” — are viewed as a key trigger of the 2008 economic crisis.

“We need financial regulation that allows businesses and the banks they use to have access to the tools that help keep prices of consumer goods—like groceries and home heating oil—steady, while ensuring that the taxpayers are never again on the hook for the types of wild bets helped crash the economy in 2008,” Himes said in a press release. “This bill maintains Dodd-Frank’s prohibition on that risky behavior at banks that are insured by the taxpayers while allowing businesses that produce products Americans use every day to continue to use swaps to maintain predictability in their operations and in the prices of their products.”

Himes, who was recently named the national finance chairman of the Democratic Congressional Campaign Committee, is a former executive at Goldman Sachs, where he was a vice president.

In 2010, Himes took heat from consumer advocates for opposing the Senate’s version of the financial reform bill, at which point he characterized derivatives as a “political football.”

“The discussion of derivatives in the political world has become a zero sum game,” Himes told the Connecticut Mirror. “But there’s a lot more common ground here than the people who are yelling about this would have you believe.

During a testimony before the Senate last week, Federal Reserve Chairman Ben Bernanke expressed support for Himes and Hultgren’s proposal, Politico reported.

This article was edited after publication to clarify the effect of the bill and updated to include a comment from Himes.

via Jim Himes, Former Goldman Sachs Executive, Introduces Bill To Roll Back Key Element Of Dodd-Frank.

via Jim Himes, Former Goldman Sachs Executive, Introduces Bill To Roll Back Key Element Of Dodd-Frank.

American Election Round up


Ny Times Obama Endorsement

New York Times Endorses President Obama’s Re-election

President Barack Obama picked up the endorsement of The New York Times on Saturday, a decision the paper’s editorial board said was due to administration policies that have placed the economy on the path to recovery, the passage of landmark health care reform, the advocating of women’s rights and a foreign policy agenda that has kept unstable regions from combustion — all accomplished, the board argues, in the face of an “ideological assault” from the Republican Party.

==================================================================================

Chicago Tribune Endorses President Again

CHICAGO — For only the second time in its 165-year history, the Chicago Tribune has endorsed a Democratic candidate for president.

Once again, President Barack Obama will enjoy his hometown Tribune’s seal of approval, the newspaper announced Friday. The paper lauded the president for his careful projection of military power abroad and pragmatism as the country’s economic “dominoes toppled.

=========================================================================

Republican Congressman Blasts Working Moms

Roscoe Bartlett, a Republican who has represented Maryland in Congress for nearly 20 years, blasted working mothers at a campaign stop last week. The Washington Post has the quote:

This isn’t the politically correct thing to say, but when we drove the mother out of the home into the workplace and replaced her with the television set, that was not a good thing.

During the same campaign swing, Bartlett said he believed “the Information Age is just a high-tech bubble,” noting “You can’t eat those electrons. They won’t keep the rain off your head. They won’t take you anywhere.”

Bartlett also recently apologized for comparing student loans to the Holocaust.

He is facing an uphill battle for re-election in a new district that is more favorable to Democrat

==============================================================================

The Telegraph (UK)

A Romney victory could spook the US markets

Were Romney to win, paradoxically, the US stock market could tumble. That’s because the former Massachusetts governor would be most unlikely to extend the tenure of Democrat-appointee Ben Bernanke as chairman of the Federal Reserve when his current second term expires in January 2014. That political reality would then cast doubt on Bernanke’s recently-issued pledge that the Fed won’t raise interest rates until well into 2015.

MovieBabble

The Casual Way to Discuss Movies

OLD HOLLYWOOD IN COLOR

...because it was never black & white

LEANNE COLE

Art and Practice

CURNBLOG

Movies, thoughts, thoughts about movies.

FilmBunker

Saving you from one cinematic disaster at a time.

From 1 Blogger 2 Another

Sharing Great Blog Posts

Wonders in the Dark

Cinema, music, opera, books, television, theater

Just Reviews

Just another WordPress.com site

Mark David Welsh

Feeding Soda Pop to the Thirsty Pigs since 2013

conradbrunstrom

Things I never thunk before.

News from the San Diego Becks

The life and times of Erik, Veronica and Thomas

The Silent Film Quarterly

The Only Magazine Dedicated To Silent Cinema

Leaden Circles

First a warning, musical; then the hour, irrevocable. The leaden circles dissolved in the air.

My Archives

because the internet is not forever

CineSocialUK

Up to the minute, fair, balanced, informed film reviews.

PUZZLED PAGAN PRESENTS

A Shrine to Pop Culture Obsessiveness. With Lots of Spoilers

Thrilling Days of Yesteryear

“Nostalgia isn’t what it used to be” – Peter DeVries

thedullwoodexperiment

Viewing movies in a different light

Twenty Four Frames

Notes on Film by John Greco

Suzanne's Mom's Blog

Arts, Nature, Good Works, Luna & Stella Lockets & Birthstones

It Doesn't Have To Be Right...

... it just has to sound plausible

NJ Corporate Portrait Photographer Blog

The life of a corporate portrait photographer who likes to shoot just about anything.

arwenaragornstar

A French girl's musings...

Jordan and Eddie (The Movie Guys)

Australian movie blog - like Margaret and David, just a little younger

Octopus Films

A place for new perspectives on films, TV, media and entertainment.

scifist 2.0

A sci-fi movie history in reviews

The Reviewer's Corner

The Sometimes Serious Corner of the Internet for Anime, Manga, and Comic related things

First Impressions

Notes on Films and Culture

1,001 Movies Reviewed Before You Die

Where I Review One of the 1,001 Movies You Should Watch Before you Die Every Day

Movies Galore of Milwaukee

Movie Galore takes a look at Silent films on up to current in development projects and gives their own opinion on what really does happen in film!

The Catwing Has Landed

A Writer's Blog About Life and Random Things

mibih.wordpress.com/

Anime - Movies - WWE

Gabriel Diego Valdez

Movies and how they change you.

The Horror Incorporated Project

Lurking among the corpses are the body snatchers....plotting their next venture into the graveyard....the blood in your veins will run cold, your spine tingle, as you look into the terror of death in tonight's feature....come along with me into the chamber of horrors, for an excursion through.... Horror Incorporated!

Relatos desde mi ventana

Sentimientos, emociones y reflexiones

Teri again

Finding Me; A site about my life before and after a divorce

unveiled rhythms

Life In Verses

Gareth Roberts

Unorthodox Marketing & Strategy

leeg schrift

Taalarmen

100 Films in a Year

12 months. 100 films. Hopefully.

%d bloggers like this: