The Administration seems to prefer ”forbearance”, meaning you just ignore the problem, hope the economy recovers anyway, and wait for time or global economic events to wash away banking insolvency concerns. But this strategy is increasingly being undermined by the banks themselves – their actions threaten financial system stability, will likely force even greater costs on the taxpayer, and demonstrate fundamentally anticompetitive practices that inflict massive financial damage on ordinary citizens.
As the NYT reported yesterday, the Federal Reserve – on behalf of all bank supervisers – recently requested banks in no uncertain terms (1) not to reveal stress test results, (2) not to give other indications of their financial health, and (3) most of all, not to announce capital raising plans immediately. The point, of course, is to manage the flow of information so that plans can be made to help the weaker banks at the same time that the market realizes exactly who needs what kind of help.
Amazingly, the biggest banks are defying the federal authorities on this point, insisting on signalling their soundness and – in the case of Goldman Sachs – rushing to raise capital. In the case of Goldman, the explicit intention is to pay back TARP funds and to escape all government-imposed limitations on compensation. This would obviously be good for Goldman and the people who run it. Anything that strengthens their advantage over competitors and increases market share will presumably raise their profits and compensation, making it easier to attract even more good people. (See my discussion with Terry Gross yesterday for more on these dynamics.)
Such developments would worsen the business prospects of other large banks and potentially threaten their financial situation. The government’s forbearance strategy is fragile unless big banks do as the supervisers tell them. But Goldman and other major players apparently think they have so much political power – and this may be more about connections on Capitol Hill than links with the Administration – that they can ignore the supervisers.
Treasury can try to refuse repayment of TARP funds, but Goldman would hardly have made its move unless repayment (particularly after announcing the intention) is essentially a done deal. Supervisers can send more assertive emails, but these are hardly likely to have any effect. The President himself can call on leading bankers to behave better, but didn’t he just do that (and isn’t that what Valerie Jarrett is working hard on)?
My practical friends in the Administration like to emphasize that “we are where we are” and that we need to understand the limitations of the policy tools in hand and the realities of our political constraints. I completely agree.
The Department of Justice’s Antitrust Division should be called in to investigate the increasing market share of major banks (remember that Bear Stearns and Lehman are gone), the anti-competitive practices of some market leaders (there’s more than one predatory way to force your rivals into bankruptcy and to move closer to monopoly power), and the broader increase in economic and political power of the biggest financial services players over the past 20 years and the last 6 months – this is potentially damaging to all consumers and, obviously, to all taxpayers.
Think of the costs arising from the market power of major banks – and it is financial market power that makes them “too big to fail”; the FDIC has no trouble handling the failure and liquidation of small banks. We started this crisis with privately held government debt at around 40% of GDP. My baseline view is that we will end up closer to 80% of GDP. This means higher taxes for all of us, and this is absolutely not a “left vs. center” or “left vs. right” issue. This is left, right, and center against those parts of the center who insist that we should go back to having the same organizations, essentially unchanged compensation schemes (and all they imply about “Wall Street owns the upside and taxpayers own the downside”), and even more concentrated market power in our financial system.
Probably we need to modernize our thinking about the exact nature of threats arising from financial trusts. Perhaps we need, at some point, new legislation that reflects this thinking. But we can make a great deal of progress, here and right now, with appropriate enforcement of our existing antitrust laws.
The pushback, of course, will be: you can’t do this in the middle of a recession – it will slow the recovery. Honestly, as my colleague Mike Mussa emphasized last week, banking is more likely to follow than lead the recovery; in fact, this is the exact logic that underpins the Administration’s forbearance strategy.
The goal of this antitrust action is to prevent some big banks from further destabilizing the system, hence reducing a serious downside risk. It’s also to limit the taxpayer costs arising from this crisis; for all major bank rescues, the cost is not just the bailout, it’s also the higher fiscal deficit, increased debt, taxes down the road and – given today’s predicament – the very real inflation risks arising from even more monetary expansion. The overarching goal, of course, is to (re)build a more sustainable, sound, and – in all senses – competitive financial system.
Originally published at the Baseline Scenario and reproduced here with the author’s permission.
2 Responses to “Bring In The Antitrust Division (On Banking)”
Many of us thought that Goldman’s equity raise was a good thing. Private capital investment in bank equity rather than government bailouts to shore up capital has got to happen before the crisis is over, and are a condition of its ending.I would have liked to see Goldman surrender its recently acquired banking charter along with the TARP money. Submitting to bank regulation was a condition of getting into the TARP honeypot. Goldman is really not the kind of “bank” that can be regulated effectively, except by markets, in my opinion. This goes to recognition of its purpose for being and its strength. Evidently, the markets like Goldman, $5 b worth in a day.So, I don’t think Goldman’s move is only about protecting the compensation scheme at the top or for the traders. It’s about institutional culture and the culture of Wall Street. And internally, it is not a culture that simply promotes outsized risk-taking without downside exposure. It’s a competitive jungle, with penalties for being too conservative and penalties for failure, pitfalls, clawbacks, back-biting politics, and the daily scorecard from the market, all of which is the price for a chance to make big money. In this context, good connections in Washington are nothing sinister, just part of the anything goes profit-making ethos. As regards regulatory compliance, money can be made pushing the envelop of regulation, you understand?Such outfits attract a certain type of personality, which will find a home taking high risk for high reward regardless of the broader economic utility of risk-taking institutions, if any. It is a type of personality that is completely different from the type that finds its way into the other kind of banking. One has its origins in a rough riding Wall Street partnership. The other grows out of a community-based fiduciary institution taking deposits and lending money.Here’s a simple way to glimpse the different mentalities: Goldman orchestrated a capital raise on the strength of a positive earnings announcement that left some analysts questioning one of the most obvious of reporting ploys. Wells Fargo made a very positive earnings pre-announcement, also suspicious to many analysts for what it didn’t say, and it’s shares rose 35%. But Wells didn’t issue any stock, even though it could surely use more capital.It is certainly true that concentration in banking has shown itself to be a problem as a result of the crisis and I agree that concentration in banking has played a role in bringing on the crisis. Anti-trust enforcement might be helpful, but it wont be fast enough to accomplish anything soon.On the other hand, the government has been too fast on the trigger when it comes to aiding the banking system. The concern has been the threat to the system of inter-bank lending, which is what is reflected in the Credit Default Swaps market that Simon has discussed in other posts. That concern has swept all before it.In contrast, the government has been able to take a different approach to the insolvency of the automakers in part because the automakers are not part of a web of instantaneous international credit exchanges of the sort that constitutes the banking system.Had there not been an over-riding concern with the horrific consequences of a breakdown of the interbank system, we might well have seen the government acting more as Obama has acted recently vis a vis GM and Chrysler. I thought now there is the President acting like a lender–more accurately like a lender in a loan workout group–addressing an insolvent company, using the promise of future investment to extract changes in management and opertaions and to guide outcomes, without exactly taking over or controlling the supplicant. You would think the bank executives would understand this language perfectly. The government as the lender of last resort has the upper hand. The banks have arguments about the greater damage that would be caused if . . . .To raise capital to offset their losses, these big financial conglomerates that are at the eye of storm should be spinning off divisions, disaggregating services and product lines, retreating from markets, selling their real-estate, closing operations, trimming executive compensation and also selling shares if they can. They should be willing to give up their jewels for the sake of survival, as Barclays has done with the sale of iShares (leaving aside the ironies of Barclays carry-back financing of the deal with CitVentureCapital). They would do so, with more alacrity than we are seeing now, if there were no government subsidies available, or being pushed at them. Banks with troubled assets ought to be required to downsize as a condition of more taxpayer subsidies, access to the PPIP and the TALP, etc.The government, for its part, should be making the advantages of having a bank charter worth more rather than less. The moves to guaranty money market mutual funds and the opening of the Fed to all kinds of securities have devalued rather than enhanced a bank’s unique access to Federal deposit insurance and the Fed’s Discount Window. The government has shown a tendency to invent new programs and institutions where it could have used the still healthy, generally smaller banks as a way to deliver credit relief , while at the same time enhancing the profit making opportunities of healthy banks, so as to make these banks attractive to private investment. This is a way to encourage less concentration in banking now.Finally, the government has been promoting more consolidation, not less, in its responses to failing institutions. The leading idea has been to associate weak or failing operations with stronger ones. They were most successful in putting Bear and WaMU with Chase, using subsidies. Wells took Wachovia without assistance, although it was intended by the regulators to shore up Citicorp (which even with subsidies in the long term might have been cheaper for taxpayers as a resolution of Citi’s problems). Bank of America gladly took Countrywide in the early days and was intended by the government to absorb Lehman, except Merrill jumped in to sell itself before it became the next casualty. It subsequently needed government support. Notably, Lehman failed because there was no backup taker, which illustrates the critical shortcoming of responding to insolvency with only a strategy of aggregation, instead of weapons of both aggregation and dis-aggregation.And for those who believe nationalization is efficient based on FDIC successes, it is worth noting that the FDIC does best when the seizure of a failed institution occurs almost simultaneously with its absorption into a healthy bank. When that kind of arbitrage is not available, you have a slow and painful process of shrinkage by dis-aggregation and divestiture. So, an anti-trust program by other means would be pro-active in the crisis. It will cost taxpayers less if insolvent firms break themselves up before they come under the control of the government. Receiverships for banks , like bankruptcy for other firms, is orderly process for overseeing the transfer of assets from weaker to stronger hands when lack of liquidity or insolvency forces a cessation of operations, but it cheapens the prices at which the transfers take place.
Unfortunately we live in a financial services oligarchy and any hope that the rule of law or any sense of propriety will ever be applied to the major financial services institutions or their senior leadership is a pipe dream. These institutions and their associates within government will do everything within their power not only to shield themselves from accountability, they will ensure that the whole nation will be dragged down with them. After all, if you were to ask the folks that lead these institutions they would tell you that the primary purpose of the citizens of the nation is to meet the needs of their institutions.