EconoMonitor

Great Leap Forward

Is Modern Banking Nothing But a Criminal Enterprise?

You’ve seen me comparing the modern financial system to Shrek’s Onion–under every layer you find fraud. If you’re among the 99%, you are the mark.

Excellent piece by Prof Christopher Peterson. He argues:

The famous thief, escape artist, and master of disguise, Willie Sutton, is rumored to have said that he robbed banks “because that’s where the money is.” It is perhaps ironic, but given the nature of corruption not surprising, that one of the first and primary targets of organized criminals—banks—have in some cases taken on the organizational strategies of our country’s most successful and feared criminals. If we learn nothing else from the Great Recession it should be this: the definition of “bank robber” needs an update.

He compares the modern banking enterprise to the fabled mafia gangsters. It is an interesting analogy.

Read the rest here:

http://kirwaninstitute.osu.edu/docs/FairHousing_FairCredit//chris_peterson_what_is_a_bank_robber_merge.pdf

 

29 Responses to “Is Modern Banking Nothing But a Criminal Enterprise?”

PaulAugust 2nd, 2012 at 5:17 am

Sorry Dr Wray, but you discredit yourself when you write ridiculous articles like this. Banks aren't criminal enterprises. They might not be the most productive and upright businesses in the world, but this is the sort of crap we would expect to see on Zero Hedge. Not from a professor at a University.

E. StevensAugust 2nd, 2012 at 1:54 pm

I guess we would all be better off if government did all the lending (like it is doing in student lending, resi mortgages today in the US).
a. last time I looked the biggest bankruptcy in the history of the world is Fannie Mae and Freddie Mac– government sponsored enterprises
b. let's see what happens with the US direct student loan program

IMO, lending to people who can't or wouldn't payback the debt is bad for both parties.
I am a simple-minded old person, but seems to me the borrower has some responsibility to ensure they can pay back the debt.
Selling a risk (e.g. MBS/ ABS by investment bankers) to people when you have reason to believe it wouldn't be paid back is IMO wrong– certainly ethically.

Commercial bank net interest margins tend to be around 2%-3%– last time I looked that didn't leave much room for too many bad ones– and if the lender makes to many bad ones I can guarantee that person will be fired!

Last time I looked, unless we want to go back to a barter system we need a bank.
I just wish they didn't make as many bad loans– for their sake and for mine

B BooherAugust 2nd, 2012 at 7:05 pm

E,

As I understand it, lending to unworthy borrowers is one of the absolute worst ways that the government can allocate capital. If the borrower cannot repay the loan and defaults, then the balance is wiped out between the borrower and the government, BUT the government's obligation to its lender still stands. The government increased it's overall deficit without adding anything to the economy.

SergioAugust 2nd, 2012 at 7:22 pm

Booher. Your comment makes no sense and it is impossible to know exactly to what problem you are referring to. It looks like a paragraph that my nine year old son would write. You need to restate your comment so that we can know what you are referring to.

SergioAugust 2nd, 2012 at 7:47 pm

Booher,

If you are referring to the massive taxpayer bailouts, central bank subsidies, and regulatory forebearance used to “rescue” highly leveraged capital maket players that created financial deals that were designed to fail while at the same time taking short positions to benefit from this failure then I agree with you. But the way you are expressing your comments is confusing and I don’t really know what you mean.

B BooherAugust 2nd, 2012 at 8:08 pm

Sergio, the insulting tone was uncalled for, but I think my point is valid so I will restate it.

I agree with E's statement that "lending to people who can't or wouldn't payback the debt is bad for both parties."

Say the government extends a loan to me to start a business (or go to school). I proceed to make terrible decisions (create a product no one wants / fail all my classes) and cannot make the money I need to pay back the government. I default on my loan. My obligation to my lender is wiped out, but my lender also loses my debt as an asset. Its a lose/lose situation; the financial asset was destroyed on both sides of the ledger.

Now, assume that the government is running a deficit. Because the government is legally required to borrow money from the private sector to extend that loan to me, the government's obligation to ITS lender still stands. The government is in no danger of defaulting on that debt, but it must now allocate assets to pay that particular obligation that it could have allocated in some other way had it not made a bad investment.

The investment did not contribute to the productivity of the country in any way, and it removed potentially productive assets from the private sector to do so. This is bad policy when done on a large scale.

LRWrayAugust 2nd, 2012 at 8:53 pm

Booher: your premise is wrong; the mortgage bankers purposely made loans that borrowers could not pay, with rigged terms that ensured default. They called these terms "nuclear options" and other such terms of endearment. They made bundles of profits off that. Then stuck the losses on the homeowners and the securities holders–such as pension funds.

With respect to government finance, you do not understand it. Go to the MMPrimer at NEP.

LRWrayAugust 2nd, 2012 at 8:54 pm

Paul: are you really that careless? The article is by a Law Prof named Peterson. He knows a bit about the law, as he is one of the foremost authorities on banking fraud having to do with real estate.

LRWrayAugust 2nd, 2012 at 8:57 pm

Thx redge (of course I did not write the article in the first place–just pointing readers to it). But this "Paul" is actually a Troll who also calls himself Phil, Fido, Anon, Sir, and any other of a number of names.

Let's have a naming contest for him. Points for cleverness!

B BooherAugust 2nd, 2012 at 9:34 pm

Prof.: I definitely appreciate the fact that fraud occurred and people profited from it. My argument is that risky loans are always bad, no matter what sector does the lending.

I certainly don't understand government finance the way you do, but I believe that conclusion naturally follows from fact that a default is equivalent to destruction of financial assets on both sides of the ledger. Thanks for the input, as I really would like to wrap my head around this.

1234August 2nd, 2012 at 9:39 pm

I found the post equally useless and I am none of the "trolls" you mention above. You've lost a lot of credibility in recent months with the way you generally behave in your posts and your comments. You should stick to scholarly papers where your true colors don't show thru quite so much.

SergioAugust 2nd, 2012 at 9:57 pm

Booher,

Look. I don’t mean any insults. Let me update you a bit in what has happened in the last 30 years. I think that the way you think about banks has to do with relationship banking. Relationship banking concentrates on the creditworthiness Of borrowers-the typical borrower-lender relationship where the banker creates relationship with client. This creates an incentive for the borrower to repay and for the banker to do correct underwriting. This is the model of the small banks which by the way are being swallowed by the bigger banks (you can look this up). This relationship banking model has been replaced by an originate to distribute model. What this means is that underwriting is now irrelevant and risk is assessed by credit agencies who do not know abou the risk of the CDOs and CMOs because these are new instruments and because they also have perverse incentives to rate them highly. The small banks that you are implicitly referring to have been driven out of business because of “cream skimming” by shadow banks and also the development of the commercial paper market.

SergioAugust 2nd, 2012 at 10:18 pm

The fed also requires a portion of bank funds to come from retail deposits. But this is expensive for the small banks because it requires that they open more branches. The government through its implicit guarantees to rescue “too big to fail” banks favors bigger over smaller banks. The competitive pressures of MMMs and commercial paper markets forced banks to abandon the expensive relationship banking model in favor of the originate to distribute model. As I said before, within this model creditworthiness assessment becomes irrelevant and the creditworthiness of the financial instrument(s) within which the loan is embodied is now left to rating agencies who are clueless abou the nature of the loan. No longer would the bank need to hold the asset on its balance sheet but if could simply create the loan and sell it in the capital market, probably to an investment bank. In fact, much of the creation of loans occurred outside banks and thrifts, mortgage originators and brokers wrote the mortgages and arranged for finance. Fannie and Freddie have been critizid unjustly because they never made or arranged any of the mortgages; they simply purchased toxic assets to attempt to diminish the negative impact of what seemed to be an impending collapse. You can Read The Big Short by Micheal Lewis to find out how the same hedge fund managers and investment banks that were creating the Collaterized Mortgage Obligations were also taking short positions on these assets because they knew they would eventually fail! These investors made billions but not because they were geniuses but because they had constructed the deals that were destined to failed (google “magnetar”).

LRWrayAugust 2nd, 2012 at 10:28 pm

Fido/Phil: can we count all the way to 5? The post points you to an article by a highly respected Law Prof. You don't find it useful? Fine. Don't use it.

SergioAugust 2nd, 2012 at 10:28 pm

Booher,

I agree with you that proper creditworthiness assessment of the borrower is crucial for promoting the economic development of the nation. The problem is that the biggest banks that Prof. Wray is referring to were/are no longer doing that. The capital development of the economy can be “ill done in 2 ways: the wrong investment may be financed by the financial system or we could have deficient or excessive investment. Now, I think you and I would agree that there was a missallocation

SergioAugust 2nd, 2012 at 10:45 pm

Of investment towards the real estate sector, too much. This is because the instrument originators and the security underwriters did not risk their own wealth on the long term prospects of the underlying investments. But good underwriting requires exactly the opposite, right? If the biggest banks that do most of the financial activities are no longer interested in evaluating the creditworthiness of the borrowers, then why do we need banks as middlemen? Anyways, banks are playing with FDIC insured money and when they are not they are counting on uncle Ben to rescue them if they make mistakes. The billionaire loss by JPMorgan shows that banks are not only too big to fail but they are also to big to manage. If they are too big to manage, we also know they are too big to regulate. In fact, Dodd-Frank has basically been murdered. Government austerity promoted initiatives have cut the funding for bank regulation by about 75%, the CFPB has been reduced to a department within another agency, Elizabeth Warren was replaced by a wall street player, the regulatory agencies have been scared to death because they feel that if they go too hard on the banks, their funds may be cut shorter. Many parts of Dodd-Frank have been killed because of “insufficient cost benefit” analysis and new clauses have been introduced to allow banks to operate without regulation in their overseas branches, etc, etc. Now, you tell me, are the banks properly assessing risk? Aren’t taxpayers getting stuck with the bills of the financial sector’s mistake?

SergioAugust 2nd, 2012 at 11:01 pm

Booher,

Risky loans are bad as you say. The problem is how do you stop them during a boom. Interest rate hikes won’t do it because the rise in the interest rate would have to be extreme. For example, if the interest rate increases from 5 to 15% I will still borrow if I think I can double my money within a year. Also, it would be the real sector that would feel most of the impact because speculators are mainly interest rate inelastic as I have just shown. Also, increasing capital requirements won’t do it because banks will just move assets and liabilities of their balance sheets! Furthermore, with higher capital ratios banks must select a higher risk/return asset portfolio to meet their desired rate of return on equity.

The truth is that the market produces perverse incentives: it punished timid managers who are risk adverse and it rewards those who take high risks wit high leverage because this will raise the price of the assets being speculated on. This is a lesson well explained by Sebastian Mallaby in his best seller More Money Than God. He explains that during the dot com boom many savy hedge fund managers knew this was a bubble and did not wish to participate in it. However, they lost most of their clients to those managers who were investing in the bubble and obtaining those stellar returns. Eventually they all jump in and the next task is to find out how to “beat the gun”

Deus-DJAugust 3rd, 2012 at 2:42 am

He doesn't discredit himself, in fact it makes him one of the few that is publicly stating the truth. The only person discrediting themselves is you, for being on the wrong side of humanity and history.

JonfAugust 3rd, 2012 at 3:01 am

I am just shocked beyond belief. First someone thinks the banks are crooked and then this Wray fella should stoop to mention it. Shocking I tell ya just plain shocking. Get real people. This is your world and it is populated by Frauds. Better to not answer the phone. You may be awakened by one of them.

Benedict@LargeAugust 3rd, 2012 at 2:49 pm

The linked article is apparently behind some sort of password-access wall (MS Outlook Web App).

CalgacusAugust 4th, 2012 at 3:40 am

No, Benedict, you just have to copy the text of the link & put it into your browser. The underlying link that you get when you click on it is bad. Same problem with most of the recent links on GLF.

Or use the well-formed link below:

What is a Bank Robber?

scott goffAugust 9th, 2012 at 5:23 pm

As Faulkner's character Flem Snopes observed, "The only reason anyone would go to the trouble and expense to organize a bank and keep it runningt is to loot it."