Our financial system is not the same as “our” big financial institutions
I’ve just listened to NPR’s recent interview of Timothy Geithner. Adam Davidson did a great job of trying to get answers from Mr. Geithner. I felt sorry, at a personal level, for our Treasury Secretary, a very smart man imprisoned in a series of talking points, desperately afraid of the consequences of holding an honest conversation.
As an aside, we’ve come to take it for granted that policymakers ought to be circumspect for fear of provoking traumatic moves in the markets. But isn’t that dumb? Markets are supposed to be about aggregating and revealing information. In what sense is it “more responsible” to hide information or ideas so that markets do not move on them? And if markets do misbehave so wildly that public officials can no longer afford to be candid because of market consequences, does that suggest an incompatibility between the kind of financial markets we have and open democracy?
Anyway. Taking for granted the constraints of the interview, what struck me most was Geithner’s repeated conflation of our “financial system” and our “institutions”. Mr. Geither’s unspoken assumption is the fixing our financial system implies ensuring that incumbent troubled financial institutions are “strong”. But that’s not right. Our financial system is composed, in part, of financial institutions, but it is supposed to be larger and more robust than any specific firm. Three years ago, Mr. Geithner would have readily conceded that financial institutions are supposed to come and go, rise and fall, succeed and fail as a matter of market discipline, and that our system is made stronger by that flow of creation and destruction than it would be if some state-manged cadre of crucial banks were at its core. Of course, we all knew three years ago that some institutions had become “too big/complex/interlinked to fail”, but we viewed that as unfortunate, and would have foreseen that if any of those banks got badly into trouble, the goverment would be forced to intervene and resolve the bank at some taxpayer cost, as it had in the case of earlier TBTF banks. Three years ago, no one would have suggested that the strength of our financial system and the strength of Citibank are inseparable.
We should not let this verbal slip go unchecked. The idea that certain large, politically connected private firms are essential to commonweal and must be supported at all costs by the state is quite the essence of “Mussolini-style Corporatism“. Fixing our financial system is not the same as rescuing any one or several financial institutions. Household names can, do and should come and go in a capitalist economy, and it’s pretty clear that quite a few familiar financials have failed the market test. What’s good for Citibank is not what’s good for America.
Did you catch this bit from Warren Buffett’s letter?
Funders that have access to any sort of government guarantee – banks with FDIC-insured deposits, large entities with commercial paper now backed by the Federal Reserve, and others who are using imaginative methods (or lobbying skills) to come under the government’s umbrella – have money costs that are minimal. Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to Treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower but often scarce for others, no matter how creditworthy they may be.
This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with a favored status. Government is determining the “haves” and “have-nots.” That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.
Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.
“Lemon socialism” has costs beyond the direct cost to taxpayers of socializing losses. It prevents assets from being shifted from inefficient to efficient firms, and penalizes healthy, well-managed companies by forcing them to compete against subsidized competitors. I don’t see how preventing healthy good banks from harvesting the organs of our megabanks “strengthens our financial system”.
I think it’s time to move beyond the nationalization/preprivatization debate and start talking about how to replace rather than reorganize failing firms. That doesn’t mean that we would shutter all of Citi’s branches. It implies having troubled banks continue to operate in a kind of run-off mode (something like Arnold Kling’s #2) while the government backstops some obligations and seeks buyers for the bank’s assets, operating as well as financial. In other words, it’s time to move beyond nationalization and talk about state-managed liquidation. I look forward to an America with a strong financial system. I think that’s more likely in a world where Citi’s logo goes all retro chic like Pan Am. Frankly, I think that’s all the (non-negative) “franchise value” that’s left in Citi, and several of its peers.
SW:
Kill Citigroup. Now! I think Geithner always favored protecting megabanks like Citigroup. Isn’t Geithner Robert Rubin’s “boy”? I have long said things like Buffett about federal subsidies to banks. Absent these subsidies, which might be 6% a year in interest, Citigroup would fail!
March 1st, 2009 at 5:51 pm PST
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Steve – Geithner, even though he’s at Treasury now, does seem to support Griffin’s assertion in “The Creature From Jekyll Island” that the Fed was created by the big banks for the big banks, at the expense of the rest of us.
The system is clearly bankrupt in more ways than one. Unfortunately, all indications are that the Fed will make things worse until it simply no longer can, with the much bigger disaster that implies.
Still, considering the consequences, I think yelling from the top of our lungs is important, however unlikely to bring about change in and of itself.
Thank you for your steady, highly articulate voice and the thorough case you make.
March 1st, 2009 at 6:09 pm PST
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The problem is that the forced mergers of the past year (and conversions to BHCs) have only served to increase the concentration and interconnectednes of the financial services industry. We are steadily moving in the wrong direction. It’s going to be very difficult to de-concentrate the industry now.
On a related note, anyone else see the news today that AIG is looking to sell an ownership stake in some of its insurance subs to the Fed and is also looking to securitize life insurance policies and sell them to the Fed? Speaking of directionally incorrect…….
March 1st, 2009 at 8:51 pm PST
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RTD – yes, and in addition to being directionally incorrect, the Fed/Treasury may very well already own most of those assets via their 80% stake. If they are indeed double counting, would that be considered fraud? Does RICO apply? Who makes the laws anyway? Oh, wait.
March 1st, 2009 at 10:56 pm PST
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The real problem with salvaging the financial system is the fact that our understanding of complex inter-organizational structure is founded on the assumptions of network analysis and neo-institutionalism.
The first is highly mathematized though generally suggests that emergent phenomena (how you describe the system versus the collection of institutions) are empirically very difficult to grasp. Of those who deal with markets explicitly, Harrison White and his followers show that corporations track the behavior of others in their market niche – not so important right now, but it implicitly assumes that institutions themselves are important.
The second is fundamentally about the cognitive capture created by organizational practice. Thus institutions are important because they attenuate individuals’ actions in particular ways.
Ironically, while both approaches treat institutional behavior as fundamental to emergent market behavior, both also suggest that Geithner et al. have completely misunderstood their insights. If they wanted to do it right they would pick a few example banks which are doing what they want other banks to do in the future, then say “We are backing these banks and others’ who adopt their model” and let everyone else sink. Organizations can only adapt to a certain extent, so those that cannot make themselves fit the mold will fail. Chop ’em up and dole the deposits out and let’s get on with this…
March 2nd, 2009 at 5:18 am PST
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OK, what is the financial system?
Being candid, the Summers-Geithner-Obama rhetoric of the day is stated for the public as ” we must preserve the PRIVATE banking system in this country”.
What they are really saying is “We MUST preserve the DEBT-MONEY system of the private federal reserve bankers in this country.
That’s ALL they really care about.
The debt-money system of the private federal reserve bankers.
I know Steve’s readership may think it banal that I quote Abe Lincoln here:
“” The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government’s greatest creative opportunity. “”
But maybe a few can be open to the notion of the Chicago school economists who drafted The Chicago Plan for Monetary Reform for FDR.
A Money System based on debt-free, government-issue.
A PRIVATE banking system based on Simons’, Fisher’s and Friedman’s 100 percent reserve lending program where bankers lend real money.
The Volcker Group defined the global financial problems we are facing quite simply: “we cannot make our debt-service payments”.
The Debt money system is broke.
Steve seems to correctly want to differentiate between what he calls the financial system, which I call the money system, and what he calls the financial institutions, which I call the banking system.
We need to reform both systems.
A new debt-free money system.
And, again as Volcker said, the banks need to get back to banking.
Respectfully.
March 2nd, 2009 at 11:11 am PST
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Good that Warren is finally in the same boat with me – I would love a subsidy to my mortgage as a reward for playing by the rules all these years. Instead I have been funding these bozos. Now Buffett can join the club.
The net effect of these “bailouts” is to provide these institutions with the power to restructure our currency and hence our country and the world. All that free money is firepower and the boys in charge will demonstrate that they really aren’t as stupid as everyone thinks they are once they play their hand.
March 2nd, 2009 at 2:21 pm PST
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That might be true for Citi or AIG, but here’s Ken Lewis last week:
“KEN LEWIS:
02:58:00:00 Well, the– the– the downsize is that you– downside is that you don’t– that you don’t win. And so, you’ve got a company that may be bankrupt that you’ve got to take. Or that you get sued for a jillion (PH) dollars and– and so that’s– they just thought the downside was so severe that– and– and the– the hit to the system, in us not doing it– and then– and then the interrelationship between– you know, what’s good for America’s also good for Bank of America. ‘Cause we’re so intertwined that it just made sense.”
Are you saying that he’s deluded?
March 2nd, 2009 at 2:30 pm PST
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My very favorite of your entries so far.
March 2nd, 2009 at 3:20 pm PST
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As a practical matter, putting C into receivership would have approximately the same effects on the banking system as the BK of Lehman. Further systemic paralysis. And it’s all because of the web of off balance sheet CDSs that banks and insurance companies sold thinking they were free money. Now these financial neutron bombs have turned many–not all–big banks into zombies. Left in place as zombies, the big banks will crumple as the oncoming waves of rate reset driven CDO defaults cause the CDS provisions to become payable.
The first step toward unlocking the banking system will be to put daylight on CDS contracts–all of them, in a searchable public database. Then watch the market action! We’d find out pretty quickly who’s BK and who isn’t.
The stress tests don’t touch any of this, and are pure cunctation.
March 2nd, 2009 at 5:21 pm PST
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Steve, what do you think about “The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?” by Timothy J. Kehoe &
Gonzalo Fernandez de Cordoba
The irony of Geithner vs Mellon: 2 tax cheats each born in the wrong era. Mellon’s liquidation is needed now(over-consumption economy) and Hi-fi bailout was needed in 1930(over-production economy)
March 2nd, 2009 at 9:24 pm PST
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Wonderful post.
Credit markets rule the world. Always have. We are witnessing the transfer of power and wealth from West to East. Jared Diamond pointed this out already.
Our only real hope in maintaining relevance is to re-invent our economy and its financial intermediaries. Obama, I think, instinctively knows this, but his academic background constrains him.
March 3rd, 2009 at 8:17 am PST
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Wal-Mart Can Do Us Good Taking on Bank of America: David Reilly
His idea? Let Walmart be the new gigantic bank, instead of trying to keep Citi, BoA et al alive.
Why do banks need to be gigantic? Sure, I understand the supposed advantages to their shareholders, but what’s the advantage for ‘the financial system’? Aren’t investments liable to be sounder if you have to persuade twenty prudent bankers of their soundness, not just one?
Has anyone ever heard a plausible explanation of why all of the small community banks and credit unions that are still in reasonably good shape couldn’t efficiently distribute the credit our economy needs to keep functioning (as opposed to the credit the financial services branch needs to blow itself up into a bubble as big as one quarter of all US corporate profits)?
Other plausible models: Canada’s banking system, with heavy state direction and regulation, which has suffered far less damage than the banking systems of most other countries.
The state bank of Nebraska, a state which is apparently surviving the downturn much better than most other states.
Given that the current giant financial institutions have obviously done a perfectly horrible job of allocating capital, I just can’t understand why so many people find it plausible that keeping them in operation is crucial to helping the economy recover.
March 13th, 2009 at 1:49 am PDT
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