An interesting observation was made today by the pollster for Martha Coakley, the hapless Democratic candidate for the Massachusetts senate seat held almost forever by Ted Kennedy. It appears polls are showing that the voters, especially independents who would normally vote Democratic in a liberal blue state like Massachusetts, have instead run to support the Republican candidate as the agent of change. Wasn’t that supposed to be Barack Obama’s signature tune?
Massachusetts voters have given up on President Obama as an agent for anything but the status quo, and this is most evident in his willingness to dole out trillions of dollars in direct and indirect support to the banks. The Massachusetts polls show this issue to be foremost on the minds of the voters.
The White House was getting this message way too late to do any good. President Obama was in Massachusetts only in the last few days, trying to work his magic with crowds to revitalize a dying effort. He also announced last week a proposal to tax the banks on their profits, hoping to generate $90 billion dollars this decade in partial payment to the taxpayers for their bailout of the banking system. He promised that one way or another, the banks would pay back every dime of the money lent to them.
It is not clear that his oratory is working or that the public is listening to him; his actions this past year have been completely at variance with his rhetoric. He is, in fact, almost as completely addled as the bank executive cronies he appears to court and coddle. This past week also saw testimony from some of the top executives in the banking industry, including Lloyd Blankfein of Goldman Sachs, Jamie Dimon of JP Morgan Chase, and John Mack of Morgan Stanley. They were all very skilled at accepting regret for what happened without accepting responsibility.
It was clear, though, that not one of them expected to change their way of business to any great degree. They acted almost as if it were their God-given right to be Too Big To Fail, and to have unlimited access to the taxpayers’ wallets when they wanted and needed it. The most astounding revelation came from Jamie Dimon of JP Morgan Chase, who said no one in his bank even contemplated the possibility that housing values might go down.
Were he to say otherwise might expose the bank to all sorts of lawsuits. Still, taking him at his word, we have to accept that none of the top executives at Jamie Dimon’s bank foresaw a housing crash or even a bubble in the making. These are men making millions of dollars a year, and they couldn’t see the housing bubble of the century in front of their eyes? If Jamie Dimon had a soupçon of personal honor he would have already resigned over this failure, and fired all his top management to boot. We are left to conclude that bankers are as much bereft of personal honor as they are lacking in a sense of personal responsibility for their failures.
These are the people Barack Obama has chosen to cozen up to in a vainglorious attempt to revive the economy. We have come to the point of no return for this administration – either it charts a drastically different course when it comes to dealing with the financial industry, or it carries on siding with clueless, inept, and in many cases immoral bankers. Maybe the electoral situation will force President Obama to see the light, but if so, he is going to have to take dramatically different action to do anything serious about reforming the banking industry. Many of the ideas afoot, like a tax on banking profits or a consumer regulatory watchdog, are helpful but don’t constitute real reform. Here, then, is an insider’s view of what really is necessary.
Fire Timothy Geithner and Larry Summers, and replaced them with people who are not integrally connected to the industry, particularly to Goldman Sachs. Withdraw the nomination of Ben Bernanke as Chairman of the Federal Reserve before it is too late. If possible, replace him with Paul Volcker or someone equally disgusted with the performance and attitudes of banking executives. Fire John Dugan as Comptroller of the Currency. He has been captured by the big banks from the get-go and needs to be replaced by someone who is not afraid to stand up to the industry.
Submit to Congress a bill to repeal last year’s instructions to the FASB to modify mark to market practices. The light of day needs to be shed on what the banks own in the way of mortgage backed securities and related derivatives, and public prices need to be applied to these assets. Instruct the GAO to conduct a complete audit of the Fed, not just the limited audit of the AIG transaction that Bernanke has approved.
A tax on bank profits is well and good, but does not get to the source of the problem behind aggressive risk taking and obscene bonuses. The real problem is with bank expectations on their return on equity. Banks, especially the top 10 largest in the US, have ratcheted up their ROE targets year by year, so that now they are at least expected to be 15% p.a. or higher. These high targets lead to abuse of leverage, lax accounting, misleading products, and ultimately Ponzi finance, in which higher volumes and greater risk are needed every year to keep the ROE scheme going. To control this, bank regulators need to go straight to the heart of the system within banks that mandates these excessive ROE targets – the hurdle rate of return for transactions. This should be mandated to be no larger than 10% return on assigned capital. Deals which generate a return greater than 20% on assigned capital should no longer be welcomed with glee, but looked at suspiciously for the undue risks involved.
Bankers love to say that if they don’t reward their best talent with fantastic bonuses, these people will leave for greener pastures. What this really means is that these people will leave for the hedge fund or leveraged buyout industries, and to a lesser extent the mutual fund industry, all of which pay extremely well. These reason these industries have thrived has been their access to cheap and unlimited credit that allows them to leverage anywhere from 2:1 up to 30:1 for some hedge funds. Without this leverage high ROEs are not possible, and therefore neither are high bonuses. There is no demonstrable economic benefit from hedge fund or leverage buyout practices, therefore the access to capital for these industries needs to be significantly constrained. Regulators need to go to the source of this capital – the banking industry – and an ideal starting point would be to cap loans to these industries going forward at the levels set in 2009.
Financial activities which constitute extraction of equity need to be outlawed. There are a number of examples of this, but two obvious examples include any home equity loan where the borrower is taking cash out from their property not directly related to the purpose of the borrowing or to be used to pay points or fees to the lender; and second leveraged buyout activity where the target is used as collateral for the buyout loan or where the buyer takes dividends out of the target’s retained earnings or pension plan.
Get Eric Holder and the Justice Department to work on the many cases of fraud and securities or tax law violations that have piled up in recent years and are now getting stale. The mortgage industry is an obvious source of indictments, but don’t be afraid to look at all the top banking industry executives who ignored warnings from the federal government as early as 2004 that no-documentation loans were rife with fraud (as was the appraisal process). These executives, including CEOs, should have seen these warnings, yet they continued to issue securities to investors without alerting them to the potential problems with the underlying mortgages behind the securities. This is securities fraud, or at the very least negligence of the highest order.
Work closely with all the major international banking regulators and their governments to insure consistent standards on financial reform and tax policies. Regulators should not be allowed to game the system and deliberately put in place lax standards to attract banking business from other countries. This means you, Switzerland!
Prepare the federal government internally, and especially the FDIC, for the possible bankruptcy and collapse of any or all of the big banks, including Citigroup, Bank of America, JP Morgan Chase, and Wells Fargo
. Have a well-thought-out emergency plan in place for such a contingency, especially for the FDIC to act as receiver-in-possession and guarantor of all qualifying deposits. Then, announce as clearly and forcibly as you can that Too Big To Fail is officially dead, and then henceforth any financial institution
which gets into trouble will receive no bailout from the government but will instead be thrown into bankruptcy.
The important aspect of this eight point program is that all of these actions can be taken here and now. The Obama administration doesn’t need to wait for regulatory reform to work its way through years of legislation and court tests. All it needs is the right leadership in the regulatory bodies, and the right prodding from the administration.
Which means all it needs is for Barack Obama to decide that the financial industry is not his friend, is not doing anything to help revive the economy, and is in desperate need of reform that gets to the very root of its practices.