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Bank rescues: the not so New Deal

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Friday, Mar 27, 2009

Economist Willem Buiter, who also serves as a highly engaging and polemical blogger for FT, wants to know why more bankers and board members are not being perp-walked.


It is clear that the vast majority of the large border-crossing banks are continuing to exploit every accounting trick in the book to avoid recognising the marked-to-market losses on their dodgy assets.  With most banks cursed with paper-thin equity cushions in relation to their assets, a more intense, let alone a quasi-forensic scrutiny of the balance sheet by a nosy expert paid for and acting on behalf of the government shareholder could easily precipitate a move from partial to full state ownership and thence into insolvency and an orderly restructuring or liquidation.
Too many bank insiders have exploited their monopoly of information and the control it bestows on them, to enrich themselves by robbing their shareholders blind.  There has been a spectacular failure of corporate governance.  Boards have foresaken their fiduciary duties.  Surely, even the liability insurance taken out by board members ought not to shelter those who are guilty of, at best, such willful negligence and dereliction of duty?  Where are the class actions suits by disgruntled shareholders? Where are the board members in handcuffs?
Now that there is no meat left on the shareholder drumstick, the rogue managers and employees are going after a piece of the really juicy bird - the ever-patient tax payer.  I hope they choke on it.


These are good questions, and it would seem imperative that some punishment be doled out to some deserving scapegoats at some point, if only to defuse populist anger. The fact that all the malefactors in this crisis can’t be punished shouldn’t prevent authorities from singling out a few and laying the groundwork for the “few bad apples” argument—i.e., it wasn’t that the whole system was bad; there were just a few naughty bankers who abused our trust.


Paul Krugman, in his editorial today, will have none of that—it sounds as though he wants, like Lionel Hutz, to put the system on trial. He describes securitization as a scheme to enrich financial intermediaries with no value added in terms of risk management or beneficial capital allocation:


Underlying the glamorous new world of finance was the process of securitization. Loans no longer stayed with the lender. Instead, they were sold on to others, who sliced, diced and puréed individual debts to synthesize new assets. Subprime mortgages, credit card debts, car loans — all went into the financial system’s juicer. Out the other end, supposedly, came sweet-tasting AAA investments. And financial wizards were lavishly rewarded for overseeing the process.
But the wizards were frauds, whether they knew it or not, and their magic turned out to be no more than a collection of cheap stage tricks. Above all, the key promise of securitization — that it would make the financial system more robust by spreading risk more widely — turned out to be a lie. Banks used securitization to increase their risk, not reduce it, and in the process they made the economy more, not less, vulnerable to financial disruption.
Sooner or later, things were bound to go wrong, and eventually they did. Bear Stearns failed; Lehman failed; but most of all, securitization failed.


Economist Arnold Kling concurs, adding the codicil that securitization has always been a perversion of free-market principles. “My view is that securitization of mortgages would never have emerged in a free market.  Instead, it came from our country’s industrial policy supporting housing.  Every major advance in mortgage securitization was a regulatory/accounting gimmick, encouraged or created in Washington.” The insane promotion of homeowning for its own sake has caused no end of trouble. Perhaps, as this Boston Globe thinkpiece suggests, we’re ready to move away from that ideology and stop subsidizing housing to the detriment of the rest of the economy.


Anyway, Krugman is wary of the few bad apples scenario, worrying that “the underlying vision” of the Obama administration “remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.” But that system, in his view, has proven a failure, and isn’t worth saving. What will replace it though? Is he perhaps edging closer to Steven Waldman’s idea of replacing credit administered by banks with a system of flat transfers for consumers, and investment trusts and locally targeted “narrow banks” for businesses. When mainstream discussion reaches that point, we’ll know then that we are truly verging on a new New Deal. 


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