Too big to bail? the new financial bubble

When the French Bourbon monarchs were restored to power after the defeat of Napoleon, it was said that they had learned nothing and forgotten nothing.  The same is true of the half dozen biggest U.S. banks after the financial crisis.  They are busy doing the same things that led to the crisis in the first place.

Blogger Michael Snyder quoted the following figures from the most recent report of the Office of the Comptroller of the Currency.  The figures show the big banks’ investments in derivatives, which are investments not backed by any asset—in short, they are not investments at all, but gamblers’ bets on the future direction of the economy.  If the banks bet wrong, they crash, and if they crash, they bring down a large part of the U.S. economy with them.

JPMorgan Chase

Total Assets: $1,948,150,000,000 (just over 1.9 trillion dollars)

Total Exposure To Derivatives: $70,287,894,000,000 (more than 70 trillion dollars)

Citibank

Total Assets: $1,306,258,000,000 (a bit more than 1.3 trillion dollars)

Total Exposure To Derivatives: $58,471,038,000,000 (more than 58 trillion dollars)

Bank Of America

Total Assets: $1,458,091,000,000 (a bit more than 1.4 trillion dollars)

Total Exposure To Derivatives: $44,543,003,000,000 (more than 44 trillion dollars)

Goldman Sachs

Total Assets: $113,743,000,000 (a bit more than 113 billion dollars – yes, you read that correctly)

Total Exposure To Derivatives: $42,251,600,000,000 (more than 42 trillion dollars)

That means that the total exposure that Goldman Sachs has to derivatives contracts is more than 371 times greater than their total assets.

via Michael Snyder.

The six largest banks control two-thirds of U.S. financial assets.  The five largest originate 42 percent of loans in the United States.  The four largest employ a combined 1 million people.  If these banks fail, it is not just their executives who will suffer (actually, the executives won’t suffer at all).

The Federal Reserve Board is trying to keep the economy afloat by keeping the big banks afloat, through its policy of Quantitative Easing.  It issues money to buy up the big banks’ bad investments prior to the previous crash, but without doing anything to stop them from setting up the same conditions again.

How much better it would have been to finance the rebuilding of crumbling bridges and dams, water and sewerage systems and other public works!

The economic scene: Links & comments 9/24/13

Add It Up: The Average American Family Pays $6,000 a Year in Subsidies to Big Business by Paul Buchheit for Common Dreams.  (Hat tip to Mike Connelly)

Paul Buchheit calculates that the average American family pays extra taxes amounting to $1,270 a year in extra taxes to offset corporate tax havens, $870 to offset special corporate tax benefits, another $870 to pay for in direct corporate subsidies and grants,  $696 to offset state and local government business “incentives” and $722 to offset subsidized interest rates in loans to Wall Street Banks.  The average family also pays $1,268 a year extra for monopoly-priced drugs, compared to what foreigners pay in a free market, and $350 a year in unnecessary frees for tax-advantaged retirement plans.  None of this would exist in a well-functioning free-market economy.

China’s Ultimate Debt Holders—Not the Borrowers by Sara Hsu for Triple Crisis.  Cross-posted to naked capitalism.

A recession looms in the Chinese economy, which means many of the loans by Chinese banks won’t be paid back.  Economics professor Sara Hsu writes that they are securitizing the loans (selling them like stocks or bonds) with the Chinese government as buyer of last resort.  This is a familiar pattern of rescuing the “too big to fail” banks while abandoning the “too small to save” debtors and unemployed workers.

Unfair Share: How Oil and Gas Drillers Avoid Paying Royalties by Abrahm Lustgarten for ProPublica.

Unethical oil and gas drillers have many techniques for avoiding payments to landowners.   Often they make deductions from royalties for unexplained or bogus expenses.  Oil and gas leases are frequently bought and sold, and sometimes the landowner doesn’t even know whom to contact for payment.

Obama’s Friends in Low Places by Robert Scheer for Common Dreams.

Why pharma’s patents are a drug on the market by Dean Baker for The Guardian.

That seems wrong to me, too

Hat tip to jobsanger.

What I’d do about Wall Street

The original title of this post was “What I’d do about the banks”.

What to do about the “too big to fail” banks is obvious.  There are many good ideas in circulation (none of them original with me).  The only problem is accomplishing anything through the current dysfunctional U.S. political system.

The most obvious and important thing to do is to break up the “too big to fail” banks.  As even Alan Greenspan has said, if a bank is “too big to fail,” it is too big to exist.  Since the banking crisis, the biggest banks have become bigger than ever, and have resumed the practices that caused them to fail in the first place.  As some point, they will become too big to save.

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Simon Johnson, former chief economist for the International Monetary Fund, and co-author James Kwak proposed in their 2010 book, 13 Bankers: the Wall Street Takeover and the Next Financial Meltdown,  that any bank be broken up if its assets are more than 4 percent of the current U.S. Gross Domestic Product or if the bank itself is more than 2 percent of GDP.   The exact percentage is unimportant.  What is important is that it be enacted into law, and not left to the discretion of regulators.  We learned from the 2008 crisis that regulators can’t be trusted to act in the public interest.

Their size limits would have applied to just six banks – Bank of America (16% of GDP), JP Morgan Chase (14%), Citigroup (13%), Wells Fargo (9%), Goldman Sachs (6%) and Morgan Stanley (5%).  Breaking up the banks would not affect their profitability.  When Standard Oil was broken up, its component parts – Exxon, Mobil, Sohio, Standard of California – did just fine.

If the banks threaten to pull up stakes and relocate to some financial haven such as the Cayman Islands, the answer would be: Let the Cayman Islands bail you out when you get into trouble.

The federal government should also:

• Set up an orderly procedure for reorganizing bankrupt banks, as was done with savings and loan associations during the S&L crisis.  During the S&L reorganizations, the failed management was fired, the depositors were held harmless, the failed investments were liquidated and the good assets were sold to soundly-managed S&Ls.  The solvent S&Ls got bargains, but that’s okay.  They were being rewarded for good management.
• Prosecute financial fraud.
• Give regulatory agencies, including the new Consumer Financial Protection Board, the resources to do their jobs, and head them by people not beholden to the financial industry.
• Reenact the Glass-Steagall Act, which separates commercial and investment banking.
• Impose a stock transaction tax of some small amount, say 1/10th of 1 percent.  Individual traders and computerized trading programs destabilize the market by trading huge amounts of stocks and commodities several times a day.  A small transaction tax would not be noticed by regular investors, but would slow down speculative trading.

As an individual, you can shift your money to a non-profit credit union or savings and loan association if you have money in one of the “too big to fail” banks, or if you think your bank is abusing you.  I do not say all for-profit banks are bad.  Many of them perform their function, which is to provide a safe haven for savings, loans for businesses and credit for consumers.  But so long as the “too big to fail” banks are saved from the consequences of reckless and exploitative actions, the prudent and ethical bankers will be crowded out.

Bailouts and the risk premium

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Interest on some kinds of bonds is higher than on others.  That is because of the “risk premium.”  The higher the risk that the borrower will default, the higher the interest rate the lender will charge.  That is why high-yield bonds are called “junk bonds.”  High interest rates on certain corporate bonds offset the risk that the company that issued the bonds goes bankrupt.  High interest rates on certain government bonds offset the risk that the government defaults.

But the policy of the Federal Reserve Bank and the U.S. Treasury Department is that bondholders should be protected from risk, no matter what the cost to the public.  This goes against the principle of a free enterprise system, which is to reward success and punish failure.

These thoughts came to mind when I read a New York Times interview with Sheila Bair, outgoing chair of the Federal Deposit Insurance Corp., an Eisenhower-type Republican who found herself in the minority when she opposed the “too big to fail” mentality so prevalent in the government.  Here are some key paragraphs from the article.

Wall Street is bigger than the real economy

The great economist John Maynard Keynes once said:

Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

via John Maynard Keynes.

The chart shows how the volume of business done on Wall Street vastly exceeds the volume of business done in the real economy.  It is as if a public library had 43 book catalogs for every actual book, and spent more time and attention keeping track of the catalogs than the books.

A well-functioning stock market and a financial services industry are necessary to the functioning of a democratic capitalist economy.  Their job, as somebody once said, is to turn savings into capital.  The financial markets are supposed to provide the means by which existing wealth can be invested to generate new wealth for society.  Even speculators provide a useful service in smoothing out the fluctuations between gluts and shortages, provided they don’t become so big and powerful that they are able to corner the market.

What the chart shows is that the financial markets have become largely disconnected from the real economy.  Instead of putting the savings of individuals and institutions to work in helping business to grow, financiers – many of them – make these savings the chips in a high-stakes poker game among themselves.  There is nothing wrong with high-stakes poker, provided you gamble with your own money. When you gamble with the public’s money, you create the Too Big to Fail Problem – which, if things go on as they are – will become the Too Big to Save Problem.

It will be hard to dial things back so that Wall Street becomes the servant instead of the master of the real economy.  One frequent suggestion is to set a small tax on transactions – say 1/10th of a cent on every dollar traded.  This would be no burden on real investors, but would slow down the gamblers and predators who trade many times a day.  Opposition to this is so strong on Wall Street it is unlikely to pass anytime soon.

Click on Too Big to Fail? for a fuller explanation by Steve Roth, the chart’s creator, crossposted to the Asymptosis and Angry Bear web logs.

Democrats vs. Republicans

The Democrats are no longer the party of wage-earners, and the Republicans are no longer the party of the property-owning middle class.  The two parties divide over cultural issues such as abortion rights, gay rights and so on, but both defer to Wall Street and entrenched wealth.

If I am wrong about this, one party or the other or both will get behind legislation to bring the banking system back under reasonable regulation and break up the Too Big to Fail institutions.