Preparing for the Next Banking Crisis
Since we bailed out the investment banks, we've done almost everything possible to assure that we have another banking crisis and another bailout opportunity.
- The banks that were too big to fail before have gotten even bigger as weak banks were merged into their less weak brethren. TARP money was used to finance the consolidation.
- Nothing effective has been done to limit the speculation banks can do with federally insured deposits. The Barney-Frank bill is as ineffectual as you would expect it would be, since it was written by the foxes who guard the henhouse.
- Even the compensation of bailed-out bankers is still rising beyond the stratosphere. This isn't the reason why the Occupiers have to repay their student loans; but it is outrageous. During the bubble bank presidents were supposedly being compensated – like football players – for success; apparently failure demands an even higher reward. We wouldn't want to damage their self-esteem.
- The real estate price plummet has been prolonged by regulatory forbearance. Banks have not been forced to write their mortgage portfolios down to their true declining values on the assumption that home owners, unlike Donald Trump or almost any other holder of a commercial loan, will keep paying instead of just walking away even though their mortgages are underwater. That makes the banks reluctant – to say the least – to agree to reduce principal amounts on residential mortgages as they would have done rather than have a commercial loan fail. Reducing the principal forces the bank to recognize its loss. It now looks more and more like the "correct" price for real estate is closer to what it sells for today than it what it could command during the bubble. So there are more foreclosures than there would have been had banks had an incentive to be reasonable, and there are still significant unrealized losses in bank portfolios.
- The euro-contagion is sure to spread here. Our banks lend to and invest in European banks. These banks will have a hard time raising capital to compensate for the 50% haircut they've agreed to take on Greek debt. They have not marked their Italian or Spanish debt down to its real value. The willingness and capacity of Germans to bailout other country's banks is limited.
How did we get in this dilemma? Tom Friedman describes a big part of the problem:
"Our Congress today is a forum for legalized bribery. One consumer group using information from Opensecrets.org calculates that the financial services industry, including real estate, spent $2.3 billion on federal campaign contributions from 1990 to 2010, which was more than the health care, energy, defense, agriculture and transportation industries combined. Why are there 61 members on the House Committee on Financial Services? So many congressmen want to be in a position to sell votes to Wall Street."
Protecting the financial services industry is almost the only bipartisan action that's been taken lately.
Friedman has some good suggestions for avoiding the next crisis:
"1) If a bank is too big to fail, it is too big and needs to be broken up. We can't risk another trillion-dollar bailout. 2) If your bank's deposits are federally insured by U.S. taxpayers, you can't do any proprietary trading with those deposits — period. 3) Derivatives have to be traded on transparent exchanges where we can see if another A.I.G. is building up enormous risk. 4) Finally, an idea from the blogosphere: U.S. congressmen should have to dress like Nascar drivers and wear the logos of all the banks, investment banks, insurance companies and real estate firms that they're taking money from. The public needs to know."
I don't know if #3 is needed if we have #2 but I sure like #4. Probably should apply to Presidential candidates as well.
In some ways we are better prepared to play hardball with the investment banks now than we were a few years ago, if we (and our congresspeople) are ready to do so. Consumers have reduced their appetite for debt; large corporations have stopped playing the financial markets with their working capital and have plenty of cash on hand to pay expenses without new bank loans; small business is getting very little from the money center banks. We're not earning any interest to speak of on our savings. Innovative new services like PayPal or cellphone payments can be done without traditional banks.
If we are not going to break the biggest banks ups now (my first choice) then the best way to avoid another bailout crisis is to make the bailout rules clear now:
- No executive of a bailed-out bank will be paid more than the President of the US.
- Bailout is a form of bankruptcy and invalidates all promises of future payments to employees as well as recovery of payments made in contemplation of bail out.
- Bailed-out banks will promptly be broken up and their deposits distributed among much smaller competitors.
Once they know the rules, the banks may figure out how to avoid another crisis. Right now they have no incentive to do so. None of this'll happen, though, unless we implement some form of Friedman's rule 4 "U.S. congressmen should have to dress like Nascar drivers and wear the logos of all the banks, investment banks, insurance companies and real estate firms that they're taking money from".