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  • In Search of a Cure with Joseph Stiglitz

    At Project Syndicate , Joseph Stiglitz takes issue with the prevailing framing of the global economic crisis. By labeling it a financial crisis, it meant that fixing the banks was the first line of defense. While Stiglitz isn't arguing that policymakers should not have taken action to fix the financial sector, he says it was clearly not sufficient to mend a full scale economic crisis. Now, he says, policymakers need to address the very serious labor market problem, along with growing inequality and "emerging markets’ massive buildup of foreign-exchange reserves." Stiglitz: Where are we today in addressing these underlying problems? To take the last one first, those countries that built up large reserves were able to weather the economic crisis better, so the incentive to accumulate reserves is even stronger. Similarly, while bankers have regained their bonuses, workers are seeing their wages eroded and their hours diminished, further widening the income gap. Moreover, the US has not shaken off its dependence on oil. With oil prices back above $100 a barrel this summer – and still high – money is once again being transferred to the oil-exporting countries. And the structural transformation of the advanced economies, implied by the need to move labor out of traditional manufacturing branches, is occurring very slowly. Government plays a central role in financing the services that people want, like education and health care. And government-financed education and training, in particular, will be critical in restoring competitiveness in Europe and the US. But both have chosen fiscal austerity, all but ensuring that their economies’ transitions will be slow. The prescription for what ails the global economy follows directly from the diagnosis: strong government expenditures, aimed at facilitating restructuring, promoting energy conservation, and reducing inequality, and a reform of the global financial system that creates an alternative to the buildup of reserves. Read To Cure the Economy here .

  • Derivative Holding Even More Centralized than in 2008

    If you subscribe to the idea that banks holding a lot of derivatives increases exposure to risk (see WaMu, Bear Stearns), and you hoped that after the events of 2008 that such exposure might be less centralized, then you will surely be disappointed, or concerned, with this chart from Tyler Durden of ZeroHedge : Durden writes: The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively. And that's your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return. Durden goes on to say that he does not accept the notion that bilateral netting limits exposure. Read Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure; Is Morgan Stanley Sitting On An FX Derivative Time Bomb? here . Hat tip to Washington Blog at The Big Picture .

  • Breaking Down Barclays Success in Lehman Deal

    Three years ago, as we were wondering whether we were witnessing the complete meltdown of the financial services industry, Bank of America bought Merrill Lynch and Barclays took over the bankrupt Lehman Brothers. Steven Davidoff --professor at the Michael E. Moritz College of Law at The Ohio State University--looks back at those deals, and he argues Barclays won, and Bank of America did not. And the primary reason, Davidoff writes at the New York Times DealBook blog, is because Barclays was more patient: Things would have been different had Bank of America waited. It would at a minimum have paid a bargain basement price for Merrill, one that was tens of billions lower at least. There is still some talk of spinning off Merrill Lynch. The operations of Merrill have already been combined with Bank of America, so a real separation would be complicated. And the recent reorganization of the bank’s management — which puts Merrill Lynch’s wealth management business under David Darnell, the co-chief operating officer, but Bank of America-Merrill Lynch under the other chief operating officer, Tom Montag — also makes a split more difficult. Ultimately, Barclays made a better deal by doing what should be done in an acquisition, carefully assessing the future liabilities and limiting them as much as possible. But let’s be clear. Barclays did this only because it was forced to by the regulator. The first lesson of Bank of America and Merrill Lynch is that impatience and a chief executive’s hubris can lead to some very bad decisions. And regulators can sometimes stop these heady moves. Read The Merrill Lynch and Lehman Deals, 3 Years Later here .

  • Gretchen Morgensen on Fannie, Freddie, and 'Reckless Endangerment'

    Gretchen Morgensen is one business and economics reporter whose work pre-Global Economic Crisis did not appear to be caught inside the same housing bubble on which she was reporting. So we are interested in he new book, which looks at the conditions and key choices that caused the crisis. Reckless Endangerment:How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon , which Morgensen wrote with Joshua Rosner , effectively places a spotlight on the impact of Fannie Mae and Freddie Mac cozying up to politicos in Washington. Morgensen discussed that relationship recently with Charlie Rose . Here is an excerpt: Watch the full interview here . And here is Robert Reich's review of the book , from the New York Times .

  • Simon Johnson Warns of Coming Financial Crisis if Policymakers Don't Reign in 'Too Big to Fail' Banks

    Simon Johnson --Professor of Entrepreneurship and Global Economics and Management at MIT's Sloan School of Management, and former chief economist at the IMF--is not bullish on efforts by US policymakers to shore up the financial sector. In this interview with Steve Sherretta of Knowledge@Wharton , Johnson repeats some of his arguments from his book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown . In short, Johnson warns us that a new, big financial crisis is coming. But first, we are likely to see a "meta-boom."

  • Lehman CEO *** Fuld's Testimony at the FCIC

    The Financial Crisis Inquiry Commission began two days of what it is calling "Too big to fail" hearings yesterday, and the star was *** Fuld , CEO of Lehman Brothers when the firm collapsed two years ago. Fuld would not take blame, or place any blame on Lehman for the investment bank's failures, telling the commission that " Lehman’s demise was caused by uncontrollable market forces and the incorrect perception and accompanying rumors that Lehman did not have sufficient capital to support its investments." And he pointed a finger at the Fed: In retrospect, one can now see that as 2007 progressed, the weakening in the U.S. housing market was worse than predicted and spread to other sectors of the financial system. Those adverse market conditions accelerated in March 2008 after Bear Stearns nearly failed. I believed then, and still do now, that had the Fed opened the financing window to investment banks just before the Bear Stearns problem, that decision might have provided the necessary liquidity to keep Bear Stearns operational and, more importantly, might have lessened the need for additional government intervention. Still, having acted, the intervention of the federal government set a precedent in the marketplace that impacted liquidity, capital formation and the expectations of creditors and stockholders for at least the next six months. At the same time, the federal government and the individual regulators involved were criticized for using taxpayers’ money to rescue a financial company, which then set another precedent of how “not” to handle the next problem. With Bear Stearns gone, L ehman, as the next smallest investment bank, became the focus of the marketplace and was subject to increasingly negative and inaccurate market rumors. Jacob Goldstein of NPR's Planet Money did a word count and found that out of the 1680 words in Fuld's opening testimony, " Fuld devotes exactly 15 words to what Lehman did wrong. " Ben Bernanke and FDIC Chair Sheila Bair testify before the FCIC today. You can find transcripts of all of yesterday's testimony here , and watch a video of the hearing here .

  • Raghuram Rajan on 'Fault Lines' and Systemic Risk

    In his new book, Fault Lines: How Hidden Fractures Still Threaten the World Economy , University of Chicago economist Raghuram G. Rajan lays out the structural flaws in the US financial sector and government policy that put the nation in danger of economic meltdown. He does not reject the notion that the behavior of bankers was a significant component, but he argues that there were systemic risks, or "fault lines," and that those risks still exist, as he writes in the introduction to the book: Although I believe that the basic ideas of the freeenterprise system are sound, the fault lines that precipitated this crisis are indeed systemic. They stem from more than just specific personalities or institutions. A much wider cast of characters shares responsibility for the crisis: it includes domestic politicians, foreign governments, economists like me, and people like you. Furthermore, what enveloped all of us was not some sort of collective hysteria or mania. Somewhat frighteningly, each one of us did what was sensible given the incentives we faced. Despite mounting evidence that things were going wrong, all of us clung to the hope that things would work out fine, for our interests lay in that outcome. Collectively, however, our actions took the world’s economy to the brink of disaster, and they could do so again unless we recognize what went wrong and take the steps needed to correct it. Rajan spoke recently at the Carnegie Council . In this excerpt, he discusses regulatory reform and dealing with the 'too big to fail' problem: Watch the full speech here . And read the introduction to Fault Lines here .

  • Simon Johnson Argues For Shrinking 'Too Big To Fail' Banks

    Simon Johnson--Professor of economics at MIT , a member of the Panel of Economic Advisers for the Congressional Budget Office , former chief economist for the IMF --and his co-conspirator at Baseline Scenario , James Kwak --formerly a McKinsey consultant and now a student at Yale Law School--came out with a new book this spring. 13 Bankers follows a theme that Johnson has been pushing for the last few years: the danger of concentrated financial power. He spoke about the book, and his argument that the 'too big to fail' banks need to be harnessed before financial crisis hits yet again, in this Thoughtcast interview: Simon Johnson Defies 13 Bankers "Too Big to Fail" from thoughtcast on Vimeo . For more on 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown , including an excerpt, click here .

  • Volcker: Government Needs Regulatory Power to 'Euthanize' Toxic Financial Institutions

    Former Fed Chair Paul Volcker told Newsweek and CNN's Fareed Zakaria that the country needs financial regulatory reform so that the government can step in and euthanize ("not save them") financial institutions that are a danger to the overall system. Volcker also discussed how he fought inflation as Fed chair, and what might be done now to fight it. Watch him in the first part of Zakaria's GPS Podcast:

  • Andrew Ross Sorkin on Lehman's Fuld, and 'Too Big to Fail'

    New York Times writer Andrew Ross Sorkin 's Too Big to Fail: Wall Street's Near-Death Experience is t he too-important-to-ignore book of the moment. The details about Hank Paulson's interactions with executives from his old firm, Goldman Sachs, when he was Secretary of the Treasury are getting a lot of attention ( from Felix Salmon, for example ). And Sorkin's detailed account of the government's efforts to broker a deal to merge Goldman Sachs and Wachovia after Lehman Brothers failed last September is another highlight (you can read an excerpt of the book that covers this at Vanity Fair ). Sorkin spoke about these and other hot topics from the book with Charlie Ros e. Here's an excerpt in which Sorkin talks about former Lehman CEO Richard Fuld: Watch the full interview here .

  • Stiglitz on International Monetary and Financial System Reform and the Too Big To Fail Problem

    Joseph E. Stiglitz , Bert Koenders , and Jose Antonio Ocampo discussed possible reform of the international monetary and financial system at the Carnegie Council on September 30. Stiglitz chaired the UN Commission of Experts on Reforms of the International Monetary and Financial System, and he told the audience that the multi-national commission's findings "provide a deeper analysis of the causes of the crisis and a long-term agenda of what to do about it than, for instance, what has come out of the G-20 communiqués and reports." One of the commission's concerns over the response to the global economic crisis, in the United States in particular, is consolidation in the banking sector. As Stiglitz said at the Carnegie Council: The problem of too-big-to-fail banks has become much worse since the beginning of the crisis. While we're making some strides in trying to improve things, we've made some things much worse. It's worse because we have bigger banks, more concentration, but also because we've increased the moral hazard problem. We've introduced in many countries around the world a new concept that never had any role in economics before: banks that are too big to be financially resolved, where you protect the bondholders and shareholders as well as the institution and the depositors. Here is an excerpt from the panel discussion: To watch the full session, click here . And you can read the Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System here .

  • Larry Summers on the Importance of Failure in the Financial System

    Larry Summers , Harvard economist and the Director of the White House's National Economic Council, spoke earlier this month at Georgetown University, and he said our financial system will not be fixed until we move past the idea that there are institutions that are "too big to fail." "Market discipline," Summers said, can't be achieved "without the prospect of failure." Watch an excerpt of the speech below. The full speech is available from Fora.tv here .

  • Cleveland Fed Proposal for Regulating 'Systemically Important Financial Institutions'

    A group of researchers at the Cleveland Fed have a new idea for how to deal with the so-called "too big to fail" institutions. In language more suited to a Fed researcher, James Thomson --Vice President and Financial Economist at the Cleveland Fed--calls them " Systemically Important Financial Institutions ," and he writes in a paper that the first step is better defining these institutions: The purpose of creating a practical definition of systemic importance is to enable supervisors to discipline systemically important financial institutions. Understanding the nature and causes of systemic importance is the foundation for creating regulations, supervisory policies, and infrastructure that will rein in the associated systemic risk; in some cases, doing so sufficiently mitigates an institution’s potential systemic impact so that it would no longer be considered systemically important. Because any two firms could be deemed systemically important for unrelated reasons, a one-size-fits-all designation such as “too big to fail” is inadequate. Consequently, the approach taken here is to propose a means of classifying systemically important financial institutions (SIFIs). And the economists at the Cleveland Fed tout a three-tiered approach to regulating SIFIs. You can more about the approach here , and watch this helpful Drawing Board video: (Hat tip to Caitlyn Kenney at Planet Money)

  • FDIC's Bair: End the 'Too Big to Fail' Presumption

    Results from the Treasury Department's stress tests are coming in, so the banking community is on its toes waiting to hear which banks are safe. And over the weekend the Federal Deposit Insurance Corporation closed four banks. FDIC chair Sheila Bair says there are more bank closings ahead, but not to worry, the FDIC has ample resources to handle the additional failures. So while she is not stressed about the results of the tests, she does want the resolution authority of the FDIC broadened so the agency has authority over an entire banking organization rather than just depositor institutions. Here is what she told The Economic Club of New York in a speech yesterday: The lack of an effective resolution mechanism for large financial organizations is driving many of our policy choices. It has contributed to unprecedented government intervention into private companies. It has fed the "too big to fail" presumption, which has eroded market discipline for those who invest and lend to very large institutions. And this intervention, in turn, has given rise to public cynicism about the system and anger directed at the government and financial market participants. We need a new resolution regime for these large institutions, which does a better job of imposing loss on investors and creditors, instead of leaving it in the hands of government and the laps of the taxpayer. To be sure, creating such a resolution mechanism would be very bold. But recent history –I believe-- has shown that it is a very necessary step. Bair also spoke to CNBC's Trish Reagan yesterday. Reagan asked about the FDIC's capacity to handle the failure of the big banks. Bair said losses on large banks are actually smaller. For example, she tells Reagan that the FDIC had zero losses off of the failure of Washington Mutual (WaMu) last year. And she further explains her contention that it is time to drop the "too big to fail" myth: You can read a transcript of Bair's speech before The Economic Club of NY here .