For those following financial regulatory reform debates, Paul Volcker’s NYT op-ed today is must-reading (NYT Op Ed, Paul Volcker, How to reform our financial system, January 31, 2010) (Thanks to Paul for pointing out misspelling.)
The specific points at issue are ownership or sponsorship of hedge funds and private equity funds, and proprietary trading — that is, placing bank capital at risk in the search of speculative profit rather than in response to customer needs. Those activities are actively engaged in by only a handful of American mega-commercial banks, perhaps four or five. Only 25 or 30 may be significant internationally.
Apart from the risks inherent in these activities, they also present virtually insolvable conflicts of interest with customer relationships, conflicts that simply cannot be escaped by an elaboration of so-called Chinese walls between different divisions of an institution. The further point is that the three activities at issue — which in themselves are legitimate and useful parts of our capital markets — are in no way dependent on commercial banks’ ownership. These days there are literally thousands of independent hedge funds and equity funds of widely varying size perfectly capable of maintaining innovative competitive markets. Individually, such independent capital market institutions, typically financed privately, are heavily dependent like other businesses upon commercial bank services, including in their case prime brokerage. Commercial bank ownership only tilts a “level playing field” without clear value added.
Very few of those capital market institutions, both because of their typically more limited size and more stable sources of finance, could present a credible claim to be “too big” or “too interconnected” to fail. In fact, sizable numbers of such institutions fail or voluntarily cease business in troubled times with no adverse consequences for the viability of markets.
What we do need is protection against the outliers. There are a limited number of investment banks (or perhaps insurance companies or other firms) the failure of which would be so disturbing as to raise concern about a broader market disruption. In such cases, authority by a relevant supervisory agency to limit their capital and leverage would be important, as the president has proposed …. …. To put it simply, in no sense would these capital market institutions be deemed “too big to fail.” What they would be free to do is to innovate, to trade, to speculate, to manage private pools of capital — and as ordinary businesses in a capitalist economy, to fail.
I do not deal here with other key issues of structural reform. Surely, effective arrangements for clearing and settlement and other restrictions in the now enormous market for derivatives should be agreed to as part of the present reform program. So should the need for a designated agency — preferably the Federal Reserve — charged with reviewing and appraising market developments, identifying sources of weakness and recommending action to deal with the emerging problems. Those and other matters are part of the administration’s program and now under international consideration.
In this country, I believe regulation of large insurance companies operating over many states needs to be reviewed. We also face a large challenge in rebuilding an efficient, competitive private mortgage market, an area in which commercial bank participation is needed. Those are matters for another day. What is essential now is that we work with other nations hosting large financial markets to reach a broad consensus on an outline for the needed structural reforms, certainly including those that the president has recently set out.
geokstr says:
Perhaps “financial reform” of banks might include some freedom from being forced by the regulators to make bad loans to people who should never get them in the name of “economic justice”? If there had never been millions of sub-prime mortgages, there would not have been a crisis.
Just sayin…
Yet Fwank and his cohorts are doubling down on the CRA, while they play misdirection of blame on everyone else. What could possibly go wrong?
January 31, 2010, 11:49 amMike P Wagner says:
My sense it that the percent of “economic justice” loans involved in the most recent debacle is incredibly small.
But I may be wrong.
Do you have any data on the magnitude of these loans?
Thanks,
Mike
January 31, 2010, 12:04 pmPaul says:
Spelling: it’s “Volcker” not “Volker”
January 31, 2010, 12:20 pmron says:
“My sense it that the percent of “economic justice” loans involved in the most recent debacle is incredibly small.”
I’m not sure of the size of that specific market but I’m not sure it really matters.
January 31, 2010, 2:06 pmSimply providing the secondary market in funny loans (freddie and fannie) was sufficient to distort the overall market, whether the loans were aimed at low-income folks, or merely speculative. Like many social-engineering programs, the intent yielded consequences which could have been foreseen, but were ignored or brushed-off.
And it’s obvious that the funny-loan market in general was a large contributor to the current situation.
Ohio Lawyer says:
When I see Volcker make full disclosure of his tax returns and financial statements for the last 10 years, I may then be able to decide if he’s speaking objectively. He’s been an insider–on Wall Street and in Washington–so his opinions are highly suspect. Both places are just revolving doors.
January 31, 2010, 2:25 pmorca says:
Are Rush’s dittoheads really still trying to blame our recent economic meltdown on a few poor people getting home loans?
How terribly sad.
The Democrat’s 5.7% GDP growth last quarter must be just killing the folks who have been praying for America to fail.
January 31, 2010, 2:29 pmAbdul Abulbul Amir says:
The problem was not “a few poor people getting home loans” but lowering lending standards so those with poor credit could get loans.
If the stabdard for mortgages was still 20% down, good credit history, and stable employment this melt down would never have happened.
BTW, banks running hedge funds had next to nothing to do with this disaster.
January 31, 2010, 4:39 pmAllan Walstad says:
I.e., control by pols and bureaucrats? I see no reason to expect them to act any more responsibly than anyone else, and no small reason, rooted in the incentives of the political game, for them to act irresponsibly to undermine both productivity and stability.
Let’s start with the biggest outlier of them all, namely, the Fed. They’re the ones who jerk around with the money supply, generating bubbles and busts. The most obvious example is the recent housing bubble. Force interest rates to subterranean levels by dumping fiat money on the markets, and you get the irresistible urge to lend to anybody, on any terms or none–particularly when the pols pressure banks to make bad loads and position Fannie and Freddie to buy up and collateralize loans, with the implicit (and retrospectively validated) assumption that they would be backed up at taxpayer expense if necessary to prevent them from going down.
January 31, 2010, 5:43 pmSwan Trumpet says:
There’s no doubt that Paul Volcker’s thoughts are worthy of consideration, but it’s curious that he doesn’t address the cause of our current crisis – the housing bubble and the subprime mortgage disaster.
Jimmy Carter passed the Community Reinvestment Act making it easier for low income people to qualify for mortgages. In 1995, Bill Clinton revised the CRA in a manner that forced banks to make these loans, and used Fannie Mae and Freddie Mac (or you and me) to unwittingly guarantee them. After that, the race was on, as housing prices for the first time in history detached from the inflation rate. With rising prices and Fannie & Freddie buying many of the riskiest loans, those who loaned the most stood to earn the most profits.
That’s why as recently as 2006 we were seeing plenty of advertisements being run for no-income check, no credit-check loans being offered. President Bush tried to get congress to enact legislation prohibiting Fannie & Freddie from taking on these risky loans in April 2001 but the Democrats in lockstep opposed it. In 2003, President Bush’s Treasury Secretary John Snow called upon congress in a public hearing to enact strong legislation to put the clamps on Fannie & Freddie. At that hearing, Rep. Barney Frank (D-MA) accused Snow & Bush of being alarmists and insisted that there was no risk of meltdown. In 2006, Federal Reserve Chairman Alan Greenspan informed the Senate Financial Committee that failure to restrain Fannie & Freddie was placing the entire financial system at risk. This time it was Sen. Chuck Schumer (D-NY) who dismissed the concerns of the experts and declared the system sound.
Sen. John McCain tried again in 2006. McCain made an passionate speech regarding the need to enact restraints on the GSEs without delay. He introduced legislation which Republicans all supported and Democrats all opposed in committee.
January 31, 2010, 6:05 pmrpt says:
What is the source of your data re millions of CRA-required subprime loans?
January 31, 2010, 6:17 pmjcm says:
In 1932. universal bank were banned . They were not guilty of the crash
January 31, 2010, 6:22 pmIn 1999, they were allowed again. None has crashed until now. Those that remained as investment bank crashed. So, what those genius do? pull back the only measure of deregulation .
Fredie Mac and Fannie Mae, they remain. who received more money from them ? Dodd, Clinton and Obama
The Loans for People Unable to payback Act ( does sub-premium means anything?) remains
rpt says:
Same old diversion story. Are any of you CRA-blamers doing any work in the bankruptcy courts or with high six figure no doc loans in default? Where’s your data?
January 31, 2010, 6:25 pmSwan Trumpet says:
John Snow and Alan Greenspan presented Congress with mountains of data. If you like, you can watch a brief 4 minute video news segment outlining the timeline warnings I mentioned in my post.
http://www.youtube.com/watch?v=cMnSp4qEXNM
January 31, 2010, 6:32 pmorca says:
How did I know it was some propaganda piece from Faux News even before I clicked the link?
I must be psychic.
January 31, 2010, 6:49 pmSwan Trumpet says:
A video showing clips of Congressional hearings and speeches on the floor is propaganda? My suggestion is watch the video, get the dates of the Snow and Greenspan hearings and verify on the C-Span site. But only do so if you’re genuinely interesting in getting facts.
January 31, 2010, 7:05 pmorca says:
Swanny, even noted Randroid Alan Greenspan admitted he was wrong and now accepts that markets fail sometimes and, given the chance, greedy bankers will gladly destroy America if it means putting a few more bucks into their own pockets.
If he can do it, so can you.
January 31, 2010, 7:12 pmAllan Walstad says:
Orca, given the chance, pols will gladly play brinksmanship with systemic failure if it pleases their base–and if they have their scapegoats lined up for when the negative consequences arrive. As for Greenspan, he didn’t say he was wrong about Fannie and Freddie, did he? He was looking for more regulation there. That’s what you want, isn’t it? More regulation? Greenspan’s “admission,” that financiers are greedier than he’d thought, conveniently finessed any need on his part to admit that his Fed was responsible for bubbles and busts by jerking around with the supply of fiat money.
January 31, 2010, 7:45 pmron says:
orca says:
“Swanny, even noted Randroid Alan Greenspan admitted he was wrong and now accepts that markets fail sometimes and, given the chance, greedy bankers will gladly destroy America if it means putting a few more bucks into their own pockets.”
Yes, that’s what markets do; maximize returns.
January 31, 2010, 7:50 pmIn an un-distorted market; those sorts of activities are competed-out. What Greenspan didn’t mention (and since he played such a big part in it, it’s not surprising he’d blame an abstraction) was the distortion caused by the Fed and government policies in general.
Regardless of CRAs, the government guaranteed a secondary market in funny loans and so they got handed out like gum-drops. And interest rates were held below market for at least ten years.
Expecting the market to correct government lunacy is lunacy itself; the government, OTOH, claims to represent the people and look after their best interest. The government not only failed in that, but by those policies, pretty much guaranteed the melt-down.
And your “randoid” and “Faux News” pretty much labels you as someone really not interested in facts. I’m constantly amazed at those on the left who read nothing other than their favorite sources and expect to have credibility when commenting on others.
leo marvin says:
Does it occur to you that might not be the most persuasive criticism of a liberal you met on a right of center website?
January 31, 2010, 9:22 pmron says:
leo marvin says:
January 31, 2010, 9:39 pm“Does it occur to you that might not be the most persuasive criticism of a liberal you met on a right of center website?”
Well, I’ve read that sentence several times and I’m still not sure of the point.
Rather than guessing on my part, would you like to be a bit more specific?
Sarcastro says:
No need for proof or numbers! When it comes to CRA stuff, all ya need to do is cite your favorite theory and *bam* the theory predicts CRA was bad!
Just like my theory that evil is caused by liberals. See, liberals distort usual human nature. In an un-distorted human, evil sorts of activities are unnatural.
QED.
Furthermore, liberalism is clearly the only cause of evil because of how well it fits the above theory, and also my sue of ‘clearly.’
Finally, experts that agree with my are authoritative, when they dissagree, they have an agenda.
January 31, 2010, 9:40 pmron says:
Sarcastro says:
January 31, 2010, 10:00 pm“No need for proof or numbers! When it comes to CRA stuff, all ya need to do is cite your favorite theory and *bam* the theory predicts CRA was bad!”
You seem to be focusing on CRAs, which is not surprising.
CRAs were the claimed social engineering ‘intent’; the enabling policies of that intent (fannie, freddie, near zero interest rates) were the cause of the results.
So the claim that CRAs didn’t cause the problem is correct; it was the policies required to supposedly accomplish that goal that were.
Of course, the goal was only marginally met, while the actual problems caused by the policies were blamed on everyone and everything *but* those policies.
Sarcastro says:
The best proof is such a bold and confusing declarative statement, with no supporting evidence!
January 31, 2010, 10:21 pmleo marvin says:
Ron, you said about Orca, “I’m constantly amazed at those on the left who read nothing other than their favorite [presumably left-wing] sources and expect to have credibility when commenting on others.” Accusing him of only reading left wing sources, when the only source you know for sure he reads is right wing, does little for your own credibility. Is that specific enough?
January 31, 2010, 10:30 pmSwan Trumpet says:
Prof. Abraham Miller has a great article on the Community Reinvestment Act’s role in the subprime mortgage market collapse. He wrote,
http://www.americanthinker.com/2008/09/the_financial_mess_how_we_got.html
January 31, 2010, 10:31 pmErnst Blofeld says:
It’s not merely a problem of individual, large banks failing. In the current unpleasantness, pretty much all the big investment banks were hip deep in bad mortgage paper–they all followed the same investment strategy over the cliff. In a case like this it’s not just a matter of the orderly shutdown a few “outlier” banks that also happen to be very large; it’s that the whole financial system is underwater. Effectively a few trillion in home equity got securitized, and when that value dropped, _somebody_ has to be left holding the bag.
I’m somewhat skeptical that regulation would have saved us. The regulators–the US government–had, as a policy, increasing home loans to dodgier homebuyers. In a battle between the one hand of government–they green eyeshade bank regulators–and the other hand–the politicians eager for more votes–I think it’s clear which side would have won.
January 31, 2010, 11:06 pmStrict says:
“If there had never been millions of sub-prime mortgages, there would not have been a crisis.”
There’s a lot of blame to go around. Some blame the bad practices of the credit ratings agencies. Some blame the shortcomings of the FICO score (individual credit rating). Some simply blame the residential/commercial real estate bubble – bubbles burst, that’s what they do. You say it’s the existence of the subprime loans themselves. Others say not the loans themselves, but rather than the delinquent payments and defaults on those loans. (And defaults were caused by personal irresponsibility, bad luck, and sketchy loan agreements – including prepayment penalties, balloon payments, late fees, and the fact that subprime loans simply have higher interest rates than prime loans). And still others blame the massive securitization of those loans: we shouldn’t have conditioned the health of our entire financial system on whether some people with poor credit history repay their loans in full and on time.
As for the existence, there are many reasons why the subprime market got big. One was the CRA. Earlier federal legislation included the DIDMCA (1980) which banned state-law caps on interest rates, the AMPTA (1982) which preempted state-law restrictions on prepayment penalties, and allowed variable-rate interest schemes and balloon payments. Another big one was the 1986 re-draft of the IRC which made subprime credit very attractive.
It’s interesting to see how conservatives view the federal deregulation of the credit market. In one sense, it’s deregulation of business and that’s good, and in another sense it’s a federal statute preempting state law via the Supremacy Clause and that’s bad…
January 31, 2010, 11:11 pmStrict says:
“The regulators–the US government–had, as a policy, increasing home loans to dodgier homebuyers.”
This is true. But the US government had, also as a policy, made it more likely that these homebuyers default by stripping them of their state-law protections from predatory lending.
January 31, 2010, 11:15 pmron says:
Sarcastro says:
“ron: So the claim that CRAs didn’t cause the problem is correct; it was the policies required to supposedly accomplish that goal that were.
The best proof is such a bold and confusing declarative statement, with no supporting evidence!”
Easily confused, are you?
January 31, 2010, 11:48 pmHow about data concerning the amount of taxpayer money used to bail them out? Or is that too confusing?
http://money.cnn.com/2009/07/22/news/companies/fannie_freddie_bailout/index.htm
And that’s *before* the lifting of *any* limits on F&F bailouts passed in December.
Sarcastro says:
We paid Fannie and Freddie money when there was a housing crisis. Thus, they caused the crisis!
Now that’s some good provin’!
January 31, 2010, 11:57 pmron says:
leo marvin says:
February 1, 2010, 12:01 am“Ron, you said about Orca, “I’m constantly amazed at those on the left who read nothing other than their favorite [presumably left-wing] sources and expect to have credibility when commenting on others.” Accusing him of only reading left wing sources, when the only source you know for sure he reads is right wing, does little for your own credibility. Is that specific enough?”
Thank you, yes it is.
But there’s nothing in orca’s statements to say orca *does* read or listen to ‘right wing’ sources. What I know is that orca offers the pretty standard diminutives of ‘right wing’ sources; calling Greenspan a “randroid” or referring to “Faux News” suggests no real acquaintance with either of them.
OTOH, anyone looking for ‘right wing’ sources has to deal with pretty constant ‘left wing’ influences (ranging from broadcast news to news papers to public school curricula) to even find them.
Suffice to say, I find those on the right more than familiar with left wing views, by default. Those on the left seem to parody the right wing view with slight knowledge.
Sarcastro says:
Wow, everything not right wing is liberal, you see. Yeah, your side is totally better informed than the other side.
February 1, 2010, 12:05 amron says:
Sarcastro says:
“Wow, everything not right wing is liberal, you see. Yeah, your side is totally better informed than the other side.”
Wow, sarcastro responds with sarcasm. Thank you. Got an argument, or just random hogwash?
February 1, 2010, 12:15 amron says:
Sarcastro says:
“We paid Fannie and Freddie money when there was a housing crisis. Thus, they caused the crisis!
Now that’s some good provin’!”
Wow, sarcasto can’t read dates! Way to go, sarcasto!
February 1, 2010, 12:16 amJohnny Longtorso says:
Here is an article with a bunch of anti-CRA hard stats, including how poorly large institutions did w/ the Act vs how small ones did:
http://limitedmodifiedhangout.blogspot.com/2010/01/community-reinvestment-act-evaluated.html
February 1, 2010, 10:06 amJanon2 says:
No one in the industry was complaining about being “forced” to buy “bad” loans for poor people while it was going on. No one who knows anything about the industry is complaining about it now. They were lining up to make and buy these loans — often for way above par — and AA and AAA securities backed by them, which they thought would be highly profitable. The only remotely plausible “affordable housing” angle to the problem is that the Bush Administration increased the GSEs’ affordable housing obligations in 2005 (in a bid for Hispanic votes and also with the silent support of their competitors) and the GSEs chose to fulfill it by buying what they thought would be highly profitable MBS, rather than by buying CRA loans as their competitors assumed that they would.
February 1, 2010, 3:19 pmSwan Trumpet says:
The Clinton administration was complaining because the general sentiment was that the Carter enacted CRA was not strong enough to force lending institutions to make risky loans. Before Congressional micromanagement of the home loan market, lenders were accountable. If a loan officer approved more than 2 loans a year that ended up in foreclosure, he wouldn’t have a job.
Before and after the Clinton reforms were enacted, financial experts complained by the truckload, in written op-eds, warning letters to Congress and testimony given at hearings.
Once Fannie and Freddie began seriously buying large segments of the riskiest loans, some players – most notably Countrywide and a GMAC subsidiary called DiTech became aggressive lenders.
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