Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

19 December 2009


[For comment on two common banking myths, click here.]

When reporters asked Jesse James why he had made a career of robbing banks, he had a simple answer: “They’re where the money is.” Nowadays, you don’t have to rob banks to be Jesse James. You just have to run them.

Bankers in general—and investment bankers in particular—recently put our global economy within days of total meltdown. They did so by taking stupendous and utterly stupid risks and overpaying themselves to do so. Now they are busy arranging social and political conditions so they can do the very same thing again and again for the foreseeable future.

Not only that. They are doing their best to make financial predation a permanent feature of our society. And they are winning.

These men (virtually all of them are male) consider themselves superior beings. They tell us only they can lead our nation forward. They call themselves “innovators.” They liken themselves to real innovators who design Boeing’s carbon-fiber Dreamliner or develop wonder drugs. They claim we will all suffer without the financial “innovation” that their excessive pay fosters. They say they are the lifeblood of our capitalist culture.

None of these things is even slightly true. They are all lies. Bankers today do what they do for same reason that Jesse James did what he did. But today they get away with it, without physical violence, by playing law and lawmakers like violins.

Far from being innovators, these men are not even smart. Intelligent innovators in science and engineering share two chief characteristics. First, they know some math. Second, their math works. That is, it predicts real events in the real world, like the Dreamliner’s successful test flight this week or the statistical success of a new drug in curing disease without debilitating side effects.

Banking math is hardly rocket science. It’s mostly arithmetic. You have to know as much about compound interest and present value as you can get from ubiquitous electronic and Web-based calculators. That’s about it.

Bankers and rating agencies did use sophisticated math to model the risk of financial derivatives. But their math famously didn’t work. It didn’t work because it assumed that housing prices and other markets would continue going up, just like bankers’ pay. Garbage in, garbage out.

If this false math proved anything real, it validated Upton Sinclair’s famous line: “It is difficult to get a man to understand something when his salary depends upon his not understanding it.” When the pay at issue is not just ordinary salary, but a king’s ransom, misunderstanding becomes a guiding star.

To see the results of so-called “innovation” in banking, just look around you. Small businesses are dying by the thousands, through no fault or lack of effort of their owners. Neighborhoods rot from within as foreclosures and boarded-up homes proliferate.

Once boring, staid and necessary servants of society, bankers have mutated into pathogens. They have made our society sick. Small-business bankruptcies and decaying, foreclosed neighborhoods are among the abscesses they have formed.

Like all successful pathogens, bankers multiply. The easy money they promise recruits greedy youth to their cause.

When I was young, our best and the brightest wanted to be scientists or engineers. Now they all want to be investment bankers, for the same reason as Jesse James. Immigrants from China and India fill our engineering and scientific graduate schools, or good positions go begging. Yet today we have more native bankers making more money that at any time in our national history, maybe in the history of the world.

We do have some antibodies. Like T-cells, groups of citizens have organized spontaneously to throw off the infection. They are resisting foreclosure and trying to save their neighborhoods. They agitate for change and fight the spread of social corruption (in the Biblical sense).

But like antibodies facing a serious plague, these organic social movements are too little and too late. Corrupt bankers from a mere handful of banks have a stranglehold on our nation’s blood supply, the flow of money. We need inoculation or a powerful antibiotic, which only government can supply.

That’s why the regulatory and restructuring bills now pending before Congress are vital. The infection that nearly destroyed us is spreading again. We need to stop its growth, and we need to inoculate ourselves against it.

We need someone trusted to explain why uncontrolled “innovation” in banking is a bad idea. We need someone to remind us how bankers nearly destroyed our economy, and why they have grown far too numerous, centralized and powerful. We need someone to split big banks up into units small enough to serve communities again, not threaten society. We need someone to teach us how bankers can morph from boring, staid servants of a capitalist economy into virulent pathogens that bring us down.

The President is the only one with the talent and power to do these things in time to save us. Calling our pathogens “fat cat bankers” in a single Sixty Minutes segment doesn’t cut it. The problem requires a sustained and concentrated effort comparable to the President’s winning presidential campaign or his push for health-insurance reform.

If this inoculation effort fails, nothing else will matter. Taking a page from bankers’ books, health insurers already have watered reform of their industry down to the vanishing point. Even if the monstrous bill passes—and I hope it does—it will mark a Pyrrhic victory. In the absence of meaningful competition or cost control, insurance premiums will rise. Health insurers, like bankers, will become more numerous and more powerful. Another class of Jesse Jameses lacking math, intelligence and public spirit will grow to subvert us.

Money is indeed the lifeblood of society. If we continue to reward people for siphoning it off for their own selfish ends through swindling and foolish risk-taking, without creating anything of lasting value, our infection will spread throughout our economy. Eventually, reform will fail everywhere. Innovation will fail. Job growth will fail. Energy independence and attempts to retard global warming will fail, at least here in the world’s second-worst polluter, because they, too, need honest money.

So the President needs to stop the infection now. He needs to reign in bankers, especially the ones within his own Administration. He needs to promote and stand behind three extraordinarily bright and public-spirited women—Sheila Bair, Christine Varney, and Elizabeth Warren—who saw it all coming and have the skill, training, will and perseverance to fight the infection.

The hour is late, and the pathogens are spreading. Pus is still dripping from our economic wounds. It is flowing in the halls of Congress. It is corrupting or emasculating people like Joe Lieberman, Chris Dodd and Barney Frank, who should know better. Stopping its flow is a fight worth fighting, for losing that fight will make all others pointless.

Two Banking Myths

While on the subject of banking, there may be merit in debunking two common myths that bankers propagate to justify their empire-building and exorbitant pay.

Myth 1. We need big banks to do big deals. Wrong. As late as the 1970s, when American banks still couldn’t yet match the size of their foreign counterparts, they did all the big deals they wanted because they had the money (and we Americans had the global currency). They did them through what was called “syndication,” i.e. several banks taking smaller pieces of a big deal.

Syndication is better than a concentrated banking industry for several reasons. First, like insurance, it spreads risk. Each participating bank risks only a part of a big deal. Second, it spreads decision making. If two heads are better than one, then several are better than two. Requiring multiple banks under independent management to participate in risky big deals brings more minds and more caution into the picture and helps avoid groupthink.

Finally, syndication keeps banks closer to human scale and avoids the kinds of pyramiding that allows a Fuld or Blankfein to treat our national (or global!) economy the way Napoleon and Hitler once treated Europe.

During the late 1970s, syndication was good enough to bail out all of Latin America from a severe financial crisis. It’s still good enough to do all the big deals that need doing. It has the singular benefit of facilitating big transactions without encouraging the kind of empire building that concentrates our financial industry in the hands of a small coterie of incestuous, ruthless, overpaid, self-important, and not-too-bright men on the island of Manhattan.

Myth 2. You can’t have rapid enough innovation in finance. Wrong again. Every financial innovation in human history has had its downside. Often the downsides took decades or centuries for markets to assimilate and properly control.

The downsides usually appeared most disastrously right after the innovations themselves. Only much later did laborious development of regulated exchanges, legal rules and customs dampen the unintended consequences and realize the innovation’s initial goal.

Examples are home mortgages and commodities futures. Mortgages arose to encourage more people to own their own homes—a worthy goal. On several occasions (including 2008), they led instead to credit for industry drying up and housing bubbles bursting. We are still trying to smooth that curve and tame that boom-and-bust cycle. No one yet has conceived a foolproof way.

Commodities futures trading arose to stabilize prices of industrial commodities so both producers and users could plan. They, too, led to excesses and bubbles until regulated exchanges arose to making trading transparent and curtail self-seeking, non-industrial manipulation.

Derivatives are no different. Their unregulated use led directly and demonstrably to our recent global meltdown. Now the finance industry wants to keep them unregulated and obscure. That’s got to be one of the dumbest ideas ever conceived by the mind of the Jesse James class, which has had some lulus!

Nobel-prize winning economist Paul Krugman and leading investor Warren Buffet have both questioned (1 & 2) whether derivatives can be regulated and brought under control at our present stage of financial development. I agree, if only because the easing of moral hazard that is derivatives’ chief goal seems to run counter to the “skin in the game” philosophy that has kept free markets working throughout history.

Maybe we’re all wrong. Maybe derivatives could be as useful as mortgages and commodities futures if we could just figure out how to regulate them and eliminate their unintended consequences. But even if we could figure that out, the answer would be more regulation, not less. More cowboy capitalism of the type that just nearly caused a second Great Depression is not the answer.

Whatever the question, the Jesse Jameses of the world will always answer “more!” They want bigger financial institutions with more money, more concentrated power and wealth (in their own hands, of course). The only thing they want less of is intervention by others, including government, which slows down their take-the-money-and-run schemes. A nation that gives in to them is heading for a fall.

Unlike real innovation in the industrial world of science, engineering and production, so-called “innovation” in finance is easy. All it takes is the bare idea of a get-rich-quick scheme and a few unscrupulous men willing use it to take the money and run. The hard work of real innovation comes later, when public-spirited, thoughtful men and women sit down to figure out how to preserve whatever social benefits the Jesse Jameses used to sell their “innovation” to the public while avoiding the downside. That’s precisely where we are now with derivatives, and where we should be for the foreseeable future.


Site Meter


Post a Comment

Links to this post:

Create a Link

<< Home