Here is a standard set of moves in talking about bank riskiness:
1. Banks take too many bad risks!
2. Regulators should only let them take good risks!
3. All better now!
There is, like, a problem there, because actually bankers tend to have compensation structures that are more directly tied to their success, and also larger, than those of bank regulators – which means that, if you had to guess who would be better at picking the good risks, you might pick the bankers over the regulators. You can try to address that problem, maybe by improving the incentives of the regulators to make them better at picking the good risks, or by improving the incentives of the bankers to make them better at picking the good risks, because after all your goal is actually not optimal regulation but optimal risk-picking.
There are other approaches available. Here is a cop-out option:
Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed.
That quote is from this baffling thing by Amar Bhidé in the Times today about how the government should guarantee all bank deposits, and then go on to “reinstating interest-rate caps, ending the competition for fickle yield-chasers that helps set off credit booms and busts,” and that once that happened “Other, more mysterious denizens of the shadow banking world, from tender option bonds to asset-backed commercial paper, would also shrivel,” and, okay, whatever, but I learned a whole lot about cross-elasticity that day I studied for the CFA and I’m pretty sure that when you lower the interest that banks can pay on deposits, people will be more, not less, interested in alternative higher-yielding thingies.
Felix Salmon also makes fun of this because he’s not down with guaranteeing deposits but I’m not sure that’s actually a big deal. Per his numbers, over half of US bank deposits are already FDIC insured, and basically any human who wants to get their bank deposits FDIC insured can do so with wholesale CD brokering and other things that I do not know much about because, sadly, I am the sort of human who fits comfortably under FDIC limits all on my lonesome. But deposits are not the thing! Other things are the thing! Worrying about the safety of the short-term liabilities of banks and nonbank financial institutions is a worthwhile activity. Worrying about the safety of actual bank “deposits” is so 1930. Here, have a chart:
The light blue is insured deposits. One of those pink bands near the top is the uninsured deposits. The rest of it is what to worry about. Bhidé just assumes that those things will go away under his plan, either because you’ll be so excited about unlimited FDIC guarantees that you’ll put your money in bank deposits even if they pay less interest than they do today, or because the other things will be banned I guess.
But I want to spend more time enjoying that quote, about how “Banks must therefore be restricted to those activities … that a regulator of average education and intelligence can monitor.” You can start by substituting other industries for “banks.” “Surgeons,” for instance, or “telephone designers.” Or “particle physicists whose work might create a black hole and destroy the universe.” The only industry that I know of that follows a rule of “never do anything that is not understandable to people of average education and intelligence” is politics and how is that working out for you?
There are real arguments for “dumb regulation” of banks, and there are real arguments that US regulation of depository banks has actually been pretty good at avoiding catastrophic risk-taking by insured banks and so has scored some points versus the more haphazard regulation of bank holding companies and investment banks and money market mutual funds and hedge funds and MF Globals. But there are, I think, some steps from there to “we should ban all financial innovation that you can’t explain to your grandmother.” We don’t do that in other industries. Not even the universe-destroying ones.
We do other things. We align incentives. (If you build a particle accelerator that destroys the universe, you are sad, or at least you aren’t happy, so you have ex ante incentives not to do that.) We impose after-the-fact liability. (If you are a surgeon who screws up, you get sued.) Sometimes, we get expert regulators and we do our very best to get them to be smart and motivated. We try all of these things in some form with financial regulation, and have pretty mixed success.
It is a tragic failing of financial industry PR that everyone just assumes that complexity is necessarily and intentionally evil, and that everyone will be better off with simplification. One way to test that theory is to look at revealed preferences. That chart, for instance: while old-school deposits (insured and otherwise) have grown a bit in the last 20 years, other forms of “money claims” have grown far more rapidly. You can tell that as a marketing story – banks bamboozled investors into taking asset-backed commercial paper when all they wanted were plain vanilla deposits – but you can just as easily tell it as a demand story – customers wanted yield or collateral or different risk exposures and so put their money into asset-backed commercial paper. (Or, if that’s not good enough, super-fancy asset-backed stuff.) The marketing story has the disadvantage of assuming that the customers are idiots. Some of them probably are. That’s probably not enough reason to dumb down the entire financial system.
Bring Back Boring Banks [NYT]
Bhidé's great-grandfather circa 1919: "Alcoholism is bad. And people do stupid and/or violent things when they're drunk. Clearly the best way to remove these societal problems is the simplest way: enact a constitutional ban on alcohol."
If banks were boring I could simply listen to the musings of Matt Levine, all day every day.
Since Matt is busy outlining his next unabridged manifesto about bank deposits, I offered to help by writing his 2012 New Year's resolutions 1) use more complex graphs that no-one will read, 2) bolster your articles with more useless quotes about physicists, and 3) reference your CFA studies at least once a day. Looks like your on your way to another successful year Matty!
Matt, you're back goddammit. with charts and all. we sorely missed you.
that chart actually looks like a geology report
Two legs bad, four legs good
Great post. Let's be honest – finance, while at times can be complicated, is not THAT hard to understand.
Why can't regulators attract the fastest and sharpest minds? They pay like crap. What's an easier task, changing the entire system to conform to this lack of talent, or fixing the root the problem, paying more to attract better talent?
And let’s be honest – are you ever going to get good laws passed with the idiots in congress? An oversimplification of very complicated issues (economic policy, foreign policy, CURRENT EVENTS) has left half the country uninformed, and formulating opinions (casting votes) without even knowing what they’re talking about.
you're*
I'll show you a 'black whole. '
F'ing hell Matt. I need my naps much earlier in the day. I have to finish things up and get out of here.
4. Vigorously defend insider trading and white collar crimes in general.
There is, like, a problem there, because actually bankers tend to have compensation structures that are more directly tied to their success, and also larger, than those of bank regulators – which means that, if you had to guess who would be better at picking the good risks, you might pick the bankers over the regulators.
A has better compensation than B and so takes better risks? One could argue the opposite actually.
I have examined Matt's motives.
If banks were actually restricted to:
" Banks must therefore be restricted to those activities, like making traditional loans and simple hedging operations, that a regulator of average education and intelligence can monitor. If the average examiner can’t understand it, it shouldn’t be allowed. "
Matt would have nothing to write about anymore.
This was a well written article, with a great lead and an understandable though somehow blurry chart. Being alongside beth's confectionary style might seem like being regis next to kelly, but who cares about kelly's opinion anyhow?
"confectionary style" ?
Go kill yourself now
Good to have you back, Matt
Matt, can you please stop insterting the word "like" in your sentences to sound cool? I love you just the way you are, and you don't need to pretend to be someone you are not to impress me.
eat me
"…a regulator of average education and intelligence…"
Is there any other kind?
Just make sure when we take over the farm we don't take the illiquid death ray equity too.
Obviously not because anyone who is above average is likely doing something illegal to appear above average.
-SEC Director of Statistic Analysis
my dog will. Just cover it in peanut butter and yell "Kneale"
I always think of Bess as more tart and tangy – with a crackly snap. The kosher dill to Matt's somewhat bland but filling kugel
Should the regulator with average education and intelligence compensate with a higher libido? Or should that be average or lower as well?
-SEC Staff Recruiter
I'be tried this with former gf's.
Never like works.
I think we should keep the current heads-we-win, tails-taxpayers-lose state of play.
Allow as much leverage and as little equity as possible, since we get paid on return on equity (certainly no one would want to get paid on risk-adjusted return on equity).
Definitely let us keep retiring with hundreds of millions and don't claw anything back when the bank fails the year after we retire.
Complex, opaque derivatives are profitable when they're profitable, so we should book as many as possible, and make sure if one bank gets in trouble, there's a run on all the others, since no one knows who will be left holding the bag.
And make sure the Fed keeps giving us free money, and above all, remember, government is the problem, not the solution.
Leverage, moral hazard, complexity, and opaque, fragile interconnections are our friends!
I'll go with that….besides, I'm new to the bessosphere.
Here at the SEC, we have one position to fill and 70 applicants. The agency heads will be running a train on each applicant to better determine fitness for the post.
Well said, now if you wouldn't mind would you go ahead and proceed to bash your wall against a brick wall repeatedly? Tyia.
1. The only people who get paid directly on ROE are the C-suite management. That's *maybe* 40 people out of the 400k-odd who work in what you could loosely define as Wall Street.
2. There are only two I can think of who retired with "hundreds of millions" before their banks failed- Stan "The Man" O'Neal and Chuck "Dancing Charlie" Prince. Even Jimmy (co)Cayne had most of his net worth in BSC common that got taken out at $10.
3. 97% of the people in this business are not derivatives salesmen, and in fact have jack shit to do with the products.
4. 99.5% of the people in this business have no control over how derivatives are carried on their company's books.
5. You would prefer the Fed raise rates? On what basis? Because 9% unemployment is too low?
Other than that, keep on killing it, k?
ouch http://www.commercialappeal.com/news/2011/dec/18/…
No one cares about Memphrica
I'd lather see a brack whore.
glass-steagall, baby! no need to be boring, just step away from the fdic teat and do whatever you want.
Matt, quit commenting on your own post.
-One who knoa
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Astrology 2012 Prophecy
Actually there is:
1)A regulator with average education and below average intelligence
2)A regulator with below average education and average intelligence
3)A regulator with below average education and below average intelligence
And finally (and this is quite rare)
4)A regulator with above average intelligence and average/below average education, who is just waiting to jump ship the minute a bank/hedge fund needs to conduct some regulatory arbitrage.