Archive for January 9th, 2011
Bill Daley, President Obama’s newly appointed chief of staff, is an experienced business executive. By all accounts, he is decisive, well-organized, and a skilled negotiator. His appointment, combined with other elements of the White House reshuffle, provides insight into how the president understands our economy – and what is likely to happen over the next couple of years. This is a serious problem.
This is not a critique from the left or from the right. The Bill Daley Problem is completely bipartisan – it shows us the White House fails to understand that, at the heart of our economy, we have a huge time bomb.
Until this week, Bill Daley was on the top operating committee at JP Morgan Chase. His bank – along with the other largest U.S. banks – have far too little equity and far too much debt relative to that thin level of equity; this makes them highly dangerous from a social point of view. These banks have captured the hearts and minds of top regulators and most of the political class (across the spectrum), most recently with completely specious arguments about why banks cannot be compelled to operate more safely. Top bankers, like Mr. Daley’s former colleagues, are intent of becoming more global – despite the fact that (or perhaps because) we cannot handle the failure of massive global banks.
The system that led to the crisis of 2008, and the recession that has so severely damaged so many Americans, encouraged excessive risk-taking by major private sector financial institutions and, yes, Fannie Mae, Freddie Mac, and other Government Sponsored Enterprises (although these were most definitely not the major drivers of the crisis – see 13 Bankers).
Today’s most dangerous government sponsored enterprises are the largest six bank holding companies: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. They are undoubtedly too big to fail – if they were on the brink of failure, they would be rescued by the government, in the sense that their creditors would be protected 100 percent. The market knows this and, as a result, these large institutions can borrow more cheaply than their smaller competitors. This lets them stay big and – amazingly – get bigger.
In the latest available data (Q3 of 2010), the big 6 had assets worth 64 percent of GDP. This is up from before the crisis – assets in the big six at the end of 2006 were only about 55 percent of GDP. And this is up massively from 1995, when these same banks (some of which had different names back then) were only 17 percent of GDP.
No one can show significant social benefits from the increase in bank size, leverage, and overall riskiness over the past 15 years. The social costs of these banks – and their complete capture of the regulatory apparatus – are apparent in the worst recession and slowest recovery since the 1930s.
Paul Volcker gets it; no wonder he has resigned. Mervyn King, governor of the Bank of England, gets it. Tom Hoenig, president of the Kansas City Fed, gets it. Elizabeth Warren, the tireless champion of consumer rights, gets it. Gene Fama, father of the efficient financial markets view, gets it better than anyone.
I discussed the issue in public for two hours at the American Financial Association (AFA) meetings in Denver on Friday with two presidents of the AFA (Raghu Rajan and John Cochrane) and a Nobel Prize winner (Myron Scholes). This is not a left-wing or marginal group – there must have been at least 500 people in the audience (video will be available). The top minds in academic finance understand the problem vividly and are articulate about it – there is no rebuttal to the points being made by Anat Admati and her distinguished colleagues.
This is not a left-right issue – again, look at the list of people who co-signed Professor Admati’s recent letter to the Financial Times. This is a question of technical competence. Do the people running the country – including both the executive branch and the legislature – understand economics and finance or not?
If the country’s most distinguished nuclear scientists told you, clearly and very publicly, that they now realize a leading reactor design is very dangerous, would you and your politicians stop to listen? Yet our political leadership brush aside concerns about the way big banks operate. Why?
Top bankers, including Bill Daley, have pulled off a complete snow job – including since the crisis broke in fall 2008. They have put forward their special interests while claiming to represent the general interest. Business and other groups, of course, do this all the time. But the difference here is the scale of the too big to subsidy – measured in terms of its likely future impact on our citizenship and our fiscal solvency, this will be devastating.
Most smart people in the nonfinancial world understand that the big banks have become profoundly damaging to the rest of the private sector. The idea that the president needed to bring a top banker into his inner circle in order to build bridges with business is beyond ludicrous.
Bill Daley now controls how information is presented to and decisions are made by the president. Daley’s former boss, Jamie Dimon, is the most dangerous banker in America – presumably he now gets even greater access to the Oval Office. Daley is on the record as opposing strong consumer protection for financial products; Elizabeth Warren faces an even steeper uphill battle. Important regulatory appointments, such as the succession to Sheila Bair at the FDIC, are less likely to go to sensible people. And in all our interactions with other countries, for example around the G20 but also on a bilateral basis, we will pursue the resolutely pro-big finance views of the second Clinton administration.
Top executives at big U.S. banks want to be left alone during relatively good times – allowed to take whatever excessive risks they want, to juice their return on equity through massive leverage, to thus boost their pay and enhance their status around the world. But at a moment of severe financial crisis, they also want someone in the White House who will whisper at just the right moment: “Mr. President, if you let this bank fail, it will trigger a worldwide financial panic and another Great Depression. This will be worse than what happened after Lehman Brothers failed.”
Let’s be honest. With the appointment of Bill Daley, the big banks have won completely this round of boom-bust-bailout. The risk inherent to our financial system is now higher than it was in the early/mid-2000s. We are set up for another illusory financial expansion and another debilitating crisis.
Bill Daley will get it done.
Simon Johnson, co-author of 13 Bankers (out in paperback on Monday)
Awww….how sad. Poor widdle bankers might not get to give themselves huge bonuses from our taxpayer money – instead the have to pay a stable of high-powered lawyers to fight the massive number of fraud charges they are facing.
From the Miami Herald:
JPMorgan Chase and the biggest U.S. banks face billions of dollars in legal costs related to their role in the financial crisis, threatening their profits and the stock price gains they made in 2010, analysts said.
JPMorgan, the second biggest bank by assets, reported $5.2 billion of legal costs in the first nine months of last year. The costs would rise if the bank reserves for multibillion-dollar lawsuits by Lehman Brothers Holdings and the trustee liquidating Bernard L. Madoff’s firm.
Bank of America and Citigroup are also besieged by lawsuits stemming from the credit crisis, brought by plaintiffs ranging from foreclosed-upon homeowners to institutional investors whose mortgage-backed bonds turned out to be money-losers.
ARRAY OF SUITS
Stephen Cutler, JPMorgan’s in-house lawyer and a former SEC enforcement chief, declined to comment through bank spokesman Joseph Evangelisti.
Bankrupt Lehman is claiming $8.6 billion in collateral from JPMorgan plus tens of billions of dollars in damages, while Madoff trustee Irving Picard is demanding $6.4 billion on the grounds that JPMorgan aided and abetted the biggest Ponzi scheme in history.
Almost nine pages of JPMorgan’s third-quarter 10-Q deal with legal issues. They range from home foreclosure investigations by state officials, to shareholder lawsuits against Bear Stearns Cos., which JPMorgan bought in 2008, to suits from nine different Federal Home Loan Banks demanding compensation for mortgage-backed securities bought from JPMorgan, Bear Stearns or Washington Mutual Bank, also purchased in 2008.
Bank of America reported $1.2 billion in litigation costs for the nine months through Sept. 30, excluding fees to outside law firms. It is suing or being sued in 5,696 legal proceedings in federal court, compared with JPMorgan’s 3,757 lawsuits, according to data compiled by Bloomberg.
Cases for which Bank of America has already reserved some money may wind up costing the bank $400 million to $1.9 billion more than it has set aside, according to its 10-Q. The bank’s nine-month litigation cost of $1.2 billion compared with $477 million a year earlier.
“Our litigation-related expenses are cyclical and are not attributable to a single factor,” said Bank of America spokesman Lawrence Grayson.
Citigroup, now dealing with 1,713 federal court proceedings according to Bloomberg data, tries to settle lawsuits, the bank said in a filing. Shannon Bell, a spokeswoman for Citigroup, declined to comment.
Wells Fargo, the fourth biggest bank, is involved in 2,758 lawsuits, according to Bloomberg data. Mary Eshet, a Wells Fargo spokeswoman, declined to comment.
Dimon articulated the bank’s approach to lawsuits in the October analyst call.
“When we’re wrong, we’re going to settle, and when we’re right, we’re going to fight,” he said.
JPMorgan was the last major underwriter of WorldCom securities to settle suits started in 2002 after an $11 billion fraud sank the long-distance telephone company and sent Chairman Bernard Ebbers to prison.
Banks have leeway under current accounting rules to report litigation costs, or not. Citibank and Wells Fargo don’t give a dollar amount for legal costs; JPMorgan and Bank of America do.
Among other things, the FASB proposal would force banks to report the basis for the legal claim, the amount being claimed and how the company will defend itself. Banks will have to regularly update their estimated loss, and when it might occur; and in cases where they are “reasonably” likely to lose, they have to estimate their possible range of loss and say how much they’ve put aside to pay for it.
JPMorgan currently is fighting Lehman’s lawsuit, which alleges the bank and Dimon helped cause its failure by siphoning off badly needed funds.
JPMorgan twice asked a judge to dismiss the suit, saying it took the $8.6 billion in collateral from Lehman under a contract to clear trades for Lehman’s brokerage. So-called safe harbor laws protect a clearing bank from being sued if a brokerage client fails, the bank said in court papers.
U.S. Bankruptcy Judge James Peck in Manhattan, who hasn’t yet ruled on JPMorgan’s request for dismissal, has at least three times rejected the safe harbor defense in other cases. Bank of America was ordered to return $500 million of deposits to Lehman, and pay $90 million in interest.
Read more here.