Glenn Reynolds writes:   The financial crisis of 2008-09 is over but not gone. We passed laws and regulations that probably won’t help much. And despite a lot of harsh words aimed at Wall Street and the banks, President Obama pretty much let individual bankers escape unscathed — perhaps because Wall Street and the banks were among his biggest campaign contributors. (That phenomenon has led some to call him “President Goldman Sachs.”)

But relying on regulators to control banks and Wall Street is likely to fail anyway. Leaving aside their extensive political influence, financial types are likely to stay ahead of regulators because 1) they’re usually smarter; and 2) they understand their industry better. Plus, they can change approaches faster than regulators can amend regulations.

Even so, the apparent change in the financial community over the past few decades has been dramatic. The economic crisis brought the activities of investment bankers into the limelight, and suddenly it seemed the staid buttoned-up banker types of the popular imagination had been transformed into wild speculators risking billions on a single trade. What happened?

According to Claire Hill and Richard Painter in their new book, Better Bankers, Better Banks:Promoting Good Business through Contractual Commitment, the reason is that the billions they’re risking on a single trade aren’t their own but somebody else’s. Hill and Painter want to do something about it by requiring that financial operators have their own assets at stake.

This isn’t a new idea. Until fairly recently, big investment banks such as Goldman Sachs or Salomon Bros. operated as general partnerships. In a general partnership, the partners are liable — individually — for debts of the firm. With potentially unlimited liability if things went wrong, the partners had an incentive to be comparatively cautious. (With corporations, on the other hand, shareholders aren’t on the hook for the firm’s debts. The most they can lose is the value of their shares.) Without unlimited liability, incentives are different. As Hill and Painter note, Salomon’s culture changed very rapidly after it became a corporate entity in which the partners, now called “managing directors,” weren’t personally at risk. Within a few years it went from a staid, conservative business to the anything-goes entity described in Michael Lewis’ Liar’s Poker.

It’s easy to engage in risky schemes when success gets you a huge bonus, while failure just costs someone else some money. One solution would be to require investment banks to be organized as general partnerships.

Hill and Painter suggest “covenant banking,” in which bankers’ compensation is at risk for bad deals. Not only would they get bonuses when things go well, but they’d have to cough up past bonuses, and salary, when deals go badly for clients.

Such an approach might be required by law, but Hill and Painter think that banks might want to do it voluntarily. As a client, wouldn’t you rather deal with a banker who stands to lose money if you do? Shareholders might even demand that their companies do business with such banks, as a way of hedging against risk. Wouldn’t it be safer to do business with people whose incentives align with your goals? (I always say I’d like my life insurance company to be in charge of my health care because it would cost them a lot of money if I died; my actual health care company, on the other hand, might save money if I kicked off quickly.)

Many of our problems come from having people in charge who don’t feel the pain when their various schemes go bad. As a theme for the coming decade, we could do a lot worse than requiring skin in the game.

 

Is Elizabeth Warren the Sheriff of Wall Street?

Richard Borosage writes:  Time Magazine hails Sen. Elizabeth Warren as the “sheriff of Wall Street.” Her effectiveness stuns the powers that be.

Fox News’ Melissa Francis says people on Wall Street think, “Elizabeth Warren is the devil.” Bill O’Reilly fulminates that she’s a “socialist,” yet “in demand, a woman of stature.” The Wall Street wing of the Democratic Party accuses her of “McCarthyism”for outing think tank scholars who argue the brief of their deep pocket contributors. The Economist muses on the “mystery of Elizabeth Warren” who has made herself into a “national politician” even though she isn’t running for president.

Senator Warren has earned the brickbats and the praise because she’s willing to take on the most powerful financial interests in the country in defense of everyday Americans. She is a first term minority party senator, but she has already earned a national following and is transforming our political debate and disrupting the corrupted politics of Washington.

A Senate hearing last month illustrated the traits that make Warren so effective and so invaluable. Republicans brought Primerica President Peter Schneider to testify against the proposed rules – championed by Warren and President Obama – that would protect the retirement savings of working people from sketchy financial advisers more concerned about fleecing their clients than serving them.

Schneider portrayed his company as dedicated to everyday Americans, clients who make as little as $30,000 a year, from homes “all too often … headed by a single mother.”

“We all agree that we must act in a client’s best interests,” Schneider said, while opposing the proposed Obama rule requirements as so costly that Primerica would be forced to abandon its vulnerable clientele.

Senator Warren once more had done her homework.   Primerica advisers were being sued for pushing firefighters and others nearing retirement to swap government guaranteed pensions for much more risky market investments that would earn Primerica far more fees. The company had put aside over $15 million to cover expected liability from 238 of these retirees.

“Do you believe,” Warren asked, “that people like these firefighters from Florida who are near retirement and have secure pensions with guaranteed monthly payments should move their money into riskier assets with no guarantees, just before they retire?”

It takes courage to challenge the Wall Street barons accustomed to getting their way in Washington. It takes intelligence and hard work to know enough to expose the hypocrisy and lies that are trotted out to justify rigging the rules.

Somehow this former law professor is pitch perfect in her ability to frame complicated issues for Americans to understand. Her speech at the 2012 Democratic Convention – “People think that the system is rigged against them. And here’s the painful part: they’re right”

But she is more than a gifted orator. The Consumer Financial Protection Bureau – that she not only conceived but, against all odds, got enacted in the Obama financial reforms – has already returned over $10 billion to 17 million Americans tricked by deceptive credit card and other financial ripoffs. She’s championed student debt relief, expanding Social Security, breaking up the big banks, reinstating the Glass-Steagall wall between taxpayer guaranteed deposits and Wall Street’s casino. And she’s only just begun.

W-T-W.org notes:  Warren thinks about the problems she presents and deeply understands them.  For instance, she has taken what is mistakenly regarded as a right wing position that too many colleges exist in America; they charge too much and invite students who can sign up for debt but will not find a college education useful.

Her personal poise, her clear convictions and her direct charm should not be under-estimated.

The banking industry is trolling the halls of Congress, trying to promote a change in the leadership structure of the ConsumerFinancial Protection Bureau.  The Bureau is a government agency the industry fought hard to keep from coming into being at all.

So why the sudden  attention on the Bureau and ‘helping it out?’

Turns out the banking industry wants to have the Bureau governed by a board of political appointees.  Their secret wish is to partially cripple the agency by fanning the fires of political controversy and internecine warfare.

Can members of Congress withstand the pressure?

Why is JP Morgan Chase exiting the private equity business?

The deal would push Highbridge Capital Management’s $22 billion private equity portfolio outside JPMorgan, which would maintain a minority interest.  Top executives, including its chief executive, Scott Kapnick, are expected to take ownership.

Big banks have been under pressure to spin off their in-house private equity and hedge funds.

The first businesses to go were the operations that invested the banks’ own money — so-called proprietary investing — which was banned by the Dodd-Frank financial reform legislation known as the Volcker Rule.  

Has pressure from regulators and investors forced the big banks to simplify their businesses?

JPMorgan will apparently keep ownership of Highbridge’s $6 billion hedge fund portfolio.

Matt Taibbi writes:  When Bill Clinton took office, it was still illegal in the United States for commercial banks to merge with investment banks and insurance companies. But toward the end of Clinton’s second term, he signed a bill called the Gramm-Leach-Bliley Act that essentially created Too Big to Fail “supermarket” banks like Citigroup.

This isn’t the only reason the financial system is so dangerous now. There’s also the matter of the extreme interconnectedness of the financial services industry. This problem came violently into play in 2008, when the failure of a single idiot investment bank, Lehman Brothers, caused a chain reaction that nearly blew up the whole financial system.

This latter problem was partially a consequence of another Clinton-era law, the Commodity Futures Modernization Act, which deregulated derivatives like swaps that were the agent of many of those chain-reaction losses.

Hillary Clinton has problems with a financial system that became dangerously over-concentrated thanks to multiple laws passed during her husband’s administration.

Mrs. Clinton says:  “Well, my plan is more comprehensive. And, frankly, it’s tougher because of course we have to deal with the problem that the banks are still too big to fail. We can never let the American taxpayer and middle-class families ever have to bail out the kind of speculative behavior that we saw. But we also have to worry about some of the other players: AIG, a big insurance company; Lehman Brothers, an investment bank. There’s this whole area called ‘shadow banking.’ That’s where the experts tell me the next potential problem could come from.”

First, it’s definitive now that Hillary has no intention of reinstating Glass-Steagall.

The second and probably more important observation is about Hillary’s rhetorical choices.

Hillary, like her close advisor Barney Frank, has been pushing an idea that banks aren’t at the root of any financial instability problem. Last night, she pointed a finger instead at “shadow banking,” non-bank actors like AIG, and a dead investment bank in Lehman Brothers. (Interesting she didn’t mention a still-viable investment bank like Goldman, Sachs, which has hosted her expensive speaking engagements.)

This squeamishness about criticizing banks is laughable to people in the industry. But of course, that’s probably the point – that the average voter won’t know how absurd and desperate it is to point to faceless “shadow” financiers as villains when the real bad guys are famed mega-firms that are right out in the open, with their names plastered all over every second city block.

The root of the 2008 crisis lay in a broad criminal fraud scheme, in which huge masses of home loans were given to people who couldn’t afford them. Those loans in turn were bought back up by giant banks and resold to investors who weren’t told how crappy the merchandise was.

The question there is how to make sure companies are small enough that the really corrupt ones can be allowed to implode organically, rather than requiring mass bailouts.

How do you make Too Big to Fail companies smaller and safer? Probably, you just do it. Mrs. Clinton will not.