13 Bankers

Simon Johnson & James Kwak, “13 Bankers” (The Wall Street Takeover and the Next Financial Meltdown), Pantheon Books, 2010, 304 Pages

Author, Simon Johnson is a Professor at MIT’s Sloan School of Management; coauthor James Kwak has had a successful business career as a consultant for McKinsey & Company. The authors present a convincing case that the six megabanks—Bank of America, JPMorgan Chase, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley—which together control assets amounting to more than 60 percent of the country’s gross domestic product, must be broken up; tighter regulation will not work. Allowing these institutions to remain “too big to fail” will assuredly lead to another financial crisis, bigger than the current one. However, except for a brief period in 2008 when even the bank CEO's agreed that 'too big to fail' must not exist, the captive politicians are now, again, being led by the bankers in the opposite direction. This book is a must read for anyone concerned with what measures must be taken to prevent another calamity.

My Notes:
Pg. 6: The political influence of Wall Street helped create the laissez-faire environment in which the big banks became bigger and riskier, until by 2008 the threat of their failure could hold the rest of the economy hostage. That political influence also meant that when the government did rescue the financial system, it did so on terms that were favorable to the banks. So long as the political establishment remained captive to the idea that America needs big, sophisticated, risk-seeking, highly profitable banks, they had the upper hand in any negotiation. The Wall Street banks are the new American oligarchy—a group that gains political power because of its economic power, and then uses that political power for its own benefit. Runaway profits and bonuses in the financial sector were transmuted into political power through campaign contributions and the attraction of the revolving door.

Pg. 78: The four money machines of modern finance are: high-yield debt (junk), securitization, arbitrage trading, and derivatives.

Pg. 89: The 1990s witnessed the final dismantling of the regulatory system constructed in the 1930s. The Riegle-Neal Act of 1994 practically eliminated restrictions on interstate banking, allowing bank holding companies to acquire banks in any state and allowing banks to open branches in new states. The Gramm-Leach-Bliley Act of 1999 effectively demolished the remaining barriers separating commercial and investment banking. Despite the scandals and crises that marked the 1990s, this was the decade when Wall Street translated its growing economic power into political power and when the ideology of financial innovation and deregulation became conventional wisdom in Washington on both sides of the political aisle. The unoprecendented amounts of money flowing through the financial sector, increasingly concentrated in a handful of megabanks, were the foundation of the new financial oligarchy.

Pg. 90: The escalating cost of campaigning has increased the importance of money. Between 1974 and 1990, the cost of a seat in the House of Representatives—the average expenses of an election winner—grew from $56,500 to $410,000; from 1990 to 2006, it tripled to $1,250,000 (more than doubling even after accounting for inflation).

Pg. 104: It is one thing to have important congressmen dependent on your campaign contributions, and to have your own people in key positions of power, and even to have some regulators enthralled by the prospect of lucrative jobs. But in addition, a cultural shift had made believers of all these people: big megabanks with little regulation was (is) believed good for the country. It was certainly good for home-buyers.

Pg. 110: The idea that owning a home is the best possible investment for a household is questionable at best. Absent government incentives, betting several times your entire net worth not only on a single type of asset, but on a single building and plot of land, is almost the worst investment you could make after accounting for risk. Many families have made money from housing price appreciation (particularly if they took out mortgages before the inflation of the 1970s), but their high returns are primarily due to the high leverage built into a typical mortgage—leverage that produces massive defaults and foreclosures in a housing downturn such as the one that began in 2006.

Pg. 120: By the mid-1990s, Wall Street was a dominant force in Washington. It had survived the implosion of the savings and loan industry in the late 1980s, the election of a Democratic president in 1992, a congressional investigation of predatory subprime lending in 1993, and a wave of scandals caused by toxic derivatives deals in 1994 without facing any significant new constraints on its ability to make money.

Pg. 147: Average real annual growth has been lower in the 2000s (through 2008) than in any decade since the 1930s; real median household income (in 2008 dollars) has fallen from $52,587 in 1999 to $50,303 in 2008. Greenspan’s lowering of interest rates after 9/11 only resulted in fueling home-buying—not real growth.

Pg. 151: Megabanks increasing use of leverage, increasing proportion of assets held for trading purposes, buying riskier assets, and selling out-of-the-money options (such as credit default swaps) are all strategies that increase returns in good times but increase losses in bad times. But this is expected by creditors as long as the government implicitly guarantees against failure. This guarantee in no longer implicit—it is explicit.

Pg. 165: Never before has so much taxpayer money been dedicated to save an industry from the consequences of its own mistakes. In the ultimate irony, it went to an industry that had insisted for decades that it had no use for the government and would be better off regulating itself—and it was overseen by a group of policymakers who agreed that government should play little role in the financial sector.

Pg. 173: Instead of issuing blank checks to the failing banks, they should have been taken over. The argument is that sick banks could only be thoroughly cleaned up via a takeover. Toxic assets needed to be removed from bank balance sheets; but as long as a bank remained independent, any such transaction had to be negotiated, and the bank’s managers (representing the shareholders) could simply hold up the government for a high price, knowing that if the bank failed, other people would be left holding the bag. If the government took over a bank, however, it could transfer the toxic assets to t separate government entity without negotiation, restore the bank to health by adding new capital, and return it to normal operation. Management would be replaced and shareholders wiped out, leaving the bank in the hands of taxpayers, who would get at least some of their money back when the bank could be sold into private hands. (Alternatively, the government could have simply bought a struggling bank at market value; at one point in March 2009, the market value of all of Citigroup’s common stock fell below 6 billion. The toxic assets could be parked on the balance sheet of the U.S. government, which could hold them indefinitely and, if necessary, absorb the losses they entailed.

Pg. 177: Takeover was only fair. Bankers who had run their institutions into the ground world no longer collect seven or eight-figure bonuses made possible only by government bailouts. Shareholders who had gambled on highly leveraged banks would lose their money. Creditors who had lent blindly would lose part of their money. Taxpayers footing the largest part of the bill would at least have the possibility of making money as banks recovered. This is how capitalism is supposed to work. Failure should be punished, not rewarded. The government should be the backstop protecting society against a financial collapse, but it should exact a price for that protection.

Pg. 194: Effective reform must address the two basic elements that created the last crisis and, absent change, will create the next one. The first is reckless borrowing and lending, which create a debt bubble that must eventually burst; the second is financial institutions that are so big or systemically important that, when the bubble bursts, they must be bailed out by the government to prevent economic disaster. The first objective should be to protect individual participants in the real economy, both households and businesses, from the potentially abusive behavior of powerful banks. But this is not sufficient to ward off a future crisis, since banks are free to load up on risky assets overseas, out of reach of U.S. protections. Therefore, the second and most important objective must be to protect the economy as a whole from the systemic risk created by enormous banks. Excess optimism, debt bubbles, and overextended banks will likely be with us forever; our goal must be a financial system where those banks can fail without being able to hold up the entire economy.

Pg. 200: ‘Too big to fail’ was the slogan of the financial crisis. It was the justification for bailing out Fannie Mae, Freddie Mac, AIG, Citigroup, and Bank of America (and extended into the auto industry, General Motors, Chrysler, and GMAC as well). It was the problem that administration officials and congressmen swore they would fix; even bank CEOs agreed. The phrase has been around at least since the 1984 government rescue of Continental Illinois. But only in 2008 did it become a pillar of government policy.

Pg. 211: The reasons to break up the big banks are simple. If there are no financial institutions that are too big to fail, there will be no implicit subsidies favoring some banks as opposed to others; creditors and counterparties will play their necessary role of ensuring that banks do not take on too much risk; banks will be less likely to engage in the excessive risk-taking that would cause the next financial crisis; and banks that do fail will not have to be bailed out at taxpayer expense. Additional regulations preventing banks from abusing their customers or exploiting loopholes to minimize their capital requirements are also necessary, of course; we do not want to relive the savings and loan crisis of the 1980s, when thousands of banks failed due to excessive risk-taking and inadequate supervision. But breaking up the big banks will help level the playing field and make the financial system better able to withstand the next crisis.

Pg. 214: The simplest solution is a hard cap on size: no financial institution would be allowed to control or have an ownership interest in assets worth more than a fixed percentage of U/s. GDP. (4% or roughly $570 billion is a reasonable choice).

Pg. 217: These size limits would only affect six banks—Bank of America (16 percent of GDP), JPMorgan Chase (14 percent), Citigroup (13 percent), Wells Fargo (9 percent), Goldman Sachs (6 percent), and Morgan Stanley (5 percent) (and none of Wells Fargo’s predecessor companies was bigger than 4 percent of GDP until a few years ago). Saying that we cannot break up our largest banks is saying that our economic futures depend on these six companies (some of which are in various states of ill health). That thought should frighten us into action

Pg. 219: Breaking up the megabanks should also help dethrone Wall Street from its privileged place in the U.S. economy. The end of ‘too big to fail’ will reduce large banks funding advantage, forcing them to compete on the basis of products, price, and service rather than implicit government subsidies. Increased competition will reduce the margins of fee-driven businesses such as securitization, trading, and derivatives, putting pressure on large banks’ profits. A larger group of competitors will also make it harder for major banks to divert such a large proportion of their profits to employee compensation; bonuses for traders and investment bankers should fall from the historically obscene to the merely outrageous.