Friday, October 23, 2009

It's Not The Size Of The Banks, Comrade Bernanke, It's...

Mr. Bernanke, speaking at a Federal Reserve Bank of Boston meeting Friday on Cape Cod, said [in response to question about "too big to fail"] he would prefer “a more subtle approach without losing the economic benefit of multi-function, international (financial) firms." WSJ

The players are laying their cards on the table at the Big Casino debates over regulation. On one side of the table we have Paul Volcker, and Alan Greenspan, Mervyn King et alios, who think that banks should be broken up (although with some difference between them on how that might be done). On the other side of the table we have current Fed Chairman (who obviously knows whom he speaks for ) Ben Bernanke who thinks that Bigger is still Better when it comes to banking.

To wit, in that Friday speech, Mr. Bernanke argued: First, recent experience confirms the value of supervision of financial holding companies--especially the largest, most complex, and systemically critical institutions--on a consolidated basis, supplementing the supervision that takes place at the level of the holding company's subsidiaries.

Leaving aside the rather obvious (to anyone but Big Bank CEOs and Ben Bernanke, it seems) point that recent experience only proves that that the value of supervision of financial holding companies was roughly nil, let's examine his argument more fully.

He continues: Second, our supervisory approach should better reflect our mission, as a central bank, to promote financial stability. The extraordinary pressure on financial firms last fall underscored how profoundly interconnected firms and markets are in our complex, global financial system. Thus, any effort to address systemic risks will require a more systemwide, or macroprudential, approach to the supervision of systemically critical firms. More generally, supervisors must go beyond their traditional focus on individual firms and markets to try to identify possible channels of financial contagion and other risks to the system as a whole.

A ha. In other words, Big Banks mean Big Regulations. According to Comrade Bernanke, it's the job of the Fed (or another even Bigger Brother) to to promote financial stability, whatever that might mean.

The thin edge of the wedge has pretty much split the log of Capitalism here. The Fed's job, at least before Humphrey Hawkins slid into obscurity, is to maintain price stability and foster as full an employment situation as is consistent with the first directive. Financial stability, under that head, is only important to the extent it impairs one of those directives.

If "Financial Stability" of Comrade Bernanke refers to the casino-derivative markets never being short of liquidity, that is a fool's dream- Big Finance will keep leveraging until they ex(im)plode. It also strikes me as anti-Capitalist. Bankruptcies, liquidity shortages, defaults and currency crises are part of the game- a self-correcting game if failure is allowed to extract its price.

Paul Volcker's "middle of the road" approach, echoed by Mervyn King, to "financial stability" is to separate the casino (he, being more genteel used, speculative) elements of finance from the utility elements. In other words, instead of "financial stability" we should aim for "commercial stability" and retain the "survival of the fittest" aspect of capitalism in the big stakes arena.

In that way, Comrade Bernanke might even get his way, although I suspect the virtues of economies of scale to which he refers are offset by the vices of complacency that flow from lack of competition. As olive branch perhaps we can separate the commercial banking departments of the Big 5 from the speculative elements and roll them into one or two big firms with some Banking Czar, like Comrade Bernanke, in charge. Not that I'll be banking there, I'm going to stick with my local bank.  Then we can see if the proprietary traders at the big banks are really worth the bucks without risking the commerical financial system in the process.

The problem, to which I alluded in the title, is not the size of the banks. It's Big Finance's use of key commercial banking aspects to shield them from speculative losses that would have sent any other not protected firm into bankruptcy. Even LTCM got wound down.  Trading is supposed to be about managing risk (at least if the intent is to allocate capital wisely), and if you can't go bust, there isn't much of that.

Of course, mine is but a lone opinion from the woods of Upstate NY. I'm eager to see how the battle progresses, assuming the debate doesn't become moot due to another crisis.


Cary said...

Cary writing here. Happy holidays. Hope all is well with you and the family. I'm helping a company complete an acquisition. Funnily enough, one of the potential strategic partners is an old friend / colleague of LY's. Old friend wanted to say hello to LY. Best way?