Goldman Sachs’s lobbying efforts

by Russ Roberts on November 6, 2011

in Financial Markets, Gambling with Other's $

From 13 Bankers by Simon Johnson and James Kwak (which I recently finished in preparation for an EconTalk interview with Johnson):

Since 1932, Section 13 of the Federal Reserve Act had given the Fed the power, in “unusual and exigent circumstances,” to make loans to anyone–but only if the collateral provided in exchange arose “out of actual commercial transactions.” This requirement specifically excluded investment securities, which meant that in a crisis, investment banks might not have any valid collateral with which to borrow from the Fed.

This danger worried the remarkably prescient executives at Goldman Sachs. At their suggestion, the “actual commercial transactions” requirement was dropped in a “miscellaneous provision” of the Federal Deposit Insurance Corporation Improvement Act of 1991, ensuring that the Fed could lend against any collateral in a time of crisis. This change gave the Fed the power to widen its protective umbrella to encompass investment banks, at the same time that those banks were increasing the riskiness of their operations by expanding their derivatives and proprietary trading businesses and taking on additional leverage. This seemingly minor change would be of crucial importance seventeen years later; when the housing bubble of the 2000s ended –and with it the seemingly unlimited supply of money flowing from novel and largely unregulated financial products–not only investment banks but a major insurance company would have to be rescued with government money.

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{ 119 comments }

Jon Murphy November 6, 2011 at 5:51 pm

It’s amazing how far back the roots of the Great Recession go back.

muirgeo November 6, 2011 at 6:01 pm

Excellent! This type of stuff HAS to be a primary focus of a common cause you would think we could all rally against. This sort of regulatory capture and lobbying for policy in my opinion undermines markets more than all the welfare programs and all the poor regulations combined.

Very much looking forward to your talk with Simon Johnson.

lamp3 November 6, 2011 at 11:31 pm

Yes, markets are definitely undermined when

a) Government fails by intervening in markets.
b) Government’s expansion of powers leads to intervention.

Were you trying to say something else?

muirgeo November 6, 2011 at 11:45 pm

If you were paying attention this is about Goldman getting good regulation overturned in their favor. Government people did not go to the free market guys…. the “free market” guys with lots of money went to the government.

This is a story about how loosening the rules lead to a bad outcome. You should not try to rewrite or re-intepret what is obvious. It is you who is trying to say something that flies against reality and truth and history.

Rob November 7, 2011 at 12:05 am

Muirgeo,

I just don’t know how many times this point needs to be made. If you want to get lobbying out of government, then rid the government of the ability to dole out favors. You have to see the naivety of your comment….”If only those poor government people had been just a little stronger in the face of all that pressure from big bad Goldman, everything would have worked out fine.” How many times do you need to see instances of regulatory capture before you realize that the solution isn’t more regulation?

Greg Webb November 7, 2011 at 12:18 am

A well-written response, Rob!

Methinks1776 November 7, 2011 at 1:03 pm

Agree. And totally wasted on the intended target.

Herman November 7, 2011 at 2:37 pm

So…? This was a provision that limited the government’s ability to dole out favors. That provision seems like a good one. We should agree on that.

It was in the context of a provision that allowed the government to dole out favors in the first place. We can disagree on whether that was the better provision to abolish, but that’s not the point in question. Given a Fed that can issue bailouts, more limitation is better.

dsylexic November 7, 2011 at 12:11 am

i have never called you names before,but this time you are a large douchebag .you have no brains.sorry.
regulatory capture,bah.no regulator,no capture,kapische?

Greg Webb November 7, 2011 at 12:21 am

Dyslexic, it’s such an easy concept to understand that it makes you mad that Muirgeo just refuses to understand. So don’t feel bad about calling Muirgeo names. You shouldn’t, but it’s entirely understandable.

CalgaryGuy November 7, 2011 at 12:25 am

Please explain why the prior regulation was good (your words) but somehow the expanded regulation made it bad.

If you believe government is so weak that the slightest pressure from a lobbyist causes them to cave, why do you want to give them more power?

Paul Andrews November 7, 2011 at 12:25 am

Which bad outcome are you referring to? The crash of 2008 happened before the “miscellaneous provision” came into play (according to the narrative above). The loosened rules were used to bail out troubled banks.

So I assume by your phrase “bad outcome” in your comment above, you mean the actual bailing out rather than the crash itself.

I agree that the bailing out should not have occurred, but this seems to have been done via a variety of measures, some of which involved simply ignoring regulations, so extra regulations would not necessarily have helped.

The problem exists in the power structure. Large corporations including banks have direct government power and fairly unfettered access to taxpayer funds, through both Treasury and the Fed. There’s no point us little guys screaming at them about regulations, because they will always write the regulations to suit themselves, and they will always fail to enforce the existing regulations that do not suit them.

There is no top-down solution for any of the above. All we can hope for is for democracy to re-activate as the people are forced, by their dire personal circumstances, to wake up and elect people who haven’t sold out and who won’t be bought. I also hope that natural attrition of the parasitic corporate-government relationship will occur gradually as the debt burden reaches a point of unsustainability, and the parasitic organizations start to starve.

Darren November 7, 2011 at 12:59 pm

The crash of 2008 happened before the “miscellaneous provision” came into play (according to the narrative above).

“At their suggestion, the “actual commercial transactions” requirement was dropped in a “miscellaneous provision” of the Federal Deposit Insurance Corporation Improvement Act of 1991

Maybe I misunderstand what you are saying, but the implementation of the ‘miscellaneous provision” was in 1991. I suppose this is not when this “came into play”, but it was certainly sitting there waiting to be exploited.

lamp3 November 7, 2011 at 1:06 am

No, I do not disagree with you at all Muirgeo:

The (regulatory capture and lobbying, or “failures of government”) are responsible for undermining (markets). I keep seeing themes about how government failure interferes with the process of profit and loss, undermining whatever market one might be looking at.

SaulOhio November 7, 2011 at 5:31 am

If they went to the government for more money, they aren’t “free market guys”.

brotio November 7, 2011 at 6:41 pm

Of course, this is different than when the “free market” guys at Chrysler, GM, the UAW, and Solyndra went to the government for special favors.

AnthonyL November 7, 2011 at 9:35 pm

Nothing regulates a free-market better than a free-market.
It’s a scary world out there. Let’s keep it equally scary for all.
It would have been great if the government folks simply turned to GS and said “sorry there’s nothing we can or should do. You’re on your own. We do not listen to industry to set policy.”
Could you imagine a politician saying such a thing!

Dan J November 8, 2011 at 2:04 am

If only we could elect the right people.
546? The number of benevolent altruistic Americans needed to run our country perfectly. It can happen. We have Obama as one. One down, 545 people to go. Then no officials would be pressured by the sinners of businesses or the evil wealthy people. It would all come together and end poverty, sickness, hunger, and inequities that are unbearable in the US.

Ssssiigghhh….. If only!

Greg Webb November 6, 2011 at 6:18 pm

Russ, I look forward to listening to this podcast. I think it is a timely topic that is sure to arouse a lot of interest. I hope that we can, once and for all, end this connection between politicians and their political cronies like Goldman Sachs.

muirgeo November 6, 2011 at 11:52 pm

Yeah Greg this will be an important one for you not to miss.

Greg Webb November 7, 2011 at 12:14 am

No, Gerorge. You should not miss it. I’m hoping you will finally get a clue as to why allowing corrupt politicians to use taxpsyer money to bail out political cronies makes you a “useful idiot” to both.

Methinks1776 November 6, 2011 at 7:13 pm

and with it the seemingly unlimited supply of money flowing from novel and largely unregulated financial products

Because the regulator could control them better than the banks? The regulator still doesn’t understand how the ultra short ETFs are constructed and the implications for the buyer in terms of gamma (short when you need it, way long when it’s useless). And this is a fairly simple one to understand too. If it did understand it, a.) regulation wouldn’t make it better and b.) the damn things exist in response to previous regulation in the first place. Regulation begets innovation of the worst sort – and that won’t stop. In fact, the drive to concoct derivatives to get around the unintended consequences of regulation has intensified…within Goldman.

The tragedy is that there is that there is a government willing to socialize risk and a Fed. A government and a central bank that encourages banks to take uncompensated risks and is itself (the Fed) levered 55:1 (the NY Fed is levered 105:1). All that 30:1 and 40:1 leverage just pales in comparison.

GAAPrulesIFRSdrools November 6, 2011 at 8:03 pm

“Regulation begets innovation of the worst sort”

That should be a masthead somewhere.

Greg Webb November 6, 2011 at 9:52 pm

Hear, hear!

Nikolai Luzhin, Eastern Promises November 6, 2011 at 8:07 pm

And, now what is the problem?

Someone had the common sense to realize that the Federal needed additional powers.

Is the complaint the jealously we always get here? It helped the rich. No, around here we defend the rich.

If there is any complaint, of course it should directed at ourselves. Goldman Sachs comes in and says, we can see events unfolding where our business plans might blow up and blow up everyone else, so you need to increase you lending capacity, and we say, “OK, go ahead, because we don’t believe in gov’t regulation ala Hayek. IOW this lands at the feet of the anti-regulation crowd, entirely. (How could one stop GS from blowing up itself and the World, except by Regulation?)

Since we wouldn’t stop GS we did the only prudent thing: opening the window at the fed.

Lesson of the day: If you are going to let private firms play with nuclear weapons of mass financial destruction, you have to build public bomb shelters.

IOW, this isn’t news

Paul Andrews November 7, 2011 at 12:37 am

“around here we defend the rich”

I think Hayek would only defend the rich who obtained their riches through fair means. He most certainly would not defend the rich parasites feeding on the government host.

Hayek was not opposed to all regulation. He merely felt it should be limited in certain ways, that he attempted to lay down. I feel that he would have been especially concerned to keep a tight reign on any central bank.

In his later writings he advocated the removal of central banking altogether, because of exactly the kinds of problems we are debating here.

Economic Freedom November 7, 2011 at 3:27 am

The rich are parasitic by definition. You librarians try to distinguish the good rich from the bad rich – you will never succeed. There is only bad rich and worse rich. People who sit home cashing dividend and rent income checks are not working; they are parasitic. The people who are laboring to bring income into the company and the the people who work to pay their rent are the ones who are working and producing. Librarians love parasites and freeloader that is why they kiss the ass of the rich whether they are the rich of the bad or worse variety. We can start to ameliorate this gross distortion of capitalism by having a progressive capital gains tax and progressive tax on rental/dividend income, etc. Librarians have their heads slammed between to books written by right-wing freaks like Hayek or Friedman or Mises. I hate Mises to pieces.

Paul Andrews November 7, 2011 at 3:44 am

I see that you are able to distinguish between “bad” and “worse”.

You see all rich people as parasites. At least you can see that some are less parasitic than others.

Which of us is entirely good? Are there not selfish labourers also? Do you not yourself have some selfish traits?

Some of us channel our selfishness into fair means of obtaining material goods. I’m not saying that makes us saints.

What I do believe is that in a free society, our natural selfishness is channeled more productively than in a chained society.

(I also do not envy the parasitic rich, I believe they lead hellish, soulless lives, a punishment in itself).

Vuk November 7, 2011 at 11:38 am

typical response from someone with no knowledge whatsoever on the subject – delivering a false argument (if the rich are parasites how did they get rich in the first place? not all of them are paris hilton you know)
and after a ridiculous elaboration follows a breath taking conclusion on how should the society be run – well done, Sir!

Darren November 7, 2011 at 1:05 pm

The people who are laboring to bring income into the company…

And where did this company come from? Do you think they are just natural phenomena waiting to for laborers to come in and start working?

Greg Webb November 7, 2011 at 6:01 am

Paul

Hayek was a running dog for the Kochs. Haven’t you read the evidence? Buckle up man

Or read

REACTIONARY MIND: CONSERVATISM FROM EDMUND BURKE TO SARAH PALIN
http://coreyrobin.com/new-book/

Greg Webb November 7, 2011 at 12:41 pm

Paul, Nikki is using my name to spread his leftist ideology. His post above is just more of his stupidity.

Paul Andrews November 7, 2011 at 5:01 pm

Nikki if this is what you need to resort to your position must be a weak one.

Greg Webb November 7, 2011 at 10:23 pm

His position is always the stupid one.

GAAPrulesIFRSdrools November 7, 2011 at 9:09 am

Why is it the left decries the concentration of power, except if is imbued in an unaccountable quasi-governmental agency?

Jon Murphy November 7, 2011 at 9:11 am

Because governments are public servants who always do what’s best for the people because they are above reproach and influence.

Vuk November 7, 2011 at 11:51 am

“If you are going to let private firms play with nuclear weapons of mass financial destruction, you have to build public bomb shelters.”

this is why you have institutions such as the rule of law and enforcement of contracts to prevent disastrous outcomes.
Some regulation is hence desirable, but when regulators wish to create a risk free society for the financial industry this is very dangerous as they paradoxically become the victims of asymmetry of information, the very thing they are trying to fight against.

vikingvista November 7, 2011 at 5:14 pm

Some regulations, arbitration, insurance, education, transportation, security, defense, nourishment, health care, shelter, clothing, etc. are always desirable, to different degrees to different people. But the state is the least desirable source for any of them.

Vuk November 7, 2011 at 6:24 pm

I agree, private provision of the goods and services you mentioned is very often done much more efficiently than public provision.
my point on regulation was that they are constantly in a paradox

Krishnan November 6, 2011 at 8:09 pm

If it took this long to figure out what one Investment Bank did to protect itself from it’s reckless behavior, one can only wonder as to what else is buried in all the laws and regulations passed that almost no one reads – but is impacted by it … A depressing thought.

Nikolai Luzhin, Eastern Promises November 6, 2011 at 8:46 pm

Wrong Krishnan

Goldman Sachs did this to protect us from our reckless behavior in letting it have nuclear weapons of mass financial destruction.

We had a choice. We could have told GS, No, you are not to engage in any business that under circumstances might require such loans from us. IOW we had choice regulate then or pay now, A or B.

Jon Murphy November 6, 2011 at 8:47 pm

Or we could have said “If you fuck up, we’ll not bail out out.”

Greg Webb November 6, 2011 at 9:21 pm

That would have been the best choice. Jon.

Jon Murphy November 6, 2011 at 9:22 pm

By the way, I apologize for my language.

Greg Webb November 6, 2011 at 9:50 pm

Jon, it’s quite understandable. I am surprised that more libertarians don’t curse at the stupidity of giving taxpayer money to political cronies.

Jon Murphy November 6, 2011 at 9:53 pm

Still, I try to control my language in public

Economic Freedom November 7, 2011 at 3:32 am

“By the way, I apologize for my language.” No, you aren’t sincere. You thought you were being cute. Washing your mouth out with soap and water is the remedy. Act like a child and you’ll be treated like one. Typical juvenile librarian bad behavior.

Greg Webb November 6, 2011 at 9:55 pm

and what would be the point of this non-option?

so we go commit financial suicide because we made a mistake.

muirgeo November 6, 2011 at 11:51 pm

Well , like maybe the NO MAJOR CRASHES for 50 years thing…

Greg Webb November 7, 2011 at 12:10 am

That’s not me. Nikki is using my name.

Jon Murphy November 7, 2011 at 7:16 am

No major crashes for 50 years? How about the 60′s? The 70′s? The 80′s? the 50′s? The only decade we didn’t have a recession (in the US) was the 90′s.

I really suggest you brush up on your history

Jon Murphy November 7, 2011 at 7:16 am

I wasn;t even alive for all of those and I know them

muirgeo November 6, 2011 at 11:50 pm

“Or we could have said “If you fuck up, we’ll not bail out out.”

Yeah because that worked so good for Black Friday (1869) , The Panic of 1873, the Panic of 1884 · the Panic of 1893 · the Panic of 1896, Panic of 1901 · Panic of 1907 · Depression of 1920–21 · Wall Street Crash of 1929 … It was endless repeated boom and bust back then. History is asking you to please pay attention.

CalgaryGuy November 7, 2011 at 12:31 am

Yeah, because there has been nothing but sunshine, lollipops and a bull market since government expanded greatly in the 30s.

muirgeo November 7, 2011 at 12:42 am

Yeah, because there is no policy difference post FDR and Post Thatcher /Reagan.

Paul Andrews November 7, 2011 at 12:44 am

There is no economic nirvana. There will always be ups and downs.

We are shortly to pay very heavily for the artificially long credit cycle caused by the loose credit policies of the last 30 years.

Take a look at a private + public sector debt to GDP chart for an idea.

One huge down, possibly catastrophic, for the sake of avoiding shorter and shallower down periods.

Greg Webb November 7, 2011 at 6:03 am

muirgeo

if we don’t bail them out we have a Greater Depression instead of a Lesser Depression

Jon Murphy November 7, 2011 at 7:14 am

Not every economic recession is financial. Therefore, not every one is be solved/prevented by bailing out banks/increasing governmental regulation.

Darren November 7, 2011 at 1:13 pm

IOW we had choice regulate then or pay now, A or B.

Yes, and our feckless leaders, whom we ‘hired’, chose to pay in (at that time) the future because they are only focused on what they can get *now* rather than on possible future complications. They did not think they would be around to catch any fallout. If they were, they could tap dance around it.

Greg Webb November 6, 2011 at 8:11 pm

Since we wouldn’t stop GS we did the only prudent thing: opening the window at the fed.

That type of thinking is why you are a “useful idiot” to corrupt politicians and their political cronies, like Goldman Sachs.

Nikolai Luzhin, Eastern Promises November 6, 2011 at 8:41 pm

No Greg, it is what you have to do when you refuse to regulate private firms and allow them to play with nuclear weapons of mass financial destruction.

You have only choice A or B. Prevent them from setting off the Bomb or cleaning up afterwards.

Jon Murphy November 6, 2011 at 8:45 pm

Out of curiosity, Nik, what’s your educational background? I mean, on what authority do you speak on this matter?

I ask because you say that Russ and Don, who have PhDs in Economics are unfit to speak on the matter. I’m just wondering what makes you more of an authority figure than them.

If you want, I’ll start first: I have a Bachelor’s in Economics and Philosophy from Framingham State University and I am currently working towards a Masters at UNH.

Nikolai Luzhin, Eastern Promises November 6, 2011 at 9:23 pm

Out of curiosity, Nik, what’s your educational background? I mean, on what authority do you speak on this matter?

The details of my life are quite inconsequential … Very well, where do I begin?

My father was a relentlessly self-improving boulangerie owner from Belgium with low-grade narcolepsy and a penchant for buggery. My mother was a 15-year-old French prostitute named Chloe with webbed feet. My father would womanize; he would drink. He would make outrageous claims like he invented the question mark. Sometimes, he would accuse chestnuts of being lazy. The sort of general malaise that only the genius possess and the insane lament …

My childhood was typical: summers in Rangoon … luge lessons … In the spring, we’d make meat helmets … When I was insolent I was placed in a burlap bag and beaten with reeds — pretty standard, really.

At the age of 12, I received my first scribe. At the age of 14, a Zoroastrian named Vilmer ritualistically shaved my testicles. There really is nothing like a shorn scrotum — it’s breathtaking … I suggest you try it.

Is there anything else you’d like to know?

Jon Murphy November 6, 2011 at 9:24 pm

Haha touche man touche. I’ll give you that one

Paul Andrews November 7, 2011 at 12:45 am

Yep, very good!

Greg G November 7, 2011 at 7:14 am

Nikolai

That bio was hysterical. I haven’t stopped laughing yet. This blog could use more humor, especially self-deprecating humor.

HaywoodU November 7, 2011 at 9:01 am

So you invoke Dr. Evil(Mike Myers) instead of responding honestly to an honest question.

You are indeed a troll.

Paul Andrews November 7, 2011 at 5:03 pm

Ah I didn’t realise this was plagiarised. It’s all starting to make sense…

muirgeo November 7, 2011 at 12:00 am

Nice public University Jon. Any government loans?

Jon Murphy November 7, 2011 at 7:11 am

Not a penny. I paid for my education entirely out of my own pocket and through private scholarships.

For those of you in college/looking to go to college, there is a ton of money in scholarships out there. You just gotta find it.

Greg Webb November 7, 2011 at 6:09 am

the bio of Nikolai Luzhin, Eastern Promises, below was put up by an impostor

Nikolai has a doctoral degree, with economics being one of several academic subjects he has mastered.

His best skills for us are that he is one of the most widely read people around. That, and because of peculiar family circumstances, he has absolutely no bias regarding economics.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 11:25 am

Truer words of wisdom have never been spoken by mortal man, or any man “born of woman.” That latter quote proves that I am a master of Shakespeare, having seen the movie version of MacBeth on TV.

Greg Webb has inadvertently forgotten to mention the following.

I admit that my English is imperfect, but in all other areas of knowledge, I am a jack off of all trades. I know you agree.

When I was 18, I began my formal training in economics by attending evil economics school. I worked my way through school on a commercial fishing boat. I started out baiting the hooks as an Assistant Baiter and was soon promoted to Master Baiter (my intellectual talents and general “smarts” having become obvious to everyone by that time).

At age 25, I took up tap dancing. I wanted to be a quadruple threat: an actor, dancer, economics journalist, stand-up comic. For this last skill, I have chosen Cafe Hayek to practice and hone my already considerable talents; those same talents that were so evident when I was working as a professional Master Baiter.

Instead of complaining about it, you should all be honored. Just sit back and enjoy.

Greg Webb November 7, 2011 at 12:44 pm

Nikki, is using my name to promote himself. Based on his poor writing and analytical skills, it appears that he has a degree in art from his 7 years in college.

Greg Webb November 6, 2011 at 8:55 pm

You have only choice A or B. Prevent them from setting off the Bomb or cleaning up afterwards.

No, Nikki. There are three choices. The third choice is to take away the tools necessary to build the bomb. No government incentives and no government bailouts.

steve November 6, 2011 at 9:25 pm

Can you cite examples of countries not bailing out their failing banks? What was the result? Were the markets wrong when we had record TED spreads with the collapse of just one moderate sized bank (Lehman)?

Russ- Many of us view regulations written to meet industry demands as being equivalent to deregulation. Could you explore that idea sometime?

Steve

Jon Murphy November 6, 2011 at 9:28 pm

Here’s an example: MF Global failed on Monday. We didn;t bail ‘em out. No problem.

Jon Murphy November 6, 2011 at 9:29 pm

Sorry, that came out kinda aggressive.

Greg Webb November 6, 2011 at 9:47 pm

Perhaps…but it is a good example, Jon.

Greg Webb November 6, 2011 at 10:01 pm

We did here in the US in the Great Depression.

We didn’t bail out our banks and thousands failed.

Austerity doesn’t work

http://seekingalpha.com/article/304761-simon-johnson-we-are-looking-straight-into-the-face-of-a-great-depression

Jon Murphy November 6, 2011 at 10:03 pm

Do we have 2 Greg Webbs?

Jon Murphy November 6, 2011 at 10:04 pm

And we didn’t do austerity during the Great Depression.

Greg Webb November 6, 2011 at 10:27 pm

Jon, that is just a troll. Cutting government spending always works.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 8:45 am

we have a lot of trolls now, like Jon, who thinks, why I don’t know, that a bottom league broker dealer would be too big to let it fail.

There is an international list of TBTF firms—there are 29 or 30, all investment banks or banks.

Greg Webb November 6, 2011 at 9:57 pm

Greg that doesn’t take away the bomb.

overnment incentives and no government bailouts are not necessary to building the bomb.

all it takes to build the bomb is to get some one sign up on the other side of a big package of synthetic CDOs

Greg Webb November 6, 2011 at 10:28 pm

Thanks for your silly comments, Nikki. You write as poorly using my name as you do with your own.

jpm November 7, 2011 at 12:15 am

I wonder if Methinks could comment of MF Global. We didn’t bail them out but it was a case where MF Global, a commodities brokerage firm took the segregated funds from their customers, the cash required for maintenance margin and invested in, of all things, Greek bonds. mixing segregated funds is just theft and the Government should have stepped in in this case to get the money back I would think. Now maintenance margin requirements have been “raised” by the CME as of Friday. This sounds suspicious. It could created some sort of run or some sort of contagion or be contagion starting. I am wondering if Methinks has any input on this.

Methinks1776 November 7, 2011 at 7:45 am

JPM, I commented my little heart out on MFG on the MFG thread a few days ago, as did PKSully, who actually cleared through MFG.

Jon Corzine bought Italian bonds, not Greek bonds. His bet was that Italy is TBTF. It is possible that he was at least partially hedged with CDS contracts on that Italian debt. However, when Greek bondholders were bullied into a 50% haircut and ISDA decided (under enormous political pressure, I’m quite sure) to protect CDS writers by not allowing the default swaps to pay out because the bondholders were bullied into a “voluntary” haircut, the value of the CDS on other sovereign debt dropped to virtually worthless. Unable to hedge their exposure, other PIIGS debt holders dumped PIIGS debt, driving its price down. That’s the spark (ISDA’s decision) that lit the fuse which blew up the MFG bond book.

The CME did not raise maintenance margin requirements (although the Friday night CME press release certainly made it sound that way). Instead, it lowered initial margin requirement to maintenance margin. The CME sent another press release to clarify. The reason for doing that was to help former MFG clients avoid a technicality in transferring existing positions to other clearing firms and suffering margin calls that could wipe them out.

I’m not a fan of Jon Corzine’s (mildly put), but it’s not clear that the firm stole from client accounts. Apparently, the books are a mess. I don’t know why since the regulator is supposed to check financial statements monthly and member firms undergo a cavity check yearly and by every exchange of which they are a member. I guess that’s just another sign of the good job a regulator is doing with large, politically connected firms. IMO, it’s fair to criticize Corzine to do such enormous size in such a risky asset, but until the evidence is gathered, it’s not fair to publicly indict him for theft. Which, btw, if he did steal, I don’t think he’ll ever do time for. They’ll find an underling to take the fall or blame it on a glitch.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 8:31 am

Methinks writes, “ISDA decided (under enormous political pressure, I’m quite sure) to protect CDS writers by not allowing the default swaps to pay out because the bondholders were bullied into a “voluntary” haircut”

First, thank you for confirming what I repeatedly tell everyone: governments create markets and distribute income.

Love them or hate them, but those are the rules of the game.

Now, to correct the misstatement of facts by Methinks. Simply put, ISDA did no such thing. ISDA provides, so to speak, the legal forms that are credit default swaps. These legal forms provide that if the creditor “voluntarily” takes less than full payment that there is no default on the contract.

In the case of Greece, under threats (express and implied) from France and Germany (not ISDA), the creditors of Greece took a “voluntary” 50% haircut. As this was “voluntary” it would appear that the CDSs on Greece did not default.

IOW, if you want to enforce you CDS, you have to stand your ground and take your medicine.

Now, apparently, the estimate was that neither Corzine/MFG or anyone else would stand their ground on Italy, so their CDS on Italian debt is also of no help.

Methinks1776 November 7, 2011 at 8:41 am

If I hold a gun to your head and force you to “voluntarily” hand over half your property to me, is that a “voluntary transfer”?

This is a rhetorical question I don’t expect you to know the answer to.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 11:00 am

You have a very quaint and impractical idea of what constitutes “voluntary” action.

If a government tells someone to “jump” or pay a fine or go to prison, and that person jumps, that would be a “voluntary” act. After all, he could have chosen not to jump and paid the fine or gone to prison. No government agent is literally forcing him to jump.

For example, paying the US income tax is clearly a “voluntary” act. No one forces you to pay it. You pay it “voluntarily” or you pay a penalty or you go to prison.

I think the “voluntary” nature of such a tax would be obvious to every US citizen.

HaywoodU November 7, 2011 at 5:40 pm

Or the definition of voluntary is something you refuse to understand.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 8:47 pm

Methinks1776

You question is a good one, one which I do know the answer to, and one which important to you.

We are talking about the rights of an innocent third party.the counterparty on the “insurance”. In the eyes of the law, I cannot take a “voluntary action” and may the position on an innocent third party worse. One has a duty to avoid consequences on their own, incurring the cost and expense, on their own.

I agree with you that the haircuts on the holders of Greek debt were not voluntary between the holders of the bonds, on one side, and Greece, Germany, and France on the other. I think the bondholders should have stuck to their guns.

What those bondholders cannot do is “cave in” to the pressure and then go to their counterparties and say, “we gave in,” pay us.

I personally believe that this is the kind of issue to which this blog should pay attention, if it has a reason for existing.

Everything I have read suggest that Greece, France, and Germany knew who the Counterparties were and that they wanted to protect them, which is why no solution for Greece ever involves a “default.”

Since it is at least our money in part, I believe we have a right to know who is being helped and who is being hurt

daniel November 7, 2011 at 1:46 am

The state has a monopoly over the money. So, if you own something then you have the right to make the rules. Right! The main problem is that you cannot oblige another person to use your product and, in the same time, you cannot ban using of alternative products. I’m refering here that the law which ban any alternatives of current money isn’t fair.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 8:40 am

Daniel

You are wrong. You can issue your money to anyone anytime you want.

Just sign them a promissory note.

Legally, there is no real difference between your promissory note and the federal reserve notes in your billfold, except the federal statutes that say that your creditors have to take federal reserve notes in payment, but they don’t have to take your promissory notes.

Throughout history everyone at some time issued their own “notes.” Our Founding Father had the good sense to give the power to the Federal Government

Jon Murphy November 7, 2011 at 9:02 am

Yes there is. A promissory note is in IOU, which will remain until you pay it off with *shock* federal notes.

The government does have monopoly on money. It’s not a bad thing. It just is

vikingvista November 7, 2011 at 10:44 am

It is a bad thing. There is no monopoly immune from the adverse effects of monopoly.

Jon Murphy November 7, 2011 at 10:47 am

True, but if we didn’t have one legal source of tender, our economy would be in a lot worse shape. That was one of the issues the Articles of Confederacy ran into.

Unless we moved to an entirely barter system.

vikingvista November 7, 2011 at 11:02 am

No, the economy would be in far better shape, since the diversity of the money product and absence of a central bank and politicized money inflating monopoly would increase economic stability and permit faster real growth.

Multiple currencies, per se, was not a problem at the time the Articles were abandoned. Branch banking regulations were. You could benefit by reading more Selgin.

Jon Murphy November 7, 2011 at 11:06 am

I’ll have to check him out. Any particular book you recommend?

Nikolai Luzhin, Eastern Promises November 7, 2011 at 12:16 pm

Jon,

Others, much more knowledgeable and far wiser than I, have had some good things to say about this little pamphlet by an Austrian economist named Murray Rothbard. They tell me it’s one of his best. It’s a free PDF download. Go for it.

“What Has Government Done to Our Money?”
http://mises.org/books/whathasgovernmentdone.pdf

vikingvista November 7, 2011 at 5:32 pm

Jon,

My posts with links go to “Your comment is awaiting moderation.” eternity. Sorry. Look up…

Central Banks as Sources of Financial Instability
Less than Zero
The Theory of Free Banking
History of Money and Banking in the United States (Rothbard)

…in that order, all available free online.

Jon Murphy November 7, 2011 at 6:54 pm

Thanks VV. I’ll add them to my list.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 8:53 am

We pay people in gov’t too little:

Abramoff: We would certainly try to make the activity legal, if we could. At times we didn’t care.

But the “best way” to get a congressional office to do his bidding – he says – was to offer a staffer a job that could triple his salary.

Abramoff: When we would become friendly with an office and they were important to us, and the chief of staff was a competent person, I would say or my staff would say to him or her at some point, “You know, when you’re done working on the Hill, we’d very much like you to consider coming to work for us.” Now the moment I said that to them or any of our staff said that to ‘em, that was it. We owned them. And what does that mean? Every request from our office, every request of our clients, everything that we want, they’re gonna do. And not only that, they’re gonna think of things we can’t think of to do.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 9:06 am

In news worth reading, Baker M, reports:

Spain – Town Hall sentenced to indemnify a sculptor for moral right infringement
The Provincial Court of Alicante has issued a judgment holding the owner of a sculpture liable for infringement of the moral right of its sculptor.

The claimant in these proceedings was a sculptor who was engaged in 1988 by the town hall of a coastal village (Town Hall) to create a sculpture for the town’s promenade. The resulting work, eventually called “Monumento al Pescador” (“Monument to Fisherman”), consisted of two different parts: one called “Timón” (“Helm”) and the other called “Proa” (“Bow”), the latter being intended to be surrounded by sea water. Between 2001 and 2004, the Ministry of Environment promoted and implemented a project for the regeneration of the town’s beach, which resulted in the sculpture being removed from the sea and instead becoming surrounded by sand.

After being dismissed in the first instance, the claim reached the Provincial Court, which held the Town Hall liable for infringement of the claimant’s moral right to the integrity of his work, for two reasons:

· For breach of its obligation to maintain the work, which obligation it was responsible for not only as owner of the sculpture, but also as a public body required to look after the artistic heritage of the municipality.
· For breach of its obligation to take the necessary measures to safeguard the artistic conception and uniqueness of the “Proa” part of the sculpture, and failing to inform the Ministry of Environment and the sculptor about the impact that the regeneration project was going to have on the work.

The Court, however, rejected the sculptor’s request that the Town Hall be ordered to remove the artificial sand and to place the “Proa” in the sea as it was originally planned, holding that there was a public interest in the regeneration project that outweighed the sculptor’s moral right. Nevertheless, the Town Hall was ordered to:

· Repair all the damaged parts of the “Proa”, as well as the light beam that visually connected at night the two pieces of the sculpture.
· Indemnify the sculptor for moral damages in the sum of €11,287.67.
· Publish, at its expense, the ruling of the judgment in a national newspaper as well as in a national art and/or sculpture-specialised magazine.

Greg Webb November 7, 2011 at 12:48 pm

The Global Regulators announced their list of TBTF (i.e., political crony) companies, which include:

1. Bank of America Corporation
2. Bank of New York Mellon
3. Citigroup
4. Goldman Sachs
5. JPMorgan Chase & Company
6. Morgan Stanley
7. State Street
8. Wells Fargo.

Now, why would anyone want to bailout these companies when the next boom busts? Muirgeo, Irritable Bowel, and Nikki advocate doing so, which makes them “useful idiots” to corrupt politicians and the above-named political cronies.

Nikolai Luzhin, Eastern Promises November 7, 2011 at 8:49 pm

not true.

I advocate breaking them up so that they are no longer too big to fail.

Jon Murphy November 7, 2011 at 8:54 pm

No such thing as too big to fail. Nothing but a slogan to justify stimulus.

Nikolai Luzhin, Eastern Promises November 8, 2011 at 7:15 am

no such thing as too big to fail

and how, pray tell, did anyone arrive at this really really stupid conclusion?

Nikolai Luzhin, Eastern Promises November 8, 2011 at 7:46 am

If we don’t somehow manage their risk, we will have to bail them out,

Why, the reason is simple and includes:

1) I don’t want to see children and families going hungry by the millions,living in tent cities

2) I don’t want to see riots for food or people dying for lack of shelter, running water, etc.

3) I am not interested in the armed overthrow of the gov’t

WhiskeyJim November 7, 2011 at 8:44 pm

An IMF study agrees with the post’s authors:

Canadian banks [which did not need bail-outs] tended to be in the third quartile in capitalization (equity over assets); not distinguished but above the fifth quartile that virtually all needed public infusions.

Neither did Canadian banks stand out in liquidity measurements, settling in at the second quartile, although US bank liquidity was particularly scarce since they treated their mortgage-backed securities as liquid. Regressions reveal though that liquidity was not as strong predictor of resilience as capitalization.

But it is in the funding structure that Canadian banks distinguished themselves. Where US banks rely heavily on the wholesale market, Canadian banks rely almost totally on retail trade. The IMF analysis is particularly interesting since it shows the following:

The fact that our analysis could predict the most vulnerable banks without using any information on asset side exposures is by itself an important result. It highlights the importance of asset and liability structure. It points to strategic decisions in business model choice instead of tactical investment mistakes as the more likely cause of some banks dismal performance during the crisis.

Rocco Huang and Lev Ratnovski, “Why Are Canadian Banks More Resilient?” (IMF, July 1, 2009), http://www.imf.org/external/pubs/ft/wp/2009/wp09152.pdf.

The top American banks remained inordinately exposed to incestuous risk and lack of independent retail capital. FrankenDodd did nothing to address that issue.

Nikolai Luzhin, Eastern Promises November 8, 2011 at 7:23 am

WhiskeyJim

Respectfully, the post has no conclusions and the IMF study doesn’t support what you imply.In fact it supports exactly what I have been saying.

As you write, “It points to strategic decisions in business model choice.”

Goldman Sachs made choice to get involved with financial nuclear weapons. That was its strategic business model. Everyone knew that was what it was doing. Buffett and Munger warned everyone. During the last years of Clinton the FDIC tried to stop such, to be blocked by Larry Summers, et al.(did you see his latest FT piece; talk about a liar about what he has done).

Following Hayek, we didn’t regulate Goldman. Thus, as you write, “top American banks remained inordinately exposed to incestuous risk” and nothing has changed. (Thanks Summers and G-Man)

IOW you just made the overwhelming case for regulating Goldman so where is you voice in ripping Hayek?

WhiskeyJim November 8, 2011 at 12:41 pm

Let us first agree on the facts, beginning with the post:

1. 13bankers identify that relieving Goldman Sachs of their commercial requirements for collateral as a fundamental reason for their collapse. I cited IMF research which explains that in fact lack of such collateral is the best predictor of bank failure. Surprisingly somewhat contrary to popular memes regarding the cause of the financial collapse, the lack of commercial capitalization predicts bank failure better than their shaky or toxic assets. IOW, banks failed because they were under-capitalized.

2. Before governments began heavily regulating banks, capitalization was generally about 25-30%. It was regulation, including the Basil Accords, FDIC, etc. that allowed that capitalization to wither to current norms of 5-10%. And in the case of the large banks most collateral as defined is arguably incestuous which increases its risk exposure in the case of crisis.

You seem to be arguing that all we need is tighter, smarter regulation. I am arguing that it is folly to rely on ‘smart’ regulation. In fact, the more standardized regulation and control, the more havoc crisis causes since there is no duplication or variation in the system; they are all wrong together. Canadian banks stand out from the crowd because they rejected accepted regulation.

Conclusion: We can not rely on super humans to write regulation. We must allow failure to teach us. I think that is basically what Hayek said.

Some would argue that allowing fractional reserve banking forever condemns it to a higher rate of failure. Those in favor argue that society will grow more slowly if we do not allow it. My argument is that especially since we allow it, we need to allow success and failure to determine where the dynamite line is, since it is impossible for regulation to prevent explosions, and given that regulation is so uniquely susceptible to vagaries caused by political special interest. This argument is not driven by economics or ideology; it is a practical one.

Greg Webb November 8, 2011 at 1:01 pm

A good analysis properly supported by facts. Thanks, WiskeyJim!

Nikolai Luzhin, Eastern Promises November 8, 2011 at 5:18 pm

if you are going to allow failure, then you must regulate firms so that they don’t become to big to let fail or you must regulate their risk or both.

you cannot, by definition, do nothing because if you don’t regulate them eventually they will explode with a bang, talking down everyone.

We just tried you way, deregulation under Bush/Greenspan and look what it got us.

Ian Random November 7, 2011 at 9:18 pm

I really don’t understand the need for the FDIC. I wish we had banks along the lines of the Postal Bank that invested your money in government securities. Some brokerage accounts do this and even let you write checks with large minimum requirements to boot, but nothing at the middle class level.

http://en.wikipedia.org/wiki/Postal_savings_system

Jon Murphy November 7, 2011 at 9:25 pm

Well, the FDIC was originally just intended to protect small deposits in savings & loan institutions (the commonly understood bank). It has since expanded into some securities

Nikolai Luzhin, Eastern Promises November 8, 2011 at 7:34 am

what a bunch of crap

The original purpose of FDIC insurance was to promote efficiency. Business do not have the time or ability to know where to keep their operating cash. Banks, generally, did not pay interest on their corporate demand deposits at the time the insurance started. Here were the initial limits

1934 – $2,500
1935 – $5,000
1950 – $10,000

Latter, with Carter, the idea of deposit insurance was used as a way to seek votes from savers by letting them earn a high rate of interest on a risk free investment, a horrible idea.

This is a favorite Republican campaign theme, even now. Ron Paul, for example, complains that in the current environment savers cannot earn interest on their money (but you never hear anyone here complain about that idiot)

Dan J November 8, 2011 at 2:11 am

Question??

At near zero govt regulations in banks, no bailouts possible, no GSE’s to purchase loans based on high risk to default category (no money down, no job or inconsistent employment history, shabby credit history, no collateral, etc.,..), and no govt poking and prod ing to meet new CRA standards of minimum quota lending……….. Do lenders lend to a standard LMI applicant who is in a high risk of default category?
If and when ALL risk is assumed by lenders…. I would bet NO!!!

Nikolai Luzhin, Eastern Promises November 8, 2011 at 7:40 am

Dan J

Wrong.

First, lenders do not lend to only good borrowers. They lend to the least bad borrowers and lend all they have to lend to stay in business in the short run. If they don’t make loans they go out of business or shrink to nothing. This is the fundamental point of banking that no one here understands. There is no rule of economics that says the amount of money that is available and has to be lent is equal to the number of good loans. This is what Prince meant when he said, “You have to Dance while the music plays and hope there is a chair for you when it stops.”

Second, lenders will make any loan they can sell for origination or servicing fees

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