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Commentary

Anything that is too big to fail is too big to exist

The Quiet Coup by Simon Johnson (HT: Reader “KVV”)

The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

… for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Several other factors helped fuel the financial industry’s ascent. Paul Volcker’s monetary policy in the 1980s, and the increased volatility in interest rates that accompanied it, made bond trading much more lucrative. The invention of securitization, interest-rate swaps, and credit-default swaps greatly increased the volume of transactions that bankers could make money on. And an aging and increasingly wealthy population invested more and more money in securities, helped by the invention of the IRA and the 401(k) plan. Together, these developments vastly increased the profit opportunities in financial services.

Not surprisingly, Wall Street ran with these opportunities. From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

The great wealth that the financial sector created and concentrated gave bankers enormous political weight—a weight not seen in the U.S. since the era of J.P. Morgan (the man). In that period, the banking panic of 1907 could be stopped only by coordination among private-sector bankers: no government entity was able to offer an effective response. But that first age of banking oligarchs came to an end with the passage of significant banking regulation in response to the Great Depression; the reemergence of an American financial oligarchy is quite recent.

It’s a smooth and great read.

(One thing that I’ve always felt uncomfortable about is the concentration of wealth in retirement funds where you can’t draw your money out, and are at the mercy of fund managers and indeed, your own risk taking in the case of 401-Ks. Such money leads to risk taking in retirement accounts and liberal spending or debt in regular accounts; not desirable. In good times, you’d risk the retirement for yield, and in bad times, when that money isn’t there to save you – when else do you need it – you have to save from what you make otherwise. Need withdrawable retirement accounts, after say five years.)

But I digress. The point Simon makes is that the financial oligarchy is holding the U.S. to ransom, using the potentially devastating impact of their own demise. A financial suicide bomber, so to speak, who ask for government help – and use it to build more explosives. And the government is yielding – because the administration is now run by the very guys who built some of those explosives.

Why else were AIG’s debts to Goldman (among others) made whole, but the government refused to respect the seniority of debts in the case of Chrysler? (They even gave an equal or more say to the unions, which are unsecured creditors – they should rank below secured debt holders!) And nothing can explain the PPIP – a plan that’ll make these oligarchs substantially richer, if it takes off.

Banks got money at far better terms from the government – a private player like Buffett extracted far more for his piece than the government could, from a company like Goldman Sachs. And they get government guarantees on their debt, but can still play around in derivative markets without regulation.

If these banks aren’t allowed to go bust, then there’s not much of a banking system. A far better deal would be to just own these banks outright – like India does. Then, when life is better, break it up, sell or dispose of the pieces, and nothing will be that gargantuan in failure. Pre-privatisation or temporary nationalisation, it needs doing.

Simon says it best: “Anything that is too big to fail is too big to exist.”