Re: The Financial Stability Oversight Council Defers To Big Banks

I'm taking my time with Taibbi's book, but I'm in the chapter about the AIG 
bailout and Goldman Sachs involvement in that.  Unfriggenbelievable, what 
Goldman Sachs did to hold this country hostage to insure it got 100 cents on the 
dollar for all their crappy, scumbag, fraudulent, deals.  And unfortunately the 
country, (the Fed and everyone else), blinked.  


Why/how Goldman Sachs hasn't been declared an enemy of the state, and treated as 
such, is mind boggling.  Tim Geitner is a piece of shit.

Mike F.  




________________________________
From: Lance McLain <lance-X3DuywwxauBWk0Htik3J/[email protected]>
To: DADL-OT (Mailing List) <[email protected]>
Sent: Thu, January 20, 2011 8:20:11 AM
Subject: [DADL-OT] The Financial Stability Oversight Council Defers To Big Banks


The Baseline Scenario 
January 20, 2011 6:56 AM 
by Simon Johnson
The Financial Stability Oversight Council Defers To Big Banks
By Simon Johnson
As required by Section 123 of the Dodd-Frank financial reform legislation, 
Treasury Secretary Tim Geithner, as chair of the Financial Stability Oversight 
Council (FSOC), has released an assessment on the costs and benefits of 
potentially limiting the size of banks and other financial institutions.  This 
report, four-and-a-half pages in a longer “Study of the Effects of Size and 
Complexity of Financial Institutions on Capital Market Efficiency and Economic 
Growth”, is represented as a survey of the relevant evidence that should guide 
policy thinking on this issue. 
Mr. Geithner’s team conclude rather vaguely “there are both costs and benefits 
to limiting bank size”, and consequently “This study will not make 
recommendations regarding limits on the maximum size of banks, bank holding 
companies, and other large financial institutions.”
This is an analytically weak report that presents a skewed and incomplete 
assessment of the evidence.  Given that the paper was prepared by some of the 
country’s top experts, who are well aware of the facts, the only reasonable 
inference is that our leading relevant officials prefer not to take the 
Dodd-Frank Act seriously with regard to reducing systemic risk.  Instead, on all 
major points, the Financial Stability Oversight Council is allowing the big 
banks to prevail – and to pursue whatever global expansion plans they see fit.
Given Treasury’s attitude during the financial reform debate of 2009-10, this is 
not entirely surprising.  Still there are three major issues with the substance 
report that should be considered particularly embarrassing to Mr. Geithner and 
his colleagues.
First, on whether large banks benefit the broader economy, the authors neglect 
to mention even the most basic facts regarding the increase in the size of our 
largest banks in recent years.  As a result, the entire discussion of bank size 
in this report reads as it is completely divorced from current economic and 
political realities.
The largest six bank holding companies in the US had assets valued at 64 percent 
of GDP at the end of the third quarter of 2010 (the latest available 
comprehensive data).  The same banks accounted for just less than 55 percent of 
GDP at the end of 2006 and a mere 17.1 percent of GDP in 1995.  (All the numbers 
in this column are updates from what we presented in 13 Bankers, using the 
latest revised official sources.)
The assets of Chase Manhattan in 1995 amounted to 4.1 percent of GDP.  The 
assets of JP Morgan Chase, as measured officially, were 14.5 percent of GDP in 
2010; if we included their off-balance sheet assets (including derivatives), 
this total would be substantially higher.  There has been a similar increase in 
all the Big Six Banks.
The balance sheet of Goldman Sachs, for example, increased from 1.3 percent of 
GDP in 1995 to around 6.2 percent of GDP at the end of last year (based on this 
week’s report); by the firm’s measure, assets expanded 7 percent from the end of 
2009 to the end of 2010.
The central issue with regard to size that should be before the FSOC is not the 
presence or absence of economies of scale in banking generally, i.e., whether a 
bank becomes more efficient as it increases from, say, $100m to $100bn in total 
assets.  The pressing policy priority is how to assess what has happened to 
efficiency within our very largest banks – and the precise way that has 
benefited the broader economy (or not). 
Second, the report’s survey of the empirical literature is highly selective to 
say the least, ignoring – for example – almost all of the research we cite in 13 
Bankers.  It also fails to mention the 2007 Geneva Report, “International 
Financial Stability,” co-authored by former Federal Reserve vice chair Roger 
Ferguson, which found that banking consolidation had not led to efficiency 
gains, economies of scale (at least above a low threshold), or economies of 
scope.
The report places a great deal of weight instead on a single unpublished working 
paper from the St. Louis Fed, by David Wheelock and Paul Wilson.  This is an 
interesting paper by serious researchers, and one that we placed in the context 
of the literature on p.212 of 13 Bankers (see also footnote 69 on p.272; all 
page numbers refer to the hard cover edition.)  But this paper is based on a 
very particular econometric specification, i.e., a way of writing down the 
equations that put structure on the data that is far from convincing.  In 
particular, it is hard – perhaps impossible – in their framework to determine 
the “true” efficiency of banks, compared with the effects of various kinds of 
government subsidies implicit in being “too big to fail” and therefore having 
cheaper access to funding.
In addition, the report fails to note that while the Wheelock and Wilson paper 
was last revised in October 2010, it uses data only through 2006.  A similar 
data limitation or worse holds for all the other papers that FSOC cites 
approvingly (e.g., by Gouhua Feng and Apostolos Serletis, who use data over 
2000-05.)
Basing banking policy on data from just part of any credit cycle is unwise, to 
say the least (and not at all what the authors of these underlying papers are 
recommending).  And it is very strange that responsible officials would think we 
should draw any relevant inference for our current situation by cutting off the 
information in the mid-2000s, i.e., before the crisis and without the ability to 
reassess who made and who lost what kind of money (and how government bailouts 
affect the relevant statistics).
This is akin to saying, “let’s pretend there was no financial crisis in 
2008-09.”  It makes no sense, unless you wish to view today’s megabanks in the 
most favorable possible light.
Third, the FSOC is completely ignoring the important work done at the Bank of 
England on bank size, “too big to fail,” and closely related issues.  For 
example, nowhere in the longer report do they cite the work of Andrew Haldane 
and his colleagues who have financial stability responsibilities in the UK.  The 
October speech by Mervyn King, governor of the Bank of England, is also a 
glaring omission – see my NYT Economix column last week for the details.
And it is simply shocking that the longer report nowhere cites the definitive 
work of Anat Admati, Peter M. DeMarzo, Martin R. Hellwig, and Paul Pfleiderer on 
the need to greatly increase equity in the banking system, i.e., reduce leverage 
(debt relative to equity) through much higher capital requirements, because this 
is an essentially zero cost way to make financial intermediation safer.  This is 
central to the broader discussion of size and complexity, because it speaks 
directly to the issue of whether banks’ buffers against losses are likely to 
prove adequate as we move forward.
There is a pattern of official behavior here.  Central banks in other 
industrialized countries are at least beginning to confront the ideology that 
supports the unfettered and undercapitalized growth big banks.
In contrast, the Treasury, the Federal Reserve, and now the FSOC are distorting 
the evidence to accommodate the views of Jamie Dimon, Bill Daley, and other 
executives who want to build bigger, increasingly global, highly leveraged, and 
much more dangerous banks.
An edited version of this post appeared this morning on the NYT.com’s Economix 
blog; it is used here with permission.  If you would like to republish the 
entire column, please contact the New York Times.
         
Commentary


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