Tuesday, April 20, 2010

Profiting from Regulation

Here's Tyler Cowen at Marginal Revolution discussing why simply breaking up the banks may not prevent a future crisis and how they may not actually be the centers of power they are made out to be in the popular imagination:
it's our government deciding to assemble a cooperative ruling coalition - which includes banks -- at the heart of its fiscal core. It's our government deciding who belongs to this coalition and who does not, mostly for reasons of political expediency and also a perception - correct or not -- of what is best for the welfare of American voters....

Ask yourself the simple question: who has both the guns and the money, including the ability to print new money at zero cost? It's Washington, not the private banks.

It's easy, and probably wrong, to simply dismiss such a notion as too conspiratorial. As luck would have it, on the same day I read Cowen's post, my google reader also included blogger Matthew Yglesias discussing the modest profit margin of Wal Mart.

Yglesias compared the profits of Wal Mart to other industries, produced a chart of the comparison and came to this conclusion:

Wal-Mart’s total profits are enormous because the company is so large. But mass-market retail is not a high-margin line of business ...

At any rate, looking at this chart I think it’s hard to avoid the conclusion that Wal-Mart is the last thing we should be worried about. The worrying trend is the domination of the corporate landscape by super-profitable firms in the heavily regulated energy, banking, and telecom sectors.
Maybe Cowen's on to something here.


J. Strupp said...

OK that's fine. But even if we should be more worried about Uncle Sam than the big banks in this country, I fail to see what that has to do with breaking up the big banks in order to limit systemic risk. The author seems to think that if we balance the budget and pay off our debt, the big banks are no longer a treat to our economic prosperity. In fact, a collapse of the major banks in this country, regardless of our fiscal situation, will still lead to mass unemployment, undercapacity and government deficits as a result. All our improved fiscal situation will do is allow us to have more room to manuver once the financial crisis takes hold in an attempt to limit the damage. Obviously, I agree that an improved fiscal outlook is essential to our long term prosperity, but assuming that we can just simply ignore the systemic risk that the big banks in this country add to the global economy because they aren't pulling all the strings is simply wrong in my opinion.

Jeremy R. Shown said...


For the record, my mind's not made up on this one. I'm sympathetic to Cowen's position that if we were simply much stronger fiscally, we would be more resistant to the siren song of Wall Street money-changers.

On the other hand, Simon Johnson has been arguing long and convincingly that the sheer size of the banks make them risky. The notion that large banks are inherently risky sounds plausible.

Just today, though, Yglesias took a look at Canadian banks and found that in relative terms they are larger than the US behemoths. I don't think anyone is arguing for the break-up of Canada's banks, are they?

J. Strupp said...

I think Yglesius' point was that bank size is not all that matters and I would agree. But it's tough to compare the big banks in Canada with the big banks here in the U.S. While the big 5 are private enterprises, they're controlled by the government much like the oil industry in various Middle Eastern nations. The Canadians are also very conservative when it comes to permitting risky financial products. Good luck getting a sub prime, balloon or 5 year ARM in Canada.

J. Strupp said...

Another quick point if I may:

The Canadian government to a certain degree has, as Krugman puts it, "made banking boring again" while our banking system is more interested in quantitative finance, the synthetic CDO and other complex financial instruments. While this isn't entirely a bad thing, I find it difficult to believe that our government is capable of competely changing the business models of our banking industry. We've proven time and time again that financial deregulation will eventually lead to an asset bubble which leads to a collapse and financial crisis thereafter. Therefor, we need to limit systemic risk as much as possible if we are to continue using complex financial vehicles that we've relied on so heavily in recent history. That means we need to regulate more effectively AND break up banks that are TBTF.

Jeremy R. Shown said...


Well said as I always, even I almost believe you.

First, "financial deregulation leads to an asset bubble time and again," show me the evidence. I'm not at all convinced there is such a direct correlation.

I would say loose money leads to asset bubbles, but then why tech stocks, why housing, why financials? Are they just 21st century tulips? I suspect we are both on to some part of the puzzle, but neither grasping the whole picture. Of course, it we were able to do that we wouldn't be spending our time on this blog.

Second, I don't think anyone wants to ignore systemic risk, least of all the Wall St. firms that are directly exposed to it. Problem is, how do you identify it? The subprime meltdown is an example of systemic risk and very few people identified the potential danger and acted to avoid it.

Do you really think that Chris Dodd or the SEC or Fed Chair are going to be able to identify systemic risk and stop it? Could someone, anyone, have stopped the issue of all subprime mortgages in say, 2000? I'm doubtful on both counts.

Seriously, when are going to start a blog?

J. Strupp said...

"'financial deregulation leads to an asset bubble time and again,' show me the evidence. I'm not at all convinced there is such a direct correlation."

The bank failures of 1930-31
The S&L crisis of the late 1980's
The failure of LTCM in 1998
The "subprime" crisis of 2007

The root of all financial crisis above were NOT caused by loose money alone. All crisis' were brought about by de-regulated financial markets, which allowed for the banking industry to extend lending practices above and beyond the typical business practices performed by the banking industry.

Secondly, in my opinion, Greenspan was not responsible for the real estate crisis. While his diagnosis of the economic realities of the mid 2000's were incorrect, complex financial instruments along with the complete lack of regulation of these instruments allowed our finanical markets to assume that they were hedging risk through quatitative finance. This happens in one way shape of form EVERY time we think that the banking industry understands risk and should be left relatively unchecked by government regulation. Notice the lull on financial crisis from the 1930's to the 1980's. What changed in the 80's then? Simple. The idea that our banking industry provides a more prosperous global economy if it's left to it's own devices.

"The subprime meltdown is an example of systemic risk and very few people identified the potential danger and acted to avoid it."

Exactly Jeremy. We can't assume that we'll be able to identify the next bubble and crisis to follow. History and human nature has proven that we have no ability to predict these events. Therefor, we should break up the big banks in this country in order to prevent against TBTF, should another asset bubble arise. It's the only way to prevent TBTF institutions from overwhelming the system like they did 2 years ago. This is PRECISELY why this is a necessary task.

We need to "make banking boring again". Will we? I'm not optimistic.

J. Strupp said...

Kind of regarding this subject.....

Ezra Klein wrote an interesting piece a couple days ago about Wall Street (I know he's big lefty). I found his 2 charts particularly interesting. What worries me is that Amercians just cannot see what's going on here. We've created a monster in the past 30 years that I'm not sure we can kill:

P.S. I should probably start my own blog soon just so I stop bothering all of you guys already doing it.

Jeremy R. Shown said...

No bother Strupp, you just seem to have more to say than can be said in a few comments.

As far as your evidence goes, post hoc ergo propter hoc?

Put me down in unconvinced column.