Secrecy favors cretins, cravens and crooks
Michael Barone asks the right questions, we offer the right answer
If Republicans had three House members or one Senator as smart as Michael the GOP would be unstoppable this fall.
No such luck.
Barone, writing today, on financial reform is right on all three points he raises in his piece.
First, Republicans must offer their own agenda on financial reform and their reforms have to be tougher and more effective than Democrats’.
Fortunately, as he points out, that would not be so hard. The great Democrat reform, crafted by two of the greatest bank-whores ever to disgrace the halls of Congress, Frank and Dodd, does nothing but hit the replay button on the past 20 years. The “council of financial regulators” perpetuates the cozy club of big bankers and big regulators that got us here in the first place. And, as Barone points out, the new FDIC-managed “resolution authority” would not only officially write too-big-to-fail into federal law, it would place that authority in the hands of an agency that gives no evidence of knowing how to shut down trillion dollar banks without blowing up the world.
Finally, Barone is right also that the consumer financial protection agency, which the GOP is spending so much energy and political capital opposing, is mostly a distraction at the moment. The consumer agency is bad in theory, maybe worse than Barone seems to think. But for the next decade or so it is unlikely to do much harm. For the couple decades preceding the crisis, the “pro-consumer” position was to give every citizen with a pulse and a plausible grievance a mortgage regardless of ability to pay, i.e. what we now call “predatory lending.” To be pro-consumer was to be hostile to bank safety. These days and for the foreseeable future, the pro-consumer fashion is to favor conservative lending. The nation can live with that.
What Barone does not offer is a suggestion for a Republican reform.
We’ve got one. We’ve been pushing it like crazy. And with help from someone like Michael it might catch on.
Any Republican solution must rest on three insights.
I. Yes, markets did fail. Financial markets should have disciplined the banks, depriving them of the funding to make bad mortgages and they didn’t.
II. Markets failed because the reigning ideology of Wall Street, backed to the hilt by the regulators and long-standing government policies favoring bank secrecy, deprived investors of the information they needed to assess the banks’ behavior. Worse, banks and regulators alike actively (and not always unwittingly) supplied disinformation to the market. Essentially every central bank and every government of the developed economies, for instance, agreed to favor banks that held impossibly complex mortgage backed securities over banks that held traditional mortgages. As Nicole Gelinas has pointed out, one reason there was such a huge market for these supposedly AAA mortgage securities was that regulators regarded them as the safest of all possible bank investments. The Basel group, which coordinates bank regulation internationally, actively encouraged banks to adopt maddeningly complex and unverifiable “risk management” algorithms in place of traditional credit analysis. Weeks before Citigroup began write-downs that would eventually total more than $40 billion, it’s “Value at Risk” algorithm told the world Citi was at risk for losing no more than $100 million. Regulators cheered; markets were blindsided.
III. The way to make markets work is to give them the information they need. Here is a simple but radical proposal that banks would hate (they do not hate the Dodd bill) but supports real capitalism and would have prevented the recent crisis:
Make the banks disclose everything they own, every stock, bond and derivative, every mortgage or commercial loan, not in an accountant’s summary but line by line, millions of lines of data for the big banks, every Monday morning before markets open.
Had such a policy been in place in 2004, the mortgage crisis would have been a speed bump and the banking crisis never would have happened. The reason the banks got in trouble is that neither bank executives nor their investors had a good handle on what the banks actually owned.
As defaults began to mount in 2004 it was just barely possible, albeit with a good deal of work, to sort good mortgage securities from bad, to identify those that were suffering lots of defaults and those that were pretty sound. John Paulson, a great American, made billions doing just that and helped contain the crisis by doing so.
What was not possible was to figure out which banks owned which mortgage securities. We could sort good securities from bad, but not good banks from bad.
The result was that for years investors took both good and bad banks at their word (backed by the regulators and the ratings agencies. After all if the Fed or the FDIC lets a bank keep operating, it must be OK, right?) Then when panic struck, investors fled all the banks, staging a modern version of a run. To this day we do not know for sure whether Bear or Lehman or even Merrill were “really” broke or simply ripped limb from limb by an angry mob.
Full disclosure would have achieved two things:
First, banks making or buying too many bad mortgages would have seen their funding dry up, probably by early 2005. Since most of the worst loans, the loans that really broke the banks, were written from late 2005 through early 2007, the mortgage crisis itself would have been reduced to a speed bump.
Second, even if the mortgage crisis had not been averted, bank creditors would have been able calmly to sort the sheep from the goats rather than creating a general panic and turning the mortgage crunch into a banking collapse.
We work in the investment industry. The one legitimate objection we can foresee to our proposal is that it would unfairly disadvantage banks compared to other investment firms. Fine. Apply the rule to everyone. Require any firm that either manages other people’s money, or at least $10 million of its own, to disclose all its investments as well, every Monday morning. We’d love to operate in such an open market. Secrecy favors cretins, cravens and crooks; smart honest firms would thrive under our plan.
Nor does our proposal violate any legitimate privacy concerns. The lien holder on a mortgage is already a matter of public record: our disclosure rule would just make it easier to review a particular banks’ loans by having them listed in one place. As for the public securities held in a bank’s portfolio, there is not and never has been any possible justification for concealing the ownership of publicly traded securities. Secrecy invites corruption.
No modern bank is a pure free market institution any more than lawyers, officers of the court, are free market players. Both live off the power and wealth of government. And government has no right to privacy.
