Category: Financial Institutions

Finance’s Revolving Door: Perfected or Passe?

Washington’s revolving door is legendary. Everyone knows the connections between lobbyists, members of Congress, staffers, and favored firms. They’ve been mapped in health care, oil, agriculture, and many other industries. Finance journalists chronicle a superclass shuttling from beltway to bourse and back. Yves Smith and Matt Taibbi post on “sleazewatches” and $2,200-a-ticket conferences where the regulated schmooze with the regulators.

But what if the revolving door is the wrong metaphor? What if, instead, there has been a fusion of state and corporate authority in the banking sector? What if Peter Orszag never left the government when he dropped the OMB Directorship to make at least ten times as much as a vice chairman at Citibank? Gabriel Sherman suggests as much when he describes a lucrative cursus honorum for DC elites:

The close alliance among Wall Street and the economics departments of the major universities and the West Wing of the White House is the military-industrial complex of our time. That it has an effect on our governance is beyond question. How pernicious and distorting these effects are, how cynical many of its participants might be, and what might be done to change the system are being fiercely debated in Washington. In fact, to the layperson, the most surprising thing might be the degree to which people like Peter Orszag see the government and Wall Street as, essentially, parts of the same industry.

Conservative Kansas City Fed President Thomas Hoenig has already argued that “big banks like Bank of America Corp and Citigroup Inc should be reclassified as government-sponsored entities.” Texas Republican Randy Neugebauer has called eight banks “TSEs,” or taxpayer-supported entities. And at a recent conference on macroeconomics, Steve Randy Waldman made a legal point fundamental to all the economic dilemmas discussed.
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ClassCrits Conference Call for Papers

The ClassCrits blog has a number of interesting posts up recently. The group has announced a call for papers for a September conference; here is the notice:

ClassCrits IV, “Criminalizing Economic Inequality”

This workshop, the fourth meeting of ClassCrits, takes as its theme the criminalization of economic inequality. The dominance of “free market” economic theory and policy has been accompanied in the U.S. by increasing reliance on the criminal justice system to make and enforce economic policy. The criminal justice system is increasingly used to control persons and groups whose participation in formal markets is marginal at best. Many aspects of traditional immigration law have morphed into “crimmigration”, appropriating domestic criminal law enforcement tools and redefining whole communities of workers and their families as “illegal people.” States and municipalities have criminalized the lives of homeless people, including those who are mentally ill.

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Fed & OCC vs. Transparency

To back up Danielle Citron’s excellent post: I just want to note that secrecy has been at the core of many troubling practices at the Fed and other financial regulators. As Gretchen Morgenson has noted,

In August 2007, as world financial markets were seizing up, domestic and foreign banks began lining up for cash from the Federal Reserve Bank of New York. . . . Thus began the bank run that set off the financial crisis of 2008. But unlike other bank runs, this one was invisible to most Americans. Until last week, that is, when the Fed pulled back the curtain. Responding to a court ruling, it made public thousands of pages of confidential lending documents from the crisis. The data dump arose from a lawsuit initiated by Mark Pittman, a reporter at Bloomberg News, who died in November 2009. Upon receiving his request for details on the central bank’s lending, the Fed argued that the public had no right to know. The courts disagreed.

It’s not just the Fed that’s been opaque. I’ve previously discussed the Office of the Comptroller of the Currency here and here. Given those accounts, it’s no surprise that the agency continues to serve, rather than police, big banks. The Maryland Commissioner of Financial Regulation has testified that OCC “forbade national banks from providing loss mitigation data to the states.” Matt Stoller explains the significance of that decision. Without loss mitigation data, regulators found it difficult to detect and deter loan modifications that hurt struggling homeowners. Once reported, officials like Kaufman could identify the practices that led to redefaults. As Stoller explains,

A redefault . . . means that instead of foreclosing immediately, or modifying a loan so that it was a workable payment structure, the bank strung out the homeowner until they drained all their savings, and then foreclosed. [I]t looks a lot like the Office of the Comptroller of the Currency knowingly prevented the release of information that would have led to lower redefault rates.

But don’t worry, Dick Parsons assures us OCC’s been run by a “good guy.” Perhaps the OCC will next try to promulgate regulations based on the Cayman Islands’s Confidential Relationships (Preservation) Law, which makes it a crime merely to ask about certain financial or banking arrangements.
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“Linking Skepticisms” About the Finance Sector

Brian McKenna published an interesting piece in the Society for Applied Anthropology Newsletter, which is reprinted here. He quotes Financial Times Managing Editor Gillian Tett on one underexplored reason for lack of public attention to “financial innovation” pre-2008: “Once something is labeled boring, it’s the easiest way to hide it in plain sight.” He also reproduces a fascinating reflection from Annelise Riles, whose work Collateral Knowledge: Legal Reasoning in the Global Financial Markets will soon be released:

I think Tett’s diagnosis should cause academics to ask some hard questions about why we did not do more to highlight and critique the problems in the financial markets prior to the crash. For myself, for example, fieldwork in the derivatives markets had convinced me long before the crash that all was not well in these markets. My husband (also an ethnographer of finance) and I often joked way back around 2002 that our research had convinced us not to put a penny of our own money in these markets.

But our own disciplinary silo made us feel that it was impossible to counter the enthusiasm for financial models out there in the economics departments, the business schools, the law schools, the corridors of regulatory institutions. There surely was some truth to our sense that no one wanted to hear that markets were not rational in the sense assumed by the firms’ and regulators’ models. But maybe we should have tried a bit harder; it turns out many other people also had doubts and thought they too were alone. What might have happened if we had all found a way to link our skepticisms?

At this point, it may well be the case that most financial economists have so barren a theory of the social purpose of financial markets that they really are only teaching people how to succeed within the current system, rather than improving the system overall. It’s a bit like a divinity school run by “believers,” rather than a religious studies department trying to study the religious (to borrow a distinction from Paul Kahn’s Cultural Study of Law).
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Watch the Banks First

I have not been a big fan of Wikileaks. I believe in diplomacy and the rule of law as cornerstones of a civilized society. But the recent revelations about a clandestine campaign to discredit Wikileaks supporters forces reconsideration of a pro-state, anti-Wikileaks position.

According to numerous press accounts, the DOJ advised Bank of America (BofA) to consult with a law firm that, in turn, consulted with “security firms” about how to address possible revelations from Wikileaks about BofA. A leaked report “suggested numerous ways to destroy WikiLeaks . . . including planting fake documents with the group and then attacking them when published; ‘creat[ing] concern over the security’ of the site; ‘cyber attacks against the infrastructure to get data on document submitters.'”
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A2K Symposium: Owning the Stars

I heard Lawrence Liang give a terrific talk at the Open Video conference in New York last Fall. His contributions to the A2K volume are also thought-provoking. Here is the conclusion from one of them:

I end this piece with a small parable that many of us will have read while we were children. The story is from Antoine de Saint Exupéry’s tale The Little Prince. The Little Prince visits a number of planets and encounters a range of different characters. On the fourth planet, he meets a businessman who owns millions of stars, and the reason why he owns them is because he was the first one to think of owning the stars.

The Little Prince is perplexed, because he can’t seem to find a reason for owning the stars beyond the fact that they can be put in a bank to enable the businessman to buy more stars. The Little Prince tells the businessman that “I own a flower myself, which I water every day. I own three volcanoes, which I rake out every week. I even rake out the extinct one. You never know. So it’s of some use to my volcanoes, and it’s useful to my flower, that I own them. But you’re not useful to the stars.”

Liang’s parable in turn made me think of ownership as an obligation, not (just) an opportunity for exploitation.

A2K As a a Statement of Progressive Intellectual Property?

In a special issue of the Cornell Law Review, four noted professors of property law wrote a brief series of propositions they identified as “A Statement of Progressive Property.” I found the following propositions particularly compelling:
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“Ten Times More Productive”

I respect Tom Friedman’s Cassandran efforts to curb American dependence on foreign oil. One can occasionally snicker at his exuberant style, but not the environmentalist substance. America needs more green hawks like him.

But I was taken aback by his casual comment on a radio show that American workers need to be “ten times as productive” as Indian or Chinese workers to maintain current earning levels. Over the past fifty years, we’ve seen CEO salaries go from about 50 times employee average pay to a 500-fold multiple. If anyone needs to become “ten times more productive,” it’s those at the top of the “value chain.”

But the myth of the coddled everyman persists, spreading to a “new global elite,” as Chrystia Freedland reports:

The U.S.-based CEO of one of the world’s largest hedge funds told me that his firm’s investment committee often discusses the question of who wins and who loses in today’s economy. In a recent internal debate, he said, one of his senior colleagues had argued that the hollowing-out of the American middle class didn’t really matter. . . . (emphasis added)

I heard a similar sentiment from the Taiwanese-born, 30-something CFO of a U.S. Internet company. A gentle, unpretentious man who went from public school to Harvard, he’s nonetheless not terribly sympathetic to the complaints of the American middle class. “We demand a higher paycheck than the rest of the world,” he told me. “So if you’re going to demand 10 times the paycheck, you need to deliver 10 times the value. It sounds harsh, but maybe people in the middle class need to decide to take a pay cut.”

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Surveillance of the War Games of Finance

Some of America’s greatest economists spent World War II devising formulas for optimal bombing. Milton Friedman, for instance, had to determine whether an anti-aircraft shell should burst into 600 small pieces or 20 big pieces in order to best accomplish a mission. Many translated their work into finance’s portfolio selection theory, which was “all about balancing risk and return.”* As Friedman said, “The logical character of the problem was the same. . . . How much power do you want to sacrifice in order to have a greater probability of hitting? [Finance theory involves] exactly the same thing: How much return do you want to sacrifice in order to increase the probability that you will get what you planned for?”

Today’s finance theorists probably have not spent much time on the battlefield. But they can still have fun with ballistics trajectories, in touchscreen video games like Angry Birds. To play, you use a virtual slingshot to launch squawking birds at pigs holed up in encampments made of glass, wood, and stone. The virtual materials in the game don’t act much like real structures; that’s not the point (who really cares whether a real vaulted bluebird would displace a girder)? Rather, you gradually learn from the game itself the strategies that cause optimal destruction, blissfully unmoored from the messiness of actual materials science.

From Wars to Games to High Finance

Stock trading now appears to be similarly deracinated, concerned less with actual fundamentals than with windows of opportunity for sudden arbitrage. In “Algorithms Take Control of Wall Street,” the indispensable econoblogger Felix Salmon (and Jon Stokes) extend a line of recent articles on high frequency trading. (I collect some earlier contributions here; this piece on news-reading technology also gives the flavor of the innovations they’re describing.) They define prop trading, algorithmic trading, and predatory trading, and tell the story of a former head of American Century Ventures who built a “neural network” to optimize his picks. They also discuss the unanticipated consequences of runaway algorithmic interactions.
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Hockett on the Financial Crisis

There is a growing consensus that our mortgage markets are fundamentally broken. In a recent article in The American Prospect, Robert Kuttner surveys a number of leading legal academics’ prescriptions for the foreclosure crisis:

Katherine Porter, a law professor at the University of Iowa and an expert in mortgage servicing, recently testified to the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP) that according to lawyers for both home-owners and banks, “a very large number (perhaps virtually all) securitized loans made in the boom period in the mid-2000s contain serious paperwork flaws, did not meet underwriting or other requirements of the trust, and have not been serviced properly as to default and foreclosure.” . . . .

One remedy, proposed by professor Adam Levitin of the Georgetown Law Center, would create a new chapter of the bankruptcy code and allow a home-owner to come before a bankruptcy judge and get the mortgage reduced to the present value of the home. The process would also clear the title. Another proposal, by professor Howell Jackson of Harvard Law School, would use government’s power of eminent domain to take securitized mortgages, compensate the holder at the securities’ (much reduced) fair market value, and use the savings to turn the paper back into whole mortgages with steep reductions in interest and principal. This would also allow millions of people to keep their home and help stem the broad decline in housing values.

I think each of these ideas is valuable. I’d also like to see them complement a broad set of proposals articulated by Robert Hockett in a recent piece in the Washington University Law Review. Hockett’s proposals are worth quoting at length, since he keenly grasps the historical dimensions of this crisis:
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Why Big Banks Fail to Act in Their Own Self Interest

In an earlier post, I characterized some financial institutions as “shadowy and unstable ensembles of desks and divisions whose main goal is slipping by whatever bonus-maximizing scheme won’t set off alarms among risk managers and regulators.” Too harsh? Well, today ProPublica’s Jake Bernstein and Jesse Eisinger offer offer yet another confirmation of value-destroying skulduggery at the core of contemporary finance. They explain how payments of a few million in “bonuses” to employees running one division of Merrill Lynch helped those running another division “offload” billions of dollars in toxic assets to their own firm:

Two years before the financial crisis hit . . . [n]o one, not even the bank’s own traders, wanted to buy the supposedly safe portions of the mortgage-backed securities Merrill was creating. Bank executives came up with a fix . . . .They formed a new group within Merrill, which took on the bank’s money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money machine moving long after it should have ground to a halt. “It was uneconomic for the traders” — that is, buyers at Merrill — “to take these things,” says one former Merrill executive with knowledge of how it worked. Within Merrill Lynch, some traders called it a “million for a billion” — meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as “the subsidy.” One former executive called it bribery. The group was being compensated for how much it took, not whether it made money.

The three men at the top of the scheme made about $6 million each that year, and there were probably some handsomely paid lieutenants beneath them. Surely, there must have been someone who objected to such deals? There was: “a Merrill trader [who refused to go along] . . . was sidelined and eventually fired.” The power in the firm was held by those who could make quick money in big deals. Has anything changed about the structure of these firms since the crisis to alter that dynamic?
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