Madness, Madness

Today the Bush administration and the Treasury department are trying to rush the Congress into the steeply priced financial sector bailout. This plan calls for the U.S. treasury to purchase all the bad debt surrounding the sub-prime derivatives crater, with a current price-tag $700,000,000,000. I for one, would not be surprised if that figure was a low-ball estimate, not least of which since even some senior Republicans believe it will cost at least $1t. Whatever your feelings on the subject or the cost or other bailouts you want to add, there really isn’t a way to maintain the financial system without some kind of massive federal intervention.

The price tag, while beyond all comprehension, is probably what it will end up costing. And there are a lot of pet policies I’d like to see enacted to prevent this sort of thing in the future: a Tobin tax; laws and institutions designed specifically to prevent unregulated instruments; a serious rethinking of banking accounting/reporting procedures (There has been a major, global credit/debt crisis every ten years since the 1970s. Something is institutionally fucked.) Save it and restructure it at the same thing

One thing I wouldn’t do, however, is repeal existing laws enacted during the New Deal to protect average people and businesses from the dramatic downsides of a poorly-regulated financial industry. Specifically, there was a law passed in 1933 that said “investment banks must be separate from commercial banks”. Effectively, this means that National City Bank can’t play the markets, and Morgan Stanley can’t maintain your savings accounts.

This was done to create a firewall between the speculators and the savers, so when the investment side of the bank got trounced by a market crash, they couldn’t raid the accounts of depositors to pay up. This is what has prevented the crisis from becoming a serious, immediate, bread/butter issue for Americans right now.

According to Bloomberg, this provision is also on the chopping block for the bailout.

The money quotes:

“The announcement paves the way for the two New York-based firms, both of which will now be regulated by the Fed, to build their deposit base, potentially through acquisitions. That will allow them to rely more heavily on deposits from retail customers instead of using money borrowed in the bond market—the leverage that led to the undoing of Bear Stearns and Lehman.”


“‘Deposit-banking is king right now,’ said David Hendler, an analyst at CreditSights Inc. in New York. ‘It’s the only meaningful critical-mass way to make money.'”

In other words, rather than try to cover their losses on bad debt by selling bonds and getting swept away, now they will use the money in deposit accounts instead.

6 thoughts on “Madness, Madness

  1. jamesh:

    Yeah, but that’s only to the tune of $100,000/account (which is lower than the operating budgets of most companies). The SEC has also set down-limits on a *lot* of financial stocks, and has allowed “national” exchanges (e.g. NYSE, NASDAQ) to add more to the list. Effectively, the government is saying that any trades which devalue a bank’s stock below some percentage of the previous day’s close (it looks like around 20% from here) are considered invalid on their face. There was some article out there that claimed this was simply because the FDIC can’t afford to bail out commercial account holders on top of everything else.


    I almost thought you were serious for a second :-). They will have to operate under slightly harder regulations so far as how deep they can leverage themselves, yes. But I’d be surprised if they didn’t get right back into this hole based on more intense schemes a decade from now, because the basic issues remain unresolved.

  2. But its okay, since if the bank folds the government will bail out all the depositors, right?

  3. Glad to see you writing about this James!

    So these investment banks are in the process of converting into “bank holding” companies. The nice thing about that move is they’ll be better regulated and limited to lever up only to 12:1. When they were investment banks they were leveraged up to 30:1.

  4. I don’t think it means that the ‘firewall’ between commercial banks and investment banks is being removed – it’s that the two investment banks are turning themselves into commercial banks. They won’t be able to raid depositors to any greater degree than the existing commercial banks. Essentially it represents the abandonment of the investment bank model

  5. Lovely.
    I thought the republicans were against spending too much money on welfare?

    Seriously though – it is probably needed. What I am missing is the whips, chains and **** probes to be used to aid in the regulation of the financial sector. If it doesn’t hurt, they’ll never learn. In my not so humble opinion the geniuses at these banks should not be able to sit down for the duration of the next decade.

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