Banks

By Heleen Mees

The fourth largest bank in the Netherlands, SNS Reaal NV, finds itself in trouble. The banking and insurance group, with €134bn worth of assets on its balance sheet as of the end of June 2012, has suffered €2.3bn in losses on its foreign – mostly Spanish – property investments. SNS Reaal’s capital reserves have fallen below levels allowed under international banking rules, while it still owes the Dutch treasury €750m from a government bailout it received in 2008.

SNS Reaal has been designated a systematically important financial institution, and therefore deemed not allowed to fail, by the Dutch government, mostly because the Dutch financial sector is already overly concentrated. That is also the reason why the European Commission in January apparently thwarted a rescue plan in which Rabobank, ING and ABN Amro would buy SNS Reaal. Read more

By Olafur Arnarson, Michael Hudson and Gunnar Tomasson

Today, from Greece to Iceland, governments are acting as enforcers or even as collection agents on behalf of the financial sector — and Iceland stands as a dress rehearsal for this power grab.

The problem of bank loans gone bad has thrown into question just what should be a “fair value” for these debt obligations. The answer will depend largely on the degree to which governments back the claims of creditors. The legal definition of how much can be squeezed out is becoming a political issue pulling national governments, the IMFECB and financial agencies into a conflict, pitting banks, vulture funds and debt-strapped populations against each other. Read more

By Laurence Kotlikoff

The Independent Banking Commission’s final report is a grave disappointment. The ICB (chaired by Sir John Vickers) seeks to reinstate Glass-Steagall by ring-fencing good banks and letting bad banks do their thing and, if they get into trouble, suffer the consequences. This proposition was tested by the collapse of Lehman Brothers, whose failure nearly destroyed the global financial system.

The commission retains the current system apart from some extra requirements primarily imposed on the good banks (the retail banks). The main impact of this is likely to be to foster more financial intermediation to run through the bad banks, i.e. if you impose more regulation on financial companies that call themselves X and less on companies that call themselves Y, companies that call themselves X will start to call themselves Y. In short, the commission has in effect taxed good banking while sanctifying shadow banking. The commission has also chosen to regulate based on what a bank calls itself, rather than on what it does. Read more

By Anat Admati and Martin Hellwig

Bankers on both sides of the Atlantic are lobbying furiously against stronger regulation. Authorities in different countries are reluctant to strengthen banking regulation as if the crisis never happened. The European Commission even hesitates to fully implement Basel III.

In this debate, many argue that global competition requires a “level playing field.” Following this argument, and concerned about the City’s competitiveness, the Interim Report of the UK’s Independent Commission on Banking avoids proposing tougher regulation for investment banks.

These “level playing field” arguments are invalid. Read more

The US is in the process of implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act. In the UK, the Vickers Commission has released interim recommendations to “ring-fence” the retail operations of banks from their investment banking activities Read more

By Laurence Kotlikoff

Dear John,

I read with great interest your terrific speech about banking reform. I agree with essentially everything you said, but want to take issue with some aspects of your brief remarks about Limited Purpose Banking. Read more

It is time to tackle the systemic flaw in housing policy – reliance on leverage – and introduce minimum downpayment regulations for all homebuyers, writes Charles W. Calomiris

Without high leverage the subprime boom and bust could not have happened. Risky no-docs borrowers would have been unwilling to deceive lenders if they had to pledge a large amount of their own savings as a downpayment (deposit). House price declines would not have produced huge loan losses if homeowners had retained a minimum 20 per cent stake in their homes.

During the 1990s and 2000s leverage tolerances on US government-guaranteed mortgages rose steadily and dramatically at FHA, Fannie Mae and Freddie Mac. The average loan-to-value (LTV) ratio of FHA mortgages rose to 96 per cent, and a third of Fannie and Freddie’s purchases leading up to their insolvencies had LTVs of greater than 95 per cent.

Not only are high LTVs destabilising, they undermine the objectives of housing policy. Its central goal is promoting stronger communities by encouraging residents to have a stake in them. But a 97 per cent LTV creates a trivial stake; homeowners become renters in disguise, able to abandon homes at little cost. Read more

Laurence Kotlikoff, economics professor at Boston University, writes an open letter to Lord Turner, chairman of the UK’s financial regulator, the FSA. Lord Turner examines Prof Kotlikoff’s proposal for a radical reform of the institutional structure for credit extension in a new book, The Future of Finance. This is the second of a  two-part open letter. You can read the first part here.

The essential challenge indeed is that the tranching and maturity transformation functions which banks perform do deliver economic benefit, and that if they are not delivered by banks, customer demand for these functions will seek fulfillment in other forms.

As previously indicated, tranching (some investors taking more risk than others within a fund) is part of limited purpose banking. Indeed, CDOs are, to repeat, effectively mutual funds with this property. The fact that so many CDOs invested in toxic loans is because the loans were fraudulent, not because the loans were risky. We don’t say that stocks are toxic, even though the stock market has fluctuated dramatically since its peak. We say mortgage-backed securities are toxic because borrowers’ incomes were misstated, collateral values were misstated, and credit worthiness was misstated. Furthermore, tranching is just one way for some people to take more risk than others. A simpler way is for more risk-averse people to simply invest in mutual funds that purchase safer asset.  I.e., tranching is not the end all and be all of risk allocation in the economy. Read more

Laurence Kotlikoff, economics professor at Boston University, writes an open letter to Lord Turner, chairman of the UK’s financial regulator, the FSA. Lord Turner examines Prof Kotlikoff’s proposal for a radical reform of the institutional structure for credit extension in a new book, The Future of Finance. This a two-part open letter; the second part will be published on the FT’s Economists’ Forum on Tuesday July 20.

Adair Turner’s Misplaced Concerns About Limited Purpose Banking

Dear Adair,

Your chapter in the just released Future of Finance is masterful. But the very strong concerns you express about Limited Purpose Banking are, I believe, misleading, misdirected, and rather surprising since LPB delivers precisely the reforms you advocate.

Let me respond in italics to the specifics of what you wrote (the bold text) and then indicate why LPB does what you say you want. Read more

An open letter from Laurence Kotlikoff of Boston University to Lord Turner, chairman of Britain’s Financial Services Authority

Dear Adair,

I listened to your terrific talk at the Soros conference. I could focus on the eloquence, fantastic delivery and numerous deep insights, but let me make a couple of comments that may be of actual value at the margin.  Take them from where they emanate – real friendship and respect.

It seems that you are questioning yourself. On the one hand, you are saying it’s critical to consider radical solutions. On the other hand, you are saying, “Too radical, too fast, is too dangerous. If we move to real safely, we may need to take decades.” Read more