Kiran Stacey

The New York Times has published 18 ways to break up the banks with minimal fuss, and I can’t find a single flaw in their reasoning. My personal favourites are “Have the bank marry Larry King or Elizabeth Taylor” and “Have the bank’s chairman saunter into the living room at 11:02 p.m. and start idly vacuuming”.

James Mackintosh, meanwhile, has pointed out that suggestion number six – “Sprinkle the banks with gaily colored, diversionary “accent pieces” like ottomans and love seats” – was tried by London hedge fund Peloton. And to great success too – the fund broke up following heavy losses in 2008.

(Hat tip to Courtney Weaver for the spot.)

James Mackintosh

The question on everyone’s lips following Scott Brown’s defeat of Barack Obama victory in Massachusetts, securing himself the crucial 41st Republican Senate seat needed to filibuster any bill: is America ungovernable? (eg here, here, and, addressing similar issues, here.)

The answer, as regards the Senate, should be discounted. Ronald Reagan had to contend with a Democratic House of Representatives, Bill Clinton with a Republican Senate. That’s democracy for you. The same question has been asked for generations, yet America has carried on, as Megan McArdle points out.

There is a real problem, though. Americans seem to be getting ever more split, with sharper divides between liberals and conservatives not just on social and religious issues but also economic issues. This isn’t just about the rise of the tea party movement, or the viciousness of much of the opposition to healthcare reform. It is about the mainstream party members – particularly Republicans – and their views.

Consider this poll of Republicans from the weekend. A few religious and cultural points:

  • 77% think schools should teach that Genesis explains how God created the world
  • 31% think contraceptives should be outlawed
  • 34% think the birth control pill is abortion
  • 73% think “openly” (horrible phrase) gay men and women should not be allowed to teach in schools
  • 68% think gay couples should be denied state benefits
  • 31% believe Obama is a racist who hates white people

Bruce Bartlett has the standard liberal reaction to this sort of survey result: “between 20% and 50% of the [Republican] party is either insane or mind-numbingly stupid”.

There isn’t any sensible way to disenfranchise stupid people – although perhaps anyone who signed the Princess Diana memorial book should be blocked from voting for taking part in a mass delusion (that’s a joke, by the way). It is fair enough that such views should be represented in Congress. Americans may have more extreme social views than Europeans, and many of them may conflict with their own constitution, but that’s democracy for you.

The problem is that mainstream voters have to choose between socially (and fiscally) extreme conservatives and socially (and fiscally) extreme liberals, because there is no serious third option. (For example: the majority view in America is now that same-sex civil unions should be allowed, but gay marriage still not.)

As America has entrenched its two-party system, it is virtually impossible for independents to be properly represented. America is not ungovernable. But it is not properly, or democratically, governed either, and won’t be as long as those of extreme views maintain their holds on the two main parties (that’s without even talking about campaign contributions, but rational behaviour there appears impossible).

Kiran Stacey

At the height of the crisis, in November 2008, the Queen asked a room of academics at the London School of Economics what could be the key question of the last few years: “Why did nobody see this coming?”

It is a question seized on by David Hare in his new play, The Power of Yes, but which is arguably better answered by Lucy Prebble (a Londoner in her 20s) in her play Enron, which debuted in London’s West End last night, and which ostensibly has nothing to do with the credit crisis and its aftermath.

Enron‘s West End debut, especially for those who, like me, were seeing the play for the first time, was a triumph. The acting was compelling and believable, especially from Sam West, who as Jeff Skilling managed to make a seamless transition from maths nerd to master of the universe. This was coupled with the kind of spectacular pyrotechnics that audiences expect from a Rupert Goold production, including a stunning representation of 9/11 (an event not exactly easy to re-create within the confines of a West End stage). Nor were the special effects out of place: Prebble explained recently in the FT that part of the point of the elaborate staging was to capture something of the out-of-control nature of Enron itself.

But the real star was the writing. Some of it seemed too prescient to have been written before the current crisis, and Prebble says in the FT piece that she re-wrote parts for the West End. But in one scene, which must have been there from the play’s inception, she captures perfectly how Enron got into the position it did and why no one saw it coming, and it is a scene that translates perfectly for the current crisis.

James Mackintosh

Barack Obama has decided to side with a state solution, if not yet a well-thought-out one, to preventing bank failures bringing down the world economy. But there is a market alternative: fix the banks so the bondholders keep bank risk-taking under control – and bear the costs if they fail in that task.

This important debate is not being framed as a state vs market discussion, but it should be. Remember state control has a dismal record in general, and in the finance sector in particular. Regulators entirely missed the bubble, missed the banks’ reliance on short-term financing and missed the fact that so much regulatory arbitrage was going on. Don’t expect things to be much different in 20 years if a state solution is accepted.

The problem is the banks (and potentially non-banks) being too big to fail, creating perverse incentives to take risks and leaving the taxpayer paying for mistakes. The state solution accepts banks are too big, but tries to control that through regulations, restrictions on what they can do (no prop trading or hedge funds), and potentially a cap on size.

A working market solution would obviously be better, as it would be pretty much immune to the high likelihood of regulatory capture – but can a market solution be made to work? I think so.

James Mackintosh

Barack Obama is finally taking on Wall Street, apparently prompted to action by the voters of Massachusetts. But he’s taking the wrong approach.

There are hundreds of competing ideas on how to stop the banks needing trillion-dollar bail-outs. Obama has chosen three, but they are the wrong three:

1. No proprietary trading
2. No owning or “sponsoring” hedge funds or private equity
3. A cap on size for deposit-taking banks

This is not to defend the banks: they made some stupid decisions, helped out by an unending appetite for cheap debt from consumers and a global debt bubble created by China’s surplus, America’s over-consumption and Alan Greenspan’s Federal Reserve. It is right that the banks should be reformed, to prevent future bail-outs.

But these actions fail to get to the root of the problem. The banks had acted just like any other borrower when presented with cheap debt (and dumb regulators): they borrowed as much as they could (often leaving them an astonishing 50 times geared), and found ways to use it from which they thought they could make money. Lenders to the (big) banks exercised no control, because they thought – correctly – that they would be bailed out if the banks failed.

The best way to fix this problem is to find a way to allow the banks to fail. If this can be put in place, the market will itself control the banks, by increasing their cost of borrowing when they take bigger risks (more transparency may be required). If investors fail to control the banks they invest in, the bank can be left to go bankrupt – as smaller banks already do. Bondholders would lose the bulk of their money, as their bonds convert into equity, either by making all (or perhaps just most) bonds explicitly convertible, or through laws requiring conversion if a bank fails.

James Mackintosh

So it is Barack Obama vs Wall Street, and both sides are pulling no punches. But while Obama has singled out the banks, hedge funds are seriously threatened too. Here’s Obama:

My resolve to reform the system is only strengthened when I see a return to old practices at some of the very firms fighting reform; and when I see record profits at some of the very firms claiming that they cannot lend more to small business, cannot keep credit card rates low, and cannot refund taxpayers for the bailout. It is exactly this kind of irresponsibility that makes clear reform is necessary.

Banks which have Federally-insured deposits or access to cheap Federal Reserve funds (such as Goldman Sachs) will be banned from trading for their own account or owning hedge funds or private equity, while those choosing to become pure investment banks will have a ceiling on assets.

According to the White House announcement the proposal would:

1. Limit the Scope-The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

2. Limit the Size- The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

This is great news for the hedge funds: they will face less competition from the banks, which do much the same thing with their own money, often on a larger scale. But it is also terrible news: the banks will have to dump holdings in huge numbers of hedge funds, including some of the world’s biggest. On top of that, they won’t be able to buy any more, removing the most common exit route for hedge fund managers wanting to cash in. For private equity this does not seem so serious, although the big private equity groups will benefit from the lack of competition from all the banks’ PE arms.

There appears to be worse news for the denizens of Greenwich, Connecticut and Londons’ Mayfair. According to the Wall Street Journal’s story:

Under the proposed rule, commercial banks would be prohibited from owning, investing in or advising hedge funds or private equity firms. Bank regulators would not be simply given the discretion to enforce such rules. They would be required to do so.

Apart from the problems of dumping their hedge fund stakes – of which there are hundreds, notably JP Morgan’s Highbridge, Morgan Stanley’s FrontPoint and Goldman Sachs Asset Management – a ban on “advising” hedge funds would appear to kill much of the lucrative banking business of prime broking, servicing hedge funds (assuming the WSJ isn’t just mixing up “advising” and the ban on being a “sponsor” of a fund, whatever that means).

If lending money to hedge funds can survive as a non-advisory, purely automated business, it could be good news for the biggest funds which can do much of the work in-house, by driving down the price of loans even further.

But for the small and mid-sized hedge funds, having no prime broker to hold their hands and introduce them to potential investors will require a major culture change, or a move onto a hedge fund platform.

Kiran Stacey

I outed a friend recently. There we were in a public place, when I asked (perhaps a little too loudly) “So when is bonus day then?” After registering the laughter and hostile stare from two people sat nearby, he quickly changed the subject.

Many will feel that as part of a vast multinational investment bank, he does not deserve his bonus at all. But if we are to believe this piece by Aditya Chakrabortty in The Guardian today, perhaps his bonus should be even larger than those of his bosses.

James Mackintosh

Jamie Dimon, who never tested JPMorgan’s portfolio to see what would happen in a housing crash, seems to have given a nod to the political pressure over bonuses. Higher-than-expected profits at the US bank, although disappointing dividends for investors. But there’s only one number the wider world wants to hear: what were the bonuses? JPM is the first bank to report, so this is the first indication of whether expectations of record payouts are right. Mixed news, for JPM at least. Even as profits rose, investment banking bonuses fell – in the final quarter. For the full year, though, total pay and bonuses soared to $9.33bn.

James Mackintosh

I could see he was grumpy as soon we starting talking. I thought it was just the restaurant’s delay bringing the beer, but it turned out to be bonuses. How unfair, he said, that the British government was imposing a bonus tax.

“It wasn’t me. I didn’t bring down the financial system. My bank [foreign, but bailed out by its own government] didn’t even take money from Alistair Darling. Why should I lose half my bonus?”

Because, I said, amazed that he didn’t get it, the whole financial system would have collapsed – including his bank – if the government hadn’t stepped in with taxpayers’ money.

“But what about the hedge funds? What about the accountants, the lawyers? They’re only still going because of the bail-outs.”

This is true. But they don’t pose a systemic risk. When Arthur Andersen collapsed, the government didn’t have to step in and rescue PwC or Ernst & Young. The hedge funds would have failed, it is true, but again the government would not have rescued them – none, in London at least, is big enough to threaten the system if it failed.

The banks are only paying out fat bonuses because of the government cash – not only would they have failed without it, but the liquidity sloshing round the markets is there because central banks provide it virtually for free to banks, and they are making big profits because of it. How bad is it for the government to take some of that back?

“But that applies to the hedge funds too. Why me? I had nothing to do with mortgages, I’m not even a trader. And where’s the beer?”

It is just politics. You can’t exclude every bit of a bank that had nothing to do with dodgy mortgage lending – although the banks are trying to do just this.

And you earn too much, I say, trying to move the discussion on to something which goes better with dinner.

“Yes,” he says, as his beer arrives at last. “Just politics.”

It isn’t really “just” politics. There is populism, certainly, the effort by Gordon Brown to draw a line between Labour and the Conservatives, or the effort by Nicolas Sarkozy to draw a line between Europe’s corporatist culture and “Anglo-Saxon” capitalism.

But there is also something deeper. Bank bonuses are causing outrage, in part, because they are being prepared while unemployment has become the new boom industry. Even more, people are annoyed because it looks as though government money goes in at one end of the bank, and bonuses pour out the other. This view is not wrong, either.

To fix this, all we have to do is make the banks pay their true cost of capital, by bringing in structures which demonstrate to investors that they will not be bailed out in a crisis (actually pretty hard to design, but CoCos are one possibility). The banks pay a lot more to borrow, profits go down – and bonuses will follow them downwards.

James Mackintosh

So Goldman Sachs is “doing God’s work”, says Lloyd Blankfein, its chief executive, in an interview with the Sunday Times. Leave us alone to make money, he argues:

“We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It’s a virtuous cycle.” To drive home his point, he makes a remarkably bold claim. “We have a social purpose.”

This didn’t go down well with Goldman’s critics, whose high horses had already been fitted with stilts to attack the $16.7bn it has so far set aside this year for staff bonuses. Charlie Gasparino, in the Huffington Post, points out that Goldman has so much money only because it was bailed out by the government, and continues to be subsidised with cheap money.

In the New York Times this morning Maureen Dowd is particularly vicious. She starts with the vampire squid analogy Rolling Stone magazine so beautifully dreamt up for the bank (to which Goldman responded that it was “painfully conscious of the importance in being a force for good”) and ends with:

…as far as doing God’s work, I think the bankers who took government money and then gave out obscene bonuses are the same self-interested sorts Jesus threw out of the temple

Not everyone is a critic, though. Jeremy Warner, former Independent business editor, in his blog, points out that the comment about God was obviously a joke.

The wording may be amusing, but the sentiment behind them is not a joke: Goldman’s clones genuinely believe they are helping make the world better, and should be amply rewarded for doing so. Hard as this is to say, they are partially right – but only about what they do, not what they should get for it.

Markets only work when they are greased by the money of speculators. Ebay may make it easier to buy directly from sellers, but imagine trying to pick up all your groceries straight from the farm, without retailers sitting in between, risking their money by stocking shelves. The same goes for shares: try selling a package of 200 shares in any lightly-traded small company and the buyer is likely to be a marketmaker who will hold them until a buyer comes along. At a more complex level, fixed-rate mortgages work only because of the interest rate swaps market. So we need someone doing the sort of speculation Goldman does so well.

The problem is that hedge funds and banks, and particularly Goldman, are fabulously good at taking out a cut along the way. They are the market equivalent of the Soviet bureaucrats who drew up the 5-year investment plans, running the economy and taking a fee for doing so.

To most people these “fees” look insanely large. There is no easy way to measure the increase in efficiency of the economy thanks to their efforts, which leave many able to retire in their mid-30s with enough money to ensure their children and grandchildren will never have to work.

In part as a result the gap between the richest and poorest in US society is at its highest since the Robber Barons of the late 19th century, the Rockefellers and JP Morgans. This is not socially desirable, even if it turns out that the bankers add more wealth to the world than they cream off.

John Kay, in the FT today, points out the dangers of businesses trying to appropriate wealth through “rent-seeking” behaviour. Governments need to wake up to the dangerously high levels of “rent” the banks are managing to extract from their role as gatekeepers for the allocation of capital to the world’s businesses.

(For more on money and morals, see

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Christopher Cook is an FT editorial writer. Before joining the FT in 2008 as a Peter Martin Fellow, he worked for three years for the Conservative party.

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