Taunter Media

Fantastic piece on regulatory capture by Bond Girl (now d/b/a James Kwak, it would appear) over at Baseline.  Check it out, while the comments are still as intelligent as the piece itself.  I’ll be here staring at CGI black holes:

Back?  Great.  Bond Girl combined what I wanted to say here and here with just about all of my rants in the “Meltdown” section.

One challenge with finding fraud is simply, well, finding it.  It is hidden, and since we only see limited snapshots of other people’s financial dealings, civilians rarely have the confidence to call the cops.  We figure if something is really wrong, surely smarter people will shut it down.  There are structural mechanisms to try to address it, some more creative ideas, but ultimately it will probably lurk as background radiation throughout human existence.

The meltdown went far beyond Bernie Madoff and whatever petty fraud went on in boiler room mortgage originators in Florida and California.  It stemmed from the very design of the regulatory system, indeed, from the very belief system that defines American finance.

America’s money center banks are run by smart, serious, important people, people who had the drive and resourcefulness to push their way past twenty thousand other smart, serious men to get to the corner office.  The folks who regulate them are decent, conscientious academics and bureaucrats who early on made the right alliances and never forget that in the Fed as in China, “Chairman” is above “President”.

Story goes that back in the day, when a GM man walked into another GM man’s office, he looked up and counted ceiling tiles.  Quick way to figure out the square footage of the office and where the guy stood in the pecking order.  Well, on Wall Street the establishment jobs are important by size (not to be confused with the carry jobs, which can make people wealthy beyond comprehension while sitting anonymously in East Setauket).  If it is being done by C/JPM/BAC/WFC/GS, it’s the right thing to do, no matter what that pesky market of great unwashed does.

I would like to think that when Goldman Sachs became a bank holding company, someone somewhere in the government considered requiring them to behave like a bank.  Get their value at risk down, get their capital ratio up, be the bank they begged to be.  But somehow that never happened.  It doesn’t seem to have dawned on anyone that there was something wrong with what Goldman was doing before, and if there was nothing wrong with what they were doing before, why let some temporary misfortune get in their way?

Here’s a little thought experiment: the FDA tells Merck that there are problems with Vioxx and the drug needs to be recalled.  Much gnashing of teeth and rending of garments in New Jersey as management thinks about what this is going to do to the stock, and then someone gets on the line.  “Yeah, got it, look, instead of a recall, do you mind just waiting until this goes off patent?  It’s only a few years, and we were really counting on the cash flow to fund some very important research that could save lives.”

It actually happened in France.  In March of 1985, the French government was warned that a large chunk of its blood supply was probably tainted with HIV.  The blood needed to be tested, immediately.  As it happened, the only test belonged to Abbot Labs.  The French government did not want Abbot to corner the HIV-screening market, so it held off testing to wait for Diagnostics-Pasteur to come up with its own test.  It just so happened that prime minister Laurent Fabius’ health adviser came from D-P.  4,400 people died from the decision.

At least – and it is small comfort to the people who died and those they left behind – the entire country was revolted, and there was a national discussion about how the leadership could possibly show such callous disregard for human life and the mission of the government.

No one has died from the financial crisis, at least not directly – if the financial crisis makes it impossible to get meaningful health care reform, we can debate indirect consequences.  But the galling thing is that the consensus of important people is that the crazy interventions of the Paulson/Bernanke/Geithner/Summers team were the right thing to do.

What the government did, without ever stating its purpose, was guarantee not only the debt of the large banks but also the equity.  It was a staggering injection of capital, or rather a staggering transfer of capital from future taxpayers to current equity holders.  We continue to pay for this every day, if in no other way than the quantitative easing that has resulted in the Treasury auction going directly to the Fed.

Lest we long for community banks as a counterweight to the establishment, please be sure that community banks are at least as reckless as the big boys, with considerably less concern for shareholder interest and more scams.  Hell, they aspire to play with the big kids, are not nearly as smart, and don’t have teams of auditors and compliance officers making their lives crazy.  The big difference is that the community banks, indeed all the banks CIT and smaller, are small enough that they can be picked off one at a time.

If we are going to reform financial services regulation, it will not be a matter of changing assignments in Washington or hoping that people who make a tiny fraction of their nominal counterparts and aspire to nothing more than joining them will ever make a difficult decision.  It will be a matter of creating binding constraints on regulatory discretion.

One simple law:

The United States Government will not invest in the equity or debt securities or provide any guarantees of any equity or debt securities of any private corporation without the restructuring of said corporation under the Bankruptcy Code and the discharge of any previous claims against said corporation.

and all of the Fannie/Freddie/AIG/TARP/TALF idiocy goes away.

The law could, of course, be waived, and might have been in September (can an all-powerful entity create an object beyond its power to move), but at least it would have created a firewall.