Under deregulation the industry became dysfunctional - but economists still won't revise their anti-regulation script.
by William K Black http://www.dollarsandsense.org (November / December 2007) This article is from the November / December 2007 issue of Dollars & Sense: The Magazine of Economic Justice. The US financial system is, once again, in crisis. Or, more precisely, twin crises - first, huge numbers of defaults among subprime mortgage borrowers, and second, massive losses for the holders of new-fangled investments comprised of bundles of loans of varying risk, including many of those subprime mortgages. These crises should shock the nation. Our largest, most sophisticated financial institutions have followed business practices that were certain to produce massive losses - practices so imprudent, in precisely the business task (risk management) that is supposed to be their greatest expertise, that they have created a worldwide financial crisis. Why? Because their CEOs, acting on the perverse incentives created by today's outrageous compensation systems, engaged in practices that vastly increased their corporations' risk in order to drive up reported corporate income and thereby secure enormous increases in their own individual incomes. And those perverse incentives follow them out the door: CEOs Charles Prince, at Citicorp, and Stanley O'Neal, at Merrill Lynch, had dismal track records of similar failures prior to the latest disasters, but they collected massive bonuses for their earlier failures and will receive obscene termination packages now. Pay and productivity (and integrity) have become unhinged at US financial institutions. As this goes to print, Treasury Department officials are working with large financial institutions to cover up the scale of the growing losses. This is the same US Treasury that regularly prates abroad about the vital need for transparency. And a former Treasury Secretary, Robert Rubin, who failed utterly in his fiduciary duty as lead board member at Citicorp to prevent the series of recent abuses, will become Citicorp's new CEO. To even begin to understand events in the US and global banking industries, you have to look back at the seismic shifts in the industry over the past thirty to forty years, and at the interplay between those shifts and government policy. The story that continues to unfold is one of progressively worse policies that make financial crises more common and more severe. These policies have their boosters, though. Chief among them are neoclassical banking and finance economists, whose ideology and methodologies lead them into blatant misreadings of the realities of the industry and the causes of its failures. When the history of this crisis-ridden era in global finance is written, the economists will no doubt be given a significant share of the blame. http://lists.econ.utah.edu/pipermail/a-list/2007-December/069754.html A New Era of Crisis The changes in the US banking industry in recent decades have been so great that a visitor from the 1950s would hardly recognize the industry. Over two decades of intense merger and acquisition activity has left a far smaller number of banks, with assets far more concentrated in the largest ones. Between 1984 and 2004, the number of banks on the FDIC's rolls fell from 14,392 to 7,511; the share of the US banking industry's assets held by the ten largest banks rose from 21% in 1960 to nearly sixty percent in 2005. At the same time, nonbank businesses that lend, save, and invest money have proliferated, as have the products they sell: a vast array of new kinds of loans and exotic savings and investment vehicles. And the lines have blurred between all of the different players in the industry - between banks and thrifts (for example, savings and loans), between commercial banks and investment banks. These changes were made possible by the deregulation of the industry. Bit by bit, beginning in the 1970s, the banking regulations put into place in the wake of the Great Depression were repealed, culminating in the Gramm-Leach-Bliley Act in 1999, which removed the remaining legal barriers to combining commercial banking, investment banking, and insurance under one corporate roof. The new world of combined financial services is exemplified by the deal, inked (but ostensibly illegal) before the 1999 law was passed, that merged the insurance and investment-banking giant Travelers with Citibank, at the time the nation's number-one commercial bank. Copyright © 2007 Economic Affairs Bureau, Inc. http://www.dollarsandsense.org/archives/2007/1107black.html http://www.billtotten.blogspot.com http://www.ashisuto.co.jp
