Banks and crime

[The_Squid]

Do you think a heroine addict has no free will? An addict has choice every time he shoots up but chooses not to exercise it. Bankers also had a choice. But that does not mean the 'dealer' (the government with its racial quotas) does not deserve part of the blame for introducing the addict to the drug.

Crooked banks have an addiction? Your analogy is seriously flawed. Assinine even.

[TimG]

Crooked banks have an addiction? Your analogy is seriously flawed. Assinine even.

Nothing wrong with my analogy. After all gambling is a recognized addiction. Why is it any different if the addict gambles with other peoples money?

Your problem is you desperately want to see "bankers" as the devil incarnate because it makes you feel better about yourself so you reject any suggestion that they might be human.

[Canuckistani]

Nothing wrong with my analogy. After all gambling is a recognized addiction. Why is it any different if the addict gambles with other peoples money?

Your problem is you desperately want to see "bankers" as the devil incarnate because it makes you feel better about yourself so you reject any suggestion that they might be human.

Well again, we have to take away their drug of choice.

[dre]

Nothing wrong with my analogy. After all gambling is a recognized addiction. Why is it any different if the addict gambles with other peoples money?

Your problem is you desperately want to see "bankers" as the devil incarnate because it makes you feel better about yourself so you reject any suggestion that they might be human.

Thats the whole problem is that of course bankers are not "evil", they are just self interested like everyone else. The problem is that structurally the system puts them in a position where they can often enhance their self interest at the expense of others.

The reality is that most of the actors during the runup to the sub prime meltdown were quite rational. It made sense to bundle mortgages into derivatives because there was demand for those products. You could sell them! It also made sense to try to hype up the best tranches of debt within those products, and try to hide the riskier tranches, and it made good sense to make sure the products were complicated enough to confuse investors.

They should still be allowed to do this if they want to. Its just capitalism.

The real problem is the huge conflict of interest thats inherent in the ratings system. Credit ratings agencies make their money from the exact same people bundling loans, and they were stamping TRIPLE AAA on all these securities full of literally worthless paper. If the ratings agencies were independant and did a good job, then it wouldnt matter if investment banks went on trying to trick investors into buying junk.

You also need to make a distinction between commercial and investment banks, as they are radically different animals. Commercial banks are quite heavily regulated, and since they accept insured deposits they are subject to FDIC regulations. Commercial banks actually behaved pretty well and caused a lot less of the problems. Investment banks, thrifts, and trusts however dont accept insured deposits and are nearly unregulated. They were the ones behind most of the bad loans and securities.

The problem with the banking system isnt so much that "bankers are evil". Its that over the years they have been able to put themselves in the position they are in, and its just as much government thats to blame for that. This goes way back to the banking crisis shortly after 1900 after which the banking industry successfully lobbied for the government to become the lender of last resort.

The government should get OUT of the banking business, and banks should get out of the monetary policy and money printing business. Until this happens these problems will just keep getting worse.

Edited August 8, 2012 by dre

[Canuckistani]

There's plenty of blame to go around, including Democratic and Republican administrations. And the current resistance to bring in proper regulations can also be laid at both parties. Looks like everybody is addicted, nobody has hit bottom yet.

[TimG]

Well again, we have to take away their drug of choice.

Ah but the 'drug of choice' serves a useful purpose in society. So it can't be taken away. The use must be controlled. But the question is how. More of the wrong regulations won't help. What we need are the right type of regulations that create the right incentives. The minority loan quotas are example of regulations that created the wrong incentives. Regulations allowing third party mortgage brokers to sign contracts, collect a commission and then have no responsibility created the wrong incentives. Regulations allowing Americans to walk away from their mortgages without declaring bankruptcy created the wrong incentives. Edited August 8, 2012 by TimG

[dre]

That article no. But it does not really get into why repackaging bad mortgages and selling them off got started. Basically banks where forced into these arrangements because of government regulations requiring them to meet racial loan quotas. The repackaging allowed them to meet these quotas without hurting their bottom line. Once they saw they could make lots of money with the scheme then greed took over.

I doubt the crisis would have occurred if the government had not imposed these quota. (i.e. like a heroine addict may never have become addicted if he had not met that dealer who gave him his first hit).

This has been parroted about a fiar bit but there isnt a whole lot of truth to it.

Heres the institutions that made most of the dangerous loans. Only two of those institutions accepted FDIC insured deposits. The vast majority of them were not subject to any of the rules you are talking about. They werent loaning to low income people because of any "racial quotas" (which dont exist by the way... not in the CRA or anywhere else for that matter). They made these loans because as the realestate bubble was inflating it was tremendously profitable to do so, and they felt that rising home prices mitigated the risk. Plus with the help of investment banks and corrupt ratings agencies they were able to move these loans off their books and sell them to investors around the world.

1. Countrywide Financial

At least $97.2 billion

2. Ameriquest Mortgage/ACC Capital Holdings

At least $80.6 billion

3. New Century Financial

At least $75.9 billion

4. First Franklin/National City/Merrill Lynch

At least $68 billion

5. Long Beach Mortgage/Washington Mutual

At least $65.2 billion

6. Option One Mortgage/H&R Block

At least $64.7 billion

7. Fremont Investment & Loan/Fremont General

At least $61.7 billion

8. Wells Fargo Financial/Wells Fargo

At least $51.8 billion

9. HSBC Finance/HSBC Holdings

At least $50.3 billion*

10. WMC Mortgage/General Electric

At least $49.6 billion

11. BNC Mortgage/Lehman Brothers

At least $47.6 billion*

12. Chase Home Finance/JPMorgan Chase

At least $30 billion

13. Accredited Home Lenders/Lone Star Funds V

At least $29.0 billion

14. IndyMac Bancorp

At least $26.4 billion

15. CitiFinancial/Citigroup

At least $26.3 billion

16. EquiFirst/Regions Financial/Barclays Bank

At least $24.4 billion

17. Encore Credit/ECC Capital/Bear Stearns

At least $22.3 billion

18. American General Finance/American International Group (AIG)

At least $21.8 billion*

19. Wachovia

At least $17.6 billion

20. GMAC/Cerberus Capital Management

At least $17.2 billion*

21. NovaStar Financial

At least $16 billion

22. American Home Mortgage Investment

At least $15.3 billion

23. GreenPoint Mortgage Funding/Capital One Financial

At least $13.1 billion

24. ResMAE Mortgage/Citadel Investment Group

At least $13 billion

25. Aegis Mortgage/Cerberus Capital Management

At least $11.5 billion

[dre]

What we need are the right type of regulations that create the right incentives.

Actually what we need I think is to separate the financial industry into its logical functions (monetary policy, commercial banking, investment banking) and make sure they all operate independantly. The government should have very little to do with banking, and really the only reason why we need a lot of regulations now is because the public left holding the bag.

We should not insure deposits, and we should not backstop fractional lending. Let banks do what they do, and let them sink or swim on their own. Same goes for investment banks. The only parts the government should be involved in is monetary policy and ratings agencies, and it should take back complete control over these things.

Deregulate the rest of it.

[TimG]

Only two of those institutions accepted FDIC insured deposits.

What are you talking about? I went down your list and most of the banks are subject to the CRA rules because they are FDIC insured (http://www2.fdic.gov/idasp/main.asp).

The fact is the repackaging of mortgages was originally done only to meet the obligations under CRA. It is true that many jumped on the bandwagon once the money making potential was realized but it would be irresponsible to ignore the spark that started the frenzy. Especially since the connection to the CRA made it easier for politicians (especially democratic politicians) to turn a blind eye to the mounting risks.

Edited August 8, 2012 by TimG

[TimG]

We should not insure deposits, and we should not backstop fractional lending.

You simply don't understand how a run on banks can destroy the economy. Deposit insurance exists to prevent panic turning minor problems into real crisis.

[dre]

What are you talking about? I went down your list and most of the banks are subject to the CRA rules because they are FDIC insured (http://www2.fdic.gov/idasp/main.asp).

The fact is the repackaging of mortgages was originally done only to meet the obligations under CRA. It is true that many jumped on the bandwagon once the money making potential was realized but it would be irresponsible to ignore the spark that started the frenzy. Especially since the connection to the CRA made it easier for politicians (especially democratic politicians) to turn a blind eye to the mounting risks.

Did you select the "As of 2007" option? If gone through the first 10 or 12 and only found 2... Wells Fargo and one other. Most of the major subprime lenders were not even banks and didnt accept any deposits what-so-ever.

Its also not true that securitization/derivatives was done to meet obligations under the CRA. The vast majority of sub prime loans were not even subject to the CRA, and investment banks doing the bundling certainly were not. Derivatives are simply a risk management tool. Furthermore derivatives would not have been a problem if there was honest independant ratings agencies.

[TimG]

The vast majority of sub prime loans were not even subject to the CRA, and investment banks doing the bundling certainly were not.

I never said they were. I said the CRA was the spark that got the banking industry into the business of securitizing loans and the CRA also shielded the banks from attempts to regulate. Edited August 8, 2012 by TimG

[dre]

You simply don't understand how a run on banks can destroy the economy. Deposit insurance exists to prevent panic turning minor problems into real crisis.

Actually I understand that very well which I why I recommending splitting the financial industry up into its logical functions. The main reason banks are subceptible to bank runs is because they loan out money that they dont have. Governments allow this activity and backstop it because its one way of growing the money supply relative to the total size of the economy.

You dont need the public to insure deposits in order to avoid bank runs, thats just one way of doing it. And if we ARE going to take on the lions share of the risk we should get the lions share of banking profits as well.

Banks can also protect themselves from runs by not leverage deposits so hard, and by establishing their own overnight rate and agreements with other banks. If this system broke down, they could borrow the money from the public at interest IF we decided it was in our best interest to lend it to them.

In any case... if we assume the risk we encourage them to take risks.

[TimG]

And if we ARE going to take on the lions share of the risk we should get the lions share of banking profits as well.

Governments don't take the risks. Private corporations do. Deposit insurance only enters into the equation when the private company has failed and all shareholder equity has been wiped out. The beneficiaries of the insurance are individuals who had nothing to do with the failures in management at the bank.

Banks can also protect themselves from runs by not leverage deposits so hard, and by establishing their own overnight rate and agreements with other banks. If this system broke down, they could borrow the money from the public at interest IF we decided it was in our best interest to lend it to them.

This is basically the way the system works now except it is the central bank doing the lending at interest.

But you can't have a useful banking system without fractional reserve banking. This means that no bank will ever have enough cash on hand to cover deposits if people demand it en mass. More importantly, if one bank fails you can have a cascading series of bank failures because the failed bank cannot make good on contracts with the other banks. So governments often need to prop up successful banks while letting the bad banks go under.

Edited August 9, 2012 by TimG

[dre]

Governments don't take the risks. Private corporations do. Deposit insurance only enters into the equation when the private company has failed and all shareholder equity has been wiped out. The beneficiaries of the insurance are individuals who had nothing to do with the failures in management at the bank.

This is basically the way the system works now except it is the central bank doing the lending at interest.

But you can't have a useful banking system without fractional reserve banking. This means that no bank will ever have enough cash on hand to cover deposits if people demand it en mass. More importantly, if one bank fails you can have a cascading series of bank failures because the failed bank cannot make good on contracts with the other banks. So governments often need to prop up successful banks while letting the bad banks go under.

We had a usefull banking system for thousands of years before fractional reserve banking. We also had fractional reserve banking for more than 100 years before we had central banks. The difference is it was the banks that had to take the hit for their risky behavior (Morgan Stanley specifically).

And you claim that banks cant be useful without leveraging deposits but theres thousands of lenders today doing exactly that.

Socializing the risk and forcing the government to be the lender of last resort was not the only answer... Its just the one the banks wanted and lobbied for.

[TimG]

We had a usefull banking system for thousands of years before fractional reserve banking.

Really. Are your evidence for that is what?

And you claim that banks cant be useful without leveraging deposits but theres thousands of lenders today doing exactly that.

Evidence?

Socializing the risk and forcing the government to be the lender of last resort was not the only answer... Its just the one the banks wanted and lobbied for.

The problem is not the backstopping of banks. The problem is the yahoos that managed the banks into the ground are still working there. I would be happy to see a change to the law that severely penalizes past and present management of banks that require bailouts. It does not have to be jail time since proving beyond reasonable doubt is tough to do. But requiring that bonuses be paid back and prohibiting the managers in question from acting as a manager for any publicly listed or regulated corporation again.

[dre]

Really. Are your evidence for that is what?

The history of banking. Fractional lending was actually a crime prior to the creation of the bank of england.

Evidence?

The literally thousands of lenders that dont accept insured deposits.

The problem is not the backstopping of banks. The problem is the yahoos that managed the banks into the ground are still working there. I would be happy to see a change to the law that severely penalizes past and present management of banks that require bailouts. It does not have to be jail time since proving beyond reasonable doubt is tough to do. But requiring that bonuses be paid back and prohibiting the managers in question from acting as a manager for any publicly listed or regulated corporation again.

The problem is that banks are no longer banks they create and loan out brand new money and rapidly expand the ammount of money in circulation. This is what creates the need for the complexed web of regulations, and gives the government skin in the game. Its also what funds the creation of all these asset bubbles and causes the business cycle. A simple lender doesnt need any government regulation. And the combining of monetary policy and with traditional banking makes the government completely dependant on these banks, and makes them essentially above the law. The government should have its own way of expanding the money supply when it needs to (and technically it does, it just almost never uses it).

Thats why as I said the financial industry should be separated into its logical functions and those functions should be performed by completely separate entities that manage their own risk and sink or swim based on their own business practices.

And this goes way beyond simply punishing managers and executives. Punish them for what? Most of what went on was pretty much legal. The banks simply had the government make the laws they needed to do it.

At the end of the day if you give me a license to print money and lend it out at interest, and promise to bail me out if I get in trouble, Im gonna have ALL KINDS OF FUN. Its just not an environment where anyone is going to be risk adverse. Allowing private banks to manage the money supply is just a really bad idea. A good example is iceland where within three years of privatizing its three major banks those banks had lent into existance 14X icelands GDP

[TimG]

The history of banking. Fractional lending was actually a crime prior to the creation of the bank of england.

So? Where is the evidence that the system was actually better? The rise of England as a global power and the industrial revolution occurred largely *after* the bank of england was created. I don't think it was a coincidence.

The literally thousands of lenders that dont accept insured deposits.

These lenders borrow money from banks and make money on the interest rate spread. No matter who makes the loan to the consumer there is money being created by a bank somewhere. Edited August 9, 2012 by TimG

[dre]

So? Where is the evidence that the system was actually better? The rise of England as a global power and the industrial revolution occurred largely *after* the bank of england was created. I don't think it was a coincidence.

These lenders borrow money from banks and make money on the interest rate spread. No matter who makes the loan to the consumer there is money being created by a bank somewhere.

I never said it was better. It was you that made the claim that banks would be useless without fractional lending. And England was already spreading out across the world at that point.

And no... thats not how most private lenders operate.

Also fractional reserve banking is entirely different now than it was even 50 years ago. Theres a difference between leveraging deposits and creating new money. The current banking system is about 40 years old and all its produced is astronomical debt which is an inescapable biproduct of the system.

Its also a violation of previous banking principles. Up until 1844 banks could actually print their own paper currency to lend out. It was outlawed because it was a destructive practice, but banks do the exact same thing today with electronic money... eventually with the same destructive results.

You act like this is the only way the financial system can work but theres a lot of other ways to build a functional banking system, and they are gaining support among both economists and bankers.

[TimG]

And England was already spreading out across the world at that point.

No. England had got its butt kicked badly by France. It created the BoE because it needed money (created from nothing) to rebuild its navy. It worked and resulting spending juiced its economy.

And no... thats not how most private lenders operate.

Actually yes it is. They can't lend money they don't have so they have to borrow from someone. Those someones are directly or indirectly banks. How do you think they get that money if they don't take deposits? Edited August 9, 2012 by TimG

[dre]

No. England had got its butt kicked badly by France. It created the BoE because it needed money (created from nothing) to rebuild its navy. It worked and resulting spending juiced its economy.

Actually yes it is. They can't lend money they don't have so they have to borrow from someone. Those someones are directly or indirectly banks. How do you think they get that money if they don't take deposits?

That entirely depends on what type of lender you are talking about. Pure mortgage companies sell shares... mortgage funds and realestate trusts raise investment capital... Either way your statement that "banking is useless without fractional reserve lending" is baseless, and ignores the fact that the banking system we have today is completely different than anything we have seen prior to the 1970's. Its a brand new system and its collapsing quickly.

[TimG]

That entirely depends on what type of lender you are talking about. Pure mortgage companies sell shares... mortgage funds and realestate trusts raise investment capital...

What are you talking about? These type of companies always use leverage (i.e. they *borrow* money from banks) to maximize their returns. I challenge you to find one example of a mortgage company or REIT that does not use leverage.

[dre]

What are you talking about? These type of companies always use leverage (i.e. they *borrow* money from banks) to maximize their returns. I challenge you to find one example of a mortgage company or REIT that does not use leverage.

No those types of companies dont "always use leverage". REITS are capital pools that allow investors exposure to the realestate market. Same goes for mortgage funds and most private mortgage companies. They are capitalized by private investors not banks.

In any case your origional description of the business model employed by these institutions "they just borrow from banks and make money on the spread!" is utterly and completely bogus.

[TimG]

No those types of companies dont "always use leverage".

Then prove it. Find an example. I have never heard of any mortgage firm or REIT that does not use leverage.

At this point I think you are just making stuff up without actually knowing.

http://www.fool.com/investing/general/2011/02/17/the-4-letter-word-that-should-worry-reit-investors.aspx

Most real estate investment trusts (REITs) buy real estate (obviously), and just like when you or I buy a home, they do it with a mix of equity and debt. But that four-letter word d-e-b-t can be dangerous, and when General Growth (NYSE: GGP ) entered what Reuters deemed a "historic real estate bankruptcy" in 2009, leverage took down a major industry player.

http://www.investmentu.com/2011/January/reits-top-sector-for-income-investors.html

So how do REITs offer the kind of killer returns we’re talking about?

Their business model is quite simple:

They borrow money using low-interest, short-term securities.

Then they use those funds to purchase high-interest, long-term assets.

Investors pocket the difference, known as the “spread,” which can be substantial.

IOW - they borrow money and make money on the spread - just like I said....

http://investor.riocan.com/Theme/RioCan/files/documents_financial/2012/Q1%202012%20Report%20to%20Unitholders%20-%20English%20version.PDF

At March 31, 2012, RioCan’s cash position was $27 million, with available undrawn operating facilities of $371 million. In the first quarter of 2012, RioCan arranged secured financing totalling $179 million at a weighted average interest rate of 3.26% and an average term of 5.2 years of which $142 million represented RioCan’s share and $37 million represented RioCan’s partners’ share. At RioCan’s share, the Trust generated secured net financing of $109 million for three months ended March 31, 2012.

Edited August 9, 2012 by TimG

[CPCFTW]

The obvious solution to Dre's complaint about socializing the risks of fractional reserve lending is to eliminate the CDIC, not to give governments the bank's profits.

Besides, I'm pretty sure banks are forced to contribute to the CDIC on an ongoing basis, so the banks pay for it anyway and it's not socialized.