The Bank Bill

I know I said I would stop writing about this, but most of my favorite bloggers are writing about it. And the big question is whether something positive will be achieved. I'm thinking it is coming down to Obama's speech tomorrow night to see what we can hope for.

In the interests of the open exchange of ideas, Paul Krugman and Tyler Cowen (in yesterday's Marginal Revolution) both disagree with Simon Johnson, Mike Konczal and me that we ought to break up the big banks. See also this discussion in today's N.Y. Times.

Roger Lowenstein raises the very good question of what useful purpose is there allowing people to bet through synthetic collateralized debt obligations.

What caused the financial crisis? Large banks and shadow banks, who were in bed with the ratings agencies, demanded more and more mortgages that they could repackage into bonds, to satisfy large investors who did not understand the risks, and so unregulated mortgage originators found new and novel ways to loan money to people who really could not afford to buy homes. When they ran out of mortgages, Wall Street constructed synthetic bonds, which greatly magnified the risks to the system. Fannie and Freddie, who had become private profit-driven entities, but still implicitly backed by the federal government, helped facilitate even more loans. All this was abetted by regulators such as the SEC and the Fed, failing in their jobs.

A few people, such as John Paulson, Michael Burry and Steve Eisman saw the doom on the horizon and bet against the system using credit default swaps. Eventually, the big boys at Goldman and Deutche Bank (led by Greg Lippman) saw the tsunami, too. Most of us were still drinking the kool-aid when it hit.

I lost a lot of money I had invested for retirmenent. A lot of people have lost their jobs. Taxpayers where made to foot the bill for Wall Street risk-taking. Bankers were given large bonuses for phony profits. And on and on. We fixed the system in the 1930's. The fixes over time were worn away by collusion between the banking lobby and Congress and innovations in finance. Time to fix it again.

Addendum: Here the Senate agriculture committee just passed Lincoln's tough bill on derivatives. This article gives an acccount of why and gives me some hope.