That is the title of Amar Bhide’s new book. In the end (p.290), he writes
I propose we reinstate old-fashioned banking, where bankers know their borrowers, by tightly limiting what banks can do: nothing besides making loans to individuals and nonfinancial businesses–after old-fashioned due diligence–and simple hedging transactions. The standard would simply be whether the loan (or hedge) can be monitored by bankers and examiners who don’t have PhD’s in finance, and whether the risk is one that bankers would take if it was their own money
Others with similar proposals have called this a separation of “utility banking” from “casino banking.” The utility banks get to have a government guarantee for their deposits, but they have limited asset choices. Casino banks can choose whatever assets they want, but they have no guarantee.
As you know, my view is that all attempts to regulate guarantees degrade over time. The casinos will try to figure out a way to gain access to guaranteed funds. And the utilities will try to figure out ways to invest in risky assets. And everybody will be hiring lobbyists to try to open up loopholes. Eventually, the regulatory fortress will be breached.
I am in the camp that wants to break up big banks, based on the hypothesis that is more synergy between politicians and big banks than between politicians and small banks. That is, I admit, a shaky hypothesis.
I also think that we ought to create a crime called “taking imprudent risks with government guaranteed funds.” No amount of regulatory approval for an activity can serve as an excuse. If you are responsible for the failure of a government-guaranteed institution, and the records show that you could have prevented that failure with sensible precautions, you go to prison. By that standard, the CEO’s of Freddie and Fannie in 2006 and 2007 would be in prison today. Top executives at AIG and a number of big banks, also.
Of course, the goal of the criminal statute is not punishment, but prevention. Right now, taking risks is a heads-you-win, tails-the-taxpayers-lose proposition. I want “tails” to mean “you could get sent to prison.”
I agree with Bhide about the hazards of securitization, as opposed to “hands-on” lending decisions. However, I think he overstates the role of mathematical modeling in promoting securitization and understates (ignores, actually) the role of political lobbying.
Overall, I think A Call for Judgment can stimulate a lot of thought and discussion. But I found myself wishing that Bhide would have used a blog rather than a book as a vehicle of expression. I think it would be more satisfying to bat these sorts of ideas back and forth in the blogosphere.
READER COMMENTS
Mitch Oliver
Dec 9 2010 at 10:30am
I’d like to propose a concomitant fine that scales up in proportion to the level of compensation of the convicted.
Chris
Dec 9 2010 at 2:05pm
my first reaction to your proposed crime for “taking imprudent risks with government guaranteed funds” was along the lines of don’t write a law giving your party more power, if you don’t want the other party using it when they’re in control. When in control the Repubs will deem A, B, and C to be “imprudent.” And when Dems are in control they’ll deem D, E, and F “imprudent.” You’ll never know what’s going to be illegal.
But then I realized that was the genius of this law. If you don’t know who’s going to be enforcing the law in the future, you avoid A, B, C, D, E, and F. It makes the banker ultra-careful not to run afoul of the “imprudent” law.
mark
Dec 9 2010 at 3:03pm
These are absolutely awful ideas. The standards are too vague for any human being to know what to comply with, which is compounded by the explicit preclusion of the ability to obtain regulatory guidance. If institution buys 30 year fixed rate first mortgages, that is as plain vanilla as it comes. But there is a lot of risk in that as the S&Ls showed in the late 70s. Interest rates on your deposits have to move up and down or the deposits move and you have a liquidity crisis. Should they buy a swap to hedge it? Well, lots of municipalities have been hurt by swaps moving in an unanticpated way. There’s Orange County for one. Even big companies like P&G have been burned on swaps. What is reasonable or unreasonable in this? How would one know.
Plus, note that neither AIG nor Lehman nor Enron nor Worldcom nor Countrywide had government guaranteed debt. So your criminal law idea wouldn’t be fixing any of them. It’s like responding to a bank robbery by pointing a gun down a crowded street and saying, I’ll shoot the next person who tries that. The banks that historically have failed who had government guaranteed debt were almost always small, sunbelt banks exposed to local real estate. AIG and Lehman and Countrywide were also so exposed. So if you want to address that issue just restrict real estate backed lending and you’ll have little to worry about.
I find it really odd that anyone with a libertarian outlook could sponsor such criminalization.
Matt C
Dec 9 2010 at 10:05pm
Thank you Mark.
Arnold, I do not understand why you believe that regulators would use these new, arbitrary powers for good. I don’t see any reason to believe this. Is this usually what happens when government officials are able to make up the rules on the fly for themselves? Why won’t the regulators just use these powers to destroy Goldman Sachs’s annoying competition? (Some have argued that is essentially what happened, when the powers that be let Lehman fail and saved AIG.)
If you are responsible for the failure of a government-guaranteed institution, and the records show that you could have prevented that failure with sensible precautions, you go to prison. By that standard, the CEO’s of Freddie and Fannie in 2006 and 2007 would be in prison today.
No they would not. We would have a few calls from people like you to use the new vague law to put them in prison, and all of you would be marginalized as cranks. The actual officials in power would explain, patronizingly, that that is not at all what the law was written for, and the mistakes of Freddie and Fannie were understandable, unavoidable and obviously unpunishable. Some other schmucks without connections–maybe the few people who got rich shorting the CDOs–they would be the ones that went to prison, if anyone did at all.
Tell me this. Tell me what the officials have done so far, within the powers that they already have, to punish the big malfeasors in the current crisis. What have the officials done to even try to punish the people who wrote CDOs on (as I understand it) an essentially fradulent basis? What about the ratings agencies, who were grossly culpable in this disaster? What sanctions have they received at all? Do you really believe there is nothing that our government could do to punish or scare these actors if it wanted to? It does not want to.
Sorry, I’m ranting. You’re a great guy and it really pains me that you can’t seem to see the obvious. Thanks for all your posts, I mostly enjoy them.
blink
Dec 9 2010 at 10:21pm
In principle, I agree. However, I think regulators are more likely to do well delineating “utility banking” from “casino banking” than to prudently implement a “go to prison” plan for excessive risk-taking. Let’s not unleash the lynch mobs.
John Fast
Dec 10 2010 at 8:26am
Dans ce pays-ci, il est bon de tuer de temps en temps un banquier pour encourager les autres.
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