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A future of financial crises

Felix Salmon recaps an interesting argument he had with Robert Pozen, author of the new book Too Big to Save:

I’m also not fully convinced by one of Pozen's big ideas, which is that banks should have small and professional super-boards which, rather than simply rubber-stamping the decisions of the CEO, take a much more active interest in the way the bank is run; Pozen has in mind here the governance structures at companies owned by private-equity shops. (Indeed, he wants to encourage more private equity companies to own and invest in banks.)

My view is that the rates of return targeted and required by private-equity investors are far too high for banking, which should be a boring industry, and that even if safeguards are put in place to stop PE-owned banks from lending to sister companies, management at such institutions will try as hard as they can to bend the rules to maximize leverage and profits. And that they will be positively encouraged to do so by their small super-boards.

Pozen, on the other hand, is fundamentally bearish on the business of banking, telling me that “if all you do is make traditional loans, you will lose money and you will go bankrupt”. I don’t think that’s true, but insofar as it is true of banks, it’s also true of investors who buy securitized loans originated by banks -- so securitization is not really a solution to the problem. More generally, I don’t like the idea of creating a banking system where banks run around trying to make money on clever innovations because they’re losing money on their core loan products. It sounds like a recipe for disaster to me.

Nevertheless, Salmon recommends the book highly, in part because he agrees with Pozen's conclusion:

What’s pretty obvious though is that most of Pozen's recommendations will not be enacted. Which raises the obvious question: if we don’t do this, what’s going to happen to the financial system and the economy? Pozen's answer: we will have more crises, they will be increasingly severe, and they will be increasingly frequent. I agree.

One of the tragedies of the current crisis is that far too many people consider it to be an anomaly, a once-in-a-century event. It isn’t. The recipe for this crisis -- a complex global financial system with large imbalances and inadequate controls -- remains in place today. And financial crises are common things: even if you exclude emerging markets, there’s generally one somewhere in the world every year or two.

We can’t afford the trillions of dollars it would cost to rescue the world from the next crisis -- yet at the same time we’re doing very little to minimize its effects or the probability of it happening. It’s a very risky game that we’re playing, and it’s liable to end in tears.

By Ezra Klein  |  November 11, 2009; 10:48 AM ET
Categories:  Financial Regulation  
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Next: The $900 billion mistake


pozen is stuck in a past era

the horse is out of the barn

goldman et al monetized their ownership and cashing in selling shares along time ago

Posted by: jamesoneill | November 11, 2009 10:59 AM | Report abuse

So why do banks lose money on their core products (where "losing money" may be defined as merely not making the outsize temporary profits they can make with "innovation")? Could it be because they're forgotten boring, old-fashioned things like due diligence? Or could it be because with all the innovations in accounting and corporate structure, due diligence has become so much harder?

Maybe we want Jimmy Stewart back in charge of banking instead of Wile E Coyote.

Posted by: paul314 | November 11, 2009 11:17 AM | Report abuse

Funny, there are plenty of local and regional banks around here that are financially strong and making money...

If these behemoths can't make money doing, you know, actual banking, maybe they should just go away.

Posted by: J-NC | November 11, 2009 11:22 AM | Report abuse

The problem is, they can make plenty of money for themselves. They just can't make money for the institution or the shareholders. Jamesoneill is right.

Posted by: Mimikatz | November 11, 2009 12:04 PM | Report abuse

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