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Preventing the Next Crisis: The Case for Boring Banks

Rep. Brad Miller (D-N.C.), chairman of the House Science and Technology Committee's investigations subcommittee, filed this blog post.

Our subcommittee has championed scientific integrity as necessary to informing public decisions. There is plenty of room for debate about policy implications, but scientific facts should be assessed by scientists without political interference.

If there has ever been a time when we need sound, neutral evaluation of economic facts to inform policy decisions, it is now. Simon Johnson said before our subcommittee today that we have a “desperately ill banking sector,” which is no overstatement. But there has been remarkably little discussion in Congress on the nature of the illness, and the diagnosis matters greatly in deciding the right treatment.

The factual premise of our policy appears to be that our banks are facing a rough patch: Many of their assets are illiquid, we are told, because there are no active markets for the assets and because persnickety accounting rules make the banks appear to be on shaky ground -- but the assets are really just fine, and so are the banks.

But others argue that the core competency of markets is determining value, and the problem with the assets isn’t that they’re illiquid and undervalued but that they’re really not worth much. Some of the people who argue that mark-to-market accounting is the real problem with the banks have in the past genuflected when the word “market” was spoken. (Steve Forbes, are you reading this?)

In his testimony, Dean Baker examined the results of the stress tests and found that the banks really don’t hold that many exotic mortgage-backed securities — a class of God only knows how many bonds based on one of God only knows how many tranches of a pool of God only knows how many mortgages. The banks were selling those, but they didn’t really hold many. What the banks have are whole mortgages, and there is an active market for those. There are regular auctions of non-performing mortgages, which is a classic active market. Unfortunately for the banks, Dean found, auctions of non-performing mortgages bring only about 30 cents on the dollar.

Dean’s findings are consistent with the view of a lot of economists that banks’ assets aren’t undervalued but are dramatically overvalued.

The most interesting question isn’t how we climb out of the hole this time, however, but how to make sure we never let this happen again.

Simon pointed out in his May Atlantic article that just a couple of years ago the same banks that now depend on various taxpayer subsidies to survive were swimming in money — compensation in the financial sector was almost twice what it was for other American workers, and much of that was skewed to vulgar compensation for top executives. Even after all that, the financial sector accounted for more than 40 percent of all corporate profits in America. That’s not a healthy financial system, either, and bouncing from one extreme to the other is especially unhealthy.

Simon urged that banks go back to being utilities, as they were in the 1950s and ’60s, when bankers could make an honest living but didn’t make a killing with insanely risky and often predatory practices. Paul Krugman has said pretty much the same thing. He said we need to make banks “boring again.”

One way to make banks boring is with boring regulations. Property and casualty insurance is all pretty boring. In most states, P&C insurers have to file policy forms with regulators. The regulator makes sure there isn't too much information asymmetry between insurer and customer. And insurers have to report to the government on their actuarial projections, sales and profit figures, and claims experience.

I’m sure banks will say such regulation would stifle great innovations like subprime mortgages and credit card fees.

Property and casualty insurers don’t often become billionaires. They aren’t Masters of the Universe. But when’s the last time you heard a P&C policy called a “toxic asset”?

How do we make sure never to fall into this hole again? Make sure to post your thoughts in comments.

-- Rep. Brad Miller is a Democrat representing North Carolina's 13th District.

By Tim Lawson  |  May 19, 2009; 8:08 PM ET
Categories:  Banking , Regulation  
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The issue confronting lawmakers is this.

Do you want to continue to promote financial innovation and the potential volatility which it can, and I would argue eventually will, bring? Are you willing to accept the attendant consequences to our institutions, industries and citizenry if things 'go south?'

Or do you prefer predictability and sound fiscal practices even though it will at best lead to slow but steady growth?

I contend the risks to our society are much too high to adopt the former approach. Financial innovation is a good thing but not if the risks are unacceptable. That is what we have here.

For supporters of of the first philosophy to now state to investors that they should have borne in mind the principle of caveat emptor is of no comfort given the situation in which all of us find ourselves even if we did not personally participate in the financially questionable activities.

I would remind everyone that even after Bear Sterns failed, Wall Street still argued against the government imposing financial regulations because those on Wall Street did not want to stifle financial innovation. Then the chain reaction caused by the financial weapons of mass destruction finally went into effect.

Now is the time for our government to show that it has learned its lesson and do what is right. Even if Wall Street remains recalcitrant.

A boring bank is a good thing. Phil Graham was wrong.

By the way, I doubt those on Wall Street would continue to support the first approach if they were in the position of no job, no liquid assets, a family to feed, and a mortgage to pay with the prospect of an impending foreclosure.

Posted by: brwntrt | May 19, 2009 9:29 PM | Report abuse

That the banks were swimming in profits has nothing to do with anything, in fact it would be great for all as long as these were real and true profits… but when profits come from convincing Joe that because of his lousy credit score he needs to pay 11 percent for his 300.000 dollar mortgage for 30 years, and then re-selling this mortgage for 510.000 dollar because you placed Joe’s mortgage in a security that got itself a triple-A rating and therefore “merited” a return of only six percent, that is when it all went wrong.

Also there is no need for boring banks… there is nothing boring in getting to know your clients business, look him in his eyes and shake his hand… much more boring is it to have the credit officers stare into monitors in order to follow someone else’s opinion.

But what we most need is some good regulators who do not believe themselves to be gods and interfere with the risk allocation processes in the financial markets in the amazing way they have done when allowing for 62.5 to 1 leverages (and that can in some cases even reach 179 to 1) solely based on some credit rating agencies awarding an AAA.

Posted by: PerKurowski | May 20, 2009 6:43 AM | Report abuse

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