The Wall Street Journal has a long page 1 article, "Life on Wall Street Gets Less Risky" describing what it's like at Morgan Stanley under the new regulatory regime. Two bits caught my eye
Your No. 1 client is the government," John J. Mack, Morgan Stanley's chairman and chief executive from 2005 to 2009, told current CEO James Gorman in a recent phone call. Mr. Gorman, who was visiting Washington that day, agreedThis is a useful anecdote to remind people what "regulation" means. I get asked all the time, "doesn't the financial crisis mean we need more regulation?" They seem to think "regulation" is something you pour in like gas in the tank. Or maybe they envision "regulation" as a simple set of impartial rules. You know, there is a 50 mph speed limit, which everyone routinely violates, a huge crash, so we enact a 30 mph speed limit and put a lot of cops on the road.
....regulators prowl the office floor looking for land mines, and Mr. Gorman phones Washington before making major decisions...
About 50 full-time government regulators are now stationed at Morgan Stanley. There were none before 2008, when it was regulated as a brokerage firm instead of a bank.
No, we put 50 cops in your car. And how long can this possibly go on before the cops start asking where you're going and why? How long can 50 regulators sit in the bank approving every decision, before "you know, you haven't made any green energy loans in a long time" starts coming up? But contrariwise, how long before those 50 regulators come to the view that Morgan Stanley's survival and prosperity is their job? 50 full-time government employees calling the shots on every deal at a supposedly private bank is a good picture to keep in mind of what "regulation" means.
It also means bureacracy and a return to the cozy banking world of the 1950s.
There now are 3,000 different limits that restrict such things as how much capital traders can put at risk, up from 30 before the crisis....
Wall Street culture has long valued grueling hours, lunches at desks and late nights in the office. In 2011 and 2012, Morgan Stanley's fourth-floor capital markets division overlooking Times Square, where several hundred bankers help arrange stock and bond deals, started emptying out earlier in the day, according to two former employees who worked there at the time.....The three-martini lunch, 2-pm tee time and "mad men" suits can't be far behind.
But there is good news in this too.
..go-go trading businesses once hailed as its future are gone or curtailed. In their place, the storied investment bank has embraced the retail-brokerage business—peddling stocks and doling out financial advice to ordinary investorsThis is great! The Volcker rule, which seemed awfully hard to define and implement as regulatoin, seems to be happening in spirit. Trading is moving out of big government-subsidized, too big to fail, commercial banks. Free marketers, cheer. This function is not dying. It is moving to hedge funds, where it belongs. And which everyone knows can fail.
For the high-rolling traders who used to make more than $10 million a year, Mr. Gorman has had a simple message: Take fewer risks or take their act to a hedge fund, where failure doesn't threaten the financial system as much.... Traders and others have left for hedge funds and private-equity firms.
...Michael Reed, who worked at the PDT desk for 16 years before leaving in 2010, laments the decline of the firm's trading culture. "Personally, I find it sad," he says. "They used to be a peer of Goldman Sachs. Now, they're just another retail brokerage."
You know, like LTCM.
Oh wait, maybe this isn't so great. "Systemic" never had any limits. How long until regulators decide the new hedge funds are "systemic?" The "intermediated finance" view gaining more and more popularity at the Fed says that leveraged intermediaries willing to buy are they lynchpin of the financial system. "Fire sales" will break out just as much if they fail...
Well, maybe I worry too much.
The other heartwarming big picture: Banks have figured out that maybe the Modigilani-Miller theorem works after all. You can operate with lower risk, lower beta, lower return on equity. That's what's going on, basically, at Morgan Stanley. And made even clearer in the Financial Times:
Credit Suisse’s chief executive has laid out a vision for a banking industry with lower but more sustainable returns and has vowed to never again make losses.
Brady Dougan... said Credit Suisse’s aim of an average 15 per cent after-tax return on equity was a much more dependable promise over the long term than the sector’s pre-crisis 20 to 30 per cent targets.
Lower risk, lower beta, less chance of failure, lower return on equity. So much for the claim banks had to give shareholders an absolute ROE independent of beta and volatility.
the problem with traders, "no skin in the game" http://bit.ly/18MZrL2
ReplyDeleteBig hedge funds and money market funds are already systemic and have been for a long time. The Fed bailed out LTCM (and its counter parties).
ReplyDeleteJamie Dimon admitted publicly that JP Morgan did not understand the instruments being traded by the "London Whale". That should never happen at an institution with an explicit or implicit government guarantee.
A useful piece of information on this subject would be to get to know how many Banca d'Italia regulators stationed permanently at Monte dei Paschi di Siena. Or, how many Bank of England regulator lunched at the RBS headquarters. And the list can be easily expanded.
ReplyDeleteAbsalon, do you think CEO at any big company fully understands what everyone in the company is working on?
ReplyDeleteMuch as it pains me to admit (no, not really) regulation can be both cumbersome AND inefficient.
ReplyDeleteOTOH, last time I checked, it was the banks who wanted that way so that they could exploit all the loopholes/regulatory arbitrage complex rules create.
I am in favour of simple rules-of-thumb: Waaay higher equity requirements. The rest will take care of itself, by and large.
Quite agree with your last paragraph. In fact I’m not in favour of making equity requirements Waaay higher: I’m in favour of making them 100%. That is, I’m in favour of Laurence Kotlikoff’s system which goes like this.
DeleteWhere anyone who wants their money to be 100% safe, the money cannot be invested or loaned on, ergo it really is 100% safe. As to money which people want their bank to lend on or invest, those people carry ALL THE RISK. I.e. they are in effect shareholders.
That way, banks as such just cannot suddenly fail. And as a result “the rest will take care of itself”.
By the way, the above ultra-simple rule makes the 10,000 pages of Dodd-Frank look like a complete shambles, which is what it is.
Ralph
DeleteAnd if such a system were more effective than traditional banking it would have arisen naturally through the market in the pre-deposit insurance era. If it were more economically efficient than submitting to Dodd Franks it will arise spontaneously as a way to avoid Dodd Franks. There is no point in imposing such a structure on everyone if the economic inefficiency costs exceed the costs of a cumbersome regulatory scheme.
What I don't get is...if we eliminated too big to fail, would you really need equity requirements for non commercial banking institutions in the first place? We don't put capital requirements on firms and they rarely let themselves get overleveraged. More importantly, very rarely do creditors LET them get overleveraged.
DeleteJames - I am not sure what you mean. How big do you think is "too big to fail"? Professor Cochrane has said that it was the shadow banking sector that was hit first and hardest - that would be an unregulated sector where the "depositors" were highly sophisticated and should have known better. I think you underestimate how often firms get "over-leveraged".
DeleteMost of the shadow banks' leverage was coming from overnight commercial paper, held by many institutions including the commercial banks. Again, you ask the appropriate question - Why would sophisticated investors really believe overnight commercial paper carried no risk? One reason I've heard is that since the commercial banks were buying and underwriting these notes, they distorted signals in the market. And because these commercial banks were essentially under too big to fail, the fault lies with too big too fail. I'm not sure I buy this argument entirely, but ultimately, my point is - are equity requirements really a cure all if the problem comes down to people making mistakes?
DeleteWell what do you want to be....a bank or a hedgefund? Why should the government insure your hedgefund money while you try to corner the market with borrowed FED money. You want to take your own money and shoot the moon...FINE...but that isn't how it works today. 1950's most productive economy ever where EVERYONE prospered. There is a difference between TRADERS, Investment Bankers, and banks!
ReplyDeleteI really wish Modigliani Miller were being embraced, but all reactions by banks to the proposed supplementary leverage ratio is all hell will break loose if, god forbid, leverage were limited to 19-to-1
ReplyDelete"No, we put 50 cops in your car." No, not in every car; only in those about the size of an aircraft carrier.
ReplyDeleteWhat happens when the regulatory hall monitors marry the natives?
ReplyDeletea worse fundamental problem is that when an other sets a value, whether high or low, right or wrong, the value has to be followed or you lose out on winning on the way to failing... hmmmm
ReplyDeletelets say the perfect number for something (for the whole group) is 25
this could be a fractional reserve, it could be whatever.
if no entity sets a value, then each entity that requires it will make a choice that fits them and hopefully is good. over time this works out more than it doesn't as those that do bad disappear. some will have a lower number some will have a higher number and the bell curve will just love that 25...
ah.. but now comes the number setters, who think that setting the number controls something. and it does. the arbitrary number they pick and define, becomes a magical lever that they claim will do what they want, but then seldom does, and causes much problems as this lever shouldnt exist, and its not millions of them for each individual, but a global lever, or a set of levers covering ranges... but the numbers of those ranges or categories are always manageable. can usually be printed.. and all too often fall into numbers related to our finger count. if there are actually 123,456 categories you can be sure, they will claim to have a way to slot that into 10 to 100 or so... (with all exceptions to their ideas being completely forgotten in the condensing)
anyway. they love this magic...
so they sett the number to 17...
now those who want or can do higher or had higher, now have to operate lower. those that operated lower, have to raise their levels to compete with their others who are doing similar. everyone who was not set at 17 now has to do so.
right now, they are running around trying to set all the levers to the middle equal position, regardless of anything else. thinking that if they can do that, the slot machine will hit jackpot (while they ignore demographic collapse, etc).
this is the peril of regulation setting things...
the other side to this bad coin is that once done, everyone adapts to it in some way, and so, whatever information stored up in the old distribution of individual numbers goes poof... the system will always try to adapt, and so, it changes to not be a system with all these varied pieces fitting together, but a system with varied pieces stretching or scrunching to meet borders set arbitrarily. once done, there is no way to improve the system or fix it, as all they will do is 'seed' the structure with a new setting and the parts will adapt to that seed with regard to the rest and try to go on or not.
in a natural setting there would be no such structure, it would never exist but for making a setting out of nothing. call it Heisenberg theory adapted to the world outside of physics, in which their is no such thing as an outside observer - the observer is part of what they observe and they change whats observed as well as it changes them... insert deep quote here
you create a test, the parts adapt to the test and it ceases to measure
you make values some structure has to follow, it no longer is real any more as no real system would settle on one number in a range of so many features and mixes of abilities.
no one could discuss 123,456 values cogently anyway
so for the number setters we forget are our servants not theirs
there is no power in real numbers either...
maybe not stated the best way...
Professor, where can I find your opinion on what went wrong in 2008, and what should be done? I started reading your blog not long ago, and only read some critics, but no suggestions.
ReplyDeleteRegards
Marco
If the Fed credibly targeted nominal GDP, we wouldn't need to worry about "too big to fail". Any single firm could go under, and the rest of the economy could rely on NGDP staying level. That might not be enough for politicians who can't stand concentrated groups like autoworkers lose their jobs, but it should be enough for economists.
ReplyDelete"How long until regulators decide the new hedge funds are "'systemic?'"
ReplyDeleteThis long:
http://www.ft.com/intl/cms/s/0/701914d4-2a15-11e3-9bc6-00144feab7de.html?siteedition=intl#axzz2gLjyb2ae