
Has Wall Street Been Tamed? - nature24
http://www.nytimes.com/2016/08/07/magazine/has-wall-street-been-tamed.html
======
cm2187
It's a bit frustrating to read articles like this which miss the most
important regulatory change in probably the past 50 years to deal with too big
to fail: the introduction of bail-in.

Bail-in is a fundamental change to insolvency law. It is a power given to the
regulator to declare a bank non viable, whether it is because of capital or
liquidity concerns, and to imposes losses on its bond holders over the course
of a week end. This would auto-recapitalise the bank which should be open for
business the following Monday with a healthy capital position. You can think
of it as a flash, extra-judiciary chapter 11, specific to banks.

The intention is to imposes losses on wholesale investors of the bank,
essentially investors in bonds and capital instruments, and to spare
depositors, even if technically depositors have the same ranking than bond
holders (and therefore would share the losses equally in a bankruptcy).
However should the magnitude of the losses require an extraordinary large
bail-in, uninsured depositors may be targeted too (essentially corporate
clients and high net worth individuals).

Banks are required to accumulate a large amount of wholesale funding to ensure
that there is enough debt to bail in the day the shit hits the fan.

This should largely mitigate the too big to fail, as it would avoid the messy
aspects of a large bank bankruptcy (Lehman scenario) while not using any tax
payer money and making investors bear the losses related to their investments.

Does it solve all problems? God knows what will be the magnitude of the next
crisis. If the US, the UK or France default, that may not be sufficient to
save the banking system. But it should certainly mitigate a lot the too big to
fail risk. And it is extremely unlikely that a bail-out would be considered
before a bail-in would have happened.

Disclaimer: I work in a bank.

~~~
erdevs
You're overselling the bail-in provisions here. Frank-Dodd and the bail-in
regulations it includes certainly introduced some much-needed improvements.
But let's not pretend that the bail-in is either proven in practice nor a cure
of any kind in truly dire situations.

The problem with the bail-in is that at the end of the day, if there isn't
enough wholesale capital available, depositors are still on the hook. Indeed,
we saw the only instance of the bail-in in practice (that I'm aware of at
present) so far in Cyprus resulted in depositors having a portion of their
savings converted to equity (in a nearly-insolvent entity).

At the end of the day, the risk still lies with the public if things get bad
enough at a big bank. Through their deposits, through the FDIC, or through a
bail-out, if the political winds blow that way.

The truly safest solution is to separate investment banking from depository
banking again and to further limit both the size and the allowable exposure
levels of investment banks.

I don't think the bail-in can yet be framed as a good thing. It's
_theoretically_ helpful in _limited situations_ where enough wholesale capital
is available (or can be made available) to solve a crisis of liquidity.
Outside those boundaries, it induces greater risk on depositors. And in that
situation, it may actually be good (in a perverse way) that the public doesn't
know more about it, because if they did it'd likely increase the
incentive/pressure on deposit bank runs.

Again, the solution here is to separate depository banking from investment
banking. Or, put another way, to very tightly regulate the sorts of
investments that depository banks can make. On top of _that_ investment bank
investments should be regulated more than they are today. And on top of all
that, continuing with a rapid-insolvency process + bail-in would make sense
for both depository and investment banks, should the need ever arise in either
case (which likelihood would be greatly reduced through these further
regulations). But the bail-in without these other measures carries risk and
will be of only limited assistance.

~~~
cm2187
You are absolutely right that bail-in only helps if you have debt to bail-in,
and that was not the case for Cyprus.

Bail-in will only be useful when the banks have built up enough bail-inable
capital, and depending on what is the definition of bail-inable capital, most
banks are not there yet (regulators take different views on what constitutes
good bail-inable debt).

However all the draft regulations that are being prepared now point to
relatively high requirements, in the region of 25-30% of the Risk Weighted
Assets, which should be ample to absorb a very large loss.

So if the crisis happens this week, it won't help, if it happens in 5 years or
after it will certainly help a lot, and be a first line of defence before
contemplating a bail out.

On the separation of commercial and investment banks, I am not convinced it
actually helps. Reproducing another of my comments on this article:

If we take the example of the UK, all of the bank failures were because of non
investment banking activities. RBS failed because of its excess of leverage as
a result of its disastrous acquisition of ABN AMRO and because of its loan
book, HBOS because of its loan book (essentially commercial real estate
exposures), and Northern Rock because of their over-reliance on wholesale
funding.

There are examples of banks failing or making large losses because of the
investment banking activities (Lehman, Merrill, Bear Stearn, UBS) but my point
is rather that the principle "Retail banking = safe, Investment banking =
risky" is simply not true.

In a way, universal banks tend to be more robust than a specialized bank, as
it benefits from funding and revenues diversification (and cheer size to
absorb losses).

~~~
erdevs
> Bail-in will only be useful when the banks have built up enough bail-inable
> capital, and depending on what is the definition of bail-inable capital,
> most banks are not there yet

I'm glad to hear you say this. There is definitely a wide gap between the
reality of available bail-in capital today and the promise of the theory if it
were available.

> However all the draft regulations that are being prepared now point to
> relatively high requirements, in the region of 25-30% of the Risk Weighted
> Assets, which should be ample to absorb a very large loss.

 _Theoretically_. But the problem is the "Risk Weighted Assets". How do you do
the weighting? A great deal of work has gone into this (as you know), but RWA
calcs existed pre-crisis, as did specific RWA tiers for securitized
instruments. We failed to properly _weight_ the risks before and nothing says
we won't do so again. The Fed is _still_ wrestling with "advanced approaches"
to RWA and the last time I checked finalizing the requisite approach was on
"indefinite delay".

Point being... we don't have any assurance here. And we don't want to repeat
the mistakes of overconfidence in our prowess of risk-assessment that we made
last time around.

> So if the crisis happens this week, it won't help, if it happens in 5 years
> or after it will certainly help a lot, and be a first line of defence before
> contemplating a bail out.

I agree with you fully here. We also need to address what happens in the more
extreme cases (and we need to go further in preventing the likelihood of more
extreme cases).

> On the separation of commercial and investment banks, I am not convinced it
> actually helps. Reproducing another of my comments on this article:

You were replying to me in that other comment as well. :)

As I mentioned there, I _also_ think depository banks should be more regulated
in a) the total risk they can take on, and b) what sorts of investments they
can make. (So the total quantity of risk and the _type_ of risk.)

The depository banks in the UK were not regulated enough, clearly. I don't see
how _combining_ poorly regulated depository banking risk with poorly regulated
investment banking risk would possibly help. Imagine Lehman directly combined
with RBS... it's an even bigger disaster.

Besides, my contention is not that retail banking = safe while investment
banking = risky. Both are risky. It's that _contagion is bad_. Increased
correlation is bad. Combining retail banks and investment banks is a bad idea
both theoretically and as proven in practice.

We should contain risk. Let's allow some institutions (investment banks) to
create complex derivatives, advanced securitizations, make markets,
participate in diverse investments, trade fairly liberally and generally do
what investment banks do. Let's put that type of risk in one bucket, and still
regulate the total risk they can take on, the means by which they are unwound
in crises, etc.

Let's have a separate bucket of risk for depository/retail banks, which is as
separated as possible (in an interconnected and fast-moving economy and
financial system) from that bucket of risk.

The only possible reason _not_ to separate these two buckets of risk is if you
think they diversify each other. But that's not right even theoretically and
it definitely has not been the case in practice.

~~~
ethbro
> Let's have a separate bucket of risk for depository/retail banks

Correct me if I'm wrong, but isn't the key ingredient for contagion (in an
available capital freeze scenario) uncertainty? And doesn't money from
depository banks eventually end up in investment banks anyway?

My (possible stupid) question: why are they attempting to regulate the actors
when the internet has shown us the benefits of regulating interfaces (i.e.
robustness, innovation, scalability).

Allow depository banks to put capital to good use via investment / other
financial institutions, but severely restrict the _instruments_ they have
available to do so. Limited differentiation, simple terms, able to be
modelled. With the goal of building a de facto contagion firewall through
standardization and control of the boundary rather than the market actions on
either side.

------
s_q_b
In the aftermath of the financial crisis, we frequently heard the term _moral
hazard._

The reason why bailout money couldn't be used to restructure underlying
mortgage debt directly, we were told, is that individual consumers would see
it as license to take on risky housing debt, believing that the government
would bail them out again in the future.

Unfortunately, that's exactly what happened, with one small difference.
Because it was the banks that were recapitalized, the largest banks are
actually incentivized to make risky bets, seeking higher returns.

The bailout now constitutes an implicit government guarantee.

~~~
cm2187
> _The bailout now constitutes an implicit government guarantee._

The bailout continues, but through monetary policy. The prolonged low rate
environment is the biggest robbery of the century. Savers are being robbed
from their savings to subsidize over-borrowed house owners. And I think it is
fair to talk about a moral hazard. I know bankers (disclaimer: I am a banker
too) who deliberately over borrow personally because they think the central
banks will always be there to save their ass through low rates, pumping
liquidity to push prices up, etc.

~~~
WalterBright
I haven't had a savings account since the 80s. It's a rotten deal, I don't
know why anyone would.

~~~
maxxxxx
What do you with your money? I assume you have some to spare...

~~~
kirrent
There's plenty of places to put money that's not in a savings account.
Personally, I only keep a couple of months living money in savings and have
everything else in one of Vanguard's funds. Pretty darn diverse with far
better returns than any savings account and whatever proportion of risk that
suits you. Hell, you can even get exposure to the housing market through
property securities if you want some of the bubble for yourself.

------
erdevs
I don't see how Wall St will be "tamed" until the following criteria are met:

* No individual bank is "too big to fail". Today we have several banks which are all too big to actually let fail, which means we're likely to need to do structured bailouts for them again.

* Commercial banking and investment banking are split again. As it stands with commercial banks and investment banks housed in the same entity and sharing risks, there is the constant risk of contagion from bad IB bets jeapordizing commercial banking assets and operations. This not only creates further interdependence and correlation between IB activity and commercial banking, but also adds more pressure for bailouts of big, cross-breed banks.

* There are legitimate personal fines and even criminal penalties and a demonstrated will of enforcement for individuals who participate in fraudulent or negligent investments. We pursued (to a lighter degree than we probably should have) the banks themselves for these activities and received judgments and settlements, yet we didn't pursue many personal penalties nor criminal cases related to any of them. See: [http://www.theatlantic.com/magazine/archive/2015/09/how-wall...](http://www.theatlantic.com/magazine/archive/2015/09/how-wall-streets-bankers-stayed-out-of-jail/399368/) We need to reconcile this and even strengthen the laws governing bank investing, so as to disincent poor investment behavior at the most personal level, rather than simply being a financial calculus for the company itself, with no expected loss or penalty for the persons involved in the decision making.

~~~
cm2187
> _Commercial banking and investment banking are split again_

If we take the example of the UK, all of the bank failures were because of non
investment banking activities. RBS failed because of its excess of leverage as
a result of its disastrous acquisition of ABN AMRO and because of its loan
book, HBOS because of its loan book (essentially commercial real estate
exposures), and Northern Rock because of their over-reliance on wholesale
funding.

There are examples of banks failing or making large losses because of the
investment banking activities (Lehman, Merrill, Bear Stearn, UBS) but my point
is rather that the principle "Retail banking = safe, Investment banking =
risky" is simply not true.

In a way, universal banks tend to be more robust than a specialized bank, as
it benefits from funding and revenues diversification (and cheer size to
absorb losses).

> _we didn 't pursue many personal penalties nor criminal cases_

I am not saying that there hasn't been any fraud in the financial crisis but I
am of the opinion that it is not fraud that caused this crisis. It is the
over-reliance on leverage, short term funding, and a belief that the US real
estate market would never go down (belief that many people have today in the
UK).

You can't send people to jail for making bad business decisions. Some banks
were run in a moronic way, but being incompetent or missing a fundamental
economic driver is not a crime.

~~~
erdevs
I fully concur with you that the sorts of investments that depository banks
can make should be more highly regulated, as should their leverage ratios. I
didn't include that on my top list for "taming _Wall St_ " because we were
discussing _Wall St_ and this wasn't as much of an issue in the US/Wall St as
in the UK. That said, I definitely agree this was an issue in the UK.

Another note here is that much of what brought down these UK banks was
contagion, due to the bubble in commercial and residential real estate pricing
and then to the spreading financial crisis and it's effects on chilling
available financing and liquidity.

> In a way, universal banks tend to be more robust than a specialized bank, as
> it benefits from funding and revenues diversification (and cheer size to
> absorb losses)

This is not only an unproven claim, but a _disproved_ claim. In the US, cross-
breed banks resulted in greater contagion across the financial sector and put
depositories at risk, increasing the need for bailout.

You could in _theory_ get the best of both worlds by having a highly, highly
regulated and constrained investment banking arm of a depository bank. But
then how well would it compete with standalone investment banks? And would we
really be able to ensure complete separation of risk between activities?
Doubtful, in practice. This is a suboptimal set up.

Depositors in a bank do not deposit their money with the idea that it is going
to be put at any significant risk. It's supposed to be effectively warehoused
and insured. Taking complex and risky bets with deposits, or capital derived
from or backed by a depository base of capital, makes no sense on first
principles and the theory of combining operations for some benefit in
diversification has been falsified in practice... the opposite happened, with
higher degrees of correlation and contagion happening _in reality_.

> You can't send people to jail for making bad business decision

No, but we didn't pursue even a tiny fraction of the cases of negligence, let
alone fraud. Also, reducing the discussion purely to jail time is a straw man.
Civil penalties for individuals are perfectly justifiable, especially when
you're well-compensated and when your decisions result in gross harm to the
public.

~~~
cm2187
> _In the US, cross-breed banks resulted in greater contagion across the
> financial sector and put depositories at risk, increasing the need for
> bailout._

I am not sure I agree. The example of Lehman has shown that a pure investment
banks (and technically not even a bank, it was a broker-dealer) can cause a
financial collapse. So I do not think we can work on the assumption that we
only need to worry about deposit taking institutions and let investment bank
collapse. Investment banks can be too big to fail too.

~~~
erdevs
You seem to keep taking my positions and reducing them to absurdity.

> So I do not think we can work on the assumption that we only need to worry
> about deposit taking institutions and let investment bank collapse.

I did not say that. Or anything like.

I'm consistently saying:

We should regulate _both_ retail banks and investment banks more.

And part of that increased regulation ought to be splitting investment banking
risk from retail banking risk again. Both are risky enough as is. Combining
their (sometimes correlated!) risk is a really bad idea.

I agree with you that retail banks can cause huge problems (eg your UK
examples). I agree with you that pure investment banks (or merely broker-
dealers) can cause huge problems. Hence the need to regulate both and do what
we can to _prevent_ crises (not just treat them more effectively), while
constraining economic activity as little as we can, of course.

~~~
princeb
> And part of that increased regulation ought to be splitting investment
> banking risk from retail banking risk again. Both are risky enough as is.
> Combining their (sometimes correlated!) risk is a really bad idea.

the implication of calling retail and investment banking risks "sometimes
correlated" is that they are also sometimes uncorrelated.

The two common examples of diversified survivors of the last GFC are Citi and
JPMC.

~~~
erdevs
Yes, they are not _always_ correlated. Obviously. What point are you trying to
make?

> The two common examples of diversified survivors of the last GFC are Citi
> and JPMC.

Are you actually holding Citi and JPMC up as examples of some kind in regard
to benefits of combining retail and investment banking? If so, would you
similarly argue that because not _all_ S&L associations had gone bankrupt or
been shuttered by the late 90s, that's somehow an indication that S&L
associations needed no regulatory reform? If there are 10 people on an island
and all of them eat a particular indigenous fruit and then 8 of them die from
it-- but two survive unharmed!!-- would you say it is wise to continue eating
the fruit?

~~~
princeb
as long as they have any kind of non-correlation, they will benefit from
merging.

> would you say it is wise to continue eating the fruit

i would say it is wise to do what the 2 survivors did... which is to have a
diversified portfolio of retail and investment banking revenue streams.

------
matt_wulfeck
The sad part about this is that so many people took their money out in 2008
out of frustration or mistrust -- and then missed one of the greatest bull
rallies in our generation.

Those that left it in, continued buying (maybe because of discipline or
because what else do you do when you're incredibly rich), became even
_wealthier_.

------
noobermin
Discussing the actual content of the article, it seems like to me, a non-
expert but one interested in the issue, that regulation and the "riskiness"
present on Wall Street is a nuanced and complicated issue, but even when there
are changes, as the author claims, it doesn't grab headlines because it's
technical and not exactly sexy or interesting details that matter.

------
Animats
"Tamed" as in "probability of catastrophic failure reduced somewhat", yes.
"Tamed" as in "returned to its classical function as a service function for
industry and individuals", no.

Real taming would mean brokerages who aren't allowed to trade for their own
account. Real taming would mean no more "hedge funds"; all funds must be
organized as SEC-registered mutual funds. Real taming would mean a Tobin tax
(0.01% on every financial transaction) to discourage high-frequency or
excessive trading. Real taming would mean not treating interest as a
deductible business expense, which would kill the leveraged buyout/private
equity industry and end equity to debt conversions.

Since at one time all of those restrictions were in effect, or something else
with the same effect was, this is the conservative approach. We know this
works.

(Restoring Glass-Stegall is in the GOP platform, amazingly enough.)

------
tvchurch
I strongly recommend reading about John Cochrane's notion of equity-financed
banking (PDF):
[http://www.hoover.org/sites/default/files/research/docs/geor...](http://www.hoover.org/sites/default/files/research/docs/george_shultz_blueprint_for_america_ch7.pdf)

It functionally eliminates bank runs and the need for most regulation.

People will be able to bank like normal, but contagion and bank failures go
away.

Not all banks need to be forced to go this route. But if you offered banks the
option to opt-out of Dodd-Frank if they were 95% financed by equity and
retained earnings, I'm pretty sure most would.

Longer essay here:

[http://johnhcochrane.blogspot.com/2016/05/equity-financed-
ba...](http://johnhcochrane.blogspot.com/2016/05/equity-financed-banking.html)

------
adrenalinelol
Nope, leverage ratios are still too generous and if a bank failed, you can bet
your ass we'd bail them out in a heartbeat.

~~~
harryh
Quite a few banks have failed in the US this year without government bailouts.

[https://www.fdic.gov/bank/individual/failed/banklist.html](https://www.fdic.gov/bank/individual/failed/banklist.html)

~~~
duaneb
The phrase "too big to fail" exists for a reason—the big banks aren't getting
smaller. Unless the big banks are shoving their liabilities into smaller ones
just before death, I don't think it's too relevant to the financial crisis.

------
Mendenhall
Government pass laws that spark crises, goverment bails out banks. People
blame Wall Street.

~~~
alanwatts
Who do you think are among the top financiers of elections who are also
pushing for deregulation? You don't think those congressmen actually wrote
those technical laws themselves, do you?

~~~
randomgyatwork
You are certainly right about that, but its not like governments didn't have a
choice.... they to choose to listen to the money rather than 'reason'.

Pretty much everyone is to blame, but the people with more power deserve much
more blame.

------
xlayn
One way to determine if the "financial game" it's more regulated now it's to
look for crazy investment.

    
    
      -Oil surging like cray.... not
      -Tech companies (cough twitter) valued in several hundred
       millions with no clear business plan... not
      -insert here next big thing to invest in
      Update:
      -medical services...
      -risky operations where blame can be deferred for a long
       time, e.g. Dupont and teflon or frackling
      -crimes against environment (gas leak on california)

~~~
alanwatts
Add student loans to the list

------
grandalf
Government and banks are collaborating on many Halliburton/Blackwater style
public/private partnerships:

\- The mortgage lending industry is largely influenced by Fannie May and
Freddie Mac, which exist under the implication of a bailout, which means they
have an undisciplined appetite for risk. They also have not been required in
the past to disclose financials like regular firms are required to. Subsidized
loans are the fountainhead of "credit as a right" policies intended to help
the poor take on debt that would not otherwise be affordable.

\- There has been a tremendous increase in education lending, which has helped
to fuel the education bubble. But unlike credit card debt, student loans are
not discharged if the borrower is forced to declare bankruptcy. Our
politicians have rallied to have more and more of this lending occur, which
has resulted in no price pressure on universities (which is why the US has the
highest priced secondary education in the world). Banks love it because they
get to live in a world where bankruptcy laws intended to protect consumers
don't exist.

\- These are all part of the "too big to fail" policy of US regulators.

When governments have a stake in particular prices (such as the price of a
loaf of bread, a home, or a college education) the market starts to distort,
and supply and demand no longer help guide investment. When a bank has
purchased massive amounts of Mortgage backed securities under the impression
that they are low risk, and the price changes, the bank cares a lot about
certain prices. The corruption is what happens when the government starts to
care and starts to build policies to shelter banks from market price movement.

Wall Street has not been tamed. For a while the game was to collude to
structure risk so that every ounce of leverage benefitted the banks and the
systemic risk was unhedged. Now the game is to engage in "credit as a right"
policies that couple the bank's outcome to a government policy goal, with
profits coming from barriers to entry and lack of competition moreso than from
successful portfolio management or efficiency.

Without the strict discipline of total failure to guide bank behavior, it is
without question that myriad perverse incentives exist and are being
exploited. Greed is not the issue, it's much simpler than that. It's
corruption. Regulators are equally at fault.

------
infinotize
Matt Levine's column had a good commentary on this (the headline at least),
among other things.

[http://www.bloomberg.com/view/articles/2016-08-03/tamed-
bank...](http://www.bloomberg.com/view/articles/2016-08-03/tamed-banks-and-
unequal-markets)

------
carsongross
No.

[http://www.acting-man.com/blog/media/2014/11/2-financial-
sec...](http://www.acting-man.com/blog/media/2014/11/2-financial-sector-by-
share-of-total-corporate-profits_large.png)

------
lintiness
negative interest rates and governments pretending like they're managing their
nations' finances wisely at zero and negative interest rates. the biggest
threat to global economic stability and growth are out of control governments
borrowing at a rate never before seen in human history.

[http://www.mckinsey.com/global-themes/employment-and-
growth/...](http://www.mckinsey.com/global-themes/employment-and-growth/debt-
and-not-much-deleveraging)

------
yompers888
If the article is posed as a question, the answer is almost surely no. Having
read the content of the question as well, I now have two reasons to come to
that conclusion.

------
rm_-rf_
It's cute that this article doesn't even mention Wall Street's personal Shill
of a presidential candidate: Hillary

------
hkmurakami
Betteridge's law still alive and well.

------
paulpauper
The sensationalist media makes it seem like bank failures and collapse are a
frequent occurrence. In reality, there have only been tow major financial
crisis in the past 100 years (1929 and 2008). So while that does not prove
there wont be another crisis, the odds are pretty long.

~~~
ProAm
1980 S&L crisis?

~~~
paulpauper
that was a big deal but not quite catastrophic. the losses were S&L losses at
$90 billion. these involved smaller 'thrift' banks

