The Financial Supermarket Bubble and Banking History

Here is a chart, using the Google ngram tool, showing the frequency of the appearance of the term “financial supermarket” over time.

Note the spike in the mid-1980s. Given that these are books, which appear with a slight lag, I would say that the spike in the media was in the early 1980s.

At this panel, I don’t know whether I will have time to get into the history of bank concentration in the U.S., but here it is.

1. The market share of the largest banks follows a hockey stick pattern since 1950. It stayed very low until the late 1970s, and then around 1980 it started to grow exponentially. Growth of banks had been retarded by ceilings on deposit interest rates, branching restrictions, and Glass-Steagall restrictions. Banks had been trying to find loopholes and ways around these restrictions, and regulators had been trying to close the loopholes. Then, during the period 1979-1994, the regulators stopped trying to maintain the restrictions, and instead cooperated in ending them. That was when the hockey stick took off.

2. The regulators thought that this would bring more competition and consumer benefits. What the banks had in mind was something else. That is where the chart comes in. The bankers all thought that “cross-selling” and “one-stop shopping” would be killer strategies in consumer banking. In 1981, when Sears bought Dean Witter, many pundits thought that putting a brokerage firm inside a department store was going to be a total game-changer.

3. It turned out, though, that consumers did not flock to brokerage firms in department stores, or to any of the other one-stop-shopping experiments in financial services. The economies of scope just weren’t there.

4. Meanwhile, concentration in banking soared thanks to mergers and acquisitions. I’ve read that JP Morgan Chase is the product of 37 mergers and Bank of America is the product of 50. All of these took place within the past 35 years.

5. Just five years into this exponential growth process, Continental Illinois became insolvent, and that was when “too big to fail” began. So out of the 35 years where we were on the exponential part of the hockey stick, 30 of them have taken place under a “too big to fail” regime. In short, the concentration in banking got started during the “financial supermarket” bubble, and from then on was supported, if not propelled, by “too big to fail.” But the market share of the biggest banks is not something that grew naturally and organically out of superior business processes.

6. As another historical point, when the S&L crisis hit, the government set up the Resolution Trust Corporation. Each failing institution was divided into a “good bank” and a “bad bank,” with the good bank merged into another bank and the assets of the bad bank bought by the RTC. While this was a somewhat distasteful bailout, it was conducted under the rule of law. When TARP was enacted in 2008, Congress and the public were led to expect something similar to the RTC, with TARP used to buy “toxic assets” in a blind, neutral way. Instead they ended up calling the biggest banks into a room and “injecting” TARP funds into them. They also spent TARP funds on restructuring General Motors. It was the opposite of government acting in a predicable, law-governed way. It was Henry Paulson and Timothy Geithner making ad hoc, personal decisions. I think that in the U.S., that is what bank concentration leads to–arbitrary use of power. That is why as a libertarian I do not think that allowing banks to become too big to fail is desirable.

Financial Report of the U.S. Government

The report is here. It looks interesting, but I find it difficult to parse. Liqun Liu, Andrew J. Rettenmaier, and Thomas R. Saving parse it this way:

The liabilities reported in the FRUSG at this time last year included $12 trillion in debt held by the public, $6.5 trillion in federal civilian and military employees’ accrued pension benefits and other retirement and disability benefits, and $1.3 trillion in other liabilities, producing total liabilities of $19.9 trillion.

They point out that the liabilities for Social Security and Medicare seem suspiciously small, because the report acts as if these could be erased quickly with the stroke of a (legislative) pen. Technically, that is true, but realistically it is not. Instead, Liu, et al, propose to include benefits payable to current retirees.

Adding the $16 trillion in accrued Social Security and Medicare benefits payable to current retirees produces a total of $35.8 trillion in federal liabilities. These accrued Social Security and Medicare benefits are larger than the debt held by the public and are 45 percent of the total.

Pointer from James Pethokoukis.

This is still not very satisfying.

1. The liabilities to pay benefits to those of us not yet eligible ought to be included.

2. If we are going to include future government expenditures as liabilities, then we ought to include future tax revenues as assets.

3. We ought to use a discounted present value concept, rather than treat dollars that will be spent or received 10 years from now as equal to dollars that will be spent or received today.

Conceptually, I believe that what we want is a present discounted value of assets (including future tax revenues) and liabilities under current law (or what CBO projects law to be under its more-plausible “alternative scenario”). You can then look at the change in these values from year to year as an accrual-accounting measure.

Resolving Illiquid Institutions

Noam Scheiber brings up the AIG bailout, once again.

Which leaves only two possible explanations for the overly solicitous treatment of Goldman and the others. The first is that their own financial position was so precarious that accepting anything less than the billions they expected from A.I.G. would have destabilized them, too. Which is to say, it really was a backdoor bailout of the banks — many of which, like Goldman, claimed they didn’t need one. Alternatively, maybe Mr. Geithner simply felt that Goldman and the like had a more legitimate claim to billions of dollars in funds than the taxpayers who were footing the bill.

Five years ago, AIG had more liquid liabilities (“collateral calls”) than liquid assets. There were a number of ways this could have been resolved.

1. No government action, AIG’s creditors go to court, they win a quick judgment, and AIG has to sell off assets in order to pay the creditors.

2. No government action, AIG’s creditors go to court, things stay tangled up for a while, meanwhile AIG’s liquidity position improves, and creditors get paid out without AIG having to sell assets.

3. What I advocated, which was that the government tell creditors that they could get most of their money now or all their money later, but not all of their money now. I called this the “stern sheriff” solution.

4. A pure government bailout, which ensured that creditors could get all of their money now, courtesy of the taxpayers.

5. What we got, in which creditors received their money, but the government made sure that AIG shareholders suffered in the long run.

Note that (5) ended up close to (1), and (3) would have ended up close to (2). Had the government done nothing, then the courts would have effectively decided which path to head down. The advantage is that we would have gotten there by the rule of law, not by arbitrary exercise of power.

I think that the lesson we should draw is that in future cases of liquidity problems, officials should stand back and let nature take its course. I think that the number of prominent economists who agree with me on that approaches zero.

Question: Suppose that the top officials involved in dealing with the financial crisis had been forced to wear cameras and an audio recorders during all of the meetings during the crisis, with the stipulation that they could delay the release of the recordings for 90 days if they determined that immediate release would be harmful to financial stability. Do you think that this would have changed either their decisions or the public perception of those decisions?

Government Accounting

Jason Delisle and Jason Richwine write,

the government’s official method for estimating cost is incomplete. It fails to incorporate the cost of the market risk associated with expecting future loan repayments. So-called “fair-value accounting,” an accounting method favored by the vast majority of finance economists as well as the CBO itself, factors in the cost of market risk. The difference transforms the official student-loan “profit” into a loss, for a budgetary swing of $279 billion over ten years. That figure demonstrates why the stakes are so high in the debate about fair-value accounting.

I recommend the entire essay. I would like to make changes to government accounting a top economic priority, because I think that avoiding a debt crisis ought to be a top priority.

If you ignore risk, then the government can appear to make a profit with all sorts of loans and loan-guarantee programs. I would go beyond fair-value accounting and subject the government budget to stress-testing, to give a measure of risk exposure.

Social Security as a Public Bad

Robert Fenge and Beatrice Scheubel write that they provide,

an empirical confirmation of the negative relationship between statutory old-age insurance or more broadly statutory social insurance and fertility. The effect amounts to a total reduction of approximately 1.7 marital births per 1000 between 1895 and 1907… [the] impact of pension insurance is comparable to the impact of an increase in urbanisation by 10-20%.

Pointer from Brian Blackstone

Off hand, it would seem to me that any form of capital accumulation by the elderly could have this effect. Private pensions certainly, and perhaps even private savings for retirement. But it might be argued that there are huge negative externalities in public pensions, in that they allow you to benefit from my having children.

New York City Pensions

The NYT reports,

Next year alone, the city will set aside for pensions more than $8 billion, or 11 percent of the budget. That is an increase of more than 12 times from the city’s outlay in 2000, when the payments accounted for less than 2 percent of the budget.

I could see the same thing happening where I live, in Montgomery County, Maryland. At some point, citizens will be paying much of their taxes not for current services but instead to try to keep unsound pension systems afloat.

Megan McArdle writes,

The core problem is that returns have not tracked with the city’s optimistic projections. In 2012, the city finally lowered its projected return to 7 percent from 8 percent, but after decades of excessive optimism, that left it with a giant hole; the payments had to be stretched out over more than two decades in order to minimize the fiscal hit. Yet this still may not be enough; it’s possible that 7 percent is still too rosy.

And of course, as many people have pointed out, a private firm’s auditors would not sign off on this sort of pension accounting.

Europe Still in Trouble

Barry Eichengreen and Ugo Panizza write,

For the debts of European countries to be sustainable, their governments will have to run large primary budget surpluses. But there are both political and economic reasons to question whether this is possible. The evidence presented in this column is not optimistic about Europe’s crisis countries. Whereas large primary surpluses for extended periods of time did occur in the past, they were always associated with exceptional circumstances.

Pointer from Mark Thoma. Read the whole thing. Shorter version: Have a nice day.

Two SNEP Goals Connected

Jed Graham writes,

The $2.8 trillion Social Security Trust Fund is on track to be totally spent by 2030, the Congressional Budget Office said Tuesday. That’s one year earlier than projected in 2013 and a decade earlier than the CBO estimated as recently as 2011.

Graham points out that lower estimates for employment are contributing to the more adverse outlook for Social Security. I would say that this links two of the three main goals for SNEP, one of which is to increase employment and another of which is to work toward a sustainable Federal budget.

In fact, the third goal, to get the FCC and the FDA out of the way of progress, also links to the other two.

Good Sentences, Bad Sentences

1. From Edward Conard:

The key to accelerating the recovery is not to generate unsustainable consumption, as Mian and Sufi propose. Rather, we must find sustainable uses for risk-averse savings

Mian and Sufi make a big deal over the fact that consumer spending fell in places where housing prices fell. Conard suggests that this is because consumers in those areas were spending at an unsustainable rate, based on capital gains in housing that disappeared.

2. From Alex Ellefson:

Laplante said he expects all 50 states to require software engineering licenses within the next decade, and possibly much sooner.

Not surprisingly, most software engineers endorse this. [UPDATE: from the article "The licensing effort was supported by nearly two-thirds of software engineers surveyed in a 2008 poll." Commenters on this blog dispute that most software engineers endorse licensing. They may be correct.] But it is really, really, not a good idea. Bad software may be created by coders. But its cause is bad management. The typical problems are needlessly complex requirements, poor communication in the project team between business and technical people, and inadequate testing.

I would favor licensing for journalists if I thought that it would keep incompetent stories like this one from appearing. But I don’t think that would work at all.

The pointers to both of these are from Tyler Cowen.

Central Banking’s New Normal

Tyler Cowen writes,

Were not these exit strategies supposed to be easy and painless? Maybe they are, except having no exit strategy is all the more easy and painless.

The title of his post is Will the major central banks evolve into mega-hedge funds? But perhaps the title should be, will the major central banks ever give up their mega-hedge fund activities?

In the wake of the financial crisis, the Fed has decided that credit allocation is too delicate and important to be left alone. The financial crisis did to the Fed what the 9-11 attacks did to national security agencies. I think that the chances that central banks will decide that they no longer need to behave like hedge funds are about as high as the chances that our national security apparatus will decide that they no longer need to treat terrorism as a major threat.