In the near corner, wearing the red trunks, number one heavyweight contender Simon Johnsoooooooooon!
Johnson is known for his doggedness and determination. This slight man with a soft voice would hardly seem to be a threat. But he almost single-handedly saved financial reform from an ignominious death. Johnson is not done. Winning a round is not enough. Johnson is the new Great American Hope! Here is the champion of the little guy, the entrepreneur, the innovator, the jobs creator, ready to take on the most powerful of persons.
In the far corner, wearing the blue trunks with the GS emblem, despised financial markets champion Goldmaaaan Saaaaaachs!
Sachs is jumping up and down and is already glazed with a greasy sweat. Goldman’s Mel Gibson eyes are flashing angrily and froth and spittle alternately spew forth. This dangerous and unpredictable champion, like Hannibal Lecter, has a taste for sweetmeats and wants a piece of Johnson. Once worked into a frenzy by a monetary prize, Goldman will turn on anyone. Even those in his corner are not safe. Goldman once cannibalized his own cut man.
Let the bout begin.
Johnson strikes first. Quoting scholarship from Stanford Professor Anat Admati, Johnson challenges the very notion that requiring banks to be well capitalized is a danger to the economy. The false claim is this:
“Some claim that requiring more equity lowers the banks’ return on equity and increases their overall funding costs,” thus lowering economic growth, the professors write.
And the answer:
“This claim reflects a basic fallacy. Using more equity changes how risk and reward are divided between equity holders and debt holders, but does not by itself affect funding costs.”
They go on to say: “High leverage encourages risk taking and any guarantees exacerbate this problem. If banks use significantly more equity funding, there will be less risk-taking at the expense of creditors or governments.”
…capital requirements should be simplified and greatly increased — relative to what the Group of 20 leaders will congratulate themselves on.
“Lending decisions would be improved by higher and more appropriate equity requirements,” they say.
And they are also completely on target with regard to the political economy problem here: “Many bankers oppose increased equity requirements, possibly because of a vested interest in the current systems of subsidies and compensation. But the policy goal must be a healthier banking system, rather than high returns for banks’ shareholders and managers, with taxpayers picking up losses and economies suffering the fallout.”
Let me put another spin on it. Some say that requiring banks to have more of their own money at risk means they will put less total money at risk and therefore provide less support to the economy. Let’s see how Goldman strikes back. First, the left jab:
Requirements that banks hold more cash to prevent against economic downturns won’t just hurt the banks themselves, but also the companies they lend to, Goldman Sachs says in a new report.
Then the right cross!
“Small- and mid-sized” companies that have relied on bank financing will be hit hardest, the report says.
And finally, characteristically below the belt…
“These firms are likely to grow more slowly than the larger firms and multinationals that enjoy more flexibility in financing. Slower growth among smaller and mid-sized firms may act as an overhang on economic growth and the job creation that these firms traditionally propel. And because the adjustment to higher prices and constraints on credit availability is a dynamic process, the potential ongoing rise in capital requirements means that smaller firms are likely to bear the cost for some time to come, acting as a continuing drag on bank loan growth.”
Ouch! Goldman is standing up for Johnson’s little guy! What an unexpected blow! It turns out that Goldman must be the New American Hope! The crowd is confused! Goldman corner man Vikram Pandit spits on Johnson!
“There is a point beyond which more is not necessarily better. Hiking capital and liquidity requirements further could have significant negative impact on the banking system, on consumers and on the economy.”
Now the Goldman corner is on the side of consumers as well! What a turn of events!
Johnson staggers, then recovers, striking at Pandit:
Why then does he advance such obviously specious arguments in the pages of the Financial Times?
The answer is straightforward.
a) He can get away with it. Modern financial CEOs float in a cloud above the public discourse; they can spout nonsense without fear of being contradicted directly in the pages of a leading newspaper.
b) Officials listen to bank CEOs and an op ed gets their attention. Perhaps they think Mr. Pandit knows what he is talking about – or perhaps they know that these arguments are completely specious. In any case, they are deferential.
c) Mr. Pandit is communicating with other CEOs and, in this fashion, encouraging them to take recalcitrant positions. There is an important element of collusion in their attempts to capture the minds of regulators, politicians, and readers of the financial press.
Mr. Pandit is engaged in lobbying, pure and simple.
14 here. I score this bout for Johnson, surprised? Goldman and Citigroup are “talking their book”. They are part of the old school that brought down the economy. They believe in a highly levered theory of finance where shareholders invest the minimum equity, maximize debt and thus try to generate more profit for themselves. Their concern for small business and the consumer is a subterfuge. Goldman, Citi, and the like have overseen the financialization of the economy. They have overseen the processes that consolidate power at the top of the economic structure, where large firms crush small ones. For them, consumers and small businesses are krill. Yes, they want them alive, so they can eat them.
They are speaking one truth though. Their model is based on leverage. If you change the leverage requirements, you threaten their standing. So in a universe where Goldman and Citi are the only hypothetical players, you would see a short term contraction in credit because of decisions they would make, because of who they are. Their choices would be to either raise new equity or to shrink their risk assets. Raising new equity would dilute the existing shareholders, reduce the metrics they use to justify their pay packages, and reduce the value of their own stock interests (common stock and stock options). So they would not choose to do that voluntarily, whether it is the right thing for the global economy or not. What their nature would require them to do is run off a portion of their assets, the least risky and profitable portion, double down on their most risky bets and try to make just as much money for shareholders with fewer assets deployed. That is not a reflection on some natural laws of business and economics. That is a reflection of their thought processes and models for doing business.
But here is the salvation, the Great American Hope. Nature fills a vacuum. The broken model of Wall Street would be filled by a new, more responsible, durable, and beneficial model. As Johnson says, the issue with the capital structure of firms is about how the returns are divided up, not about what the returns from business operations are. Wall Street confuses those issues, because their primary concern is with their returns.
Saving Wall Street at the expense of Main Street is the policy of our government. Enough is enough. Do not buy the baloney.