Confidence Game

     Many moons ago, when I was in college, my friend Ray offered to drive a professor’s locked trunk across the country to New York.
     Ray was going there anyway, so what the heck.
     Somewhere in Nebraska, a Highway Patrolman stopped him for speeding.
     The trooper asked Ray if he had any drugs. This was in the early 1970s.
     “No, Sir,” Ray told him.
     “May I search your car?” the trooper asked.
     Sure, Ray said. And the cop found a big chunk of hashish rolled up in Ray’s underwear.
     “You lied to me,” the trooper said. “Where’s the pipe?”
     “There is no pipe,” Ray said.
     The cop searched again and found the pipe.
     “You lied to me again,” the cop said. “What’s in the trunk?”
     Ray said he didn’t know what was in the trunk, that he was driving it to New York for a professor.
     The cop said: “You’ve lied to me twice. Why should I trust you again?”
     And Ray told him: “Because this time, I give you my word.”
     
     That sums up all there is to say about the 113th Congress. And the 112th. And the 111th.
     Remember how Congress was going to straighten out the banks, so they couldn’t throw the country into Reverse overnight, ever again?
     An interesting piece in the latest London Review of Books is subtitled “How the Big Banks Got Away With it.” University of Edinburgh professor Donald MacKenzie deals mostly with European banks, but the diagnosis and the illness is the same as we’re suffering here.
     It’s that bankers continue to reward themselves for the same behavior that crashed the world economy more than five years ago. In fact, they get incentives to repeat it.
     Take “return on equity.” Suppose Bank A makes $100 million using only $10 million of its own money: a 10-to-1 return on equity.
     Then suppose Bank B makes $100 million using only $1 million of its own money: a 100-to-1 return on equity.
     Bankers at Bank B would get bigger bonuses, because their profits come not from risking the bank’s money, but from risking other people’s.
     But no major bank in the developed world puts anything close to 10 percent of its own money into its business. Lloyd’s had only 3.3 percent equity in its balance sheet before the crisis, Deutsche Bank 2.9 percent. Bank of America today has just 5 percent.
     So a drop of 5.1 percent in the bank’s real assets – the homes it finances, for instance, or rather, the projected income from the people who are buying the homes – would, and did, push the banks into insolvency.
     Yet it’s not unlikely that home prices may drop by 5 percent in any given year.
     But wait, there’s more. Banks essentially regulate themselves, through a trick called “risk-weighted assets.”
     There’s risk involved in securitized mortgage bundles, for example. But if banks lend and borrow and invest in other banks, the “risk weight” for that money is zero.
     That’s right! Banks can run up their return on equity, theoretically, to infinity, because there’s no risk from financial incest!
     The smaller a bank’s real protection against default – equity, i.e., real stuff, if only money – the more the bankers make in bonuses. And the more expensive it is for you and me when we have to bail them out again.
     I heard a banker say on the radio this week that if Congress regulates derivative trading – which now eclipses, in dollars, our real economy – that all the jobs in derivatives trading will go overseas.
     Great! Good riddance!
     Why should we, and Congress, and the European Union, let bankers and Wall Street traders continue to write their own rules, and stack our decks?
     Because this time, they give us their word?

%d bloggers like this: