Monthly Archives: March 2012

Would You Bend Over to Pick Up a Penny?

Posted on March 30, 2012 by jf139239

I would not bend over to pick up a penny, nickel or dime. What’s the point? I can’t use this form of currency unless I find hundreds of them. I even dread receiving change at the store; the coins just sit in my drawer taking up space. Now, I might bend over for a quarter because quarters still possess some utility for certain services, e.g. parking meter or washing machine.

Would you bend over to pick up a penny?

In fact, you soon won’t be able to pick a penny in Canada. The Canadian government announced yesterday they no longer plan to mint their penny. Why? It costs a lot to make these coins. Australia and the UK decided long ago to phase out their equivalents of these coins.

This news story reminded me of the murky fact in my brain that the US spends more to produce most coins than their worth. How much more? According to a recent report from MSNBC, it costs more than two cents to make a penny. Minting a nickel costs 11.18 cents. These costs relate directly to the increase in costs for the metals used in the coin production: copper, nickel and zinc.

Given that these coins offer no utility and cost more than they’re worth, why is the US government still producing them for circulation?

 

 

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Too Big To Fail — Something Conservatives and Liberals Agree On

Posted on March 23, 2012 by jf139239

Too Big To Fail (TBTF) has become part of our language–worse part of our reality. If you don’t already know, TBTF refers to centralization of financial assets in the United States into very small number of systemically important institutions. According to the Dallas Federal Reserve, the top 10 banks account for 61%  of the assets in commercial banks up  from 26% just 20 years ago. The biggest and worst offenders being Citi and Bank of America, which prove the weakest bank stocks in the sector.

Oddly enough, removing the risks from TBTF banks has support from both liberals and conservatives. I realized this reading one of my favorite blogs today: Naked Capitalism. Obviously, liberals have no issue with increasing regulations on big banks to ensure they act ethically and pose no systemic risk. In fact, much of the impetus for the passage of Dodd-Frank Act came from the left.

What about conservatives? One might think conservatives oppose regulation because it interferes with the workings of a free market capitalist system. And disapprove of regulation they do! But conservatives favor “creative destruction” and uninhibited growth. Moreover, conservatives stand strong against “socializing” anything, which should include the huge losses racked up by TBTF banks.

Anyone following the moves of the Federal Reserve since the financial crisis in 2008 knows almost every program enacted has operated as a bailout for TBTF banks’ balance sheets. In essence, banks can make tons of money holding short term debt at low rates and lending long term debt to clients at a higher rate. They net the spread for profit. The Fed has ensured rates stay low for exactly this purpose, although secondary effects also aid the general economy. Remember this–the Fed’s primary clients are banks, not the government not the public. Wouldn’t all those trillions of dollars been better served going into the real economy, rather than shoring up TBTF balance sheets?

Both conservatives and liberals can agree on the reprehensibility of impediments to sustainable growth. Dallas Fed President Richard Fisher made this point very clearly in their 2011 annual report (linked above). Anyone who reads Paul Krugman’s blog, titled the Conscience of a Liberal, has familiarity with his discussions on handling “zombie” banks: the Swedish solution. This refers to Sweden’s taking over all of the bad banks they had in 1994, closing them down, recapitalizing healthy banks to ensure lending to the public and private sector. Eventually, the Swedish government privatized all the assets.

The key take away from this discussion; theoretical grounds for ending TBTF exist. I would hope that Dodd-Frank was the first of several steps trying to put an end to TBTF. Anyone have any constructive thoughts on how to end TBTF?

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Debate on the Investment Bank Model or how to avoid moral hazard

Posted on March 20, 2012 by jf139239

The public resignation, via the New York Times Op Ed page, of Greg Smith reverberated through the financial world and his erstwhile firm–Goldman Sachs. His decision sounded an insight at the core of the financial industry: making money for clients vs. making money for the firm.

Opinions raged on both sides of the debate. Many cited the example as another illness found on Wall Street requiring a cure. Others said Smith merely stated the obvious Wall Street symptom–greed. I present here one of the more nuanced opinions from the Epicurean Dealmaker:

But it is important to realize just how much Goldman Sachs—and other investment banks—sold their legacy, franchise, and long-term value down the river by offering shares to the public.1 Conversion from partnership to publicly-traded investment banks was not a sufficient cause for the recent financial crisis or our ongoing struggle with the proper form and function of the industry, but it certainly was a contributing factor.

In reality, The author of the blog post discusses a topic mentioned everyday in business school: Moral Hazard. The inner workings of the modern investment banks prove opaque and impossible to value. (Some argue even banks fail to understand the risk on their own books because VaR poorly predicts true risk.) Clients, regulators and shareholders have no idea how much risk banks pose. It was so much simpler when investment banks were smaller and partnerships.

Sadly, we have learned nothing from history. Following the crash of 1929, Congress held hearings in regards to the causes of the crash and the resulting Great Depression. The findings were published in the Pecora Commission Report. Using the recommendations, the Congress passed important regulations instituting transparency and limiting the nature of investment banking.

Returning to the present, how do we fix the moral hazard in the investment banking industry? Perhaps it will fix itself. Clients may tire of being called “muppets,” realizing banks fail to provide a value added product, leaving on their own volition. Maybe the government will decide to reinstate the Glass-Steagall Act to remove the conflicting interests of commercial and investment banking.

The question I end on is: How do we return to a time when banks advised clients and took risks limited to their means (partnerships) — not shareholders and society at large?

Discuss.

 

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