Geithner supports mega-banks

Simon Johnson, Massachusetts Institute of Technology economist and author of “13 Bankers,” fears Treasury Secretary Timothy Geithner will let U.S. mega-banks grow as large as they want, in hopes they can capture much of the new financial business abroad, and ignore the potential for risk to U.S. taxpayers far beyond that of 2007 and 2008.

Johnson quotes Geithner from a New Republic profile:

I don’t have any enthusiasm for…trying to shrink the relative importance of the financial system in our economy as a test of reform, because we have to think about the fact that we operate in the broader world…It’s the same thing for Microsoft or anything else. We want US firms to benefit from that…Now, financial firms are different because of the risk, but you can contain that through regulation.

Geithner’s confidence in regulators is puzzling given their failures leading up to the crisis of 2007 and 2008. The financial crisis was primarily the result of giant financial institutions taking on too much debt in the shadow banking system, mainly on the repurchase market.

Geithner’s comfort with mega-banks also is puzzling given his early understanding of the risks posed by the interconnectedness of the giants.  For example, he said in a June 9, 2008 speech:

The structure of the financial system changed fundamentally during the boom, with dramatic growth in the share of assets outside the traditional banking system. This non-bank financial system grew to be very large, particularly in money and funding markets. In early 2007, asset-backed commercial paper conduits, in structured investment vehicles, in auction-rate preferred securities, tender option bonds and variable rate demand notes, had a combined asset size of roughly $2.2 trillion. Assets financed overnight in triparty repo grew to $2.5 trillion. Assets held in hedge funds grew to roughly $1.8 trillion. The combined balance sheets of the then five major investment banks totaled $4 trillion.

In comparison, the total assets of the top five bank holding companies in the United States at that point were just over $6 trillion, and total assets of the entire banking system were about $10 trillion.

This parallel system financed some of these very assets on a very short-term basis in the bilateral or triparty repo markets. As the volume of activity in repo markets grew, the variety of assets financed in this manner expanded beyond the most highly liquid securities to include less liquid securities, as well. Nonetheless, these assets were assumed to be readily sellable at fair values, in part because assets with similar credit ratings had generally been tradable during past periods of financial stress. And the liquidity supporting them was assumed to be continuous and essentially frictionless, because it had been so for a long time.

The scale of long-term risky and relatively illiquid assets financed by very short-term liabilities made many of the vehicles and institutions in this parallel financial system vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks. Once the investors in these financing arrangements—many conservatively managed money funds—withdrew or threatened to withdraw their funds from these markets, the system became vulnerable to a self-reinforcing cycle of forced liquidation of assets, which further increased volatility and lowered prices across a variety of asset classes. In response, margin requirements were increased, or financing was withdrawn altogether from some customers, forcing more de-leveraging. Capital cushions eroded as assets were sold into distressed markets. The force of this dynamic was exacerbated by the poor quality of assets—particularly mortgage-related assets—that had been spread across the system. This helps explain how a relatively small quantity of risky assets was able to undermine the confidence of investors and other market participants across a much broader range of assets and markets.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s