Volcker and Blankfein on ‘too big to fail’
The central bankers strike back.
Former chairman of the Federal Reserve Paul Volcker today pulled the rug from under the current direction of reregulation of our financial system, which he suggested was “papering over and tinkering around the edges of a broken system”.
In testimony to the US Congress, he took the argument that many of America’s (and indeed Britain’s) biggest financial institutions remained too big to fail.
He highlights the fact that the big banks use practically free public money, and the tacit backing of the state, to indulge in risky casino-like activity like sponsoring hedge funds, private equity and their own so-called proprietary trading on stock markets. His critique echoes that of Mervyn King.
That line of argument is losing in the august portals of the G20, however. If you want to know why, have a read of this excellent interview in Der Spiegel with Lloyd Blankfein.
We don’t hear from Mr Goldman that often, but if you want to get a feel for how the world looks from Planet Goldman Sachs, then take a look at this.
Blankfein: The size of the bank is not the most important factor. Whether a certain risk is bundled at a single bank or spread across several is completely irrelevant. That doesn’t diminish the size of the risk. In fact, this would only change the problem from “too big to fail” to “too many to fail.”
Spiegel: Wouldn’t another way to avoid such crises in the future be a reinstatement of the Glass-Steagall Act, which stipulates the strict differentiation of banks that accept customer deposits from investment banks, which can, among other things, develop, sell and trade in highly speculative capital market products?
Blankfein: No, I think you are assuming that this crisis was caused solely by highly complex derivative products. It wasn’t. Just look at a typical bank balance sheet. Most banks value their loans at the price at which they were issued. This applies to corporate and consumer loans, mortgages and credit card debt. All seemingly bread-and-butter transactions. And then there are a few derivatives and some more complex products.
Spiegel: What are you trying to say with that?
Blankfein: This crisis was not just caused by complex derivatives.
Spiegel: What caused it, then?
Blankfein: Too much money was lent to people who had bitten off more than they could chew. When the bubble burst and recession hit, default rates went through the roof “