Michael Lewis' The Big Short: Diabolical Castles in the Sky

Voiding Credit Default Swaps

In a book stuffed with scathing insights and blockbuster revelations, here's perhaps the biggest one (courtesy of Michael Lewis, writing in The Big Short):

The reason Citigroup (amongst others) is considered "Too Big Too Fail" isn't because it holds over $1 trillion in ordinary Americans' savings in their vaults.

It's not because inflicting billions of dollars of losses on Citigroup's creditors and shareholders would jeopardize other financial institutions -- and by extension, the U.S. financial system and economy (domestic and global).

And it's not even because the U.S. would then have to step up and make good on its guaranties of hundreds of billions of Citigroup's crappy mortgages and other collateral.

The Real Reason Citigroup is TBTF

No, the real reason that Citigroup is considered to be TBTF is that it may be the object of billions -- maybe trillions -- in Wall Street bets, just like the housing market was before:

Citigroup's failure . . . would trigger the payoff of a massive bet of unknown dimensions: from people who had sold credit default swaps on it to those who had bought them. This is yet another consequence of turning Wall Street partnerships into public corporations: It turns them into objects of speculation. It [is] no longer the social and economic relevance of a bank that renders it too big too fail, but the number of side bets that have been made upon it.

--Michael Lewis, The Big Short (p. 263)

What to Do

If Lewis is right -- and I have no reason to think he isn't -- the appropriate policy response couldn't be more obvious, or necessary.

Step One: the federal government should void all such credit default swaps, immediately.

Aren't those private contracts?

So what?

So were millions of contracts (presumably unwritten) making human beings owners of other human beings.

What do you think happened to all those contracts on January 2, 1863? (the day after The Emancipation Proclamation).

Step Two. Break up the monster banks that ushered in this toxic, dysfunctional and highly combustible state of affairs (cue Warren Buffett's line about "financial weapons of mass destruction").

Step Three. Hold their leaders accountable for their epic greed, negligence and corruption* (vs. giving them, collectively, ongoing billions in bonuses).

No, that hasn't happened yet.

In fact, it hasn't even started.

*Let the courts figure out the proper weighting; mine would be 50% greed, 30% corruption, 20% negligence.

Whose Laws? The Political (vs. Business) Case for Ending TBTF

The Too-Big-To-Fail Debate

Advocates for cutting so-called "too big to fail" financial institutions down to (less threatening) size -- I'm one of them -- have rightly focused on the systemic risk such entities pose; the unfair, distorting effects on competition such a policy causes, due to the implicit federal guaranties backing TBTF companies (which drives down their borrowing costs); and the monopoly profits TBTF companies enjoy simply as a result of having survived when their smaller ("not-TBTF") competitors have all perished.

But there's an even more compelling reason to break up TBTF entities.

Namely, entities like Goldman Sachs wield far too much political power, which they've clearly used to game the system. (From Wall Street's perspective, showering money on politicians is no doubt just an especially shrewd form of "reinvesting profits.")

"Thumb -- and elbow, and thigh, and . . -- on the Scale"

Perhaps the most insidious aspect of the financial debacle the last two-plus years is to read about some especially egregious Wall Street conduct -- is it still possible to be shocked anymore? -- then to hear the perpetrators claim that "no laws were broken."

As a former corporate lawyer, I take strong issue with that: even given the watered-down (or non-existent) rules governing Wall Street, I can still toss out -- practically in my sleep -- multiple grounds for suing various investment banks.

Like breach of fiduciary duty; conflict of interest; self-dealing; fraudulent and/or misleading disclosure; gross negligence . . . . and ???

Still, my best guess is that the legion of clients screwed by Goldman Sachs and its ilk aren't suing -- yet -- not because of some decision on the legal merits, but: a) because they're broke; and b) Goldman Sachs very much isn't.

Litigation is a financial marathon, and there are plenty of plaintiffs who've walked away empty-handed and financially drained, years later, not because their arguments lacked merit, but because the defendants had more staying power (can you say, "Exxon Valdez?").

Who Made the Rules?

That said, there's no denying that Wall Street got the financial rules that it wanted the last 20-plus years.

A partial list would include:

--Repeal of Glass-Steagall, allowing commercial and investment banks to combine.

--Lax accounting rules for banks, allowing them to substitute "mark to make-believe" for "mark to market."

--Amazingly, no regulation --still -- of credit derivatives -- the instruments at the heart of the AIG debacle (and dubbed "financial weapons of mass destruction" years ago by Warren Buffett).

--Wall Street-engineered exemptions on leverage, allowing Lehman Bros., Bear Stearns etc. to borrow as much as $40 for every $1 of their own money.

So, the next time you hear someone on Wall Street defend their latest skulduggery by saying "no laws were broken," stop to ask, "who made the laws??"

Sen. Ted Kaufman: 'Break 'em Up!'

An Independent Voice on Financial Reform
(Hmm, I wonder why . . .?)

Senator Ted Kaufman, Joe Biden's replacement in the Senate, has rapidly emerged as perhaps the leading Congressional advocate for real financial reform (Chris Dodd's version doesn't come close).

Not a few people have noted that Kaufman's path to the Senate -- he was appointed -- insulated him from the soul-rotting temptations of Wall Street campaign cash.

Here's Kaufman's latest:

Letting giant institutions fall into bankruptcy is not the answer to "too big to fail." When Treasury Secretary Hank Paulson decided to let Lehman Brothers fail, the credit markets immediately froze and the worldwide financial system was on the brink of collapse. If we do nothing about these megabanks and wait for another crisis, future presidents—whether Republican or Democrat—will face the same choices as President Bush: whether to let spiraling, interconnected TBTF institutions, like AIG, Citigroup and others, collapse in a contagion, sending the economy into a depression, or step in ahead of bankruptcy and save them with taxpayer money.

The answer instead is to break up these megabanks. As even Alan Greenspan has realized about our current predicament: "If they're too big to fail, they're too big."

--Letter to Editor, The Wall Street Journal (4/14/2010)

And the arguments against this are??