The Temptation of Servitude
One question that lingers, often unanswered, in accounts of bankers seeking direction from Washington or yielding to government dictate not backed by any law is, "why?" In some case the answer is intimidation or fear, the sense that one would be fighting a superior power. An example of this was the Fannie Mae executives, about to have their company seized, who reportedly got the message in a meeting with Treasury Secretary Paulson: "If you oppose us, we will fight publicly and fight hard, and do not think that your share price will do well with all of the forces of the government arrayed against you." But there are other, more complicated dynamics that are also coming into play. Bloomberg News has an interview with a lawyer who represents a lot of banks, H. Rodgin Cohen, chairman of Sullivan & Cromwell LLP. "Rather than split up banks, regulators should provide better supervision and require tougher capital requirements," Bloomberg paraphrases Mr. Cohen as saying. When you think about it, this is an unusual thing for a lawyer to say on behalf of his clients: "Please, Mr. Government, supervise me more closely, allow me to borrow less money, and force me to take less risk." He sounds like a lawyer for a convicted criminal asking a judge to mandate more frequent meetings with a parole officer. After all, nothing is stopping the banks from increasing their capital requirements or upping risk controls internally on their own, without a government mandate, other than maybe the pressure from shareholders who know that doing that might decrease short-term returns.
Here are six possible explanations for Mr. Cohen's statement:
1) Maybe Mr. Cohen is choosing the lesser of two evils on behalf of his clients, big banks that don't want to be broken up. In a perfect world for them, they wouldn't want "better [government] supervision" and "tougher [government-imposed] capital requirements" either. But the bankers and their lawyers have made a political judgment that there are going to be some consequences from Washington for their role in the crisis, and they are making a pragmatic decision to choose the less onerous of the consequences. If the banks can avoid getting broken up, they will grudgingly accept "better supervision" and "tougher capital requirements" as the price to pay for that.
2) Mr. Cohen knows that his banker clients are so incompetent or evil that without more strict supervision from the government, they will fail, and the taxpayers will then have to pay to bail them out. He believes that "better supervision" and "tougher capital requirements" will prevent such failures, and is putting his patriotic duty as a taxpayer ahead of his clients' desire to be free of stricter regulation.
3) Mr. Cohen realizes that even if his clients are competent and acting in good faith, they will sometimes fail, because of bad luck, or because of circumstances they could not have predicted or planned for. He believes that "better supervision" and "tougher capital requirements" will prevent such failures or reduce the chances of them because government supervisors are better predicters and planners than the bankers themselves.
4) Mr. Cohen realizes that failure (whatever the reason) by banks followed by bailouts makes them so unpopular that it poses risks of high taxes, compensation restrictions, and difficulty competing for talent. He thinks that "better supervision" and "tougher capital requirements" will reduce the risk of such failures and are thus in the long-term best business interests of the banks.
5) Mr. Cohen realizes that his banker clients are incapable or unwilling to increase their capital requirements or up risk controls internally on their own, without a government mandate, because doing so might A) decrease the short-term returns and stock prices to which their own compensation is linked B) if they do it themselves and their competitors don't go along, doing so might decrease the return of their own stock relative to competitors, again adversely affecting their compensation C) For the bankers, the benefits of taking more risk (making lots of money) outweigh the costs (chancing job loss but no compensation clawback, and a government rescue/takeover if the risks don't work out as planned). So Mr. Cohen wants the government to protect the banks as institutions by making them do in unison what their managements won't do on their own individually.
6) Mr. Cohen's banker clients don't want the responsibility for taking the risks that go along with leading a company in capitalism, including the risk of failure. They'd rather blame the government, so they can tell the press, their shareholders, congressional committees, their own consciences, creditors and class-action lawyers, "Hey, it wasn't my fault we failed. We were just doing what the supervisors told us, and we were well capitalized by the standards imposed by the government." It's a kind of abdication of individual responsibility. It's understandable, in a way, because the feeding frenzy after a failure can be severe, including attempts at criminal prosecution. The concept of a "safe harbor" can be an attractive one given the vagaries of liability law, which is why some drug companies and even cigarette makers want the FDA to regulate their products.
My point about how a large government role "tends to lessen the opportunities for differentiation and competition by businesses" applies here. A federal requirement of a certain fuel economy standard, for example, reduces the likelihood of one auto company winning customers by selling cars that offer unusually high fuel economy. Federal imposition of safety features reduces the chance of a car company appealing to customers by boasting that their models offer certain safety features not found on their competitors. Once the government sets a uniform standard for carry-on baggage, no airline is going to compete for passengers by saying, "On our airline, you can carry on as much luggage as you want, and our flight attendants won't hassle you for it, because we have the largest overhead bins." One can understand the desire to impose certain minimum standards for safety -- it's hard to imagine an airline having to advertise, say, that its pilots are more likely to be sober during take-off and landing than those on the other airlines. But if, say, the government required every car to be as safe as a Volvo, Volvo wouldn't be able to market its brand as a safety leader, and it probably wouldn't bother investing much in research and development of safety features.
Federal deposit insurance sharply reduces the need for banks to appeal to consumer customers on the basis of being well-capitalized or risk-averse. The depositors, after all, are assured of getting their money back (at least up to $250,000) even if the bank fails. In the absence of such market incentives for capitalization and risk-aversion, Mr. Cohen would have the government impose regulations. Many of the objections I made to the similar suggestion by Nicole Gelinas in our online discussion of her book After the Fall apply here as well; questions like who would enforce these rules, how would we know that the enforcement wasn't arbitrary, how would we make sure this isn't just the government enabling its own borrow-and-spend habits by forcing banks to own more government bonds.
Anyway, perhaps I have overlooked an explanation other than the six (eight if you count variants 5A, 5B, and 5C) listed above. Readers are welcome to submit their own answers via the comments. And I will query Mr. Cohen himself and update if he responds.
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