Cobra Capital’s president Dale Kluga lets everyone have it — from Washington politicians to Wall Street bankers — as he expresses his frustration with Too Big To Fail/Too Big To Manage banks. However, he goes beyond bemoaning the current state of affairs and offers solutions in addressing these trillion-dollar banks.
If there is one thing I’ve learned in the last 31 years, it’s that capital has very little to do with a bank’s ability to survive. Since the Great Depression, banking has always been and always will be, more about liquidity than capital. I’m not sure how our politicians and Wall Street bankers have forgotten this basic principle, but they have. They naively continue to rely upon static capital levels to justify huge irresponsible bets with Main Street depositor money.
The world’s greatest banker will not be able to stop any stampede run on his leading U.S. bank even with a “fortress” balance sheet and excessive “capital” levels. Nope, just look at history. All it took back in 1984 was one irresponsible banker, an international crisis and that “best managed” bank, according to Institutional Investor, was toast and became the largest bank failure in U.S. history.
Here’s the thing though, back then at Continental Illinois (CINB), we actually knew our risk was concentrated in overnight funding positions. Today it’s much scarier however, because our Too Big To Fail/Too Big To Manage (TBTF/TBTM) trillion-dollar banks don’t have a clue as to the nature of their collective Achilles heel … witness JPM’s now infamous, “CDX.NA.IG.9“ Credit Default Swaps. Just like JPM, our arrogance and over confidence at CINB turned into complacency which, in CINB’s case, inevitably morphed into total failure.
Instead of bemoaning how we got here, I’d like to discuss some solutions that work, as I see them.
SOLUTION #1: A ‘Skin in the Game’ Approach
Here’s a crazy idea to help solve our TBTF/TBTM trillion-dollar bank problem. Why don’t we start requiring that big bank CEOs be required to have a more meaningful, and almost a painful level of cash invested equity in their business? Not gifted, granted warrants or other forms of non-cash, performance awarded equity. Not equity funded by insider company loans. No, cold hard cash equity, as in they have to write a meaningful personal check to remain CEO. I bet that those obscure, stratospheric risk management policies will change the minute the CEOs’ wire transfer hits their employer’s deposit account.
The CEO could also be issued a special class of equity that gets burned through first before it hits the common and preferred classes. At a minimum, this “skin in the game” solution will force all the trillion-dollar bank CEOs to start asking common sense questions.
SOLUTION #2: Break ‘Em Up
Your bank is too big for the CEO to honor the personal cash call? No problem, let’s break them up to a smaller level where the CEO can personally meet the cash call. For example, take JPM’s Living Will and break it up into 20 regional $100 billion banks with 20 competent bankers able to more reasonably manage their smaller franchise having much greater risk management diversification from every human and financial perspective. Smaller size, in this case, can actually be better for everyone involved. Big business does not need big banks. Big banks need big business.
More human interaction is better than strictly relying upon highly intellectually, brain numbing computer models. Just take a look at what we do for disaster events, we don’t ask fewer people to jump on the problem to figure it out, we ask more people with different perspectives to solve it. In this respect we have fundamentally lost our way in basic bank risk management, we rely more on technology to manage human risks rather than expecting people to use technology as just another tool rather than the holy grail of decision making.
SOLUTION #3: Look to People, Not Technology
Our TBTF/TBTM oligopolistic trillion-dollar banks have dangerously and rapidly grown during this economic crisis and have changed a very fundamental part of their business model. Big banks have stopped lending in any material way to small business, our greatest hope of any U.S. jobs recovery and have therefore pushed into the future any hope of a real U.S. economic recovery. The big banks have ditched their traditional small business lending skills and have now created self-inflicted job skill atrophy, or as the Fed’s Janet Yellen said, “job hysteresis.”
Banks have made a fatal mistake by favoring technology and credit scoring platforms over the human judgment lending skills required for small business lending. Small business loans and credit cards have been converted into camouflaged forms of consumer credit which are primarily predicated upon an owners personal credit score having little, if anything, to do with the actual health of the small business itself.
Let’s also insist that banks start talking truthfully about the 1% factor. I’m not talking about the 1% richest individual income earners. No, I’m talking about the TBTF/TBTM banks that slickly advertise that they are patriotically supporting our country by lending to small business. But when you drill down into their numbers, the truth is that they are falsely advertising that they are materially and aggressively lending to small business.
Fact: except for Wells Fargo, each U.S. trillion-dollar bank lends approximately only a mere 1% of their bank’s balance sheet to the same small business they claim they are seriously supporting (Wells actually lends 1.7%). If the Washington politicians want real, effective regulation, try this—create a new “Truth in Bank Advertising” (TIBA) with a cigarette-like disclosure in every bank ad that honestly states the actual amount of each bank’s small business loans as a percent of their total assets. For five brutal years, small businesses have been fed up with the lies and egregious big bank misrepresentations that they are lending in any material way to us.
Our banking system has only become more risky as a result of TBTF/TBTM banks, which has produced rapid and dangerous industry consolidation. Dodd-Frank has done little to reduce actual risk, as our big banks’ share of U.S. output has only risen sharply from 43% to 56% in just four short years. All that regulation has done is focus on perceived political risk and perpetuate the credit freeze on the source of any U.S. economic recovery, the mortgage market and small business job creators. Over regulation is no more than self-serving fodder for those bad politicians to promote their ridiculous and embarrassing brand identities.
SOLUTION #4: Fix Washington First
However, don’t expect to fix banking until we first fix Washington and its out-of-control and gargantuan-sized deficits. The simple solution to this problem involves requiring politicians to have some skin in their game as well. As Warren Buffet said on CNBC, “I could end the deficit in five minutes, you just pass a law that says anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.”
How about other simple ideas: create term limits, eliminate lobbyists and force crony politicians out of office. Why not return political office to those who create their own obsolescence? I argue this philosophy will do more to cut through the red tape than any damage from crying, self-serving pols who say, that they “need more time to change the system.” Yeah, we tried the “change” platform thing and look where that got us – the worst recession, worst economic recovery and worst labor participation rate since the Great Depression.
SOLUTION #5: Listen to the Professor
I completely object to government intervention on nearly every level. I was opposed to TARP, which did nothing to fix our banking system. It protected the TBTF banks, which have only gotten bigger since the crisis. However, as Professor Marvin Goodfriend at Carnegie Mellon explained to me, at some point the risk of doing nothing can be much worse. He was not referencing TARP, he was talking about our current unemployment problems with our historically low 64% labor participation rate and our 15% U6 real underemployment.
If most economists agree that any recovery must come from small business job creation, and the big banks continue to refuse to lend materially to small business, then something has to give before our economy can move forward. Enter the depression-era Reconstruction Finance Corporation (RFC), which directly funded private businesses and bypassed the cash-hoarding zombie banks.
It was not a TARP “kick the can” solution, which has only perpetuated our small business credit freeze and caused banks to hoard cash rather than lend it out so small business could grow and create jobs. I think Professor Goodfriend is on to something here with a current day RFC because it is a direct lender to private business and bypasses the broken banking system. During the Great Depression, the RFC actually helped create entire industries like the rubber industry, which was a consortium of hundreds of small entrepreneurial businesses that created jobs.
These solutions are not intended to please the machine bankers or politicians. Quite the contrary, they are disruptive since they do more to upset our “orderly” and “viable” system, if that’s what you call a 64% labor participation rate and the worst credit freeze on small business since my grandparents lost their life savings in U.S. Gold Bonds during the Great Depression (yet another genius investment that preyed on loyal and patriotic families not unlike our current day Credit Default Swaps.) Haven’t we learned anything since 1932?
I say we try some or all of my TBTF/TBTM Solutions. What do we have to lose…other than the opportunity to create more jobs?