Dangerous Ambiguities


In politics, we are often told, we should not let the perfect be the enemy of the good. That’s why so much of what comes out of our policy-making process ends up as politically-driven compromise. In Washington, splitting the baby is often considered better than no baby at all.
But, as the financial crisis brings the worlds of finance and politics into increasingly overlapping orbits, we need to take note that what may be acceptable compromise in politics can be dangerous ambiguity when applied to finance.
Today, many banks are faced with openly ambiguous mandates that border on outright conflict.
On the one hand, these publicly-listed banks are expected to pursue their business models and to respect their fiduciary obligations to maximize return for their shareholders. These days any financial institution worth its salt is assessing how to take advantage of the opportunities presented by the current financial crisis – especially the hyper-generous financing being provided by the US Government.
At the same time, many of these same players have been deemed “systemic” and “too big to fail”. That often means that their businesses are being heavily subsidized, directly or indirectly, by the federal government to the tune of hundreds of billions of dollars.
In return for these subsidies, banks are being poked, pushed and prodded so as to further public policy goals, respond to (understandable) populist pressures to reduce compensation, restart credit markets, “lend like crazy” and, in some cases, to eschew the very opportunities that many talented financial professionals are champing at the bit to pursue. (It doesn’t get much better than 93% US Government financing, folks.) All this, so as to bring order and stability to the financial system as a whole.
This inherent conflict is why, in spite of my general skepticism about the health of the financial sector, semi-secret stress tests and the accounting gimmickry surrounding the banks’ first quarter results, I was pleased to hear that Goldman Sachs intends to pay back its TARP funds as soon as possible and that JP Morgan hopes to do so as well.
I am not a cheerleader for Goldman. But I am glad that they resisted reported pressure from the Government to refrain from taking advantage of a relative sweet spot in the equity markets to raise private capital and pay back TARP funds. Had they failed to do so, they would have been effectively handing the US Government a major seat at their management table, potentially at the expense of their public shareholders. Their decision to remove this ambiguity about who the bank’s management really reports to was the right thing to do.
I would have thought that last year’s implosion of Fannie Mae and Freddie Mac would have raised major red flags that we need to be especially careful to avoid ambiguity when blending the realms of policy and finance.
Fannie Mae is a particularly illuminating case in point. For the first thirty years of its existence, when completely controlled by the US Government, Fannie was enormously successful in using financial tools and market mechanisms to advance public policy goals. It was only when it was privatized for budgetary reasons, that messages became mixed and things got complicated. It was at that point that, with an ambiguous mandate to serve both the interests of its public shareholders and to further the policy directives of its government masters, its sad fate was effectively sealed.
Similarly, as applied to today’s US banking system, various government plans and financing schemes, combined with efforts to resist taking ownership stakes in these entities, have led to the creation of dangerous ambiguities through the financial system. While well-intentioned, and perhaps politically necessary, the current banking landscape appears to be the result of a desire to preserve the status quo of the financial system, to remain true to our free market ideology and to avoid seeking additional funds from Congress to address the underlying weakness in the banks’ balance sheets.
This has led to the creation of programs, like the Public-Private investment Program (“PPIP”), which have the risk of “conflict” written all over them.
Shortly after the PPIP was announced, the press started running stories in which they “uncovered” what I would have thought was obvious – that many of the major institutions currently receiving billions of TARP funds were preparing plans for how to take advantage of the PPIP – and the very generous leverage and terms that it provides. These banks are not only in the business of making money for their shareholders and employees, but are also holders of much of the “private capital” that the PPIP hopes to mobilize to jump start the financial sector itself. So expecting them to refrain from taking advantage of the program, whose goal is to help these very same institutions, would be to fundamentally misunderstand how big banks operate. Sound confusing? That’s because it is. That’s my point.
It remains unclear to me whether the government plan considers these large financial institutions to be sick patients in need of urgent medical help, or conversely, highly experienced medical professionals, whose private capital and expertise are being encouraged (through generous financing packages) to come to the aid of those very same patients. Or both.
Unfortunately, a financial crisis that compels significant government intervention is bound to be handcuffed by political considerations – thereby making ambiguity almost inevitable. One of the reasons that historically these banking crises have ultimately been solved by “nationalization” or good bank/bad bank schemes is that they are clear cut and free of ambiguities.
While politically necessary perhaps in the short run, the longer these ambiguities exist in the financial system, the more confused and at risk the system may ultimately be. Unlike in politics, in finance today, as in King Solomon’s time, most people understand that in the end, you have to make a choice – because a split baby isn’t really much good to anyone after all.
— Douglas Rediker


6 comments on “Dangerous Ambiguities

  1. ... says:

    dan kervick, i think you sum it up well but with a few too many words… “They are not chartered to serve the public interest as charitable organizations.” ought to read as “They are not chartered to serve the public interest” instead…. it appears the gov’t is chartered to serve the banks interests however and that is the hitch…
    steve your captacha system works like crap…


  2. rich says:

    “I take it that Douglas’s main point here is that the policy challenges in the financial sector can’t be tackled simply by giving banks government assistance, and then expecting to guide them by informal moral suasion based on winks and nods, a sentiment of reciprocity, or the weight of public media pressure.”
    I like that and am all for it. Need to give this the time/attn it deserves.
    Where policy & profit conflict, I agree that “we either have to take ownership stakes in the banks so that we can run them as we see fit, or else we need to write new laws.”
    ” .. . banks will assess the new environment that this plan creates, and then calculate the best way to MAKE MONEY in that environment. That’s what banks do. That’s what they are chartered to do. That’s what their shareholders demand that they do. They are not chartered to serve the public interest as charitable organizations.”
    No one said they were chartered to serve the public interest as a charitable organization.
    Charters do require banks to have a service area, do a certain amount of local lending in that area (unless solely under CRIA’78) — and make a profit. They do have a responsibility to the public. The confluence of policy and profit is obvious, long-codified, and in the public interest. There’s plenty of room for that confluence. We want profitable banks — as long as it’s not at the cost of everybody else’s profit, survival, and the health of the entire economy, profit’s great.
    As it is, banks seem to be making money every which way but Sunday, most of it through government welfare, dubious products (fraud), and opaque or questionable bookkeeping, in that order. Make it transparent — and only then will you convince anyone the bailout is being handled on the up-n-up.
    Of course banks are there to make profit (duh). Where arrangements are muddy, there’s great potential for abuse. But only where banks are eager to violate long-codified public responsiblities can such ‘conflicts’ be used to excuse continued abuse & profiteering.
    It’s precisely the notion that there is no reciprocal relationship, entailing an obligation by banks to the public, that has led to this crisis.
    It’s simply not unreasonable to set rules that ensures banks don’t fail, or to impose public policies that regulate bank activities. Some of those public policies legitimately require lending to American businesses rather than, say, to overseas operations using slave labor. Or that they invest in American small businesses rather than, say, swapping viable operations for 6 magic beans.
    These banks failed for a reason — and it was precisely because they put short-term profit above their fiduciary responsibility to their company & its shareholders; and put short-term profit above their responsibility to their customers and to the American people & nation. Not to mention the financial system as a whole.
    Had they not done so, no one would be so concerned about the ‘conflict’ between private profit and public policy. The concern is they have no fealty at all to the common good and national interest, and are actively milking the taxpayer at every spigot, at every opportunity. That’s the pattern, and guys like Phil Gramm (and Charles Hurwitz), who opened the barn door to this stuff, are just Exhibit A.
    Why should we trust Rubin or the CEOs now? But the normal obligation to “MAKE MONEY” does not mean there has never been a public obligation on the part of banks to meet policy rules. Nor that there isn’t such a public policy onus now.


  3. Dan Kervick says:

    I take it that Douglas’s main point here is that the policy challenges in the financial sector can’t be tackled simply by giving banks government assistance, and then expecting to guide them by informal moral suasion based on winks and nods, a sentiment of reciprocity, or the weight of public media pressure. Banks are profit-maximizers, and are determined by culture and the obligations of their charters to serve their shareholders, not the public interest. If they do manage to serve the public interest in the end, that can only through by the vaunted invisible hand magic of the free market system.
    Thus, if we want banks to behave in ways that policy-makers believe will better further desirable policy goals, when those behaviors might be contrary to the private interests of the banks’ shareholders, then we either have to take ownership stakes in the banks so that we can run them as we see fit, or else we need to write new laws that legally require the banks to behave in the ways we want.
    If we don’t do those things, and instead decide on a plan like the current one that subsidizes private risk-taking and leverages private capital in order to create a new market in “legacy assets”, then we have to accept the fact that the banks will assess the new environment that this plan creates, and then calculate the best way to MAKE MONEY in that environment. That’s what banks do. That’s what they are chartered to do. That’s what their shareholders demand that they do. They are not chartered to serve the public interest as charitable organizations.


  4. rich says:

    What conflict?
    Making a profit is in the public interest, and that’s the main purpose of these supposed ‘public policy goals’.
    In theory, there could be a conflict. In practice, the banks brought it on themselves. Specifically, they abandoned their fiduciary responsibility to siphon off profits and sell dubious product at the expense of the viability of their own business. If Uncle Sam is a shareholder, every demand that these banks function according to their charters by fulfilling their public responsibilities is totally legitimate. Meeting those obligations before siphoning off more obscene ‘bonuses’ & undeserved salaries is hardly burdensome, nor is it a conflict. A rational and modest salary should concentrate the CEO mind wonderfully on their fiduciary responsibility. The lure of untold riches isn’t just bait for betraying long-term profit and any sustained future of these businesses — it totally severs these guys from the public responsibilities their companies DO have. And these banks do have charters; their CEOs do have obligations to a social contract, literally and figuratively.
    You want conflict of interest? We’ve had that in spades thanks to the dogma of deregulation:
    Anyone could have told you and Phil Gramm (& Bill Clinton & Bush and Chris Cox) were sodden with “conflict.” NO one wanted to listen at all — (though Tom Friedman had the temerity to mock the WTO protesters, he still hasn’t apologized). Now we’ve got a disaster on our hands, to the tune of trillions, and nary a responsible word from Rubin or Summers.
    I will revisit your post in detail. I’m reacting mainly to the dogma that there is or was ever a strict separation between public interest and private enterprise. Particularly in the banking sector. There is no wall; there is a relationship. To assert the waters cannot be muddies is to be a slave to dogma — and deregulatory dogma is what got us into this mess.
    I agree that the waters are too muddied now. Where the money is going and why is not clear, and I am not comfortable that fraudsters and con-men are reaping billions when what they’ve done is criminal in nature. Fire them; recreate whole new entities, then shovel cash back into those companies, if you really have to. But this is a heist of mythic proportions — and had policy folks listened to a few sane voices, America’d never be in this position.
    This cash is clearly not being funneled anywhere that is in the national interest, nor in the interest of the American people, our businesses or the national economy. I put that on Summers and Rubin.
    You may be in agreement. But the dogma of ‘conflict’ where there has to be a mutually-obligatory relationship between public and private, is not useful given the history of ideologically reckless free marketeers.


  5. ... says:

    it seems like tyranny of the minority to me… a few folks argue for less gov’t, less tax and etc. and you get less regulation in the banking industry, because ya know…. gov’t is bad…. no one ever gets around to thinking maybe banks are bad and that the gov’t would be better to run it then them… if ever there was a form of taxation that needed to be understood, it’s how the banks create money out of nothing while expecting to have it paid back to them with interest that is more exorbitant that any tax system going… banking is a racket… that is why those folks dress up nice in suits.. they can fool many folks with their fine attire, but they are a deceitful group that need to be removed from power…


  6. JamesL says:

    The sick patient is the American public. The ambiguity is the confusion over whether business serves people or people serve businesses. The task of a demopcratic government is to express the will of the people, and the implied will is anticipated to serve people. The mishmash of ‘individual rights’ vs ‘individual rights to make money’ via a business has resulted in an impenetrable complex of laws largely designed by business for business, and by the way we help people make money. There’s no good in creating a law or policy that benefits 51% of the people and harms 49%. Distinctions must be drawn to shift issues away from tyranny of the majority. If we cannot do this, we will fall victim to our own inflated concept of our cleverness: that we could control the monster we had created. At this moment, the people do not control what they have allowed to be created.


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