YouTube video

Yves Smith: Finance sector controls the regulatory process – there needs to be a publicly controlled alternative to the private banking system

Story Transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay, coming to you from New York City. We’re at Rizzoli Bookstore in New York on 57th Avenue, who have generously provided the space. Yves Smith, the founder of, in her book ECONned wrote the following. Capture of the executive branch and much of Congress by a well-heeled financial services industry means that we have not merely let a crisis go to waste; we have actually allowed a predatory financial services industry to further its self-serving agenda. The industry has seized control of the regulatory process. Now joining us is Yves Smith, the founder of Thanks for joining us again.


JAY: So in your book you make a proposal for how we can get out of this mess, and it fundamentally comes down to banking should be–or at least some banking should be a public utility. So what’s your thinking on that?

SMITH: Well, the whole notion is that the reason that banks enjoy such extensive protection is that these are essential public services. You know, people need payment services. They need places where they can store their money. You know, they need access to certain types of debt products. And that’s why they’re backstopped so heavily. And the thing that most people don’t realize is the extent of the subsidies that the banking sector enjoys. You know, deposits are insured. We’ve seen that banks are bailed out when they get in trouble. They are now getting continuing subsidies via the super-low interest rates that the Federal Reserve and other central banks around the world are keeping in place. That’s basically a massive tax on savers in order to allow the banks to earn very easy profits, because they can borrow at very low interest rates and, if they wanted to, earn completely risk-free returns by buying Treasury bonds. So, you know–and these are just–you know, even military contractors don’t get this level of subsidy.

JAY: Or they take some of this almost zero interest Fed money and walk it over to Brazil and get a three-, four-point spread.

SMITH: Exactly. Exactly.

JAY: Or they just–one way or the other, they find ways to make money out of it, rather then putting it back into the economy.

SMITH: No, that’s correct. That’s correct. The–so what’s happened is that we’ve got a system where the banks have really lost sight of their public role. And I think if–the proof of the pudding is what happened immediately after the bailout. I mean, if the industry had behaved, even for a couple of years, and said, okay, we just got a lot of money from the government, you know, we really should be very grateful, let’s rein in the bonuses for a couple of years and then we’ll go back to life as normal, I would have had some sympathy for their position. Instead, 2000–instead, 2009 bonuses and 2010 bonuses were at record levels. You know, if they wanted to do the responsible thing, they would instead have reined back the pay and used that to rebuild their balance sheets, because in fact their balance sheets are not as strong as the Treasury and other public officials have been saying.

JAY: And you point out in your book, when Sweden went through something like this, they fired all the management of their banks that had gone down, and, in fact, at GM, they make the president of GM step out. But in New York [incompr.] they actually got bigger bonuses.

SMITH: No, that’s absolutely right. And then none of these contracts were questioned, right? The unions, to extend what you’re saying, the unions, everybody in the GM case was made to take a haircut–the bondholders, the unions. You know, instead, with the banks, the bondholders didn’t take any haircuts, the employee contracts were all kept in place. I mean, the asymmetry is enormous. I mean, it’s very clear who’s driving the train here.

JAY: Okay. So let’s jump to what would it mean to have banks or some banks as a public utility. What would that look like?

SMITH: You’d have to have–you’d have very strict regulation. You’d have very strict regulation of what products they were permitted to be involved in. You’d have much more intrusive examinations than they have right now. You would probably have at least informal regulation of pay. I mean, for example, there’s been a proposal made on a completely different front of what one writer at the site called a maximum wage, of, say, you can only pay so much of a multiple of the lowest-paid staffer. But you wouldn’t have–or you could–or [incompr.] just say, look, we’re going to set an aggregate level; you can’t pay–you know, it’s considered to be unacceptable–again, it would be informal. I mean, you–.

JAY: And this would imply there’d be some massive wall, then, against what’s normal traditional banking and speculation and proprietary trading.

SMITH: Yeah. If people–if people want to go out and set up a hedge fund, fine, but the hedge funds can’t get their money as they do now. For example, right now, hedge funds borrow from what they call the prime brokerage units of banks. The biggest players in the prime brokerage market are Goldman Sachs, Morgan Stanley, and Deutsche Bank. Those are all backstopped by their respective governments. So the hedge funds are basically benefiting from the fact that they have access to the backstopped banking system. Similarly, a big source of money for the banks is what they call repo. I don’t want to go into the detail, but it’s a way of doing overnight funding. And money market funds are significant–are a big source of repo money. Paul Volcker has basically said we need to eliminate the way we’ve backstopped money market funds. You know, money market funds have this $1 net asset value. That’s a promise; it’s not a guarantee. You know, if people had lost one cent or two cents of what they put into money market funds, maybe they’d wake up and realize they need to be careful about this, and maybe they should put their money in regulated banks if they’re really concerned about safety.

JAY: So the principle here is, if you’re going to take public money, if you’re going to expect public backup, if you go on deposit insurance, which is public money, you’re going to be super-regulated because the public’s involved in your business, you’re not normal commercial business, as you point out in the book, that can go down. So you’re subject to very, very serious regulation.

SMITH: Right. Exactly.

JAY: If you want to go off and speculate, go and do it, but you have no access to public money.

SMITH: Exactly.

JAY: Alright. So here’s the other problem, the argument which also kind of comes out of your book, which is, it doesn’t seem you can win the regulatory fight. Even, like, what you’re saying makes so much sense. Even the smallest regulation seems unpassable in Washington right now.

SMITH: Well, no, and that’s–gets back to we’re probably going to have to have another crisis to fix this. And I don’t know that even if we have another crisis this will be fixed. I mean, quite–you know, I mean, quite frankly, it’s a–.

JAY: Yeah, we were told this was the Apocalypse, though.

SMITH: Right, we were told this was the Apocalypse. And for example–and the cost–what’s very offensive is this discussion that, oh, the bailouts paid for themselves. That’s absolute nonsense. The proper way to measure–first thing, a lot of chickens haven’t come home to roost yet. You know, look at what’s happening with the debt–with the European crisis and with the budget fight right now. We have a lot of plates in the air. If any of those plates fall, God knows what’s [going to] happen to the financial system. The other big problem, of course, is campaign finance reform. You know, this is all sort of circular, right, that the banks have now become so powerful that nobody seems able to break them. Now, an interesting analogy, however, is to that of Fannie Mae. You know, Fannie Mae similarly seemed a completely unbeatable force in Washington. You know, Fannie, Fannie was, you know, a huge institution, enormously profitable. Jim Johnson, its CEO, had succeeded in basically buying every housing analyst, had succeeded in, if anybody criticized a housing policy, of going after them through lobbyists. And yet when they–they were taken down by cheating on their accounting. I mean, that was–. You know. So even as powerful an organization as Fannie was brought to heel. So it’s not impossible; it’s just very difficult.

JAY: One option some people have suggested is that if you–that–well, they say the problem is, if you get into this regulatory fight, like what’s taking place in Dodd-Frank legislation right now, where you can’t even get something so obvious as position limits to try to, you know, rein back what’s going on in derivatives trading, that, you know, you wind up with–I think it was–what is it?–40 or 50 lobbyists from Wall Street for every member of Congress or some crazy ratio.

SMITH: No, it’s a huge ratio. Well, the problem is that Dodd-Frank was a lot weaker than most people want to admit. I mean, in fact, a lot of–one writer characterized Dodd-Frank as a bill to ride a bill. A tremendous amount of Dodd-Frank was not decided at the time Dodd-Frank was done, but instead was either kicked over to studies or was kicked over into rule-making. And that meant that that put it–that gave the–Wall Street another whack at it. So it was significant amounts of Dodd-Frank were designed to be retreaded in a weekend. And that part of the story just hasn’t gotten the press that it deserves.

JAY: One proposal I’ve heard is that because so many of these banks would have been bankrupt without public money, and still there is public–significant public ownership, really, in some of these banks [incompr.] just take one of them and you make it a public utility, and you say, okay, you now have a public interest mandate, and if people want to, they can choose to deal with this public utility bank. If they want to deal with the private banks, they can. And you create a real public option in banking. Does that make any sense?

SMITH: That’s actually a decent idea. I mean, you know, we’ve spoken in the past about the Bank of North Dakota, which is a public bank. It’s been profitable, it’s provided significant returns to the government, and it has a fairly narrow mandate in terms of what it does. It does a lot of lending, and it also actually provides support to the private banks in the state as well. But, again, it does it on very specific issues when it thinks there’s a public interest involved. I hate to say it: we may have the opportunity sooner than we think, because Bank of America isn’t in the greatest shape, and I don’t see it getting out of its problems with housing anytime soon. The market’s already got significant question marks over Bank of America, as you can see from its stock price. It’s actually trading at a significant discount to its reported equity, which is a big vote of no confidence.

JAY: So the Bank of America could be a–

SMITH: Wind up being a test case.

JAY: –a test case for a public banking system. Of course, you’d need somebody in Washington that wasn’t so beholden to Wall Street to get that done.

SMITH: That’s true.

JAY: Thanks for joining us. And thank you for joining us on The Real News Network, coming to you today from Rizzoli Bookstore on 57th in New York City.

End of Transcript

DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.

Creative Commons License

Republish our articles for free, online or in print, under a Creative Commons license.

Yves Smith has written the popular and trenchant financial blog "Naked Capitalism" since 2006.

Yves has spent more than 25 years in the financial services industry and currently heads Aurora Advisors, a New York-based management consulting firm specializing in corporate finance advisory and financial services. Prior experience includes Goldman Sachs (in corporate finance), McKinsey & Co., and Sumitomo Bank (as head of mergers and acquisitions). Yves has written for publications in the United States and Australia, including The New York Times, The Christian Science Monitor, Slate, The Conference Board Review, Institutional Investor, The Daily Deal and the Australian Financial Review. Yves is a graduate of Harvard College and Harvard Business School.