James Grant: Put bankers’ own assets on the line again.

The market is the best regulator. After almost 100 years, it’s time we brought it back.


Jim Grant has been the living best banking historian since 1995 when Murray Rothbard kicked the bucket. Last week in WaPo, he put forth is old-time solution to banking reform: make bank executives and even shareholders personally liabile for depositors’ losses.

The trouble with Wall Street isn’t that too many bankers get rich in the booms. The trouble, rather, is that too few get poor — really, suitably poor — in the busts. To the titans of finance go the upside. To we, the people, nowadays, goes the downside. How much better it would be if the bankers took the losses just as they do the profits.

Of course, there are only so many mansions, Bugattis and Matisses to go around. And many, many such treasures would be needed to make the taxpayers whole for the serial failures of 2007-09. Then again, under my proposed reform not more than a few high-end sheriff’s auctions would probably ever take place. The plausible threat of personal bankruptcy would suffice to focus the minds of American financiers on safety and soundness as they have not been focused for years.

“The fear of God,” replied George Gilbert Williams, president of the Chemical Bank of New York around the turn of the 20th century, when asked the secret of his success. “Old Bullion,” they called Chemical for its ability to pay out gold to its depositors even at the height of a financial panic. Safety was Chemical’s stock in trade. Nowadays, safety is nobody’s franchise except Washington’s. Gradually and by degree, starting in the 1930s — and then, in a great rush, in 2008 — the government has nationalized it.
No surprise, then, the perversity of Wall Street’s incentives. For rolling the dice, the payoff is potentially immense. For failure, the personal cost — while regrettable — is manageable. Senior executives at Lehman Brothers, Citi, AIG and Merrill Lynch, among other stricken institutions, did indeed lose their savings. What they did not necessarily lose is the rest of their net worth. In Brazil — which learned a thing or two about frenzied finance during its many bouts with hyperinflation — bank directors, senior bank officers and controlling bank stockholders know that they are personally responsible for the solvency of the institution with which they are associated. Let it fail, and their net worths are frozen for the duration of often-lengthy court proceedings. If worse comes to worse, the responsible and accountable parties can lose their all.
The substitution of collective responsibility for individual responsibility is the fatal story line of modern American finance. Bank shareholders used to bear the cost of failure, even as they enjoyed the fruits of success. If the bank in which shareholders invested went broke, a court-appointed receiver dunned them for money with which to compensate the depositors, among other creditors. This system was in place for 75 years, until the Federal Deposit Insurance Corp. pushed it aside in the early 1930s. One can imagine just how welcome was a receiver’s demand for a check from a shareholder who by then ardently wished that he or she had never heard of the bank in which it was his or her misfortune to invest.

Nevertheless, conclude a pair of academics who gave the “double liability system” serious study (Jonathan R. Macey, now of Yale Law School and its School of Management, and Geoffrey P. Miller, now of the New York University School of Law), the system worked reasonably well. “The sums recovered from shareholders under the double-liability system,” they wrote in a 1992 Wake Forest Law Review essay, “significantly benefited depositors and other bank creditors, and undoubtedly did much to enhance public confidence in the banking system despite the fact that almost all bank deposits were uninsured.”

Like one of those notorious exploding collateralized debt obligations, the American financial system is built as if to break down. The combination of socialized risk and privatized profit all but guarantees it. And when the inevitable happens? Congress and the regulators dream up yet more ways to try to outsmart the people who have made it their business in life not to be outsmarted…

For the record, I agree 100% with Grant’s solution. Moral hazard is THE cause of the de-facto bankruptcy of nearly every major bank in the US.
The US banking system pre-1913 was not perfect (unscrupulous bankers were always trying to use the power of the government’s guns to game the system), but it was much safer and more honest than today’s.
Bankers did not yet have a license to blow bubbles, since there were no black checks from their creation, the Federal Reserve, which can simply print paper money to bail them out in the inevitable busts. Before the Fed, their own assets were on the line, and before FDIC, the depositors’ assets were at risk. These two parties had a very strong incentive to keep lending standards prudent.
There were booms and busts, but they were localized, and at no time did the entire banking system become insolvent like it has been since 2008. Weak banks lost their depositors to those who had been prudent, and depositors knew that they were taking a risk when they chose a bank paying higher interest.
In sum, the market is the best regulator. It’s time we brought it back.

Listen to the people who predicted this: No bailouts, no New Deal, no serfdom.

Here is a list of popular personages who predicted this credit implosion and depression while the bubble was still being blown:

  • Robert Prechter. In 2002, he published Conquer the Crash, How to survive and prosper in a deflationary depression. So far right on the money except gold hasn’t fallen hard (yet).
  • Jim Rogers. The man has good timing when it counts. He bought a NYC townhouse for 107k in 1977 and sold it for 16 million last year and got the heck out of Dodge. He moved his family, business and money to Singapore and shorted the US market. Missed the turn in commodities, though, and refused to sell China out of some kind of principle.
  • Peter Schiff. Published Crash Proof in 2006, which has been pretty accurate other than Schiff’s missing the deflation stage and holding commodities and foreign stocks too long. The results of the New Deal and bailouts are likely end with the currency failure he predicts.
  • Mish Shedlock. Publisher of a popular blog, Mish has been warning of a deflationary depression since 2005 or 2006, and now has the best record of predicting its course (deflation, bailouts, gold and the dollar doing well).
  • David Tice. Manager of the Prudent Bear Fund, BEARX, which is performing spectacularly.
  • Doug Casey, the original international speculator, and publisher of the Casey Research newsletters. Missed the deflation part, also burned by commodities, but spot on about fascism.

There are countless others who saw this coming, including Congressman Ron Paul, who’s own studies of monetary policy inspired him to first run for office.

What do all of these men have in common that allowed them to see around the corner? They understand money and the credit cycle. How did they learn it? Not in college, that’s for sure, because colleges teach perverse Keynesian claptrap. They have all read the Austrian economists, in particular Ludwig von Mises and his American pupil Murray Rothbard. Their explanation of the business cycle as the credit cycle is both elegant and extremely powerful.

And what do all of these followers of the Austrian School think we (meaning our governments) should do, now that their worst fears are coming true? In a word, to a man, nothing.

Don’t fear the crash. Fear fascism.

You see, the very worst fear of Austrians is not a crash or a depression, which is actually the healthy restoration of sanity after a credit-fueled mania, but the expansion of government that seems to follow these events like day follows night. Frederic Hayek laid out these fears in The Road to Serfdom, and that is exactly where we are going: utter economic collapse. The government is going to hamstring the markets and drain our resources for its pet projects and wars, all for our own good. Their aim is to stave off a proper accounting of the losses that have already taken place, and to preserve the power of those who inflated our way into this mess.

The damage from the bubble is already done. Government adds new damage.

What not one person in 10,000 understands is that the losses have already taken place. The losses were the waste of resources and labor for doomed endeavors that never made sense: think McMansions in the desert, and the roads, power plants and strip malls that served them. The price declines that we are now experiencing are necessary to restore valuations that reflect true values, because proper pricing clears markets — it allows people to accurately assess the worth of certain items against that of others.

A 5000 sqaure foot house on a dry hillside 20 miles outside of Phoenix is a money pit, not a million dollars. It was never properly valued in terms of the labor and raw materials that went into it. But because bankers, backed up by the Fed and various government programs and guarantees, would lend $1 million to buy it, those resources were drawn out into the desert instead of to sustainable productive uses.

An honest, gold-backed monetary system and a free-market banking system with no government support would never have allowed bankers to misprice assets so greatly. Any that did would face severe difficulties inducing the public to trust them with deposits. But with FDIC, who cares what your bank does with your money? And bankers say, “with the Fed to bail me out, who cares if all my loans blow up?”

What will happen if government doesn’t lift a finger?

The owners of McMansions will lose them to the banks or other mortgage holders, and those mortgage holders, if they bought the paper with loans of their own, will lose them to others, and so on. Almost every bank in the world will fail. They have all come to depend on deposit insurance and central banks to cover for the fact that they have been reckless and insolvent from nearly day one. There will be no bank lending at all.

What will happen to the depositors? Well, almost all of their money will be lost.

So, that is what we are looking at: every bank failing, zero bank lending, almost all the money in the world going to heaven. How is that not the end of the world? Simple: It is a reverse split. In 2006, let’s say, there was a million dollars in total bank deposits. Then in 2008 all the banks go under. All that is left is the cold cash in people’s pockets, let’s say $100,000 in all.

That remaining cash becomes extremely valuable. It has to work where one million did before. If you had $10 in your pocket and $90 in the bank, you now treat each dollar as if it were ten. The key is that so does everyone else. The world still has its unit of account and medium of exchange, we have just moved the decimal point over on all prices. (Note: gold and silver would rapidly re-enter circulation and quickly become the preferred money, as they always do until government outlaws them).

Of course, deflation on this scale makes debts unpayable, so essentially all debt is defaulted upon, but of course most creditors are bankrupt too. Contracts have to be renegotiated or annulled. No big deal, really. The assets are all still there, just the same as before. Nothing has burned down. A car bought on credit still gets the same mileage as before its loan went bad, a house keeps you just as dry.

Trust the prudent and smart, not bankers and politicians.

Such an event brings about a massive transfer of wealth from the reckless to the prudent and farsighted, who are exactly the people you want making the decisions about what to do with money and assets after the crash. They are statistically and philosophically the best equipped to decide what will generate the highest returns with the lowest risk. Life goes on. There is nothing to rebuild because nothing was destroyed. It is all just reordered in a more sensible fashion. The house in the desert is scrapped for materials. The Lehman mortgage traders find something productive to do, like drive cabs.

But that outcome is so quaint, so 1800s, so gold standard. We’re more scientific today. Bernanke is a wise economist. Congress is benevolent. War is peace, and lies are truth.

Finally, a little bit of outrage.

Jim Grant (of the excellent but pricey, Grant’s Interest Rate Observer) penned an essay for the Wall Street Journal this past July, in which he lamented the indifference citizens were showing as bankers repeatedly helped themselves to tax dollars, during a crisis that they brought upon us.

“Raise less corn and more hell,” Mary Elizabeth Lease harangued Kansas farmers during America’s Populist era, but no such voice cries out today. America’s 21st-century financial victims make no protest against the Federal Reserve’s policy of showering dollars on the people who would seem to need them least. …

Possibly, there aren’t enough thrifty voters in the 50 states to constitute a respectable quorum. But what about the rest of us, the uncounted improvident? Have we, too, not suffered at the hands of what used to be called The Interests? Have the stewards of other people’s money not made a hash of high finance? Did they not enrich themselves in boom times, only to pass the cup to us, the taxpayers, in the bust? Where is the people’s wrath? …

The American people are famously slow to anger, but they are outdoing themselves in long suffering today. In the wake of the “greatest failure of ratings and risk management ever,” to quote the considered judgment of the mortgage-research department of UBS, Wall Street wears a political bullseye. Yet the politicians take no pot shots. …

Wall Street is off the political agenda in 2008 for reasons we may only guess about. Possibly, in this time of widespread public participation in the stock market, “Wall Street” is really “Main Street.” Or maybe Wall Street, its old self, owns both major political parties and their candidates.

Grant goes on to suggest that the reason there is no outrage is that the populists of the early 1900s won the battle over the role of government in monetary policy. This system of paper money, easy credit, government-sponsored loans, inflation and debt forgiveness is exactly what the fire-breathers (and bankers, I would add) wanted.

Well, the bailout to end all bailouts is finally inspiring a bit of anger, though most of those expressing it seem to be among that narrow segment of the population that knows what a central bank is. The responses to a recent WSJ.com blog post were overwhelmingly negative, although at a fairly high level of sophistication, sort of like the crowd that chimed when any major news outlet to mentioned Ron Paul last year. Here are some excerpts:

If I could only get the Treasury to buy my lottery tickets that didn’t pan out, at what i paid for them!

I’m sick of this!!! Wall Streeters are behind the scenes pulling every lever they can find to get themselves out of this mess at OUR (i.e. the TAXPAYERS) expense under the guise of “saving the economy”. Lenders WILL lend money when they think they will be paid back…period. All of housing will, going forward, be federally related and subsidized. All the big lenders and banks are going to offload the bad loans and securities collateralized by same onto the Government, i.e. the TAXPAYERS so equity investors can salvage investments, directors and officers can minimize lawsuits, and Goldman Sachs and Morgan Stanley can keep their stock price up…so for God’s sake, let’s spend a trillion of our money..

Essentially, it’s a game of hot potato. The mortgage and credit industry created a huge lot of bad debt. They didn’t want this risk, so they sold it to investment banks as complicated financial instruments no one really understood. The financial companies passed this risk to their investors, who are in many cases cash rish foreign governments. Now, when everybody came to the realization this debt was not going to be paid, the US government didn’t want to pi$$ off the foreign governments paying for our little credit party, so they passed the “hot potato” to the U.S. taxpayer. The U.S. taxpayer, essentially powerless, now holds the potato. Is that about right?

Bernanke, Bush, Cheney, Paulson, “The Four Horsemen of the Apocalypse’ and my homeboys, go forth pillage, plunder. You have obeyed your masters the international global fascists! The people are broke but you don’t care!

This is completely outrageous. ‘Bailout’ Bernanke and his cronies are inflicting the biggest scam on the US taxpayer in history. Why are we destroying our economic health to bail out some rich cats whose fraud caught up with them?

Interesting that the first bailout attempt, “the Entity”, never materialized because private capital did not want to purchase toxic assets. Never fear, the most recent bailout, aka the Treasury Garbage Machine, ignoring the precedent suggested by The Entity, will purchase these very same assets. If Credit Suisse is even close in its forecast of $6 trillion in foreclosures, have pity on the US taxpayers.

Gee, I wish I knew six months ago that I could have left all my cash in a more volatile money market and be just as secure as when I transferred into a Treasury based fund at 150 less basis points. Stupid me. I’ll never make that mistake again. I should have known that Mssrs. Paulsen, Bernanke, Dodd and Co. would come to the rescue. That’s why I call them the Dukes of Moral Hazard.

Welcome to the USSA. The free market is no more.

when time names its man of the year it should not be a human being

it should just read


ps you forgot barney franks housing bailout bill

what a sad day to be a responsible american

Nothing new. The idiots in government are buying idiotic loans made by the idiots in banking so the idiots who can’t afford the loans they got from the idiots in banking will be foreclosed on by the idiots in government. The real idiot is the guy who doesn’t leave the country.

These comments are from straight down the line, hardly skipping a post. If only the majority of the country didn’t get more from the government than it gave, we might just have a quorum.

But that’s what you get with democracy (we were given a republic, but couldn’t keep it): start with a few handouts, and you create a class that grows bigger and dumber with every generation, until it is so easy to control that the leaders only have to maintain the illusion of democracy.

How about a little George Carlin?