January 29, 2009

Why are big banks bad banks?

There are a lot of little banks that are doing okay right now, but the biggest financial institutions keep needing gigantic bailouts. Why is that?

My published articles are archived at iSteve.com -- Steve Sailer

26 comments:

Anonymous said...

Ha!

Because the fix is in. Robert Rubin and the gang make bad loans on purpose because the know they will be bailed out, just like he did with Goldman Sachs loans to Mexico in Bush the Elder's presidency and just like he did with Citi Financial this time around.

They knew these loans would go bad, and they knew they were "too big to fail".

They are using the stimulis money to buy out the smaller banks (their competition). In thirty years, this debacle will probably look like a smart business move on the part of Wall Street's biggest banks and mortgage giants.

Eddy Elfenbein said...

They became big banks by leveraging up.

Anonymous said...

If small banks could get away with making dumb loans during periods of exuberance and having taxpayers foot the bill with no risk, they too would "need" bailouts a lot more.

Anonymous said...

Steve
Money is dirty, that is what is taught in many homes (or, I suspect, many gentile homes at least).

Bigger confers some anonymity, some sanction.

USAA is quite big but has a different history - it springs from a culture that values money in an ancillary way. The military - everyone knows everyones status and finances explicitly.

AllanF said...

The little guys were squeezed out of the residential mortgage market by the big guys. The little guys were therefore forced to do commercial lending. Commercial typically lags residential, but the CRE bust is on the way, make no mistake.

Also, there's the matter of reporting bias. Podunk bank in southern Iowa isn't going to make the news the way the big, national guys do. But if you keep an eye on the FDIC site (or the Calculated Risk blog) you'll see there's been a few small banks go under already this year. The joke is, the weekend hasn't started until the FDIC announces a bank closure. Since Friday after banks close is when they typically make such an announcement.

Piper said...

A lot of small banks are privately or closely held; their boards and stockholders have much greater commonality of interest.

It's also true that the bigger the bank, the worse the govt-guarantee moral hazard.

Anonymous said...

I have read that the best way for the gov to deal with the crisis would be to break up the big banks and let the small banks buy them up in small chunks. And the only reason this is not done is b/c the big banks gave big bucks to politcal campaigns.

Anonymous said...

A lot of the small banks stuck with the traditional mortgage lending model: demanding down payments, doing their own underwriting, keeping the loans on the books. Since they didn't securitize loans or deal with structured finance products based on securitized mortgages, they didn't get burned when the secondary market for mortgages went bust.

Mortgage lending is actually pretty low risk when you stick to the "copybook headings", as it were: Make sure the borrower has a job, get a realistic appraisal of the house, demand a hefty down payment and don't lend more than 80% of the value of the house. That way, if a borrower stiffs you, you can sell the property for 20% below its appraised value and still come out even.

Dave

Anonymous said...

The big banks were busy making money in the casino, while small banks, particularly community and regional business banks, stuck to traditional banking. While there will be some failures of the latter, particularly in the sand states, most business banks will come out of this recession/perhaps depression relatively stronger than when they entered it, because the big banks that survive will have to revert to banking, and won't be able to afford to continue to lose money on traditional lending, as they did in the last 5 years.

As an interesting aside, there has never been any evidence of increasing returns with size in the banking industry. The highest ROE has always been generated by small to mid-size banks. Most large bank mergers in the last decades made sense only by increasing returns to management, not shareholders.

AllanF said...

Here's a link to a story discussing the residential-commercial banking divide at CR just last week:

http://www.calculatedriskblog.com/2009/01/bank-failures-and-commercial-real.html

Tino said...

Steve:

Good question, I taught about this too. I think have an answer. There are around 5500 banks in the US, and the smallest 5000 only account of about 20-25 of deposits. Many people used to say the US had too many banks, and that we would see consolidation. But surprising the experts the small banks survived. They did so by finding a niche: geographical locations, being close to their borrowers and having local information (in the Hayek sense). They were also more conservative, being smaller forces you to have a larger solidity in financial theory to handle random shocks.

These two factors made them more careful investors, earning less but taking less risk, and being more prepared for risk. Many small banks never entered the MBS market, while the larger banks behave like hedge funds.

I don’t know how the medium size regional banks behaved, maybe somewhere in the middle?

The success of the small, often owner-managed banks, often small-town oriented banks is a nice story of traditional economic conservatism compared contrasted with the failure of WSJ finance market capitalism. Both theories are laissez-faire, but there is more to be said beyond free markets.

Free markets do better when there are built on norms, traditions, informal institutions, rather than in vacuum. Or worse, built around modern day ideology of diversity and fell-good logical soft headedness, in organizations staffed by undersupervised arrogant cosmopolitan adolescents.

PS. Some commentators suggest a more straightforward theory of moral hazard, small banks know they would not be bailed out, big banks were too big to fail, I am sure that is part of the story as well.

PeterW said...

As much fun as banker-bashing and conspiracy-theorizing is, guys, there is a sound reason for wanting to prop up banks in an economic downturn. Banks effectively grease the wheels of the economy. Their lending not only directly controls the money supply (witness the ineffective Fed trying to increase M1 when bankers are running scared - no luck), but bank failures lead to enormous losses of confidence among business investors, which drive the economy. And this is to say nothing of the effect of bank failures on depositors, which could trigger devastating bank runs, even with the higher FDIC limit in place.

This is no reason to bail out shareholders and managers, but it does mean that 1) depositors must be protected at all costs, and 2) bank failures need to be "cushioned" to avoid chain-reaction failures in the wider economy. The people leading the banks need to feel the pain, but banks themselves need to remain somewhat stable, and even their collapse needs to be carefully managed

I would challenge later posters to avoid anti-bank demagaugery and speak only from their knowledge of economics. After all, we race realists are always bemoaning the populist posturing lack of scientific rigor of the blank-slaters. It would be hypocritical for us to suddenly turn into the very ignorant mobs that we ordinarily condemn.

Robert Rubin said...

I would challenge later posters to avoid anti-bank demagaugery and speak only from their knowledge of economics. After all, we race realists are always bemoaning the populist posturing lack of scientific rigor of the blank-slaters. It would be hypocritical for us to suddenly turn into the very ignorant mobs that we ordinarily condemn.

I'm Robert Rubin, and I approve this ad.

ben tillman said...

Really makes you wonder what MCorp did to piss the government off so severely that the OCC would seize all the MBanks, despite the fact they were solvent.

Anonymous said...

It takes a big bank to take big risks.big firms have a mix of trading and underwriting businesses that were positioned to create all sorts of trouble. Glass steagal existed for a good reason.

Anonymous said...

I would challenge later posters to avoid anti-bank demagaugery and speak only from their knowledge of economics. After all, we race realists are always bemoaning the populist posturing lack of scientific rigor of the blank-slaters. It would be hypocritical for us to suddenly turn into the very ignorant mobs that we ordinarily condemn.

It's a statement like this that gives "race realist" a bad name. "Philistine" comes to mind. I challenge you to read Faulkner's Snopes trilogy (The Hamlet, The Town, The Mansion). Though no economist, Faulkner anticipated the potential pernicious influence that banking could have on morals, community, art, and, ultimately, the human spirit.

bjdouble said...

Big banks tend to be big because they're run by empire-building megalomaniacs (google bankstocks.com and Ken Lewis). And they got big by buying smaller banks, but they have no idea what's in those banks, and the information is buried deep in 15 different IT systems.

Henry Canaday said...

I have eight banks within four blocks of my home, which does seem a bit too much. (How about some bowling alleys or pool halls to encourage development of useful skills?) The local banks have great service but give lousy rates on CDs, so I assume they are lending cautiously and locally. The Citibank branch gives great CD rates, but they are so sloppy in recording transactions that, even before the crisis, I would not have trusted them with a dime unless it was federally insured. PNC, which is a major bank, gives good rates and is apparently sound. But they are headquartered in Pittsburgh, so maybe they avoid the temptations of New York and LA

Anonymous said...

Steve,
Here is my guess, or what I believe to be part of it.

Years ago, I asked my husband about his employer: "Doesn't x worry about being sued for not hiring enough minorities; all the workers are white men after all."

His reply: "No, it's too small of a company".

I wonder if the same dynamic has applied to banks. Are larger banks under more scrutiny than smaller ones for discriminatory lending?

Relatedly, I asked him the other day if his employer would ever try to bring in immigrants and he again replied that it was too small. I now wonder if importing Asians solves two problems: getting cheaper labor and to be able to head off any affirmative action suit: "We're not discriminating against blacks, we don't have whites, either."

Lucius Vorenus said...

ben tillman: Really makes you wonder what MCorp did to piss the government off so severely that the OCC would seize all the MBanks, despite the fact they were solvent.

Care to elaborate?

I googled, and found a summary of the case about a third of the way down here:

http://vlex.com/vid/18394047

Also, the case is referenced in this subsequent case:

http://www.occ.treas.gov/law/SpiegelHoldingsvOCC(Dep-Dec).pdf
[PDF FILE]

From the first link:

The Board alleged that MCorp was engaging in unsafe and unsound practices, "likely to cause substantial dissipation of the assets of MCorp that could be used to allow MCorp to serve as a source of financial strength for the subsidiary Banks." A week later the Board issued an Amended Notice of Charges, which sought, among other things, to require MCorp to "implement[ ] an acceptable capital plan that would ensure that all of MCorp's available assets are used to recapitalize the Subsidiary Banks that are suffering capital deficiencies." MCorp's subsidiary banks were suffering heavy losses from real estate and energy loans.

From the second link:

The Supreme Court relied on the “plain, preclusive language” contained in § 1818(i)(1) in holding that the section barred judicial review of administrative actions pending before the Board of Governors of the Federal Reserve System (“Board”). Board of Governors v. MCorp Financial, 502 U.S. 32, 112 S. Ct. 459 (1991). MCorp, a bank holding company, filed a voluntary bankruptcy petition and initiated an adversary proceeding against the Board to enjoin the prosecution of two ongoing, nonfinal administrative proceedings against it. The Court concluded that § 1818(i)(1) was not qualified or superseded by the general provisions in the Bankruptcy Code, including the automatic stay provision. Id. at 39-42.

zylonet said...

Many of your readers have made some good points. My thoughts are that big banks failed because the top brass were smart in the street sense. The brass was comprised of people motivated by money and pretty much only money. Therefore, they engaged as much profit taking as possible and focused on filling their individual coffers. They were smart, because they ended up rich and that was the only incentive offered to them. They knew the calculus: take all you can and extend the bank as far as possible. The demands for profit were driven by the market, so it did not behoove a manager to play to banking ideals of conservatism. The key was to give the market what it wanted and to earn as much as possible. Let the chips fall where they may. Who needs job security once your net worth is past $10 million?

Our society has devolved into nothing but a trading market and immigrant servicing center. There is nothing left to hold us together as one peoples. There have always been greedy people, but today's world makes it easier than ever for the greedy to succeed. I am somewhat jealous of the bankers' good intelligence, for they knew to take it all. I have made the opposite mistake twice and at great personal cost. If only I had known at the time, that the world could give $.02, then I might have chosen more wisely.

Here is the deal:
Smart guy realizes world could care less about anything, therefore, he understands that he should take all that he can.

Dumb guy thinks world cares and desires to make world a better place, therefore, he takes less and believes in greater mission.

End result: world goes to hell, but smart guy has millions and dumb guy has nothing

David Davenport said...

Ah yes, those virtuous smaal, local banks that stayed in touch with their customers:

Three regional banks fail

FDIC says local banks in Maryland, Florida and Utah were closed by financial regulators Friday.

By Ben Rooney, CNNMoney.com staff writer
Last Updated: January 30, 2009: 7:09 PM ET


NEW YORK (CNNMoney.com) -- Three regional banks were closed Friday, bringing the total number of failed banks this month to six, as the financial crisis continues to take a toll on small banks nationwide.

Suburban Federal Savings Bank in Crofton, Md., was closed by the Office of Thrift Supervision. The FDIC said the failed bank's seven offices will reopen on Saturday as branches of Tappahannock, Va.-based Bank of Essex.

The FDIC said it entered a "loss-share" agreement with Bank of Essex, whereby the purchasing bank will share some of the losses associated with certain of the failed bank's "asset pools." The arrangement is intended to maximize returns on the assets by keeping them in the private sector, according to the FDIC.

In Florida, the Office of the Comptroller of the Currency shuttered the four locations of Ocala National Bank and entered into a purchase agreement with CenterState Bank in Winter Haven, Fla.

Ocala National Bank had total assets of $223.5 million and total deposits of $205.2 million, while Suburban Federal had total assets of approximately $360 million and total deposits of $302 million.

Taken together, the two failures will cost the FDIC an estimated $225 million.

Separately, the FDIC said it was unable to find another financial institution to take over the banking operations of Salt Lake City-based MagnetBank, which regulators also closed on Friday. As a result, it expects to mail checks to retail depositors for their insured funds Monday morning.

...

http://money.cnn.com/2009/01/30/news/economy/failed_banks/index.htm?postversion=2009013019

Robert Rubin said...

Our society has devolved into nothing but a trading market and immigrant servicing center. There is nothing left to hold us together as one peoples.

This is fascist crimethink. We do not need to be held together as one people since there is only one race, the human one!

What holds us together as a nation is the proposition that all men are created equal. Anyone who believes this proposition is an American wherever they are, despite your racist hatespeech about "immigrant servicing". Family values don't stop at the Rio Grande.

Here are some other foundational truths regarding our union that it would be good for you to keep in mind:

* Islam is a religion of peace

* Diversity is our greatest strength

* Freedom is slavery

Frankly, your reactionary desire for ein volk and your implicitly anti-semitic attack on the greatest of all conceivable human values, the totally free movement of labor and Capital, make you no better than than a Nazi.

At long last, have you left no sense of decency?

Old Atlantic Lighthouse said...

Push for the return of state banking. A bank has to choose its state. Separate brokerage from investment banking and banking. If they take money from the public, they can't also take money or do services for the corporations. Separate it all. Possibly restrict brokerages to a single state as well.

Mr. Anon said...

"PeterW said...

I would challenge later posters to avoid anti-bank demagaugery and speak only from their knowledge of economics."

I would challenge you, PeterW, to never again express any opinion on any matter of which you do not have direct experience. Got that? Do you have an opinion on global warming, the Kelo decision, 2nd amendment rights? Well, unless your an atmospheric scientist, a scholar of constitutional law, or John Lott, I don't care - sit down and shut the f**k up.

To paraphrase Clemenceau, economics is too important to be left to the economists.

Anonymous said...

"Here is the deal:
Smart guy realizes world could care less about anything, therefore, he understands that he should take all that he can.

Dumb guy thinks world cares and desires to make world a better place, therefore, he takes less and believes in greater mission.

End result: world goes to hell, but smart guy has millions and dumb guy has nothing"

I object to the belief, all too common these days, that a person who ethically chooses to live his/her life ethically is stupider than a person who unethically chooses to do unethical things.