Wednesday, April 27, 2011

New FDIC Paper on the Resolution of Lehman Brothers

Mike Konczal at Rortybomb has a relatively short summary of a new paper just released by the Federal Deposit Insurance Corporation explaining how the Dodd-Frank financial reforms - had they been in effect in 2008 - would have allowed the FDIC to dismantle Lehman Brothers and salvage the good parts of the company without any cost to the taxpayers and without blowing up the entire world financial system.

Two points I want to make: first, Konczal's short summary provides a good idea of how devilishly complex modern finance has become. Whether the FDIC report mentions it or not, this means that it is extremely important that financial regulators be highly trained to be able to deal with these complexities, and highly paid to diminish as much as possible the temptation to slide through the revolving door to a lucrative position with the industry they were previously regulating. I think a senior financial regulator should be pulling down at least $1 million a year, while being subject to extremely strict, almost onerous, ethical codes and security checks. Why? Because we are going to be depending on these regulators to attack and dismantle the most powerful oligarchical faction that now (mis)rules America, and the rest of the world.

Second, the disastrous results of the (mis)rule by the financial oligarchy can be seen by merely scanning the headlines immediately below on the developing world food crisis, which is almost entirely caused by global misallocations of credit and money to predatory financial activities instead of to productive economic investments in industry, agriculture, mining, transportation, infrastructure, and social programs such as education and welfare. What is singularly missing from Konczal's summary, and I assume the FDIC report, is an understanding that a world past the brink of peak oil and global climate change can no longer afford to have six or seven trillion dollars in hot money every day sloshing around the globe in a search of the "highest investment return." Credit and money are creations of society through the agency of government - even if created by private companies, those companies are created and exist at the sufferance of societies and their governments. If credit and money are being misused, then the physical capacity of society to sustain and support human life eventually erodes until the crisis point of widespread penury and starvation is reached, as evidenced in the stories below. If we took just one day of the world's hot money flows - six or seven trillion dollars - what wonders could be created and deployed to make the world's agriculture not only fully adequate, but entirely sustainable?

Until we get to the point where we apply the normative judgment "Does this help society be more economically productive and fair?" rigorously and ruthlessly to every aspect of our monetary and financial affairs, recurring economic crises are inevitable. We don't need trillions of dollars a day in what are essentially gambling bets on interest rates or currency fluctuations. We need trillions of dollars a day flowing through the hands of scientists, engineers, and producers seeking to solve our urgent real problems such as sustainable energy and food production and distribution.
The New FDIC Paper on the Resolution of Lehman Brothers

On April 18th, the FDIC released a paper, The Orderly Liquidation of Lehman Brothers Holdings under the Dodd-Frank Act, which explains how it could have used the resolution authority in Title II of Dodd-Frank to taken down Lehman Brothers with no losses to taxpayers and without collapsing the financial system.

It’s always good to remind ourselves what we want our law to do in terms of failure. Failure is a legal concept, and our laws reflect our values on how we want failure to proceed. We want those who benefit the most from risks to take the largest losses. We want to preserve the ongoing value of the firm if there is any. We want to coordinate the behavior of creditors – so value is based on legal rights, not the speed of action – and ameliorate the hardships caused to debtors and provide a fresh start to the entity.

The bailouts shredded these values – those who took the biggest risks also got huge upsides. Creditors were rewarded in all kinds of ways that were unfair. The firms weren’t stripped down to the core ongoing value but instead left with all kinds of bad zombie debts that needed to be recapitalized through earnings and squeezing consumers. We need better laws capable of handling failures of things we hadn’t traditionally expected to fail in a spectacular way, and the FDIC is arguing that Dodd-Frank gets us a lot of the way there. How does it do that?

Read more.

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