A Fed official on the need for "post-crisis" reform

From the speech entitled Financial Reform: Post Crisis? by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City

In the United States, we observe with each crisis and market collapse that policymakers consistently intervene to protect an ever broader group of creditors and investors from loss. This includes the LDC debt crisis, the failure of Continental Illinois, and the thrift industry and stock market collapses of the 1980s. These previous public interventions, though, pale in comparison to what was done recently. Market participants and large financial institutions have little reason to doubt that they will be bailed out again.

Let me offer just one staggering example. When Gramm-Leach-Bliley was passed in 1999, the five largest U.S. banking organizations controlled $2.3 trillion in assets, or about 38 percent of all banking industry assets. Currently, Bank of America by itself and in spite of its need for government support during the crisis has the same level of assets – $2.3 trillion – as the top five did in 1999 and the top five now have 52 percent of all banking industry assets. What clearer sign could we find that market discipline no longer exists?

Past actions and this growth have given our largest organizations significant competitive advantages over other financial institutions. For example, creditors and uninsured depositors at too-big-to-fail organizations believe that there is almost no chance that they will have to take a loss. This idea is formally acknowledged by the credit rating agencies when they give these organizations separate “support” and “standalone” ratings, which explicitly factor in the government support they likely will receive. The difference in these two ratings thus provides one measure of the funding advantages that too-big-to-fail organizations have over others.

Haldane estimated that this funding advantage amounted to about $250 billion in 2009 for 28 of the largest banks in the world. At the Federal Reserve Bank of Kansas City, we estimated the ratings and funding advantage for the five largest U.S. banking organizations during this crisis. In June 2009, these organizations had senior, long-term bank debt that was rated four notches higher on average than it would have been based on just the actual condition of the banks, with one bank given an eight notch upgrade for being too big to fail. Looking at the yield curve, this four-notch advantage translates into more than a 160 basis point savings for debt with two years to maturity and over 360 basis points at seven years to maturity.

In a competitive marketplace, where just a few basis points make a difference, these funding advantages are huge and represent a highly distorting influence within financial markets. I’ll name three. They don’t have to sell creditors on the strength of their condition. They have significant advantages in competing for funds. And, they have significant incentives to take on more risk, hold less capital, and book more assets.

Of course, the salient fact that Hoenig leaves out of the equation is that between 40 and 45% of those trillions in big bank assets are worthless, according to my calculations. Which is why more government support will almost certainly be required in order to keep the “too big to fail” banks from failing.

No deal

Even the editors at NRO can’t stomach the ludicrous no-cuts deal that Boehner is attempting to strike with the Senate and White House:

We initially supported the deal House Speaker John Boehner cut with the White House to cut $38.5 billion from the rest of the fiscal year 2011 budget. It was only a pittance in the context of all of Washington’s red ink, but it seemed an acceptable start, even if we assumed it would be imperfect in its details. What we didn’t assume was that the agreement would be shot through with gimmicks and one-time savings. What had looked in its broad outlines like a modest success now looks like a sodden disappointment….

As they push a bargain that is still not fully understood, Boehner and the leadership have put their members in an awful fix with another deadline to keep the government open fast approaching. We’d vote “no,” even if we understand the impulse to move on to more important matters and to avoid a leap into the dark that might include a politically damaging shutdown. At the very least, freshmen and other conservatives should be frank about the deal’s shortcomings, refusing to exaggerate its merits as their leadership often has. The episode is strike one against the speakership of John Boehner.

I think it was fairly obvious from the start that Boehner was a fraud, his tears and odes to the Tea Party notwithstanding. I have very little confidence that he will stand up and refuse to raise the debt ceiling next month either, which would explain Treasury Secretary Geithner’s apparent confidence that he will soon have more money to spend.

The problem with the NRO perspective is that the advertised $38.5 billion deal wasn’t any more financially serious than its $300 million revised version, it merely provided better window dressing for the House Republicans. But as Republican cheerleaders, the NRO editors have real cause to be concerned because Boehner’s actions are all but guaranteeing some sort of third party challenge to the Republicans in 2012 and 2014.

New wars, old strategies

Admiral Mahan on the best use of “the fleet in being”:

For the reasons that have been given, the safest, though not the most effective, disposition of an inferior “fleet in being” is to lock it up in an impregnable port or ports, imposing upon the enemy the intense and continuous strain of watchfulness against escape. This it was that Torrington, the author of the phrase, proposed for the time to do. Thus it was that Napoleon, to some extent before Trafalgar, but afterward with set and exclusive purpose, used the French Navy, which he was continually augmenting, and yet never, to the end of his reign, permitted again to undertake any serious expedition. The mere maintenance of several formidable detachments, in apparent readiness, from the Scheldt round to Toulon, presented to the British so many possibilities of mischief that they were compelled to keep constantly before each of the French ports a force superior to that within, entailing an expense and an anxiety by which the Emperor hoped to exhaust their endurance.
– Mahan, Lessons of the War with Spain

This strategy of “the fleet in being” is very similar to the strategy that has been utilized by the global jihad for the last decade. Since the danger posed by its “army in being” is most threatening so long as it remains largely hypothetical, there is little advantage for the jihad in directly engaging Western forces. It’s far more effective to stretch out the Western militaries then bleed them in as many different locations as possible. The Western divisions are like battleships, capable of crushing the mobile torpedo boats of the enemy any time they can bring them to bear, but seldom presented with the opportunity of doing so. It is the most sophisticated expression yet of what VDH describes as the Eastern way of war.

Due to the geographical extent of the conflict and the extremely limited amount of information involved, the ongoing war between the Islamic jihad and the nations of the West is strategically more akin to naval war taking place in the Age of Sail or the Age of Steam than any ground war from any period in history.

Mahan notes “it is evident that the active use of a “fleet in being,” however perplexing to the enemy, must be both anxious and precarious to its own commander. The contest is one of strategic wits”. Therefore, to defeat the jihad, contain its expansion, and return the Dar al-Islam to its previously quiescent state, it will be necessary to force it to reveal its forces and put them in the field. How this can best be done is a matter for strategic and tactical consideration, but it seems obvious that it cannot happen so long as an official policy of secular tolerance is in place throughout the West. And, of course, one is hesitant to have much confidence in a contest of strategic wits with the likes of CINC Obama and General Petraeus providing what passes for the wits.

In other words, this means that widespread ethnic and religious violence is almost certainly inevitable in the intermediate future. The recent ban of the burqah in France and the law against future minaret construction in Switzerland may be the first indications of an eventual European Reconquesta. Unfortunately, at this point, the two most probable outcomes would appear to be either a) secular submission to Islam or b) ethnic cleansing on a scale dwarfing that of any previously known to history. Both appear unthinkable now, and yet it is not difficult to see that the demographics dictate that one or the other will eventually come about. Either way, the multiculturalists and immigrationists are almost certain to be burdened with a historical legacy so terrible as to make the likes of Viktor Quisling and Neville Chamberlain appear national heroes by comparison.