I recently had a lunch conversation with Arianna that was mostly about ethics; so I suddenly felt ashamed of not having publicly denounced what appears to be a blatant generator of moral hazard. As someone who claims to be as independent as one can possibly be, with nothing to lose, and fear of nobody (except my mother's occasional reprimands), I am even more obligated than anyone else to expose hidden scams.
The story is as follows. Last year, in Davos, during a private coffee conversation that I thought aimed at saving the world from, among other things, moral hazard, I was interrupted by Alan Blinder, a former Vice Chairman of the Federal Reserve Bank of the United States, who tried to sell me a peculiar investment product. It allowed the high net-worth investor to go around the regulations limiting deposit insurance (at the time, $100,000) and benefit from coverage for near unlimited amounts. The investor would deposit funds in any amount and Prof. Blinder's company would break it up in smaller accounts and invest in banks, thus escaping the limit; it would look like a single account but would be insured in full. In other words, it would allow the super-rich to scam taxpayers by getting free government sponsored insurance. Yes, scam taxpayers. Legally. With the help of former civil servants who have an insider edge.
I blurted out: "isn't this unethical?" I was told in response, "We have plenty of former regulators on the staff," implying that what was legal was ethical.
It has taken me so long (18 months) to react to the event partly because Prof. Blinder is scholarly, gentle in manners, the kind of likable person with whom I would have an intellectual conversation on occasion. In addition, having spent the last few years immersed in the classics, a certain sense of grandeur (from which I am looking for a cure) inhibited me from the reporting of journalistic anecdotes -- Alan Blinder is certainly not the worst violation of my sense of ethics; he probably irritated me because of the prominence of his previous public position and due to the context of the Davos conversation, which was meant to save the world. But I have to transcend my human proclivities and swallow my sense of grandeur: someone used public office to, at some point, legally profit from the public.
Tell me if you understand the problem in its full simplicity: former regulators and public officials who were employed by the citizens to represent their best interests can use the expertise and contacts acquired on the job to benefit from glitches in the system upon joining private employment -- law firms, etc.
Think about it a bit further: the more complex the regulation, the more bureaucratic the network, the more a regulator who knows the loops and glitches would benefit from it later, as his regulator edge would be a convex function of his differential knowledge. This is a franchise. (Note that this franchise is not limited to finance; the car company Toyota hired former U.S. regulators and used their "expertise" to handle investigations of its car defects).
I have several remarks.
First, the more complicated the regulation, the more prone to arbitrages by insiders. So 2,300 pages of regulation will be a gold mine for former regulators. The incentive of a regulator is to have complex regulation.
Second, the difference between letter and spirit of regulation is harder to detect in a complex system. The point is technical, but complex environments with nonlinearities are easier to game than linear ones with a small number of variables. The same applies to the gap between legal and ethical.
Third, regulation, like drugs, has side effects, and like drugs, it can harm the patient -- something in my work I call the iatrogenics (harm done by the healer). People do not mention that regulation helped promote the Value-at-Risk method of risk measurement in replacement to age-tested heuristics -- these methods blew up banks.
Fourth, we need a more severe monitoring of the activities of public officials and a solution to the following conflict. In African countries, government officials get explicit bribes. In the United States they have the implicit, never mentioned, promise to go work for a bank at a later date with a sinecure offering, say $5 million a year, if they are seen favorably by the industry. And the "regulations" of such activities are easily skirted.
Fifth, and more philosophically: during the lunch with Arianna, the conversation kept sliding into the ethical basin of attraction, the compatibility of some professions and service of the public. The Greeks had respect for the banausoi, those who had to make a living in the professions, but many argued against trusting them in running the affairs of the city on grounds that "a funeral goods merchant would not be trusted to wish for the good health of his fellow citizens." The point has been debated through the ages, from Xenophon to Seneca (who took the opposing point), but it is even starker today in the age of lobbyists and a shift in middle class values that tolerates the "everyone needs to make a living" even when the means to "make a living" are harmful to society.
These accumulated moral hazards have blown up banks and will keep blowing up the system.
In an antique city state, or a modern municipality, shame is the penalty for the violation of ethics; in larger organisms like the mega Nation-State, with a smaller role for face to face encounters, shame ceases to play its duties of disciplinarian. We need to re-establish it. (This is one of the causes of the fragility of the nation state).
Cleon, the hero of the Peloponnesian war, advocated the public renouncement of friends upon dealing with public affairs -- he paid for it with some revilement by historians. Sorry, Alan Blinder, you are a nice guy, but I have duties.
P.S. Why is this on the Huffington Post and not the New York Times? This is part of a broader discussion of journalistic ethics to come later.
Greed is a bigger problem though ethics is a close second in my book.
http://www.nakedcapitalism.com/2010/08/taleb-calls-out-alan-blinder-for-questionable-ethics.html
You are a perfect example of what Taleb is talking about: The rich learn how to disproportionately benefit from a loophole, then they begin to think they are entitled to it.
Limits are for the small people, right OTOH?
This is exactly what the average American has been saying since 2008.
Where are the prosecutions? Where are the police? Where are the jail sentences? Who will rid us of the criminals in the highest places?
Set an example, for pity's sake, someone.
cool your jets. There is nothing illegal or unethical about this practice. Nassim is like the foreigner who went to one of these smogusboards up in Wisconsin . . . and when he saw people getting up to fill their plates a second and third time (they're big eaters) he thought it was unethical and when he related the story some people concluded that it was illegal. The truth of the matter is that you can have deposits in 100 separate banks, and in each case to the max, and if all 100 banks fail you get the whole ball of wax and all you have to do is present id. It is really that simple.
1. Deposit the excess overseas.
2. Put the money under his mattress.
Neither of those two options does anybody else in the U.S. any good. The other options:
3. Buy physical gold, art, collectibles.
4. Buy real estate.
5. Buy stocks and bonds.
These all suffer from illiquidity, currently or potentially (and some are of very limited benefit to the economy).
Deposits in bank accounts are among the least lucrative investments, but conversely they produce some of the largest public benefits. Therefore the FDIC's insurance is there to encourage that behavior. Those who spread their deposits among institutions in order to take advantage of the FDIC insurance do no wrong, what they are doing is furnishing needed liquidity to banking institutions--the returns to them are more modest than they might expect from other investment options, but the safety is greater.
Even the supposed evil of "brokered deposits" is overblown, so long as a bank is not excessively dependent on them, and we depend on regulators to do their work in examining banks and determining whether their dependence on such deposits is excessive.
You must have us mixed up with someone who actually liked that slimey dick, Cheney and his Haliburton ways. If leftists are upset about anything it's that the criminal cabal of the prior administration is not prosecuted.
It's know in the Investment community as Brokered CD's
I also challenge people to define "rich". Clearly, a person making $200 - $500k a year is not going to be able to play all these loop-hole games, but let's address the Warren Buffets, et al who pay less % in taxes than their executive administrative assistant!!!
As for the revolving door regulation experts, it's all a matter of semantics and euphemism. One person's bribes is another person's political donations or great job.
Quite awhile ago, Chicago's Aldermen in a great sense of moral and ethical certitude passed a law that they could not hire their family members for (bogus) jobs, but saw nothing wrong in hiring each others relatives.
The FDIC insurance premium is paid by every bank on the basis of their deposits. Banks are chosen by Americans for many reasons--those with significant funds are well advised to either split up their deposits or pay exceptional attention to the strength and diversification of their banks' loan portfolios.
But to suggest that there is any ethical component to what is surely merely an issue of convenience is to waste moral umbrage on something that makes no sense. The FDIC limit applies to banks, not to depositors.
Up to and after the failure of the FSLIC in the early 90s, there was this notion of brokered deposits. Along with "supply-side" economics brokers like Merrill Lynch would broker certificates of deposit to savings and loans that were willing to pay the highest rates. There was no "risk" up to 100000 because of deposit insurance. One of the great masters of this phenom was Donald Regan(of Merrill Lynch) who was sec of treas and chief of staff for no less a phenom than the Gipper himself. Well.... as it turns out, many a failed savings and loan in the late 80's received a daily transfer of liquid cash via (supply side) brokered deposits from Merrill Lynch et al at the highest rate imaginable all insured by the government. Had they not received this transfusion of cash they would die the death of illiquidity. In hindsight, the insanity of all of this is quite clear. Failed savings and loans would receive brokered deposits by Merrill lynch paying the highest rates. Merrill and their customers loved this. No risk until the bernie madoff "bell" rang and then the phenomonon of the "china-syndrome" would toll on the taxpayer $250 billion. The insanity continues.
If you were a student of history or of finance you'd realize that deposit insurance is not really intended for the Blinder group or any single depositor. It is to prevent "runs" on banks by depositors who think their deposit may be at risk in case the bank were to fail.
Imagine for a second that you had one million dollars to deposit and that deposit insurance were $100000 per depositor. You would walk around the city and deposit $100000 in ten separate banks and your one million would be protected. Instead of you walking around the city and wasting the shoe leather plus the erst-while value of your time, you could have the Blinder group take care of this.
There is a larger point you miss: Deposit insurance is socialism that denys the market system the ability to define the risk of a failing bank by preempting deposit runs due to the "social" (as in socialism) net of safety provided by the government. It would work much better (assuming we were a free enterprise capitalist system) if the deposit was insured only at 85% of deposit amount up to 100000 deposit. Then watch the big boys scream with indignation!!! (even though the big boys love the braggadocio of capitalismic free enterprise)
The program you are referring to is the Certificate of Account Registry Service or CDARS. The program is far from a "scam" on taxpayers. It is incredibly beneficial for the banking system and the economy as a whole. CDARS distribute funds that would otherwise find their way into Too Big to Fail banks and distributes them to small community banks throughout the country. Yes, they are FDIC-insured, but the banks PAY premiums to the FDIC for that insurance.
The "scam" being perpetrated is by the TBTF banks who pay a pittance for deposits that are de-facto "insured" via taxpayer-funded bailouts.