Streetwise Professor

August 24, 2011

That’s Crazy Talk

Filed under: Economics,Financial Crisis II,Politics,Regulation — The Professor @ 12:42 pm

There are rumors flying around–all adamantly denied–that JP Morgan Chase will acquire tottering Bank of America.  In my opinion, that’s crazy talk.  It’s crazy because JPM has to be smarter than to buy a toxic loan dumping ground and lawsuit magnet.  (There’s a joke going around: “Will the last person to sue Bank of America turn out the lights?”)

The only way it would not be crazy in the sense of it might actually happen is that another shotgun marriage is being arranged, with Uncle Sam at the trigger.  I can see that.  This is a tried and true regulatory game.  It happened in 2008: Bear (with JPM), Merrill (BAC), Lehman (with Barclays, ultimately aborted).  It happened during the S&L Crisis.  Regulators like this because offering financial support to dodgy banks through the front door is politically radioactive, and that’s especially true now.   Mashing together a (relatively) healthy bank and a very unhealthy one kicks the problem into the future, and miracles–including resurrection–can happen in the future, dontcha know.  Moreover, regulators can reduce the risk of leaving fingerprints if they do it this way.  If it turns out bad, it looks like the dealmakers made the mistake (witness BAC’s Ken Lewis).

But it would still be crazy in the sense of economic irrationality.  The first order problem that needs to be addressed right now is rightsizing banks, not creating fewer, bigger ones.   Moreover, the analogy that I made with respect to Europe–amputation vs. gangrene–works here too.  Grafting the definitely gangrenous Bank of America on top of the still healthy (in comparison to its peers around the world) JP Morgan would extend the rot far more directly than would be possible along the normal inter-bank connections.  It would be better to ringfence, isolate, quarantine Bank of America and deal with the problem straight up (like the Swedes did in the early-90s, or the Resolution Trust Corporation did with S&Ls in the same time frame).  But that would be politically parlous, which means that the sensible thing might not happen.

I believe–and hope–that this rumor is only that, the product of heated imaginations dealing with possible resolutions of BAC.  If it isn’t, if there is there there, be afraid.  Be very afraid.  Because it will mean that things are very bad indeed, and that the political and regulatory will does not exist to deal with the problem in a rational, hardheaded way.

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  1. I don’t think the regulators would feel warm and fuzzy about further concentrating deposit risk. The combined entity would have something like 20% of demand deposits, right? I can’t imagine that would happen.

    Comment by BRM3 — August 24, 2011 @ 1:58 pm

  2. I don’t think they would like it, except compared to other alternatives . . . e.g., direct support to BAC. To the regulators it could be like Churchill said of democracy, the worst way to resolve a tottering bank, except for all the others that have been tried from time to time.

    The ProfessorComment by The Professor — August 24, 2011 @ 2:02 pm

  3. Corporatism is as corporatism does. Don’t bash zombie capitalism SWP or you’ll be tased by Big Sis’s unmanned helo-zapper.

    Comment by Mr. X — August 24, 2011 @ 11:58 pm

  4. @Streetwiseprofessor – Ah but you were forgetting the other banking investor of last resort – Buffett, who always gets a great deal from these situations.

    See and for details.

    Comment by John Wilson — August 25, 2011 @ 10:39 am

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