Cronyism, Crony Capitalism, and Shadow Banking (last revised Sept. 18, 2017)
Copyright?2017 Ronald David Greenberg. All rights reserved.
DRAFT
Cronyism, Crony Capitalism, and Shadow Banking
Cronyism
Cronyism is the giving jobs to friends. See, e.g., https://www.merriam-webster.com/dictionary/cronyism (“partiality to cronies especially as evidenced in the appointment of political hangers-on to office without regard to their qualifications”), https://www.collinsdictionary.com/us/dictionary/english/cronyism ("the practice of appointing friends to high-level, esp political, posts regardless of their suitability"); https://dictionary.cambridge.org/us/dictionary/english/cronyism (“the situation in which someone important gives jobs to friends rather than to independent people who have the necessary skills and experience”) (emphasis added).
Crony Capitalism.
Crony capitalism may result in collusion that diminishes the effectiveness of a competitive market. See, e.g., Richard W. Rahn, Crony capitalism against the real thing: Collusion between government and business corrupts the free market, WASHINGTON TIMES (July 24, 2017), https://www.washingtontimes.com/news/2017/jul/24/crony-capitalism-disrupts-the-free-market/ (noting the importance “to distinguish between free-market capitalism and crony capitalism. Crony capitalism exists when politicians and government bureaucrats collude with business people to restrict competition and obtain monopoly advantages.”).
The U.S. banking industry may experience some cronyism vis-à-vis Congress given the relationship, and political power, of the oligopoly of several banks constituting almost a 50% share of market. See, e.g., Jeff Cox, 5 biggest banks now own almost half the industry, CNBC (2:33 PM ET Wed, 15 April 15), https://www.cnbc.com/2015/04/15/5-biggest-banks-now-own-almost-half-the-industry.html. To what extent has the large bank oligopoly influenced Congress with crony capitalism (i.e., largest banks having close relationship with Congress)?
# cronyism
# crony capitalism
Shadow Banking -- Quasi Cronies?
A related issue pertains to so-called shadow banking, where banks are not subject to influence of regulators, but may relate to, and influence, each other to some extent -- like cronies. Many financial institutions that act like banks are not supervised like banks. See, e.g., Laura E. Kodres, What Is Shadow Banking?, IMF (June 2013, Vol. 50, No. 2) (emphasis added), https://www.imf.org/external/pubs/ft/fandd/2013/06/basics.htm:
If it looks like a duck, quacks like a duck, and acts like a duck, then it is a duck—or so the saying goes. But what about an institution that looks like a bank and acts like a bank? Often it is not a bank—it is a shadow bank.
Shadow banking, in fact, symbolizes one of the many failings of the financial system leading up to the global crisis.
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Commercial banks engage in maturity transformation when they use deposits, which are normally short term, to fund loans that are longer term. Shadow banks do something similar. They raise (that is, mostly borrow) short-term funds in the money markets and use those funds to buy assets with longer-term maturities. But because they are not subject to traditional bank regulation, they cannot—as banks can—borrow in an emergency from the Federal Reserve (the U.S. central bank) and do not have traditional depositors whose funds are covered by insurance; they are in the “shadows.”
Home mortgages
Shadow banks first caught the attention of many experts because of their growing role in turning home mortgages into securities. The “securitization chain” started with the origination of a mortgage that then was bought and sold by one or more financial entities until it ended up part of a package of mortgage loans used to back a security that was sold to investors. The value of the security was related to the value of the mortgage loans in the package, and the interest on a mortgage-backed security was paid from the interest and principal homeowners paid on their mortgage loans. Almost every step from creation of the mortgage to sale of the security took place outside the direct view of regulators.
The Financial Stability Board (FSB), an organization of financial and supervisory authorities from major economies and international financial institutions, developed a broader definition of shadow banks that includes all entities outside the regulated banking system that perform the core banking function, credit intermediation (that is, taking money from savers and lending it to borrowers).
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Why there is a problem
As long as investors understand what is going on and such activities do not pose undue risk to the financial system, there is nothing inherently shadowy about obtaining funds from various investors who might want their money back within a short period and investing those funds in assets with longer-term maturities. Problems arose during the recent global financial crisis, however, when investors became skittish about what those longer-term assets were really worth and many decided to withdraw their funds at once. To repay these investors, shadow banks had to sell assets. These “fire sales” generally reduced the value of those assets, forcing other shadow banking entities (and some banks) with similar assets to reduce the value of those assets on their books to reflect the lower market price, creating further uncertainty about their health. At the peak of the crisis, so many investors withdrew or would not roll over (reinvest) their funds that many financial institutions—banks and nonbanks—ran into serious difficulty.
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Authorities engage
The official sector is collecting more and better information and searching for hidden vulnerabilities. Banking supervisors also are examining the exposure of traditional banks to shadow banks and trying to contain it through such avenues as capital and liquidity regulations—because this exposure allowed shadow banks to affect the traditional financial sector and the economy more generally. Moreover, because many shadow banking entities were either lightly regulated or outside the purview of regulators, the authorities are contemplating expanding the scope of information reporting and regulation—of both entities and the markets they use. And the authorities are making sure that all potential shadow banking entities or activities are overseen in a way that discourages shadow banks from tailoring their behavior to come under the supervision of the weakest (or of no) regulators—domestically or globally.
. . . .
Estimating the size of the shadow banking system is particularly difficult because many of its entities do not report to government regulators. The shadow banking system appears to be largest in the United States, but nonbank credit intermediation is present in other countries—and growing.
Shadow banks would seem to have an important role in their increasing influence on the financial system in a market economy. See, e.g., What is the 'Shadow Banking System, INVESTOPEDIA (last visited Sept. 17, 2017), http://www.investopedia.com/terms/s/shadow-banking-system.asp:
A shadow banking system refers to the financial intermediaries involved in facilitating the creation of credit across the global financial system but whose members are not subject to regulatory oversight.
What is a financial intermediary? See, e.g., financial intermediary, INVESTOPEDIA (last visited Sept. 17, 2017) (emphasis added), http://www.investopedia.com/terms/f/financialintermediary.asp:
What is a 'Financial Intermediary'
A financial intermediary is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank , investment banks , mutual funds and pension funds. Financial intermediaries offer a number of benefits to the average consumer, including safety, liquidity, and economies of scale involved in commercial banking, investment banking and asset management. Although in certain areas, such as investing, advances in technology threaten to eliminate the financial intermediary, disintermediation is much less of a threat in other areas of finance, including banking and insurance.
What is a financial system? See, e.g., financial system, INVESTOPEDIA (last visited Sept. 17, 2017) (emphasis added), https://www.investopedia.com/terms/f/financial-system.asp:
What is a 'Financial System'
A financial system is the system that covers financial transactions and the exchange of money between investors, lender and borrowers. A financial system can be defined at the global, regional or firm specific level. Financial systems are made of intricate and complex models that portray financial services, institutions and markets that link depositors with investors.
What is disintermediation? See, e.g., disintermediation, OXFORD DICTIONARIES (last visited Sept. 17, 2017) (emphasis added), https://en.oxforddictionaries.com/definition/disintermediation
Economics
. . . .
Reduction in the use of intermediaries between producers and consumers, for example by investing directly in the securities market rather than through a bank.
What is the role of commercial banks? See, e.g., Andrew Beattie, The Role of Commercial Banks in the Economy, INVESTOPEDIA (last visited Sept. 17, 2017) (emphasis added), https://www.investopedia.com/articles/investing/062513/role-commercial-banks-economy.asp.
In this article, we’ll look at commercial banks . . . [and] what their larger purpose is in the overall economy.
When is a Bank a Commercial Bank?
Between 1933 and 1999, it was fairly easy to tell banks apart thanks to the Glass-Steagall Act. If you helped companies issue shares, you were an investment bank. If you were primarily concerned with deposits and lending, then you were a commercial bank. From the late 1990s onward, however, the ability to enforce Glass-Steagall as a black-and-white rule eroded, and the act was effectively repealed. Since then, the old distinction between a commercial bank and an investment bank is essentially meaningless. For example, as of 2013, JPMorgan Chase Bank is among the largest commercial banks in the U.S. by assets and, in 2012, the same bank was one of the lead underwriters in the Facebook IPO.
More generally, see, e.g., Peter J Boettke, The Battle of Ideas Economics and the Struggle for a Better World, NEW ZEALAND ROUNDTABLE (2007) (emphasis added), at pages 11, 29-30, https://mercatus.org/uploadedFiles/Mercatus/Publications/20070827_boettke.pdf:
In An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith argued that there was a virtuous circle that led to increased prosperity. The source of economic growth and development was the gains from specialisation and trade realised through the greater division of labour and the expansion of the market economy. (at 11)
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Conclusion
The great classical economist John Stuart Mill pointed out that:
Ideas, unless outward circumstances conspire with them, have in general no very rapid or immediate efficacy in human affairs; and the most favourable outward circumstances may pass by, or remain inoperative, for want of ideas suitable to the conjuncture. But when the right circumstances and the right ideas meet, the effective is seldom slow in manifesting itself (2006 [1845], 370). [at 29]
Ideas do ultimately rule the world, as John Maynard Keynes (1936, 383) taught us, but they must conspire with circumstances for their influence to be felt in the world of public policy. Sometimes the changes that result from the conspiracy of economic ideas and political and historical circumstances can be for great good (for example, the alliance of economists and abolitionists in the nineteenth century to eliminate slavery) and at others for great evil (for example, the rise of communism and fascism in the first half of the twentieth century). [at 29]
Economic ideas play a vital role in the struggle to realise a better world. The hope for the twenty-first century, after the bloodshed of the twentieth and the inauspicious beginning of this century in terrorism and militarism, resides in the liberal ideal of a free and prosperous cosmopolitan order. We need an ethic for strangers that transcends national borders, rather than an ethic of geopolitics that rewards allies and aggresses against perceived enemies. The civilising role of commerce and trade, a role recognised by the classics such as Voltaire, Montesquieu, Hume and Smith, must be appreciated once again. [at 29]
The economic advancement of countries is a consequence of realising the gains from trade (associated with the insights of Adam Smith on the division of labour) and the gains from innovation (associated with the insights of Joseph Schumpeter on entrepreneurship and creative destruction). The economic retardation of countries, on the other hand, is a consequence of foolish government policies that hamper exchange relations and curtail creative efforts of individuals. Therefore, the fate of humanity ultimately turns on the outcome of a ‘race’ between Smithian gains from trade, Schumpeterian gains from innovation, and government folly in terms of policies that attempt to thwart exchange and curtail innovation. Rather than thwarting exchange and curtailing innovation, good rules of the game will thwart the predatory proclivities of rentseeking actors and unleash the creative potential of mankind. (at 29-30)
# shadow banking
Crony
A crony seems to used to refer to a close friend, but universally to be informal and derogatory.
See, e.g., crony, MERIAM-WEBSTER (last visited Sept. 18, 2017), https://www.merriam-webster.com/dictionary/crony ("crony: a close friend especially of someone powerful (as a politician)").
See also, e.g. crony, Oxford Dictionaries (2017), https://en.oxforddictionaries.com/definition/crony ("crony noun: informal, derogatory, A close friend or companion."); crony, COLLINS DICTIONARY (2017), https://www.collinsdictionary.com/us/dictionary/english/crony ("You can refer to friends that someone spends a lot of time with as their cronies, especially when you disapprove of them. [informal , disapproval]"); crony, CAMBRIDGE DICTIONARY (last visited Sept. 18, 2017), https://dictionary.cambridge.org/us/dictionary/english/crony , ("a close friend or companion, esp. someone who may not be honest").
Do various economists from different eras, such as, e.g., Stiglitz, Krugman, Samuelson, Summers, Shiller, Friedman, Smith, Keynes, Coase, Hayek, Buchanan, Mill, von Mises, share any degree of commonality (née a quasi-cronies) with Adam Smith? They all are economists of varying stripes, but most of them are not cronies in any strict sense (contemporary friends) except to the extent that they are economists, with each having particular ideas on economics that overlap, more or less. Despite their wide variety of views on economics, they all share an affinity, more or less, with Adam Smith. But to call them cronies would be a disservice.
So what can be said about the relationship between the "too big to fail" banks and Congress? See, e.g., post by ronald david greenberg (April 21, 2011 at 02:25 AM) (emphasis added):
Thanks for the above information. These other measures mentioned above could have had a weighty effect but apparently did not for a combination of reasons mentioned above as well.
I agree, in any event, with Roubini generally, and your comments to my post. A lingering question for me is that competition (with, e.g., all "too big-fail banks" being smaller) coupled with deposit insurance might impart necessary discipline.
And, further, Glass-Steagall should reinstated, in a fairly strong form, with or without covered bonds usage (for all financial institutions) or securitization (for investment banks only, not depositary institutions (banks, credit unions, et al.)).
You appropriated my usual thunder "But what do I know". Economics is not an exact science (like present-day physics (!) with its string and other exotic (?) theories).
Banking is critical to the health and wealth of worldwide society. Dodd-Frank and other measures (e.g., in England) may be effective. In addition I hope that the general tone and culture found in the financial system tends to emphasize its historic (on the whole) honorable, along with its profit, dimension.
Reinstate Glass-Steagall: Roubini says yes, ECONOMIC DREAMS - ECONOMIC NIGHTMARES (May 13, 2010), https://forestpolicy.typepad.com/economics/2010/05/reinstate-glasssteagall-roubini-says-yes.html?cid=6a00d83451b14c69e201538df06712970b#comment-6a00d83451b14c69e201538df06712970b