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“Risky Business”: Brinksmanship And The Return Of Financial Crisis

A government shutdown once again loomed, and familiar deadlines and ultimatums flew around Washington. And Congress just used the threat to loosen the rules created in the wake of the financial crisis, a victory for Wall Street banks in their constant and well-funded campaign against reform.

The rules they have targeted are designed to reduce the risk of another financial meltdown, like the one that drove us into the Great Recession and could have been much worse. Though the repeal has been styled by some as a technical amendment, nothing could be farther from the truth.

Think about the best way to decide legislative policy in the devilishly complex and risk-laden area of derivatives. These are the financial contracts that brought down AIG, the event that triggered the crisis. You might imagine careful deliberation and debate, leading to a thoughtful vote in Congress in which elected representatives must stand up and be counted so that they could be held responsible for a difficult decision.

Of course, that is not how the House of Representatives works, especially not the current lame duck version. A 1,600 page Omnibus Spending Bill appeared Tuesday night and passed the House late on Thursday night. We have become familiar with these spending bills that have replaced reasoned budgeting and serially risk shutdowns just so the administration can be bullied every few months.

This time around, House sponsors attached a provision amending the Dodd-Frank financial reform law. They did this in the dead of night and at the last minute. Lobbyists, who are paid to make certain that the banks can continue to do as much risky business as possible despite the new regulatory regime, pushed to have a provision repealing the “swaps push-out” section of Dodd-Frank slipped into the spending bill so that any resistance to the repeal would risk another shutdown. Citigroup lobbyists wrote 70 out of 85 lines of the original bill.

That’s Washington style representative democracy for you.

The swaps push-out provision requires banks to transact their swaps business in separate subsidiaries. The concept is that any bank swaps business should be done outside the bank itself, which is backed by FDIC deposit insurance and the many supports provided by the Federal Reserve.

Swaps are complex derivatives contracts requiring payments in the future that change as markets prices for stocks, bonds, oil and many other traded assets change. Thus, they create large and volatile financial obligations going back and forth between a bank and its contract “counterparty,” either a company (like AIG), a government or another bank.

Counterparties to the banks who rely on the banks’ performance of its obligations can rely on these federal supports and can assume that the government will step in if a problem occurs. This can embroil the government in any bank default making a bailout more likely, good news for bank creditors like the swap counterparties. To avoid this, the swaps push-out requires a separate corporation, not entitled to the federal supports, to create a firewall, insulating taxpayers from the riskiest trading.

Though swaps were regulated in Dodd-Frank, there were plenty of loopholes, so a great deal of that business will go forward just as before. The swaps push-out section now under threat was already watered down in the original Dodd-Frank deliberations. Nonetheless, it still provides important protection. With swaps push-out, there’s some possibility that the federal government wouldn’t be dragged into a bank default because of the bank safety net.

But members of Congress, urged on by big money from Wall Street, decided that this sensible buffer between casino-like derivatives trading and the American taxpayer was such a bad idea that it had to be discarded through surreptitious and disguised means.

The banks have been out to kill the swaps push-out from the beginning. That makes sense for them since the capital needed to back a subsidiary would cost them more than their basic capital. Banks can raise general capital cheaply since investors have learned that failure is not a concern for banks that are too-big-to-fail. Capital funding for a subsidiary that is separated from this safety net is more costly because a bail out is less likely.

The banks also got some of their customers who often enter into swaps with the banks to urge repeal. The customers complained that their swaps would cost more. Of course they would, since the bank subsidiary’s capital backing the swaps would cost more. But the customers, as contract counterparties, have been relying on the too-big-to-fail safety net. Like investors in the banks, these customers simply should not benefit from a pipeline to the American taxpayers. Any additional cost is an element of elimination of that benefit, nothing more.

In Washington, banks have been allowed to set the terms of the regulatory debate. The financial crisis provides many lessons, but one of its central was that allowing banks free reign leads to disastrous results for all Americans. Six years after the onset of the financial crisis, it’s too soon to forget that lesson and revive too-big-to-fail.

 

By: Wallace Turbeville, The American Prospect, December 12, 2014

December 14, 2014 Posted by | Big Banks, Congress, Omnibus Spending Bill | , , , , , , , | Leave a comment

“A New Day For Liberals”: What We Learned In The Epic Clash Over The Spending Bill

The House passage of the omnibus spending act is on its face a defeat for the progressive wing of the Democratic Party that fought to block it. In the end, though, risking a government shutdown over the bill’s ugliest provisions – restoring government protection to risky bank maneuvers and raising the cap on party contributions, astronomically – was probably too much to expect. According to Greg Sargent, Dem sources say that while House Minority Leader Nancy Pelosi fought it ferociously, in the end she signaled that members could vote their conscience.

And what did that vote tell us about the Democratic Party? Most of the departing Blue Dogs who lost their seats voted for the bill, predictably. In a break with President Obama, who lobbied for it, most of the Congressional Black Caucus did not. The remaining House Democrats are going to be more reliably critical of Wall Street, and less inclined to bow to the White House. 2015 is going to be interesting.

I admit, for a few hours on Thursday I thought Democrats might be able to win the public relations battle if they blocked the bill. Why should taxpayers protect risk-taking banks? The story of how Citigroup wrote the provision, and Wall Street’s friends snuck it in, is so outrageous I thought it had a chance to carry the day. So Republicans wouldn’t pass a spending bill without this giveaway to Wall Street? That would make them responsible for a government shutdown. But Sen. Ted Cruz and his allies may have thought the same thing about their message when they shut down the government last year.

We’ll never know if Democrats could have mustered populist outrage over Washington catering to Wall Street in the event of a new shutdown. But what else did we learn from the battle?

We now know that Nancy Pelosi is through guaranteeing the votes for ugly messes liberals hate (like the debt ceiling and sequester deals) but that House Speaker John Boehner can’t pass alone. In a new Congress where many Blue Dogs lost their seats, this sets the stage for House Democrats to block elements of the GOP agenda, especially when there can be left-right alliances.  Tea Party defenders say it was partly inspired by outrage at the 2008 Wall Street bailout and corporate-government cronyism; it would be nice if House adherents remembered those roots.

We also know that Elizabeth Warren wasn’t tamed by her ascent into Senate Democratic leadership; she was emboldened. While her star turn may increase the pressure on her to run for president, I’m with Elias Isquith here: I still hope she doesn’t. A President Warren would lack a Sen. Warren protecting her left flank. Giving Warren more progressive Senate allies would be more politically productive than elevating her to the White House.

We’re also seeing a more clearly defined bloc of Wall Street critics emerge in the Democratic Party, just in time for 2016. The Warren-led battle over Treasury nominee Antonio Weiss is also heating up – and both fights pit the popular progressive against President Obama.

Many news accounts have depicted the spending bill battle as Warren vs. Obama, setting up an ongoing clash between the two Democratic leaders. But I think the Warren vs. Obama story line can be overblown. It’s probably too much to expect the president to veto the spending bill and effectively shut down the government – clearly he doesn’t share my optimism that Democrats could win that P.R. battle.  But if the noxious measures hidden in the bill came to him as individual pieces of legislation, he’d be under a new level of pressure from congressional Democrats to veto them, and I expect he would. Obama made clear that while he wanted Democrats to support the spending bill he shared their opposition to both provisions.

In fact, the next two years will be a test of who the president really is: the change agent who inspired progressives, or the guardian of Wall Street power that his left-wing detractors claim he is. Bloomberg’s Dave Weigel makes the case that Warren, rather than being an Obama opponent, could be the best protector of his legacy that the president has. We’ll see.

 

By: Joan Walsh, Editor at Large, Salon, December 12, 2014

December 13, 2014 Posted by | Big Banks, Democrats, Federal Budget | , , , , , , , | Leave a comment

“Relentless Wal Street Crime Spree”: Fines Are Not Adequate Deterrents To Corporate Misbehavior

When future historians look back at our era, they will doubtless be puzzled about how we allowed it to come to pass that faceless corporations were granted all the freedoms and protections of real people, but faced none of the consequences that real people face for criminal behavior. This puzzle is related to the problem I wrote about earlier this morning, in which social problems for normal people are solved with fines and jail time, but social problems caused by corporate “citizens” are given market solutions and self-regulation instead.

The latest case in point comes as six major banks guilty of manipulating currency markets were given the laughably small fine of $4.3 billion, and not a single one of the actual perpetrators is coming close to facing jail time.

On Wednesday, six massive international banks agreed to pay $4.3 billion to settle allegations from regulators in the United States, the United Kingdom, and Switzerland that their traders tried to manipulate the $5.3-trillion-a-day foreign-currency exchange market. But Wall Street watchdogs say the banks got off with a slap on the wrist.

From 2008 through 2013, traders at JPMorgan Chase, Bank of America, Citigroup, HSBC, the Royal Bank of Scotland, and UBS colluded to coordinate the buying and selling of 10 major currencies to manipulate prices in their favor….

In the real world, the crime spree being perpetrated by global corporations, particularly those in the financial sector, will never abate until the criminals perpetrating them are actually thrown in jail.

But critics say the banks, which were not forced to admit wrongdoing, deserved a much harsher punishment. “The global too-big-to-fail banks are again allowed to evade responsibility and accountability by using shareholders’ money to pay big fines, which will generate headlines but do little if anything to stop the relentless Wall Street crime spree,” Dennis Kelleher, the president of Better Markets, a financial reform advocacy shop, responded in a statement.

David Weidner, who covers Wall Street for MarketWatch, agrees. The settlements “appear to be just another cost-of-doing-business budget line for the banks,” he wrote. What’s more, financial reformers say, none of the employees involved in the rate-fixing will face criminal charges. “It’s corrupt, as usual,” says one House staffer. Regulators should “send crooks to jail.”

Fines are utterly inadequate to deter this sort of behavior. We understand this implicitly when it comes to check kiters and liquor store robbers. If you’re convicted of those things you go to jail. But if you collude to debase another country’s entire currency for your own profit, your company pays a small fine.

That’s going to look very weird and very corrupt in about 100 years. Or else it won’t–in which good luck to us all.

 

By: David Atkins, Political Animal, The Washington Monthly, November 15, 2014

November 19, 2014 Posted by | Big Banks, Corporations, Wall Street | , , , , , , | Leave a comment

“Obama’s Other Success”: Dodd-Frank Financial Reform Is Working

Although the enemies of health reform will never admit it, the Affordable Care Act is looking more and more like a big success. Costs are coming in below predictions, while the number of uninsured Americans is dropping fast, especially in states that haven’t tried to sabotage the program. Obamacare is working.

But what about the administration’s other big push, financial reform? The Dodd-Frank reform bill has, if anything, received even worse press than Obamacare, derided by the right as anti-business and by the left as hopelessly inadequate. And like Obamacare, it’s certainly not the reform you would have devised in the absence of political constraints.

But also like Obamacare, financial reform is working a lot better than anyone listening to the news media would imagine. Let’s talk, in particular, about two important pieces of Dodd-Frank: creation of an agency protecting consumers from misleading or fraudulent financial sales pitches, and efforts to end “too big to fail.”

The decision to create a Consumer Financial Protection Bureau shouldn’t have been controversial, given what happened during the housing boom. As Edward M. Gramlich, a Federal Reserve official who warned prophetically of problems in subprime lending, asked, “Why are the most risky loan products sold to the least sophisticated borrowers?” He went on, “The question answers itself — the least sophisticated borrowers are probably duped into taking these products.” The need for more protection was obvious.

Of course, that obvious need didn’t stop the U.S. Chamber of Commerce, financial industry lobbyists and conservative groups from going all out in an effort to prevent the bureau’s creation or at least stop it from doing its job, spending more than $1.3 billion in the process. Republicans in Congress dutifully served the industry’s interests, notably by trying to prevent President Obama from appointing a permanent director. And the question was whether all that opposition would hobble the new bureau and make it ineffective.

At this point, however, all accounts indicate that the bureau is in fact doing its job, and well — well enough to inspire continuing fury among bankers and their political allies. A recent case in point: The bureau is cracking down on billions in excessive overdraft fees.

Better consumer protection means fewer bad loans, and therefore a reduced risk of financial crisis. But what happens if a crisis occurs anyway?

The answer is that, as in 2008, the government will step in to keep the financial system functioning; nobody wants to take the risk of repeating the Great Depression.

But how do you rescue the banking system without rewarding bad behavior? In particular, rescues in times of crisis can give large financial players an unfair advantage: They can borrow cheaply in normal times, because everyone knows that they are “too big to fail” and will be bailed out if things go wrong.

The answer is that the government should seize troubled institutions when it bails them out, so that they can be kept running without rewarding stockholders or bondholders who don’t need rescue. In 2008 and 2009, however, it wasn’t clear that the Treasury Department had the necessary legal authority to do that. So Dodd-Frank filled that gap, giving regulators Ordinary Liquidation Authority, also known as resolution authority, so that in the next crisis we can save “systemically important” banks and other institutions without bailing out the bankers.

Bankers, of course, hate this idea; and Republican leaders like Mitch McConnell tried to help their friends with the Orwellian claim that resolution authority was actually a gift to Wall Street, a form of corporate welfare, because it would grease the skids for future bailouts.

But Wall Street knew better. As Mike Konczal of the Roosevelt Institute points out, if being labeled systemically important were actually corporate welfare, institutions would welcome the designation; in fact, they have fought it tooth and nail. And a new study from the Government Accountability Office shows that while large banks were able to borrow more cheaply than small banks before financial reform passed, that advantage has now essentially disappeared. To some extent this may reflect generally calmer markets, but the study nonetheless suggests that reform has done at least part of what it was supposed to do.

Did reform go far enough? No. In particular, while banks are being forced to hold more capital, a key force for stability, they really should be holding much more. But Wall Street and its allies wouldn’t be screaming so loudly, and spending so much money in an effort to gut the law, if it weren’t an important step in the right direction. For all its limitations, financial reform is a success story.

 

By: Paul Krugman, Op-Ed Columnist, The New York Times, August 3, 2014

August 4, 2014 Posted by | Big Banks, Dodd-Frank, Financial Reform | , , , , , , | Leave a comment

“Keeping Regulation At Bay”: One More Step Toward The Next Meltdown

The delaying tactics we told you about nearly two years ago have worked beautifully. The bailout worked (if not for homeowners, at least for the banks). It worked so well that the underlying problems that led to the financial crisis have remained largely ignored.

The regulations that have been written (and continue to languish during their extended comment period) are on their way to being eliminated or weakened yet again by Congress. The House helped out this week by passing a bill (HR 4413) that ensures that if any regulations do get approved, they will be difficult to enforce.

As we reported back in 2012, JPMorgan Chase in London managed to avoid examination and enforcement by the Commodities Futures Trading Commission simply by labeling their massive speculation in credit default swaps as “portfolio hedging.” It was a loophole big enough for a whale to swim through.

Another loophole made enormous by HR 4413 is the cutoff separating “end users” from “swap dealers.” In the CFTC draft regulations written after Dodd-Frank initiated oversight on the swap business, any market player with more than $100 million in swaps per year was considered a dealer, and subject to stricter oversight and capital requirements.

After the industry complained, the CFTC agreed to delay that stronger oversight for two years and put in a temporary $8 billion cap that was due to drop to $100 million later this year. The bill that passed the House makes that $8 billion cap permanent. Now any firm that wants to do $100 billion in business without regulation has the option to create 13 separate companies.

From the point of view of the people who profit from the lack of regulation, streamlining the lack of oversight is financially sound. After all, real estate values in waterfront Greenwich estates, the Hamptons, and even Park Avenue will likely suffer if bankers and hedge fund managers make less money.

For those who trade in opaque markets, profits are maximized when some participants have information that their customers and competitors don’t have. An open market with published prices and capital reserves would limit profits and return on equity. Complying with regulations and keeping records available for supervisory review costs money. It all cuts into profits.

And if profits get squeezed by an overbearing, overregulating government, how can a valuable part of our capital markets survive? It’s not cheap, after all, to employ the people needed to execute this business that virtually no one understands and that the government doesn’t want to regulate.

Remember when AIG Financial Products blew up? Even though there were traders, accountants, clerks, lawyers and others from Lehman who found themselves jobless, the Treasury Department decided to pay more than a million dollars in bonus payments to each of the valuable AIG employees that had bet so big, and so badly.

Thankfully, the lobbyists hired by the industry have figured out how to keep the business profitable, and how to turn the task of complying with new regulations into a potential new profit center. They helped incorporate a brilliant strategy into HR 4413, and got 265 members of the House to vote for it.

The CFTC will be required to create and publish cost-benefit studies prior to adopting new compliance policies, and those studies will be subject to judicial review. That will take some time. After the CFTC rules go into effect, market participants will be free to argue that the cost estimates were inaccurate. Because the studies are subject to judicial review, the companies being regulated can theoretically get the government to pay them for any additional costs they incur when complying. With a little creative accounting, maybe the swap dealers will turn a profit on compliance departments.

While the delaying tactics written into the bill keep regulation at bay, trading in credit default swaps will continue as it has, with the risks it has, here and abroad. Over half of the hundreds of trillions of dollars in swaps on the books of our banks belong to foreign subsidiaries. A condition of the new bill requires the CFTC and the SEC to certify that derivatives regulations are not already in place in those foreign jurisdictions before they become subject to the new “regulations.” All a bank or hedge fund needs to do is dispute the nature of existing derivatives regulations in their legal places of business overseas, and any oversight can come to a grinding halt while they all work it out. In the meantime, they can enter into lots of credit default swap contracts.

Perhaps the most brilliant part of HR 4413 is hidden in the budget. The congressionally mandated increased workload has no accompanying increase in the commission’s budget. It won’t be easy to run thousands of legal and economic analyses without the people to do it or the money to hire them.

Speaking of people, the bill passed in the House also peculiarly reinvents the org chart. Key regulatory and enforcement personnel currently report directly to the commissioner of the CFTC, but under the new law, those people would instead report to five different members of the commission. Hiring, firing, and departmental budgeting will be decided by all five members together.

Have you ever reported to five bosses at the same time? I did, for about a year, and it’s nearly impossible to get anything done.

By the way, in case you thought our government didn’t have a sense of humor, Congress tells us we can call HR 4413 the “Customer Protection and End User Relief Act.”

Correction: The “hundreds of trillions of dollars” figure cited in the 12th paragraph refers to all swaps, not just credit default swaps as this post originally stated.

 

By: Howard Hill, Former Investment Banker, The National Memo, June 27, 2014

June 30, 2014 Posted by | Big Banks, Financial Crisis, Financial Institutions | , , , , , , | Leave a comment

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