The Fourteenth Banker Blog

May 11, 2010

What We Need In Addition to Criminal Prosecutions

Filed under: Uncategorized — thefourteenthbanker @ 12:14 AM

My comments are interspersed in this article.

Zach Carter: What’s Still Worth Fighting For On Wall Street Reform?

by Zach Carter

Last week, Congress decided it would not confront Too Big To Fail, the single gravest threat to our collective financial security. But there are still several key Wall Street reforms worth fighting for–reforms that must be enacted before the next crisis hits, with or without a big bank break-up. And fortunately, key Senators have authored amendments dealing with each one.  14 here. I agree that TBTF is a chicken that will come home to roost.  No fund is substantial enough for another crisis.  If it takes something between $700B and $1T to deal with this little bank run in Greece and it’s sisters, no $50B will ever do anything in a pinch.  The banks remain and will remain too interconnected to allow one to fail.  Resolution Authority is a fiction and many including the Minn Fed Pres admit it.

Blanche Lincoln’s Derivatives Bill

The most important fight from here on out is protecting the surviving elements of the derivatives bill crafted by Sen. Blanche Lincoln, D-Ark. The key reform in Lincoln’s bill would force big banks who deal derivatives to spin off those operations into separate companies. Derivatives are a breeding ground for straightforward gambling.For every $1 in legitimate risk-hedging in the derivatives market, there is $78 in speculative betting. That speculation is being backed by taxpayer perks–FDIC-insured deposits and Federal Reserve loans–that are supposed to support safe and productive lending, not reckless gambling. Lincoln would ban all federal backstops for this insanity, making the derivatives market less profitable, and therefore smaller, in the process.

This element of Lincoln’s bill is already in the Senate legislation, but Sen. Judd Gregg, R-N.H., is pushing an amendment to gut this plan. Don’t let him get away with it. A vote for Gregg’s amendment is a vote for more– and more expensive– bank bailouts.   14 here.   I agree that 80% of this market needs to simply go away.   It is a casino.  Very few understand them.  Regulators will not be able to stay in front of “innovation”.   They can bring down the system.  We need a few simple products for legitimate hedging needs.  Counterparties need to be qualified and also be regulated so that their risks are within their liquidity and solvency parameters.  It is also a market where people can be snookered.  Even the most simple interest rate derivatives are not so simple and many businesses that are simply trying to hedge interest rate risk do not know all the ins and outs, nor can they easily get fair pricing.  Monopoly power gives gouging power.

The Volcker Rule

The Volcker Rule has a similar aim to Blanche Lincoln’s derivatives plan. Economically essential banks shouldn’t be speculating with taxpayer money. The Volcker Rule would ban banks who receive Federal Reserve loans from conducting risky securities trades for their own accounts. Gambling with taxpayer money doesn’t help the economy in any way, it just produces short-term profits for banks while subjecting our tax dollars to long-term bailout risk. Whether the trades take the form of securities or derivatives, if they’re speculative, they shouldn’t be connected to the commercial banking system.

Sens. Carl Levin, D-Mich., and Jeff Merkeley, D-Ore., have authored an amendment that would require regulators to implement the Volcker Rule banning proprietary securities trading at commercial banks.

14 here.  I think this is a good idea but very hard to implement.  So, I would probably default to capital requirements as a way to discourage this activity.  I’m not sure if “Front Running” falls into this category for Market Makers, but that should be regulated.

Audit The Fed

The Federal Reserve is the chief bailout engine for the U.S. banking system, and it operates under conditions of almost complete secrecy. Since the crisis broke out, the central bank has pumped nearly $4.3 trillion into the nation’s banks, but the taxpayers on the hook for these loans know almost nothing about them. We don’t know who the Fed extended loans to, the terms of the loans, or what Fed officials signed off on them.

This is a disgrace to democracy. Nowhere else in American government can public officials spend public money without detailed disclosure. Sen. Bernie Sanders, I-Vt., has authored a bill that would subject the central bank’s bailout operations to a thorough and public audit. A more comprehensive audit authored by Reps. Alan Grayson, D-Fla., and Ron Paul, R-Texas, passed the House late last year. Both are worth supporting. If the Sanders amendment cleared the Senate, the audit could be widened in a conference with the House. But any effort to hold the Fed accountable is better than none.  14 here.   I would have stood for independence of the Fed a few years ago.  But now the situation is out of control.  Too much money is tossed around and it finds its favorites.  The revolving door establishes the most fertile field for larceny ever.

Protect Consumers

When President Barack Obama first put forward his Wall Street reform proposals in June 2009, the strongest provision was a plan to create an independent Consumer Financial Protection Agency (CFPA), whose sole charge was cracking down on abusive bank lending. Our current crop of regulators totally failed to perform this job over the past decade, as millions of foreclosure victims can attest to. Today’s bank regulators are charged with ensuring both bank profitability (a type of regulation known as “safety and soundness”) and that consumers are treated fairly. In practice, that has meant regulators ignore bank rip-offs, provided they create short-term profits.

Unfortunately, Obama’s strong CFPA bill has been watered down over the course of nearly a year of negotiations. Instead of an independent agency, the current Senate bill would house the consumer regulator at the Federal Reserve, a regulator which had the authority to crack down on mortgage market abuses throughout the crisis, but failed to exercise it. What’s worse, the current Senate bill limits the scope of the new consumer regulator’s rule-writing authority, gives the existing, failed regulators veto power over those rules, and restricts the new regulator’s ability to enforce its rules.

There was no good economic reason for the Senate to make any of these changes–they were all simply concessions to deep-pocketed bank lobbyists, nothing more, nothing less. Sen. Jack Reed, D-R.I., has an excellent amendment that would restore Obama’s original CFPA language, and provide real protection for consumers.

14 here.  I think this is a good idea but not likely to be effective.  I think what is most important is to have some simple products and very clear and simple disclosures.  Then folks can vote with their feet.  I also have another idea to help consumers and small businesses but that will have to wait for another post.

Cap Leverage

Banks amplify their bets by borrowing loads of money, a phenomenon called leverage. As the crisis unfolded in 2008, some banks found themselves with $40 or even $60 in borrowed money for every $1 of their own cash. That meant big profits while markets were moving up, but epic losses when markets started falling. The Senate must impose a hard cap on leverage to complement the 12-to-1 cap included in the Wall Street reform bill that cleared the House last year. The Brown-Kaufman amendment would have limited bank borrowing to $16.67 for every $1 of their own money. Brown-Kaufman also would have broken up the six largest U.S. banks, and was rejected in the Senate last week. The Senate should vote on the leverage cap as a stand-alone amendment.

14 here.   This is absolutely critical.  The principle is that the shareholders should have their money at risk first.  A substantial equity cushion needs to be available to protect taxpayers from bailout risk and to reduce the likelihood of bank runs.  As discussed in the various “Ownership Conundrum” posts, the shareholders need to have a different character as well.


  1. Here’s a start –

    UPDATE – 12:10 p.m. – The amendment to open the Fed to a one-time audit of its lending between December 1, 2007 and the present passed 96-0.

    Comment by Sandi — May 11, 2010 @ 1:22 PM | Reply

  2. Excellent interview on Charlie last night with Roubini where he lays-out his suggestions for FSI Reform. Watch it here –

    Comment by lucyhoneychurch — May 12, 2010 @ 1:49 PM | Reply

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