May 31, 2010
Although the cartoon above appeared in my local paper, it came to my attention only because Barry Ritholtz posted it on his website, The Big Picture. Congratulations to Jim Morin of The Miami Herald for creating one of those pictures that’s worth well over a thousand words.
Forget about all that oil floating in the Gulf of Mexico. President Obama, Harry Reid and “Countrywide Chris” Dodd are too busy indulging in an orgy of self-congratulation over the Senate’s passage of a so-called “financial reform” bill (S. 3217) to be bothered with “the fishermen’s buzzkill”. Meanwhile, many commentators are expressing their disappointment and disgust at the fact that the banking lobby has succeeded in making sure that the taxpayers will continue to pick up the tab when the banks go broke trading unregulated derivatives.
Matt Taibbi has written a fantastic essay for Rolling Stone, documenting the creepy battle over financial reform in the Senate. The folks at Rolling Stone are sure getting their money’s worth out of Taibbi, after his landmark smackdown of Goldman Sachs and his revealing article exposing the way banks such as JP Morgan Chase fleeced Jefferson County, Alabama. In his latest “must read” essay, Taibbi provides his readers with an understandable discussion of what is wrong with derivatives trading and Wall Street’s efforts to preserve the status quo:
Imagine a world where there’s no New York Stock Exchange, no NASDAQ or Nikkei: no open exchanges at all, and all stocks traded in the dark. Nobody has a clue how much a share of IBM costs or how many of them are being traded. In that world, the giant broker-dealer who trades thousands of IBM shares a day, and who knows which of its big clients are selling what and when, will have a hell of a lot more information than the day-trader schmuck sitting at home in his underwear, guessing at the prices of stocks via the Internet.
That world exists. It’s called the over-the-counter derivatives market. Five of the country’s biggest banks, the Goldmans and JP Morgans and Morgan Stanleys, account for more than 90 percent of the market, where swaps of all shapes and sizes are traded more or less completely in the dark. If you want to know how Greece finds itself bankrupted by swaps, or some town in Alabama overpaid by $93 million for deals to fund a sewer system, this is the explanation: Nobody outside a handful of big swap dealers really has a clue about how much any of this shit costs, which means they can rip off their customers at will.
This insane outgrowth of jungle capitalism has spun completely out of control since 2000, when Congress deregulated the derivatives market. That market is now roughly 100 times bigger than the federal budget and 20 times larger than both the stock market and the GDP. Unregulated derivative deals sank AIG, Lehman Brothers and Greece, and helped blow up the global economy in 2008. Reining in derivatives is the key battle in the War for Finance Reform. Without regulation of this critical market, Wall Street could explode another mushroom cloud of nuclear leverage and risk over the planet at any time.
At The New York Times, Gretchen Morgenson de-mystified how both the Senate’s “financial reform” bill and the bill passed by the House require standardized derivatives to be traded on an exchange or a “swap execution facility”. Although these proposals create the illusion of reform – it’s important to keep in mind that old maxim about gambling: “The house always wins.” In this case, the ability to “front-run” the chumps gives the house the power to keep winning:
But the devil is always in the details — hence, two 1,500-page bills — and problems arise in how the proposals define what constitutes a swap execution facility, and who can own one.
Big banks want to create and own the venues where swaps are traded, because such control has many benefits. First, it gives the dealers extremely valuable pretrade information from customers wishing to buy or sell these instruments. Second, depending on how these facilities are designed, they may let dealers limit information about pricing when transactions take place — and if an array of prices is not readily available, customers can’t comparison-shop and the banks get to keep prices much higher than they might be on an exchange.
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Finally, lawmakers who are charged with consolidating the two bills are talking about eliminating language that would bar derivatives facilities from receiving taxpayer bailouts if they get into trouble. That means a federal rescue of an imperiled derivatives trading facility could occur. (Again, think A.I.G.)
Surely, we beleaguered taxpayers do not need to backstop any more institutions than we do now. According to Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond, Va., only 18 percent of the nation’s financial sector was covered by implied federal guarantees in 1999. By the end of 2008, his bank’s research shows, the federal safety net covered 59 percent of the financial sector.
In a speech last week, Mr. Lacker said that he feared we were going to perpetuate the cycle of financial crises followed by taxpayer bailouts, in spite of Congressional reform efforts.
“Arguably, we will not break the cycle of regulation, bypass, crisis and rescue,” Mr. Lacker said, “until we are willing to clarify the limits to government support, and incur the short-term costs of confirming those limits, in the interest of building a stronger and durable foundation for our financial system. Measured against this gauge, my early assessment is that progress thus far has been negligible.”
Negligible progress, 3,000 pages notwithstanding.
When one considers what this legislation was intended to address, the dangers posed by failing to extinguish those systemic threats to the economy and what the Senate bill is being claimed to remedy — it’s actually just a huge, sleazy disgrace. Matt Taibbi’s concluding words on the subject underscore the fact that not only do we still need real financial reform, we also need campaign finance reform:
Whatever the final outcome, the War for Finance Reform serves as a sweeping demonstration of how power in the Senate can be easily concentrated in the hands of just a few people. Senators in the majority party – Brown, Kaufman, Merkley, even a committee chairman like Lincoln – took a back seat to Reid and Dodd, who tinkered with amendments on all four fronts of the war just enough to keep many of them from having real teeth. “They’re working to come up with a bill that Wall Street can live with, which by definition makes it a bad bill,” one Democratic aid eexplained in the final, frantic days of negotiation.
On the plus side, the bill will rein in some forms of predatory lending, and contains a historic decision to audit the Fed. But the larger, more important stuff – breaking up banks that grow Too Big to Fail, requiring financial giants to pay upfront for their own bailouts, forcing the derivatives market into the light of day – probably won’t happen in any meaningful way. The Senate is designed to function as a kind of ongoing negotiation between public sentiment and large financial interests, an endless tug of war in which senators maneuver to strike a delicate mathematical balance between votes and access to campaign cash. The problem is that sometimes, when things get really broken, the very concept of a middle ground between real people and corrupt special interests becomes a grotesque fallacy. In times like this, we need our politicians not to bridge a gap but to choose sides and fight. In this historic battle over finance reform, when we had a once-in-a-generation chance to halt the worst abuses on Wall Street, many senators made the right choice. In the end, however, the ones who mattered most picked wrong – and a war that once looked winnable will continue to drag on for years, creating more havoc and destroying more lives before it is over.
The sleazy antics by the Democrats who undermined financial reform (while pretending to advance it) will not be forgotten by the voters. The real question is whether any independent candidates can step up to oppose the tools of Wall Street, relying on the nickels and dimes from “the little people” to wage a battle against the kleptocracy.