Those whales are back in the news again — this time due to calls for their slaughter. In case you’re wondering what kind of person would advocate the killing of whales, I would like to identify two people who recently spoke out in favor of such action. The first of these individuals is one of my favorite columnists at The New York Times, Gretchen Morgenson, winner of the Pulitzer Prize in 2002 for her “trenchant and incisive” coverage of Wall Street. The second is the chair of the Federal Deposit Insurance Corporation, Sheila Bair. Two women want to have whales killed? Yes. However, the “whales” in question are those infamous financial institutions considered “too big to fail”. On October 3, Gretchen Morgenson wrote a piece for The New York Times, entitled: “The Cost of Saving These Whales” in which she defined “to big to fail” institutions as “banks that are so big and interconnected that their very existence threatens the world”. She discussed the problems caused by the continued existence of those whales with this explanation:
During the credit bust, our leaders embraced the too-big-to-fail policy, reluctantly bailing out large institutions to save the system from collapse, they said. Yet even as the crisis has abated, these policy makers have shown little interest in cutting financial monsters down to size. This is especially disturbing given that some institutions have grown even larger as a result of the mess.
It is perverse, of course, to reward big banks’ mistakes with bailouts financed by beleaguered taxpayers. But the too-big-to-fail doctrine benefits the banks in other ways as well: the implication that an institution will not be allowed to fall gives it significant cost advantages over smaller, perhaps more responsible competitors.
On October 4, Sheila Bair of the FDIC gave a speech before the International Institute of Finance at their annual meeting in Istanbul, Turkey. At the outset, she pointed out that “the first task” in creating “a more resilient, transparent, and better-regulated financial system” would be to scrap the “too big to fail” doctrine. She went on to explain how to go about killing those whales:
To do this we need a resolution regime that provides for the orderly wind-down of banking and other financial enterprises without imposing costs on the taxpayers.
The solution must involve a practical and effective mechanism for the orderly resolution of these institutions similar to that used for FDIC-insured banks.
This new regime would not permit taxpayer funds to be used to prop up a firm or its management. Instead, senior management would be replaced, and losses would be borne by the stockholders and creditors.
On September 23, 2009 Treasury Secretary “Turbo” Tim Geithner testified before the House Financial Services Committee to explain his planned financial reform agenda. Here’s what Turbo Tim had to say about the plan for dealing with the “too big to fail” problem:
First, we cannot allow firms to reap the benefits of explicit or implicit government subsidies without very strong government oversight. We must substantially reduce the moral hazard created by the perception that these subsidies exist; address their corrosive effects on market discipline; and minimize their encouragement of risk-taking.
So, in other words … the government subsidies to these institutions will continue, but only if the recipients get “very strong government oversight”. In his next sentence Geithner expressed his belief that the moral hazard was created “by the perception that these subsidies exist” rather than the FACT that they exist. Geithner’s scheme of continued corporate welfare for the biggest financial institutions is consistent with what we learned about him from Jo Becker and Gretchen Morgenson in their New York Times article back on April 26. That essay gave us some great insight about Turbo Tim’s blindness to moral hazard:
Last June, with a financial hurricane gathering force, Treasury Secretary Henry M. Paulson Jr. convened the nation’s economic stewards for a brainstorming session. What emergency powers might the government want at its disposal to confront the crisis? he asked.
Timothy F. Geithner, who as president of the New York Federal Reserve Bank oversaw many of the nation’s most powerful financial institutions, stunned the group with the audacity of his answer. He proposed asking Congress to give the president broad power to guarantee all the debt in the banking system, according to two participants, including Michele Davis, then an assistant Treasury secretary.
The proposal quickly died amid protests that it was politically untenable because it could put taxpayers on the hook for trillions of dollars.
“People thought, ‘Wow, that’s kind of out there,’” said John C. Dugan, the comptroller of the currency, who heard about the idea afterward. Mr. Geithner says, “I don’t remember a serious discussion on that proposal then.”
But in the 10 months since then, the government has in many ways embraced his blue-sky prescription. Step by step, through an array of new programs, the Federal Reserve and Treasury have assumed an unprecedented role in the banking system, using unprecedented amounts of taxpayer money, to try to save the nation’s financiers from their own mistakes.
And more often than not, Mr. Geithner has been a leading architect of those bailouts, the activist at the head of the pack. He was the federal regulator most willing to “push the envelope,” said H. Rodgin Cohen, a prominent Wall Street lawyer who spoke frequently with Mr. Geithner.
Geithner’s objective of putting the prosperity of the banks ahead of any concern for the taxpayers was again demonstrated in this AFP report from October 6:
On proposed changes to the financial system, Geithner said it was “legitimate” for banks to be influential and admitted that reform could “pose risks to financial innovation.”
Nevertheless, he stressed that “the most important issue is that if stability (of financial institutions) is not guaranteed, it will become harder to raise capital.”
On October 6, Newsweek published an interview conducted by Nancy Cook with William Black, a former federal regulator during the Savings & Loan crisis and a professor of economics and law at the University of Missouri – Kansas City. The interview included a discussion of the government’s response to the financial crisis. One remark made by Mr. Black reinforced my opinion about Turbo Tim:
“Some of the things Bernanke did were very bad, but he is in sharp contrast to Geithner who has been wrong about everything in his career. When Geithner was once answering a question in response to Ron Paul, he said, ‘I’ve never been a regulator.’ He was then the President of the New York Federal Reserve, and he purports that he was never a regulator? That is a demonstration of what is wrong with the Federal Reserve banks if the head of the unit doesn’t think he’s a regulator. He’s a disaster.”
It should come as no surprise that Richard Carnell, a Professor at Fordham Law School and former Assistant Treasury Secretary for President Clinton, would have this to say about Geithner’s financial reform agenda, when asked for his comments by Kim Thai of Fortune:
The plan includes useful reforms. But it’s also naive, timid, misguided, politically inept, and intellectually dishonest.
It places naive faith in regulation. Yet regulation failed disastrously over the past decade. Bank regulators had ample powers to keep banks safe but did too little, too late. They let banks use $12-13 in borrowed money for every $1 in shareholders’ money. The administration’s response? Give regulators more powers.
[The plan] preserves a preposterous tangle of overlapping regulators. And it didn’t arrive until June, seven months after the election. By then the crisis had faded and special interest politics had come roaring back.
It entrenches bailouts for large financial institutions. Voters know that’s rotten policy. It makes firms like General Electric divest their banks. That serves no purpose. It’s like trying to ward off the Mexican Mafia by fortifying the Canadian border. Small wonder voters remain skeptical.
It appears as though Turbo Tim is not up to the job of killing those whales. Perhaps the President should find someone who is.
On Thursday, October 1, Federal Reserve chairman Ben Bernanke testified before the House Financial Services Committee. That event demonstrated how the Fed has fallen into the crosshairs of critics from both ends of the political spectrum. A report in Friday’s Los Angeles Times by Jim Puzzanghera began with the point that the Obama administration has proposed controversial legislation that would expand the Fed’s authority, despite bipartisan opposition in a Congress that is more interested in restricting the Fed’s influence:
Worried about the increased power of the complex and mysterious Fed, and upset it did not do more to prevent the deep recession, Capitol Hill has focused its anger over the financial crisis and its aftermath on the central bank. The Fed finds itself at the center of a collision of traditional political concerns – conservatives’ fears of heavy-handed government intervention in free markets, and liberals’ complaints of regulators who favor corporate executives over average Americans.
More than two-thirds of the House of Representatives has signed on to a bill that would subject the central bank to increased congressional oversight through expanded audits. A key senator wants to strip the Fed of its authority to regulate banks. And the chairman of the House Financial Services Committee wants to rein in the Fed’s emergency lending power, which it used to help engineer the sale of Bear Stearns Cos. and bailout American International Group Inc.
The article noted the observation of Jaret Seiberg, a financial policy analyst with Concept Capital’s Washington Research Group:
“The Fed is running into unprecedented opposition on Capitol Hill,” he said.
“In the Senate, there’s open hostility toward any expansion of the Federal Reserve’s authority. And in the House, you certainly have Republicans looking to focus the Fed solely on monetary policy and strip it of any larger role in financial regulation.”
Mr. Puzzanghera’s report underscored how the Fed’s interventions in the economy during the past year, which involved making loans (of unspecified amounts) and backing commercial transactions, have drawn criticism from both sides of the aisle. The idea of expanding the Fed’s authority to the extent that it would become a “systemic risk regulator” has been criticized both in Congress and by a former member of the Federal Reserve Board of Governors:
House Republicans want to scale back the Fed’s power so the bank focuses on monetary policy. And many have opposed the administration’s proposal to give the Fed the new role of supervising large financial institutions, such as AIG, that are not traditional banks but pose a risk to the economy if they fail.
“I’m not alone with my concerns about the Fed as a systemic regulator,” said Rep. Scott Garrett (R-N.J.). Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) has similar concerns, as do others on his panel. In fact, Dodd has proposed stripping the Fed of all of its bank oversight functions as part of his plan for creating a single banking regulatory agency.
Former Fed Gov. Alice M. Rivlin also said it would be a mistake to increase the Fed’s regulatory powers because it would distract from the central bank’s monetary policy role.
“Do we want to augment the regulatory authority of the Fed? . . . My answer is no,” said Rivlin, a senior fellow at the Brookings Institution. “My sense is many people would be nervous about that augmentation.”
The colorful Democratic chairman of the House Financial Services Committee, Barney Frank, recently published a report card on the committee’s website, criticizing the Fed’s poor record on consumer protection. The report card contrasted what Congressional Democrats had done to address various issues (categorized under the heading: “Democrats Act”) with what the Fed has or has or has not done in dealing with those same problems.
Meanwhile, Republican Congressman Ron Paul of Texas, is making the rounds, promoting his new book: End The Fed. A recent posting at The Daily Bail website includes a YouTube video of Ron Paul at a book signing in New York, which resulted in a small parade over to the New York Fed. Although the Daily Bail piece reported that Paul’s book had broken into the top ten on Amazon’s list of bestsellers — as I write this, End The Fed is number 15. I would like to see that book continue to gain popularity. Perhaps next time Chairman Bernanke testifies before a committee, he will know that something more than his own job is on the line. It would be nice to see him make history as the last Chairman of the Federal Reserve.
On Tuesday September 29, H. David Kotz, Inspector General of the Securities and Exchange Commission, issued two reports, recommending 58 changes to improve the way the agency investigates and enforces violations of securities laws, as a result of the SEC’s failure to investigate the Bernie Madoff Ponzi scheme. The reports exposed a shocking degree of ineptitude at the SEC. On September 10, Mr. Kotz testified before the Senate Banking Committee. You can find the prepared testimony here. (I suggest starting at page 8.) Having read that testimony, I wasn’t too shocked at what Mr. Kotz had to say in Tuesday’s reports. Nevertheless, as Zachery Kouwe explained in The New York Times, the level of bureaucratic incompetence at the SEC was underestimated:
Many on Wall Street and in Washington were surprised that some of Mr. Kotz’s proposals, like recording interviews with witnesses and creating a database for tips and complaints, were not already part of the S.E.C.’s standard practice.
The extent of dysfunction at the SEC has been well-documented. Back on January 5, I wrote a piece entitled: “Clean-Up Time On Wall Street”, expressing my hope that the incoming Obama administration might initiate some serious financial reforms. I quoted from Steven Labaton’s New York Times report concerning other SEC scandals investigated by Mr. Kotz last year. My posting also included a quote from a Times piece by Michael Lewis (author of Liar’s Poker) and David Einhorn, which is particularly relevant to the recent disclosures by Inspector General Kotz:
Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.
Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors.
This sentiment was echoed on Tuesday by Barry Ritholtz at The Big Picture website:
The agency is supposed to be an investor’s advocate, the chief law enforcement agency for the markets. But that has hardly been how they have been managed, funded and operated in recent years.
Essentially the largest prosecutor’s office in the country, the SEC has been undercut at every turn: Their staffing was far too small to handle their jurisdiction — Wall Street and public Corporations. Their budgets have been sliced, and they were unable to keep up with the explosion in corporate criminality. Many key positions were left unfilled, and morale was severely damaged. A series of disastrous SEC chairs were appointed — to be “kinder and gentler.” Not only did they fail to maintain SEC funding (via fines), but they allowed the worst corporate offenders to go unpunished.
Gee, go figure that under those circumstances, they sucked at their jobs.
* * *
The bottom line of the SEC is this: If we are serious about corporate fraud, about violations of the SEC laws, about a level playing field, then we fund the agency adequately, hire enough lawyers to prosecute the crimes, and prevent Congress critters from interfering with the SEC doing its job.
To be blunt: So far, there is no evidence we are sincere about making the SEC a serious watchdog with teeth.
Congress sure hasn’t been. Staffing levels have been ignored, budgeting has been cut over the years. And it’s the sort of administrative issue that does not lend itself to bumper sticker aphorisms or tea party slogans.
Financial expert Janet Tavakoli explained in a presentation to the International Monetary Fund last week, that regulatory failures in the United States helped create an even larger Ponzi scam than the Madoff ruse — the massive racket involving the trading of residential mortgage-backed securities:
Wall Street disguised these toxic “investments” with new value-destroying securitizations and derivatives.
Meanwhile, collapsing mortgage lenders paid high dividends to shareholders (old investors) and interest on credit lines to Wall Street (old investors) with money raised from new investors in doomed securities. New money allowed Wall Street to temporarily hide losses and pay enormous bonuses. This is a classic Ponzi scheme.
* * *
Had regulators done their jobs, they would have shut down Wall Street’s financial meth labs, and the Ponzi scheme would have quickly choked to death from lack of monetary oxygen.
After the Savings and Loan crisis of the late 1980’s, there were more than 1,000 felony indictments of senior officers. Recent fraud is much more widespread and costly. The consequences are much greater. Congress needs to fund investigations. Regulators need to get tough on crime.
As Simon Johnson and James Kwak explained in The Washington Post, the upcoming battle over financial reform will be hard-fought by the banking industry and its lobbyists:
The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.
* * *
Even back in April, the industry was able to kill Obama’s request for legislation allowing bankruptcy judges to modify mortgages. Five months of profits later, the big banks are only stronger. Is Obama up for this fight?
Our new President must know by now, that sinking a three-point shot is much easier than the juggling act he has undertaken with health care reform, the wars in Iraq and Afghanistan as well as his recent quest to help Chicago win the bid for the 2016 Olympics. If Mr. Obama can’t beat the health insurance lobby with both the Senate and Congress under Democratic control — how will the voters feel if he drops another ball in the fight for financial reform? Thanks to Harry Truman, the American public knows where “the buck stops”. The previously-quoted Washington Post commentary looked even further back in history to explain this burden of leadership:
During the reign of Louis XIV, when the common people complained of some oppressive government policy, they would say, “If only the king knew . . . .” Occasionally people will make similar statements about Barack Obama, blaming the policies they don’t like on his lieutenants.
But Barack Obama, like Louis XIV before him, knows exactly what is going on. Now is the time for him to show what his priorities are and how hard he is willing to fight for them. Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can’t blame it all on the banking lobby.
I’ve seen quite a few articles and broadcasts from “mainstream” news sources during the past few weeks that have actually made me feel encouraged about the public’s response to the financial crisis and our current economic predicament. Six months ago, the dirty picture of what caused last year’s near-meltdown and what has continued to prevent the necessary reforms, was something one could find only by reading a relatively small number of blogs. Michael Panzner wrote a book entitled Financial Armageddon in 2006, predicting what many “experts” later described as unforeseeable. Mr. Panzner now has a blog called Financial Armageddon (as well as another: When Giants Fall). At his Financial Armageddon website, Mr. Panzner has helped ease the pain of the economic catastrophe with a little humor by educating his readers on some novel measurements of our recession level — such as the increased use of hair dye and “The Hot Waitress Index”. (He ran another great posting about the increasing number of disastrous experiences for people who tried to save money by cutting their own hair.) Meanwhile, Matt Taibbi has continued to serve as a gadfly against crony capitalism. Zero Hedge keeps us regularly apprised of the suspicious activities in the equities and futures markets, which are of no apparent concern to regulatory officials. Some bloggers, including Jr Deputy Accountant, have criticized the manic money-printing and other inappropriate activities at the Federal Reserve — which resists all efforts at oversight and transparency. One no longer experiences the stigma of “conspiracy theorist” by accepting the view that our financial and economic problems were caused primarily by regulatory failure.
On September 23, Dan Gerstein wrote a piece for Forbes, about the impressive, 25-page article concerning last year’s financial crisis, written by James Stewart for The New Yorker, entitled: “Eight Days”. At the outset, Mr. Gerstein noted how the New Yorker article provided the reader with some shocking insight on someone we all thought we knew pretty well:
But the biggest eye-opener was that the most incisive and damning questions raised by any of our leaders during this existential crisis came from none other than the era’s top free-market cheerleader in Washington, George W. Bush.
* * *
Paulson and Bernanke alerted Bush that AIG was about to fail, warned of the massive ripple effect AIG going bust would have on the global economy, and explained why the Fed could not intervene with an insurance company to stop this systemic threat. In response, Bush asked “How have we come to the point where we can’t let an institution fail without affecting the whole economy?”
The question raised by President Bush is still tragically apt, since nothing has been accomplished in the past year to break up or downsize those institutions considered “too big to fail”. Mr. Gerstein’s experience from reading the New Yorker article helped reinforce the understanding that our current situation is not only the result of regulatory failure, but it’s also a by-product of something called “regulatory capture” — wherein the regulators are beholden to those whom they are supposed to regulate:
Once disaster was averted and the system stabilized, Paulson, Geithner and Bernanke had no excuse for not laying down the law to Wall Street — figuratively and literally — in the ensuing weeks. By that I mean restructuring the deals we struck with the banks to get far better returns for taxpayers and rewriting the rules governing the financial system to prevent them from ever thinking they could gamble risk-free with our money again.
* * *
There’s no apparent sense of apartness or independence between regulator and regulated. To the contrary, there’s a power imbalance in the wrong direction, with the regulators dependent on and even at the mercy of the regulated. What does it say about the integrity and even the sanity of this system when the doctors have to ask the inmates how to restructure their treatments?
I was particularly impressed by Dan Gerstein’s closing remarks in the Forbes piece. It was encouraging to see another commentary in a mainstream media source, consistent with the ranting I did here, here and here. Mr. Gerstein expressed dismay at the lack of attention given to the unpleasant truth that we live in a plutocracy which won’t be changed until the people demand it:
That’s why I was so disappointed to find Stewart’s epic article buried in the elite pages of the New Yorker. It should have been serialized on the front pages of every newspaper in the country last week, so every American would be reminded in full detail of just how warped and rigged our financial system has been — and why it still is. Maybe then it might sink in that getting mad won’t get us even in the power struggle with the financial elites for control of our economy, and that change won’t happen until taxpayers demand it. You want public accountability for Wall Street? Let’s start with an accountable public.
Each time an article such as Dan Gerstein’s “Too Close For Comfort” gets widespread exposure, we move one step closer to the point where we have an informed, accountable public. It’s unfortunate that his commentary was buried in the elite pages of Forbes. That’s why I have it here. Spread the word.
Last year’s financial crisis and our current economic crisis have exposed some pretty ugly things to an unsuspecting public. As news reporters dig and as witnesses are called to testify, these investigations are turning over a very large rock, revealing all the colonies of maggots and fungus infestations, just below ground level, out of our usual view. The voters are learning more about the sleaziness that takes place on Wall Street and in the halls of Congress. Hopefully, they will become motivated to demand some changes.
A recent report by American Public Media’s Steve Henn revealed how the law prohibiting “insider trading” (i.e. acting on confidential corporate information when making a transaction involving that company’s publicly-traded stock) does not apply to members of Congress. Remember how Martha Stewart went to prison? Well, if she had been representing Connecticut in Congress, she might have been able to interpose the defense that she was inspired to sell her ImClone stock based on information she acquired in the exercise of her official duties. Mr. Henn’s report discussed the investment transactions made by some Senators after having been informed by former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, that our financial system was on the verge of a meltdown. After quoting GOP House Minority Leader John Boehner’s public acknowledgement last September that:
We clearly have an unprecedented crisis in our financial system. . . .
On behalf of the American people our job is to put our partisan differences aside and to work together to help solve this crisis.
Mr. Henn proceeded to explain how swift Senatorial action resulted in a bipartisan exercise of greed:
The next day, according to personal financial disclosures, Boehner cashed out of a fund designed to profit from inflation. Since he sold, it’s lost more than half its value.
Sen. Dick Durbin, an Illinois Democrat, who was also at that meeting sold more than $40,000 in mutual funds and reinvested it all with Warren Buffett.
Durbin said like millions of others he was worried about his retirement. Boehner says his stock broker acted alone without even talking to him. Both lawmakers say they didn’t benefit from any special tips.
But over time members of Congress do much better than the rest of us when playing the stock market.
* * *
The value of information that flows from the inner workings of Washington isn’t lost on Wall Street professionals.
Michael Bagley is a former congressional staffer who now runs the OSINT Group. Bagley sells access and research. His clients are hedge funds, and he makes it his business to mine Congress and the rest of Washington for tips.
MICHAEL Bagley: The power center of finance has moved from Wall Street to Washington.
His firm is just one recent entry into Washington’s newest growth industry.
CRAIG HOLMAN: It’s called political intelligence.
Craig Holman is at Public Citizen, a consumer watchdog. Holman believes lobbyists shouldn’t be allowed to sell tips to hedge funds and members of Congress shouldn’t trade on non-public information. But right now it’s legal.
HOLMAN: It’s absolutely incredible, but the Securities and Exchange Act does not apply to members of Congress, congressional staff or even lobbyists.
That law bans corporate insiders, from executives to their bankers and lawyers, from trading on inside information. But it doesn’t apply to political intelligence. That makes this business lucrative. Bagley says firms can charge hedge funds $25,000 a month just to follow a hot issue.
BAGLEY: So information is a commodity in Washington.
Inside information on dozens of issues, from bank capitol requirements to new student loan rules, can move markets. Consumer advocate Craig Holman is backing a bill called the STOCK Act. Introduced in the House, it would force political-intelligence firms to disclose their clients and it would ban lawmakers, staffers, and lobbyists from profiting on non-public knowledge.
Mr. Henn’s report went on to raise concern over the fact that there is nothing to stop members of Congress from acting on such information to the detriment of their constituents in favor of their own portfolios.
I understand, and share, concern that the financial crisis has revealed weaknesses in our regulatory and supervisory agencies as well as in the activities of private financial institutions. There has been criticism of the Federal Reserve itself, and even proposals to remove responsibilities other than monetary policy, strictly defined, from the Fed.
Mr. Volcker discussed a number of suggestions for regulatory changes to prevent a repeat of last year’s crisis. He criticized Treasury Secretary “Turbo” Tim Geithner’s approach toward what amounts to simply baby-sitting for those financial institutions considered “too big to fail”. Here is some of Mr. Volcker’s discussion on that point:
However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.
Will not the pattern of protection for the largest banks and their holding companies tend to encourage greater risk-taking, including active participation in volatile capital markets, especially when compensation practices so greatly reward short-term success?
Are community or regional banks to be deemed “too small to save”, raising questions of competitive viability?
* * *
What all this amounts to is an unintended and unanticipated extension of the official “safety net”, an arrangement designed decades ago to protect the stability of the commercial banking system. The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises – even greater crises – will increase.
This concern is often discussed as the “moral hazard” issue. William Black, Associate Professor of Economics and Law at the University of Missouri – Kansas City published an excellent paper concerning this issue on September 10. He made some great suggestions as to how to deal with these “Systemically Dangerous Institutions”:
Historically, “too big to fail” was a misnomer – large, insolvent banks and S&Ls were placed in receivership and their “risk capital” (shareholders and subordinated debtholders) received nothing. That treatment is fair, minimizes the costs to the taxpayers, and minimizes “moral hazard.” “Too big to fail” meant only that they were not placed in liquidating receiverships (akin to a Chapter 7 “liquidating” bankruptcy). In this crisis, however, regulators have twisted the term into immunity. Massive insolvent banks are not placed in receivership, their senior managers are left in place, and the taxpayers secretly subsidize their risk capital. This policy is indefensible. It is also unlawful. It violates the Prompt Corrective Action law. If it is continued it will cause future crises and recurrent scandals.
* * *
Under the current regulatory system banks that are too big to fail pose a clear and present danger to the economy. They are not national assets. A bank that is too big to fail is too big to operate safely and too big to regulate. It poses a systemic risk. These banks are not “systemically important”, they are “systemically dangerous.” They are ticking time bombs – except that many of them have already exploded.
Mr. Black then listed twenty areas of reform where these institutions would face additional regulatory compliance and restrictions on their activities, including a ban on “all new speculative investments”. Paul Volcker took that issue a step further with his criticism of “proprietary trading” by these institutions, which often can result in conflicts of interest with customers, since these banks are trading on their own accounts while in a position to act on the confidential investing strategies of their clients.
Paul Volcker made a point of emphasizing the need to clarify the overlapping jurisdictions of the Securities and Exchange Commission and the Commodity Futures Trading Commission (CFTC). On September 18, David Corn wrote a piece about the CFTC, describing it as:
… a somewhat obscure federal agency, but an important one. Its mission is to protect consumers and investors by preventing misconduct in futures trading that could distort the prices of agricultural and energy commodities. In 2000, the CFTC wanted to regulate credit default swaps — complicated and privately traded financial instruments that helped grease the way to the subprime meltdown — but Republican Sen. Phil Gramm, then the chair of the Senate Banking Committee, Fed chair Alan Greenspan and Clinton administration officials (including Lawrence Summers, now President Obama’s top economic adviser) blocked that effort. Had the CFTC been allowed to police swaps, the housing finance crisis that begot the economic crash of last year might not have been as bad. So the CFTC is a critical agency. And under Obama’s proposal for more robust financial regulation — which he talked about during a Wall Street visit on Monday — the CFTC would have greater responsibility to make sure no one was gaming the financial system. Consequently, the composition of the CFTC is more significant than ever.
Mr. Corn expressed his concern over the fact that the Obama administration had nominated Scott O’Malia, a Republican Senate aide, to be a commissioner on the CTFC:
For the past seven years, he’s been a GOP staffer in the Senate. But before that he was a lobbyist for Mirant, an Atlanta-based electricity company. According to House and Senate records, while at Mirant O’Malia was registered to lobby for greater deregulation at a time when his company was exploiting the then-ongoing deregulation of the energy market to bilk consumers. Remember the Enron-driven electricity crisis in California of 2001, when Enron and other companies were manipulating the state’s deregulated electricity markets, causing prices to go sky-high, creating rolling black-outs and triggering a statewide emergency? Mirant was one of those other companies. According to state investigators, Mirant deliberately held back power to force prices up.
After the crisis, Mirant was investigated by various federal and local agencies and became the target of a number of lawsuits. It ultimately agreed to pay California about half a billion dollars to settle claims it had screwed the state’s residents. It also was fined $12.5 million — by the CFTC! — for attempting to manipulate natural gas prices.
Mr. O’Malia had previously been nominated for this position by President George W. Bush. Nevertheless, Washington Senator Maria Cantwell helped block the nomination. As a result, David Corn was understandably shocked when O’Malia was re-nominated for this same position by the Obama administration:
Yet Obama has brought it back. Why would a president who craves change in Washington and who wants the CFTC to be a tougher watchdog do that?
The answer to that question is another question: Does President Obama really want the CFTC to be a tougher watchdog or just another “lap dog” like the SEC?
After all the promises of the needed regulatory “clean-up” to prevent another financial crisis, can we really trust our current leadership to accomplish anything toward that goal?
TheCenterLane.com offers opinion, news and commentary on politics, the economy, finance and other random events that either find their way into the news or are ignored by the news reporting business. As the name suggests, our focus will be on what seems to be happening in The Center Lane of American politics and what the view from the Center reveals about the events in the left and right lanes. Your Host, John T. Burke, Jr., earned his Bachelor of Arts degree from Boston College with a double major in Speech Communications and Philosophy. He earned his law degree (Juris Doctor) from the Illinois Institute of Technology / Chicago-Kent College of Law.
Kill The Whales
October 8, 2009
Those whales are back in the news again — this time due to calls for their slaughter. In case you’re wondering what kind of person would advocate the killing of whales, I would like to identify two people who recently spoke out in favor of such action. The first of these individuals is one of my favorite columnists at The New York Times, Gretchen Morgenson, winner of the Pulitzer Prize in 2002 for her “trenchant and incisive” coverage of Wall Street. The second is the chair of the Federal Deposit Insurance Corporation, Sheila Bair. Two women want to have whales killed? Yes. However, the “whales” in question are those infamous financial institutions considered “too big to fail”. On October 3, Gretchen Morgenson wrote a piece for The New York Times, entitled: “The Cost of Saving These Whales” in which she defined “to big to fail” institutions as “banks that are so big and interconnected that their very existence threatens the world”. She discussed the problems caused by the continued existence of those whales with this explanation:
On October 4, Sheila Bair of the FDIC gave a speech before the International Institute of Finance at their annual meeting in Istanbul, Turkey. At the outset, she pointed out that “the first task” in creating “a more resilient, transparent, and better-regulated financial system” would be to scrap the “too big to fail” doctrine. She went on to explain how to go about killing those whales:
On September 23, 2009 Treasury Secretary “Turbo” Tim Geithner testified before the House Financial Services Committee to explain his planned financial reform agenda. Here’s what Turbo Tim had to say about the plan for dealing with the “too big to fail” problem:
So, in other words … the government subsidies to these institutions will continue, but only if the recipients get “very strong government oversight”. In his next sentence Geithner expressed his belief that the moral hazard was created “by the perception that these subsidies exist” rather than the FACT that they exist. Geithner’s scheme of continued corporate welfare for the biggest financial institutions is consistent with what we learned about him from Jo Becker and Gretchen Morgenson in their New York Times article back on April 26. That essay gave us some great insight about Turbo Tim’s blindness to moral hazard:
Geithner’s objective of putting the prosperity of the banks ahead of any concern for the taxpayers was again demonstrated in this AFP report from October 6:
On October 6, Newsweek published an interview conducted by Nancy Cook with William Black, a former federal regulator during the Savings & Loan crisis and a professor of economics and law at the University of Missouri – Kansas City. The interview included a discussion of the government’s response to the financial crisis. One remark made by Mr. Black reinforced my opinion about Turbo Tim:
It should come as no surprise that Richard Carnell, a Professor at Fordham Law School and former Assistant Treasury Secretary for President Clinton, would have this to say about Geithner’s financial reform agenda, when asked for his comments by Kim Thai of Fortune:
It appears as though Turbo Tim is not up to the job of killing those whales. Perhaps the President should find someone who is.