Claims of Financial Reform Victory? You Can't Reform Vampires and Zombies
If nothing else, the Obama Administration has learned the virtues of Clintonian spin. The so-called "financial reform victory" claimed Friday over approved new rules for over-the-counter derivatives is, in reality, akin to using a band-aid to treat gangrene.
Any kind of bill which (in the words of the Reuters report), "strives to balance a desire to curb speculative market excess with preserving the market's useful role in helping corporations hedge against operational risks" ignores the fact that it is not the market playing a "useful role in helping corporations hedge against operational risks," but the product of a big financial subsidy to Wall Street. Lack of transparency is a hallmark of these instruments and this gives huge pricing power to the banks. More importantly, it makes them tougher to regulate. There is no public, continuous record of Credit Default Swap trades that is comparable to the data available to investors and regulators from the major cash and derivatives exchanges, and the "reforms" introduced by the House of Representatives Financial Services Committee do nothing to address this reality for Credit Default Swaps.
This is in sharp contrast to the available pricing for other OTC derivatives, which is generally good and tracks the highly visible cash basis that underlie many other derivatives markets, OTC and exchange-based. Whether you are talking about currency swaps or a commodities related product, the world of OTC derivatives excluding CDSs is largely standardized in line with the exchange-traded products. Hence, they do not generate the same volumes of profits for Wall Street, which explains why the latter have fought to retain the status quo in spite of almost blowing up the entire financial system last year.
Obama clearly believes the BS fed to him by Jamie Dimon. I guess we should not be surprised; the President taught at the University of Chicago, after all, and clearly seems to have imbibed some of the Chicago School's free market ideology, and the unspoken assumption that free, unfettered markets are the optimal state. Anything else is a distortion or a rigidity. That of course fails to address the problem of fraud, which my colleague, Bill Black, has tirelessly sought to highlight.
Dealing with fraud is not only an important moral issue, but also crucial on basic economic grounds.
If we don't know what's really going on, we can't gauge whether the government's economic policies are working or not. The advantages of living in a society governed by the rule of law require both the right laws that, with common agreement, public purpose, as well as enforcement sufficient to deter non-compliance in the first place. Laws that most agree are okay to break, and a lack of enforcement, break down the core morality of the system, and result in a dangerous degeneration into lawlessness.
Leaving aside political agendas, the truest test of any reform is: will it have any kind of positive effect? As far as the current financial regulatory reforms go, the answer is probably yes in a very limited fashion, but that is more a function of the impairment of the capital markets themselves, which is precluding additional proliferation of these horrible Frankenstein financial products. If you don't deal with a cancer fully, it comes back and spreads, even if you conduct surgery to remove some of the tumor the first time around. And, as any oncologist can tell you, it's the secondary recurrence that usually kills.
Reform of the current US financial sector is neither possible nor would it ever be sufficient. It's a bit like saying, "Well, this slavery thing has a few problems, but we can 'reform' it and make it better." As any student of horror films knows, you cannot reform vampires or zombies. They must be killed (stakes through the hearts of Wall Street's vampires, bullets to the heads of zombie banks). In other words, the financial system must be downsized.
Downsizing can begin with the following set of actions:
a) All bank assets and liabilities must be brought onto balance sheets, and made subject to reserve and capital requirements and, more importantly, to normal oversight by appropriate regulatory agencies. Any assets and liabilities that are left off balance sheet will be declared null and void, unenforceable by US courts.
b) All CDSs must be bought and sold on regulated exchanges; otherwise they will be declared unenforceable by US courts.
c) Unless specifically approved by Congress, securitization of financial products such as life insurance policies will be prohibited and thus unenforceable by US courts.
d) The FDIC will be directed to examine the books of the largest 25 insured banks to uncover all CDS contracts held. These will then be netted among these 25 banks, canceling CDS contracts held on one another. CDS contracts with foreign banks will be unwound. The FDIC will also examine derivative positions with a view to determine whether unwinding these would be in the public interest.
e) In its examination, the FDIC will determine which of these banks is insolvent based on current market values-after netting positions. Those that are insolvent will be resolved. Resolution will be accomplished with a goal of i) minimizing cost to FDIC and ii) minimizing impacts on the rest of the banking system. It will be necessary to cover some uninsured losses to other financial institutions as well as to equity holders (such as pension funds) arising due to the resolution.
These actions should substantially reduce the size of the financial sector, and would eliminate some of the riskiest assets, including assets that serve no useful public purpose. The financial system would emerge with healthier institutions and with much less market concentration.
Failing that, we should at least have the government get into the insurance business as credit insurer of last resort. Private firms can't do it, as they do not have the financial resources to meet the potential claims (see AIG). And private firms have a tendency to mis-price credit risk (again, see AIG), which creates further incentives to bad behavior. As "Credit Insurer of Last Resort" (Professor Perry Mehrling's term, not mine), the government can charge proper premiums for it, which will have the additional impact of mitigating the worst behavior of Wall Street. The government can put a floor on the value of the best collateral in the system. As Mehrling says (in a variation of the Bagehot rule - i.e. "lend freely but at a high rate during a crisis"): Insure freely but at a high premium.
We can spend more time blogging about these issues, but now is the time to do something about it. As my friend Dean Baker has already noted, those disgusted by the rapacious and highly destructive behavior of our bankers can go to Chicago on the dates of Oct. 25-27th when the American Bankers Association is having their annual meeting and make yourselves heard. If we stay quiescent, we'll get the kinds of "reforms" we deserve. To paraphrase Rahm Emanuel, it's time to ensure that this crisis does not go to waste.
Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.
Hale "Bonddad" Stewart: The Economic Recovery Continues
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If Uncle Milty was still alive everything would be ok. After the shock of the financial collapse the masses would have accepted martial law. For capitalism to work, we just need a big disaster. And of course, we cannot have democracy get in the way.
Ridiculous.
'the unspoken assumption that free, unfettered markets are the optimal state'
has been a thing of the past ever since Akerlof, Stiglitz and the whole series of people working in Mechanism Design.
What's left is that markets are optimal IF a list of conditions are fulfilled. Which is not the case.
The question what's optimal then, after having acknowledged that it need not be markets (because in those cases markets will fail and dissolve) is very knotty.
The only thing that's certain is that the pretense that this whole thing is a question of political convictions is going to push those who should think clearly over the edge. These are questions of understanding and knowledge, not of preferences, and not of power.
These are excellent times for those in power to remind themselves about the basic truths concerning power: Whenever power is the only thing that's able to restore order, you know you're on a slipperly slope already. So be glad that these are not questions of power, but of understanding. And understand.
I'll keep my silver bullion bullets for the zombies and vampires that will undoubtedly attack my home. I'm pretty sure they'll work.
Obama better wake up to the fact that he HAS to TAX the über-class like Clinton did if he wants to reduce the deficit, AND the DNC should go on an ad blitz and show how CEOs who were getting 40 times what a worker was before Reagan are now getting 400 TIMES what a worker gets...no matter how shrilly the limbaughnistas cry "socialism" the majority of Americans WILL realise they're getting screwed!
But now that the president IS a member of the über-class, maybe he's looking out for his own money down the road.
When do they mail out our Citibank dividend checks?
Sorry, taxing the uber-class at 100% will not even make a dent in the deficit.
Yes, Obama, through Summers has absorbed the unspoken assumption that free, unfettered markets are the optimal state.
But, since his real constituency is the executives of big business, particularly bankers, that makes sense.
By his actions you shall know him. By his actions you can know his priorites.
If you've seen the White House, or the current Democratic Party, do anything of substance for the average taxpayer - besides give them the bill for the bankster's party - let us know.
At least Congress is fighting back against allowing the Fed to regulate derivatives! I call that PROGRESS.
Sorry Carol, Congress preventing the regulation of derivatives is not progress.
Congress preventing the FED from becoming the super-regulator over derivatives IS progress.
They are preventing the FED from regulating derivatives.
Agree 100%!
"Off-Balance-Sheet" for the five largest Banks ranges from is $32 Trillion to $82 Trillion
“Off-Balance-Sheet” Toxic Derivatives according to 0ffice of Comptroller of Currency, 0CC, quarterly Report:
1 JPM0RGAN $81TRILLION in Toxic Derivatives
2 BofA $78TRILLION
3 G0LDMAN $48TRILLION
4 M0RGAN $39TRILLION
5 C1T1GROUP $32TRILLION
http://www.occ.gov/ftp/release/2009-72a.pdf
Page23!
_____________________
Marshall's UNWINDING of “TOO-BIG-TO-FAIL”
1. Bring All bank assets and liabilities onto balance sheet and subject to reserve and capital requirements.
2. Full Balance Sheet receives oversight by regulatory agencies.
3. Assets+Liabilities left OFF balance sheet are declared null and void=unenforceable by US courts
4. All CDSs must be bought and sold on regulated exchanges or declared unenforceable by US courts.
5. Securitization of financial products (life insurance policies) are prohibited and unenforceable by US courts unless exception approved by Congress
6. FDIC will examine books of largest 25 banks to uncover all CDS contracts held.
7. Net and cancel CDS contracts held on one another with CDS’s on foreign banks unwound.
8. FDIC examine derivative positions to determine unwinding is in the public interest.
9. FDIC determines which banks are insolvent based on current market values-after netting positions.
10. FDIC will Resolve insolvent Banks minimizing FDIC cost+impacts on the system
11. FDIC will cover some uninsured losses to equity holders+pension funds
Barney Frank Campaign Funding:
[source: opensecrets.org]
Finance/Wall Street/Banking/Insurance Funding: $2,987,000
#1 Real Estate $637,808
#2 Securities & Investment $592,455
#4 Insurance $551,131
#5 Commercial Banks $503,300
#8 Accountants $197,592
#9 Misc Finance $187,878
#10 ½ Lobbyists $173,429
#13 Finance/Credit Companies $141,850
#16 Business Services $88,130
He gets FAR MORE FROM WALL STREET than anyone else in the HOUSE and more than MOST SENATORS!
That tells me he is selling Americans OUT!
Phil, did you see the article here on how Frank's Committee and the Agriculture Committee decided to DELETE the passages in the proposed "derivatives regulation" by the FED? People don't seem to understand this is a GOOD THING.
Looking at it just before I saw your post!
Outrageous but like you I think the FED has proven to be incapable of doing any regulation!
Remember Geither saying he has "never been a regulator!"
I am disturbed; the colorable mechanizations that facilitated the bailouts are not being perceived as a financial offensive; financial irregular warfare against the United States.
How can a defeated, bankrupt enemy, command the financial resources of the United States, without any contracts describing contingencies, duties, responsibilities, payment schedules, etc. Germany after WWI had to pay a vindictive, cruel, collosal debt as reparations. However the United States is not a conquered country; and yet the emasculated citizenry is paying for the 20 plus trillion dollar bailout on the backs of children, women, the elderly, etc.
The administration will not use national government power to protect the population. We are made to endure "market forces". The administration is set to manage an economic and population contraction policy; contraction will create more contraction.
If the United States does not implement economy formation measures now, the U.S. economy will stop functioning; with unimaginable consequences.
Stop the bailouts, recover the bailout trillions, reconfigure the stimulus plan. Put the Fed into bankruptcy protection, banks that qualify will join the U.S. National Bank. Credits and currency will be issued into the population's physical economy; with the executive of creating, improving and expanding the necessary facilities that enhance human survival/our standard of living.
The international monetary financial system is a killer of populations. It can not be fixed. Only the United States can confront the International Monetary Financier Power; can lead and cooperate with other nations in reorganizing the world economic/financial system.
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