Former Fed Chair Paul Volcker (appointed by Jimmy Carter and reluctantly reappointed by Ronald Reagan) is the person most responsible for a horrible recession in the 1980s that put to bed our high rates of inflation. My first house loan in 1980 was for a whopping 16.8% at the time. I was also getting raises twice a year that usually fell somewhere between 15-20% (yes, in banking). It was a whole different world back then.
Volcker is an imposing man both intellectually and in appearance. He towers over nearly every one in a room. He also has the ear of President Obama who placed him in charge of the analysis and planning for policy to rid the country of the systemic risk that characterizes our financial system today. The Glass-Steagall Act (GSA) of 1933 set the regime for the post-depression banking system. The Gramm-Leach Bliley Act (GLBA) of 1999-2001 removed that regime. The Volcker Rule seeks to remove the excesses of the GLBA. It is not quite GSA, but its goal is to return to separation of commercial banking from investment banking and hedge fund speculation, tighter capital controls, and a less concentrated industry.
The first details of Volcker’s suggestions are being made public. The Banker Pinata picture came from The Economist which is running a series of articles on The Volcker Rule. Right now, they’re interested in the Wall Street Reaction. I also woke up to an Op-Ed in the NYT by the man himself on How to Reform Our Financial System. Dodd is already showing signs of caving to the FIRE Lobby and is considering removing some of the language and the agency that would most protect consumers. This doesn’t surprise me because I expect him to be in the FIRE lobby by a year from now and he’s undoubtedly already beefing up his post-Senate credentials. We’ve seen Obama’s leadership method which is basically to give the right wing everything they want without doing a thing. He retreats at the mention of challenge. Volcker will not retreat. However, he’s in the process but outside the system so how truly effective can he be?
Volcker’s op ed is a concise call to action to stop the excesses of regulation capture, monopoly formation, and extraordinary profits and bonuses that resulted from the removal of transparency and oversight.
A large concern is the residue of moral hazard from the extensive and successful efforts of central banks and governments to rescue large failing and potentially failing financial institutions. The long-established “safety net” undergirding the stability of commercial banks — deposit insurance and lender of last resort facilities — has been both reinforced and extended in a series of ad hoc decisions to support investment banks, mortgage providers and the world’s largest insurance company. In the process, managements, creditors and to some extent stockholders of these non-banks have been protected.
The phrase “too big to fail” has entered into our everyday vocabulary. It carries the implication that really large, complex and highly interconnected financial institutions can count on public support at critical times. The sense of public outrage over seemingly unfair treatment is palpable. Beyond the emotion, the result is to provide those institutions with a competitive advantage in their financing, in their size and in their ability to take and absorb risks.
As things stand, the consequence will be to enhance incentives to risk-taking and leverage, with the implication of an even more fragile financial system. We need to find more effective fail-safe arrangements.
There are substantial differences–and I’ve said this a million times in this forum–between the roles of commercial banks and the roles of investment banks in a modern economy. Commercial banking should be boring and operate on a very slim margin. It consists of pooling the funds of households and businesses and placing them into loans for mundane things like inventory and cars. Just because the government now insures those deposits doesn’t mean the banks should be allowed to gamble with them. If you want to play high stakes financial engineer, got to an investment bank and go to one that doesn’t have an implicit guarantee not to fail when you screw up royally which you eventually will because the role of randomness in the financial markets is huge. You’ll get more of a sure thing in Las Vegas where the population of cards and the distribution of aces, tens, and sevens is known. The Volcker rule recognizes and respects these differences. It codifies it once more in a way not unlike the GSA but not exactly the same.
The article referenced from The Economist is the one that looks at the banks’ reaction and it is as expected. I lifted the table for your reference and the article describing the political dance around the Volcker law is referenced within the quote. (I have to tell you, there is a lot I would give up before I gave up my subscription to The Economist.) You can see exactly who the vampire squid in the room is in the graph. No wonder they own the Treasury and the White House lock, stock and FIRE bought barrel.
Though widely characterised as a return to the Glass-Steagall act, the plan falls far short of the Depression-era law that separated commercial banking and investment banking (and was repealed in 1999). Banks can continue to offer investment-banking services to clients, such as underwriting securities and making markets. The plan’s aim, say officials, is narrow: to stop Wall Street from gambling in capital markets with subsidised deposits.
The timing of the proposal—two days after Mr Obama’s party suffered a thumping Senate-election loss in Massachusetts—looks nakedly political. But it was not dreamed up overnight. Last year the president’s economic lieutenants had seemed content to shackle the banks with tougher regulation and higher capital ratios, rather than limiting their activities. In recent months, though, they warmed to the ideas of Paul Volcker, a former chairman of the Federal Reserve, who was advocating more drastic action—and after whom the new rule is named (see article).
Banks have been scrambling to estimate the potential damage. Despite the lack of detail, for most the impact looks manageable. Officials admit that new limits on non-deposit funding are designed to prevent further growth rather than to force firms to shrink. Banks were already scaling back their proprietary-trading activity sharply as a result of the crisis: some say its contribution to revenue has fallen by more than half in the past three years. Prop trading now typically accounts for a mere percentage point or two of firms’ revenues (see table)—if it is defined narrowly to exclude risk-taking related to client business. Drawing a line between the two will be horribly difficult, but that will be the regulators’ problem.
This article from the Economist on Obama’s Economic Team goes more into depth about the relative coziness of Geithner and Summers to the Wall Street Bonus class and the one thing Obama can ride back to above 50%: hatred of bankers. There may be a growing disconnect here that bodes well for the Volcker Rule. While it’s unlikely we’ll see capped bonuses, it is possible for a rework of the GSA and the so called firewall in a less intense sense. Oddly enough, Biden is a friend of Volcker’s and is playing a role in pushing the spine-challenged Obama in the direction of the Volcker Rule. There are some really odd political dynamics to this game.
I know how hard it is to get folks interested in economics and finance as I’ve now chosen this as my occupation rather than sitting inside these institutions doing the strategic planning and the overall asset-liability alignment that I used to do back in the days when my house loan was nearly 17% instead of the 7% I’ve got today. I have no idea why I find it a fascinating game of detective. Perhaps it’s something I inherited from my central banker grandfather. Perhaps it’s just one of the many quirks I’ve developed over the years. I do know, however, that now is not the time for you to go all glassy-eyed over complex derivatives. What this suggests is a way to make commercial banking boring again so that almost any one could do it and still have time for that ABA game of golf on a Wednesday afternoon.
Watch what happens to the proposed Volcker Rule. It could very well be the difference between real change and chump change. Lobby your senator and congressman because you know the FIRE lobby will be doing so vigorously and with a lot more money than you and I will ever have.
So the so-called conservatives are having their so-called freedom event with so-called commentators and news anchors from so-called news stations. It’s all a side show to the real problems of the country. It’s easy to misplace anger in an environment where misinformants rule the airwaves.
So, let me show you where the real theft is happening, in case you may have missed it.
First, the FDIC released yet another move towards creating a financial banking cartel. Another one bites the dust.
Corus Bank, National Association, Chicago, Illinois, was closed today by the Office of the Comptroller of the Currency, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect the depositors, the FDIC entered into a purchase and assumption agreement with MB Financial Bank, National Association, Chicago, Illinois, to assume all of the deposits of Corus Bank, N.A.
But you know there’s really nothing to see here at the NY Times: A Year After a Cataclysm, Little Change on Wall St. Much more important to focus on creeping socialism and taking our government back from imagined enemies.
One year after the collapse of Lehman Brothers, the surprise is not how much has changed in the financial industry, but how little.
Backstopped by huge federal guarantees, the biggest banks have restructured only around the edges. Employment in the industry has fallen just 8 percent since last September. Only a handful of big hedge funds have closed. Pay is already returning to precrash levels, topped by the 30,000 employees of Goldman Sachs, who are on track to earn an average of $700,000 this year. Nor are major pay cuts likely, according to a report last week from J.P. Morgan Securities. Executives at most big banks have kept their jobs. Financial stocks have soared since their winter lows.
No nothing to see here. Wait, a minute. Maybe we should listen to people with some expertise instead of Glenn Beck or Rush Limbaugh who couldn’t even get one college degree or a freshman’s worth of credits between them . Maybe we shouldn’t focus on sycophants like Chris Matthews or Keith Olbermann who just want to hear themselves talk and hump each others legs until they tingle.
In fact, though, regulators and lawmakers have spent most of the last year trying to save the financial industry, rather than transform it. In the short run, their efforts have succeeded. Citigroup and other wounded banks have avoided bankruptcy, and the economy has sidestepped a depression. But the same investors and economists who predicted, and in some cases profited from, the collapse last fall say the rescue has come at an extraordinary cost. They warn that if the industry’s systemic risks are not addressed, they could cause an even bigger crisis — in years, not decades. Next time, they say, the credit of the United States government may be at risk.
Yup, what have we been talking about here for month after month after month, while we get named called every imaginable insult from one end of the political spectrum to another. I must defy definition if one day I can be called a racist republican ratfucker then be called a greenie and a leftie the next.
Oh, meanwhile …
A blueprint of the Obama administration plan to extend Federal Reserve Role in the markets was released last night. I have to agree with Felix Salmon at Reuters about the increased density of DC alphabet soup. If you want to wade through 85 pages of sleep inducing regulatory policy, knock yourself out here. Frankly, this sort’ve stuff is my job and I had to run for another cup of coffee. Then again, you can rely on some of the folks that get paid to suffer through that kind of torture, like Salmon.
Do you know a FHC from a BCBS? If not, you’re going to have a hard time wading through the government’s white paper on financial reform, which is full of such things. (An FHC is a financial holding company; the BCBS is the Basel Committee on Banking Supervision. The link is to the WaPo leak of the paper, there might be minor changes in the final document.) This, for instance, is a real sentence from the paper:
The United States will work to implement the updated ICRG peer review process and work with partners in the FATF to address jurisdictions not complying with international AML/CFT standards.
But never fear! Your tireless blogger has waded through all 85 pages, and I’m pretty sure I’ve got the gist of it at this point.
In a nutshell: If you thought this was going to make the current horribly-complicated system of financial regulation less complicated, think again.
Today’s Wall Street Journal highlights the Details Set for Remake Of Financial Regulations. The question on every one’s mind is will it be real this time instead of some show that shuts down the minute the press leaves the room. (You know when Barny Frank and Chris Dodd trot out the single malt and the Cuban Cigars and party down to Chain, Chain, Chain … chain of Fools.
President Barack Obama is expected Wednesday to propose the most sweeping reorganization of financial-market supervision since the 1930s, a revamp that would touch almost every corner of banking from how mortgages are underwritten to the way exotic financial instruments are traded.
We shall see, we shall see. In today’s WAPO, Timothy Geithner and Lawrence Summers are inkling their strategy in A New Financial Foundation. They identify five key problems in the article they see with the current regulation regime.
First, existing regulation focuses on the safety and soundness of individual institutions but not the stability of the system as a whole. As a result, institutions were not required to maintain sufficient capital or liquidity to keep them safe in times of system-wide stress. In a world in which the troubles of a few large firms can put the entire system at risk, that approach is insufficient.
Capital requirements are always nice in a fractional reserve system. After all, banks only make money by lending out the funds they hold at a higher rate, but this needs to be closely examined; especially with capital from government sources at the risk or implied government guarantee of assets. I talked before about Stiglitz’s concept of Banks Too Big to be Restructured. Many of us feel that these banks don’t need to be better regulatedbut completely busted up. The joint statement appears to say that the Obama Adminstration is prepared to let them dither in Zombie land while making them come up with more capital. (The only thing I can say is how long and with whose money?) I call this passage a stinker, but I’ll wait to see the details in the bill itself. If they regulate it the way they regulated Fannie and Freddie, hide your savings under your nearest mattress and try to get all your income in Eurodollars.
The administration’s proposal will address that problem by raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms. In addition, all large, interconnected firms whose failure could threaten the stability of the system will be subject to consolidated supervision by the Federal Reserve, and we will establish a council of regulators with broader coordinating responsibility across the financial system.
While, GM’s bankruptcy and Chrysler’s emergence from bankruptcy grab front page headlines, yesterday’s banks with issues are positioning themselves at the table to discuss future financial regulation. This comes as some of the premier researchers in financial economics look for systemic solutions. As you know, I’m a huge advocate for finding new regulations that promote transparency of process and recognize the importance of fiduciary responsibility when the financial industry takes on risk. Harvard’s Oliver Hart and University of Chicago’s Luigi Zingales, both NBER researchers, have just produced A New Capital Regulation For Large Financial Institutions. I want to review some of their findings and suggestions in conjunction with two more mundane articles.
The first of these articles is an astounding piece on Alternet that finds information suggesting Larry Summers has been taking kickbacks from big troubled banks. Another article is in today’s NY Times that shows how the banks have been spending a good year–even as they took TARP funds and cheap money from them FED–girding for a fight on forthcoming regulations.
I would think that the big lesson from the last few years is this is not time to go back to business as usual. However, the mindset of those making major decisions in the White House (Treasury Secretary Geithner and CEA head Summers) is this is just a glitch and there’s no chance anything like this could happen again. In other words, we don’t need to look for systemic problems, we just need to send the patients home with some aspirin and they can call back in the morning. This aspirin prescription has been particularly expensive. It is either utterly naive or completely disingenuous to think that pouring money into financial institutions and waiting this out is going to prevent any future occurrence of financial meltdowns. We need to be prepared to offset what may be an elaborate hoax to convince that nothing really needs to change systematically and a major congressional influence- and administration influence- buying spree by the big banks. Even as we see Dow de-list Citibank, we see evidence that Citibank possibly manipulated its stress tests results through Summers.
If the Alternet article is correct, Summers should be in trouble and the trustworthiness of the large institutions should be questioned by a congressional committee. This sure looks like pay-to-play to me. (HT to Dr. BB for the link.) The post by Mark Ames is a must read.
Last month, a little-known company where Summers served on the board of directors received a $42 million investment from a group of investors, including three banks that Summers, Obama’s effective “economy czar,” has been doling out billions in bailout money to: Goldman Sachs, Citigroup, and Morgan Stanley. The banks invested into the small startup company, Revolution Money, right at the time when Summers was administering the “stress test” to these same banks.
A month after they invested in Summers’ former company, all three banks came out of the stress test much better than anyone expected — thanks to the fact that the banks themselves were allowed to help decide how bad their problems were (Citigroup “negotiated” down its financial hole from $35 billion to $5.5 billion.)
The fact that the banks invested in the company just a few months after Summers resigned suggests the appearance of corruption, because it suggests to other firms that if you hire Larry Summers onto your board, large banks will want to invest as a favor to a politically-connected director.
Last month, it was revealed that Summers, whom President Obama appointed to essentially run the economy from his perch in the National Economic Council, earned nearly $8 million in 2008 from Wall Street banks, some of which, like Goldman Sachs and Citigroup, were now receiving tens of billions of taxpayer funds from the same Larry Summers. It turns out now that those two banks have continued paying into Summers-related businesses.
I continue to read current economic thought on the state of the economy and the state of the Obama administration’s response. I don’t’ know if you’ve ever made a trip to Project Syndicate, but it’s an interesting site where you can read contributions by brilliant people to newspapers around the world. It’s another one of those places that I’ve found since I’ve completely given up on the US MSM’s ability to provide real news, insight, or criticism of the world today.
Joseph Stiglitz is a frequent contributor. He’s a 2001 Nobel Laureate Economist. This is a contribution of his to The Guatemala Times from March 6, 2009. It’s called How to Fail to Recover. I’ve talked a lot about how the stimulus package isn’t big enough, that it contains too many tax cuts and that it is a bandage approach to a systemic problem that started in the financial system with bad lending practices egged on by Washington and greedy megainvestors. I feel vindicated because that is Stiglitz take too.
The stimulus package appears big – more than 2% of GDP per year – but one-third of it goes to tax cuts. And, with Americans facing a debt overhang, rapidly increasing unemployment (and the worst unemployment compensation system among major industrial countries), and falling asset prices, they are likely to save much of the tax cut.
Almost half of the stimulus simply offsets the contractionary effect of cutbacks at the state level. America’s 50 states must maintain balanced budgets. The total shortfalls were estimated at $150 billion a few months ago; now the number must be much larger – indeed, California alone faces a shortfall of $40 billion.Household savings are finally beginning to rise, which is good for the long-run health of household finances, but disastrous for economic growth. Meanwhile, investment and exports are plummeting as well. America’s automatic stabilizers the progressivity of our tax systems, the strength of our welfare system – have been greatly weakened, but they will provide some stimulus, as the expected fiscal deficit soars to 10% of GDP.
In short, the stimulus will strengthen America’s economy, but it is probably not enough to restore robust growth. This is bad news for the rest of the world, too, for a strong global recovery requires a strong American economy.
The real failings in the Obama recovery program, however, lie not in the stimulus package but in its efforts to revive financial markets. America’s failures provide important lessons to countries around the world, which are or will be facing increasing problems which are or will be facing increasing problems with their banks.