In the “They
snuck it in while we weren’t watching” category, the big winner is….US
Commercial banks. The one paragraph item is relegated to the last page of the world
and national news section of the local rag, right beside the notice that Chuck
E, Cheese has declared bankruptcy. Of course, Mr. Cheese has been bankrupt in numerous
other ways, primarily having to do with good taste, for decades.
The issue at hand
is what has been called the “Volker rule.” For those not intimately familiar with
commercial banking regulations (which included the kid) the news rang no bells …that
is until I reflected upon recent history, like, say, the great recession of
2009-13 and the words “commercial banks” rang a bell. First, the sobriquet “Volker
rule”, named for former “Fed Head” Paul Volker refers to section 619 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, which sets forth
rules for implementing section 13 of the Bank Holding Company Act of 1956.
The Dodd–Frank
Wall Street Reform and Consumer Protection Act (commonly referred to as
Dodd–Frank) is a United States federal law that was enacted on July 21, 2010,
primarily as an attempt to stave off, by legislative fiat, further financial sector bleeding from risky use
of clients’ money by large commercial banks. The law’s intent was to overhaul
and increase financial regulation in the aftermath of the Great Recession. You
remember, TARP, bailouts, mortgage foreclosures, unemployment, all that “stuff?”
It made changes affecting all federal
financial regulatory agencies and darned near every part of the nation's financial
services industry. Much of the act was consumer protection oriented.
This act was a
direct result of proposals by President Obama aimed at helping to prevent
another epic economic tanking based on malfeasance at high levels of the US
banking industry. Responding to widespread calls for changes to the financial
regulatory system, in June 2009, Obama introduced a proposal for a
"sweeping overhaul of the United States financial regulatory system, a transformation
on a scale not seen since the reforms that followed the Great Depression".
That pretty much sums up Dodd-Frank. The bill, based on his proposal, was
introduced in the US House by Congressman Barney Frank, and in the Senate by
Senator Chris Dodd. As one might expect, Most Congressional support for
Dodd-Frank came from members of the Democratic Party, but three Senate
Republicans voted for the bill, allowing it to overcome the Senate filibuster.
One provision, the
afore mentioned Volker rule, restricts banks from making certain kinds of
speculative investments. The act also repealed the exemption from regulation
for security-based swaps, requiring credit-default swaps and other transactions
to be cleared through either exchanges or clearinghouses. The Trump administration
is eliminating most of the Volker Rule’s
regulatory prohibitions and provisions
For the uninformed,
market manipulation, intentional or not, resulted from the sheer size of funds
involved in questionable securities, chief among them being high risk
mortgages, bundled as viable and sound instruments. Proffered by agents for the
big commercial banking houses which bundled and sold these dogs, there were
easy customers aplenty such as union pension funds or state employee pension
funds, or simply large fund managers, seeking safe (hopefully) and profitable
(primarily) places to put their money.
Added to the mix were credit default swaps. This
is bordering on a Grad school economics course, so I’ll just describe credit
default swaps (CDS) as “I’m buying insurance to pay me if your investment tanks.”
Think of it like this: Tom buys a racehorse with money borrowed from Bob. He
plans to pay for the horse with its winnings. I don’t know either Tom or Bob, who
lent him the money. Bob, the original lender, might buy insurance (a CDS) that
pays off the loan if Tom defaults. Bob can then, since he feels sure the horse
is a winner, sell me that CDS. If the horse
wins the triple crown and Tom pays off the loan as promised, the lender, and I, or whoever bought the swap, is out the premium we paid the underwriter as well as
I’m out the money I paid the Bob, the original lender, to buy the swap.
However, should
the horse break a leg and never run, the owner of the credit default swap (me) will
(usually) collect the full value of the loan. Bob, however, gets the asset (the
horse), now worth only its glue value. This
little gem of an idea (one of many concepts to use money to make money which
have no real product or service whatsoever in the mix (derivatives). What it
did do, was to entice such insurance giants as AIG to insure these bets against
the system with large premiums involved, and investors to buy them.
When the
bundled mortgage housing bubble imploded, and the “tranches” or groups of
unsound mortgages were just paper, and worth nowhere close to the literally trillions
of dollars pinned on the illusion of their value, everyone lost.
Insurers lost,
because the amount of massive defaulted credit they had insured via CDS would
have bankrupted several of them, so, the buyers of the CDS also lost because
the Insurer couldn’t pay (and they had paid the CDS sellers for the swaps) and
the sellers of CDS were left with almost worthless bundles of impending foreclosures.
By the end of 2007, the outstanding CDS
amount was $62.2 trillion. For a bit of
perspective, that figure was over ten times the national debt!
Commercial
banks, like Bear, Stearns, Lehman Brothers and Merrill Lynch were in trouble. Lehman Bros, with $600 billion in bonds
outstanding went bankrupt. AIG, having insured individuals world-wide against
such defaults via by CDS was saddled with far more claims than the dollars to pay
them. As we know, the recovery was long and painful,
and many have pointed fingers each at another, but one salient fact remains
uncontested: CDSs are not traded on an
exchange and there is no required reporting of these transactions to a
government agency.
This has been called a “shadow banking system” by economists.
This situation is a result of unregulated market capitalism. The 2010 financial
crisis demonstrated the lack of transparency in this large market which became
a concern to regulators as it could pose a systemic risk to the US economy if
allowed to function unchecked. This and other issues were prime concerns of the
framers of Dodd-Frank.
Oddly enough, as
a candidate, Donald Trump was the most anti–Wall Street presidential candidate
since FDR in the 1930s. He attacked Wall Street relentlessly, directly, and
explicitly throughout the 2016 campaign and attacked his opponent, Hillary
Clinton, nonstop as being “In the pocket of Wall Street.” He even put the
then-CEO of Goldman Sachs, Lloyd Blankfein, in his last campaign ad as “one of
the biggest threats to the people of the United States!” So, the Donald must be
a fan of Dodd-Frank, huh? Not so much. C’mon, we all know he’s a lying sack of
shit, why should this be different.
Predictably, critics
of financial reform have claimed that the law and rules would kill banks'
revenue and profits, which would prevent them from lending and would in turn
kill economic growth and jobs. They did the same thing when FDR signed the Glass-Steagall
banking act 1933. Glass-Steagall was different in that its principal regulatory
function was to separate investment banking from retail banking. Repealed in
1999 by another banking act, the Gramm‐Leach‐Bliley Act, much of Glass-Steagall survives (separation of commercial and investment banking, FDIC, etc.).
Neither would have stopped greedy lenders like Wells-Fargo, Washington Mutual
or Indy Mac from making bad loans to persons willing to borrow today without
regard to the inevitable adjustable rate increase next year.
Republicans tend
to push the blame to Federal initiatives urging the cessation of red-lining and
other discriminatory (and racially motivated in many cases), lending practices. Likewise, private mortgage brokers in (too)
many cases simply threw rational thought and responsibility to the winds, realizing
that, the more mortgages sold, the more commission and that the vast bulk of
them would be resold to banks before the ARM kicked in triggering, in a lot of
such instances, default.
So, did Dodd-Frank and the Volker rule damage or stifle the
vitality of the commercial banking industry as some have predicted? Hardly. In fact, in virtually every quarter since
2009, including throughout 2018 and the first quarter of 2019, the biggest
banks recorded or eclipsed record revenues, profits, and bonuses while at the
same time increasing lending. Even so, at least 115 Dodd-Frank rules remained to be
completed when the Obama administration ended, including executive compensation
rules, securities-based swap rules, credit rating agency reform, and commodity
speculation rules.
Despite his constant
excoriation of Wall as a candidate, and since taking office, the Trump
administration has set about dismantling the core pillars of financial reform
by a number of regulatory reductions some of them are:
Lowering capital requirements (easier, riskier commercial loans,
important to Trump, himself heavily leveraged)
Enabling more unregulated derivatives dealing (you know,
like the CDS that triggered the bubble damage)
Rolling back consumer and investor protections reducing
prudential regulation of systemically significant banks (this is critical
because it takes Federal eyes off those banks not considered critical, which
now is every major “non-bank” as these commercial entities are sometimes
called.
Both GE capital
and AIG are examples of “too big to fails” which are now off the list. AIG, not only failed spectacularly and engaged in egregiously irresponsible
conduct, but also required an unlimited bailout, which ultimately amounted to
$182 billion. The other was General Electric (GE), which, although with fewer
headlines and less egregiousness, would have gone bankrupt without being bailed
out as well. removing all of the “non-banks” from scrutiny is insane and even bankers
outside that unique arena have said so'
And finally, neutering the
regulation of systemically significant nonbanks and the shadow banking system, stopping
enforcing the laws, if not actually siding with the predators. Goodbye Volker rule.
From 1929
through 2010 the US has experienced a number or recessions, some have been
cyclic adjustments with no singular or specific cause, several were adjustments
from wartime to peacetime employment. Three, however, (and two of these are 21st
century phenomena) were the result of a specific sector of the nation indulging
in irresponsible market operations based on that most base of motives greed, leading
to runaway speculation. All three, the great Depression, the Dot-com crash and
the great recession are the result of individuals who rarely,if ever get their
hands dirty,playing fast and loose with other people’s money or betting other’s
money on “what ifs.”
Trump favors
loosening responsible observation and regulation of these entities. His
sycophants echo that claim. History says he and they are wrong. History is
powerful proof that regulation and financial stability don’t stifle growth and
prosperity, but that broad-based deregulation is. That is why Dodd-Frank
re-regulated the financial industry and why the Trump administration's
deregulation is so reckless and dangerous. The Volker rule is simply the latest
insult.
For more, and more entertaining, discussion watch or read “The
Big Short”
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