REGULATING THE BIG BANKS (Part 1)

Here’s issue #32 of my Policy and Politics Newsletter, written 5/29/12. JPMorgan Chase’s recent multi-billion dollar loss from securities trading has focused attention on the regulation of our large banks. This issue of my newsletter and the next one take a look at this issue.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in 2010. Its goal was to put an end to practices in the financial industry that led to the 2008 collapse of the financial sector and our economy.

One of its goals was to prevent speculative securities trading by banks that many equate to gambling with taxpayers’ money. This trading, called proprietary trading, enhances banks’ profits (when things go right) and senior managers’ bonuses, but do not benefit or serve bank customers. The Volcker Rule, named after former Chairman of the Federal Reserve (under Presidents Carter and Reagan), Paul Volcker, who proposed and supports it, is the specific piece of the Dodd-Frank law that bans such trading by banks. It would reinstate a key provision of the Glass-Steagall Act, put in place after the Great Depression but repealed in 1998, that required separation of banking from proprietary trading.

The reason for separating banking and proprietary trading is that banking is protected and supported by the federal government to ensure the safety of depositors’ money. Banks’ deposits are insured by the Federal Deposit Insurance Corporation (FDIC) and banks have access to very low cost funds from the Federal Reserve. Proprietary trading is speculative and risky, providing potentially big gains and big losses to the banking corporation and its executives. If a bank, while protected and supported by the government, is allowed to engage in proprietary trading, this amounts gambling with taxpayers’ money. [1] And as we have just experienced, banks that are “too big to fail” will receive bailouts using taxpayer funds if their bets go bad.

During the process of writing the Dodd-Frank law, and now during the writing of regulations to implement the law, including the Volcker Rule, the financial industry from Wall Street has worked tirelessly to water down, delay, complicate, and confuse the process. [2] Using legions of lawyers and lobbyists, large campaign contributions, media campaigns, and friends in Congress and the Executive Branch (some who have traveled through the revolving door of moving between financial industry and government jobs), Wall Street works to add provisions and loopholes that complicate the result, and to undermine support for reform. Those working to create solid regulation and limitations try to write provisions that allow reasonable activities but close loopholes, knowing that after the fact the financial institutions will exploit any loopholes they can find.

The Volcker Rule’s ban on proprietary trading by banks only significantly affects the six biggest banking corporations, [3] as they are the ones who engage in extensive proprietary trading. Proprietary trading is not an essential banking activity and it creates a conflict of interest between the bank and its customers. The other 20 regional banks and 7,000 community banks are generally supportive of the Volcker Rule but find it “impossible … to challenge” the six big banks on this issue. The Volcker Rule is scheduled to go into effect in July 2012, but the banks have managed to get a two year delay and will have until 2014 to comply. [4] Two of the six big banks, Goldman Sachs and Morgan Stanley, got their banking licenses during the recent financial crisis specifically to reassure their depositors that their deposits were protected by the FDIC and to get access to support from the Federal Reserve. [5]

The recent $2 billion plus proprietary trading loss at JPMorgan Chase really grabbed everyone’s attention because JPMorgan is touted as having the best risk management in the industry. Its highly regarded CEO, Jamie Dimon, has been leading the charge against the Volcker Rule, claiming it is unnecessary. [6] If proprietary trading at JPMorgan in calm financial markets could result in such a big loss, many are wondering how great the current risk of huge losses at other banks might be, let alone what it would be when financial markets are more volatile.

The next issue of my newsletter will cover the response to this JPMorgan trading loss.

[1] Silver-Greenberg, J., &Schwartz,N.D., 5/17/12, “JPMorgan losses reportedly up $1b,” The Boson Globe

[2] Taibbi, M., 5/24/12, “How Wall Street killed financial reform,” Rolling Stone

[3] The six biggest banks are JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. They average $1.6 trillion in assets.

[4] Rohde, D., 5/11/12, “Break up the big banks,” Reuters

[5] Moyers, B., with Volcker, P., 4/5/12, “Gambling with your money,” Moyers & Company on National Public Radio

[6] Gogoi, P., 5/15/12, “Dimon likely to face ire, not ouster at JPMorgan meeting,” The Boston Globe

THE 2008 FINANCIAL COLLAPSE: CONTEXT AND FOLLOW-UP

Here’s issue #25 of my Policy and Politics Newsletter, written 3/25/12. The previous issue provided highlights from the movie Inside Job, a documentary on the 2008 collapse of US financial firms that caused our current recession, which I highly recommend. Here’s some context and follow-up on the 2008 financial collapse.

The 2008 collapse was the product of deregulation of the financial industry over the last 30 years that led to three financial crises, each of increasing severity. These three crises were the Savings and Loan (S&L) crisis of the late 1980s, the “dot-com” stock bubble burst of 2000-2001, and the financial collapse of 2008.

In the early 1980s, the S&Ls were deregulated and by the end of the 1980s their newly allowed risky investments brought numerous bankruptcies that cost taxpayers $124 billion. 747 out of the 3,234 S&Ls failed, contributing to the 1990–91 economic recession. ^{^[1]}

Then in 2000-2001, the bubble in stock prices burst resulting in $5 trillion in losses and again contributing to a recession. This “dot-com” bubble was the result of speculation fueled by respected business publications, such as Forbes and the Wall Street Journal, that encouraged the public to invest in risky companies, despite some of the companies’ disregard for basic financial and even legal principles. Not all of the companies involved were actually “dot-com” companies. Enron and WorldCom engaged in illegal accounting practices to exaggerate profits. Several companies and their executives were accused or convicted of fraud and the Securities and Exchange Commission (SEC) fined top investment firms like Citigroup and Merrill Lynch millions of dollars for misleading investors – encouraging them to buy stocks the companies knew were risky at best. In all, large financial firms paid $1.4 billion to settle possible claims and promised not to engage in misleading practices again. ^{^[2]} Nonetheless, similar misleading practices occurred with mortgage-backed derivatives leading up to the 2008 collapse.

The US Senate’s investigation of the 2008 financial collapse found “that the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regu-lators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.” ^{^[3]} As in the S&L crisis, the regulators had been too close to the industry and had ignored problems. Moreover, two years after the 2008 crash, the FBI’s investigation had one-fourth of the resources the agency used during the S&L crisis, despite the fact that the 2008 collapse was 10 times as large. ^{^[4]} While the S&L debacle led to felony convictions of over 1,000 senior S&L executives, no significant criminal charges have been filed based on the 2008 collapse. ^{^[5]}

Economist Paul Krugman notes that Canada, despite a similar concentration of its financial industry in five large firms, exhibited remarkable stability while US firms were in crisis. He and others believe that this is because of stricter oversight and regulation. For example, Canada has: [6]

An independent Financial Consumer Agency to protect consumers from deceptive lending
Strong restrictions on subprime-type lending
Limits on the packaging of mortgages and other debt into securities to be sold to investors
Limits on the risks banks can take and on the reserves they have to keep to protect against losses

The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 addresses some of the causes of the 2008 collapse, although many analysts believe it is too weak to prevent another crisis. Nonetheless, Wall St. and its allies on Capitol Hill are trying to weaken the law and block its implementation. This is an example, both before and after the fact, of crony capitalism – cozy relationships between our financial corporations and our public officials in Washington, in Congress and in the Executive and Judicial branches of government, blocking meaningful regulation that is necessary to protect citizens and our economy.

[1] Wikipedia, retrieved 3/21/12, “Savings and loan crisis,” http://en.wikipedia.org/wiki/Savings_and_loan_crisis

[2] Wikipedia, retrieved 3/21/12, “Dot-com bubble,” http://en.wikipedia.org/wiki/Dot-com_bubble

[3] Wikipedia, retrieved 3/21/12, “Late-2000s financial crisis,” http://en.wikipedia.org/wiki/Late-2000s_financial_crisis

[4] Willoughby, J., 4/13/09, “The Lessons of the Savings-and-Loan Crisis,” Barron’s

[5] Black, W. K., 5/4/10, “Wall St. Fraud and Fiduciary Responsibilities: Can Jail Time Serve as an Adequate Deterrent for Willful Violations?” Testimony before US Senate, Committee on the Judiciary, Subcommittee on Crime and Drugs

[6] Krugman, P., 2/1/10, “Good and boring,” The New York Times

INSIDE JOB: THE 2008 COLLAPSE OF US FINANCIAL FIRMS

Here’s issue #24 of my Policy and Politics Newsletter, written 3/23/12. Last week, I finally watched the movie Inside Job, a documentary on the 2008 collapse of US financial firms that caused our current recession. I highly recommend it. Here are some highlights.

The movie Inside Job documents how the deregulation of the financial industry over the last 30 years has led to three financial crises, each of increasing severity. These three crises were the Savings and Loan (S&L) crisis of the late 1980s, the Internet stock bubble burst of 2000-2001, and the financial collapse of 2008.

The 2008 collapse was the worst of the crises and was largely caused by risky and fraudulent practices in the mortgage industry and by financial firms’ packaging of mortgages into securities that were sold to investors. These practices had fueled a bubble in the housing market – unwarranted price increases and over-building – that then caused a dramatic decline in house prices. This resulted in millions of mortgage defaults and foreclosures, and an economic recession – often called the Great Recession – that is the worst since the Great Depression of the 1930s. The losses in households’ wealth, primarily in housing and investment assets, exceed $14 trillion. Tens of millions of homeowners, who had significant equity in their homes in 2007, now have little or nothing. It is estimated that homeowners who owe more on their mortgages than their homes are worth – who are “underwater” – owe $700 billion more than their homes are worth. ^{^[1]}

Inside Job documents that despite warning signs former Federal Reserve Board Chairman Alan Greenspan, Treasury Secretaries Lawrence Summers and Henry Paulson, and SEC Chairman Arthur Levitt (among others) vehemently opposed any regulation of complex financial instruments known as “derivatives” (because they are “derived” from other financial instruments such as mortgages). They blocked efforts of the Commodity Futures Trading Commission under the leadership of Brooksley Born to regulate derivatives. By the late 1990s, the unregulated derivatives market involved $50 trillion of securities and was (and is) described by many as legalized gambling.

The movie notes that an orchestrated campaign by Wall St. and its lobbyists for deregulation of the financial industry, along with the incestuous revolving door which had formerWall St. executives in senior positions in government, succeeded in creating widespread support for deregulation. Greenspan, Summers, Paulson, and other senior government officials, as well as many in Congress, supported deregulation. This led to:

The 1999 repeal of the Glass–Steagall Act of 1933, passed in the aftermath of the Great Recession, which had required the separation of Wall Street investment firms and their risky investments from banks to reduce the risks that banks and their depositors would need a government bailout
Staff cuts at the Securities and Exchange Commission (SEC), which oversees our financial markets
Financial firms being allowed to decrease their reserves that protect against bankruptcy to as little as 3% of their assets, increasing the risk of the need for a taxpayer bailout
Academic economists supporting deregulation and downplaying risks
Specific warnings about high levels of risk being ignored
Credit rating agencies (e.g. Standard & Poor’s) covering up the risks of mortgage-related derivatives

The mortgage industry pushed unaffordable, sub-prime mortgages on unwitting customers because it received higher fees for them. Then, financial firms packaged these mortgages into derivatives and sold them as safe investments when the firms knew they were risky – and often made side bets that underlying mortgages would go into default and that the derivatives would decline in value.

The next issue of my newsletter will provide more context and some follow-up on the 2008 financial collapse, including steps to take to reduce the likelihood of another financial crisis. Unfortunately, it is not at all clear that Congress and the regulators will take these steps.

[1] Wikipedia, retrieved 3/21/12, “Late-2000s recession,” http://en.wikipedia.org/wiki/Late-2000s_recession

GASOLINE PRICES: WHY SO HIGH?

Here’s issue #22 of my Policy and Politics Newsletter, written 3/5/12. This issue takes a look at gasoline prices and why they are so high.

Gasoline prices have been rising and have become an issue in the presidential campaign. So why are prices so high and is there anything that can be done about it?

Current gas prices are NOT driven by supply and demand. Supplies of oil and gas are up and demand in the US is down; so basic economics says that the price should be low. According to the Energy Information Administration, supply is higher than three years ago when gas prices fell (briefly) to around $2.00. And demand is at the lowest level since April 1997. [1] The US is actually producing more oil and gas than we can use, so we are exporting 3 million barrels of oil products per day. [2] All of this suggests that gas prices should be low.

Tension over Iran and concern about the oil it supplies to world markets is putting some upward pressure on oil prices. Financial speculators see this as an opportunity to make money and jump into the market heavily, which drives prices up much more. Wall Street firms and other financial players dominate the buying and selling of oil, even though they have no intention of ever taking possession of the oil they buy. Ten years ago, producers and end users (airlines, oil refiners and retailers, etc.) were responsible for 70% of the trading of oil; now the financial speculators make up 65% – 80% of the market. The only reason they are in the market is to make money and the money they make comes out of our pockets through higher prices. [3]

Estimating how much speculation increases the price of oil and gasoline is difficult; however, many experts, including ones from Exxon Mobil, Delta Airlines, and Goldman Sachs, believe that speculation drives up the price of oil by 40%. This is a “speculators’ tax” that we all pay. There is historical evidence to support this. For example, in the summer of 2008, when speculators were driving the oil market, gas prices spiked to over $4.00 a gallon before declining sharply to $2.00. [4]

Congress and the President tried to reduce the impact of this speculation as part of the Dodd-Frank financial reform legislation. The law directed the Commodity Futures Trading Commission, which regulates this market, to set a cap on how many contracts for oil any one trader or company could control, which would limit the level and impact of speculation. After significant delays, such a cap was proposed in October 2011. However, many supporters of the cap view the proposal as quite weak. Nonetheless, the speculators are suing to block the implementation of even this modest reform. [5]

Through speculation in the oil markets, the Wall Street-based financial industry is making substantial sums of money that are coming out of the pockets of average Americans. The motivation is to make money for the few; however, there’s no added value for society at large, only costs. This is a variation on the theme that also drove the subprime mortgage market – make money regardless of the consequences. Due to campaign contributions, lobbying, and the revolving door between Wall Street and the federal government – in other words, due to crony capitalism – it’s likely that nothing significant will be done and we will all continue to pay this “speculators’ tax.” As a result, the Wall Street speculators will get richer while we get poorer as we pay more for gas than we should.

[1] Sanders, B., 2/28/12, “Wall street greed fueling higher gas prices,” CNN.com

[2] McClatchy Newspapers, 2/21/12, “Once again, speculators behind sharply rising oil and gasoline prices,” The Sacramento Bee

[3] McClatchy Newspapers, see above

[4] Sanders, B., see above

[5] Common Dreams staff, 3/2/12, “Obama’s oil speculation task force missing in action,” CommonDreams.org

CRONY CAPITALISM AND WINNER TAKE ALL POLITICS

Here’s issue #21 of my Policy and Politics Newsletter, written 2/29/12. This issue will begin to link the issues of corporate power, great inequality of income and wealth, and campaign finance. It is a bit long, as it is a summary of the first three shows of Bill Moyers’ return to public TV.

In case you haven’t heard, Bill Moyers is back on public television. (In theBostonarea, he’s on Sunday at 4:00 on channel 2. Or you can do what I do, download the podcasts from billmoyers.com or other sources.)

His first show back on (Jan. 13) was on Winner Take All Politics, the title of a recent book by Hacker and Pierson, whom Moyers interviews. The book and show document that the huge income disparity in the US (see issue #4 of my newsletter) is, in large part, the result of government policies over the last 30 years. Although globalization, technological change, and other changes in our economy have been factors, the real culprit is our public policies and how they have responded to these challenges. Other countries face these same challenges but have not experienced the dramatic increase in inequality that has occurred in theUS.

Over the last 30 years, the top income tax rate has been reduced from 70% to 35% (see issue #7 of my newsletter) with even lower rates for unearned (i.e., investment) income. As we’ve heard recently, multi-millionaires like Presidential candidate Romney are paying less than 15% of their income in taxes. If you were making around $20 million a year as he is, every one percentage point reduction in your tax rate puts $200,000 in your pocket. And with your tax rate cut in half, you are saving $3 million or more a year, or over $90 million over the last 30 years. Specifically, the Bush tax cuts of the early 2000s have given $50 to $100 million to each of the 400 richest Americans over the last 10 years.

This sets up a reinforcing cycle as some of these riches are funneled back into our political system through campaign contributions and Super PACs, further increasing the influence of the well-off and getting them favorable treatment. In addition, the lobbying capacity of the corporations and very rich has grown, while that of the middle class, particularly unions, has shrunk, further expanding the gap in political power and influence.

Hacker and Pierson note that politicians have learned that they can get re-elected despite ignoring or only giving symbolic support to the middle class, while moving the agenda of the corporations and very rich forward.

On Moyers’ second show (Jan. 20), David Stockman, President Reagan’s budget chief, was a guest. Stockman is writing a book entitled The Triumph of Crony Capitalism. He defines crony capitalism: using political power such as campaign contributions and lobbying to get returns that can’t be gotten in the market. He states that in theUS we do not have free market capitalism or democracy, but crony capitalism.

Stockman believes that we need to re-institute and strengthen the separation of the investment business and its risks from the banking system, as was in place prior to 1999 under a law called Glass-Steagall. Otherwise, he predicts that we will have recurring economic crashes. He says that financial institutions that are too big to fail are too big to exist and he advocates for banning corporate money from our political system and capping all campaign contributions at $100.

Moyers’ third show (Jan. 27) was with John Reed, who retired as CEO of Citigroup in 2000 after presiding over the merger of Citibank with Travelers Insurance. This merger led to and actually required the repeal of the Glass-Steagall law. The mantra at the time was that the new, enhanced financial system could handle the increased risk better than before and therefore repealing the separation of banking from the investment business wouldn’t be a problem. There was an extensive public relations and lobbying campaign to deliver this message, which ultimately skewed almost everyone’s thinking about this deregulation.

Reed, in retrospect, says that it’s amazing that everyone was so wrong and that the system as a whole went so far off the tracks that it caused the great recession we are now experiencing. He states that this was the result of crony capitalism between Wall Street executives andWashington politicians.

In other countries, including Canada, the crisis in the financial institutions wasn’t nearly as bad as here in the US. Our financial deregulation allowed financial institutions (including banks) to take great risks and to provide huge rewards to their people, an important part of our income and wealth inequality. And ultimately, these institutions and individuals did not bear the risk when things went wrong; the government and the public bailed them out.

Reed calls for re-regulation of the financial system, noting that regulations are need so that appropriate risks can be taken. He makes the analogy that cars have brakes (regulation) so that we can drive fast (take risks), but control our speed as needed. If cars did not have brakes, we’d all drive only very slowly. He is amazed that those lobbying against re-regulation and strengthening of oversight of financial institutions have any credibility given the crash they caused with deregulation. He notes that when corporations and the wealthy can buy the rules (or lack thereof), the situation is unstable.

One person who loudly warned of the dangers and, as Glass-Steagall was being repealed in 1999, predicted that in 10 years we would all come to realize that a big mistake was being made, was Senator Byron Dorgan of North Dakota. He noted that the deregulation was designed by those with a self-interest and that the complex securities, i.e. “derivatives,” that have been created are casino gambling with trillions and trillions of dollars. He states that the Dodd-Frank re-regulation law, which is being heavily lobbied against by Wall Street, is too weak to prevent the next collapse.

Another Moyers guest was Gretchen Morgenson of The New York Times who has written a book entitled Reckless Endangerment. She noted that there have been no meaningful penalties for the individuals or institutions that caused the collapse of the financial system and no one has gone to jail. Furthermore, the same people who drove the ship into the iceberg are still in leadership roles on Wall Street and in the federal government.

Moyers closes by calling the Supreme Court’s Citizens United decision, which allows unlimited spending by corporations in our political campaigns, “grotesque,” stating that it corrupts our political system and means that those with no (or little) money have no speech. He calls Winner Take All Politics immoral and notes that we have experienced a deep undermining our democratic institutions.

He cites a sign he saw at Occupy Wall Streetas telling it like it is: “The system isn’t broken, it’s fixed.”

I encourage you to listen to the podcasts of these three shows. They are 52 minutes each and will provide you the richness and depth that I can’t in this summary.