Saturday, October 31, 2009

Back to the real world, Part 2

Updated This year, 2009, has been the worst year for bank failures since 1992. The total so far this year is 115, including nine seized on Friday. That was
the most in a single day since the financial crisis began and the latest stark sign that substantial parts of the nation's banking industry are being crippled by bad loans. ...

More lenders are expected to go under this year as the industry tries to get a handle on commercial real estate loans that will continue to worsen, as more strip malls go vacant and residential developments stall.
In other words, it ain't nearly over.

The assets of the banks closed on Friday were acquired by US Bancorp, which has been aggressively buying up failed banks.
"This transaction is consistent with the growth strategy that we have outlined many times in the past, which includes enhancing our existing franchise through low-risk, in-market acquisitions," said Rick Hartnack, vice chairman of consumer banking for U.S. Bancorp.
Thus does "too big to fail" get even bigger, an unhappy fact which gains extra relevance in light of Thursday's testimony to the House Financial Service Committee about proposed "financial reform" legislation by Richard Trumka, president of the AFL-CIO, an advance copy of which was obtained by the Campaign for America's Future.
The discussion draft appears to take the most problematic and unpopular aspects of the TARP and makes them the model for permanent legislation[, Trumka testified]. ...

The discussion draft would appear to give power to the Federal Reserve to preempt a wide range of rules regulating the capital markets - power which could be used to gut investor and consumer protections.
The problem is two-fold. First, as the CAF explains, the proposal would give the Federal Reserve authority to decide on its own which financial institutions are bailed out in a crisis rather than it being one of a few agencies which together make that decision. The thing is, the Fed regulates bank holding companies, including the parent companies of the nation's largest banks. But while regulatory authority rests with the Fed's Board of Governors, responsibility for oversight has been delegated to the regional Federal Reserve Banks - and those banks are controlled by their member banks, whose holding companies the Fed regulates. Those member banks pick the majority of the members of the boards of the regional banks, which in turn select the presidents of the regional banks, who are in essence the boss of the regulatory staff.

In other words, turning the decision about bailouts over to the Fed amounts to turning it over to the banks themselves. The second problem is what happens when a bailout takes place.
We are also[, Trumka said,] deeply troubled by provisions in the discussion that would allow the Federal Reserve to use taxpayer funds to rescue failing banks, and then bill other non-failing banks for the costs.
Which would make everything a win-win for any bank or financial institution deemed "too big to fail." In fact, it positively encourages them to renew (or continue) the riskiest sorts of behavior of the type that nearly brought the entire economy down in a smoking ruin just one year ago. The riskier the investment, the bigger the payout if it succeeds. But if it fails, then under this plan other banks, healthy banks, the ones who proceeded safely, are the ones who would bear the cost of the loss, not the giant playing long shots with other people's money.

There is another important point here, one raised by Prof. David Moss of the Harvard Business School, which is
the explicit requirement in the bill that the identification of systemically dangerous financial firms by federal regulators remain entirely secret, and never be revealed to the public.
(Via Corrente.)

The bill says there will be “no public list of identified companies,” which means there is supposed to be no way for the public to know what financial institutions have been identified by federal regulators as "systematically dangerous," that is, which are in danger of failing. Even regulators' reports to Congress are supposed to be confidential. This clearly protects the banks, but how it protects the public is a mystery.

Rep. Brad Sherman calls the proposed bill "TARP on steroids," arguing
that the $700 billion Troubled Asset Relief Program at least had a cap on spending, an expiration date, congressional approval, independent oversight and some executive pay limits for the banks on the receiving end of the taxpayers’ largesse,
none of which safeguards are in the current proposal, which by its lack of limitations would also allow for the Fed bailing out banks into the trillions of dollars without Congressional approval or involvement and without even informing the public.

In short, it simply increases the power of the powerful. "They dress the wound of my people as though it were not serious. 'Reform, reform,' they say, when there is no reform."

Footnote: There is an alternative, one sufficiently middle-of-the-road that even Paul Volcker has endorsed it: Reinstating the authority under the Glass-Steagall Act (or something like it) to separate investment banking from commercial banking, a wall that existed from 1933 to 1999.

Writing at the Huffington Post last May, Sam Stein remembered some of the senators and economists who "got it right" during the debate over the move to dismantle that wall, with several warnings about banks becoming "too big to fail." As one economist put it, "nobody will be able to discipline a Citigroup" once the legislation passed.

And, stroking my own ego, in March 1991, facing an earlier attempt by Shrub Sr. to dismantle Glass-Steagall (which failed; we had to wait for a "liberal Democrat" president to sign it), I wrote in the print version of Lotus that
[i]f the bill passes, big banks will get bigger and start dealing in stocks, mutual funds, and insurance - while brokerage and insurance houses ... will start running their own banks. ... Not only does this raise obvious threats of an even greater concentration of wealth than already exists, but ... allowing, indeed encouraging, an already-shaky industry to engage in potentially wildly-speculative ventures seems dumb on its face; doing it with the experience of the $1 trillion S&L bailout staring right at us is downright stupid.

So why do it? The real answer was revealed, probably inadvertently, in a largely fawning newspaper article about the glories of the new "financial services landscape." It was headlined "Bush reform proposal will help the giants."

Reinstating Glass-Steagall is reasonable, workable, and its provisions for decades provided protection against the sort of self-interested stupidity among the banks and bankers that nearly took us under. Which of course means it's completely off the table.

Same as it ever was.

Updated with the issue raised by Prof. David Moss.

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