Tag: financial regulation

Supporting Swap Desk Spinoffs Just Got Easier

The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here).  Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.

It’s about time. Yesterday, by a vote of 96 – 0, the U.S. Senate passed a ground-breaking amendment to the financial reform bill. Introduced by Senator Bernie Sanders of Vermont, this amendment would require an audit of all emergency actions taken by the Federal Reserve since December 1, 2007.  In addition, the amendment mandates that by December 1, 2010, the Fed reveal those who received $2 trillion in zero or near zero interest Fed loans and what those institutions did with the money.

This was the second recent “yes we can” show of bipartisanship. Last week, by a 96 -1 vote, the Senate approved an amendment introduced by Senator Barbara Boxer of California. The Senator described its purpose was to “protect taxpayers” through the creation of an “orderly process to liquidate failing financial firms and ensure that Wall Street pays to clean up its own messes.” Whether the amendment can live up to that promise is a good question. The answer depends less upon government intervention once a firm nears collapse and far more upon government prevention of the excesses that lead both to widespread failure and government support.

Continue reading “Supporting Swap Desk Spinoffs Just Got Easier” →

The Other Battle

By James Kwak

One battle in Washington — the one that has been in the news this week — is over resolution authority and the supposed “bailout fund” attacked by Mitch McConnell. Another battle will be over the Consumer Financial Protection Agency, which Republicans are likely to try to cripple behind the scenes. While most of the reviewers of 13 Bankers have seized on the call to break up big banks, few have discussed the first part of that chapter, which argues for strong consumer protection. Simon and I wrote an op-ed in The Hill to reiterate the point and warn against some of the tactics opponents may use.

“The Derivatives Dealers’ Club”

By James Kwak

Robert Litan of Brookings wrote a paper on the derivatives dealers’ club — the small group of large banks that control most of the market for certain types of derivatives, notably credit default swaps. It’s a blunt analysis of how these banks can and will impede derivatives reform in order to maintain their dominant market position and the rents that flow from it.

I haven’t had time to do it justice, so I recommend Mike Konczal’s analysis in parts one and two (but particularly one). As Konczal says, “In case you weren’t sure if you’ve heard anyone directly lay out the case on how the market and political concentration in the United States banking sector hurts consumers and increases systemic risk through both political pressures and anticompetitive levels of control of the institutions of the market, now you have.”

And note that Litan is no bomb-thrower; most recently he mounted a defense of most financial innovation (my comments here).

Taxation and Prohibition

By James Kwak

Andrew Haldane (of “doom loop” fame) has another provocative paper, “The $100 Billion Question,” delivered in Hong Kong last week. A central theme of the paper is what Haldane sets up as a debate between taxation and prohibition as approaches to solving the problem of “banking pollution” — the systemic risk externality created by the banking industry. Taxation is higher capital and liquidity requirements; prohibition is structural reforms that limit the size or scope of financial institutions. Drawing on work by Weitzman and Merton, Haldane discusses when one approach would be superior to the other.

The advantages of prohibition include modularity (ability of a system to withstand a collapse of one component), robustness (likelihood that regulations will work when needed), and better incentives (since tail risk is a function of banker behavior — not weather patterns — the risk-seeking nature of banking means that no capital level will necessarily be high enough).

Continue reading “Taxation and Prohibition” →

Greenspan: Love Him, Hate Him

By James Kwak

Alan Greenspan is just as maddening in his retirement as he was during his nineteen-year reign over the global economy. Today in his appearance before the Financial Crisis Inquiry Commission (extensive coverage by Shahien Nasiripour and Ryan McCarthy here), Greenspan seems primarily concerned with passing the buck and preserving the remaining shreds of his legacy, a pathetic quest epitomized in his “I was right 70 percent of the time” remark. At the same time, however, he does make some very blunt statements about the financial industry and financial regulation that policymakers should ignore at their peril. (I’m not saying that because Greenspan was wrong before, he must be right now; I’m saying that when the most ardent defender of free financial markets reverses course, that should increase your skepticism toward free financial markets.)

Greenspan’s prepared testimony begins with a massive attempt to pass the buck. The first two pages of his account of the financial crisis have to do with rapid economic development overseas and the accumulation of the fabled global glut of savings. But he reaches even farther back to . . . the fall of the Berlin Wall and the discrediting of communism.

Continue reading “Greenspan: Love Him, Hate Him” →

Financial Regulation and Fools

By James Kwak

Last week I disagreed with Paul Krugman’s dichotomy between limiting banks’ scale and scope and restricting banks’ risky behavior. Today Krugman has another op-ed, this time criticizing the current Senate bill for not being sufficiently “fool-resistant.” This time, I basically agree with him.

The problem with the Dodd bill, in Krugman’s words, is that “everything is left at the discretion of the Financial Stability Oversight Council, a sort of interagency task force including the chairman of the Federal Reserve, the Treasury secretary, the comptroller of the currency and the heads of five other federal agencies.” Citing Mike Konczal,* Krugman points out, “just consider who would have been on that council in 2005, which was probably the peak year for irresponsible lending” — Alan Greenspan, John Snow, and John Dugan. (If you’re following the logic of Krugman’s argument, those would be “fools.”)

Continue reading “Financial Regulation and Fools” →

Krugman on Financial Regulation

By James Kwak

Several people have asked us to comment on Paul Krugman’s op-ed yesterday (both by email and in our bookstore event yesterday), in which he contrasts the Paul Volcker school (“limiting the size and scope of the biggest banks”) with the other school (“the important thing is to regulate what banks do, not how big they get”). Krugman says he is in the latter group. But Mike Konczal* beat me to it:

“For me, it’s not an either/or but a both/and question. I think we should do both (a) and (b), impose a hard size cap of $400 billion to $500 billion and then expand regulation over all the broken-up shadow banks. If you look at the conclusion of 13 Bankers, I think Simon Johnson and James Kwak are in a similar boat.”

Continue reading “Krugman on Financial Regulation” →

A Whiff of Repo 105

The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here).  Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.

To the uninitiated, the term ‘Repo 105’ evokes the name of a basic finance course or perhaps an expensive perfume.  However, the broader implication of Lehman’s corrupt accounting strategy is neither simple nor does it pass the smell test.

While hiding $50 billion off balance sheet is nothing to sneeze at, ‘Repo 105’ may be an unfortunate distraction. We should focus our attention on a far more mainstream and dangerous use of repurchase agreements backed by securitized bonds to grow balance sheets. This practice, enabled by a 2005 legal change, directly destabilized the financial sector and led to the ultimate credit crisis of 2008. In other words, the approximately $7-10 trillion repo financing market created what Gary Gorton and Andrew Metrick call the “run on repo” or what Gerald Epstein describes as a “run on the banking system by the banking system.”

A repurchase agreement or “repo” is a two-part arrangement. The seller (cash borrower) agrees to sell securities at a slight discount to a buyer (cash lender). Under that same agreement, that original seller agrees to buy them back at a future date at a higher price. The securities are known as “collateral.” The discount is known as the margin or a “haircut.” The ratio between the increase in price and the original price is known as the rate.

With ‘Repo 105,’ Lehman, according to volume III of the examiner’s report, acting as a seller (cash borrower), treated $50 billion in repo transactions as sales instead of financing transactions. Lehman did not reveal to investors that it was doing so. In contrast, standard practice was to record these transactions on balance sheet by increasing both cash (assets on the left side) and collateralized financing (liabilities on the right side). Thus a properly recorded repo transaction results in both a larger balance sheet and also higher leverage ratios.

Not wanting to issue more equity to boost leverage ratios, Lehman instead chose a cosmetic solution. With ‘Repo 105,” near the end of a reporting period, Lehman treated the transactions as sales and used the cash proceeds to pay down other liabilities. This made the firm appear to have a smaller balance sheet and less leverage than it truly had. The transactions were called ‘Repo 105’ and ‘Repo 108’ in reference to the size of the haircut. In other words, for ‘Repo 105’ transactions, Lehman would provide collateral purportedly worth 105% of the amount of cash it received.

As we blame the bad apples at Lehman, we fail to see how recent legal changes brought about bigger problems in the repo markets and how instead of reversing these missteps, the law may instead amplify it. Indeed, as discussed below, language in the Dodd draft released Monday, March 15th suggests we have not learned some basic lessons.

Continue reading “A Whiff of Repo 105” →

Uncontrolled Lending to Consumers Spawned the Financial Crisis

This guest post was contributed by Norman I. Silber, a Professor of Law at Hofstra Law School, and Jeff Sovern , a Professor of Law at St. John’s University. They were principal drafters of a statement signed by more than eighty-five professors who teach in fields related to banking and consumer law, supporting H. 3126, which would create an independent Consumer Financial Protection Agency.  Some of the research on which this essay is based is drawn from an article by Professor Sovern.

Did under-regulated lending to consumers play a big part in destabilizing the financial system? Many knowledgeable people say yes, but Professor Todd Zywicki disagrees. (“Complex Loans Didn’t Cause the Financial Crisis,” Wall Street Journal, February 19, 2010).  He claims that the present troubles resulted from the “rational behavior of borrowers and lenders responding to misaligned incentives, not fraud or borrower stupidity.”

Professor Zywicki’s argument enjoys, at least, the modest virtue of technical accuracy, because many objectionable misleading sales practices and agreements that lenders used were, and continue to be, unfortunately, quite legal.  Lending practices may have been regularly misleading and confusing and reckless-but fraudulent?  Well, no, usually not unlawful by the remarkably low standards of the day.   But that in itself is an argument for saying consumer protection laws failed.

Continue reading “Uncontrolled Lending to Consumers Spawned the Financial Crisis” →

Is Vikram Pandit in Favor of Real Reform?

Testifying today before the TARP Congressional Oversight Panel, Citigroup CEO Vikram Pandit took pains to strike the right notes. Near the beginning of his prepared testimony, he said, “First, however, I want to thank our Government for providing Citi with TARP funds. For Citi, as for many other institutions, this investment built a bridge over the crisis to a sound footing on the other side, and it came from the American people.” Saying “thank you” may not satisfy many people, but it is a step in the right direction.

More importantly, Pandit said that Citigroup is on the side of the angels — in this case, the side of real financial reform:

“Citi supports prudent and effective reform of the financial regulatory system. America – and our trading partners – need smart, common-sense government regulation to reduce the risk of more bank failures, mortgage foreclosures, lost GDP and taxpayer bailouts. Citi embraces effective, efficient and fair regulation as an essential element in continued economic stability.”

When it comes to the substance, though, I’m not sure how much Pandit had to say that was new, although he took care to say it in the nicest way possible.

Continue reading “Is Vikram Pandit in Favor of Real Reform?” →

Dallas Fed President: Break Up Big Banks

By James Kwak

We’ve cited Thomas Hoenig, president of the Kansas City Fed, a number of times on this blog for his calls to be tougher on rescued banks and to break up banks that are too big to fail. This has been a bit unfair to Richard Fisher, president of the Dallas Fed, who has been equally outspoken on the TBTF issue (although we do cite him a couple of times in our book).

Bloomberg reports that Fisher recently called for an international agreement to break up banks that are too big to fail. Here are some quotations, taken from the Bloomberg article (the full speech is here):

“The disagreeable but sound thing to do” for firms regarded as “too big to fail” would be to “dismantle them over time into institutions that can be prudently managed and regulated across borders.”

Continue reading “Dallas Fed President: Break Up Big Banks” →

Krugman: No Bill Is Better Than a Weak Bill

By James Kwak

Paul Krugman begins this morning’s column this way:

“So here’s the situation. We’ve been through the second-worst financial crisis in the history of the world, and we’ve barely begun to recover: 29 million Americans either can’t find jobs or can’t find full-time work. Yet all momentum for serious banking reform has been lost. The question now seems to be whether we’ll get a watered-down bill or no bill at all. And I hate to say this, but the second option is starting to look preferable.”

Krugman says he would be satisfied with the House bill, but that the need to bring moderate Democrats and at least one Republican on board in the Senate could lead to a severely watered-down bill, in particular one without a Consumer Financial Protection Agency. Instead of accepting such a deal, he says:

“In summary, then, it’s time to draw a line in the sand. No reform, coupled with a campaign to name and shame the people responsible, is better than a cosmetic reform that just covers up failure to act.”

Continue reading “Krugman: No Bill Is Better Than a Weak Bill” →

The Systemic Risk Solution

By James Kwak

From The New York Times: A council of regulators chaired by the treasury secretary, with the Fed chair or his designate as the vice chair. At present, that would be Tim Geithner and Ben Bernanke.

I wouldn’t ordinarily write a whole post about this (if I just want to link to something, I try to use Twitter), but I had to point out this line by Calculated Risk:

“I can just imagine a council in 2004 and 2005 led by ex-Treasury Secretary John Snow with Alan Greenspan as Vice Chair. Yeah, that would have worked well …”

What’s a Populist?

By James Kwak

As Simon has previously discussed, “populist” has become a smear, epitomized by David Brooks’s frankly offensive attempt to classify populism as an “organization of hatreds” akin to racism and sectarianism. Brooks asserts, without support, that populism amounts to “simply bashing the rich and the powerful,” “class war,” “random attacks on enterprise and capital,” and a “zero-sum mentality” — proving that ideologies are easy to bash when you assume their properties.

“Populism” has been rolled out repeatedly over the last year to marginalize people who criticize Wall Street and the financial oligarchy as angry, know-nothing, Luddite, Trotskyist, ungrateful, envy-filled people who don’t understand the modern world and would return us to a barter economy. A search for “Krugman populist” returns 1.7 million hits. (“‘Simon Johnson’ populist” returns 180,000. ) So I was pleased to read Louis Uchitelle’s New York Times article that begins with this clever introduction:

“Put aside for a moment the populist pressure to regulate banking and trading. Ask the elder statesmen of these industries — giants like George Soros, Nicholas F. Brady, John S. Reed, William H. Donaldson and John C. Bogle — where they stand on regulation, and they will bowl you over with their populism.”

Continue reading “What’s a Populist?” →