Shocked and Persuaded

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Separating Fact From Fiction

My Ideas for Ameliorating The Next Great Recession

The following is an excerpt from a book I am working on geared towards Generation X and the prevention of The Great Decoupling,

According to the FDIC you Mr. Big Banker (i.e., 109 banks with more than $10 billion in assets) have no qualms with giving depositors a measly 0.8% annually, while the country’s 7,651 local/smaller banks paid 1.29% vs. values of 0.49% and 0.69% in 2009 [184], respectively, even though it was you not them that we the taxpayer bailed out and we Generation X will continue to feel the austerity backlash of for years to come. It doesn’t take a rocket scientist or a fifth-grader for that matter much in the way of mental exertion to understand how easy it is to mint huge profits when you borrow money from The Fed or investors for the aforementioned paltry rates and lend it to private citizens or the Tim Geithner led Treasury at 3-4%, however, in doing so you Mr. Banker are failing to do what you most likely state in your charters “furnishing money to firms and funding capital investments.” [185] We need our banks to act as utilities not casinos. Banks must stop making in the words of the Bank of England’s Andrew Haldane mirages look like miracles and just do your boring but admittedly useful service to society absent extraordinarily leverage and quarterly bonuses. If they refuse Generation X must by any means necessary make them stop because their reckless gallivanting is only hurting the long-term viability of this country and in a more circuitous way this planet and possibly even the true principles of democracy. This will involve Generation X when we get the reins of power putting serious constraints on capitalism and more specifically the financial sector including the ten steps listed below:

1) decreasing leverage ratios to less than 10:1 (See LTCM),

2) increasing counter-cyclical capital requirements to ≥19% or even 40-50% of risk-adjusted assets (See Eugene Fama[1], Switzerland[2], and the People’s Bank of China[3]) effectively reinstating a crucial provision of the Depression-era and highly effective Glass-Steagall Act of 1933 [186, 187],

3) limiting loan-deposit spreads to ≤4.5-5%, marking everything to market all the time no exceptions,

4) graduated bank taxes based on the percentage of funding that is short-term/”hot”[4],

5) putting a 2% ceiling on the percentage of US deposits individual banks can have at any one time,

6) pushing the murky world of derivatives trading onto Over-The-Counter (OTC) exchanges and eliminating non-agriculture (i.e., necessity vs. portfolio allocation decisions) and certain energy sector participants entirely (i.e., those overweight on derivatives due to unsafe capital cushions), what Michael Masters of Masters Capital Management, LLC respectively called “Bona Fide” Physical Hedgers and Wall Street bank controlled. Translation: leave the agricultural hedging to farmers not Gordon Gecko-types whose flippant money misallocation has a disproportionate effect on global food prices given that equity markets are 240 times larger than commodity futures contracts *$44 trillion vs. $180 billion in 2004),

– Worse still speculation demand is exponentially positively correlated with commodity/food price increases creating a nasty and pro-cyclical Positive Feedback Loop of Mass Destruction (PFLMD).

– The Traditional Speculators “provide liquidity by both buying and selling futures”, while the nascent Index Speculator Mafia “buy futures and then roll their positions by buying calendar spreads. They never sell. Therefore, they consume liquidity and provide zero benefit to the futures markets.” (i.e., Zero Social Benefit!)

7) establishing a predatory lender watch list and agency,

8) reengineering bonus payouts in a manner similar to what is commonly called “contingent core Tier-1 capital” or “CoCo” whereby deferred, say 10-years, payments convert to bonds in the long-term if bank’s Tier-1 capital falls below some predefined safety cutoff (See 2 above) preventing the intoxication brought on by short-term profitable but highly levered ventures [188, 189]. This would better synchronize managers’ schemes with those of shareholders,

9) eliminating the influence and conflicts of interest associated with the Big Three rating (i.e., Moody’s Corp, Fitch Rating[5]), Standard and Poor’s) and accounting (i.e., Deloitte Touche Tohmatsu, Prcewaterhouse Coopers, Ernst & Young, and KPMG[6]) firms as both trios are corrupt and painfully lagging indicators of reality OR explicitly writing into law that the rating firms must be paid at all times by purchasers rather than issuers, and

10) a federal version of New York’s 1921 Martin Act which gives the attorney general “broad powers to pursue financial corruption and a wide berth to conduct civil or criminal investigations by issuing subpoenas, taking depositions and compelling document production.” [190] The Act was employed with a high degree of efficacy and bite by New York’s recent AGs turned Governor Andrew Cuomo and Eliot Spitzer.

11) demanding that all bonuses for all employees be directly coupled to a given bank’s most risky ventures in the form of restricted stocks that can’t be sold an earlier than 5-10 years from the day they are issued, and require that at least eighty cents of every dollar in revenues comes from raising capital for companies and advising small businesses on how to grow and increase employment in this country not somewhere else. As it stands only fourteen cents in every dollar goes towards the latter, while the eight cents mentioned is derived from buying and selling of securities according to John Cassidy [191].

184. Cox, R., Still too big, in Reuters Breakingviews. 2010, Reuters: New York, NY.

185. Cassidy, J., The Economy: Why They Failed, in The New York Review of Books. 2010: New York, NY.

186. Staff, Regulating Swiss banks: First mover, in The Economist. 2010: London, UK.

187. Gang, F., China’s Monetary Sterilization, in Project Syndicate. 2010: Prague, Czech Republic.

188. Cox, R., Loco for CoCos, in Reuters Breakingviews. 2010, Reuters: New York, NY.

189. Staff, Contingent capital: CoCo nuts, in The Economist. 2010: London, UK.

190. Lattman, P., Cuomo Sues Ernst & Young Over Lehman, in DealBook, A.R. Sorkin, Editor. 2010, The New York Times: New York, NY.

191. Cassidy, J., What Good Is Wall Street? Much of what investment bankers do is socially worthless, in The New Yorker. 2010.


[1] The father of the “Efficient Market Hypothesis” told CNBC’s “Squawk Box” host Joe Kernen on Friday May 28th, 2010 that elevated capital requirements needed to be discussed as a pushback mechanism against TBTF and TBTS banks.

[2] As was noted earlier Switzerland’s Big Two Credit Suisse and UBS have combined assets in excess of 6.5×GDP, which means if they can impose these types of restrictions we can most assuredly to the same or stronger here in The States where the same figure for our 8,430 FDIC-insured banks is 70% of GDP.

[3] In the immediate aftermath of The Fed’s QE2 bombshell the People’s Bank of China announced its equivalent of an increase in capital although they call it the Required Reserve Ratio (RRR) to 18.5%. The PBC wanted to “sterilize over-liquidity and get the money supply under control in order to prevent inflation or over-heating” in the event that “hot” capital began to flow en masse into China as it was only 1997 that their Asian Tiger neighbors failed to do so and were scorched once by speculative yield hogs and secondly by the IMF and World Bank’s lending based on vertical and lateral imposition of austerity.

[4] Short-term/”hot” makes banks great and small more susceptible to liquidity crises and likely to require substantial bailouts.

[5] The rating agency’s good seal of approval was instrumental if not required to create the $3.2 trillion of subprime mortgages that exploded before our eyes in 2007-2008.

[6] This was once the Big Five until a little firm called Enron and its accountant Arthur Andersen blew up in 2002. In March of 2010 we saw a redux of the disastrous consequences of the intimate accountant-banker relationship with the Repo 105 scandal that embroiled Ernst & Young’s tacit approval of Lehman Brothers construction of such transactions. Repo 105 quite simply is an accounting trick whereby a firm in this case Lehman Brothers sells some of its assets in the short-term (i.e., days or weeks) to another party and books the transaction as a sale even though the cash it receives to delever is used – following a public audit of its balance sheet – to repurchase or Repo those dodgy assets with interest. Lehman performed this kind of dodgy accounting with the assistance of Ernst & Young just before the end of financial quarters in order to facilitate its balance sheets mustard test. This was a practice that was implicitly approved of throughout Wall Street but one that former NY Attorney General and current Governor Andrew Cuomo didn’t take kindly to bringing charges against Lehman’s accountant in December of 2010. Merry Christmans Ernst & Young! This Repo market boomed just prior to The Great Recession to $12 trillion according to Yale economist Gary Gorton. In normal times these transaction don’t remove the highly levered assets from the bank’s balance sheet but low and behold Ernst & Young broke out the whiteout for their friends over at Lehman, with the “105” coming from the fact that the bonds Lehman was selling were worth 105% of what they were being sold for allowing the buyer to make a healthy profit upon repurchase days later. According to the Chapter 11 Proceedings Report filed by the law firm Jenner & Block “Lehman did not disclose its use…of Repo 105 to the Government, to the rating agencies, to its investors, or to its own Board.” Notice the report said nothing about Lehman’s accountant Ernst & Young. This Repo 105 technique was a nontrivial component of Lehman’s efforts to stay afloat as it was used to push $50 billion off of its ledger in Q2 of 2008.

Category: Economics

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