Shocked and Persuaded

Excerpt from a project I am working on and a helpful blueprint for how to curb irresponsible activities throughout the financial services industry:

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 [275], 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.” [276] 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) always and everywhere demand that Wall Street mark all their assets and liabilities to market.

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

3) 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 [277, 278]. Increasing capital requirements is imperative from a structural perspective regardless of the country or generation in question because as Simon Johnson former IMF chief economist put it “equity capital is…“loss-absorbing,” meaning that only after losses wipe out all of the equity do they need to be apportioned between creditors. Banks’ capital, therefore, is what stands between bad loans and insolvency.” [279] However, the pushback from banks against such a TBTF firewall lies in their being a slave to returns on equity that are not adjusted for risk, which means that the socialized risk and the privatized profit are immense at the peaks and the troughs alike. Banks across the world including liberal bastions like Sweden – where capital requirements at its Big Four average 12.55% well above US institutions [280] – will forever resist this idea as “a bit strange” or “not realistic” because it prevents them from levering the farm and projected fictitiously robust quarterly earnings. To this hyperbolic phraseology former Chilean Minister of Finance Andres Velasco suggests all non-bankers “would be well advised to ask for another drink.” [281]Capital resisters have friends in high places included The Big Banks eternally unquestioning servant the New York Fed, actually would decrease capital requirements an amazing and pompous proclamation when you consider how this bank’s former boss Tim Geithner, current boss and former Goldman Sachs executive Bill Dudley, and its entire board of directors are essentially cherry picked by the banks it is charged with overseeing and hopefully scolding in bad times (Note: And the banks wonder why Main Street is skeptical of the phrase “self-regulation”.) [282]. However, even the editorial page of The Wall Street Journal far from a liberal or socialist enclave ardently backed a 14% capital floor across all implicit and explicitly TBTF firms. Unfortunately the Basel III committee that conjures up capital requirement policy on a global scale sided with the MegaBanks in requiring no more than 10% and as little as 7% for the 30 largest TBTF instutions globally, but the rub is that these requirements would not be instituted until 2019. As Jamie Dimon told his daughter when she asked him to define ‘financial crisis’ “’it’s the type of thing that happens every five, ten, seven, years.’ And she said: ‘why is everybody so surprised?’ So we shouldn’t be surprised…” So that means that if The Great Recession officially ended  in 2009 we could potentially incur 2-3 crises before the Basel consortia get their head out of their ass and take offensive rather than defensive and asymmetrically feeble measures to insure that when banks fail only the shareholders and employees pay the toll. Instead Basel has permitted another wider and deeper case of socialized risk and privatized profits for the next decade at the very least.

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

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

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

7) 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). This radical notion was supported in January 2009 by of all people Abdalla el-Badri OPEC’s secretary-general in the aftermath of his group’s most volatile peak-to-trough ever, although what we are talking about here is across the board derivatives in the commodity arena, because while oil powers machines food powers and sustains people [283].

– Worse still speculation demand is exponentially and 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!)

– Speculative commodity-linked Exchange Traded Funds (ETFs) had $277 in investments at the end of 2009, which was 50 times the $5.5 billion at the turn of the 21^st century.

– Mega lobbying shops like the Chamber of Commerce and Business Roundtable are going to have to do better than the pseudo-research they released via their intellectual servants at Keybridge Research that spoke to derivatives regulation as a 160,000 job and $6.7 billion corporate spending destroyer. As even Keybridge’s president – and former Clinton National Economic Council member – Robert Wescott said when confronted by The Times Andrew Ross Sorkin “the client had asked us” to put the report together. “It was a hypothetical study.” [284] Well that is a fine how do you do in the direction of sound and empirically derived scientific research. Just do what “the client” asks and the scientific method be damned! And economist wonder why their credibility is waning with every passing day and documentary (See “Inside Job”. No really see it you’ll be blown away by the lack of academic integrity and transparency in the likes of Columbia’s Glenn Hubbard and Frederic Mishkin or Harvard’s Martin Feldstein).

8) establishing a predatory lender watch list and agency,

9) 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 [285, 286]. This would better synchronize managers’ schemes with those of shareholders and prevent needless large scale bailouts based on “size, interconnectedness, lack of substitutability, global (cross-jurisdictional) activity and complexity”, which a report by Reuters implicates 30 of the planet’s largest commercial banks including HSBC, Deutsche Bank, and JP Morgan Chase [287],

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 is currently being used to investigate Goldman “Vampire Squid” Sachs and broadly speaking gives attorney generals “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.” [288] 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 [289].

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

[B] 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.

[C] 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.

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

[E] 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.

[F] 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 and by the SEC but one that former NY Attorney General and current Governor Andrew Cuomo didn’t take kindly to bringing charges – that were later dropped in the summer of 2011 – against Lehman’s accountant in December of 2010. Merry Christmas 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.