Tag Archives: too big to fail

IT’S OFFICIAL: TOO BIG TO FAIL IS ALIVE AND WELL

By L. Randall Wray

Thank heaven for Tom Hoenig, the only proven-honest central banker we’ve got. Yes, I know he’s moved on from the KC Fed to serve as Vice Chairman of the FDIC. He actually might do a lot more good over there, anyway.

In recent months, we’ve heard how Wall Street’s Blood-sucking Vampire Squids have reformed themselves. They no longer pose any danger to our economy. They’ve written “living wills” that describe how they’ll safely bury themselves without Uncle Sam’s help next time they implode.

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The U.S. Attorney Who Prosecutes JPMorgan Will Be Its First Witness

By William K. Black
(Cross Posted at Benzinga.com)

The U.S. Attorney for the Eastern District of California is Benjamin Wagner.

“Once the U.S. government built a case against J.P. Morgan and settlement talks began, the Justice Department made several threats that it would file its civil lawsuit, and each time J.P. Morgan responded by offering to talk more or increase the amount of money it might pay, the people familiar with the discussions said.

One critical moment came as the department set an internal deadline, Sept. 24, to file a suit against the bank.

The day before the deadline, the bank offered to pay $3 billion to settle a case tied to mortgage-backed securities—an offer the attorney general rejected. That same day, Ben Wagner, the U.S. attorney from Sacramento, Calif., flew to Washington with two large charts he meant to display at a news conference describing the bank’s alleged misconduct. A criminal and civil investigation into J.P. Morgan’s past sale of mortgages bonds had been handled by Mr. Wagner’s office.”

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The “Lessons” that Wall Street, Treasury, and the White House Need You to Believe Five Years After the Collapse of Lehman Brothers

By Robert E. Prasch
Department of Economics
Middlebury College

Five long years have passed since the demise of the once venerable firm of Lehman Brothers. To mark the occasion, Wall Street, the United States Treasury Department, the White House, and their several political proxies and spokespersons have taken to the mass media to instruct the public in the “lessons” to be drawn from the financial crisis of 2007-09. Regrettably, we are witnessing the propagation of several self-serving falsehoods in the hope that the public can be induced to embrace them now that the immediacy of the events in question is in the past. Some of the lessons are so flagrantly false that they demand immediate correction.

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NEP’s Bill Black Appears On CCTV’s Biz Asia America

CCTV America’s Phillip Yin speaks with Bill Black about new US bank regulations. Bill warns against ‘too big to fail institutions’ and the attempts to create a ‘tame tiger’ through policy, which he believes is a reckless path to the next financial crisis

Brown-Vitter Will Not and Cannot Work but it is Criminogenic

By William K. Black

Introduction

Senators Sherrod Brown (D-OH) and David Vitter (R-LA) have introduced a bill entitled “Terminating Bailouts for Taxpayer Fairness Act of 2013.”  It is a miracle of modern staffing that Vitter, who loves polluters as much as his prostitutes, was able to pull himself away from demanding that President Obama’s nominee to run the EPA answer over 600 questions and join Brown in proposing the bill.  Under Obama, bipartisan bills have a dismal fate because the Democrats negotiate away key elements necessary to create a good bill and add provisions that make parts of the bill harmful – just to pick up a few token co-sponsors – and then the Republicans kill good parts of the bill anyway and try to enact the bad parts. Continue reading

Why did Obama and Cameron save a Criminal Enterprise like HSBC?

By William K. Black

Why is HSBC still in operation?  On the same day (December 10, 2012) that the Obama administration leaked the story of the HSBC settlement a story ran in the New York Times that was full of self-praise by the Obama and Cameron (U.K.) governments for their “cooperative approach” to cracking down on systemically dangerous institutions (SDIs).  SDIs are treated as “too big to fail” because they pose a global systemic risk when they fail.  The HSBC settlement puts the lie to the Obama/Cameron crack-down on the SDIs for it revealed a disgrace – Obama and Cameron treat the SDIs as too big to prosecute.  Indeed, HSBC demonstrates that the SDIs’ senior officers are treated by Obama and Cameron as too elite to prosecute.   The propaganda meme of the NYT story – that the SDIs would never again be given special favors due to reforms being adopted by Obama and Cameron – lasted four hours before it was destroyed by the disgraceful reality of the Obama and Cameron governments’ refusal to prosecute HSBC and its officers for their tens of thousands of felonies.

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Romney implicitly endorses Too Big to Fail Banks

By William K. Black
(Cross posted at Benzinga.com)

I explained in a prior column that Gregory Mankiw, Governor Romney’s lead economist, wrote a column endorsing the regulatory “competition in laxity.”  “Romney’s Lead Economist Urges Policies that will Cause the Next Financial Crisis.”  One of the key events in “winning” the regulatory race to the bottom is welcoming significantly dangerous institutions (SDIs).  The SDIs are the leading contributor to U.S. politicians – and the politicians of many nations).  The difficulty is that “too big to fail” (TBTF) institutions are unpopular with both parties’ voters.  Historically, TBTF was a misleading phrase, for TBTF banks could fail.  TBTF actually meant that the general creditors would be bailed out by the government.

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Embedded Examiners always married the Natives, but now their Bosses Do Hook Ups

By William K. Black
(Cross-posted from Benzinga.com)

Jessica Silver-Greenberg and Ben Protess have written an extraordinarily important column for the New York Times about embedded examiners at JPMorgan.

Embedded examiners’ are federal regulators whose normal work station is a desk at the bank.  We only embed examiners for systemically dangerous institutions (SDIs) – banks so large that they pose a systemic risk to global economy.

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William K. Black on the MF Global Cover-up: “All those that doeth Evil hateth the light!”

Did Dodd-Frank Act End “Too Big To Fail”?

By Robert E. Prasch

Since the triumphal passage of the Dodd-Frank Wall Street Regulation and Consumer Protection Act on 21st of July 2010, we have been told repeatedly that the United States would “never again” be confronted with a “choice” between bailing out a large insolvent financial institution “or else.” If so, this means that one of the most pernicious and damaging features of capitalism has been forever solved. Were we convinced that the 111th Congress and the Obama Administration had actually achieved this, all right-minded persons would surely exclaim, “What a gift to the country, what a gift to humanity!” Yet, it is evident that few of us are doing that. Is the problem in ourselves? Are American voters hopeless ingrates? Or, is it that our suspicions are well-grounded?


With the emergence of Occupy Wall Street only a year before the 2012 elections, the prospects and promise of the Dodd-Frank Act is – as it should be — pivotal to our assessment of the record of this Congress and Administration. As such, let us take a moment to contemplate the specifics of the much-vaunted process that – we are told – will ensure the most important promise of Dodd-Frank – the anticipation and prevention of another fantastically costly bailout. The recent and very public troubles of Bank of America suggest that a test may be coming soon. If Dodd-Frank works as advertised, BofA’s pending failure should not cost the public a cent – and that certainly is good news, is it not? 

To assess this core claim of Dodd-Frank, let us contemplate the specifics of the process that will — we have been told — successfully identify, take over, and resolve large systemically important financial institutions before they fail. To reiterate, we have been told that firms fitting this description can and will be taken over before they are insolvent, and especially before the problem becomes a charge on the public purse. As this process is best understood by an example, let us begin by supposing that one of the nation’s largest systemically important bank holding companies (BHC) is in trouble (although it could be any financial institution designated previously as systemically important). Let us further suppose that this BHC – as so many do — relies upon short-term borrowing in the markets to support a highly-leveraged portfolio of speculative, risky, and now-troubled assets. To keep it real, let us suppose that few of these assets can be traded and thereby “priced” in open or competitive markets. It is, of course, unnecessary to point out that when traders and senior managers put together these deals they greatly enriched themselves. But, they have long since cashed their bonus checks, so the problem now belongs to the bank – and potentially the public.

Today, the BHC’s stock price is falling, credit default swap premiums on its assets and the debt it issues are rising, and counter-parties are demanding ever-greater collateral to provide short-term financing. Many money-managers who have had long-standing lending relationships with this bank are refusing to provide further financing at any price, and large clients are beginning to withdraw their funds and move their accounts. Stated bluntly, the future of this firm is bleak and the situation is worsening at an accelerating pace.

What happens now? The bank’s first defense is — as always — a flat-out denial that they are in trouble. But such protests are unlikely to convince its peers, big-time money managers, or other savvy counter-parties or players. In the nineteenth century, it used to be said that if a lady had to publically defend her reputation, it was too late. Times may have changed in these matters, but for financial institutions this old adage remains true. A need to publically proclaim its solvency can — and should — be taken as prima facie evidence that a bank either is, or is about to be, insolvent. Let us, then, suppose that the situation continues to worsen for our hypothetical firm.

The bank’s second step is to highlight its internal audit, along with the clean bill of health it has received from its highly reputable outside accountants and lawyers. Wall Street will not be convinced. Why? Because they know that these audits are readily and routinely rigged through “creative accounting.” To illustrate this point, I have my classes guess how many quarterly earnings statements showed losses at New Century Financial before its massive collapse in March 2007. The answer, dear reader, is zero. The process by which one goes from being a high-flying and highly-profitable darling of financial innovation to catastrophic bankruptcy without ever passing through an unprofitable quarter is, I will submit, “complicated.” Indeed, the SEC also thought that it was “complicated” and brought a suit. Unfortunately, this suit was settled for essentially a pittance – a “lesson” not lost on other Wall Street players and those who are obliged to interact with them. Least this case be considered a singular event, I remind them that S&P gave Lehman Brothers an “A” rating until weeks before its collapse. Similar examples abound throughout this and earlier crises.

Third, an upsurge of campaign “donations” from the troubled BHC will ensure that at a substantial portion – if not a majority — of Congresspersons will avidly assent to the firm’s own assessment of its condition and prospects (Let us note that if it is indeed insolvent, these donations and other lobbying and public relations expenses are de facto additions to the federal debt). Although the reasoning and arguments then presented to the public by these august tribunes of the people might be embarrassingly shallow, we can be sure that they will lean on the political appointees heading the regulatory agencies to take “a broad interpretation” of the situation. Simultaneously, the bank’s senior compliance and legal advisors, who in all likelihood are former senior staff at the regulatory agencies to which it answers, will contact their old colleagues to argue and reargue the bank’s version of its financial condition. They will emphasize its singularly sunny prospects for future success.

Let me digress by observing that it will not escape the attention of those who staff the government’s regulatory agencies that their former colleagues have moved into substantially higher tax brackets and much tonier neighborhoods. To that end, perhaps we should allow our regulators to indulge in a moment of wistfulness. After all, in the aftermath of such reunions it is only human to feel somewhat conscious of one’s own comparably modest socio-economic status. If our public servants are at all like most people, they might pause to consider a career move… But such ruminations are beside the point. Or are they?

Let us suppose that our regulators remain stalwart, undaunted, resolute, and unmoved by such considerations. They are good people, professionals who readily eschew fantastic opportunities to remain faithful public servants. Nevertheless, as a consequence of the bank’s previous moves, Congress is in an uproar, the White House is worried, and Wall Street has closed ranks behind the bank (the latter are sufficiently intertwined with its fortunes that they stand to take large losses). Outside of the halls of power, think-tank “experts,” television “opinion leaders,” newspaper reporters, and editorialists are running unfavorable stories about the supposed “anti-market” bias of regulators, etc. Meanwhile, the regulators, if they are doing their job properly, are not conducting interviews or discussing the story with the media. Consequently, their side of the story – and only they have access to the bank’s balance sheet – is underrepresented in the press. Moreover, those few newspapers running stories that suggest that the bank’s problems may be real will be accused of being irresponsible or anti-business. They may even have been – quietly — threatened with lawsuits claiming libel. We should recall that even spurious lawsuits can be expensive for most daily or weekly newspapers.

As the disinformation campaign moves into high gear, the regulators must get the Board of Directors of the FDIC to vote that this bank is on the brink of collapse and for that reason should be taken over quickly, before it becomes insolvent and thereby a public charge. This Board, let us recollect, is made up of three permanent members serving six year terms in addition to the head of the Office of the Comptroller of the Currency and the head of the Office of Thrift Supervision, who both serve in ex officio status. All of them are appointed by the President with Senate approval and no more than three of the five of them may be from the same political party. Stated simply, the Board may represent a variety of views, but we can be confident that the largest financial institutions have had an opportunity to carefully vet all of the participants in the discussion. After all, few administrations or senators have the stomach to fight the nation’s most powerful industry over what — to the public — may appear to be relatively obscure bureaucratic appointments. However, to give credit where it is due, over the last five years the FDIC is one of the few agencies to have shown some life in regulatory matters. One reason may be the personalities involved. Another may be that it is their funds that are used to cover depositors’ accounts and, for that reason, they are the agency left “holding the bag” in the event of a catastrophic failure.

Supposing that the FDIC has decided that this bank must be resolved, the next to vote is the Federal Stability Oversight Council (FSOC). This group is Chaired by the Secretary of the Treasury and its nine other voting members include the Chairman of the Federal Reserve Board, the Chair of the Commodity Futures Trading Corporation, the Comptroller of the Currency, the Chair of the Securities and Exchange Commission, etc. Each and every one of these individuals took their positions only after a Presidential appointment and a Senate hearing. Once again, banker views were fully present and accounted for. In short, these are people known in Wall Street/D.C. circles for their “sound views” — that is to say long-standing sympathy toward politically prominent banks, bankers, and related financial institutions. In many if not most instances, they were themselves formerly bankers or worked in law or accounting firms catering to the financial sector. This characterization also describes the bulk of their deputies. The final step is to formerly notify and advise the President of the FSOC’s decision. While lawyers and others who have examined Frank-Dodd have not agreed as to whether the President has the authority to override a vote of the FSOC, it is difficult to imagine that these several senior appointees would have allowed the process to advance this far without White House approval.

Now, let us recall that all of the above will occur as the large financial institution in question is in the throes of a rapid and accelerating downward spiral – yet it is supposed to be completed even as the firm remains – if just barely – solvent. While the Feds might try to keep their deliberations a secret, it is hard to imagine that financial markets will long remain in the dark about them. For that reason, the bank in question will find that it must post ever-greater collateral to retain the short-term financing it requires to operate. Credit Default Swaps will soar, ratings agencies might decide to (belatedly) issue a downgrade on the firm’s debt, and the bank will struggle to place its commercial paper or otherwise raise funds. Consequently, it will become increasingly dependent upon the Fed’s Discount Lending facility, which means that that latter institution stands to be even more embarrassed by the pending failure, and for that reason inclined to postpone the resolution of this bank.

Since the passage of Dodd-Frank a year ago, I have attended multiple conferences in a variety of locations in the United States and Canada. At each of them, I have informally polled a range of colleagues studying monetary and financial economics to find out if they believed that the above process has any chance of working as described. I specifically ask them if they believe that the FDIC and FSOC could (1) identify a pending failure some time before it becomes insolvent, and then (2) organize the regulatory and political will to take over a massive, interconnected, and politically powerful institution, and (3) navigate the process of arriving at a decision in a time frame sufficiently short to avoid a massive run on the institution, a run that could readily spread to similar institutions and to those firms dependent upon them. Let us recall that the prevention of just such a run is the primary task of financial regulation. To date, I have not found a single individual who believes that it will work.

For myself, I will continue to accept the view of Vermont Senator Bernie Sanders (I-VT), that “If an institution is too big to fail, it is too big to exist.” Despite what we were told, alternatives to Frank-Dodd do, and did, exist. For example, on November 6th 2009, Senator Sanders introduced legislation that would give the Secretary of the Treasury 90 days to report to the Senate with a list of commercial banks, investment banks, hedge funds, insurance companies, and other financial institutions that were “Too Big To Fail” (TBTF). The Secretary would then be granted a year from the date of that report to break them up. Sanders’ bill was not taken up.

Later, Senators Sharrod Brown (D-OH) and Ted Kaufman (D-DE) actually got a bill called the SAFE Banking Act of 2010 to the Senate floor. It would have imposed binding leverage and liability limits on bank holding companies and financial institutions, thereby effectively breaking up the largest of them. This bill was opposed by most Republicans and leading Senate Democrats (including Senators C. Dodd (CT), D. Feinstein (CA), J. Kerry, and both Senators from New York and New Jersey). The White House and the Treasury Department were also opposed. Unsurprisingly, it failed by a vote of 61-33 on June 17th, 2010 despite attracting the support of three Republicans. Senator Judd Gregg (R-NH), whose “centrist” views had once moved the Obama Administration to nominate him for Secretary of Commerce, summarized the sentiments of those voting against this act, “I don’t understand this Brown-Kaufman Amendment. Basically, what it says is if you’re successful … you’re going to break them up? I mean, where does this stop?”

Alternatives to Frank-Dodd’s cumbersome resolution authority clearly exist, and continue to exist. The key is prevention – do not allow individual banks to become so large or so leveraged as to threaten the system (while the system itself can be a source of risk, that is a separate issue). The problem was and remains a lack of political will on the part of both political parties. On the matter of Too Big To Fail, Occupy Wall Street and the broader American public are themselves asking, “Where does this stop?” Good question, maybe the Senator from New Hampshire, one of his colleagues from the Democratic Party, or someone from the Treasury or the White House will deign to let us know. 

Robert E. Prasch is Professor of Economics at Middlebury College where he teaches courses on Monetary Theory and Policy, Macroeconomics, the History of Economic Thought, and American Economic History. His latest book is How Markets Work: Supply, Demand and the ‘Real World’ (Edward Elgar, 2008).