Regulation

Obama Sees Through Glass-Steagall Darkly; Cantwell Shineth In Darkness

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A ragtag team of misfits pulls together to beat the mighty American economy into submission.

The good news about President Obama's proposed new banking regulations is that they're mostly irrelevant. Here's how the president described the new regs in an appearance this morning:

First, we should no longer allow banks to stray too far from their central mission of serving their customers.  In recent years, too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward.  And these firms have taken these risks while benefiting from special financial privileges that are reserved only for banks.

Our government provides deposit insurance and other safeguards and guarantees to firms that operate banks…

But these privileges were not created to bestow banks operating hedge funds or private equity funds with an unfair advantage.  When banks benefit from the safety net that taxpayers provide –- which includes lower-cost capital –- it is not appropriate for them to turn around and use that cheap money to trade for profit.  And that is especially true when this kind of trading often puts banks in direct conflict with their customers' interests…

It's for these reasons that I'm proposing a simple and common-sense reform, which we're calling the "Volcker Rule"—after this tall guy behind me.  Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers.  If financial firms want to trade for profit, that's something they're free to do.  Indeed, doing so –- responsibly –- is a good thing for the markets and the economy.  But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.

In addition, as part of our efforts to protect against future crises, I'm also proposing that we prevent the further consolidation of our financial system.  There has long been a deposit cap in place to guard against too much risk being concentrated in a single bank.  The same principle should apply to wider forms of funding employed by large financial institutions in today's economy.  The American people will not be served by a financial system that comprises just a few massive firms.  That's not good for consumers; it's not good for the economy.  And through this policy, that is an outcome we will avoid.

Whip Inflation Now.

Despite or because of the combative tone of Obama's remarks (among other things the president declared himself "ready to have…a fight" with congressional and financial leaders), White House economic advisor Austan Goolsbee has been dispatched to deny that the president is seeking to re-impose the Depression-era Glass-Steagall Act. David Corn has a nice roundup of Goolsbeeisms. Corn also notes that the podium positioning and name checking at this morning's event were all about former Fed Chairman Paul Volcker and not at all about Treasury Secretary Tim Geithner, advisor Christina Romer, or any other members of the president's brain trust.

What will the new regs do? Not much. Commercial banks already have capital limits on affiliate investments, and the repeal of some Glass-Steagall provisions under Bill Clinton, after a flurry of interest in 2008, turned out to have had little to do with the long-overdue correction in the still-inflated real estate market. Nor would investment limits have prevented, for example, the failure of a bank like Countrywide, which went down on the basis of bad mortgages. (Even commies agree that mortgage lending is a basic operation of a bank, and there's nothing in the proposal that would do anything to change that—though it might limit a bank's exposure to the mortgage-backed securities market.)

The distance between the president's proposal and the behavior of the financial markets can be seen in this exchange between Sen. Maria Cantwell (D-Washington) and a CNBC panel. Under heavy questioning, Cantwell waxes metaphorical, with flames burning up dark markets and grand implosions:

We have a lot of work to do to get money flowing again to small businesses. We have something like an 83 percent increase in small business bankruptcies, and still the money is going through these large institutions into dark markets.

But Sen. Cantwell, I think that what Sue's getting at: Many people are saying that restoring Glass-Steagall would not have prevented the financial crisis.

Oh I think that you have to be specific about the details, but clearly a line like Glass-Steagall is important and in making sure federal regulators don't write any loopholes into the statute that allow them to get around Glass-Steagall.

Sen. Cantwell, aren't you afraid that if we do this we hobble U.S. banks and we let foreign banks become far larger and beat em to the punch.

No, I'm concerned that the standard of the United States, if it continues to be allowing dark market activity with reserves of U.S. deposits, that that kind of activity around the globe will funnel into an even larger implosion than what we saw in September of 2008.

Do we know for sure, guys, that deposits went into this stuff? I thought the bank's own capital did, but there were rules, even with the elimination of Glass-Steagall, that prevented banks from using deposits for high-risk stuff.

No, it's the capitalization of those deposits, the capitalization of them.

Sen. Cantwell, correct me if I'm wrong here, but an awful lot of companies that seemed to precipitate this crisis, like Bear Stearns, or became victims of it like Lehman, weren't sort of federally regulated banks, and neither was Morgan Stanley nor was Goldman Sachs in a major way at the time the crisis was at its worst. They weren't really banking operations, they were trading houses. So how does this then do away with some of the problems—and AIG as Sue mentioned—how does this do away with the problems that we all think are systemic risk?

It isn't a solution in and off itself to the problem that you have a derivatives market that is a dark market, not on exchanges and without transparency. But when you combine the commercial banking and the investment banking, you add fuel to that fire that is burning in the dark markets, and it implodes to a much grander scale as we saw with credit default swaps. So they are related but separate issues. And I think Mr. Volcker has spoken out saying you have to have the over the counter derivative markets excluded from commercial banking.

I had thought it was illegal even now under the rules, to use depositor money for risky stuff, and you said it's the way they capitalize deposits. I'm not sure I understand that. Could you explain that to me please?

Well, when you take commercial banking and merge it with investment banking, and obviously a lot of money is flowing into over the counter derivatives, and my objection is not enough is flowing into business investment, into manufacturing, into small business activities. People are making a ton of money creating something like a $50 billion derivatives market, much of which is dark.

Update: Jake Tapper reports that Geithner is getting cold feet about the plan too. Thanks to commenter virginia for sending along Mish Shedlock's tentative thumbs up for the proposal. Mish also argues for removing Goldman Sachs' status as a protected bank holding company. Goldman's status as a mom and pop bank is certainly one of the largest and most obvious frauds currently being perpetrated. As far as I can tell, Goldman has not made a single gesture at developing a retail banking arm since issuing a press release to that effect almost two years ago.

NEXT: Reason.tv: Tim Carney on "Obamanomics"—Crony capitalism disguised as progressive reform

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  1. Tim is the most poetic of the reason contributors.

  2. Once again I have to admit ignorance on financial stuff. What the heck is a dark market?

    1. Ben,
      Do you remember the Dark land of Mordor in the ‘Lord of the Rings.’ “Dark Markets” are like Mordor
      — fictional lands made up by retards like Cantwell.

      1. No, I think Dark Market was in that one Fafhrd and Grey Mouser story, the one in which Ningauble of the Seven Eyes and Sheelba of the Eyeless Face band together to protect the world form alien Devourers….

        1. It runs at ludicrous speed, out pacing the regulators. food that burns fat | lose belly fat in 2 weeks

    2. This doesn’t seem to be the answer, but I’m still looking.

    3. My understanding is that dark markets are essentially securities exchanges, like the NYSE, that are run entirely privately, allowing very big market players to do their transactions invisibly from the public markets.

    4. I think she meant ‘Opaque Markets’ (which sort of makes sense) but being a drolling moron, she mixed it up.

      1. Believe me “dark markets” is going to be the new catch phrase used by the typical scaremongers to drum up support for this regulation.

    5. It runs at ludicrous speed, out pacing the regulators.

  3. Will the new regs protect bankers from having their children terrorized at school by the likes of NACA?

  4. EEEK DARKIES!!!!

  5. Damn straight, brotherben. What the hell is a dark market? Whatever Cantwell doesn’t understand.

    1. See above and learn your other world history you alleged Syth.

  6. I’ve been running a dark market for years now. I don’t report my full income so I’m taking taxpayer money and funneling into dark enterprises. Such as a car, tuition, and, of course, bourbon. Mmmmmmmmmmm. Bourbon.

    1. I was thinking that too. They are using dark instead of black. Are they going to start calling Blacks “Darkies” too? Senator Reid, ruling please?

  7. What the heck is a dark market?

    The opposite of “redlining.”

  8. So, I take it that the light-skinned markets are OK with Sen. Cantwell. Sen. Reid says, “Two enthusiastic thumbs up!”

  9. You want to know why whatever Congress decides to do with financial oversight will be wrong? Read no further than the above comments by the distinguished Senator.

  10. That last Q/A was classic! Can you explain what you mean? No, because I have no idea what I’m talking about.

    Glass-Stegall or lack thereof has nothing to do with commercial banks being insolvent. Having far too few reserves for their losses in assets is what makes them insolvent.

    Once again, Obama either purposely skirts the real issue or is too stupid to understand it. We can make depositors whole, even if we have to print money to do it. It IS inflationary, but it’s a one-time payout per affected depositor so it isn’t perpetual inflation. But what about pension funds? Those are insolvent too, and it’s not a one-and-done payment unless you give major haircuts to the defined benefits – which will ruin whoever happens to be in the seat of power when they happen. Making pension funds whole will be a major, perpetual inflation event.

    And of course there’s Paul Volcker – the man who refuses to acknowledge that his massive upping of interest rates stopped the inflation problem but started the S&L crisis… which led to the blurring of the lines between investment and commercial banking in the first place.

    1. The S & L crisis was the result of congresscritters changing the laws to allow ridiculous amounts of leverage. A few investors could pool together $450,000 or so, get about 10x that amount in loans from the Fed, and then invest that in CCC-rated bonds making 15%. It was a gold mine until the companies with the high-yield bonds stopped paying.

      1. The S & L crisis was the result of

        a lot of different things. Hell, you could blame part of it on the (otherwise welcome) Tax Reform Act of 1986, because by reducing the value of money-losing real estate as tax shelters, it caused it to go down in value unexpected and made various bets go sour.

      2. The S & L crisis was the result of congresscritters changing the laws to allow ridiculous amounts of leverage.

        …. because S&L’s were restricted to home loans and therefore had assets on their books all earning next to nothing because they were written at 7% while the inflation rate was 15%; they were losing gobs of money.

        You are correct that the cure was even worse than the disease, I am merely pointing out that Volcker didn’t think shit through enough before he started begging congress to make these changes lest S&L’s go under. And now again he isn’t thinking stuff all the way through. Volcker takes ten minutes to make up his mind instead of the typical 8 seconds in D.C. But it’s still pretty fuckin’ lazy.

  11. Banks take depositors money and invest them in stuff that makes more than they pay out. Thats what they do. The distinction between a “hedge fund” or writing a mortgage on a local house is wholly arbitrary. They both have non-zero risks.Is FDIC membership going to come with new risk metric strings attached? That wouldn’t really that bad AFAIK. I mean FDIC shouldn’t really exist in the first place, so making it harder to use would be fine with me. But it’ll probably just end up providing new space for regulatory arbitrage, which is part of how we got here.

    How bout this Mr Obama? If you want to stick it to the bankers, why don’t you stop using the federal government to prop up the banking cartel? You know, the Federal Reserve. Do something like that, and maybe I’ll buy this new-founded anti-banker populist rage schtick you are trying to pull off. Until then it smells like BS to me.

    1. Agree regarding the Fed; however, your point about the distinction between hedge funds and mortgage lending is intentional oversimplification. The scale of leverage and the lack of opacity regarding prices and value of highly leveraged investments such as CDOs is precisely why there should be (and it seems that there will be) higher minimum capital requirements on banks. However, it’s a bit absurd to suggest that commercial banks – who take deposits from individuals (most of whom are not particularly sophisticated investors) and use that money to then trade in hard to value securities for the banks’ own account – and on top of it all, not give the depositors much of a return on that money. I think this move is one of the first smart moves that #44 has made in a long time.

      Moreover, using an exchange from a CNBC panel of Wall Street cheerleaders is not exactly a reasonable foundation for making an argument against this regulation. Most everyone here knows that most of our Senators are fairly clueless, save for the ability of their staffers to cut the big pieces of policy into digestible pieces for them.

      1. Re-reading this, I wasn’t as clear as I could have been regarding the use of depositors’ money. No, the money is not directly used – that’s where Cantwell was shown to be clueless. However, the deposits serve as a capital base that then allows the banks to leverage up and effectively put depositors’ money at risk. There used to be a Net Cap rule for broker-dealers but that was repealed for big B-Ds, with the result that these folks could take on a ton of debt through prop trading operations (much of it not adequately disclosed) and as a result, contribute heavily to the problems that we saw in 2008. While that wasn’t the whole of it, it was one of the important factors – and I’ve seen no evidence to suggest otherwise.

  12. Cantwell and Obama don’t seem to understand the concepts of a bank holding company and non-bank affiliates.

  13. Does this mean that Obama is anti-semitic now? He did say something bad about banks, and everybody knows thats just dog-whistle-secret-code for anti-semitism, right?

  14. Mish thinks it’ll prevent some fraud, like Government Sachs front-running trades.

    http://globaleconomicanalysis……-wish.html

    but yeah, that’s about it from Glass Steagall.

  15. I don’t see Obama and Volcker, I see Dan Aykroyd and Eddie Murphy talking about their $1 bet to make themselves rich and the other guys poor (Trading Places, such a timely movie)

  16. Darth Volcker is only a pawn of The Emperor.

  17. There are a number of absurdities about all this. Among them…

    Some of the behemoths the government wants to break up now were forced to merge by the government. …by some of the same regulators now calling for them to be broken up!

    Really, go back and look at the headlines from the time. How much of a choice did BofA have when they “acquired” Merrill Lynch? Apparently not much…

    “Congressional testimony by Bank of American CEO Kenneth Lewis, as well as internal emails released by the House Oversight Committee, indicate that Bank of America was threatened with the firings of the management and board of Bank of America as well as damaging the relationship between the bank and federal regulators, if Bank of America did not go through with the acquisition of Merrill Lynch.”

    http://en.wikipedia.org/wiki/M…..of_America

    Another example of the same thing, Washington Mutual, despite being in compliance with all reserve requirements, was seized by the OTS and “sold” by the FDIC to JP Morgan in a secret auction.

    http://en.wikipedia.org/wiki/W…..S_and_FDIC

    …by the same FDIC chair that’s still in Obama’s administration today!

    In addition to forcing these commercial and retail banks together in the first place, only to try to tear them apart now, you know what else is absurd about what the government’s doing?

    The timing.

    This was a credit led recession, and in case people haven’t noticed, we have a lot of unemployed people in this country right now. And that situation isn’t likely to get much better until banks start lending again. …and there are already plenty of good reasons not to lend. Have you guys been paying attention to how much money banks are keeping at the fed right now? …to collect next to nothing in interest? Rather than lend it?

    How does regulatory uncertainty help that situation?

    The correct answer is “it doesn’t”. It hurts that situation to tell the truth. But shouldn’t getting the banks lending again be the Obama Administration’s top priority? Rather than heaping holy terror upon lender’s heads? Hello?

    Here’s probably the most under-reported fact going right now. In 30 or so of the top appointed positions in the Obama Administration, in his cabinet and elsewhere, Obama has no one–not one person–with experience in the private sector. Every one I looked at was either a lawyer, an academic or a career bureaucrat with no experience in private industry.

    And it shows. They seem to be doing everything they can to discourage Wall Street from financing the recovery, and it doesn’t even seem to occur to them that what they’re doing could be counterproductive.

    I wish it were just a case of them not knowing what they’re doing, but I think it’s worse than that. I think they think they’re doing the smart thing. And it’s ridiculous.

  18. I hear ya bro. Good work.

  19. in his cabinet and elsewhere

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