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Friday March 12, 2010 - 20:33:45 GMT
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Banking Crisis Amnesia, Regulator Preservation

Let me start by saying I make a living largely from the banking system, and certainly entirely from the financial system.  So I am aware of the adage don’t bite the hand that feeds you.  Well considering my ability to influence mainstream thought on key financial questions, I am afraid to admit that any bite on the banking system’s hand from me is more akin to being gummed by a toothless octogenarian. 

 

Reading the reports of the Lehman Repo 105’s in the press today sparked my own sense of outrage.  How could something so blatantly misleading and deliberately misleading ever be allowed to have happened in 2008 after Bear Stearns was gone and after regulators actually went into Lehman in Q2 to conduct reviews of the balance sheet for potential problems?  Ernst and Young signed off on this creative accounting, internal controls signed off on it, Dick Fuld presumably signed off on it and counterparties took the other side of the repo presumably knowing the intent (otherwise why was their a haircut…of was it the cost for silence?). 

 

Why no one at this institution, which probably even more than Bear (by lots) was responsible for near death of capitalism, is not behind bars some 2 years after the fact is mindboggling.  Is there a statute of limitations in play?  Are regulators so worried about any prosecution revealing embarrassing regulatory failings that they have more or less killed any effort to bring charges against the perpetrators?  I don’t get it.

 

And Congress which is supposed to legislate so that this crisis never happens again is allegedly being shown all new regulatory measures from the lobbyists of the banks as well as banks directly.  I would like to see the phone logs and office logs of Senator Dodd, Senator Corker and Senator Shelby.  Clearly the banks are of the view that what happened in 2008 was a perfect storm and won’t happen again which means minimal regulatory reform in the banking system is needed and surely that does not include an independent consumer financial regulatory agency.   Big banks, leveraged balance sheets, broadly defined capital requirements, ongoing opaque OTC derivatives market and near zero cost of funds (most don’t see ZIRP changing until 2011) are all considered sacrosanct.  In other words the way of doing things pre-Lehman were fine then and fine now…but not fine for a very brief period in 2008. 

 

Banks are also fighting tooth and nail to keep the OTC market in derivatives from being forced onto exchanges (even basic products like FX swaps).  While there is some argument for throwing the baby out with the bath water if this reform happens, I hardly think moving derivatives to exchanges (much of this business is already there) is a game changer –yes one can see unintended consequences as some owners of derivatives may have a legal out from their contracts and we could see another rush to call in collateral.   How insignificant would it be if the one “big”change in banking is a much reduced OTC derivatives market?  And with the run on Greek debt and subsequent rise in sovereign Greek CDS, the momentum to regulate CDS and other derivatives away has mushroomed. 

 

But what about banks being 30-40% of all corporate profits (US) as was happening in 2007?  As best I can tell officials and regulators think this is a sustainable model.  If they did not then there would be a far more serious effort to break up large banks and turn them into boring, highly regulated utilities that actually exist to perform their time honored function – creation of credit – rather than highly leveraged, high risk businesses that have to generate massive revenues based on massively high costs (compensation).  A Tobin tax on transactions to pay for future failure (large unwinds) seems a small price to keep the industry pretty much intact despite a near death experience in 2008. 

 

I liked the way the world looked before 2007…I benefited personally no doubt.  But I for one can’t believe that anything short of a massive reinvention of banking to Glass-Steagall world is going to yield any different outcome than the one we just went through. How can any reasonable person ever feel confident in the banking system again if it’s key components remain in place. 

 

And those pushing for real overhaul like Volcker, face serious pushback from the very pro-Wall Street likes of Geithner and Summers.  If anything the current approach of regulators and US government to reforming the banking system reminds me of how Toyota is dealing with its unintended acceleration problem…now that I think if it the very name has an eerie application to 2008.

 

David Gilmore

Well considering my ability to influence mainstream thought on key financial questions, I am afraid to admit that any bite on the banking system’s hand from me is more akin to being gummed by a toothless octogenarian. 

 

Reading the reports of the Lehman Repo 105’s in the press today sparked my own sense of outrage.  How could something so blatantly misleading and deliberately misleading ever be allowed to have happened in 2008 after Bear Stearns was gone and after regulators actually went into Lehman in Q2 to conduct reviews of the balance sheet for potential problems?  Ernst and Young signed off on this creative accounting, internal controls signed off on it, Dick Fuld presumably signed off on it and counterparties took the other side of the repo presumably knowing the intent (otherwise why was their a haircut…of was it the cost for silence?). 

 

Why no one at this institution, which probably even more than Bear (by lots) was responsible for near death of capitalism, is not behind bars some 2 years after the fact is mindboggling.  Is there a statute of limitations in play?  Are regulators so worried about any prosecution revealing embarrassing regulatory failings that they have more or less killed any effort to bring charges against the perpetrators?  I don’t get it.

 

And Congress which is supposed to legislate so that this crisis never happens again is allegedly being shown all new regulatory measures from the lobbyists of the banks as well as banks directly.  I would like to see the phone logs and office logs of Senator Dodd, Senator Corker and Senator Shelby.  Clearly the banks are of the view that what happened in 2008 was a perfect storm and won’t happen again which means minimal regulatory reform in the banking system is needed and surely that does not include an independent consumer financial regulatory agency.   Big banks, leveraged balance sheets, broadly defined capital requirements, ongoing opaque OTC derivatives market and near zero cost of funds (most don’t see ZIRP changing until 2011) are all considered sacrosanct.  In other words the way of doing things pre-Lehman were fine then and fine now…but not fine for a very brief period in 2008. 

 

Banks are also fighting tooth and nail to keep the OTC market in derivatives from being forced onto exchanges (even basic products like FX swaps).  While there is some argument for throwing the baby out with the bath water if this reform happens, I hardly think moving derivatives to exchanges (much of this business is already there) is a game changer –yes one can see unintended consequences as some owners of derivatives may have a legal out from their contracts and we could see another rush to call in collateral.   How insignificant would it be if the one “big”change in banking is a much reduced OTC derivatives market?  And with the run on Greek debt and subsequent rise in sovereign Greek CDS, the momentum to regulate CDS and other derivatives away has mushroomed. 

 

But what about banks being 30-40% of all corporate profits (US) as was happening in 2007?  As best I can tell officials and regulators think this is a sustainable model.  If they did not then there would be a far more serious effort to break up large banks and turn them into boring, highly regulated utilities that actually exist to perform their time honored function – creation of credit – rather than highly leveraged, high risk businesses that have to generate massive revenues based on massively high costs (compensation).  A Tobin tax on transactions to pay for future failure (large unwinds) seems a small price to keep the industry pretty much intact despite a near death experience in 2008. 

 

I liked the way the world looked before 2007…I benefited personally no doubt.  But I for one can’t believe that anything short of a massive reinvention of banking to Glass-Steagall world is going to yield any different outcome than the one we just went through. How can any reasonable person ever feel confident in the banking system again if it’s key components remain in place. 

 

And those pushing for real overhaul like Volcker, face serious pushback from the very pro-Wall Street likes of Geithner and Summers.  If anything the current approach of regulators and US government to reforming the banking system reminds me of how Toyota is dealing with its unintended acceleration problem…now that I think if it the very name has an eerie application to 2008.

 

David Gilmore

 

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