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Wednesday, July 14, 2010

More Stuff About Financial Reform

This is a huge and very complex bill, and a great many of the provisions have to explicated with regulations - so it is impossible to know right now exactly how a lot of this will work out.

More on the non-bank side, discussing the scope of the regulations which need to be written. Former SEC Chair Pitt. The farmers are worried.

For smaller banks, there are several insuperable problems, but the worst is that rule-making for consumer protection laws will be separated from the safety-and-soundness regulatory function. Not only is this weird, but it points up the difficulties of assessing system-wide risk. Without knowing what banks are doing and what they can safely do, one runs the risk of cutting off a great deal of funding to Main Street. Indeed, this has already happened in several initiatives of this administration. Allowing people who don't know anything about banking to regulate it is self-defeating. The current ridiculously high credit card rates and the new barriers to getting home equity loans are cases in point.

In all regulation there are pros and cons. Balancing the damage of regulating with the damage of not regulating is quite difficult.

For me, there's yet another problem. This bill makes service providers to banks subject to the new consumer protection agency. I don't see any way around that, which is why I think I'm doomed in my current function. I can't even see how I can ethically stay in business if I may be forced to disclose information to the agency, and I expect the recklessness of the current new crop of joyous academics to escalate under the current circumstances.

So far, they've effed up everything they've touched. After reading this bill, it seems clear that they don't take any responsibility for it either.

The funniest part about this is that once again, larger organizations are not complying, but community banks have to comply, and that is where the flow of cash to Main Street gets cut off.

The only reasonable way of controlling financial risk is to go back to the Glass-Steagall framework again. That worked by insulating small depositors from the risks of bad commercial banking (by insurance) and by insulating money supply (controlled by lenders) from the activities of insurers (think AIG) and investment banks. Instead of recognizing the abject failure of the 1990s financial reform, this new effort doubles down.

The USD became the reserve currency for several reasons, but one was that our post-GD system of firewalls created an impressive stability. This bill does not even recognize what really went wrong.

I'm probably showing my ignorance here, but would Glass-Steagall really have stopped the banks from levering up on CDOs? After all, the ones they bought for house accounts were supposed to have been AAA, "safe as houses" so to speak.

Likewise, wouldn't the investment banks have levered up on the chancier stuff no matter what? I wouldn't think that Glass-Steagall could have firewalled the core banking functions from a fundamental mis-appraisal of systemic risks, which ultimately traces back to malfeasance in Congress, at Fannie and Freddie, at the Fed, and at the ratings agencies.

Not that I think it would have made much difference even if everybody had done the best they could. When the tide goes out, you find out who's been skinny dipping--and the Baby Boomers are the biggest financial tidal wave in the history of man.
Neil - investment banks often do go postal, but that is why having the firewalls works so well.

Of course, we have encouraged the investment side to go nuts by bailing them out multiple times. The DC-in-bed-with-WS era began in the 1990s, and you see the fruits.
I do want to tag along on Neil's post, but eliminate the reference to "investment banks". Specifically, even with Glass-Steagall, could not BAC and C have been able to buy those CDO's and MBS's that were rated AAA?

In essence, I do not understand what a return to Glass-Steagall brings to the table. Sure, the banks would not be selling stocks (a la Merrill) nor would they be selling insurance, but I thought the major problem for the commercial banks was bad loans and CDO's and MBS's that turned out to be worth almost nothing.

I am probably misunderstanding Glass-Steagall.
I was going to post essentially the same comment as Rick before I saw his, so I will truncate what I was going to say.

As I understand the current state of things, our underlying problem is badly performing loans, and lots of them. All the discussion of CDO and derivatives and interconnectedness and tranches and all of the other bogeymen of NPR's Marketplace only hides the fact that loans were made to people who could not pay them back. Sure, after they were made they were thrown all over the place through different financial vehicles, but aren't those vehicles all zero sum games? If the loans are paid, the system is a net winner. If the loans are defaulted, the system is a net loser. Terrible evaluation of risk was made, assets were misallocated, and now the financial system has a hangover. And it may have syphilis, too, but the party was sure great while it lasted.

How does separating the savings banks from investment banks change the underlying problem? I lumped Glass-Stiegal in together with CDO's, and derivatives as a distractor from the bad loans, but when you cite it as a reason I am tempted to take it off my list. Would the bad loans not have gotten out of the savings banks and into the investment world? Wouldn't financial vehicles still have been created? Wouldn't the party still have ended with the US economy in bed with a bunch of bad loans that sure looked better under the influence of a six pack of housing-bubble?

So much for being short, but I think this is a teachable moment. I come to the mount of MOM for wisdom on things financial. Speak, O wise one :)

I'll get to your comments later. I wanted to post that nauseating stuff about the June receipts and get it over with.
Would it not be shear lunacy to expect Paul Krugman to do anything but stay on this path, as he is a Keynesian through and through? His economic training is so deeply rooted in this economic model, that he can't see the trees for the forest, but the forest is burning before his eyes and he is calling in for bombers full of fuel instead of water.
Glass-Steagall was the first domino to fall, we are just watching the rest of the pieces falling and are mesmerized by the "beauty" of the economic world tumbling to its death. The entertainment factor is only funny and wonderful for those who have paid the band to play on the deck of the ship!
MoM said: "I can't even see how I can ethically stay in business if I may be forced to disclose information to the agency, and I expect the recklessness of the current new crop of joyous academics to escalate under the current circumstances."

If disclosure is the issue, have you thought of offering your service in conjunction with a lawyer? I don't know what your service is or who your clients are, but if you add a lawyer to the mix anything they do is protected by lawyer/client privilege. Or so I naively think, anyway.

Possibly a deal cut with a handy shark could keep the lights on at MoM's place.
Reminds me of P.J. O'Rourke commenting on a session in the House of Representatives one fine day. They passed an amendment banning mining of pumice.

One legislator belatedly said, "Oh, hey, we just legislated the stone-washed jeans industry out of business."
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