Arbitraging Catastrophe: We're All in Danger - And It Could Get a Lot Worse

It's a sign of our shadowy times that the latest regulatory "reform" bill hasn't been laughed out of Washington. Same goes for the latest bankers' complaint, this time about being asked to cover their own bets. And if you think it's bad now, wait and see what happens if Romney takes over.

Think "global catastrophe."

While bank-friendly politicians offer insipid legislation, the world economy is still at risk. And it could get worse.

Off the Leash

The Independent Regulatory Analysis Act (S. 3468) might seem to make sense - until you spoil the illusion by thinking. At the President's discretion, regulators could be forced to perform up to thirteen additional costly and complicated steps before any new banking rule is enacted. it would be a costly and complicated process filled with bureaucratic red tape. In other words, it's everything politiicians claim to despise -

- unless they help banks, it seems. An excellent review by Demos [1] estimates that Senate bill 3468 would delay the implementation of Dodd/Frank financial reforms by as much as a year and a half.

That's the point, of course. Mark Gongloff's summary [2] of this Act in the Huffington Post had the pithy headline, "Senators Want To Give President Power To Stop Insufficiently Lenient Financial Regulations." That pretty much sums it up.

This bill is so bad that a blue-ribbon list of regulators like Fed chair Ben Bernanke and the SEC's Mary Shapiro - hardly liberals - signed a letter saying it would give "any President unprecedented authority to influence ... independent regulatory agencies and would constitute a fundamental change in (their) role."

Among other things, the Act would force regulators to explain why they believe "private markets" have failed to solve any problems the rule addresses. (We suggest creating a Word macro for this section that reads as follows: "Um, because this is the real world.")

The bill's sponsors [3] - two Republicans and Democrat Mark Warner - seem especially proud of a provision requiring regulators to estimate the cost of new rules before implementing them. But they already do that wherever possible.

The process was simpler under the Bush Administration, as it no doubt would be under Romney's: Just appoint bank-friendly regulators (preferably bank lobbyists) who won't implement any regulations at all.

Estimate This

Here's the problem with this whole 'cost estimate' idea: Nobody's being asked to estimate the cost of not to implementing regulations. Want to know how much it cost us to de-regulate Wall Street in the decade before the 2008 crisis? $12.8 trillion, according to a comprehensive analysis [4] by the folks at Better Markets. That was the total cost of a financial crisis caused by the actions of Wall Street bankers acting without adult supervision.

$12.8 trillion.

And, as Better Markets CEO Dennis Kelleher observes [5], that's a conservative estimate. Tens of millions of lives have been tragically disrupted in this country alone, while hundreds of millions have suffered serious financial losses.

The Dodd/Frank bill was at best a modest start on the financial reforms we urgently need. And yet multimillionaire Wall Street bankers continue to whine that the bill has too many pages. C'mon, guys! Have your chauffeurs turn 'em for you!

A modest proposal for the elimination of Dodd/Frank paperwork

A quick story: A friend of mine, who's a pretty reasonable guy, manages an investment fund with one of the biggest too-big-to-fail banks around. One day he came up to me at a social event. "Listen," he said, "I know where you're coming from, but man! You wouldn't believe the paperwork we have to fill out now!"

I said I had an easy fix for that. "Let's just break you guys up so you aren't connected in any way with traditional banking." He thought for a second. "You're right."

He can't say that publicly, of course. He'd lose that fund.

Just one more roll of the dice! We're good for it, honest!

Now Wall Street's complaining about a new rule that says they have to put up some collateral before engaging in massive swaps and derivatives deals like those which crashed the economy in 2008. The alternative is to work through financial clearing houses that would Bankers insist they'll follow in Warren Buffett's footsteps and stop doing these kinds of deals if this rule is enacted.

You say that like it's a bad thing.

Banks have another option under Dodd/Frank: They can use something called a "financial clearing house." The clearing houses are supposed to provide some measure of transparency and stability, and can establish rules for these transactions which can then be monitored more easily by regulators.

Here's the thing: The clearing house concept under Dodd/Frank is a clunky, Rube Goldberg sort of contraption. They're its way of getting around the Too Big to Fail problem (and a couple of others, too). Regulators are still working out the details. However inadequate this solution may be, it'll be a lot more inadequate if those details are written by bank lobbyists under a Romney Administration.

Gambling in the Dark

Here's how little we, and the regulators, know about the banking industry. Bankers say it will cost them $30 trillion - that's "trillion" with a "t" - to obey this rule. Peter Eavis helpfully notes [6] in the New York Times Dealbook that this sum is nearly twice our country's GDP, and more than the total assets of the world's ten largest banks put together.

Skepticism, as they say, is warranted.

The $30 trillion figure comes from an industry group which for our purposes we shall call The Association for Making Sh*t Up, drawing on the talents of the many fine analysts in its Department of Extracting Numbers From Posteriors. What would it really cost banks to comply with this rule? They don't really know.

A study [7] by the Office of the Comptroller of the Currency says it could be as high as $2 trillion, but they don't really know either.

Arbitraging Catastrophe

Here's what everybody in this conversation seems to be overlooking: If it's going to cost banks $2 trillion or $14 trillion or $30 trillion to cover their own bets, then they shouldn't be making those bets. Because the next time bankers get their bets wrong - which they have powerful economic incentives to do - we're going to have another financial crisis.

We dodged an enormous bullet in 2008, when entire global economy nearly crashed. And I mean, really crashed.

It's true that millions of people around the country, and around the world, are still trapped in the wreckage of the last crisis. But a global depression would be much, much worse - for them, and for everyone. If bankers are really making $30 trillion in bets which they can't cover, they must be stopped now.

That's what's at stake - this year, and in the years to come. What's worse: That, or a little paperwork for bankers? They have their answer, of course. They'd still have their bank accounts. But the rest of the planet's population would be living through a tragedy not of its own making.

Like a lot of other people, I've repeatedly been frustrated, disappointed, and even infuriated by the way our government has treated Wall Street over the last four years. I'm painfully aware that Dodd/Frank only does a little to fix our broken financial system.

But when you're staring down the barrel of a global catastrophe, a little can suddenly seem like a lot.