break up the banks

Too-Big-For-Paperwork: Fixing Wall Street's Foreclosure Fraud Disaster

Zach Carter — Fri, 08 Oct 2010 14:43:51 -0400

Anybody looking for a primer explaining why the current foreclosure fraud issue is a major systemic risk for the financial system should check out Mike Konczal's new post for the Roosevelt Institute. I'm going to try and simplify it even further here, and present the only serious avenue available to solve the problem.

Three parties stand to lose big. The most obvious is homeowners—they're being slapped with enormous, illegal fees invented by fraudulent documents, and frequently being illegally exiled from their homes.

Next are the mortgage servicers. These are the mortgage industry's debt collectors, and their mere existence often creates huge conflicts of interest that have made the foreclosure mess much harder to clean-up. The dominant servicers are owned by megabanks—Bank of America, JPMorgan Chase, Wells Fargo, Citibank and GMAC control the vast majority of this work. A massive loss for a mortgage servicer means a massive loss for a massive bank.

Mortgage servicers are supposed to collect payments and negotiate with troubled borrowers in order to maximize the returns to investors. Who are these investors? Hedge funds and banks that bought mortgage-backed securities during the housing bubble.

The basic job of a mortgage servicer is to collect payments from borrowers, and pass them on to investors. If borrowers stop paying, servicers have to make those payments to investors out of their own pocket—until they actually foreclose. At foreclosure, the servicer gets to recoup its costs. So in many cases, servicers have a very strong incentive to cut whatever corners they can in order to recoup their costs and avoid forwarding more money to investors (This is only part of the story—since the servicers are megabanks, the other assets of the servicer bank can give the servicer wing an incentive to stall the foreclosure process like crazy—more on that in another post).

The point is, in many cases, servicers have a clear incentive to cut corners to speed up the foreclosure process, and stand to lose a lot of money if they don't.

Servicers should have a set of key documents for every mortgage that has been bundled into the securities they operate. But they don't. Why? Because the original bank who sold the original mortgages to homeowners never handed over the documents when the security was created.

That brings us to the investors. Mortgage-backed securities involve different levels of risk—investors don't just buy one security composed of lots of mortgages. Instead, the pool of mortgages is cut into different pieces according to how risky they are. The riskiest bits fetch the highest monthly payments for investors, but are the first to take losses if the mortgages go bad. The safest parts bring in lower monthly payments, but are the last to take losses.

Investors who have the safe parts of the security want to see the foreclosure process burn through as fast as possible. The faster it goes, the lower the expenses for the servicer, and the more these investors will be able to recoup after foreclosure.

But investors who have the risky parts of the security have the exact opposite incentives. They want foreclosures stalled for as long as possible, so that the servicer has to keep forwarding them payments for as long as possible. The servicer doesn't take its cut from the investors after foreclosure, it takes them from the sale of the house. So the risky investors (junior bondholders in finance-speak) are hoping to delay foreclosures, while the safer investors (senior bondholders) are hoping to stall for time, since time means more payments.

So there's a war going on right now between risky and safe investors, many of which have different risk positions in different securities.

But servicers don't have the necessary documents, and they can't get them. The Florida bank lobby says that destroying mortgage documents was standard operating procedure during the bubble years. If you can't provide the documents, then in many cases, you simply do not have the right to foreclose at all. That means catastrophic losses for both safe investors and servicers, since they never get to recoup any losses.

So no matter what happens, the most obvious, immediate losses and the most serious long-term legal liability are at the big mortgage servicers. These are all megabanks. And investors of all stripes are going to do everything in their power to stick the investment banks who created these securities with the bill. These are also megabanks.

As Mike emphasizes, there are $2.6 trillion worth of mortgage-backed securities out there. That's more than enough in potential losses to sink every major bank and hedge fund in the United States.

There are two ways to deal with this. One is to bailout the banks for engaging in systematic, documented fraud, and further screw over the homeowners they're defrauding by changing the legal standards for mortgage documentation. This is what the bank lobby wants, and it is obviously unacceptable. This won't only hammer homeowners, it'll also blast investors who hold the risky end of mortgage-backed securities.

The other is to adopt a massive principal-reduction program which creates new, real documents for every troubled borrower in the country, and reduces their debt burden so that they don't end up in foreclosure. This solution means catastrophic losses for investors, but not as catastrophic as being unable to foreclose.

But barring another massive bailout, our biggest banks are right back up against the wall again, no matter what happens. And they'll keep coming back to the brink of insolvency so long as they remain too-big-to-even-file-their-damned-paperwork.

Break up the banks.

Want To Create Jobs? Break Up The Banks.

Zach Carter — Fri, 08 Oct 2010 11:08:02 -0400

I attended two big economic gatherings this week, one on financial reform organized by finance blogger Mike Konczal for The Roosevelt Institute, another on the economic outlook, presented by the American Enterprise Institute. Each event was depressing in its own right, but combined, they spell out very big trouble for the U.S. economy. Things are about to get much, much worse for just about everybody, even as big banks deploy their lobbying armies to secure the right to make things even more miserable. Despite all of this bad news, I think we might actually be on the verge of some real economic progress. Let me explain.

The general mood at the Roosevelt Institute forum was one of caution bordering on pessimism. Congress passed Wall Street reform legislation that gives regulators a lot of powers to rein in banks that behave badly. Without intense and sustained pressure from reformers, those powers will not be used, especially if Republicans take control of at least one house of Congress next year, and use it to divert regulatory attention with intentionally meaningless inquiries and investigations. The regulatory battle has just begun, and further legislative action is needed to deal with some of the most pressing problems, particularly too-big-to-fail and the foreclosure mess. With a few exceptions, the thirty or so people who attended the Roosevelt Institute event were the individuals most responsible for getting that legislation through Congress—for them to be sounding the alarm is significant (see Annie Lowrey's write-up of the conference for more details).

The AEI panel was packed with a cadre of intellectually boring conservatives, notable for the fact that many were actually advocating strong federal action to right the economic ship. But the discussion was unquestionably dominated by the remarks of Nouriel Roubini and Christopher Whalen, two very smart people who don't work for AEI.

Whalen made the most persuasive case of the group. We haven't fixed the banking system. Banks aren't lending, they aren't trying to lend, and they aren't going to try until they've finished absorbing all the foreclosures embedded in their balance sheets. Left to their own devices, banks will drag that process out as long as possible in order to avoid immediate losses. And the past four years of horrific foreclosure statistics are just the beginning—Whalen thinks we're, at best, about 25 percent of the way through process.

What's worse, the mortgage situation is effectively serving as a blockade against economic policy. Any action the government takes is going to be stymied by the fact that millions of American households are struggling to pay of homes that aren't worth their sticker price.

Fortunately, there's a solution to that problem. Take over the banks, and write-down the amount that troubled borrowers owe so that they can stay in their homes without pissing away their money to banks that don't lend. In Whalen's view, if we want to solve unemployment and get the economy growing again, we have to break up the banks and help troubled homeowners.

That just happens to be my view, as well. Essentially, Whalen—who describes himself as a conservative libertarian—and the progressive braintrusters from the Roosevelt Institute agree about what needs to be done. The critical question is whether there is any political will to do it. And that's where Nouriel Roubini's presentation gets scary.

If we don't fix the banks and don't fix foreclosures and don't get serious about fiscal policy to ease unemployment, we're going to have another financial crisis within a few years. And the next time around, a financial crisis will mean a real fiscal crisis for the U.S.-- not just phony fear-mongering by opportunistic traders.

This isn't the first time Roubini has issued that warning. He said the same basic thing when I interviewed him in May. The trick is, back in May, none of the bank analysts and traders who attended yesterday's AEI event really took him seriously. Now even those elites believe that the economy is in deep trouble and in need of a major shot in the arm from the federal government.

Perversely, all of this bad news gives me some cause for optimism. Wall Street's lobbyists are as powerful as ever, but the intellectual debate over the economic path forward is getting more reasonable as the economy deteriorates and people realize that conservative policies and liberal half-measures are simply not working.

That doesn't mean that securing real reform will be a walk in the park. Both panelists and attendees of the AEI shebang bemoaned the new Basel III capital regime as overly onerous for banks and a barrier to economic recovery—a view which is simply wrong on both points. Given that they're averse to higher capital requirements for the banking industry—the bare minimum move for greater financial stability—convincing them to break up Bank of America and Wells Fargo will be a major task.

But at least those people aren't laughing the reformers out of the room anymore. That's a step in the right direction, and it shows that financial reform isn't really about any kind of ideological divide between the left and right. It's about the basic functioning of the economy, and more broadly speaking, of democratic systems. Coupled with the fact that banks have created a legal nightmare for themselves by cutting corners on their mortgage paperwork, there's quite a bit of room for persuasion.

Of course, if things don't get fixed prior to another crisis, then we not only have prolonged social misery, we have an unimaginable economic disaster. But hell, we might actually fend it off. Get out there and make a fuss.

New Bank Regulations Would Bless Lehman's Risk-Taking

Zach Carter — Mon, 13 Sep 2010 16:56:15 -0400

International bank regulators have finally agreed to a new set of rules to rein in financial excess, and the reviews thus far are cautiously positive. But the new capital requirements announced today by the Basel III accord are not actually as sturdy as they seem. By relying on definitions that can be manipulated by Wall Street, regulators have agreed to standards that place an international seal of approval on Lehman Brothers-style risk-taking.

In every financial crisis in history, banks have ruined themselves by overleveraging. "Leveraging" means "borrowing money," and "overleveraging" means "borrowing too much money." The basic process has been repeated hundreds of times: banks borrow tons of money and use it to place bets in the capital markets. When those bets are good, high leverage dramatically amplifies bank profits—and bank bonuses. But when those bets are bad, high leverage creates enormous losses—and enormous bailouts.

There are dozens of different ways to define leverage, but the most difficult one for banks to manipulate is also the simplest and most common-sense: total assets to total equity. If you have a lot of assets and not much equity, it means you're borrowing a ton of money to finance your business. It's going to be very hard to pay back all that debt if your banking bets start going bad.

By 2007, the official leverage ratio that Lehman Brothers reported to the public was 31-to-1 (see page 29 of their 2007 annual report). Despite lots of new tables about risk-weighted assets and Tier 1 capital, the only hard new leverage rule we have from Basel is a straight cap at 33-to-1. The means the new standards would leave plenty of room for the crazy risk-taking that brought down Lehman Brothers.

So why are so many smart people (Mike Konczal, Felix Salmon, Ezra Klein) saying good things about Basel III? Well, the new Basel capital standards are indeed a step forward—but that says more about how pathetic the current capital standards are than about how great the new rules are. For years, regulators have used very lax definitions of what constitutes "capital" in calculating their capital ratios. They've also allowed banks to use lax definitions of what constitutes an "asset," and allowed the minimum ratios to be far too low.

Basel III improves on the old regime by strengthening the definition of "capital" and raising the bar for the ratios themselves. It does not do much about the definition of an "asset," however, which leaves the new standards open to abuse.

So while it's good to see minimum capital ratios increase from 4 percent to 7 percent, the reality is less exciting. Those percentages do not correspond to hard asset values, but rather to "risk-weighted" asset values. Right now, risk-weights are basically determined by ratings on various securities—ratings which proved fundamentally unreliable and potentially fraudulent over the past decade. Combined with the fact that banks themselves get to apply the risk-weightings to their assets, the new Basel III standards are subject to an obvious source of abuse, and will encourage new risks. Banks will apply inappropriate risk-weights in order to take on more leverage while technically conforming to the letter of the law, and they'll systematically seek out assets that have inappropriately low risk-weights in order to take on higher leverage, fueling asset bubbles in things like, say, subprime mortgage-backed securities.

Under the standards released last night, international regulators did agree that banks must hold equity equal to 3 percent of total assets. That's as hard as any leverage or capital standard can be, it's just completely inadequate. To reiterate: 31-to-1 leverage brought down Lehman Brothers, and Basel III will permit 33-to-1 leverage.

All capital standards, however rigorous and however well-defined, depend on honest accounting. If a bank insists that an asset is worth a lot of money when it's really a worthless pile of garbage, banks are able to book phantom profits instead of taking losses. That's exactly what happened as the crisis unfolded, with regulators bending over backwards to offer accounting leniency. One agency actively cooked the books for banks, while Congress browbeat the board who oversees accounting standards into letting banks make up their own asset values. That accounting "flexibility" is still in place today, with banks refusing to write down all kinds of mortgages, especially second-lien mortgages, which are borderline worthless once housing prices fall.

But these accounting absurdities aren't really a knock on Basel III—they're a problem inherent in any attempt to rein in banks by resorting to capital requirements alone. A hard, meaningful cap on leverage would be a dramatic improvement over what Basel III has produced. But still better would be a market in which banks were not so bloated that their failure could jeopardize the entire economy. We have to break-up the big Wall Street banks.

Yet U.S. policymakers have refused to go this route, and as a result, all of our financial stability eggs are in the Basel III basket. So while the new rules are a legitimate step forward, they're not up to the task that Congress and the Treasury Department have set for them. Basel III will not be enough to prevent another massive financial crisis in the near future.

Wall Street Reform: Five Key Fights After The Bill Is Signed

Zach Carter — Wed, 21 Jul 2010 10:05:46 -0400

Today, President Barack Obama will sign into law the first serious effort to regulate Wall Street in decades. The bill has much to be said for it, but the unfortunate truth is that it ducks several of the most critical reforms needed to protect our economy from banker abuse. As regulators work to implement the legislation, reformers must turn up the heat on Congress to adopt further reforms, and recognize political opportunities to further economic progress.

Five policy fights stand out as particularly pressing. Many of these policies can be implemented this year, while others will probably have to wait until the next Congress. All of them are critical to ensuring that our financial sector works to support a healthy economy, instead of a reckless bonus machine.

1. Break Up The Banks

Not long ago, breaking up the banks was viewed as an impossible pipe dream, but when the Senate finally weighed in on the matter in May, a surprisingly high number of Senators supported it, with even a handful of Republicans voting to bust 'em up (five other Republicans abstained, afraid of voter backlash from a vote for Wall Street excess). The plan ultimately failed, of course, so what has changed since May? Fannie Mae and Freddie Mac.

Congress will have to decide the fate of the two mortgage giants sometime in the relatively near future. There are plenty of problems with Fannie and Freddie, but the overriding disaster was caused by the firms' quest for private profits with an implicit government guarantee. For years, investors allowed Fannie and Freddie executives to make reckless bets, expecting that taxpayers would pick up the tab if the firms got into trouble. That situation meant huge profits for Fannie and Freddie until the companies totally blew up, at which point taxpayers did indeed eat the losses (this had nothing to do with affordable housing efforts—Fannie and Freddie were mimicking their Wall Street competitors by purchasing loads of lousy mortgage-backed securities issued by Wall Street banks). That's the exact problem posed by megabanks Goldman Sachs, Citigroup, Morgan Stanley, Bank of America, J.P. Morgan Chase and Wells Fargo. When Congress begins debating the future of Fannie and Freddie, no solution will be complete without dealing with the same too-big-to-fail problem posed by the megabanks.

2. Tax Wall Street Gambling

The financial crash of 2008 was a direct result of wild and unrestrained speculation on Wall Street—raw gambling that creates big risks while doing nothing to boost the broader economy. There's no law of economics that says this kind of activity needs to take place, and taxpayers can make serious money by reining it in. In London, financiers are subject to a tiny tax on their securities and derivatives trades. The tax is small enough that it doesn't discourage serious long-term investment in productive businesses, but significant enough to make traders think twice about buying huge volumes of securities only to dump them a few minutes or hours later.

This tax—known as a financial transactions tax or a tax on Wall Street gambling—is a double-win for economic stability. It limits destructive speculation, while raising revenue for the government. How much? According to the Center for Economic Policy and Research, a tax on trading would reap somewhere between $177 billion and $354 billion a year. If right-wingers want to make a fuss about the budget deficit this year, make them put their money where their mouth is and adopt a financial transactions tax.

A transactions tax is also one of the most effective ways to rein in outrageous Wall Street bonuses. If banks can't score huge profits from gambling, they can't pay out bonuses based on those profits.

3. End The Foreclosure Nightmare

The foreclosure crisis has been deepening unabated since 2006. That is a public policy obscenity: politicians rushed to rescue bankers who pushed predatory garbage loans on the public, while leaving troubled homeowners to fend for themselves.

Foreclosures are being fueled by gimmick accounting schemes that are artificially boosting bank profits—and bonuses. Home prices are down dramatically from their bubble-peak levels, and they aren't coming back—it was a bubble, after all. That means that millions of borrowers owe more on their mortgages than their homes are worth. When they have trouble making payments, they can't sell their house and find a more affordable place—foreclosure is the only option.

But borrowers are only up against the wall because banks are refusing to reduce their debt burdens to reasonable levels. If banks cut the amount that borrowers owed on their mortgages to whatever the house is actually worth, then borrowers could afford to keep their homes, and bank accounting would reflect their actual financial condition. Instead, banks are refusing to negotiate with borrowers and booking bogus accounting profits on loans that are never going to be repaid.

There are several ways to make banks play fair. Right now mortgages cannot be renegotiated in bankruptcy—unlike every other kind of consumer debt. Congress could change that. Lawmakers could also adopt a right-to-rent policy, requiring banks to let foreclosed borrowers rent their homes for several years at a fair market rate. Since banks don't want to be landlords, this policy would give borrowers some negotiating leverage. Other options don't require Congressional action at all—the administration could simply urge bank regulators to exercise more vigilant oversight of mortgage accounting practices. The government could also exercise its powers of imminent domain to buy up mortgages at a discount, requiring banks to take losses, and then cut borrowers a break.

4. Prosecute Fraud

The Big Crash of 2008 was fueled by absolutely staggering levels of fraud at multiple levels of the financial system. The FBI warned of an "epidemic" in mortgage fraud starting in 2004, and bankers ran wild with these disastrous loans in every way they could think of. They invented new devices to hide debt from investors, mislead their investors on exposure to toxic mortgages, and concocted abusive derivatives to screw over their own clients. According to the United Nations, banks went so far as to help launder hundreds of billions of dollars in drug money in order to get their hands on quick cash when markets froze up.

More than 1,100 bankers went to jail in the aftermath of the savings and loan crisis, but we've seen almost no serious action this cycle to ensure that financial fraud does not go unpunished. We need strong action against both individuals who commit fraud and the companies that tolerate it. Without prosecutions and indictments, the outrageous behavior of the past decade will be repeated, and soon.

5. Stop Subsidizing Risky Business

The bill Obama signs today includes two critical measures to rein in big banks—an end to taxpayer subsidies for derivatives dealing, and a ban on risky proprietary trading. The trouble is, both measures were punched through with tremendous loopholes at the last minute, rendering them extremely weak.

Commercial banks perform some of the most critical functions in the economy, accepting consumer deposits and extending loans that keep society moving. Banks receive key taxpayer perks designed to ensure that those activities are safe and productive: cheap loans from the Federal Reserve and deposit insurance from the FDIC. But after Congress ripped away the Glass-Steagall Act in 1999, banks started engaging in all kinds of other businesses that weren't essential to the core financial functions of accepting deposits and making loans. Since these banks still had access to taxpayer perks, citizens were actively subsidizing these riskier businesses. When Congress deregulated the derivatives market in 2000, things got even worse. Five big banks now hold over $300 trillion in derivatives—trillion with a 't'—just waiting for an AIG-style blow-up. When big banks succumb to those risks, those essential loan-and-deposit activities break down, and the result is an economic disaster.

If hedge funds want to speculate, fine (though they should be subjected to a financial transactions tax), but economically essential banks shouldn't be subsidized for injecting enormous risks into the economy. If banks want to hedge risks with derivatives, that's fine too, but they shouldn't be getting subsidies for dealing derivatives to other firms and amplifying speculative activity in the financial system.

Wall Street Reform Clears Final Filibuster

Zach Carter — Thu, 15 Jul 2010 13:36:31 -0400

Good news: The Senate just secured 60 votes to proceed on Wall Street reform, clearing the way for the legislation's final passage today or Saturday.

The legislation garnered the votes of every Democrat except Sen. Russ Feingold, D-Wis., who argued that the bill was too weak to support. Every Republican opposed the bill, except Sens. Susan Collins, R-Maine, Olympia Snowe, R-Maine, and Scott Brown, R-Mass. Brown's influence over the bill was particularly pernicious, which I'll elaborate more on later.

As I've argued previously, the bill is far from perfect, but is still a step in the right direction. After thirty years of deregulation, Congress is finally moving back to actually regulating Big Finance. The bill won't end too-big-to-fail, but it will create a powerful new regulator to protect consumers from banker abuses, and it will establish some useful financial infrastructure that can be expanded by future legislation.

Wall Street reform is going to pass. That fact is worthy of celebration, but citizens and activists must maintain the pressure on Congress and the administration to pass more significant reforms in the coming months and years. A brief list of what's left to do: breaking up the megabanks, imposing a tax on financial speculation and barring banks from backing risky derivatives operations with taxpayer funds.

Six Key Fights For Wall Street Reform's Next Phase

Zach Carter — Fri, 21 May 2010 11:59:08 -0400

Thursday night's passage of Wall Street reform by the U.S. Senate is an event to be celebrated, but several key issues remain in play as the House and Senate seek to iron out differences between their respective versions of the legislation. And while the final bill will provide regulators with important new tools to fight financial excess, many of the most critical issues facing our economy will simply not be addressed, leaving the next Congress with plenty of work to do.

Here's a list of key issues to watch as Congress moves to the conference committee between the House and Senate:

1. The Volcker Rule

The best version of President Obama's signature Wall Street reform was an amendment written by Sens. Jeff Merkley, D-Ore., and Carl Levin, D-Mich. It was never voted on in the Senate, and the House bill contains no version of any ban on proprietary trading by commercial banks. The Senate bill does include a weak version of the Volcker Rule that bank-friendly regulators can easily defang if they choose. Watch to see if negotiations lead to a concrete ban on gambling with taxpayer money.

2. The Consumer Financial Protection Agency

The House version of this agency is generally stronger than the Senate version, with more independence and broader authority. But the House version also exempts auto dealers from CFPA oversight, which the Senate version does not.

3. Derivatives

The Senate's language on derivatives is much stronger than that produced in the House, with one major exception. The Senate bill contains fewer and narrower loopholes than the House version, in addition to a requirement that banks spin-off their derivatives dealing operations into an independently capitalized unit. But both versions of the bill have weaknesses related to actually enforcing the new derivatives rules, and the problems in the Senate version are much deeper than those in the House (this is why Sen. Maria Cantwell, D-Wash., voted against the bill). Barney Frank has said he wishes the House had better derivatives language, so watch for this to be strengthened.

4. Capital and Leverage

Thanks to Sen. Susan Collins, R-Maine, the Senate bill contains the strongest language to toughen capital requirements at big banks, forcing them to have more money on hand to cushion against losses. There is no corresponding language in the House bill, but the House legislation does contain a related provision capping bank leverage--the amount of borrowed money banks can use to place bets in the capital markets casinos. How these good amendments fare in the conference committee will significantly impact how the financial system functions over the next decade.

5. Rating agencies

Sen. Al Franken pushed through an amendment that substantively changes the corrupt business model at rating agencies. Right now, rating agencies do not get paid by the investors who use their ratings, but by the very banks who are issuing those securities. Franken would end this system, having regulators to select which rating agencies rate which securities, rather than the banks who issue the securities. The House bill largely leaves the rating agency business model unchanged.

6. Swipe fees

When you buy something at a store with a credit or debit card, Visa and Mastercard charge that store a fee. The store, in turn, charges you more for its products, making everything everybody buys more expensive. Sen. Dick Durbin, D-Ill., pushed through language cracking down on debit card fees, but there is no language addressing swipe fees of any kind in the House.

How Did The Senate Do?

The fact that many of these issues are even in play marks a surprise victory for progressives and other reform advocates. Nobody expected Franken's rating agency bill to make it through, nor were swipe fees considered to be in play. Even better, we know with certainty that the Federal Reserve's multi-trillion-dollar bailout operations will finally be subjected to public scrutiny, no matter what happens in the conference committee. Progressives like economist Dean Baker and conservatives like Rep. Ron Paul, R-Tex., have been pushing for an audit of the Fed for years, with little progress. The fact that the Fed's most secretive and controversial programs will finally be revealed to the public is a major event, one that should fuel calls for further reform.

There were also several disappointments in the Senate. The fact that Merkley-Levin never came up for a vote is a major embarrassment to the Democratic leadership, especially Majority Leader Harry Reid, D-Nev., Chris Dodd, D-Conn., and Obama himself. The fact that the derivatives language contains serious loopholes is also unacceptable, as are the depth of Dodd's concessions on the Consumer Financial Protection Agency, and the measures the Senate adopted to impede state regulators who try to crack down on predatory lending.

Nevertheless, the bill really will establish some important new economic tools. The new resolution authority to shut down complex banking conglomerates will not end too-big-to-fail, but it will give regulators the ability to cope with some failing institutions that it currently cannot handle. Regulators already have the authority to shut down boring commercial banks, but they do not always invoke it when those boring banks are big enough, and we can expect a similar pattern for more complex institutions. Similarly, whatever concessions bank lobbyists ultimately get in committee, Congress will also create new infrastructure to bring this multi-trillion-dollar market out of the shadows, and an agency that will give Elizabeth Warren an avenue to go after predatory lending.

The Next Step

Of course, it has been clear for some time that this bill will not address many of the deepest problems plaguing the financial system. The only way to end the political and economic domination of our too-big-to-fail banking behemoths is to break them up into smaller firms that can fail safely. The bill does not do that. It also does not reform the corrupt structure of the Fed, in which banks are allowed to choose their own regulators. No serious action will be taken against hedge funds, private equity vultures, Fannie Mae or Freddie Mac. Nothing will be done to treat the foreclosure epidemic that is still hammering homeowners. The hard, clear division between boring commercial banking and risky investment banking that protected our economy from bailouts for over fifty years still needs to be restored.

In short, the Senate's passage of Wall Street reform legislation is a critical step in the right direction. But there is still important work to be done in the coming weeks, and even more important work for the next legislative cycle.

Congress Backs Wall Street, Rejects Big Bank Break-Up

Zach Carter — Fri, 07 May 2010 10:01:09 -0400

Late last night, the U.S. Senate rejected the single most important element of Wall Street reform by a vote of 33 to 61. The SAFE Banking Act would have forced the break-up of the nation's six largest banks, and dramatically reduced the political clout of America's financial elite. The 61 votes against the measure are votes in favor of Wall Street's stranglehold on our economy. No matter what else is ultimately enacted in the name of Wall Street reform, Congress has decided that it will not confront the single greatest problem in the U.S. economy: Too Big To Fail.

On Wednesday, the Senate also voted down a $50 billion Wall Street tax that would have been used to fund the cost of shutting down a major failing bank. By rejecting both the break-up bill and the bank tax, the Senate has punted on ending too-big-to-fail. For now, it appears that Wall Street has emerged from the Great Financial Crash of 2008 with even greater political might than it wielded during the reign of George W. Bush. In the Citizens United era, both Democrats and Republicans have decided they can only get so tough with Corporate America.

Last night, 27 Democrats joined all but three Republicans to vote against breaking up the banks. President Barack Obama opposed both the tax and the break-up measures, and hosted J.P. Morgan Chase CEO Jamie Dimon for dinner at the White House on Monday. J.P. Morgan is the largest U.S. bank, and spent more money on lobbying in 2009 than any other bank. House Minority Leader John Boehner (R-OH) has aggressively courted Dimon for campaign cash.

There is literally no economic evidence that megabanks do anything to help the economy that cannot be accomplished with smaller institutions. By contrast, centuries of research has shown that giant banks are destructive. Adam Smith was warning against the dangers of megabanking back in the 18th Century. And the current crisis in Europe-- which appears to be deepening by the day-- should make those dangers apparent to everyone living in today's economy. There are plenty of good economic reasons to cut our financial behemoths down to size, and no good reasons not to.

The good news is, there are still some smaller-bore reforms in the legislation that are worth voting for, and it appears that some version of reform, however tepid, will ultimately be approved. Congress will be deploying a screwdriver to perform a job fit for a bulldozer, but a few weeks ago, it was not obvious that even the screwdriver would make it through.

Shortly before the vote on breaking up the banks, Sen. Bernie Sanders (I-VT) cut a deal with Sen. Chris Dodd (D-CT) that would subject all of the Federal Reserve's bailout operations to a thorough public audit. Despite all of the attention heaped on the Treasury Department and the Troubled Asset Relief Program, the Fed has operated as the chief bailout engine of the U.S. government, pumping $4.3 trillion into the banking system without almost no public disclosure. We don't know who received money, or on what terms, or who approved the transactions. It now appears very likely that this information will finally see the light of day. Obama, who had opposed a more comprehensive Fed audit, now supports the Sanders plan.

But by allowing megabanks to remain super-sized, Congress has insulated them from the fallout associated with the Fed disclosures, and given them a tool to fight other reforms. Our giant financial institutions are not only too-big-to-fail, they are too-big-to-regulate. There are meaningful reforms still on the table—a ban on risky proprietary trading, an overhaul of consumer protection and the reining in of the crazy derivatives casino that brought down AIG—but all will be much more difficult to enforce at the complex megabanks which currently dominate both the marketplace and Capitol Hill.

Major economic realignments are not quickly established. It took seven years for Franklin Delano Roosevelt to pass all of his New Deal-era banking reforms. We have known for some time that this legislation, however stringent, would be incomplete. Hedge funds, credit rating agencies, Fannie Mae and Freddie Mac all must be addressed by separate legislation. The SAFE Banking Act must be considered in every subsequent reform package.

Here are the Senators who voted last night to preserve Wall Street's power. Senators in bold also voted for the bailout bill in 2008:

Akaka (D-HI)

Alexander (R-TN)

Barrasso (R-WY)

Baucus (D-MT)

Bayh (D-IN)

Bennet (D-CO)

Bond (R-MO)

Brown (R-MA)

Brownback (R-KS)

Burr (R-NC)

Carper (D-DE)

Chambliss (R-GA)

Cochran (R-MS)

Collins (R-ME)

Conrad (D-ND)

Corker (R-TN)

Cornyn (R-TX)

Crapo (R-ID)

Dodd (D-CT)

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Stand Up To Wall Street Today

Zach Carter — Thu, 29 Apr 2010 08:45:35 -0400

Today is the big day: thousands of people will march on Wall Street this afternoon to protest big bank abuses.

After watching Wall Street stack the economic deck against, well, just about everybody, it's time for reform. Big Banks secured the most generous bailout in history back in 2008, and today they're back to business as usual, placing trillions of dollars worth of risky bets in the capital markets casinos and paying out epic bonuses to their executives. And the sad truth is, megabanks still hold enormous sway in Washington, D.C. Sweeping reform is still possible. We can still change the very way Wall Street does business-- but only if we make our voices heard.

The Securities and Exchange Committee's fraud suit against Goldman Sachs and the recent hearings held by Sen. Carl Levin (D-MI) have detailed what millions of families fighting foreclosure already knew: Big Banks are out to make money any way they can, and they won't let pesky details like ethical standards, or even the law, get in their way.

Wall Street's reckless excess cost our economy more than 8 million jobs, pushed foreclosures to record levels, and decimated retirement accounts all over the country. But even as more and more homes move into foreclosure, bank profits are going up, fueled by trillions of dollars in bailouts from U.S. taxpayers and accounting gimmicks blessed by corrupted regulators.

This isn't about Republicans or Democrats, it's about Democracy. Big Finance doesn't have to play by the same rules the rest of us do. When they take big risks with other people's money, they win no matter what. If the bets pay off, bankers get rich. If the bets backfire, taxpayers eat the losses, and bankers get rich anyway. When they aren't being bailed out, Big Banks are flexing their political muscles to keep regulators from cracking down on obvious abuses. Banks issued hundreds of billions of dollars in outrageous subprime mortgages during the years of the housing bubbles, and backed hundreds of billions more by propping up other predatory lenders. Regulators looked the other way. Wells Fargo was the top subprime lender at the height of the housing bubble. Has anybody gone to jail? No. Has the Federal Reserve even sanctioned the firm? No.

So long as our economy is dominated by giant firms that we all know are too big to fail, this is how our economy will function. Congress must order the break-up of our biggest banks, and write new rules to crack down on predatory lending and excessive risk-taking. We need a new Consumer Financial Protection Agency that looks out for citizens, not bank profits. The crazy derivatives casino that brought down AIG must be dismantled.

The atmosphere is changing in Washington. The SEC is standing up to Goldman Sachs. Senate Republicans have abandoned their filibuster against Wall Street reform. Congress will spend the next two weeks in heavy debate over how to fix our broken financial system, and some kind of reform bill now seems certain to pass. But without pressure from ordinary citizens, Wall Street's army of lobbyists will ensure that the final bill is a toothless reform-in-name-only. But if you tell Congress we need real reform, Congress will listen.

If you live in New York, meet at City Hall Park (Broadway and Chambers) at 3:30. If you don't live in New York, call your Senator and say you're fed up with abusive banks.

Liveblogging The Goldman Sachs Hearing

Zach Carter — Tue, 27 Apr 2010 17:00:44 -0400

6:05

This hearing has now been going for more than eight hours, and for better or for worse, I need to head over to do an interview with Al Jazeera English. It goes on at 7:00. I'll be talking about financial reform, in addition to the Goldman fraud case.

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6:00

For those who don't know, Goldman took $10 billion in TARP funds, received at least $11.9 billion through the AIG bailout, and issued $21 billion in government-guaranteed debt under the Temporary Liquidity Guarantee Program, debt which is still outstanding, and which the government is still liable for losses (though is unlikely to take any losses any time soon).

Blankfein's 2009 bonus was $9 million. Goldman's profits would have been impossible without government backing.

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5:50

John McCain is keeping it simple and going for the jugular. He just asked Blankfein how much TARP money Goldman received and how big his bonus was for 2009.

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5:40

Lots of disagreement between Levin and Blankfein over market-making. Blankfein is insisting that it does not need to tell its clients who buy the long side of a deal when Goldman is taking the short side. Blankfein says that since somebody takes the opposite side of a deal, it's irrelevant whether Goldman takes it or not.

Levin is pressing him on other cases, when there is no baked-in short side to a deal, cases where Goldman just sells a security to an investor, and then goes and bets against it without telling the investor. Levin wants to know whether Goldman had an obligation to tell these investors that Goldman was betting against what it was selling. Blankfein says no.

This is hard to square with most understandings of ethical conduct. Goldman has a sales force that goes out and pushes products to investors. When Goldman bets against those same products, and doesn't tell the people it's selling them to, that is not good.

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5:00

"I don't beileve so."

That's Viniar's response to Sen. Tom Coburn (R-OK), asking whether an unbiased person could look at what Goldman did in its Abacus synthetic CDO deal. Viniar is the only person in the room who believes that.

"I don't believe it's unethical."

That's Viniar's response to releasing many emails from Fabrice "Fabulous Fab" Tourre that paint him in a very undignified light. Coburn has suggested throughout the hearing that Goldman is throwing Tourre under the bus, and has made a very convincing case. It is, in fact, the smart thing for executives to do, and they do it all the time-- chalk a problem up to a few bad apples, say there's no bigger problem at the firm, and wash their hands of the incident.

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4:00

To clarify, I don't have an objection to Goldman shorting the housing market, in principle. As I said earlier, shorting as such can be a useful economic activity. But while Goldman was shorting the market, it was simultaneously packaging securities based on that market and selling them to investors, believing all the while those securities were doomed.

That's pretty horrible, even if Goldman's net long/short position adds up to zero. They're still fueling a fire for assets that they think are no good, and in the process, making the subprime mortgage mess worse. It is not important whether Goldman's total contribution to this disaster is large or small relative to other firms. It's clear that Goldman's subprime mortgage activities added up to billions of dollars, and that it hurt actual people in the real economy. That's terrible.

It's also clear from the testimony of everyone on the panel today that none of those people think they have any responsibility to the broader economy. If Goldman Sachs makes money ruining the economy, that's fine with them.

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3:45

A week or so ago, Goldman put out an official statement insisting that they did not short the housing market. Levin is making a strong push to show that the statement Goldman issued was misleading.

After starting out with straightforward answers, Viniar appears to be dodging.

The best stab Levin has made so far is the point that Goldman was, in fact, net short by billions of dollars in 2007. The company's "we didn't short the housing market" claim is only makes mathematical sense if you combine both 2007 and 2008.

This actually hurts Goldman more than it sounds like it does, because for much of 2007, investors were still clamoring for mortgage-backed securities and CDOs, and Goldman was packaging them and selling them, despite taking an overall stance against those securities.

Viniar says it was all a strategy to reduce risk. But reducing risk would have meant simply offsetting the long positions. "You blew right by zero," Levin says, and that's true.

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3:30

Goldman CFO Viniar says Goldman's total net revenues from mortgages in 2007 were less that $500 million-- less than 1 percent of its total revenues. He also says Goldman lost money on the mortgage market in 2007 and 2008 combined.

There are a lot of ways to account for revenues, and a lot of ways to define the "mortgage business." I'd like to hear more detail on this.

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3:00

Goldman's strategy so far today has been to stall, stall, stall. They're doing their best to not answer questions, and take as long as possible not answering questions. This started at 10:00 and has been going on now for five hours.

The Goldman execs are coming off as very unpleasant and dishonest people. There is clearly a lot of documentation to sort through here, but these guys are doing their best to just say nothing and stay as unrepentant as possible.

Here's what happened. These guys sold people stuff that Goldman was betting against, without telling them that Goldman was betting against it. By stalling and evading, the Goldman execs may have dodged criminal charges against themselves. But nothing they have presented today has convinced anyone watching that the basic activity under question-- betting against your clients without telling them-- is wrong.

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2:30

I'm ready to see Viniar and Blankfein.

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1:05

Probably worth doing a break-down of what "market-making" is. Clients come to Goldman saying they want to place a bet on something. Goldman arranges a transaction, which people can bet for or against. The defense offered by everybody at Goldman is that they weren't betting against their clients, they were simply arranging a transaction, which people could be long or short (bet for or against). In some of these transactions, Goldman took the short side of the deal.

This is a decent defense, up to a point, provided you haven't been deceiving investors in arranging the deal. That's what the SEC says Goldman did. That's also what the emails Levin dug up imply.

But it's only a good defense up to a point. When Goldman is knowingly creating assets that are economically destructive-- assets that set up foreclosures and fuel a subprime frenzy-- they've done something wrong. When a client comes to you and says he wants to bet against subprime mortgages issued in California, and you know that allowing him to do so will cause more economically destructive subprime mortgages to be issued in California, you do have a responsibility to say no.

Imagine if Goldman Sachs were an auto manufacturer. One of its suppliers comes to the company and says it is going to cut a lot of costs by legally dumping tons of toxic chemicals on poor people in Central Michigan. In that case, Goldman would have a responsibility to find another supplier-- regardless of the effect on its bottom line. Even though it's legal, it's wrong, and a good corporate citizen wouldn't do it. It's just as wrong to knowingly wreak economic havoc, which Goldman was obviously doing.

Now, of course, major corporations in the United States do not behave ethically, and many people reading that last paragraph probably think it sounds a little quaint. And I agree, we are going to be disappointed if we expect corporations to behave in the public interest if they don't have to. I think that says something really horrible about American business. But it also underscores the role of government in a market economy. If pervasive practices are both legal and destructive, they have to be countered through regulation, or outlawed. To talk about the free market in this context is nonsensical.

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12:15

Sen. Ted Kaufman (D-DE) is having a field day with stated-income mortgages. A stated-income loan (also known as a no-doc loan) involves no documentation of the borrower's income. Stated-income loans are completely stupid. Even Ben Bernanke thinks they ought to be outlawed. There are "prime" stated-income loans and "subprime" state-income loans, but in every case, their risk is impossible to determine-- there is no way to tell whether the information in them is accurate or not, and they're a huge invitation to fraud (80% of which is committed by lenders, according to the FBI).

This is Sparks' defense of Goldman's participation in the stated-income loan business: "There were people in my business unit who actually wanted to be long that risk."

This relates to a lot of points Goldman has been making about sophisticated investors. It really is true that a lot of sophisticated investors did incredibly stupid things, sincerely believing that housing prices would never drop. It is also true that these people were paid a lot of money to do this, even though it cost their company tons of money.

It is also true that a lot of sophisticated investors bought stuff they thought was going to tank at some point, but believed they'd be able to sell it off before those assets dropped in value. Think of it as subprime hot-potato. Many of these investors were wrong, mistimed their trades, and got paid a lot of money to make decisions that ultimately wrecked their firms.

It is also true that a lot of sophisticated investors bought assets because they were systematically defrauded by other sophisticated players.

But in all of these cases, the major trouble could have been prevented by straightforward, boring consumer protection regulations in the mortgage market. Regulation matters. If Ben Bernanke, Alan Greenspan or John Dugan had cracked down on garbage mortgages, Wall Street would not have been able to run wild with our neighborhoods. These people completely failed us over the past five years, and there is no reason to believe they will not completely fail us again. What we need is a new Consumer Financial Protection Agency with the authority to both write and enforce consumer protection rules for anybody extending credit to consumers.

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11:50

Nice work again from Collins. "If Goldman's position was truly . . . to remain as neutral as possible, how do you account for all of these references [from company executives] to 'the big short'?"

Sparks is really a marvel. He just says he wouldn't "speculate" about what those words mean.

Goldman shouldn't have to retreat from shorting the housing market. That's how it made a lot of money, and shorting can be a totally responsible strategy for both its investors and the economy.

What's not responsible in any business is withholding crucial, financially important information from your clients. And that's how it appears that Goldman went about shorting the housing market, which is why nobody from Goldman wants to talk about how it made money betting against the housing market-- the way it placed its bets was totally dishonest.

It's also worth emphasizing that shorting stocks is an economically useful function because it's a transparent operation (excluding naked shorts, which are illegal). Stocks are traded on an exchange, so shorting helps move stocks in rational directions and notify the market when a company is in trouble.

But Goldman's shorts were not transparent, because they were conducted in the totally opaque market for credit default swaps, which are not traded on exchanges. The kind of behavior Goldman is being accused of here would have been impossible-- repeat, impossible-- if the derivatives bets they made were open to the investing public. There would be no way for Goldman to exploit its information asymmetries if we had market systems that eliminated them.

That's why Goldman Sachs spends a lot of money on lobbying. Derivatives reform, in particular, would make it a lot harder for the company to screw over its clients for money. A strong Volcker Rule would make it even harder for Goldman to do that.

In case you forgot, yesterday every Senate Republican and Sen. Ben Nelson (D-NE) voted against even opening debate on financial reform.

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11:35

Collins is off to a good start with the witnesses. She asked Sparks whether he believes he had a responsibility to act in the best interest of his clients. Market makers do not have legal obligations to do this in the sense that investment advisers do-- that is to say, they can't be sued for failing to do so-- but it's still really ugly for them to be arranging transactions that hurt their clients.

Sparks dodged the question, so did The Fabulous Fab.

Collins: "Your clients are not paying you big fees just to efficiently conduct transactions . . . they're paying you for judgment as well."

And now Collins is asking whether companies like Goldman Sachs should be subject to a clear "fiduciary duty"-- ability to be sued-- to act in their clients' best interest.

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11:33

I do not want to get on Carl Levin's bad side.

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11:30

Ha! Levin just asked Sparks whether he was aware that subprime lender Fremont had a bad reputation in 2007. Sparks said he couldn't recall.

Apparently I was working in the wrong business in 2007, because as a lowly financial journalist, I was aware, along with everyone in the newsroom I worked in, that Fremont had a terrible reputation. What's more, I can remember the fact! Apparently we all could have been making a lot more money by being out of the loop at Goldman Sachs.

There's another point here that Levin isn't really going after, because it only involves indirect unethical behavior. Goldman packaged $700 million in Fremont loans into securities and pushed them to investors. Fremont, a terrible, terrible lender, never would have been able to make its subprime loans if Wall Street had not been itching to securitize them. Fremont's business model only worked when it could sell off its bad loans to Wall Street to be sold in securitized form to investors. When it stopped being able to sell off those loans, the company collapsed.

That means that while Goldman didn't issue many mortgages directly, it was clearly fueling the subprime fire. Fremont depended on Goldman for its very existence. And neighborhoods paid the price with a tidal wave of foreclosures.

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