finreg

Why Wall Street Reform Should Hammer Bank Profits

Zach Carter — Tue, 05 Oct 2010 13:11:42 -0400

Of the universal-policy-bloggers who occasionally wade into financial waters, Matt Yglesias is generally one of the best. But sometimes he's just flat wrong, and his post today on financial profits is one of those times. Matt argues that looking to financial profits to measure the effectiveness of Wall Street reform is not a good idea, and he's missing the point. The good news is, Annie Lowrey wrote a great piece explaining the current landscape surrounding Wall Street reform, one in which responsible policymakers understand that lower bank profits are an important sign of economic progress.

Here's the key passage from Matt's blog:

"Much has been made, for example, of financial sector profits as a share of overall corporate profits. The numbers are sufficiently striking as probably constitute cause for alarm, but as a metric this is an odd one. If competition between cell phone carriers becomes more robust, leading to falling prices for consumers that’s a good thing. But since it implies smaller profits for Verizon and AT&T it means banking sector profits will rise as a share of overall profits. But who cares?"

This is silly. When people cite this statistic—and I'm one of the people who like to do so—they're not comparing Citibank's profitability to Verizon's. They're comparing the entire financial sector to the entire corporate economy. The idea that innovations in corporate governance, technology and overall corporate efficiency could be applicable to the entire economy except finance should be extremely suspect. Many of these innovations should apply to corporations generally—whether they're banks or boat-manufacturers. Moreover, there is no reason to believe that literally every sector of the economy except finance has found a way to make itself more efficient over the past few decades, while finance has remained the same old bloated bureaucratic beast.

And if we look at the actual recent history of finance, we see that there have, in fact, been dozens of major financial innovations—but innovations that served to extract rents from other players in the economy. Finance, and banks in particular, figured out great ways of simply gobbling up other peoples' money. This didn't create new, better economic activity—it destroyed economic activity and converted it into bonuses for bankers and traders.

And you can measure this phenomenon by examining financial profits as a share of overall corporate profits. It's one way of analyzing the extent to which finance is cannibalizing the real economy. That problem is very significant, even if you ignore the fact that big banks need to be bailed out and create financial crises that have brutal effects on the broader economy. The crashes and bailouts are bad, but finance is eating jobs and converting them into bonuses without them. That's worse.

Matt also emphasizes the need for international coordination on financial reform. It's true to a point, but essentially meaningless so far as U.S. policy is concerned. Sure, if the U.S. adopts really tough Wall Street regulations, and the rest of the world doesn't, then reckless financial activity will move overseas. And eventually, financial excess elsewhere can create trouble here.

But financial recklessness abroad doesn't create the same kind or degree of economic fallout that financial excess at home does. It's bad for the U.S. if global credit markets freeze up because of a real estate bubble in France. It's much worse for the U.S. if global credit markets freeze up because millions of Americans are in foreclosure. "International cooperation" has become a lame excuse not to regulate finance at home, but we can only expect our friends abroad to be as stringent as we are here. If the U.S. continues to allow its banks to take on huge risks as taxpayers guarantee losses, then we're setting ourselves up for economic trouble—much worse economic trouble than we'd have if Europe alone was allowing financial excess.

Matt is commenting on Annie Lowrey's excellent write-up of the Roosevelt Institute conference organized by finance blogger Mike Konczal. Lowrey's piece is a superb summation of the event, and an excellent snapshot of where financial reform stands at this moment—both its enormous economic potential and its perilous political straits.

I'll have my own write-up on the conference tomorrow, but here's a quick summary: Getting Congress to pass any legislation reining in Wall Street was a major task, and the bill we got gives regulators several useful tools. The trouble is, it doesn't give regulators all of the tools, and the regulators who want to fix problems are about to get badgered to death by a Republican Congress that has already threatened to de-fund key parts of the legislation. We'll know if Wall Street reform works if bank profits decline for the right reasons-- not just because the economy sucks, but because banks aren't devouring other economic activity.

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.

Help Ensure House & Senate Managers "Aren't in a Good Mood" About Shady Auto Deals

Richard Eskow — Mon, 21 Jun 2010 14:22:35 -0400

"What do I have to do to get you into this car?"

"How much can you afford to pay every month?"

"My manager's in a good mood."

These are the car salesman cliches everybody knows. Now they're trying to add a couple more to the repertoire:

"When you take out a car loan - probably the second-biggest financial decision of your life - you don't need a watchdog looking out for you."

"Watch out ... this will cost you a lot more if somebody's representing your interests."

And if you believe those last two statements, allow me to show you this brand new baby - it's got whitewalls and mag wheels, tinted windows, I'll throw in the deluxe sports package along with that ... oh, and we strongly recommend undercoating.

Fortunately, there's something you can do: You can go to this site, prepared by CREDO and Campaign for America's Future, where a simple one- or two-click process will send a fax to Barney Frank and Chris Dodd urging them protect American consumers from shady auto loans. It's easy to do, it's important - and, if you act now, it's absolutely free! (Racing stripe and rustproofing not included with fax.)

It's easy to sound flippant, since everybody knows why we all hate car dealers, but the topic is deadly serious: As we've discussed at length, auto dealer lending practices are a disgrace. A massive, multi-year study showed that African Americans are charged more than whites for the same loans. Auto dealers routinely mark up the loans they offer, without disclosing that information to customers - a practice that costs consumers $20 billion per year and adds an estimated $647 to the cost of each vehicle sold. Auto dealers also play games with "gap insurance" that covers the replacement cost of your vehicle for loan purposes if it's totaled.

Another common car dealer trick is to "sell" a car to a customer by claiming they qualify for a no-interest or low-interest loan, letting them drive away in it, then calling them a week or two later to say the loan fell through. Dealers do this because most customers will have gotten used to the car by then, which means that many of them will accept loan terms that wouldn't been unacceptable at the point of sale.

Car lenders have made a particular point of preying on young soldiers, who are living far from home in great distress. That's why Holly Petraeus, wife of Gen. David Petraeus, is strongly in favor of regulating auto loans. The Petraeus family are hardly known for their left-wing views. Mrs. Petraeus speaks movingly of the harm unscrupulous salespeople have inflicted on our troops.

What are the counterarguments? Car dealers and their allies love to say they should be exempted from financial reform because they weren't part of the financial crisis. But think about it: Why should auto loans be regulated when they're provided by banks and credit unions, but not when they're provided by auto dealers? That's anticompetitive. What's more, we've already seen that auto dealers sometimes encourage applicants to lie when applying for a loan. If bank auto loans are regulated but car dealer loans aren't, unscrupulous bankers will simply use car dealers as willing minions to make an end run around consumer protection. With auto lending a nearly $1 trillion market, the last thing we need is a replay of the "no doc" mortgage scandal with car salesmen playing the part of mortgage brokers.

The defend-car-salesmen crowd has a couple more arguments, and a credulous Associated Press commentary by Rachel Beck summarizes them: First Ms. Beck repeats the assertion that lending legislation would affect dentists who allow patients to pay over time (the Senate bill does not and this will undoubtedly be clarified and corrected in conference.) Then, she conflates "family dentists" with auto dealers, as if they were both trusted service providers. (It's true that buying a car is as painful as a root canal, but that's as far as the comparison goes.)

That sleight of hand allows her to come up with this:

Just like the dentists, (auto dealer Tony) Federico says that more regulation will boost his costs. It could mean he does fewer loans, or is less generous in the deals he offers. Consumers then would have to seek out loans elsewhere, which could be less convenient and cost more.

"I am always looking out for my customers' best interests, but I also want to do deals that are worthwhile," Federico says.

So, who are you gonna believe - somebody named "Holly Petraeus," who's concerned about military families, or your trusted family friend Tony Federico? Tony says you'll pay less getting a loan through him, even when he's done taking his market - and when has a car salesman ever lied? Sure, studies show that he's wrong, but who are you gonna trust here - the Center for Responsible Lending .... or your old pal Tony?

I'm sure Rachel Beck is a very nice person, but her piece is embarrassing to read. Why would newspapers run it? Let's not forget that, like politicians, newspapers rely on car dealer revenue for their bread and butter. (Why, the Sun-Times was even willing to cut a deal with the New York Times this week to run luxury car ads in the Chicago market; luxury ads are especially lucrative.) Ad revenue buys a lot of credulity, especially on the editorial pages.

Hey, maybe everybody's wrong but Tony Federico and Rachel Beck. They're not - but let's say for argument's sake they are: : Why not support this provision anyway? It doesn't prevent auto dealers from handling loans, it simply provides oversight when they do. If the Federicos of the world are really providing better loans at reasonable rates, there's no reason why the Consumer Financial Protection organization won't simply give them an "attaboy" or "attagirl" and tell them to keep up the good work. (Attaboy, Tony!)

Or look at it the other way: If they're not doing anything wrong, why are they so concerned about a little oversight?

Auto dealers throw a lot of lucrative fundraisers back home for DC politicians. That's why 62 House Democrats have joined their Republican colleagues in pushing for an auto dealer exemption. That's the money talking. Talk back to it: Send a fax. Call your Senator and Representative. If you do, we can have you in a nice financial reform package, complete with consumer protections against auto dealer rip offs, probably by this time next week.

Now that's what I call a deal.

Law and Order: AIG

Richard Eskow — Tue, 01 Jun 2010 19:48:12 -0400

President Obama's Department of Justice announced last week that there would be no indictments in the collapse of AIG, an event which led to a worldwide economic collapse and cost the American taxpayer trillions. As someone who once worked for AIG I was shocked, but apparently that's how this mystery ends: Hundreds of millions of victims, smoking guns in every room, and not a perp to be found anywhere.

Yves Smith is disappointed that PriceWaterhouseCoopers, the auditors who signed off on AIG's financial claims despite mounds of disturbing evidence, escaped serious legal scrutiny. She observes that our "Potemkin" financial reform (her word) won't remove the barriers that prosecutors face in pursuing secondary parties like auditors (although I believe the Supreme Court ruling she cited only addressed civil suits.) Not only is the auditor protected, but that allows the fraudster himself to use the defense that he kept his auditor informed - kind of like Bush and Cheney using John Yoo's legal opinion to inoculate themselves from criminal prosecution.

Here's another possible reason there won't be a prosecution: Our economy was shattered by a syndicate, a ring, a cabal at the top of the financial pyramid. To move against any one of them - AIG's Joe Cassano, the auditors, Goldman Sachs, or even the credit agencies - would trigger a chain reaction of rats turning on one another, summoning each other to testify, and spilling each other's dirty secrets in an attempt to save themselves.

Of course, that's exactly what most prosecutors want. But doing that could topple that pyramid at the top of our economy, and it looks like our leaders don't recognize that this would be a good thing. We must protect the booming stock market, whatever it takes. If it means leaving the con artists in power, leave 'em in power. If it mean breaking America's longstanding social contract in the name of "deficit reduction," that's okay too. (There's an irony in the fact that Great Britain's new government is under pressure to make cuts to keep its AAA rating. and that we may be next. The ratings agencies are part of the problem, and now it looks like they're controlling governments instead of the other way around.)

Was there reasonable suspicion regarding Cassano and AIG Financial Products? Let's review the record: AIG paid $80 million to settle criminal charges against Cassano's unit in 2004 when it helped PNC Financial conceal assets. AIG didn't just pay a settlement. It also signed a deferred prosecution agreement with the Justice Department leaving it open to criminal prosecution if it misbehaved again. (There's a good timeline here.)

After that Cassano kept reassuring the public - and investors - that his products were safe throughout 2007. (It's illegal to mislead investors.) Cassano fought the independent auditor who was brought in to watch his books, preventing him from looking at certain critical books of business and eventually driving him to resign. Cassano insisted that PwC stay out of his way when he prepared for a presentation to investors in December 2007 (hello, Securities and Exchange Commission!)

Then, of course, all hell broke loose. With that history, why didn't Cassano face trial? As the Wall Street Journal reports, "prosecutors obtained information about Mr. Cassano's disclosures to AIG senior executives and AIG's outside auditor, PricewaterhouseCoopers LLP. That changed the course of the investigation, these people said." So he stonewalled the outside auditor, but he shared info with the cozy inside one? Apparently a compliant auditor is even better than a Father Confessor - you're absolved when you tell him your sins, and he'll never give you "go and sin no more" nonsense.

PriceWaterhouseCoopers weren't just AIG's auditors. They were Goldman Sachs', too. That's right: they had another huge contract with the counterparty whose thirteen billion dollar claim was paid in full on the instructions of Tim Geithner's New York Federal Reserve. So PwC let two massive financial institutions engage in a highly speculative venture - one possibly misleading the other - and raised no warning flags.

Publicly traded companies are required to disclose corporate threats in their 10-K statements, which are approved by their auditors. Here's what AIG said in its 2005 statement (buried several pages into the "Risk Factors" section): "AIG's liquidity could be impaired by an inability to access capital markets or by unforeseen significant outflows of cash." (Gee, ya think?) That's about it for risks. PwC either ignored or missed the warning signs as AIG accumulated losses great enough to break the world's economy.

How have they suffered for this dismal track record? Their revenues rose 8% to $28.2 billion in 2008, and operating profits grew in the fiscal year ending June 2009. And why not? A lot of businesses enjoy the, uh, shall we say flexibility that comes with an auditor like that. Of course, there's no proof their conduct was criminal. They may have just overlooked the worst meltdown in modern financial history.

How about the ratings agencies? The warning signs were there: A plea deal on a charge of criminal fraud, ongoing negotiations with the New York Attorney General, leading economists expressing concern about the stability of the housing market. Yet remarkably (or not), leading ratings agencies S&P and Moody's were rating AIG well right up until September of 2008, when it became clear that it had already lost $18.5 billion and the worst was yet to be revealed. Until that point, S&P had given AIG's counterparty deals the top rating of A-1+, which means "obligor's capacity to meet its financial commitment on the obligation is (very) strong."

In 2007, well after the Spitzer investigation was underway, Best's affirmed that in its judgment AIG's creditworthiness was "superior," saying that "AIG's renewed focus on accounting integrity and future successful remediation of accounting concerns provides a level of stability."

Accounting integrity? Write your own joke, as Ed McMahon used to say. When it comes to PwC and the ratings agencies, Upton Sinclair got it right: "It is difficult to get a man to understand something when his job depends on not understanding it."

We've already reviewed the emails and internal documents showing that ratings agencies were always selling their services to these institutions, a hopeless conflict of interest. The Franken Amendment would improve that situation significantly, but there's no guarantee it will survive the House/Senate negotiations - which should be fully transparent to the public (sign the petition to televise them here, folks.)

My own background as an AIG exec adds an extra dimension to my sense of outrage. The company was destroyed by the ratings agencies, the auditors, and Goldman Sachs (AIG's replacement CEO, Edward Liddy, served on the Goldman board). I heard horror stories about hard-working people who had nothing to do with the scandal receiving death threats or having to pull their kids out of school. Joe Cassano kept his ill-earned salary and bonuses, and for a while after he left was paid $1 million every month at Liddy's behest. PwC had a boom year, and the ratings agencies still (remarkably) have some credibility.

But a once-thriving company is dead. We've paid hundreds of billions of dollars directly, and trillions of dollars indirectly. 15 million people are out of work. The gamblers in the Wall Street casino are still placing bets, secure in the knowledge we'll cover their debts. As they said about Nicky in Casino, they "had a good system: When they won, they collected. When they lost, they told the bookies to go f**k themselves."

And now we're told that nobody's guilty. That's getting it backward. It's like Murder On the Orient Express: They all did it. But apparently we're the only ones who are going to pay for it.
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(We'll be discussing financial reform and other critical issues with Simon Johnson, Nancy Pelosi, Alan Grayson, Robert Kuttner, Arianna Huffington, Bob Herbert, and a host of other luminaries at the Campaign For America's Future Annual Conference on June 7-9.(1) Walk-ins welcome! More info here. Come on in!)

(1) As they (never) taught me on Wall Street, "always be closing."