Wall Street bailout

Stress Testing Tim Geithner

Mary Bottari — Thu, 26 Jan 2012 12:54:38 -0500

Thanks to Occupy Wall Street, in the State of the Union this week President Obama struck some of his most populist themes yet. He wants to tax millionaires, bring back manufacturing and prosecute the big banks. He touted his Wall Street reforms saying the big banks are “no longer allowed to make risky bets with customers deposits” and “the rest of us aren’t bailing you out ever again.”

But are we safe from the next big bank bailout?

Many experts are dubious and Wednesday the consumer advocacy group Public Citizen decided to test the theory in the most direct way possible. They used the administrative law process to formally petition the nation’s top bank regulators to move swiftly to break up Bank of America (BofA) asserting in their petition: “The bank poses a grave threat to U.S. financial stability by any reasonable definition of that phrase.”

A Ticking Time Bomb

BofA is not just big, its behemoth. With assets of $2.1 trillion, equal to more than 14 percent of U.S. GDP, it is bigger than many small countries. Yet, its stock is trading at $7.

What does Wall Street know that we don’t?

The petition provides a compelling list of disturbing data points. In 2008-2009, BofA publicly took $45 billion in TARP bailout funds and secretly took another $1 trillion in emergency Federal Reserve loans. Yet, several analysts predict that BofA is woefully short of capital reserves and facing potentially billions in legal liability for its role in the crisis.

Although the bank declared net profits in recent quarters, these profit comes from accounting tricks, one-time asset sales and stock swaps. BofA’s share price to tangible book value is extremely low. The market suspects the bank is worth roughly half of what management claims and the price of credit default swaps (a type of insurance) on BofA recently rose to record highs.

“The bank is a ticking time bomb,” says David Arkush of Public Citizen. “If Bank of America in its current form were to fail, it would devastate the financial system. We’re asking the regulators to make sure that never happens. The only way to be sure is to reform the institution into something safer before any crisis materializes.”

Public Citizen asked the new Financial Stability Oversight Council (FSOC), which is chaired by Treasury Secretary Tim Geithner and made up of the nation's top bank regulators, to use the tools provided in the Dodd-Frank Wall Street reform law to act before a crisis occurs and to break BofA into smaller separate institutions. The law allows the FSOC to limit big bank mergers and acquisitions, restrict products and services or order it to divest assets or off-balance-sheet items after a vote to designate the institution a “grave threat” to financial stability.

“Too Big to Fail” Alive and Well

Although President Obama said the goal of Dodd-Frank was to end the era of “too big to fail,” neither Geithner nor Fed Chair Ben Bernanke got the memo.

Geithner told the Special Inspector General for the Troubled Asset Relief Program in 2011 future bailouts are possible: “In the future we may have to do exceptional things again if we face a shock that large. You just don’t know what’s systemic and what’s not until you know the nature of the shock. It depends on the state of the world – how deep the recession is. We have better tools now, thanks to Dodd-Frank. But you have to know the nature of the shock.”

Bernanke may already be engaged in a back-door bailout of BofA. Recent news reports indicate that BofA is trying to move $22 trillion in derivatives out of its Merrill Lynch subsidiary into its FDIC-insured bank. The Fed favors the move. The Federal Depository Insurance Corporation (FDIC), which provides insurance to depositors if a bank fails, does not.

“By taking this action the Fed is allowing these derivatives to pose a direct risk to the FDIC insurance fund, keeping taxpayers on the hook for another bailout,” according to Arthur Wilmarth of George Washington Law School.

Groups like Public Citizen fought hard during the Dodd-Frank debates to insert into the bill tools to allow regulators to break up big banks and prevent the next crisis. With BofA on the brink, its time for a “test of the machinery,” said scholar Lawrence Baxter of Duke Law School.

Expand the Stress Tests

Geithner is right when he says regulators can’t predict future shocks; will it be the EU debt crisis, a multi-million dollar damage award against the bank or exposure to something out of the blue? While we may not know its origin, we know the shock is coming.

Remember in the Dodd-Frank debates, an amendment to break up the banks was rejected, efforts to restore Glass-Steagall were rejected, a proposal to force banks to spin off and separately capitalize their dangerous derivatives desks was quashed. In leading the fight against the stronger measures, Geithner instead pushed the FSOC to scan the horizon for risk and keep an eye on the behemoth banks. He also pushed “stress tests,” which all too many banks seem to pass with flying colors.

Now its time to stress test Geithner. If the FSOC fails to deliberate and vote on the very serious condition of BofA, the whole exercise will be proven a sham.

Click here to tell the President to Break Up Bank of America.

Ridiculous Idea of The Day: Melissa Bean for CFPB

Zach Carter — Mon, 08 Nov 2010 11:38:20 -0500

This is a joke. Politico is floating the idea that notorious Wall Street crony Rep. Melissa Bean, D-Ill., could be tapped to head the Consumer Financial Protection Bureau if she loses her close election with Republican Joe Walsh. Even for Politico's rumor-mill, this is pretty funny stuff—only slightly less absurd than suggesting that Alan Greenspan might be picked to head the new agency.

The idea just gets a single paragraph in Politico's Morning Money column, and it even features an administration official shooting down the idea. With good reason, because it makes no sense. President Barack Obama went to the mat to put Elizabeth Warren in charge of the CFPB, and she is doing a terrific job setting up the agency. She's named one of the world's best researchers on consumer finance, Raj Date, as a top adviser, and has started cracking down on deceptive fine print in credit card contracts. There's no reason to replace her with anybody, much less a notorious consumer foe.

Melissa Bean is probably the single greatest consumer antagonist in the Democratic Party. As financial reform moved through Congress, Bean repeatedly slipped in amendments aggressively defending Wall Street's right to pillage our pocketbooks. She single-handedly held up negotiations in the House Financial Services Committee for months, hamstringing the reform process and earning plenty of enemies in the Democratic leadership and the Democratic base. She is simply unconfirmable.

Fortunately, Obama doesn't need to do much looking to find a good CFPB director. He's already got the best person for the job, Elizabeth Warren, steadily building a record of effectiveness getting the agency off the ground. When the time comes to name a permanent CFPB director, that record, along with Warren's decades of work protecting the middle class, will make a very compelling case for her appointment. To be sure, the Republican leadership will filibuster whoever Obama nominates, but Warren already has strong relationships on Capitol Hill with members of both parties, and is extremely popular with the public. If anyone can survive a Republican filibuster, Warren can.

Here's the silly plant in Politico:

MELISSA BEAN FLOATED AS CFPB HEAD – Buzz on Friday had Rep. Melissa Bean (D-Ill.) possibly getting tapped as the first Consumer Financial Protection Bureau head depending on the outcome of her too-close-to-call reelection race, in which Republican Joe Walsh maintained a slight lead as of Sunday afternoon. But a possible Bean nomination is not sitting well with reformers on the left who say the moderate Illinois congresswoman is far too close to the banking industry. Said one administration official: “It’s not clear she would be acceptable to the reformers.”

Banker-Run Third Way Opposes Foreclosure Moratorium On Banks

Zach Carter — Wed, 20 Oct 2010 12:28:16 -0400

The so-called “centrists” at Third Way Foundation have come out against a national foreclosure moratorium, but like many of Third Way’s policies, there’s nothing centrist about their opposition. Third Way is simply throwing American homeowners under the bus in the service of Wall Street profits. That sellout isn’t surprising when you examine the membership of Third Way’s Board of Trustees. Fully two-thirds of the think tank’s board work in finance, including some of the nation’s largest financial firms: JPMorgan Chase, Morgan Stanley, Fortress Investment Group and other Wall Street titans who stand to lose big bucks in the foreclosure fraud fallout.

Third Way Vice Chairman David Heller is the Global Head of Equity Trading for Goldman Sachs, and sits on the firm’s risk-committee. Goldman Sachs has placed enormous bets on the housing market, and other Third Way board members face similar sraits: William Daley works for JPMorgan Chase—a bank that has already suspended foreclosures in order to sort out its own problems. Derek Kirkland is global co-Head of Morgan Stanley’s Financial Institutions Group, and Michael Novogratz is President of Fortress Investment Group, one of the largest hedge funds in the world.

Daniel Loeb has a spot on the board. Yes, that Daniel Loeb, the whining Wall Street hedge fund manager who infamously complained that President Barack Obama wanted to violate American protections against "nonpunitive taxation, constitutionally guaranteed protections against persecution of the minority and an inexorable right of self-determination"-- because Obama favored raising the capital gains tax. All of these people, and dozens of others on the Third Way board, stand to lose or gain enormous amounts of money from the foreclosure fraud outbreak and the federal response.

Even the author of the memo, Jason Gold, used to work for bailed-out banks First Horizon, Bank of America and Merrill Lynch. All of this information is available on Third Way’s website, but not one word of the think tank’s memo on a foreclosure moratorium mentions any possible conflict of interest, nor are any actual conflicts of interest detailed.

Independent think tanks shouldn’t be promoting policies that their board members stand to financially benefit from without explaining their financial interests. If Jason Gold and Third Way want to oppose a foreclosure moratorium, fine—but they should demonstrate exactly what they have to gain from such a policy in their memo.

Third Way and other centrist groups like to claim they’re staking out political middle ground, when in fact they’re just advocating policies that funnel money to entrenched corporate interests. Wall Street is very good at this game, as evidenced by the fact that 20 of the 30 members of Third Way’s board work for Wall Street. These aren’t policies that create jobs or improve the economy—they’re just giveaways for special interests. As one Democratic policymaker who requested anonymity told me, "Third Way's policy model is an utter catastrophe. They are basically Weimar Democrats."

Aside from the glaring conflicts-of-interest, Third Way’s argument against a foreclosure moratorium is totally incoherent. None of the points made stand up to even cursory levels of economic scrutiny—it’s the sort of thing you’d expect to see from the Mortgage Bankers Association, not an independent think tank. Third Way claim that a moratorium will scare buyers away from the market and put downward pressure on home prices. It’s a nice talking point, but any sane buyer should already be spooked by the facts that have emerged on bank documentation policies. The moratorium isn’t going to reduce confidence—years of banker abuse already has. Banks skimped on their paperwork to cut costs, and are now resorting to systematic fraud to cover-up very big problems. They’ve charged borrowers illegal fees, foreclosed on the wrong homes, and sold the same mortgage to different investment banks to be packaged into different securities. That kind of behavior scares borrowers. Repairing the damage isn’t nearly as frightening.

Third Way also claims that a moratorium would hurt community banks and credit unions. Hard to see how that’s the case if the moratorium only “forestalls” foreclosures, rather than preventing them, as Third Way claims, but if this is really a huge problem, just exempt credit unions and banks with less than $1 billion in assets from the moratorium. Illusory problem solved.

Third Way also argues that a moratorium is unfair to taxpayers—but taxpayers are likely to be the single largest party defrauded in the documentation scam. Taxpayers own trillions of dollars in mortgage-backed securities through the Federal Reserve, Fannie Mae and Freddie Mac. A moratorium can help us indentify problems and make claims against banks who have acted inappropriately.

This reasoning is not simply divorced from economic reality—it’s internally inconsistent. Third Way says that a foreclosure moratorium would only “forestall” foreclosures, not prevent them—and then turns around and insists that a moratorium would encourage people not to pay their mortgages. If it’s not a permanent solution, no sane borrower is going to stop paying.

Unless it already makes sense for borrowers to stop paying their mortgages. Third Way board member Derek Kirkland is a bigwig at Morgan Stanley. Last year, Morgan Stanley realized that a handful of properties it had purchased in San Francisco were not worth what Morgan Stanley owed on the mortgages. So Morgan Stanley made a rational decision: instead of wasting its money on payments for a devalued property, it walked away from the mortgages. This is called a “strategic default,” and Third Way explicitly comes out against it in their memo. But iff the board members of Third Way are okay with strategic defaults, what right do they have to hold American homeowners to a different standard?

Helping homeowners isn’t part of some radical leftist agenda—it’s a basic prerequisite for economic recovery. When homeowners are burdened with unnecessary, predatory, and even fraudulent debt, they don’t have money to spend on productive economic activities that create jobs. Punishing borrowers for fraud committed by bankers simply doesn’t make sense. A foreclosure moratorium won’t solve all of our problems, but it can help us sort them out so that homeowners who deserve help can be identified, along with bankers who have committed fraud.

Calls to Third Way were not immediately returned.

Crony Capitalism: Wall Street's Favorite Politicians

Zach Carter — Tue, 28 Sep 2010 17:02:59 -0400

A full 90 members of Congress who voted to bailout Wall Street in 2008 failed to support financial reform reining in the banks that drove our economy off a cliff. But when you examine campaign contribution data, it's really no surprise that these particular lawmakers voted to mortgage our economic future to Big Finance: This election cycle, they've raked in over $48.8 million from the financial establishment. Over the course of their Congressional careers, the figure swells to a massive $176.9 million.

The complete list of these Crony Capitalists is below, along with the money they pulled in from Big Finance, according to data compiled by the Center for Responsive Politics (opensecrets.org). The career data goes back to 1989. Of the 69 House members who voted with Wall Street on both the bailout and financial reform, 60 are Republicans, while nine are Democrats. All 21 Senators who voted with Wall Street on both issues are Republicans, and Republicans raked in over 90 percent of the total campaign contributions. Here's a chart showing Wall Street's total contributions to this crowd for the 2010 cycle, by political party:

And here's one showing total Wall Street contributions over the course of their careers:

These aren't the only politicians carrying water for Wall Street—only the most flagrant. Some of the bank lobby's savviest servants on Capitol Hill do their dirty work early in the legislative process. They push through technical amendments and deploy complex procedural tricks to defang a bill, but when the final vote comes, they can still create the appearance of taking a stand against Wall Street's interests. Rep. Melissa Bean, D-Ill., is a master of this technique, and Tea Party favorite Sen. Scott Brown, R-Mass., was able to claim credit for voting in favor of reform after demanding—and receiving—a host of big bank giveaways in return for his vote.

Nor are Republicans the only recipients of Wall Street largesse. Bean, for instance, has pulled in over $773,000 from Wall Street in the 2010 cycle alone, while working overtime to carve loopholes into new consumer protections (she's scored $2.4 million over the course of her Congressional career). And the Democratic leadership has received millions as well.

When it comes to dealing out economic damage, no special interest group has been able to wreak more havoc that Big Finance. After inflating an $8 trillion housing bubble and sparking a recession that has cost the economy over 8 million jobs, public pressure to crack down on Wall Street was intense. And the public is still clamoring for Wall Street accountability—after two years in office, the Wall Street reform bill remains the most popular legislative effort championed by President Barack Obama, and getting tough on Big Finance has been a reliable re-election strategy for embattled incumbents.

But harnessing the Wall Street beast proved a tortuously long and difficult process, taking nearly two years despite its economic urgency. And while the bill that Congress approved this year has plenty of virtues, many of the most critical reforms were simply not addressed by the legislation. The too-big-to-fail financial behemoths that taxpayers bailed out in 2008 are even bigger today, banks can still gamble with taxpayer money, and the foreclosure crisis continues to ravage neighborhoods across the country. Until these issues are addressed, the U.S. economy will remain beholden to Wall Street's bonus-crazed whims.

But if you follow the money, it's obvious why so much work remains to be done on financial reform. This year alone, Wall Street spent a staggering $251 million fighting financial reform. According to a separate analysis of campaign contributions performed by Public Citizen, lawmakers who voted with Wall Street on both the bailout and reform received nearly triple the campaign cash of those who opposed Wall Street (figures in the Public Citizen study don't correspond to those I've compiled, as Public Citizen examined contributions from 2007 through July of 2010).

Despite the popularity of Wall Street reform, 90 members of Congress didn't even want to publicly pretend to support reining in almost universally reviled banks. When you're trying to decide which bums to throw out in November, here's one place to start. These members of Congress are okay with setting up economic calamities, and they don't mind paying for them with your tax dollars.

Here's how Wall Street's contributions break down among Wall Street's 21 Senate Cronies. For 2010:

For their careers:

And here are all of the Cronies, along with their Wall Street hauls:

Senator	2010 Wall Street Cash	Career Wall Street Cash
Sen. Lamar Alexander (R-TN)	$1,600,000	$4,900,000
Sen. Robert Bennett (R-UT)	$1,500,000	$2,600,000
Sen. Kit Bond (R-MO)	$333,600	$3,300,000
Sen. Richard Burr (R-NC)	$1,500,000	$3,300,000
Sen. Saxby Chambliss (R-GA)	$2,500,000	$3,500,000
Sen. Tom Coburn (R-OK)	$451,700	$1,200,000
Sen. Bob Corker (R-TN)	$3,100,000	$3,300,000
Sen. John Cornyn (R-TX)	$3,200,000	$4,700,000
Sen. John Ensign (R-NV)	$1,300,000	$2,600,000
Sen. Lindsey Graham (R-SC)	$1,100,000	$2,000,000
Sen. Judd Gregg (R-NH)	$233,200	$1,100,000
Sen. Orrin Hatch (R-UT)	$1,400,000	$2,600,000
Sen. Kay Bailey Hutchison (R-TX)	$1,400,000	$4,700,000
Sen. Johnny Isakson (R-GA)	$1,500,000	$4,200,000
Sen. John Kyl (R-AZ)	$2,800,000	$3,800,000
Sen. Dick Lugar (R-IN)	$412,200	$2,500,000
Sen. John McCain (R-AZ)	$947,600	$34,000,000
Sen. Mitch McConnell (R-KY)	$4,300,000	$5,300,000
Sen. Lisa Murkowski (R-AK)	$268,200	$909,700
Sen. John Thune (R-SD)	$1,600,000	$3,900,000
Sen. George Voinovich (R-OH)	$435,200	$2,800,000
21 Republicans
0 Democrats
Senate Total	$31,881,700	97,209,700

House Member	2010 Wall Street Cash	Career Wall Street Cash
Rep. Rodney Alexander, R-La.	$106,500	$422,300
Rep. Spencer Bachus, R-Ala.	$611,600	$4,400,000
Rep. Gresham Barrett, R-S.C.	$20,400	$806,700
Rep. Marion Berry, D-Ark.	$24,900	$663,700
Rep. Judy Biggert, R-Ill.	$395,000	$1,900,000
Rep. Roy Blunt, R-Mo.	$1,200,000	$3,800,000
Rep. John Boehner, R-Ohio	$1,300,000	$3,700,000
Rep. Jo Bonner, R-Ala.	$90,400	$702,200
Rep. Mary Bono Mack, R-Calif.	$190,000	$733,400
Rep. John Boozman, R-Ark.	$257,700	$491,000
Rep. Dan Boren, D-Okla.	$123,100	$722,200
Rep. Rick Boucher, D-Va.	$92,700	$1,400,000
Rep. Charles Boustany Jr, R-La.	$226,300	$934,600
Rep. Kevin Brady, R-Texas	$157,000	$840,500
Rep. Henry Brown, R-S.C.	$35,700	$494,000
Rep. Vernon Buchanan, R-Fla.	$336,800	$1,400,000
Rep. Ken Calvert, R-Calif.	$180,300	$940,300
Rep. Dave Camp, R-Mich.	$588,000	$1,700,000
Rep. John Campbell, R-Calif.	$413,400	$1,200,000
Rep. Eric Cantor, R-Va.	$2,100,000	$4,400,000
Rep. Mike Castle, R-Del.	$749,100	$3,200,000
Rep. Howard Coble, R-N.C.	$23,400	$502,500
Rep. Tom Cole, R-Okla.	$110,000	$686,000
Rep. Mike Conaway, R-Texas	$161,500	$711,800
Rep. Ander Crenshaw, R-Fla.	$86,100	$717,000
Rep. Henry Cuellar, D-Texas	$90,600	$606,900
Rep. Charlie Dent, R-Pa.	$177,900	$881,000
Rep. Chet Edwards, D-Texas	$324,200	$1,900,000
Rep.Vernon Ehlers, R-Mich.	$8,500	$292,200
Rep. Jo Ann Emerson, R-Mo.	$143,900	$904,400
Rep. Mary Fallin, R-Okla	($1,000)	$340,700
Rep. Rodney Frelinghuysen, R-N.J.	$86,200	$840,300
Rep. Jim Gerlach, R-Pa.	$251,600	$1,800,000
Rep. Kay Granger, R-Texas	$140,000	$1,100,000
Rep. Wally Herger, R-Calif.	$171,500	$1,100,000
Rep. Peter Hoekstra, R-Mich.	($1,000)	$300,600
Rep. Bob Inglis, R-S.C.	0	$572,800
Rep. Peter King, R-N.Y.	$173,900	$1,600,000
Rep. Mark Kirk, R-Ill.	$1,900,000	$4,200,000
Rep. John Kline, R-Minn	$170,900	$989,100
Rep. Jerry Lewis, R-Calif.	$31,800	$748,000
Rep. Daniel E. Lungren, R-Calif.	$147,700	$622,500
Rep. Howard McKeon, R-Calif.	$132,100	$1,100,000
Rep. Gary Miller, R-Calif.	$144,500	$902,000
Rep. Harry Mitchell, D-Ariz.	$130,900	$558,000
Rep. Sue Myrick, R-S.C.	$93,600	$1,200,000
Rep. Soloman Ortiz, D-Texas	$40,200	$381,700
Rep. George Radanovich, R-Calif.	$24,900	$462,000
Rep. Mike Rogers, R-Ala.	$128,200	$1,000,000
Rep. Hal Rogers, R-Ky.	$50,200	$468,000
Rep. Ileana Ros-Lehtinen, R-Fla.	$127,000	$986,000
Rep. Paul Ryan, R-Wis.	$531,500	$1,900,000
Rep. Jean Schmidt, R-Ohio	$121,900	$519,700
Rep. John Shadegg, R-Ariz.	$39,700	$1,200,000
Rep. Bill Shuster, R-Pa.	$30,700	$403,600
Rep. Mike Simpson, R-Ind.	$20,500	$266,900
Rep. Ike Skelton, D-Mo.	$112,500	$524,200
Rep. Lamar Smith, R-Texas	$258,900	$1,300,000
Rep. Mark Souder, R-Ind.	$40,500	$405,800
Rep. Zack Space, D-Ohio	$169,300	$476,300
Rep. John Sullivan, R-Okla.	$79,200	$494,800
Rep. Lee Terry, R-Neb.	$202,600	$1,400,000
Rep. Mac Thornberry, R-Texas	$42,500	$603,400
Rep. Patrick Tiberi, R-Ohio	$555,500	$2,800,000
Rep. Fred Upton, R-Mich.	$81,700	$929,400
Rep. Greg Walden, R-Ore.	$180,700	$732,400
Rep. Zach Wamp, R-Tenn.	0	$715,700
Rep. Joe Wilson, R-S.C.	$155,500	$580,200
Rep. Frank Wolf, R-Va.	$90,400	$1,100,000
60 Republicans	$15,873,400	$72,443,800
9 Democrats	$1,108,400	$7,233,000
House Total	$16,981,800	$79,676,800

Basel III Is Still Bonkers

Zach Carter — Wed, 15 Sep 2010 13:23:01 -0400

It's been two days, and the new Basel III bank regulations are still lousy. Martin Wolf slams the international banking accord here and Yves Smith agrees here, although Felix Salmon notes some improvements over the current banking regime here and Tim Fernholz offers a full-throated cheer for the new rules here.

What makes the new rules so unnerving? Martin Wolf nails it. First, as I emphasized on Monday, he says that the only real line of defense Basel III deploys involves risk-weighted capital, and risk-weighting can be gamed. More importantly, the new capital requirements just aren't anywhere near the levels needed to rein in banks that know they have access to unlimited government support. We haven't fixed too-big-to-fail, the banks know it, and as a result, we'll need much, much higher levels of capital than Basel III actually demands.

How much more capital? Wolf says 20 percent to 30 percent, without risk-weightings. What does Basel III actually deliver? A paltry 3 percent. As I noted on Monday, that's equivalent to a leverage ratio of 33-to-1, actually higher than the 31-to-1 leverage Lehman Brothers deployed at the peak of its crisis-era excess.

What's worse, this hard leverage cap is only a test. In a few years, the Basel committee will reconvene to determine whether such measures are even necessary. I can foresee only two possible outcomes. First, the global economy has suffered another major financial calamity and all will agree that the cap must be higher—this should be unacceptable. In the second, the economy is improving, the banks are making lots of money, and regulators agree that silly things like leverage caps are a relic of the past, an overreaction to a crisis that the world has moved on from, nevermind the millions of jobs lost and careers ruined in the process. Nobody is going to suggest moving the cap to 5 percent, much less 20. Catastrophe quickly ensues.

Felix Salmon acknowledges that the risk-weighting issue remains problem, but still sees reason to be "unapologetically happy and optimistic." Whatever it's flaws, Basel III is still better than what we've got now—this is unquestionably true, by the way—and besides, Basel III also features new liquidity rules, which will help keep catastrophes like Lehman from developing, so things aren't really that bad. Basel II included no liquidity constraints, which was certainly a mistake.

This is the general consensus on Lehman's collapse, but it's not really accurate. Lehman did experience a massive run immediately before its failure, but the Federal Reserve had already given the bank access to its discount window. The whole purpose of the discount window was to provide liquidity in the face of a bank run. But the Fed didn't lend to Lehman, because Lehman didn't have the collateral to support such a loan. In other words, Lehman wasn't just shy on liquidity, it was insolvent.

Moreover, there's a reason why investors pulled the plug on Lehman in the first place. The bank was totally overleveraged, and had invested in absolute garbage. Lehman knew it was overleveraged, and knew that the market was concerned, which is why it resorted to a complicated derivatives scam of dubious legality in order to hide a mountain of debt from its investors.

Sure, tighter liquidity rules are better than no liquidity rules at all. But without major capital requirements, banks are going to be prone to massive runs, and when the market reaches its verdict on a bank's viability, all the liquidity in the world won't stop the run. When Bear Stearns went down, investors wouldn't even accept U.S. Treasury bonds as collateral. No regulatory measures can overcome such a panic.

The key is to prevent the panic in the first place, and make sure that the consequences of the panic do not overwhelm the broader economy. At an absolute minimum, that means stringent capital requirements. Tim Fernholz thinks Basel III delivers the goods, calling the accord "a tough new international regime" and "a rare sign of optimism in the battle with the banks."

I just can't understand that view. My point is not that Basel III is worthless—it's very clearly a step in the right direction. But this is the structural response to the worst financial crisis in history. Given that backdrop, Basel III is laughably weak.

This was not the savings and loan crisis. Every major U.S. bank other than Lehman Brothers had to be bailed out on a massive scale, and bank bailouts in Europe sparked a string of sovereign debt crises that almost toppled the Euro. As a result of this enormous economic catastrophe, international regulators plan to bump up risk-weighted capital minimums from 4 percent to 7 percent (Basel II was 2 percent, but the U.S. implemented 4 percent) and acknowledge that liquidity can sometimes be a problem. This is akin to a doctor telling an alcoholic to keep drinking, but start taking vitamins. After he's suffered a heart attack.

Salmon says that critics who demand that Basel III prevent the next crisis are asking too much. Whatever the regulatory regime, he says, financial crisis are always possible. It's true-- we cannot predict the unforeseeable. But this truth is also meaningless. We can take measures to ensure that whatever crisis may come is not a global economic disaster, we can ensure that the cost of cleaning it up is low, and we can ensure that the costs to the broader economy are contained. Basel III falls short on all three of these goals. What's worse, all three of them are attainable.

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.

Bernanke Admits It: Too-Big-To-Fail Lives On

Zach Carter — Tue, 07 Sep 2010 16:12:25 -0400

Last week, Federal Chairman Ben Bernanke finally acknowledged that his preferred "solution" for ending Too-Big-To-Fail is likely unworkable. When the financial crisis exploded in 2008, top Fed and Treasury officials insisted that they did not have the legal authority to shut down faltering megabanks, leaving them no choice but to resort to massive bailouts. At a critical hearing last week, many of those same officials acknowledged that in at least one case, policymakers had plenty of authority, and actually went to extreme lengths to sidestep it in order to provide a bailout. Even Bernanke now seems to believe that we can expect the same insanity when the next crisis hits.

Bernanke has spent the past two years fighting efforts to break up the largest U.S. financial behemoths. Instead of downsizing dangerous banks, Bernanke, along with Treasury Secretary Timothy Geithner and other figures in the administration pushed to create a new "resolution authority" that allows regulators to unwind megabanks when they fail.

The FDIC has had this authority over boring commercial banks for decades, and it has worked very well, even through the crash of 2008. When these banks get into trouble, the FDIC wipes out their shareholders, kicks out their executives and liquidates the bank without much trouble. The trick is, these commercial banks are usually relatively small, with simple lines of business all housed in the United States. Last week, Bernanke acknowledged that Wall Street megabanks are different. Even when armed with the technical legal authority to shut them down, regulators will be extraordinarily reluctant to actually pull the trigger.

"Let me just be clear: this is not going to be easy to implement," Bernanke said. "I think the one area that's going to take a lot of effort is the international element."

The resolution authority is a U.S. law, but the big Wall Street banks operate all over the globe, making it extremely difficult to coordinate the their liquidation. Former IMF Chief Economist Simon Johnson has been emphasizing this point for years, and has been ignored by Bernanke and Geithner as they insisted a resolution authority would end Too-Big-To-Fail. Now that Congress has adopted their plan, Bernanke wants to emphasize that it will be extremely difficult to actually use:

"One of the banks that we supervise has offices in 109 countries, each one with its own bankruptcy code and its own rules and so on."

What's more, the FDIC's resolution authority doesn't even work on simple, commercial banks if they're big enough. Bernanke should understand this, since it was the Fed who pushed to bailout Wachovia when that bank teetered on the verge of collapse in 2008. The Fed official who demanded that Wachovia be spared was none other than Timothy Geithner, who was heading the New York Fed at the time.

Last week's hearings detailed the bailout negotiations between Geithner and FDIC Chairman Sheila Bair that took place in late September, shortly after Lehman Brothers filed for bankruptcy. Bair wanted to simply shut down Wachovia and limit losses for taxpayers, while Geithner wanted to spare losses for the bank's investors. Ultimately, bair relented to Geithner's demands, declaring a "systemic risk exemption" to the FDIC's ordinary procedures and arranging a merger that would make sure Wachovia's creditors didn't lose a dime, while the Treasury Department altered a decades-old tax rule in order to funnel billions of dollars to Wachovia's shareholders.

It's conceivable that Bair was actually right about the Wachovia bailout—it may have been unnecessary. But whether she was right or wrong about liquidating Wachovia doesn't really matter so far as public policy is concerned. In the Wachovia episode, policymakers were too concerned about the prospective fallout from the bank's failure to roll the dice and let the bank go down—even though they had a proven, codified, decades-old process for doing just that.

Resolution authority works very well with small, simple institutions. And it turns out that small, simple institutions work better than bloated financial behemoths. There is no economic evidence—absolutely none—that megabanks provide any economic benefits that cannot be provided by smaller banks. Our economy doesn't need the massive banks that caused the worst recession since the Great Depression.

The Wall Street reform bill that Congress passed this summer codified several useful new policies. But the top official at the Federal Reserve just emphasized to the public that the job is not finished. Too-Big-To-Fail lives on, and breaking up the banks is the only way to kill it.

Liveblogging Bernanke & Bair

Zach Carter — Thu, 02 Sep 2010 11:23:00 -0400

1:20

All done. Lesson: Break Up The Banks.

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1:00

Most of the discussion surrounding too-big-to-fail at this hearing has dealt with a relatively short period in time: the decision to bailout a firm, and what happened right after that decision.

This is an important part of the issue, but it's by no means the whole story.

Right now, three banks control 55 percent of the mortgage market, while 10 banks control 95 percent of it. Banks this large, with this much control over the financial spectrum are impeding normal market functions. Even if we allowed these megabanks to fail, the current system is fundamentally anti-competitive, and the broader economy pays a significant price for it. Loans are more expensive because banks can force higher prices on the rest of the economy due to their market clout. Those higher prices do not create any economic benefit for the broader economy-- the exact opposite is true. Big Finance is eating away at the real economy, hamstringing businesses, hampering innovation and making people poorer in the process. That would be bad even if policymakers could credibly say they'd allow Citi and JPMorgan Chase to fail. Which they can't.

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12:45

Georgiou just asked her point blank if, given everything that went on in 2008 and 2009, the resolution authority for complex financial institutions is at all credible. Bair said yes. Bair can credibly say yes because she wanted to apply the resolution authority to Wachovia, because she didn't think it would result in a systemic nightmare.

I think Bair is living in fantasy-land here, but unlike every other major player from 2008, she is at least consistent.

But remember, even if Bair was ultimately right that bailing out Wachovia bondholders was unnecessary, its not the whole story.

When it went under, Wachovia was a commercial bank with about $700 billion in assets. Citigroup, Bank of America and JPMorgan Chase all have well in excess of $2 trillion in assets, under dozens of different lines of financial business. They have massive derivatives operations and lots and lots of complex securities trading. From a strictly technical standpoint, these megabanks much more difficult to unwind than a bank that does almost nothing other than accept deposits and extend loans.

And this ignores Bernanke's admission that it will be impossible to unwind banks across international boundaries.

We may not be able to end too-big-to-fail. In the past, the U.S. has chosen to subsidize the creditors of banks much smaller than Wachovia. Since the Reagan era, the top banks have all been given special treatment. But the price and the consequences of subsidizing creditors in the 1980s were vastly smaller than those of the 2008 and 2009 bailouts. Breaking up the banks at least gives regulators a fighting chance to shut down our largest banks when they fail. If breaking them up isn't feasible, the cost of bailing out a $50 billion bank is a lot lower than the cost of bailing out a $5 trillion bank.

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12:30

Holtz-Eakin just made a great point. Prompt corrective action laws lay out a set of binding, concrete steps that bank regulators have to take when banks get into trouble, staring with restrictions on bank activities and, if the bank is unable to raise enough private capital, ending with liquidation. Regulators do not have the discretion to inject taxpayer money into the bank to keep it afloat.

But the stress tests, of course, sidestepped these laws for the 19 largest banks. Treasury injected capital into these banks and ignored the codified process for reining them in.

Bair responded that the stress tests were a commitment to keep banks above the capital thresholds where prompt corrective action would have applied. Geithner said this repeatedly when the stress tests occurred, and it's totally absurd. It requires us to believe that banks really are perfectly healthy, but the government has to inject capital into them anyway. If the banks really were healthy, why on earth were taxpayers asked to stand behind them?

This is, of course, a technical legal note that keeps policymakers out of jail. But as Holtz-Eakin notes, regardless of what happens to policymakers, the signal to financial markets is absolutely clear. When things break down and crisis sets in, the law doesn't apply. Whatever Congress puts on the books, regulators will do whatever they think is necessary to save the system when the system breaks down.

That does not bode well for the new requirements Congress just imposed on regulators for shutting down "systemically important" firms.

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12:25

Bair says she never knew that the IRS was planning to restructure tax code. Also says she was surprised by Wells Fargo's competing offer for Wachovia.

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12:20

Angelides is digging into the dispute between Bair and Geithner (then at NY Fed) over whether Wachovia creditors should have been fully protected.

Bair is not a perfect regulator and she wasn't perfect on Wachovia, but unlike just about everybody else running the regulatory, she actually respected the laws on the books and actually wanted to see creditors and shareholders take losses.

She wasn't totally sold on invoking a systemic risk exception for Wachovia, because she wanted to hit Wachovia's bondholders with losses. It's been clearly established for decades that commercial bank bondholders take a hit when commercial banks fail. Depositors are protected, other creditors have to deal with the consequences of failure, and they've always known that.

Geithner wanted to protect bondholders, and you protect bondholders by either bailing out the bank or by arranging a merger. The systemic risky exemption which allowed the FDIC to act outside some of the prompt corrective action mandates came from Geithner. Bair resisted, but ultimately gave in.

Geithner may actually have been right about bailing out Wachovia bondholders. It may have been systemically critical to shield them from losses (although if it was, it probably wasn't necessary to shield all bondholders from all losses).

There's an obvious lesson to this episode, and there's really no excuse for Geithner failing to learn it, given his role in the mess. Resolution authorities do not work for big banks. Even under the most generous interpretation of Geithner's actions on Wachovia, one has to conclude that in a crisis, big bank investors need to be subsidized, whether there's a legal structure that prevents this subsidy or not.

Let me emphasize this: Geithner was the very person demanding that the resolution authority be ignored for Wachovia. But his policy for ending too big to fail? Expanding the FDIC's resolution authority to new types of financial firms.

Break up the banks.

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11:55

Bair is beginning.

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11:45

Capital requirements only matter if you actually apply firm accounting standards. If you let banks account for their assets however they want to, they don't have to take losses, because they can simply invent profits and erase losses on their balance sheets, irrespective of what's going on in the real world.

This is why stronger capital requirements alone are unlikely to help in the next financial crisis. Bank accounting is generally a flexible enterprise, and regulators allow banks to get away with murder when financial crises hit. This time around, they went so far as to formally reinterpret accounting rules that required banks to account for their assets at their current market value. That sounds crazy, and it basically is crazy, although there are some crazy people who think market-based accounting was actually what caused the financial crisis, not any fundamental problems on Wall Street.

In response to a host of questions about capital requirements Bernanke basically cautioned against getting too aggressive with new standards, and also cautioned against getting too stringent with accounting guidelines. This stuff is hard, you don't want to screw up, but I believe in markets, and mark-to-market accounting is useful, etc.

The problem is, Bernanke's reticence here is fundamentally anti-market. He's saying that if we pay too much attention to markets in a time of crisis, asset prices will go down too much and banks will be in more trouble than they need to be. If we give banks some flexibility on accounting during a crisis, they won't have to take immediate losses, and once asset prices rebound from their panic-driven lows, everything will be okay. It just means that marking to market is good, so long as market prices are high. When market prices are low, we're somehow being unfair to banks by making them recognize those low prices.

But even if Bernanke is right, and there is something fishy about mark-to-market accounting during a financial crisis-- what's the alternative? Letting banks make up whatever asset values they want? That was the plan in 2008, and it's still the plan today, especially on second-lien mortgages, which banks continue to value at hundreds of billions of dollars, even though second-liens are worthless once home prices decline.

Over and over and over again we've heard Timothy Geithner and Alan Greenspan and Ben Bernanke say we need higher capital requirements. But nobody has any plan for actually enforcing those standards.

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11:15

More on the legality of the Wachovia arrangement. There are some loopholes in the prompt corrective action process, and the FDIC did invoke a systemic risk exception so that it didn't have too dump Wachovia's assets at the least cost to the taxpayer.

But Bair was still planning to auction off Wachovia's assets before Treasury changed the tax law to facilitate the Wells Fargo deal. And no matter what happened, if there was even uncertainty about whether Wachovia was solvent, the OCC totally failed to enforce prompt corrective action laws in the run-up to the bank run. There are multiple categories of capitalization, Wachovia was at the highest. When you slip down into weaker categories, regulators are required to take actions which the OCC did not take.

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10:45

Did Bernanke just admit that the Wachovia bailout was illegal? Wallison is now pressing Bernanke on the same liquidity stuff he presented yesterday to NY Fed's Baxter.

The discount window should be able to provide unlimited liquidity to any solvent bank. It's supposed to help deal with bank runs. If the bank can put up collateral, it can get a loan from the Fed, and the run won't kill the bank.

When Wachovia failed in 2008, regulators blamed a liquidity run (as they did for IndyMac and other banks that failed that year). But that's not supposed to be possible. So, Wallison asks, what happened?

"Their liquidity demands were such that they thought they could not meet them even with the discount window," Bernanke said.

Wallison pushed back. Really? They were solvent but they didn't have the collateral to get loans from the Fed?

Then Bernanke half-admits what must have been going on:

"I think there was uncertainty about whether they were solvent or not," Bernanke said.

This is a very big deal, because the regulators had clear, well-defined authority to unwind Wachovia. It wasn't an investment bank like Lehman Brothers, it was a commercial bank like Washington Mutual. Not only that, under prompt corrective action statutes, regulators and a clear, well-defined legal obligation to shut down Wachovia if it was in fact insolvent. In fact, they had a clear, well-defined responsibility to shut down Wachovia before it became insolvent in order to protect taxpayers. Instead, policymakers arranged a complex bailout by abusing the tax code to subsidize Wells Fargo's acquisition of Wachovia.

If Wachovia was insolvent, this was not just reckless policy, it could have been illegal.

There are accountability questions here-- investigations? prosecutions?-- but also systemic regulatory questions. Even if the new resolution authority for megabanks is technically feasible, can we realistically expect policymakers to use it after the Wachovia mess?

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