Bailed-Out Banks Haven’t Changed

Wall Street hasn’t learned and isn’t repentant.  We’re likely to have another crisis. Maybe this year, maybe next. Maybe they keep it together for a few years.  But sooner or later this house of cards falls.

Derivatives is one of the dirty words of the financial crisis. Though these often-risky bets were blamed by many for helping fuel the credit crunch and the downfall of Lehman Brothers and AIG, it seems that Wall Street has yet to learn its lesson.

U.S. commercial banks earned $5.2 billion trading derivatives in the second quarter of 2009, a 225 percent increase from the same period last year, according to the Treasury Department.

More than 1,100 banks now trade in derivatives, a 14 percent increase from last year. Four banks control the market: JPMorgan Chase, Goldman Sachs, Bank of America and Citibank account for 94 percent of the total derivatives reported to be held by U.S. commercial banks, according to national bank regulator the Office of the Comptroller of the Currency.

The credit risk posed by derivatives in the banking system now stands at $555 billion, a 37 percent increase from 2008. “By any standard these [credit] exposures remain very high,” Kathryn E. Dick, the OCC’s deputy comptroller for credit and market risk, said in a statement.

via Derivatives: Bailed-Out Banks Still Making Billions Off Risky Bets. – BreakingNews – New bubble created by U.S. policy

Steven Pearlstein of the The Washington Post explains via this story in the Hamilton Spectator why the run-up in the stock exchange of the last 6 months isn’ t necessarily a good thing.  Instead of being a predictor of good times to come, the run-up in the stock market is more likely the latest in a series of financial bubbles.  We started with real estate & S&L’s in the 80’s, then it was dot-com’s and tech stocks in the nineties, then back to real estate and houses until 2006, then oil and commodities in 2007-8 (remember $130 barrel oil?).  We still aren’t reforming our financial system and we’re still letting speculators, bubble-blowers, and Wall St drive our policies.

Less encouraging is what’s happening on Wall Street. It turns out that all those bold and necessary steps by the Federal Reserve to prevent the financial system from collapsing wound up creating so much liquidity that it has now spawned another financial bubble.

Let’s start with the $1.45 trillion that the Fed has committed to propping up the mortgage market – money that, for the most part, was simply printed. Effectively, most of that has been used to buy up bonds issued by Fannie Mae and Freddie Mac from investors, who turned around and used the proceeds to buy “safer” U.S. Treasury bonds. At the same time, the Fed used an additional $300 billion to buy Treasurys directly. With all that money pouring into the market, you begin to understand why Treasury prices have risen, and interest rates have fallen, even at a time when the government is borrowing record amounts of new money.

At the same time it was printing all that money, the Fed was also lowering the interest rate at which banks borrow from the Fed and each other, to pretty close to zero. What didn’t change was the interest rate banks charged for everyone else. As a result, “spreads” between what banks pay for money and what they charge are near record highs.So who is doing the borrowing? By and large, it’s not households and businesses, which are reluctant to borrow during a recession. Rather, it’s hedge funds and other investors, who have been using the money to buy stocks, corporate bonds and commodities, driving prices to levels unsupported by the business and economic fundamentals.

I recommend reading the full story at the link.

“Change”: I don’t think this word means what they think it means.

From the Huffington Post:

Hmmm. This isn’t exactly confidence inspiring.

Tim Geithner’s new nominee for number two at the Treasury Department, Neal Wolin, played a key role in drafting legislation in the late 1990s deregulating the banking system, a former Treasury Department official confirms to us.

We aren’t going to fix the mess in banking (and the economy) by turning to the same cast of characters whose lack of vision and deregulatory ideology got us into the mess.

Bankers as Royalty

Arianna Huffington has a very good read today about why bankers continue to get preferential treatment at the expense of Main Street. Here’s just an excerpt:

Just this week, the bankers and their lobbyists — who you might have reasonably thought would be the political equivalent of lepers in the halls of power these days — have kneecapped substantive bankruptcy reform in the Senate, helped pull the plug on a government-brokered deal with Chrysler, and tried feverishly to throw up a roadblock in the way of credit card reform in the House.

You heard me right. America’s bankers — those wonderful folks who brought us the economic meltdown — are still being treated as Beltway royalty by those in Congress.

According to Sen. Dick Durbin, the banks “are still the most powerful lobby on Capitol Hill. And they frankly own the place.”

When it comes to reforming our financial system, we are truly through the looking glass. I mean, since when did it become “to the vanquished go the spoils”? How do the same banks that have repeatedly come to Washington over the last eight months with their hats in their hands, asking for billions to rescue them from their catastrophic mistakes, somehow still “own the place”?

But the banks continue to be rewarded for their many failures.

Debt revamps hindered by credit default swaps Dealscape

Chrysler files bankruptcy.  Let’s be clear about who is responsible here.  It is the banks, bondholders, and Wall St. that created the derivatives and Credit Default Swap (CDS) monster.  Derivatives have already created the current economic depression (Bear Stearns, Lehman, Merrill, etc).  Now the presence of CDS’s distorts the normal workings of a market economy and prevents the proper functioning of institutions.  In times past, the threat of bankruptcy (itself a centuries-old institution) worked to make all stakeholders: labor, capital, and management work together through difficult and unforeseen times.  Now, no longer.  Now capital demands full compensation with no risk.  It demands sacrifice by all others, but not itself.  It kills the goose in order to get a larger share.

THE DEAL PIPELINE SNEAK PEEK: Credit default swaps are complicating efforts to work out bank, auto and other restructurings outside of bankruptcy.

As the holders of billions in credit default swaps against a bankruptcy of General Motors Corp. and Chrysler LLC, the automakers’ lenders have so far rejected the government negotiators’ demands to greatly reduce their claims on the car companies.

Emboldened by credit default swaps, bondholders in other restructurings have resisted efforts to reduce the amount of money they are owed or refused to accept offers to swap debt for equity in hopes of at least sweetening the deal after a bankruptcy filing. They also are fighting to reserve their right to CDS payoffs, bankruptcy experts and analysts said.

The prevalence of credit default swaps has been blamed for at least worsening the financial crisis. Now they are complicating efforts to clean up balance sheets, ease debt burdens and unwind the tangle of financial obligations between financial firms and their counterparties — critical steps in reviving the economy.

GM: Some Bondholders Want Bankruptcy – BusinessWeek

Business Week catches up to Econproph from last month.

The barriers to getting a deal done with GM bondholders, and negotiating away enough of that debt to strike a deal and avoid a planned, government-assisted bankruptcy, remain very big, with five weeks to go before the deadline.

…And second, some of the bondholders own credit default swaps, which amount to an insurance policy against the debt and pay them in full if GM defaults. Those bondholders actually fare much better if GM goes into bankruptcy.

Using Anti-trust to remedy “too big to fail”

Simon Johnson, along with Joseph Stiglitz, and Thomas Hoenig argued yesterday in hearings that we need to break-up “too big to fail” banks. I heartily agree.

But of course our argument, both in the Atlantic and more broadly, is not against finance per se. In fact, we’ve received some strong expressions of support from within the financial sector – just not particularly from firms that are Too Big To Fail – as well as from many in the risk-taking entrepreneurial sector. And here Thomas Hoenig – President of the Kansas City Fed, with long experience regulating, winding down, and generally overseeing banks; and very far from being a sensationalist – absolutely nailed it towards the end of yesterday’s hearing. My recollection of his exact wording is: whenever you have banks that are too big to fail, you will get oligarchs yes, he said oligarchs.

But, we need to realize more than an act of congress is needed.   Ideology, economic theory, and the lure of oligarchs can prevent enforcement of even a recently passed anti-trust law. Remember it was almost 2 decades after the Sherman Act was passed before it was really enforced.

If we start looking at anti-trust as a way to prevent “too big to fail banks” (which I whole-heartedly endorse doing), we will run into another ideological roadblock from our freshwater economic friends. In this crisis we have already encountered the freshwater economic views of New Classical & RBC macro theories. These theories started with the assumption that the macro econ is at a general equilibrium and the (surprise!) draw the conclusion that no generalized glut or similar disequilibrium is possible.

Anti-trust has been neutered since Reagan I. With the exception of the Microsoft case and some explicit price-fixing cases, anti-trust enforcement has stalled. Anything goes. Bigger is better has been the Justice dept philosophy. And the intellectual foundation for the abandonment of anti-trust has been “contestable markets” theory and game theory – the idea that no market power will be exercised for fear of encouraging new entrants. It’s a theory that holds that 2 or 3 firms will engage in the same degree of competition that a plethora of small and medium firms will. In much the same way that macro became infatuated with elegant DGE models regardless of their empirical emptiness or uselessness, oligopoly and monopoly theory in IO has become enamoured of elegant game theory formulations that offer clever expressions of intriguing hypothetical situations, but they offer little empirical content, testability, or practical policy guidance. Just as macro needs to go back and re-learn some of Keynes’ (and Fischer and Wicksell) messy, inelegant insights into real economies, IO will need to re-discover structure, conduct, and performance.

As long as contestable markets and similar “the free market is self-regulating and self-limiting” ideology persists in Anti-trust division, even a new bill from Congress won’t help.