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Sunday, November 4, 2012

Clearinghouses Profit as Too Big To Fail

According to Gretchen Morgenson of the New York Times, “failing to confront the too-big-to-fail question is a serious oversight.” Lest it be assumed that the financial reform law passed in 2010 after the financial crisis of 2008 makes it less probable that taxpayers would again be made to bail-out financial institutions without any strings attached, Morgenson argues that the legislation “actually widened the federal safety net for big institutions. Under the law, eight more giants were granted the right to tap the Federal Reserve for funding when the next crisis hits.” Those institutions, including the Chicago Mercantile Exchange, the Intercontinental Exchange, and the Options Clearing Corporation, were even able to avoid the penalties for failure specified in the Dodd-Frank Act of 2010.
The clearinghouses successfully argued that even though only banks had been allowed to borrow from the Fed’s discount window, the clearinghouses are not financial institutions (rather, they are “financial utilities”) so they should not have to be “wound down” by regulators according to Dodd-Frank should they fail. This is essentially having it both ways and getting away with it. To explain this nice arrangement, we would need to look under the hood, where I suspect we would find an exclusive world wherein vast private wealth is itself political power, even apart from any lobbying activity.
In 2011, the CME Group, the parent company of the Chicago Mercantile Exchange, made almost $3.3 billion in revenue. Craig Donohue, the CEO, received $3.9 million in compensation and held an additional $10 million worth of equity outstanding. With this kind of money comes inherent influence, politically speaking.
At the very least, great wealth has an intrinsic status, particularly in American culture. Even though some non-rich people might sympathize with the interest of riches in hopes of being rich someday, I suspect it is the power in the wealth itself that accounts for the “gravitational pull.” This subtle force operates on legislators and regulators too, and thus complements both the influence of lobbying and campaign contributions, and the ability or wherewithal of great wealth to “reward” and “punish.”
Abstractly speaking, great wealth has inherent political power by virtue of its status. In addition, the wealth can fund lobbyists and even political campaigns. Lastly, it can be used more generally to “help or harm” specific individuals. The systemic risk of such wealth to the viability of a republic thus goes beyond simply regulating lobbying and even campaign contributions. The sheer existence of the huge concentrations instantiates a risk to the system as a whole. If this thesis seems novel or different, it may because it is not in the interest of the subterranean power-brokers that it be made known. They would much prefer that secondary issues be debated or used as talking points.  
It should be no surprise that when the managers at the clearinghouses “were drooling at the prospect of having access to loans from the Fed,” according to Sheila Bair, the former head of the Federal Deposit Insurance Corporation, “top officials at the Treasury and the Fed, over the objections of the F.D.I.C.,” pushed Congress to allow the non-banks access to the Fed’s discount window as part of the Dodd-Frank Act even while saving the clearinghouses from being subject to the law’s “wind-down” requirements.  
According to Morgenson, the “clearinghouses have considerable clout in Washington. From the beginning of 2010 through [November 2012], the CME Group . . . spent $6 million on lobbying.” If I’m correct, the sheer wealth of the Group (and its executives!) and the related ability to “reward and punish” added to the efficacy of the lobbying. There are precious few Davids willing to sling-shot a giant; most people consider it entirely reasonable to simply step out of the way.
As though a rationale were needed, managers at CME argued that once their institution received Dodd-Frank’s designation of “systemically important,” the Fed “should provide access to emergency lending” and without strings. Not included in the Act’s penalties for failure, CME hardly deserved an “offsetting” benefit. The lack of symmetry here is the “smoke” indicative of “fire”—the conflagration here being the furtive, innate political power of huge amounts of concentrated (i.e., in one organization) private wealth.
As an alternative to Dodd-Frank, legislation could have mandated that clearinghouses too big to fail be broken up in terms of not only operation (i.e., product lines), but also management, physical location, and ownership (i.e., stockholders). Too big to fail means that the very existence of the institution represents too much systemic risk for the economy and financial system. In answer, the institution itself would have to be downsized or split apart until no such institution exists. Unfortunately, such reasoning must push off from the gravity of the tremendous mass that is hyper-concentrated capitalism—an economic system far indeed from that theorized by Adam Smith., wherein each producer is a price-taker, and thus by implication not off significant gravity even in the market, let alone Congress.
In short, the clearinghouses got it both ways when they should have been broken up. I contend that the culprit behind this feat or acrobatics is none other than the political power of large concentrations of private capital or wealth. Ultimately, it is the sheer mass itself that is too big to fail, both economically and in terms of representative democracy. It is as though mega-corporate kidney stones were passing uncomfortably through society’s innards with society itself heavily sedated. Everything is fine.

Systemic risk goes involves much beyond its financial or even economic dimension. When, according to Morgenson, “large and systemically important financial utilities that together trade and clear trillions of dollars in transactions appear to have won the daily double—access to federal money, without the accountability [in being wound down after failing as per Dodd-Frank’s process for systemically-important financial institutions],”—we can and should ask, at what cost to us as a people and even as a society to be passed on to posterity?


Gretchen Morgenson, “One Safety Net That Needs to Shrink,” The New York Times, November 3, 2012.