According to the Dodd-Frank financial reform Act of 2010,
financial firms are required to set aside higher reserves to cover losses on
trades of derivative securities, including those that “swap” the risk of
default in the basis of a given security, such as mortgages. As if drug addicts
or alcoholics shirking boundaries, traders set about getting around the “margin
requirements” by treating “swaps” as futures, which do not require the higher
reserves. Whereas a futures contract for corn to sell at a certain price limits
residual risk, swaping the risk of the default of an investment puts a party on
the line for the entire investment. Moreover, unlike futures contracts, swaps
have significant systemic risk because claims can all be made at once,
overwhelming the parties assuming the liability in the swaps (e.g. AIG in
September 2008). Wall Street over-discounts such high-risk, low-probability
outcomes. Less in reserve means more
money is available to put into high-risk investments—hence more profit today.
Accordingly, the trajectory already as of the beginning of 2013 was toward yet
another systemic collapse of the financial system.
“As the market
gravitates to the cheaper platform -- and it’s cheaper because it’s unsafe—that
creates risk for everyone,” James Cawley, CEO of trade execution firm Javelin
Capital Markets, told The Huffington Post. Put another way, market participants
were operating according to the greatest profit, the greater risk
notwithstanding. “In a distress scenario, you basically have what you had from
AIG in 2008,” Cawley said. “Then someone has to step in, and we all know who
that someone is: the U.S. taxpayer.” So the question is perhaps that of whether
the SEC has the taxpayer’s back or is enabling a cozy revolving door with Wall
Street firms.
Lest it be supposed that the U.S. Treasury Department would
see to it that the Dodd-Frank reserve requirements would not be circumvented
during President Obama’s second term, Senator Hatch speaking at Jack Lew’s
confirmation hearing in early 2013 raised the question of whether Lew would act
to constrain banks’ risky proprietary trading, given that he had headed units
at Citigroup that were involved in just such practices that would violate the
Volcker Rule in Dodd-Frank.
For example, Lew was COO of Alternative Investments at Citi.
MAT and Falcon investment funds were sold there as low-risk. Yet those funds
were actually hedge funds with high risk. Lew, who was COO of the unit by the time of
the implosion, refused to offer the misled customers full refunds. At least fourteen arbitration panels
subsequently gave the customers the full refunds they sought. If Lew was not
willing to right matters then, how could the taxpayer have faith in his
willingness as Treasury Secretary to go up against his prior world to protect
the public? Although he had not been involved in selling the funds, he did
manage units that engaged in risky proprietary trading and he failed to right
the wrong done to customers. The public would be justified in wondering if they
too would be left on the hook rather than protected by their government should
Wall Street once again get out of hand.
One of the downsides of plutocracy, or the rule of wealth,
is that the excesses of reckless greed are not met by a viable exogenous
constraint from the state because the government is the agent rather than
master of wealth. As Senator Dick Durbin had said after the banks’ complicity
in the financial crisis of 2008, “Congress is owned by the banking lobby.” As
long as this condition holds, Wall Street will have the edge in circumventing
even regulations that are in its own systemic interest.
Sources:
Eleazar Melendez, “Wall
Street Setting Itself Up For Next Derivatives Crisis, Market Participants Warn,”
The Huffington Post, February 14, 2013.
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