Showing posts with label TBTF. Show all posts
Showing posts with label TBTF. Show all posts

Thursday, September 12, 2013

Insurance Companies Gaming the States’ (Flawed) Regulatory System

In September, 2013, New York pulled out of a framework that the States had agreed to try out. Known as “principle-based reserving,” freed insurance actuaries from having to follow statutory requirements in their calculations, allowing the actuaries “to use their own data and assumptions."[1] That compromise has resulted in such a loose framework that it had made the “gamesmanship and abuses” in the industry ever worse, according to Ben Lawsky, the financial services superintendent of New York. A sample of sixteen insurance companies were found to have increased their reserves by a combined total of only $668 million, far short of the $10 billion that would have been required had the companies had to follow the statutory formulae.

The full essay is in Cases of Unethical Business, available in print and as an ebook at Amazon.com.  

Monday, July 22, 2013

Financial Reform: Did Congress Shoot a Blank?

On the third anniversary of the Dodd-Frank Act, former U.S. Senator Ted Kaufman (D-DE) penned an excellent yet concise critique of the law’s efficacy over three years. The news is not good. I submit that it is worse than Kaufman is willing to admit—worse in the sense that Congress had mishandled the writing of the bill before it became law. I will get to this matter after summarizing Kaufman’s points.

                                                                                                     Former Sen. Ted Kaufman
  
Kaufman points out that the big banks can still take high-risk gambles with FDIC-insured deposits. Essentially, the U.S. taxpayer is underwriting the additional risk. The mammoth $6.2 billion “London Whale” loss at JP Morgan in 2012 suggests that the banks are indeed taking advantage of the loophole. Kaufman points to a second loophole. Although Dodd-Frank contains new regulations on the financial derivatives that had played such a dramatic role in the near-meltdown in September 2008, the big banks can simply move their financial derivatives to “off shore” offices. Citigroup alone has more than 2,000 foreign subsidiaries.[1]

As for the dysfunctional Fannie Mae and Freddy Mac, Kaufman points out that they are not even mentioned in Dodd-Frank! Nor can any solution to the structural conflict of interest facing the rating agencies, which are still “bought and paid for by the entities they rate.”[2] Nor, I might point out, does the law do anything to obviate the “client-pays” conflict of interest facing public accounting firms (e.g., Arthur Andersen as the “permissive” auditor of Enron). I would generalize to suggest that American lawmakers and the general public are woefully ignorant of the harm just in looking the other way rather than deconstructing an institutional conflict of interest. In fact, I submit that such a conflict is inherently unethical, rather than being so only if it is exploited.

As for the “ordered liquidation” feature of Dodd-Frank, Kaufman’s critique portrays the mechanism as if it were a sand castle sitting just above a rising tide. Although making actual sand castles on some beach might teach members of Congress how to get along, an orderly liquidation of one bank is not likely to be sufficient to stop the contagion of fear and short-selling from spreading to other banks, as they are so interconnected. Would an orderly liquidation procedure invoked for all of the large banks stave off the collapse of the financial system? 
Kaufman cites an analysis by Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corp., which finds that JPMorgan Chase, Citibank, and Bank of America had become the three largest banks globally during the three years of Dodd-Frank’s existence. Add in Wells Fargo and those four banks have combined assets of 97% of the U.S. GDP in 2012.[3] Given the continued high-risk trades and possibility of off-shore financial derivative “bundling” and selling, the “too big to fail” problem has grown more perilous, not less. Meanwhile, only 155 of the 389 rule makings required by Dodd-Frank were finalized during the law’s three years of existence.[4] Put another way, a law that is utterly insufficient to eliminate the “too big to fail” systemic risk was after three years still “half baked.” The obvious question is why, and in Washington that question is answered in terms of power.

Kaufman points to the legislators in Congress who “passed the buck” to the regulators, who would have to face the powerful Wall Street lobbyists. However, he doesn’t include the impact of those lobbyists on the members of Congress themselves. That is to say, the law may have been watered down as it was being written, or “marked up,” as lawmakers gave too much influence to the financial interests that would face stiffer regulation. It is not uncommon for legislative aides to use legislative clauses written by the regulated entities themselves. Here we have stumbled on yet another tolerated structural conflict of interest!

Therefore, we can generalize perhaps in concluding that the Dodd-Frank law is insufficient even in theory, let alone practice, to solve the problem of systemic risk because of the excessive influence of Wall Street over lawmakers. As Sen. Dick Durbin said in the wake of the banks' culpability in 2008, the banks still "own" Congress.[5] That is, the endurance of excessive systemic risk has in great part been due to Congress having become more of a plutocracy than a house of the people. Consider, for example, how much chance the proposal by Sens. Warren and McCain to break up the megabanks has in the U.S. Senate (not to mention the House!), and it will be clear just how much power Wall Street actually has in Washington. This is the real problem, any solution to which is sadly not even on the horizon, and this is, kein Zufall, no accident either.



1. In a “slip of the tongue,” Kaufman wrote “subsidies” instead of “subsidiaries.” Might he have been wanting, at least unconsciously, to tell us more?
2. Ted Kaufman, “Happy Birthday to Dodd-Frank, A Law that Isn’t Working,” Tedkaufman.com. Accessed July 22, 2013.
3. Ibid.
4. Ibid. Kaufman cites the Davis Polk law firm as coming up with the numbers.
5. U.S. Sen. Dick Durbin (D-IL) said “Congress is owned by the banks” after they stopped his amendment that would have allowed judges to modify contested mortgages in foreclosure.

Sunday, June 23, 2013

Consolidation From 1913: The Federal Reserve, Megabanks, and the U.S. Government

In 1911, the U.S. Supreme Court ruled that federal anti-trust law required the break-up of Rockefeller’s mammoth Standard Oil Company, which had replaced ruinous competition with coordination in the American refining industry. The ruling’s impact was truncated because each of the resulting companies had the same ownership; the existing trust certificates were simply exchanged for shares in each company. The respective managements even remained in the same office building in New York City. In effect, the court had mandated oligopolistic collusion and still more restraint of trade. Undaunted, the elderly Rockefeller worked on his golf game.
One hundred years later, the U.S. Treasury and the Federal Reserve were still striving to salvage the economy from a near direct-hit in September 2008. The Fed’s massive bond-buying program of some $7 trillion would dwarf the $750 billion in the democratically-enacted TARP (Troubled Assets Relief Program) funds. In 2010, Congress had passed the Dodd-Frank Act, which was designed to solve the problem of banks and other companies being too big to fail without actually breaking any up. Not surprisingly, by 2013 it had become apparent that systemic risk was still much too high. The government that had broken up Rockefeller’s mighty managerial machine had apparently lost its spunk for breaking up enterprises, at least those whose very existence involves an intolerable amount of systemic risk to the economy as a whole.  
A century earlier, in 1913 to be exact, the sixteenth amendment to the U.S. Constitution was ratified, making a federal income tax constitutional. Congress promptly passed the Revenue Act of 1913, which reinstituted the federal income tax and lowered tariffs. The assumption was that the revenue from the income tax would make up for the decrease from the lower tariffs. As the graph below indicates, the income taxes would do more than compensate for reduced tariff revenue. The ratification of the amendment and the passage of the Revenue Act laid the groundwork for an expansion in the fiscal role of the federal government. In the constitutional convention, some delegates had been concerned that a federal income tax would “crowd out” the states as they seek to raise more revenue for domestic purposes.
 
Also in 1913, exactly a century before the Federal Reserve’s board wrestled with whether to reduce the central bank’s bond-buying program, a fiscal stimulus to reduce unemployment, the bill establishing the central bank became law. Charles Lindberg, the father of the famous flyer, predicted from his seat in the U.S. House of Representatives that the Act would establish “the most gigantic trust on earth” that would be an “invisible government by the money power.”[1] At the time, it was assumed that the gold standard would provide sufficient constraint. This assumption would go flat in 1973 with Nixon’s termination of the Bretton Woods agreement. By 2013, the premise of the Act, which specifies three purposes for the Fed: “to furnish ‘an elastic currency,’ to provide a market for commercial paper so that banks would have more liquidity, and to improve supervision of banks,” had been superseded to a degree that would have stunned even the advocates of the original bill.[2]
Speaking before Congress on June 23, 1913, President Wilson said banks should be “the instruments, not the masters, of business.”[3] William Jennings Bryan, the U.S. Secretary of State, went one step further in insisting that banks answer to the public rather than to themselves or business.[4] A century later, was the Fed buying trillions in dollars of bonds to help the banks, whose executives had gone largely unscathed in terms of bonuses, or the public? If the latter, shouldn’t the Congress and the elected U.S. president have played more of a decisive role by legislating the program?
The democracy deficit in the Fed’s increasing “job description” is not the only danger, however. Not even democracy can be relied on to safeguard the checks and balances afforded by federalism or even federalism itself. Simply in being such a consolidated power at the U.S. level, the Federal Reserve further consolidates power as it expands its fiscal power. Federalism pays the price not only directly, but also in that the Fed is prohibited by federal law from buying the bonds of heavily-indebted state governments. That is to say, the Federal Reserve can come to the aid of the U.S. Treasury as well as large consolidated banks, while the state governments are on their own. The bias here favors further consolidation at the expense of federalism.
Europeans have been much more sensitive to the impact of the European Central Bank’s expansive bond-buying program on the E.U.’s federal system. Even though the ECB would be purchasing the bonds of indebted state governments, the centralization in the purchasing and the associated fiscal redistribution delayed agreement on the program. In 1913 as the Federal Reserve legislation was going through Congress, federalism was not sufficiently considered, and thus protected. Paul Warburg, a financier who had immigrated from Germany to New York, thought the banking system was too decentralized in the United States. Oblivious to the American federal mindset that still treated the federal level of government as properly assuming empire-level powers such as defense and regulating commerce between the republics, he wanted to replicate the Reichsbank of his native state for the United States as a whole.[5]
Avoiding that political category mistake, Rep. Carter Glass, the chief sponsor of the Federal Reserve Act, “wanted to restrain federal authority” even in banking and yet he “wanted a more elastic currency to avert money panics and moderate depressions” through banking reform.[6] He proposed privately-owned regional reserve banks and referred to Wilson’s proposal “that a Reserve Board sit atop” those banks as a federalist design at odds with the rights of the states.[7] That the resulting Act was more along Wilson’s lines suggests that the federalism was not sufficiently consulted in the legislative process, which was not coincidentally entirely at the U.S. level. That is to say, federal-level officials established a central bank that would operate to the advantage of that level. Also in 1913, the seventeenth amendment, by which U.S. senators would no longer be elected by their respective state legislatures, was ratified; the state governments would henceforth had even less wherewithal at the federal level to thwart encroachments by the U.S. Government.
In conclusion, a consolidating trend favoring both big business and the U.S. Government at the expense of the states can be discerned from legislation passed in 1913. The consolidation of banking power in a few megabanks like Citigroup and JPMorgan and of political power in the U.S. Government evident in 2013 can thus be viewed as having historical underpinnings.  


1. Robert Lowenstein, “The Federal Reserve’s Framers Would be Shocked,” The New York Times, June 22, 2013.
2. Ibid.
3. Ibid.
4. Ibid.
5. Ibid.
6. Ibid.
7. Ibid.

Tuesday, May 14, 2013

A "Banking Union" or Coordinated State Laws and Regulations?

A subtle though important difference exists between American and European federalism, each of which covers both the "kingdom" (i.e., early modern, now mostly republics) and "empire" (i.e., ancient and early modern, now usually huge federal systems) scales. So I am referring to federal systems like the U.S., E.U. and Russia (and U.S.S.R), rather than to federal systems within any of their respective political subunits (e.g., Belgium, the Netherlands, and Germany). The difference between the E.U. and U.S. that I discuss here can be grasped by looking at the two competing proposals for federal bank regulation in the European Union. The crucial question facing the E.U. finance ministers concerns which system of government. 


The complete essay is at Essays on Two Federal Empires.

This picture depicts the distinctive European model of modern federalism wherein the state governments play a salient role in implementing (and modifying) federal law.   source: mapperywordpress.com