Sunday, May 27, 2018

European and Mid-Sized American Banks Engineer Risk Shift


The financial crisis of 2007-2008 led to enhanced regulation that was designed to preserve the power hierarchy of banks, while regulating their risk production in the US and Europe (see my book here).

Wall Street has been attacking Dodd-Frank legal reforms instituted after the 2007-2008 financial crisis since they were instituted.  Consider this article from 2015 that describes the Republican-led assault: 
Weisman, Jonathan and Lipton, Eric. In New Congress, Wall St. Pushes to Undermine Dodd-Frank Reform. January 13, 2015, http://www.nytimes.com/2015/01/14/business/economy/in-new-congress-wall-st-pushes-to-undermine-dodd-frank-reform.html?emc=edit_th_20150114&nl=todaysheadlines&nlid=32962000&_r=0
WASHINGTON — In the span of a month, the nation’s biggest banks and investment firms have twice won passage of measures to weaken regulations intended to help lessen the risk of another financial crisis, setting their sights on narrow, arcane provisions and greasing their efforts with a surge of lobbying and campaign contributions.

The continuing assault on the 2010 Dodd-Frank law has achieved remarkable success, especially compared with the repeated failures of opponents of another 2010 law, the Affordable Care Act.

The financial industry has been methodical, drafting technically complicated legislation that can pass the heavily Republican House with a few Democratic votes. And then, once approved, Wall Street has pushed to tack such measures on to larger bills considered too important for the White House to block.

Now, with the help of some Democrats, the Republicans have successfully loosened regulatory governance of the so-called mid-size US banks, which are actually huge by historic standards:
May 22 2018 Congress Approves First Big Dodd-Frank Rollback. The New York Times. https://www.nytimes.com/2018/05/22/business/congress-passes-dodd-frank-rollback-for-smaller-banks.html

The legislation will leave fewer than 10 big banks in the United States subject to stricter federal oversight, freeing thousands of banks with less than $250 billion in assets from a post-crisis crackdown that they have long complained is too onerous….

…. A report from the Federal Deposit Insurance Corporation on Tuesday said that the combined net income of the nation’s commercial banks and savings institutions reached $56 billion in the first quarter of 2018, a 27.5 percent increase from a year ago…

…. The legislation also offers a reprieve to big — but not behemoth — banks, allowing large institutions like American Express and BB & T to no longer be deemed “systemically important” and subject to stricter oversight.

The bill also exempts some loan originators, including small lenders, from certain disclosure requirements under the Home Mortgage Disclosure Act.
Majia here: In addition to loosening of regulations governing the so-called “mid-sized” banks, there are also efforts underway to eliminate or loosen the Volcker Rule requirements and to reduce mandated capital ratios. The Republicans are targeting the consumer protection bureau as well.

The 2007-2008 financial crisis resulted in a huge transfer of wealth that has been detailed thoroughly by Michael Hudson and Dean Baker among other critical observers.

The crisis itself was caused by risk-seeking, particularly by powerful financial actors. Crisis costs were staggering. In April of 2009, the International Monetary Fund stated that the global losses resulting from the financial meltdown exceeded $4 trillion, with approximately $2.7 trillion of those losses derived from loans and assets originating in the US[i] 

Keep in mind that of those losses, only $400 billion could be attributed directly to the US residential mortgage market loans, according to Federal Reserve Governor Mishkin. 

Although sub-priming mortgages have been identified as the security base responsible for precipitating a four-trillion (US dollar) financial crisis that began at the end of 2007, these instruments were merely the bottom of a speculative bubble of derivatives contracts that were created out of, or that insured, debt-backed bonds deriving ultimately from mortgages, consumer loans, municipal bonds, etc. 

Government responses to the crisis in the US and Europe were organized around preserving the largest banks' solvency. National and international governmental agencies made huge capital infusions into the financial sector, preserving the most powerful players that happened to be precisely those responsible for engineering the crisis.

In the US, even the mainstream media found the federal response unsatisfactory: In 2011, Bloomberg news reported that:
“Fed Chairman Ben S. Bernanke’s unprecedented effort to keep the economy from plunging into depression included lending banks and other companies as much as $1.2 trillion of public money, about the same amount US homeowners currently owe on 6.5 million delinquent and foreclosed mortgages.”[ii]
It would have been more cost-effective to have bailed out homeowners but the money went to the banks and insurers.

Post-financial regulation was nowhere near as strict as it needed to be (e.g., the de-fanging of the Volcker Rule). 

Today's de-regulatory push will produce another financial crisis, there is no doubt. 

Where will the next crisis begin? Its possible the next crisis of financial contagion will start in the European banks based on an article published in the Wall Street Journal describing a regulatory work-around by European banks:
Max Colchester (2018, May 24). European banks engineer a risk shift. The Wall Street Journal, B1, B11.
The strategy works like this: banks seeking to “free their balance sheets” are engaging in a form of “synthetic securitization” whereby the banks pay a fee to investors to cover potential losses on loans.

This allows the banks to reduce their capital reserves, which essentially means the bank balance sheets are more leveraged. 

These deals are “privately structured,” meaning payment terms aren’t transparent. 

The interesting article reporting on this risk trade does not specify the nature of the investors purchasing banks’ synthetic securities. The question is what happens to these investors’ capacity to insure losses in the event of a crisis?  Remember what happened with AIG? 

The European banks’ health doesn’t seem to good right (e.g., Deutsche Bank plans on cutting up to 10,000 jobs).

US and European banks are producing risk while their highest-compensated employees make out like bandits. The risk they produce will ultimately generate costs for the economies that are disrupted in the next crisis. People will lose jobs. Homes will be lost and small businesses closed. Lives will be disrupted.

But the banks and their most vaulted employees will be fine. 

Rinse and repeat until there is no wealth left to extract from the body of the population.


END NOTES

[i] Mark Landler and David Jolly, “I.M.F. Puts Bank Losses from Global Financial Crisis at $4.1 Trillion,” The New York Times, April 22, 2009, accessed April 23, 2009 http://www.nytimes.com/2009/04/22/business/global/22fund.html?th&emc=th.


[ii] Bob Ivry, Bradley Keoun and Phil Kuntz “Secret Fed Loans Helped Banks Net $13B,” Bloomberg.com, November 27, 2011, accessed November 29, 2011, http://www.bloomberg.com/news/2011-11-28/secret-fed-loans-undisclosed-to-congress-gave-banks-13-billion-in-income.html.

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