Crossposted from New Deal 2.0
By Marshall Auerback, Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.
FinReg may fall short if power is channeled into Geithner’s hands.
More depressing news from the “change” President. The Washington Post has reported that one of the major impacts of the FinReg bill passed last week by Congress is the accretion of new power to Obama’s Treasury Secretary. According to the Post, Tim Geithner stands to inherit vast power to shape bank regulations, oversee financial markets and create a consumer protection agency.
Make no mistake: this is Timmy’s bill, plain and simple, as the Post makes clear: “The bill not only hews closely to the initial draft he released last summer but also anoints him — as long as he remains Treasury secretary — as the chief of a new council of senior regulators.”
The Geithner Treasury repeatedly pushed back against many sensible legislative proposals that would have made significant structural changes to practices that brought about the current economic crisis. And the article itself represents latest in a series of attempts to embellish the Treasury Secretary’s hagiography.
Reading it, one wonders whether the Washington Post inhabits a strange parallel universe. Have the writers actually paid attention to what is truly happening in the economy? The WaPo persists in towing the party line that Geithner’s tenure has been marked with conspicuous success, supposedly by advocating a response to the financial crisis that allegedly later proved correct: “Geithner vigorously resisted calls by some lawmakers and financial experts to nationalize the nation’s largest and most troubled banks during the most perilous days. Instead, he helped get the financial system back on its feet, in particular by pressing for stress tests of big banks.” (my emphasis)
Oh, really? I would argue that Washington continues to allow the big banks to operate “business as usual” and to cook the books to show profits so that they can pay out big bonuses to the geniuses who created the toxic waste that brought on the crisis. Most continue to show profits based not on fundamentally health lending activity, but one-off gains, and accounting gimmickry. Commenting on the latest JP Morgan results, my friend and colleague Randy Wray has noted:
JP Morgan’s results were horrendous: it lost deposits, it made fewer loans, and even its fees fell by 68%. So how could a bank manage to profit on such dismal results? Well in the old days it was called window dressing-banks would move one little chunk of gold among themselves to show that they were credit worthy. In Morgan’s case, the profits supposedly came from ‘trading”‘ In reality they mostly came from reducing ‘loan loss reserves’. In other words, Morgan decided it had set aside too many reserves against all the bad loans it made over the past decade. After all, borrowers will almost certainly start to make payments on all their debt over the next few months and years, won’t they? Sure, homeowners are massively underwater, and losing their jobs, and cutting back spending, but recovery is just around the corner.
Sure it is. Other than the Big 5, it’s hard to make a case that we have a vigorous and healthy banking sector today. The Big 5 continues to benefit from a massive financial subsidy courtesy of the Fed and an unfair playing field in which they are perceived to be “too big to fail.” This, in turn, creates huge competitive disadvantages for the smaller banks seeking to attract deposits. Small banks, in particular, are being crushed by a substantially higher cost of funding than the big banks. Currently the true marginal cost of funds for small banks is probably at least 2% over the fed funds rate that large ‘too big to fail’ banks are paying for their funding. And remember, the small banks for the most part were not the institutions at the forefront of great financial innovations such as credit default swaps and collateralised loan obligations.
The Post, like virtually every other mainstream publication, continues to perpetuate the fiction that the stress tests performed on the banks were real. But as Yves Smith has noted repeatedly: “Just look at the numbers. 200 examiners for 19 banks? When Citi nearly went under in the early 1990s, it took 160 examiners to go over its US commercial real estate portfolio (and even then then the bodies were deployed against dodgy deals in Texas and the Southwest). This is a garbage in, garbage out exercise. The banks used their own risk models to make the assessment, for instance, the very same risk models that caused this mess. And there was no examination of the underlying loan files.”
Given his hapless performance at Treasury, one can begin to understand why Timmy was so loath to have government take over the banks via an FDIC style restructuring. It’s a projection of his own incompetence and timidity. Rather than ask what needed to be done to be sure of a solution, Geithner asked instead, what was the best Treasury could do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress?
Why did a new administration, confronting a huge crisis, not try to change the terms of debate? Contrast the behavior of the Geithner today with the actions undertaken by the Roosevelt Administration. During the period in which the banking system was being restructured under Jesse Jones, Chairman of the Reconstruction Finance Corporation, the RFC required letters of resignation from the top three bankers of any institution receiving aid. These were not always accepted, but their mere existence was a potent deterrent to repeat behavior.
How many managers have been replaced during the current crisis? How many are being charged for fraudulent behavior? Elizabeth Warren has at least made attempts at some sort of public accounting. As a result, her future job security is being compromised, despite the fact that Warren is the obvious choice to take over the newly formed Consumer Protection Agency.
By contrast, the Geithner Treasury has persistently frustrated every attempt to gain better understanding of the causes of the financial crisis via endless court challenges, obfuscation, lies and delaying tactics. Additionally, Treasury has consistently opposed any serious attempts to engender structural changes in the banking system as the Financial Regulation bill worked its way through Congress. Because Elizabeth Warren has refused to play ball with this insidious bankers’ club, she’s deemed not to be a “team player” by Geithner.
They extol his calls for great capital, but don’t seem to have noticed the blatant failure of the Geithner strategy to “just raise capital requirements” as the way to deal with distorted incentives and the tendency of banks to take irresponsible risks has been comprehensively blown off by the financial sector. Treasury insisted on “capital first and foremost” throughout the Senate debate this year – combined with their argument that these requirements must be set by regulators through international negotiation, i.e., not by legislation. But the big banks are chipping away at this entire philosophy daily through their effective lobbying within the opaque Basel process – as one would expect. Take a look at the article below from the Wall Street Journal:
Banks Gain in Rules Debate
Regulators Seen Diluting Strictest New ‘Basel’ Curbs; Fear of a Credit Crunch
By DAMIAN PALETTA and DAVID ENRICH
The world’s banks appear to be winning a reprieve from tough new capital requirements and curbs on risk-taking, as regulators and central bankers are moving toward less stringent rules than initially proposed.
Bowing in part to fears that tougher requirements would diminish the credit needed to revive a sluggish global economy, officials gathered in Basel, Switzerland, are trying to strike a compromise over a set of new international banking standards initially proposed in December. The final accord will have a more global reach, and thus in some respects a more potent impact, on banks and borrowers than the financial regulatory bill likely to pass the U.S. Congress Thursday.
The new Basel rules, as they are called, would still be stiffer than existing standards. Industry officials fear the changes could shrink bank profit margins and make credit tighter and more costly for consumers and businesses. Alterations under discussion this week would ease key requirements that have been under discussion for months. Advocates for a tougher line have argued that excessive concessions could leave the financial system vulnerable to problems the entire process is intended to address.
Check out the rest of the article here.