Enough With The Sweetheart Subsidies To Wall Street
Thomas M. Hoenig, vice chairman of the Federal Deposit Insurance Corp, writes in the WaPo that the federal government should stop subsidizing Wall Street -- and I sure agree, and then some:
Financial firms can borrow money -- their equivalent of fuel -- more cheaply and with less market scrutiny when they have access to government guarantees of deposit insurance, loans from the Federal Reserve and, ultimately, taxpayer support such as we saw with the Troubled Assets Relief Program in 2008. This safety net was intended to stabilize the financial system by protecting the payments system that transfers money around the country and the world as well as the essential lending that commercial banks provide. But these protections also assure those who lend to banks that they will be repaid regardless of the condition of the bank. Under such circumstances, creditors give the firms a discount on the cost of the funds they borrow.Things are made more difficult by the fact that the largest financial companies now combine traditional commercial banking with higher-risk activities such as trading so that both their banking and betting activities get access to these government protections and the multibillion-dollar subsidy that comes with them. Using subsidized money to finance the conglomerates' bets encourages ever-higher levels of debt, risk and interconnectedness not attainable or sustainable in a truly free market.
While some suggest that the 2010 Dodd-Frank Act removed all protections and subsidies for these largest firms, there is no evidence to support that assertion.
...This form of corporate welfare allows the protected giants -- those "too big to fail" -- to profit when their subsidized bets pay off, while the safety net acts as a buffer when they lose, shifting much of the cost to the public. For example, the conglomerates can cover -- and even double down on -- their trading positions for extended periods using insured deposits or discounted loans from the Federal Reserve that come with the commercial bank charter. The subsidy often allows them to stay in the game long enough to win the bet, but it supersizes the loss if the bet should finally fall apart.
This system distorts the market and turns appropriate risk-taking into recklessness. The result is a more concentrated and powerful financial sector -- and a more fragile economy. The way to return the financial services industry to the free market is by separating trading from commercial banks and by reforming the so-called shadow banking sector. Government guarantees should be limited primarily to those commercial banking activities that need it to function: the payments system and the intermediation process between short-term lenders and long-term borrowers.
Non-banking financial activities such as proprietary trading, market making and derivatives should be placed outside of commercial banks and so outside of the safety net.
I've made this comment before but I think it's worth repeating. There's a real argument to be made that banks should be regulated more like public utility companies. We all need electricity just like we need money, so why not treat the local bank more like the local electrical company? Any bank that doesn't want to take insured deposits or have access to the Fed's discount window can finance itself with uninsured deposits and equity.
Tyler at March 29, 2013 6:16 AM
Tyler, that sounds good in theory, but it's been tried, and state-owned or state-monopoly banks always wind up failing. At least that's been the history in the U.S.
A big part of the problem is that there are supposed to be barriers between a bank's depositor accounts and its own trading accounts -- but the existing laws don't seem to be enforced. I've gone blank on the guy's name, but consider that bank run by the ex-New Jersey governor. It pilfered billions from its customer's accounts, yet oddly Mr. Law and Order, Eric Holder, and his Justice Department can't seem to find anything prosecutable about it.
Cousin Dave at March 29, 2013 9:12 AM
Incidentally, according to something I read yesterday from Richard Shelby, most of Dodd-Frank hasn't actually been implemented. The reason why is because the law itself is such a Gordian knot of interconnected and interlocking requirements, prohibitions, and exceptions, that the SEC can't figure out how to write the rules to implement it.
Cousin Dave at March 29, 2013 9:15 AM
Cousin Dave, you're thinking of Jon Corzine, the former co-CEO of Goldman Sachs, former Senator, former Governor, and former CEO of MF Global.
(This article outlines the role of MF Global Counsel Laurie Ferber in helping change the rules on collateral: http://www.bloomberg.com/news/2011-11-16/tiny-rule-change-was-at-the-heart-of-mf-global-s-failure-william-d-cohan.html)
In essence, instead of having to hold US Treasuries notes, bills and bonds, futures firms were allowed to hold sovereign debt of other countries. Enter Jon Corzine, former bond trader, who used the MF Global collateral to make speculative trades. This completely changed the business model.
The business model of a futures firm should be to invest the customer's collateral in something safe and make a bit of interest. The bulk of the revenue should come from commissions on futures trades. But in a shrinking revenue environment with pressure on commission revenues, Corzine thought it was a good idea to trade the collateral in the sovereign government debt of countries like Greece. When he bet the firm's capital and was wrong, it led to massive losses that destroyed the capital position of the firm.
MF Global wasn't a bank, though. And because the rule changes made years before, Corzine's incredibly irresponsible actions were technically legal.
Tyler at March 29, 2013 10:11 AM
Maybe it would make more sense for people to deal with their local credit union. The equity of the firm is then mutualized among the depositors. That way, no one really owns the bank and is trying to achieve an unreasonably-high return on equity.
Depositors would be covered by deposit insurance and mortgages would be either below 75% loan-to-value or insured by the Federal Housing Authority. Securitization of loans and mortgages would be restricted or curtailed. In the event of a bank run or other credit market shock, the credit unions could access the Fed's discount window to keep them liquid and meet depositors redemptions.
The only problem with this model is that no one gets filthy rich.
Tyler at March 29, 2013 10:24 AM
"I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the Bank. ... You are a den of vipers and thieves."
—Andrew Jackson in 1834 on closing the Second Bank of the United States.
It's been going on for a long, long time.
Ken R at March 29, 2013 3:51 PM
And there is nothing new under the sun.
The Second Bank of the United States was authorized for a twenty year period during James Madison's tenure in 1816. As President, Jackson worked to rescind the bank's federal charter. In Jackson's veto message (written by George Bancroft), the bank needed to be abolished because:
• It concentrated the nation's financial strength in a single institution.
• It exposed the government to control by foreign interests.
• It served mainly to make the rich richer.
• It exercised too much control over members of Congress.
• It favored northeastern states over southern and western states.
• Banks are controlled by a few select families.
• Banks have a long history of instigating wars between nations, forcing them to borrow funding to pay for them.
"That which has been is what will be,
That which is done is what will be done,
And there is nothing new under the sun.
Is there anything of which it may be said,
'See, this is new'?
It has already been in ancient times before us."
Ecclesiastes 1:9-10.
Ken R at March 29, 2013 4:08 PM
Ah, the banks.
Yeah, they've been at it for a long, long time.
http://www.youtube.com/watch?v=ZPWH5TlbloU
Love that vid.
Gog_Magog_Carpet_Reclaimers at March 29, 2013 5:14 PM
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