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Archive for the ‘Financial System’ Category

Bill Black is interviewed by Amy Goodman for Democracy Now. Video of the full interview is embedded following these notes.

The story that JP Morgan is telling us: They had about $15 billion in distressed European debt. Europe has been in trouble, so those investments were losing value. Their story, which does not make sense, is that they decided to hedge this position with a derivative of a derivative. In this case, it was an index of credit default swaps, which is the form of derivative that blew up AIG. JP Morgan’s story is that instead of offsetting the risk, the hedge increased the losses dramatically. They woke up one morning, and they had a $2 billion loss.

Why it does not make sense: If you have distressed European debt, you are supposed to have already reserved against the losses in it. So why hedge the position at all? Just sell it. Get rid of these incredibly risky assets before they can suffer any additional losses. If you already have losses, it is not necessary to recognize a loss, because you have already reserved for it. So, you should not have had to hedge, period

Second, the way you would hedge something like this is by buying a credit default swap which is protection against the bad assets. In other words, if you lost on the value of the European debt, the credit default swap would go up in value, and you would be protected against loss. Instead, they have allegedly bet in the opposite direction by buying this derivative of a derivative – so if the European debt lost value, the derivative of the derivative was also likely to lose value. That is not a hedge. That is double speculation in the same direction.

And the reason you are calling it a hedge is that it is illegal, under the Volcker Rule, to speculate in this fashion. So the story coming out of JPMorgan does not make any sense as a financial matter. It seems reasonably clear that these are faux hedges. This is to hedging, as truthiness is to truth. This is hedginess: not really a hedge, but you call it a hedge to evade the law.

Jamie Dimon on Meet the Press: We support getting rid of “too big to fail.” …[We] support “too big to fail.” We want the government to be able to take down a big bank like JPMorgan, and it can be done. We think Dodd-Frank, which we supported parts of, gave the FDIC the authority to take down a big bank, and when it happens, I believe compensation should be clawed back, the board should be fired, the equity should be wiped out, and the bank should be dismantled, and the name should be buried in disgrace. That’s what I believe. We need to put that back in the system, and we’ll work with the regulators to try to get that back in the system.

Bill Black’s response to Dimon’s statement: You cannot have a system work the way he is saying. If the institution is allowed to stay this large, it will be too big to fail, and its creditors will be bailed out; that is to prevent what is feared to be a cascade of failures, in which one big bank would then cause the failure of the next big bank, etc., etc., and you would have a global crisis. Even conservative economists call this crony capitalism, and they say that it creates such competitive advantage for the systemically dangerous institution—JPMorgan in this case—that it is the equivalent, when they compete with smaller banks, of — and I’m quoting — “bringing a gun to a knife fight.”

What is needed to correct the danger posed by Systemically Dangerous Institutions (TBTF banks): The only way this can work is to shrink the systemically dangerous institutions— the 20 largest banks in the United States — down to the point that they no longer pose a systemic risk, they are no longer too big to fail, and, therefore, they will no longer have this implicit federal subsidy that completely distorts competition.

The threat of “too big to fail” to democracy: Having banks this big destroys democracy, because these giant institutions have so much political power.

On Dimon’s integrity in making such a statement: The statement is completely disingenuous because JPMorgan in fact opposes all efforts to get rid of “too big to fail.”

On Dimon’s assertion (see video) that the acquisitions of Bear Stearns and Washington Mutual were beneficial to us all: The world is not made better off by the acquisitions of Bear Stearns and Washington Mutual; the banks made themselves even more powerful and made it even more impossible to have them fail, and therefore vastly increased their political and their economic power.

On the financial sector’s record supporting responsible regulation: The big banks lobbied to create the Gramm-Leach-Bliley Act, which repealed Glass-Steagall. Glass-Steagall had worked brilliantly. It separated commerce and investment. And it would have prohibited and prevented the losses that JPMorgan just suffered. The big banks also pushed the Commodity Futures Modernization Act. If that act had not been passed, we would have avoided much of the entire financial crisis that we just went through, and we might well have avoided the $2 billion loss that JPMorgan has just suffered. The big banks fought tooth and nail, and continue to fight tooth and nail, to destroy the Volcker Rule. Again, if the Volcker Rule had been in place – with real regulations – this loss would have been prevented. The big banks also fought tooth and nail to prevent transparency in the derivatives market – through a clearing house – which also would have prevented this $2 billion loss. That rule is not in effect because JPMorgan led the effort to delay the adoption of these rules and to weaken these rules so much that they are completely unenforceable.

On Elizabeth Warren’s call for Jamie Dimon to resign from his position as Director of the New York Fed: There are 12 regional Reserve Banks in the USA. They have as their directors, overwhelmingly, executives from the banks that they are supposed to regulate. Most regulation in the Federal Reserve is done through the field, through these regional Federal Reserve banks. Timothy Geithner was supposed to be the top regulator in New York in his role as president. But no real regulation occurs, of course, because you cannot expect people to regulate their bosses.

Congress has acted previously to correct an analogous conflict of interest: Congress recognized this in a completely analogous situation. In 1989, in the FIRREA legislation to deal with the savings-and-loan crisis, it looked at the Federal Home Loan Bank System, which was set up in a parallel way to the Federal Reserve banks. And it said this is an impossible conflict of interest. You cannot regulate your bosses. And so, it removed all governmental authority from the Federal Home Loan Banks. The same thing desperately needs to be done in the Federal Reserve, where it is far more damaging because these are much bigger players and much more destructive players.

On the current state of the Volcker Rule: There is a Volcker Rule because it was these derivative positions that caused the global financial crisis. All of the systemically dangerous institutions failed in large part because of these financial derivatives – what we call the green slime. That’s what brought down Fannie and Freddie and Lehman Brothers and Bear Stearns and Washington Mutual, Lehman, Merrill Lynch and Wachovia. After those catastrophic disasters that caused the Great Recession, cost six billion Americans their jobs directly, prevented another five to eight million jobs from being created, helped lead to a global crisis called the Great Recession—after that, the banks still fought to be allowed to do exactly the same kind of derivative trades. And even when the Volcker Rule was adopted, over the banks’ opposition and over the opposition of the Federal Reserve and of Treasury Secretary Timothy Geithner, they gutted the rule—at least the draft rule to implement the Volcker Rule. Unless it is changed, the Volcker Rule will be essentially unenforceable, because the current draft allows financial institutions to simply call their trades “hedges”, even though they operate exactly opposite to the way a hedge would work.

Capitalism Without Failure

Christopher Whalen is a Senior Managing Director of Tangent Capital Partners in New York City. Christopher is co-founder and vice chairman of the board of directors of Lord, Whalen LLC, parent of Institutional Risk Analytics, the Los Angeles based provider of bank and company ratings, custom analytics and consulting services.

The bank runs that we are watching right now in Greece are shocking, but they are only just the beginning.  Since May 6th, nearly one billion dollars has been withdrawn from Greek banks.  For a small nation like Greece, that is an absolutely catastrophic number.  At this point, the entire Greek banking system is in danger of collapsing.  If you had money in a Greek bank, why wouldn’t you pull it out?  If Greeceleaves the euro, all euros in Greek banks will likely be converted to drachmas, and the value of those drachmas will almost certainly decline dramatically.  In fact, it has been estimated that Greek citizens could see the value of their bank accounts decline by up to 50 percent if Greece leaves the euro.  So if you had money in a Greek bank, it would only make sense to withdraw it and move it to another country as quickly as possible.  And as the eurozone begins to unravel, this is a scenario that we are going to see play out in country after country.  As member nations leave the eurozone, you would be a fool to have your euros in Italian banks or Spanish banks when you could have them in German banks instead.  So the bank runs that are happening in Greece right now are only a preview of things to come.  Before this crisis is over we are going to see bank runs happening all over Europe.

If Greece leaves the euro, the consequences are likely to be quite messy.  Those that are promoting the idea that a “Grexit” can be done in an orderly fashion are not being particularly honest.  The following is from a recent article in the Independent….

“Whoever tells you a Greek exit would be no big deal is an idiot, lying or disingenuous,” said Sony Kapoor of the European think-tank Re-Define. Economists fear that a disorderly exit would prompt a huge run by investors on Spanish and Italian debt, forcing those countries to seek support from an EU bailout fund, which, with a capacity of just €500bn, is widely regarded as too small to cope with those pressures.

A Greek exit from the euro would not only result in a run on Spanish and Italian bonds, but it would also likely result in a run on Spanish and Italian banks.

If Greece is allowed to leave the euro, that will be a signal that other countries will eventually be allowed to leave as well.  Nobody in their right mind would want their euros stuck in Spanish or Italian banks if those countries end up converting back to national currencies.

Fear is a powerful motivator.  If Greece converts their euros back to drachmas, that will be a clear signal that all euros are not created equally.  The race to move money into German banks will accelerate dramatically.

And a Greek exit from the euro is looking more likely with each passing day.  Even the IMF is now admitting that it is a very real possibility….

Christine Lagarde, head of the IMF, warned she was “technically prepared for anything” and said the utmost effort must be made to ensure any Greek exit was orderly. The effect was likely to be “quite messy” with risks to growth, trade and financial markets. “It is something that would be extremely expensive and would pose great risks but it is part of options that we must technically consider,” she said.

Meanwhile, banks in other troubled European nations are already on shaky ground.  The Spanish banking system is an absolute disaster zone at this point and on Monday night Moody’s downgraded the credit ratings of 26 Italian banks.

The situation in Italy is especially worth keeping a close eye on.  As Ambrose Evans-Pritchard recently noted, things are not looking good for Italy at all….

Italy’s former premier Romano Prodi said the EU risks instant contagion to Spain, Italy, and France if Greece leaves. “The whole house of cards will come down”, he said

Angelo Drusiani from Banca Albertini said the only way to avert catstrophe is to convert the European Central Bank into a lender of last resort. Otherwise Italy faces “massive devaluation, three to five years of hyperinflation, and unbearable unemployment.”

So what can be done about any of this?

Well, there is actually a lot that could be done if politicians in Europe were willing to think outside of the established global financial paradigm.

The truth is that Greece could solve their current financial problems in four easy steps.  They would have to be willing to stick it to the rest of Europe and to risk being blackballed by the international community, but it could be done.

The following is my prescription for Greece….

1) Default on all debts.

2) Leave the euro.

3) Issue drachmas that are debt-free and that do not come from a central bank.  Instead, have the Greek government create them and spend them directly into circulation.

4) Enjoy a return to prosperity.

In such a scenario, the Greek national debt would no longer be a problem, the Greek government would never have to borrow any more money and austerity would no longer be needed.

Yes, inflation would be an issue with the new currency, but a bit of inflation would be a walk in the park compared to the horrible economic depression that Greece is experiencing right now.

And once the Greek economy was growing again, it would certainly be possible for them to make the transition to “hard money” if they wanted to.

It is imperative that we all understand that just because the global financial system works a certain way today does not mean that it must always work that way.

The Economic Collapse