Wednesday, October 5, 2011

Bust Up the Big Banks! Here's Why.

In 1933, in the wake of the Great Depression, as a way to prevent the kind of reckless speculation that drove that economic calamity, the Glass-Steagall Act was signed into law by FDR. Among other things, including the establishment of the FDIC, the Act prohibited commercial banks, which took customer deposits and issued loans, from practicing investment banking, or issuing securities. This law worked beautifully for 66 years, preventing risk-taking with customer deposits while allowing investment banks to generate securities and trade to their heart's content.

Beginning around 1980 the banking industry began lobbying for the repeal of Glass-Steagal. In 1987 the Congressional Research Office issued a report, which concluded that there was a significant conflict of interest between issuing credit (lending) and using credit (investing) within the same institution. The report further argued that depository lenders possessed enormous power in holding other people's money and they needed to be prudent in their activities using that money, while securities investment was a risky endeavor. Congress did not act on the repeal at that time. 

But in 1999, the banks got their way. The impetus for repeal? Citigroup (a commercial bank) merged with Travelers (a conglomerate with investment activities) in 1998. According to law, Citigroup had to divest itself of the non-depository divisions within 2-5 years. But it took them less than two years to bribe Congress into repealing the act. 


This figure displays what happened to our banking system in the wake of the repeal of Glass-Steagal. Within a single decade the commercial and investment banks had merged into four behemoths, which represent an enormous proportion of all banking activity in the United States.

At the same time, complex derivatives have become the stock and trade of these investment banks. Remember, these derivatives in the form of mortgage backed securities, crashed the global economy in late 2008. They're largely unregulated, often referred to as shadow banking. Banks make enormous fees for originating, selling, and managing new derivatives vehicles. This derivatives business has become unfathomably large.   

Add to this the investment bank Goldman Sachs, and you've got 5 institutions that combined hold approximately $5 Trillion in assets. That's $5,000,000,000,000. That's a lot of money.That's more money than the yearly GDP of any country in the world save the U.S., China, and Japan. So where's the problem? 

The trouble is in the derivatives market. In 1996 the derivatives market represented approximately $30 Trillion in investment exposure, which was about 4 times the entire U.S. GDP. According tot the Comptroller's Office, that investment exposure currently sits at $249 Trillion in the U.S. alone. Now here's the startling part - 96% of that risk is held by the 5 largest banks. $239 Trillion against $5 Trillion in assets. They're leveraged at nearly 48:1. 

Now there's an financial trick known as bilateral netting, which essentially means that a bank holds a collateralized debt obligation (CDO) and then buys insurance against that CDO with a credit default swap (CDS). Therefore, presumably, their risk is minimized since they will not lose all of their investment. If the CDO fails, the CDS pays out. According to the same OCC report, bilateral netting currently covers approximately 90% of the exposure in the derivatives market. It doesn't matter. On the eve of the crash in 2008, bilateral netting covered 84% of all derivatives. It still brought down Bear Stearns, Lehman Brothers, and Merrill Lynch. It destroyed AIG. But for a ton of bailout money and more Federal Reserve support, the largest insurer in the world would have vanished from the face of the earth. At that time the bulk of the risk was spread accross 12 banking institutions. Today it is concentrated in just 5. 

So if Europe goes down the drain - and Europe is going down the drain - our 5 biggest banks' exposure to European banks, European sovereign debt, and European derivatives stands to bring these banks to their knees, again. And our economy with them.

The Dodd-Frank Act was passed as a bandaid for the hemorrhaging wound that is our banking system. It's done next to nothing. It is not protecting our citizens from the risk inherent in the combination of commercial and invsetment banks. It is not protecting our economy from the recklessness of these banks with derivaties ... remember how mortgage backed security derivatives brought down our economy in 2008? At that time our national exposure was approximately $180 Trillion. In just 3 years that figure has risen 38%. So rather than reining in the risk taking on Wall Street, things have continued to grow unabated.  

Ready for another bailout? Ready for another recession? Ready for our current first world problems to look meaningless in the face of the second major financial crisis in less than a decade?  

It's coming. Unless we act. 



Tuesday, October 4, 2011

Is OccupyWallStreet failing?


Any number of political pundits have dismissed #OccupyWallStreet as a failure for a wide variety of reasons. Mytheos Holt (pseudonym?), a writer for the usually fairly intellectually honest if right leaning Frum Forum wrote a piece on Why the Wall Street Protests are Failing. On the face of it he argues that it is and will continue to be ineffectual while citing activist Saul Alinsky's keys to successful protest. Ironic coming from the right, but that's beside the point.

The point is that Mr. Holt and his compatriots among the establishment media are dead wrong. 

The protests have been more successful than most anyone believed possible. 

Remember, this whole thing started 18 days ago!

In 18 days the protesters have managed to accomplish:

  • worldwide news coverage with the pepper-spray incident
  • facetime with celebrities (Susan Sarandon, Russell Simmons), celebrity rabblerousers (Michael Moore), social activism intellectuals (Cornel West), politicians (Former NY Governor David Paterson), and media pundits (too many to name).
  • the support of several large unions
  • the largest mass arrest in New York City history
  • 87,000+ facebook "likes"
  • 38,000+ twitter followers
  • blocked from trending on twitter (JP Morgan Chase recently invested $400M)
  • coverage on almost every large media outlet 
  • front page of the NY Times and several other big dailies
  • 147 spin-off protests in cities throughout the United States
  • a Boston protest group that's already had a 3,000 person march and several arrests
  • a San Francisco group that is actually occupying bank property
  • 28 spin-off protests in foreign countries on 3 continents

While their recent Declaration of the Occupation of New York City may read like a group-think classroom project and lacks the polish of some alternatives, such as FDR's proposed Worker's Bill of Rights, it also has some strong language including this gem: 

As one people, united, we acknowledge the reality: that the future of the human race requires the cooperation of its members; that our system must protect our rights, and upon corruption of that system, it is up to the individuals to protect their own rights, and those of their neighbors; that a democratic government derives its just power from the people, but corporations do not seek consent to extract wealth from the people and the Earth; and that no true democracy is attainable when the process is determined by economic power. 

The list of proposed demands on their website is also a bit silly in parts, but it's a work in progress. However, if they want to be taken seriously and supported by a majority of Americans, they'll need to revise or eliminate demands such as:

Demand eleven: Immediate across the board debt forgiveness for all. Debt forgiveness of sovereign debt, commercial loans, home mortgages, home equity loans, credit card debt, student loans and personal loans now! All debt must be stricken from the "Books." World Bank Loans to all Nations, Bank to Bank Debt and all Bonds and Margin Call Debt in the stock market including all Derivatives or Credit Default Swaps, all 65 trillion dollars of them must also be stricken from the "Books." 

That, of course, would be catastrophic for our economy and violate billions of legal contracts. So it's absurd on its face.  

In fairness, these are proposed demands written by a member of the movement. Not the demands the movement has actually chosen to support. They are using a voting system to accomplish that. Having now gone through the voting process, most of the demands garnering overwhelming support are reasonable expectations from a movement focusing on getting money out of politics, reining in invsetment banks, and reforming our government. Fortunately, debt forgiveness for all doesn't appear anywhere in the proposal. 

This is what direct democracy looks like. It's messy, sloppy, and full of equality. We, fortunately, live in a representative republic in which representatives air the issues rather than having every citizen vote on every issue. That would result in chaos and the tyranny of the majority. At some point the OccupyWallStreet protest will need to move beyond their horizontal leadership model if messages are going to coalesce and become more effective. But now is not that time. 

I look forward to watching this evolve. I hope they're successful. As a country, we need these issues resolved for our great experiment to flourish.  

Remember, it's only been 18 days. They don't need a firm message or set of demands yet. 

This is only the beginning.