The Bennett NewsletterRegulation Needed.
After allowing Lehman brothers to collapse last year, Governments have indulgently propped up the financial system. This set a precedent that is already encouraging greater risk-taking by the private sector. The world is saddled with monstrous banks, enormous debts, tremendous wealth loss, yet regulation is continually postponed.
I am not complaining merely of procrastination: new bubbles are forming. I fear the mistakes of the past will be repeated.
Risk-taking resumes
According to Associated Press, the US big banks are bigger and betting big on bonds, commodities and exotic financial products: trading that had caused the crisis because of their excessive leverage. There have been no significant changes in the rules that govern their behaviour.
The dangers are greater than ever because the surviving banks have increased their size, and are still making bets larger than the capital they have assigned to cover their plays. Bailing them out set a terrible precedent: they now know they will not be allowed to fail (especially as they are bigger than ever). Most officials agree more regulation is necessary but it is held up by lobbyists and lawmakers.
President Obama has warned “We will not go back to reckless behaviour and unchecked excess, where too many were motivated only by the appetite for quick kills and bloated bonuses”. His administration has, however, prioritized health, energy and emissions above finance. But he wants to act on “excessive bonuses” and introduce a “systemic risk regulator” because the big bank’s important trades are with divisions of other big banks. So the big banks are wired together in so-called “counterparty risk’, where the failure of one bank to honour its commitments on derivatives could bring a cascade of steep losses.
The US Administration also wants to increase bank’s capital requirements but G20 have not yet assented: the US plan is to get agreement on a new capital requirement level by 2010 and impose it in 2012. Meanwhile the banks are making hay.
They are back to the old tricks of securitising mortgages or life policies or credit cards into oxymoron packages of safe, high yielding products. They have a nice number in sub-primes repackaged as “real estate investment conduits”. The New York Times warns that their new interest in securitising “life settlements” (policies which the sick and elderly can sell for cash) could be the subprime problem all over again.
In the last quarter, Goldman Sach’s accounts indicate that their trading departments’ source half of total revenue. This is a sure sign of massive trading. In the same quarter the big 5 banks’ average potential losses from a single trading day exceeded one billion dollars, which is 76% more than two year ago. Their profits were $13 billion compared to $20 billion in the heyday of 2007. They are rehiring spectacularly.
The Bank of International Settlements reports that the derivative market has rebounded to $426 trillion, and the market is unstable and prone to crises.
Although these banks got government assistance, pay is excellent. Goldman paid out $6 billion in the last quarter, a 34% increase on 2 years ago. Citigroup owes a star trader $100 million. The lobbyists are also doing fine. They have stalled regulation in Congress, and have managed to avoid the threat of hedge funds having to disclose their holdings with the SEC.BIS reports “huge counterparty risk in hedge funds.”
Were bailouts good?
At the time I favoured bailouts as I though there would be conditionality. Things went wrong, starting with Bear Stearns. The Fed took $29 billion of toxic securities and sold the rest to JPMorgan, creating the expectation of intervention. When Lehman tettered it turned down offers from Warren buffet because it believed the Fed would refinance it. Perhaps if Bear Stearns has been allowed to fail Wall Street would have to have been more active in cleaning up the mess.
Rick Newman writing in Yahoo finance questions the AIG bailout. Briefly, the Fed issued $85 bn credit for 79% of ownership. The insurance business was good, but AIG Financial Products played the derivative game, making huge gambles in mortgage-backed securities. Executives in AIG FP received $165 million in bonuses. Barry Ritholtz in “Bailout Nation” argues the FP division should have been treated like a failed bank, with its customers in the derivative trade taking a big hit. Ritholtz says you should suffer pain if you deal with a corrupt entity like AIG FP.
Bernanke said AIG was not a bank so it could not have been taken over and dismantled. This is tough for tax payers who will not get repaid but it proved very nice for Goldman Sachs. It has $6 billion in deals with AIG and got a 100% recovery. Normally it would have nothing. Treasurer Henry Paulson, formerly CEO of Goldman, is blamed for this sweet deal.
One may wonder what the Fed is doing with these toxic assets. It put on a brave face saying it could recover some value but it has $1.25 TRILLION of mortgage backed assets which includes not only the original toxic assets but also current foreclosures. This is an utterly inappropriate asset class for a central bank but it is not disposing of it.
Wall Street banks will be extremely pleased by the Stock Market’s recovery. There is something odd about it, not least “the rush for trash”. Stocks in companies with very little equity, kept alive only by bailouts are being very actively traded: Fannie Mae, Freddie Mac, AIG, Citi and Bank of America made up about one third of NY Stock Exchange’s volume in August. The word is that day traders were the main impetus. That is ludicrous because day traders could not fund movements on this scale.
I have concentrated on the US example of banks resuming questionable practices. The same things are happening in the UK and Europe where there is outrage at the size of bonuses. In New Zealand Westpac has lightened mortgage deposit requirements. The Bank of International Settlements (www.bis.org ) is trying to get more regulation but I think tax payers are going to be left with great debts accumulated by the banks, while the banks continues to take risks; the profits will be theirs, and the losses will be the taxpayers’.
|