DODD-FRANK | Maloney Asks Five Agencies for Data

Rep. Carolyn B. Maloney (NY-12)

East Hampton, N.Y., August 30, 2016 – Yesterday Congresswoman Carolyn B. Maloney (NY-12) wrote to five U.S. financial regulators requesting trading data that the agencies have been collecting since July, as part of implementing the Volcker Rule.

Rep. Maloney is the Ranking Member of the House Financial Services Subcommittee on Capital Markets and GSEs. The five regulatory agencies are as follows:

• Federal Reserve System,
• Federal Deposit Insurance Corporation,
• Commodity Futures Trading Commission,
• Office of the Comptroller of the Currency,
• Securities and Exchange Commission.

The Volcker Rule, named after Paul A. Volcker, former Federal Chairman from 1979 to 1987, is formally §619 (12 U.S.C. §1851) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Rule is designed to identify and control the risk-taking of financial institutions. Information on trading information in needed to assist agencies in distinguishing between prohibited proprietary trading and legitimate market-making and hedging activities. This information is also valuable to anyone seeking to understand the exposure to risk of financial instruments and markets.

In her letter to the five regulators, Maloney notes:

[T]here has been a vigorous debate about the liquidity of certain U.S. fixed-income markets, such as corporate bonds, and about whether the liquidity of these markets has deteriorated in recent years. Data on the inventory turnover, inventory aging, and customer-facing trade ratios in the fixed-income market-making units of the large banks could prove particularly informative in this debate.

Compliance with Dodd-Frank has been slow. Some banks have been asking for extensions to 2022 to comply with some of the provisions of the law, and numerous proposals have been introduced to weaken the law.

BANKS | Comptroller Curry Is Scary

Thomas J. Curry, Comptroller of the
Currency

Thomas J. Curry, Comptroller of the Currency, gave mild speeches on March 2 and April 2 focused on risks from terrorist attacks on cybersecurity, a threat to bank operations. Worrisome, but with an enemy on some distant shore and technical fixes waiting in the wings.

Yesterday at the Exchequer Club in Washington, it was different. He allowed himself to step out and make a few spicier comments. He acknowledges that at this stage of the credit cycle, credit quality is and can be expected to deteriorate, and "credit risks are coming to the forefront," ahead of threats from jihadist hackers.

Curry doesn't go much further than that in his remarks. But he plants the seeds of worry. Wall Street on Parade spells out what Curry might have said. Reforms have failed and we may see in this credit cycle a repeat of what led up to the disaster of 2008. One solution is more unified oversight of the financial sector at the Federal level, i.e., encompassing the securities industry.

When I was working for the Federal Reserve and FDIC in the 1960s, the Bureau of the Budget was looking at unifying financial regulation just as a matter of efficiency as well as effectiveness. But if you are an institution being regulated, the last thing you want is efficiency and effectiveness. You want the maximum number of regulators, so you can shop among them.

And if you are the regulator, you don't want your agency eliminated. We can't expect the Comptroller of the Currency, speaking for a 150-year-old office that has had to fight to remain independent from the Federal Reserve System, to advocate for consolidation of Federal oversight agencies.

The issues are surfacing now because of the good work of Pam and Russ Martens of Wall Street on Parade, who are keeping up a steady Pecora-like stream of revelations of what Senator Wright Patman used to call malfeasance, misfeasance and nonfeasance. The candidacy of Bernie Sanders has kept the Glass-Steagall issue in the public eye during the first Democratic debate.

Here is a snippet from today's post from the Martenses outlining the problem:

What Curry didn’t mention are the real elephants in the room – the casino room on Wall Street: the $180.29 trillion of derivatives held at the insured banking units of just four banks: JPMorgan Chase, Bank of America, Citibank (part of Citigroup) and Goldman Sachs. Just those four banks hold 91.1 percent of all derivatives held at the thousands of banks in the U.S. If that’s not concentrated risk, we don’t know what is. Curry also didn’t mention the frightening reality that some of the biggest banks are up to their old dirty tricks of dodging capital requirements through trades with dubious counterparties.
In June, the U.S. Treasury’s Office of Financial Research (OFR) released a report that set off alarm bells. The report, written by Jill Cetina, John McDonough, and Sriram Rajan, revealed that the big Wall Street banks are ginning up their capital measures by engaging in non-transparent “capital relief trades.”
The report indicated that JPMorgan’s London Whale trades, exposed in 2012 and the subject of multiple Congressional hearings and an in-depth report by the Senate’s Permanent Subcommittee on Investigations, was, in fact, a capital relief trade. JPMorgan Chase has owned up to losing at least $6.2 billion of bank depositors’ money on those trades.

Back in 1933, the Pecora Committee - a Senate Committee that was, unusually, named after the aggressive staff counsel, a New Yorker named Ferdinand Pecora - held hearings that led to the Glass-Steagall Act of 1933 and the Securities and Exchange Act of 1933 (while, alas, also skewering a few people who should not have been so impaled).

The Glass-Steagall Act was well-conceived and lasted 70 years. Banks traded deposit insurance for ring-fencing around the commercial banks to keep out the investment bankers. The flaw in the Act was there from the beginning, namely that the securities business was regulated separately and inadequately. The financial lobby has exploited that loophole in stages, notably in 1999 and 2002. The Economist Magazine in 1999 wisely opined that if the Congress was going to take away some Glass-Steagall controls, they would have to extend controls on the securities business; the reverse happened.

A predecessor of Curry as Comptroller of the Currency, John D. Hawke, Jr., in a speech to the NY State Bankers Association in 2000 said:

Regulatory competition has stimulated innovation and efficiency. Competition keeps all of us on our toes, and provides incentives to add real value to our supervision. While the system unquestionably provides opportunities for regulatory arbitrage, there is little evidence that it has stimulated the competition in laxity that former Federal Reserve Chairman Arthur Burns discussed 30 years ago.

Competition in laxity is exactly the term I would choose to describe what happened to the mortgage sector during the next seven years. New York State has now recognized that financial services has  become one industry, and has consolidated banking and securities oversight into one regulatory oversight body that talks openly about financial risk and the risk-taking enemies closer to home. It's time we consolidate financial regulation in Washington.

LEVERAGED LOANS | Again a Threat

Nov. 5, 2014–Junk Bonds used to be the Big Scare for financial regulators. Those are bonds issued based on revenue from risky companies with little collateral.

The bonds pay a higher interest rate, which attracts buyers, but the inherent risks are often misunderstood. It's a financial crisis waiting for the next downturn.

Now the same issues are being raised in connection with Leveraged Loans. The difference between them and Junk Bonds is that Leveraged Loans are sold off privately to pension funds, mutual funds and hedge funds. We know loans now exceed the high point of the last bubble.

Recently the Federal Reserve System and the Comptroller of the Currency have shown concern about the expansion of this market. The average debt-to-revenue of companies obtaining leveraged loans in 2014 so far has risen to a multiple of 4.9, up from 3.9 in 2011.

In other words, the total debt of new borrowers is nearly five times annual revenue (i.e., EBITDA - earnings before interest, taxes, depreciation, amortization).

It gets worse. The loan contracts have been dropping certain protections to the lenders. Of recent leveraged loans, 63 percent lack these protections, up from 25 percent in 2007. In these seemingly small ways does the quality of bank credit deteriorate.

The old Glass-Steagall wall between banking and investment banking matched up bank deposits against either liquid assets or loans subject to review by bank examiners, who have had the power to mark down debt that is substandard, doubtful or loss. Equity and risky debt was matched up with money from "sophisticated" individual investors or financial institutions. The system worked for the next 70 years until banks and non-banks both sought more freedom to do what was done in the 1920s.

Leveraged loans take on the character of investment banking. Smaller corporate borrowers like them. Bank lenders like them. But in the absence of deposit insurance, consumers of bank services would worry deeply about them.  The Glass-Steagall Act traded deposit insurance (which banks wanted) for regulatory constraints (which they did not). The constraints have been eased while taxpayers' liability for deposits - in the form of Treasury and Fed support of the Federal Deposit Insurance Corporation - has continued.

We should be concerned about Leveraged Loans as bank depositors, as taxpayer-guarantors of bank deposits, and as consumers with a stake in stable financial markets.

Time for Reform of Financial Regulation

After the meltdown of the savings and loan industry in the 1980s, the Federal Home Loan Bank Board was ended and the Office of Thrift Supervision was put in its place in 1989 to end mortgage chicanery once and for all. With Meltdown II originating in the subprime loan business, it is clear that the 1989 reform was inadequate. Risks were mispriced, mortgage lenders were out of control and the effects are being felt with foreclosures and financial losses in every community in America.
A December 27 Wall Street Journal article, Wall Street Wizardry, showed how subprime mortgage loans were repackaged and resold at prices that did not reflect their risk, using the example of Norma to show a "hairball of risk".
It's no surprise that Wall Street was able to engage in such practices because the financial regulatory system is a hairball of its own. The Comptroller of the Currency, Federal Reserve, the Federal Deposit Insurance Corporation and 50 state bank regulators share with the Office of Thrift Supervision and the SEC the responsibility for overseeing financial institutions and their innovations. Bankers prefer multiple regulators because they can then shop among them for the one they like best. The idea of a super-regulator "sends chills down the spine" of bankers, says a 2003 memo prepared for the FDIC, which observes that calls for consolidation of bank regulation are "nothing new" and argues for competition among regulators.
However, the outcome of the existing system has been the subprime meltdown, which has also sent chills down the spine of bankers, with more chills and spines to come.
One problem is that bank supervision is not a priority for the top management of the Federal Reserve System, which clusters around the FOMC and the federal funds rate like moths around a flame. An article by Gretchen Morgenson of the NY Times describes Fed Chairman Alan Greenspan's meeting with two representatives of the 15-year-old Greenlining Institute, who expressed concern about the lack of oversight over subprime mortgage lending practices. Greenspan is reported as not being interested because he did not wish to interfere with financial innovation.
To be fair to Mr. Greenspan, he and his colleagues have had other things to worry about besides bank supervision. The Fed was originally created in 1913 to maintain orderly financial markets and maintain the value of the dollar. In 1946 it was given the additional task of ensuring full employment. These multiple tasks conflict. How does one tackle a threatened debt-induced recession in 2008 when oil hits $100 a barrel and commodity prices generally are rising along with global growth? If orderly markets require continued infusion of liquidity, how does one battle inflation? What is the long-run impact on the Fed's ability to control inflation of perennial budget deficits?
The problem with the lack of oversight over the Wall Street wizards is that when their innovations blow up, the taxpayer histroically picks up the pieces, and the breakdown in financial markets poses problems for monetary policy.
When President Bush addressed the hairball of multiple agencies involved in homeland security, he consolidated the agencies under one leadership. We have a problem now with financial security. The subprime crisis is worse than the savings and loan mess. As subprime losses are revealed in other countries, it can't be good for the future of Wall Street as a global competitor.
The agency best equipped to assess and charge for financial risk is the FDIC. Washington legislators should hold hearings about possibilities for consolidating financial regulatory functions under the FDIC, which can price risk and assess insured institutions a deposit insurance premium based on this risk. This would encourage market-based incentives to disclose and control risks.