David Paul: The world of finance is indeed a rigged game

David Paul wrote an interesting Huffington Post column in which he observed that 'the world of finance is indeed a rigged game' and since the beginning of the financial crisis the banks have been able to fend off all efforts to control them.

This is the direct result of global policy makers and regulators adopting the Japan model (banks only recognize their losses as they generate the income to absorb them) for dealing with the financial crisis.

It is virtually impossible on the one hand to provide cover for the banks so that they can hide their losses on and off their balance sheet and on the other hand to exert any discipline over these same banks.

The world of finance is indeed a rigged game. As the world of finance came crashing down four years ago, aggregate losses on Wall Street and in the banking sector totaled in the trillions, exceeding the combined profitability of the industry over the previous century. 

That the Fed made over $7 trillion available to restore our financial system, as tabulated by Bloomberg, was only made more obscene by the fact that billions were restored to the balance sheets of our banks -- including Goldman and Morgan Stanley who essentially became banks just so they could benefit from Fed largesse -- filtered through a risk-free carry trade from which massive bonuses were deducted before flowing to bank capital accounts. 

Americans are not stupid. They know a rigged game when they see it. But if the past four years have proven nothing else, it is that the tightly interwoven relationship between Washington and Wall Street has survived the collapse as strong as ever. 

From the outset of the crisis -- when within weeks of the first passage of the $700 billion TARP program banks succeeded in stonewalling the sale of toxic assets because they didn't like the proposed pricing and succeeded instead in getting the public dollars for free -- the major banks have succeeded at almost every turn in defending their interests. 

Four years later, the industry is more concentrated than ever, trillions of dollars of derivatives trading remains opaque and the industry culture of privatized profits and socialized risk has been codified into law. 

Like the Cioffi-Tannin case, last week's "settlement" with mortgage brokers, whose patent fraud contributed to the housing bubble and ensuing collapse, was embarrassing -- whether one believes it was supposed to constitute compensation for damages, restitution for conduct, or deterrence against future abuse. That settlement, approved by 49 participating states' attorneys general, was one more example of a resurgent finance industry that has walked away largely unscathed from the havoc it wrought. 

Late last year, another U.S. District Judge, Jed Rakoff, stood up for the dignity of society -- someone had to -- when he rejected a Securities and Exchange Commission settlement with Citigroup. 

It was one of those many cases floating around these days where one of our leading banks sold bundles of mortgage-backed securities to investors, while secretly betting against those same securities. Rakoff rejected the proposed settlement as "pocket change," and "neither fair, nor reasonable, nor adequate, nor in the public interest." But the real source of Rakoff's wrath, like Block's this week, was that the Citi settlement included no admission of wrongdoing. 

And so the game goes on. No one admits to any wrongdoing, and four years later almost nothing has changed.... 

This week, our finance industry is on the attack again. 

The industry target now is the Volcker rule -- the proposed rule that would limit the ability of banks to trade for their own account. Leading the attack has been JPMorgan CEO Jamie Dimon, who has turned to thinly veiled derision of Paul Volcker, as Dimon continues to make the case for scale and opacity in banking....

As regular readers know, the leading casualty of adopting the Japan model and facilitating banks hiding their losses on and off their balance sheet is transparency.

It is transparency that ends the tightly interwoven relationship between Wall Street and Washington.

When banks are required to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants know exactly what the banks are hiding.  More importantly, market participants can assess the risk that the banks are taking either in their lending or capital market business and adjust the amount and price of their exposure to each bank to reflect this risk.

Concentration and risk in the banking system has grown steadily since Clinton-era deregulation, and only increased since 2008. Today, the four largest U.S. banks hold over 50 percent of the assets of the banking system and the four banks most active in the largely unregulated and opaque derivatives market hold 94 percent of the $250 trillion volume of financial derivatives in the U.S. banking system. 

Dimon is taking on Volcker because he can. A towering figure in the finance world, Volcker's support brought great credibility to Barack Obama as a candidate. But since Obama took office, Volcker has been marginalized, and replaced by advisors more closely aligned with the banking industry. 

Since the financial collapse, the industry has won nearly every round as it has sought to protect its privileges and power. 

While many might complain about the dizzying complexity of Dodd-Frank legislation, the truth is that the industry beat back the most substantive restrictions on derivatives trading as well as any constraints on size or leverage.

The industry beat back all attempts at valuation transparency.

Valuation transparency is disclosure that provides market participants with all the useful, relevant information that they need in an appropriate, timely manner so they can independently value a security.  This independent valuation is used to compare against the price shown by Wall Street to make buy, hold and sell investment management decisions.

One area where the banks beat back valuation transparency was structured finance.  Here we had opaque toxic securities that blew up the global financial system and government could not bring itself to require these securities to provide valuation transparency by disclosing observable event based reporting for the underlying collateral.

If it can minimize the effect of the Volcker rule, the industry will have protected the two greatest sources of profitability for the big banks -- derivatives and proprietary trading -- despite those being the greatest sources of risk to the public and the farthest away from the public purpose of the banking system. 

This Friday, in an assault on the Volcker rule that might on the surface seem to have been in support of Dimon, the Wall Street Journal editorial board ... rightly argued that Dodd-Frank promotes the illusion that an increasingly complex regulatory apparatus can prevent systemic failure. 

It is simply not reasonable to imagine that regulators can begin to track and monitor, much less regulate, the complex risks embedded on bank balance sheets -- hidden away in collateral rules, language arbitrage and collateral valuation. 

This is why banks must provide ultra transparency.

As the Bank of England's Andrew Haldane observed, regulators are not up to the task of assessing the detailed exposure data.

Fortunately, there are a number of market participants who are capable of turning the data disclosed under ultra transparency into useful information.  The list of market participants includes competitors and experts.