Tuesday, May 15, 2012

Obama backs tougher Wall Street regulation

The Guardian reports that as a result of JP Morgan's $2 billion trading loss, President Obama is backing tougher regulation of Wall Street.

If that is true, in the spirit of bipartisanship he will support Mitt Romney's call for 'greater transparency ... that gives investors more clarity'.  Areas Mr. Romney cites as examples needing transparency include inter-bank relationships and derivatives.

In short, Mr. Romney is calling for the banks to provide ultra transparency and disclose their current asset, liability and off-balance sheet exposure details.  This is the information that investors, including other banks, need to assess the risk of each bank.

There is still plenty of time left in the Congressional calendar to get ultra transparency passed into law and for President Obama and the Democrats to claim it shows how they can work with the Republicans to implement an  idea whose time has come.

President Obama has said JP Morgan Chase's $2bn (£1.2bn) trading loss demonstrates the need for tighter financial services regulation... 
Obama said the losses at JP Morgan were so big that the US government might have had to step in if the trading blunders had happened at a smaller institution, where they could have prompted a bank run....
Even at a smaller bank there would not be a bank run as depositors know that the government explicitly and implicitly guarantees their deposits.

After all, there is a significant moral obligation to bailout creditors and equity holders after the regulators run a stress test and pronounce the bank solvent.  It is hard to then inflict losses on creditors and equity holders given the regulators have better access to information than the investors currently do.
"Keep in mind if we get all the rules that we proposed and were passed by Congress implemented into law, it should prevent this kind of stuff from happening.
Actually, as this blog and others have documented, there is nothing in Dodd-Frank that would have prevented this kind of stuff from happening.

The only way to prevent this kind of stuff from happening is to shine sunlight onto the activities of the banks.  This is accomplished by requiring ultra transparency.
But this, again, is going to be part of what the election is about. We've got real differences here, because Governor Romney, members – some of the Republican members of Congress and the financial industry have been arguing that this is unnecessary....
Apparently Governor Romney and the Republicans understand that the vast majority of Dodd-Frank could be replaced and more effectively achieved by simply requiring ultra transparency.

To the extent that President Obama and the Democrats want to protect Wall Street, they will continue to block adoption of ultra transparency.
Barney Frank, co-author of the act, said the fiasco showed how important it is. "It shows how wrong [Governor Romney] is in arguing that the legislation is not needed," he told the Guardian. "This isn't a stupid mistake at some poorly run company. It's not some outlier like Countrywide [the fallen sub-prime mortgage giant]. Dimon is a very able guy. But even in a well-run institution things like this can happen."
Exactly the reason that ultra transparency is needed so that the market can enforce discipline and ensure that banks are well-run and do not take on trading positions like this.
Obama's interview was recorded on Monday as the president raised cash for his reelection campaign at the New York apartment of Tony James, head of private equity firm Blackstone Group.
At the fundraising event, which 60 donors had paid $35,800 each to attend, Obama warned that Congress would not provide another bailout if banks faced another credit crisis...
Of course Congress will.  Regardless of what it says in Dodd-Frank, Congress will extend funds if doing so would prevent the financial system from melting down.  Under these circumstances, not extending the funds would be unjustifiable.

This points out one of the major problems with Dodd-Frank.  It simply does a terrible job in preventing the next crisis. (The only two parts of Dodd-Frank worth saving were injected by third parties and both of these address prevention:  the Consumer Financial Protection Bureau courtesy of Elizabeth Warren and the Volcker Rule by way of Paul Volcker.)

In the 1930s, it was realized that transparency was necessary to prevent a crisis.  It took Wall Street almost 80 years to re-insert enough opacity into the financial system (think structured finance securities and bank balance sheets) to cause a financial crisis.

It is time for real reform and ending opacity in the financial system.

Treasury Secretary Tim Geithner confirmed that Dodd-Frank is not about preventing the next crisis.
Geithner said the administration’s overhaul of financial regulations isn’t meant “to prevent the unpreventable in terms of mistakes in judgment, but to make sure when those mistakes happen -- and they’re inevitable -- that they’re modest enough in size, and the system as a whole can handle them.” 
The loss “points out how important it is that these reforms are strong enough and effective enough,” he said.
Your humble blogger prefers to rely on the market rather than rely on the judgment of bank management and regulators who the current financial crisis has shown to be error prone.

One of the advantages of providing the market with ultra transparency is that the market can exercise discipline in the form of high cost of and reduce access to funds that when mistakes happen they are modest enough in size that the system can handle them.

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