Friday, July 27, 2012

Will scandals cost banks any of their clout?

In his NY Times' column, Floyd Norris argues that with the Libor scandal and JP Morgan credit default swap trading losses, banks may finally have seen a reduction of their clout with politicians and financial regulators.

Not a chance.

Regular readers know that there is a financial/academic/regulatory complex with the banks at the center.

For example, when the NY Fed needed suggestions for how to prevent manipulation of Libor, who did it turn to?  It turned to the banks that were manipulating Libor.

After the financial crisis, nothing was more surprising than the speed with which the banks regained their self-confidence and their influence, not to mention their haughtiness. 
“They feel more powerful to me than they did before the crisis, when they were healthy,” one regulator told me recently.
 Banks should feel that way after all policymakers and financial regulators are implementing the Japanese model for handling a bank solvency led financial crisis.  Under this model, bank book capital levels and banker bonuses are protected at all costs.

Given that neither the banks nor the bankers experienced any negative consequences from the financial crisis and the bankers are back to making near record amounts of money, it should not be surprising that bankers feel like Masters of the Universe.
That sense of power may have peaked this spring, before JPMorgan Chase disclosed its $2 billion — now $5.8 billion and counting — “hedging” loss and before the public firestorm erupted, largely in Britain, over the Libor scandal. 
In trying to understand how it is that an industry whose excesses nearly brought down the world economy could recover so quickly, it may be helpful to remember the answer attributed — probably erroneously — to Willie Sutton, the Depression-era criminal, when asked why he robbed banks: “That’s where the money is.” 
The banks, for all their sins, remain the principal source of capital for people and companies, particularly small ones. Getting them to lend more — without resorting to the excesses that caused the crisis — is a reasonable goal for public policy. That means that any regulation that bankers oppose may be vulnerable to arguments that it will hurt the economy. 
And then there are campaign contributions. People who make millions of dollars a year can make big ones.
Please re-read the highlighted text as Mr. Norris has nicely summarized how banks control the financial/academic/regulatory complex.
Now there is a question as to whether that power is in danger of being broken as a result of public revulsion over the JPMorgan hedging fiasco and the Libor scandal. 
The banks had turned this year’s debate into one about “excessive regulation,” and seemed likely to at least win a few concessions.....
Regular readers know that banks like prescriptive regulations as they are a substitute for requiring the banks to provide transparency that the banks can easily circumvent.

Consider the Volcker Rule.

The regulators published a 300-page opus filled with prescriptive regulations for complying with the simple requirement that banks are not allowed to take proprietary bets.  According to JP Morgan's Jamie Dimon, this would not have prevented the credit default swap trade.

Now compare the 300 pages of prescriptive regulations to the 2 pages the Volcker rule would be if banks were required to provide ultra transparency.

  • On page one, in very large type, it would say "financial institutions are prohibited from taking proprietary bets".  
  • On page two, also in very large type, it would say "on an on-going basis, financial institutions shall disclose all of their current global asset, liability and off-balance sheet exposure details".  With this disclosure, market participants, including regulators, could see if the banks were taking proprietary bets and violating the rule.

Does anyone imagine that JP Morgan could have built up the exposure they did in the credit default swap market without anyone noticing?  Does anyone think that JP Morgan would not have built up this position if everyone could see what it was doing for fear that the market would trade against it?
To understand how the world may have changed, it is worth looking at how perceptions have changed regarding both the JPMorgan loss and the Libor scandal since they were originally disclosed.... 
The invisible hand of the market has many benefits, but it sometimes needs to be restrained. “People of the same trade seldom meet together,” wrote Adam Smith, the patron saint of free markets, “even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” 
Market manipulation is at the heart of the Libor — London interbank offered rate — scandal. The idea that such a thing could happen seems not to have occurred to bank regulators for years, a reality that speaks volumes about their mind-set....
Regular readers know that the necessary condition for the invisible hand to operate properly is transparency (disclosure of all the useful, relevant information in an appropriate, timely manner) so that the buyer knows what they own.

The Libor manipulation could only occur because the financial regulators let it be set in an opaque manner.  Had banks been required to provide ultra transparency, Libor could have been based off of actual trades.
It is a strange fact that effective regulation can empower banks. American banks are now far better capitalized than most European institutions because the American regulators forced them to raise capital.
This is an assertion of opinion as without banks providing ultra transparency there is no supporting evidence.   We know that US financial regulators have been engaged in regulatory forbearance, so there is no telling how bad the losses hidden on and off the US bank balance sheets are.
Before the current crisis of confidence, that had encouraged banks to step up campaigns to blunt the new rules. European banks, which were not forced to raise capital, face the specter of more regulation, with some of it coming from euro zone institutions that may be less easy to manipulate than were national regulators.
For banks, all of these institutions and national regulators are easy to manipulate.  That is because the regulators' job is dependent on helping the banks protect opacity.  Imagine who many fewer regulations would be needed if banks had to provide ultra transparency! 

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