Bank earnings have never been more complicated

In his Fortune column, Allan Sloan asks the simple question of how can Washington regulate the big banks when the earnings release of a large bank like Citi is a 100+ page opaque document.

As shown by our current financial crisis, Washington cannot successfully regulate the big banks.

One of the reasons for requiring the banks to provide ultra transparency is it subjects the big banks to market discipline.  Market discipline that links a bank's cost of funds to the risk it is taking.

This market discipline also strengthens Washington's regulatory discipline and improves the chances that it is successful by allowing Washington's regulators to tap the market for analytical expertise in understanding exactly what the banks are doing.

After all, who better to analyze Citi than JP Morgan and visa versa. 

Happy Birthday Dodd-Frank: a law that was designed not to and isn't working

In his Huffington Post column, former Senator Ted Kaufman looks at how the Dodd-Frank Act was designed not to address the causes of our current financial crisis and fails to make a future financial crisis less likely.

Failure was built into Dodd-Frank from the beginning. Instead of writing laws that addressed the abuses that led to the crisis, it nearly always kicked the can down to agencies, instructing them to write new regulations.

Regular readers know that by definition Dodd-Frank could not address the causes of the financial crisis because it was completed prior to the conclusion of any inquiry into the actual causes.

Instead, Dodd-Frank, with the notable exception of the Consumer Financial Protection Bureau and the Volcker Rule, was written by the bank lobbyists for the benefit of the banks.

The US is not alone in pursuing bank friendly reform legislation.

In the UK, Parliament is just taking up financial reform legislation almost 6 years after the financial crisis began.  There have been two commissions that looked into the crisis: the Vickers Commission and the Commission on Banking Standards.  By and large, the proposed financial reform legislation either ignores or adopts a weakened version of the recommendations made by the commissions.

By and large, those regulatory agencies have been overwhelmed by a combination of congressional underfunding and a massive lobbying effort by the megabanks that increasingly seem to control Washington....

When Dodd-Frank was being drafted, the bank lobbyists knew that the regulatory rule making process favored their positions.

Regulatory rule making favors the banks for 3 reasons: money, known by regulators, and act together.

Supporters of financial reform tend not to have the same financial resources, tend not to be known by the regulators and tend to focus only on the financial reforms of interest.

So making the regulators work on a large number of rule makings was intentional.

Here are just a few examples of Dodd-Frank's failure: 

• The banks still are gambling with FDIC-insured money. The JPMorgan Chase "London Whale" fiasco was just the latest proof that there has been no change in the casino speculation of Wall Street banks. 

• There is still a giant loophole in derivatives trading. Although there are new regulations curbing the kind of derivatives trading that was a key element in the crisis, those regulations do not cover the foreign subsidiaries of megabanks. Banks can easily move trading activities into different offices. He wasn't called the "London Whale" because he worked in Philadelphia. 

• No one has gone to jail. And no one will. There are many examples of criminal behavior during the meltdown, but not one megabank executive has been jailed. Without that deterrent, white-collar crime is not just profitable but inevitable. 

• Reform of the credit-rating agencies is a long way off. "Essential cogs in the wheel of financial destruction," as the Financial Crisis Inquiry Commission described them, the credit-rating agencies still operate as they always have, bought and paid for by the entities they rate. 

• Fannie Mae and Freddy Mac have not been fixed. In fact, they weren't even mentioned in Dodd-Frank, despite the fact that everyone agrees they played a role in the meltdown.

Regular readers know that brining transparency back to the financial system would fix four of these failures.

It would end banks making proprietary bets.  JP Morgan showed with its closing out the London Whale trade when it became known to the market that transparency ends proprietary betting.

It would end concern over where derivatives are traded.  With transparency, banks must disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  So derivatives traded in London would still be disclosed and investors could adjust the cost of the bank's funding to reflect these derivatives.

It would reform the credit rating firms by making them just another voice offering their views on an investment.  When market participants have access to the same data as the credit rating firms, market participants can independently assess the risk and value an investment or hire a third party to do it for them.  They don't need to have any reliance on the credit rating firms.

It addresses the reform of Fannie and Freddie by restarting the private label mortgage securitization market.  With the private label market unfrozen, Fannie and Freddie's portfolios can be run off.

There were lots of heated debates before passage of Dodd-Frank, but no disagreement from anyone in the administration or Congress about one thing. The bill had to end the possibility that American taxpayers would ever again have to bail out a big bank because its failure would have a severe impact on the entire economy. 

You would think that by now at least that problem would have been addressed. But it hasn't been. 

Eliminating the need for taxpayer bailouts won't occur until banks are required to provide ultra transparency and disclose their exposure details.  It is only with this data that market participants can limit their exposure to each bank to what they can afford to lose given the risk of each bank.

Wall Street and the potential to manipulate commodity markets

Bloomberg's Bob Ivry looked at the potential for Wall Street to manipulate commodity markets and highlighted the key issue: opacity.

Because of opacity, market participants cannot see and help the financial regulators assess the extent to which Wall Street is manipulating commodity markets through its participation in the physical markets.

“When Wall Street banks control the supply of both commodities and financial products, there’s a potential for anti-competitive behavior and manipulation,” [US Senator Sherrod] Brown said in an e-mailed statement. Goldman Sachs, Morgan Stanley and JPMorgan are the biggest Wall Street players in physical commodities.... 

Now, “it is virtually impossible to glean even a broad overall picture of Goldman Sachs’s, Morgan Stanley’s, or JPMorgan’s physical commodities and energy activities from their public filings with the Securities and Exchange Commission and federal bank regulators,” Saule T. Omarova, a University of North Carolina-Chapel Hill law professor, wrote in a November 2012 academic paper, “Merchants of Wall Street: Banking, Commerce and Commodities.” 

The added complexity makes the financial system less stable and more difficult to supervise, she said in an interview. 

“It stretches regulatory capacity beyond its limits,” said Omarova, who is slated to be a witness at the Senate hearing. “No regulator in the financial world can realistically, effectively manage all the risks of an enterprise of financial activities, but also the marketing of gas, oil, electricity and metals. How can one banking regulator develop the expertise to know what’s going on?”

An example of "Trying to pierce a Wall Street fog"

In her NY Times column, Gretchen Morgenson looks at the credit default swap market and finds that because of opacity the market is not acting in a competitive manner and Wall Street's informational advantage enables it to extract a much higher profit margin.

Regular readers are not surprised by this finding.  As Yves Smith said, nobody on Wall Street is compensated for developing low margin, transparent products.  Credit default swaps are an example of a high margin, opaque product.

BACK in 2009, the Justice Department said it was investigating the large Wall Street banks for possible collusion in the huge and opaque credit default swaps market. The question was whether the big financial institutions had worked to keep transactions in these insurance-like instruments closed to competitors and more profitable for themselves....

On July 1, the antitrust division of the European Commission announced that its investigators had come to a “preliminary conclusion” that the banks and two entities controlled by them had infringed European antitrust rules. These entities colluded, the commission said, “to prevent exchanges from entering the credit derivatives business between 2006 and 2009.” 

Credit default swaps were at the center of the financial crisis. These instruments allow holders of bonds or other debt to hedge their risks in those positions. But the swaps also let speculators bet on a debt issuer’s default. ... 

But the market for these swaps has been conducted in the shadows. Trades were made over-the-counter — between private parties and not on an exchange. This meant that participants’ positions were not disclosed to regulators. 

Wall Street likes the fog of over-the-counter markets because the profits generated by executing customers’ trades in them are far greater than in more transparent arenas. 

Think of the way you might shop for a mortgage: if mortgage rates were not publicly available, it would be hard to know whether the rate one banker offered was competitive. Customers that dealt with only one banker on their credit default swaps almost certainly did not get the best prices. 

The 13 banks under the microscope on credit default swaps include Bank of America Merrill Lynch, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS. Two associated entities controlled by the big banks are also being scrutinized — the International Swaps and Derivatives Association, a lobbying organization, and Markit, a data service provider....

“There was no question the banks did not want the C.M.E. to make the market more liquid and transparent,” said one person briefed on the banks’ internal discussions who asked for anonymity because he was not authorized to speak publicly. “This was their cash cow, and they didn’t want to give it up.”...

The banks have pushed to keep the market for credit default swaps in the dark. 

Three years ago, the Dodd-Frank legislation aimed to bring more competition by pushing trading onto exchanges and swap execution facilities. Wall Street tried to beat back regulators’ efforts to write tough rules after the legislation’s lead. They won some and they lost some. For instance, dealers now have to report swap transactions to regulators. 

There was a reason for the banks’ pushback: money. The Deloitte study cited a 2010 analysis by Citigroup showing that the big banks’ trading in over-the-counter derivatives generated revenue of $55 billion, or 37 percent of the total at these institutions. Such profits will fall as more swaps trade on swap execution facilities under the new rules.... 

“When you have markets that are .... opaque and where market players don’t have access to the same information, the markets are not functioning in a competitive fashion. Those that have the information can take advantage of that fact and extract anticompetitive leverage over those that lack the information.”

Please re-read the highlighted text as it nicely summarizes why transparency needs to be brought back to all the opaque corners of the financial system.

The Volcker Legacy: Too Big to Fail

Most people associate Paul Volcker with his role as the chairman of the Federal Reserve when inflation was defeated in the early 1980s.  For that, he deserves all the kudos he receives.

Few people associate Paul Volcker with his role as the chairman of the Federal Reserve and through his leadership of bank supervision and regulation creating the concept of Too Big to Fail banks.

However, it is the creation of Too Big to Fail banks that our current financial crisis has shown is his most important, lasting legacy.

In a very interesting American Banker article, Francine McKenna discusses how Continental Illinois was the first Too Big to Fail bank.  The collapse of Continental Illinois was the result of opacity that hid from the market what a combination of irresponsible lending, self-interest, hot money and lack of restraint by the Fed was allowing to be done to a bank that faced no market discipline.

In a related article, Ms. McKenna lays out the lack of regulatory restraint on banks and the adoption of the Too Big to Fail policy.

“The Congressional testimony of the OCC’s Conover in September 1984 also mentioned that the OCC had considered earlier whether it should have taken action much sooner to stop Continental from growing so quickly and, in hindsight, so recklessly.  

Conover testified that he believed such action would have been inappropriate but that the OCC could have placed “more emphasis on . . . evaluation and criticism of Continental’s overall management processes.” 

Federal Reserve Board Governor Charles Partee is quoted in William Grieder’s 1987 book “Secrets of The Temple” saying: “To impose prudential restraints is meddlesome and it restricts profits. If the banking system is expanding rapidly, if they can show they’re making good money by the new business, for us to try to be too tough with them, to hold them back, is just not going to be acceptable.” 

If that’s not enough foreshadowing of the policy prescription the Federal Reserve would deliver during the 2008 financial crisis, here’s Conover again during his testimony explaining to Congress why everyone but shareholders was made whole in the Continental Bank bailout: 

“…had Continental failed and been treated in a way in which depositors and creditors were not made whole, we could very well have seen a national, if not an international, financial crisis, the dimensions of which were difficult to imagine. None of us wanted to find out…” 

The day after Conover’s testimony, the Wall Street Journal published an article by Tim Carrington, “U.S. Won’t Let 11 Biggest Banks in Nation Fail—Testimony by Comptroller at House Hearing Is First Policy Acknowledgement”.

By the mid-1980s, Too Big to Fail had become the policy of the Federal Reserve and other bank regulators.


Regular readers know that I have written extensively about the Loans to Less Developed Countries crisis as it was the next step on the evolution of the concept of Too Big to Fail banks.  This crisis was very important for two reasons:

1. It cemented into the regulatory culture the notion that if the regulators and the Too Big to Fail banks "hid" the true extent of the losses at these banks, the market would go on as if the losses did not exist.
2. It drove monetary policy as the Fed, after informing the banks, chose to cut interest rates in an effort to generate earnings that could be used to recapitalize these institutions.

A little background is necessary to understand these conclusions.

Walter Wriston, a former chairman and CEO of Citicorp, said that "people go bankrupt, but countries don't".  Based on this observation, the large US banks plunged into lending to Less Developed Countries.

Of course, Mr. Wriston was wrong.  Countries do go bankrupt and this point had become obvious by the mid-1980s.  

Unfortunately, by the time this point was obvious, the exposure of the large US banks to the Less Developed Countries was multiples of their book capital levels.  A fact that was well known to market participants as banks disclosed the level of their exposures to the Less Developed Countries.

In fact, the general magnitude of the losses on these loans was also known to the market as predecessors to Bloomberg reported the prices at which the Loans to Less Developed Countries traded. When a Less Developed Country's loans trade at fifty cents on the dollar, it was a pretty safe bet that the value of the loans held by the banks reflected this pricing.

So the question that the Fed as the lead regulator for the Too Big to Fail banks faced was do we require the banks to write down their loans to Less Developed Countries upfront to reflect current market valuations or do we engage in regulatory forbearance and let the banks engage in extend and pretend and bring the losses slowly through their income statement as they generate earnings?

The Fed chose regulatory forbearance and the idea of "hiding" the actual magnitude of the losses from the market.

Please note, the market had a very good idea of the size of the losses, it just did not know the exact amount of the losses.

When John Reed at Citicorp eventually recognized the losses on the Less Developed Country loans, the market responded by bidding up Citicorp's price.  The write-off confirmed the market's conclusion about the size of the losses.

The Fed mistakenly believed that the fact the market had not collapsed when it became obvious the banks were insolvent and the subsequent positive reaction by the market was an endorsement of its policy choice.

The market didn't collapse because there was sufficient transparency into each of the Too Big to Fail banks to determine a) the general magnitude of loss and b) whether the bank's net interest income was greater than its ongoing operating expense after adjusting for the income actually generated by the loans to Less Developed Countries.

The Fed's policy response set another precedent.

Is Wall Street winning or because of its high profits losing the long-war against regulation

Approximately one month ago, in her Guardian column, Heidi Moore described why Wall Street is winning the long-war against regulation.

Feeble as it was, Dodd-Frank was a high point of reining in abuses. Thanks to financial lobbying, it's business as usual.

Today, in his NY Times column, Peter Eavis describes why Wall Street's high profits set them up to lose the long-war against regulation.

In recent weeks, the Treasury Department, senior regulators and members of Congress have stepped up efforts intended to make the largest banks safer. 

The banks have warned that more regulation could undermine their ability to compete and curtail the amount of money they have to lend, but the strong earnings that came out over the last week could undercut their argument. 

Which view is right?

Ms. Moore described how Wall Street wins the long-term war against regulation.

It will surprise no cynic that there is a financial connection between the members of Congress who approve these measures and the industry they are supposed to regulate.... 

It's no surprise, of course – given the well-known influence of Wall Street in writing and influencing the bills that regulate Wall Street. Citigroup lobbyists infamously drafted 70 lines of an 85-line amendment that protected a large acreage of derivatives from regulation.... 

Wall Street is keenly interested in weak regulation and weak regulators.... 

Think of derivatives – these complex securities that render ignorant and bewildered even the CEOs of the finance firms that engineer them – and think about whether a newcomer has a chance against the slick bankers and lobbyists armed with intimidating jargon. 

No matter how strong the personality, knowledge matters, and it takes years to understand the Wall Street fast-talking game....

All of this is part of the process of killing off the one flailing, pathetic attempt at financial reform: the Dodd-Frank Act. 

Dodd-Frank, bloated and vague from the beginning, was never a threat to Wall Street. 

Big banks thought they could wait out the outrage, then start undermining the intent of the law. 

They were right, this time. 

Mr. Eavis counters.

The most pressing concern for banks is a relatively tough new rule that regulators proposed last week that could force banks to build up more capital, the financial buffer they maintain to absorb losses.

Relatively tough might be overstating the new rule.  Many regulators, like the FDIC's Thomas Hoenig, and Economists, like Anat Admati, would like to see rules that require twice the amount the regulators proposed last month.

By setting the proposed level of bank capital where the regulators set it, the banks have already effectively won when it comes to capital regulation.

But the banks did not demonstrate any difficulty in meeting the proposed rules, and the banks now appear to have fewer allies in Washington than at any time since the financial crisis.

This was highlighted on Wednesday when the Treasury secretary, Jacob J. Lew, effectively issued an ultimatum to Wall Street, calling for the swift adoption of rules introduced through the Dodd-Frank financial overhaul law, which Congress passed in 2010.... 

“If we get to the end of this year, and cannot, with an honest, straight face, say that we’ve ended ‘too big to fail,’ we’re going to have to look at other options because the policy of Dodd-Frank and the policy of the administration is to end ‘too big to fail,’ ” Mr. Lew said.... 

In Congress on Thursday, Ben S. Bernanke, the Federal Reserve chairman,... said that if the measures already planned did not remove the risks posed by large banks, “additional steps would be appropriate.”

Still, some analysts remain skeptical that the Fed and the Treasury would really lend their weight to the sort of aggressive measures some lawmakers are contemplating. The recent comments may be an attempt to gain some political benefit from looking tough on the banks. 

And the remarks may be aimed at reducing any momentum that the more draconian pieces of bank legislation are gaining in the Senate.... 

Still, the stronger words from government officials could shift the balance of power away from the banking industry. 

“I sense a sea change in this,” Sheila C. Bair, a former chairwoman of the Federal Deposit Insurance Corporation, a primary bank regulator, said. “It’s not moving with the banks, it’s moving against them.” 

The resurgence in bank profits appears to have been an important factor in persuading regulators to do more....

“The regulators are doing this because they can,” Michael Mayo, a banking analyst at CLSA, said. “And they can at this time of relative stability.”....

Excuse me, but the argument that stability was needed before the banks and the financial system could be reformed is pure and utter garbage.

By late 2008, governments around the globe had put the financial system on life support.  This support was the equivalent of putting a patient on a heart/lung machine so that the patient's heart can be operated on.

While the financial system was on life support it would have been easy to pass and implement the necessary changes to fix the financial system and end Too Big to Fail.

Global policy makers and financial regulators did not do so.  They couldn't even be bother with taking the time to set up the equivalent of a Pecora Commission to discover what caused the crisis in the first place, opacity.

Instead, they rolled out the Dodd-Frank Act which was effectively written by and for the banks by the banks' lobbyists.

Still, Mr. Mayo and others question how healthy the banks are.... 

Mr. Mayo and others are going to continue questioning how healthy the banks are until such time as the banks are required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Without this level of disclosure, there is no telling what risks and losses are hidden on and off the banks' balance sheets.

Still, some banking experts think the banks are bluffing when they say more regulation could hamper lending. 

“They can’t see that it is in their long-term interests to have a credible regulatory process,” Ms. Bair said.

The banks understand that they have already captured the regulatory process.

The only way for the regulators to re-establish any credibility is by giving up their monopoly on all the useful, relevant information about banks and requiring the banks to provide ultra transparency.

Retirement savings: the million-dollar myth explains why consumer demand not rebounding

In her Guardian column, Helaine Olen discusses how in today's low interest rate environment, $1 million in savings is inadequate for retirement.

This is a very important point because it triggers what your humble blogger has called the Retirement Plan Death Spiral.

Individuals saving for retirement or in retirement understand the million-dollar myth and are reducing their current consumption in response so they don't run out of money while they are retired.

This creates the interesting situation where central banks are trying through low interest rates to get individuals to loosen their purse strings and spend while at the same time individuals are cutting back their consumption to offset the loss of income while they are retired on their retirement savings.

As Japan passes the 2+ decade mark and the EU, UK and US pass the half decade mark, it is clear that individuals preference for not running out of cash when they retire overwhelms their urge to spend because central bankers keep rates low.

Is Economics a science or religion? Religion.

In his Bloomberg column, Mark Buchanan asks a terrific question: is economics a science or religion.

Science is based on facts.  Theories are proven or disproven based on their ability to explain all the facts.

Religion, on the other hand, allows you to believe something in the absence of any supporting facts.

A strong case can be made that economics is a religion based on the unwillingness of economic professionals to actually look at the facts.

The unwillingness to consider inconvenient facts isn't surprising as the standard economic analysis starts off by making a series of assumptions.  Assumptions that the economic professionals consider so basic that they don't bear repeating.

Unfortunately, they are assumptions that the facts frequently show to be wrong.

For example, the economics community has championed the call for banks to hold more capital.  The core argument that the economists make is that if banks have a higher level of book capital, this will reduce if not eliminate the amount of or need for a taxpayer bailout.

On the surface, this argument seems perfectly reasonable.  By definition, if the bank has a higher level of book capital, it has a greater capacity to absorb losses before it reduces its book capital to a level where it presumably needs to be bailed out.

However, if we scratch the surface, we find out that this argument has several assumptions embedded within it.  The first of these embedded assumptions being that regulators will require banks to recognize their losses upfront and not protect bank book capital levels out of fear for the safety and soundness of the financial system.

But is there any evidence to support this embedded assumption.  If we look at the US Savings and Loan crisis, the answer is no.  If we look at our current global financial crisis, the answer is no.

There is absolutely no evidence on a global basis that regulators will require banks to recognize the losses hidden on and off their balance sheets.

Instead, as the Bank of England's Andrew Haldane elegantly said it, there is evidence that regulators have an irresistible urge to bailout the banks.

Oops.

Believing that banks holding higher levels of capital won't need to be bailed out or require as large a bailout is simply a religious belief as there are no facts to support it.

Hence, the observation that economics is a religion.

Being a universal banking means participating in all of bankings misdeeds

In his Rolling Stone column, Matt Taibbi catalogs all the fines and legal fees that JP Morgan has paid as a result of its involvement in all types of misbehavior.

It is not surprising the breath or depth of JP Morgan's involvement in all the sordid aspects of banking, it is simply a reflection of the current universal bank business model.

As you read through the list, please note how many of these activities would not have occurred if JP Morgan had been required to report on an ongoing basis its current global asset, liability and off-balance sheet exposure details.

On the other hand, most of these activities would not have been prevented by either the complex regulations spelled out by the Dodd-Frank Act or the need for banks to hold more capital.

It really is true that sunlight is the best disinfectant.

For sheer curiosity's sake, I thought I'd list, in capsule form, some of the capers Chase has been caught up in in recent years: 

They were fined $153 million for the infamous "Magnetar" fund case, another scam in which a bank allowed a hedge fund to create a "born-to-lose" mortgage portfolio to bet against. Very similar to the Abacus case that's at the heart of the ongoing "Fabulous Fab" trial; 

Chase paid $228 million for its role in the egregious municipal bond bid-rigging case we wrote about in Rolling Stone in 2011; 

Chase paid $297 million to the SEC last November for fraud involving mortgage-backed securities; 

Chase paid $75 million in cash and generously agreed to forego $647 million in fines in the Jefferson County, Alabama mess, in which a small-town pol was bribed into green-lighting a series of deadly swap deals; 

In two separate orders this spring, Chase was reprimanded by the OCC and the Fed for money-laundering behaviors similar to the infamous HSBC case, and also for regulatory failures and fraud in the London Whale episode. There was a separate FBI investigation into the London Whale probe in which they allegedly lied to customers and investors about the loss; 

They're under investigation for allegedly failing to disclose Bernie Madoff's trading activities to authorities; 

They were one of 13 banks asked to pay up in this year's $9.3 billion robosigning settlement; 

They were one of four banks last year to settle for a total of $394 million with the OCC for improper mortgage servicing practices; 

They were ordered by the CFTC to pay $20 million last year for improper segregation of customer funds (this was part of the Lehman investigation). The CFTC also fined Chase $600,000 last year for violating position limits in the cotton markets; 

Last year, Chase paid a $45 million settlement to the federal government for improperly racking up fees for veterans in mortgage refinancings. Hey, if you're going to steal from everyone, you can't leave out those veterans overseas! 

In 2010, Chase paid $25 million to the state of Florida for selling unregistered bonds to a state-run municipal money-market fund; 

The bank last year was convicted in Europe along with several other banks for fraudulent sales of derivatives to the city of Milan. A total of about $120 million was seized from Chase and three other banks. 

There have been so many settlements with so many agencies around the world (I'm in a hurry and can't get to Chase's messes in Britain, Japan and elsewhere) that they're almost impossible to count. Some papers are reporting that Chase is being investigated by as many as eight different agencies in the U.S. alone. 

There are some other civil actions left out, too, like the $110 million class-action settlement for improper charging of overdraft fees, or their part in the gigantic $6 billion settlement completed last year involving Visa, MasterCard and other credit card providers for manipulating card service rates. And states like California have only just begun crawling up Chase's backside for its role in the lunatic filing of erroneous credit card collection lawsuits, a scam outed by whistleblower Linda Almonte. 

Chase is turning into the Zelig of the corruption era. In virtually every corruption scandal, the bank is in the background somewhere. The HSBC money-laundering mess? Chase was reprimanded for similar abuses. The Madoff story? They're under investigation there. MF Global? As banker to Jon Corzine's notorious firm, they were part of a $546 million settlement to return money to MF Global's outraged customers. Jefferson County? That was them. And again, you might have heard of Abacus, but Magnetar was just as bad. Not that anyone's counting or anything.

Not on the list yet of course is manipulating Libor.

Bernanke's epitaph: "We had to do something"

In his testimony before the US House of Representatives, Fed Chairman Ben Bernanke provided his own epitaph when he observe "we had to do something" in response to the financial crisis.

Remarkably, since the moment he appeared in panic before Congress to testify on the need for TARP, the self-described Great Depression expert hasn't been unable to come up with a better thought through strategy for ending the financial crisis than "we had to do something".

Actually, as Mark Twain would say, you only have to pay taxes and die.  Everything else you do is optional.

Mr. Bernanke's testimony confirmed that either he a) didn't understand that he was dealing with a bank solvency led financial crisis and the solution is adoption of the Swedish Model or b) he understood that pursuing the Japanese Model would not work and he is trying to defend his legacy.

Bernanke's defensiveness can probably be chalked up to the one thing he could plausibly be afraid of: watching his legacy go the same way as that of former Treasury Secretary Tim Geithner, who left while excoriated for his seeming friendliness toward big banks.

The Geithner Doctrine doesn't "seem" friendly to big banks.  It is designed to be friendly to big banks.

The Geithner Doctrine is don't do anything that will harm the profitability or reputation of big and/or politically connected banks (hat tip Yves Smith).

Bernanke has done more than Geithner did, and took on the economic job left undone by a dysfunctional Congress and a distracted president as well. He became a one-man economic Mr Fix-it, not by choice but by necessity.

Mr. Bernanke told everyone who would listen that he is an expert on the Great Depression.  Hence, he was a logical person to lead the response to our current financial crisis.

The one problem as pointed out by Anna Schwartz, Milton Friedman's co-author and a noted expert on the Great Depression too, is that Mr. Bernanke learned the wrong lessons (see here and here) about the Great Depression.

When faced with a bank solvency led financial crisis, ending the crisis requires having the banks recognize upfront their losses on the excess public and private debt in the financial system.

Until banks recognize the losses, monetary policy is not going to end the crisis.

A fact that should be apparent to all as we approach the six year mark on August 9, 2013 of the beginning of the financial crisis.

Now, facing the end of his term, he is fighting an uphill battle to get the credit for the work laid at his door. 

He wasn't often right – in fact, in forecasting, often wrong – but his Fed did more than any other government or private entity to tackle the country's economic problems. 

That's something.

Your humble blogger would give Mr. Bernanke a significant amount of credit for trying and doing something were it not for one small fact: he didn't use all the tools at the Fed's disposal from the beginning of the financial crisis.

As he testified before Congress, he talked about not being successful at ending the crisis and the need for the Fed to have additional tools if it were to successfully end the crisis.  However, he completely ignores the fact that the Fed has an entire toolkit from its role as lender of last resort and responsibility for bank supervision that he chose not to use.

The Fed could have used both of these tools to end the financial crisis by requiring the banks to recognize their losses upfront on the excess public and private debt in the financial system and protect the real economy and the social contract.

Mr. Bernanke elected not to do so.

He chose to pursue zero interest rate and quantitative easing policies that Walter Bagehot, who invented the modern central bank in the 1870s, said would create economic headwinds that render these policies ineffective.  Turns out Bagehot was right. The economic headwinds existed in the form of the Retirement Plan Death Spiral as both individuals and companies cut back current consumption to fund the shortfall in earnings on retirement assets.

He chose to allow bankers to continue to pay themselves large cash bonuses at the same time the Fed engaged in regulatory forbearance and let the banks transform their non-performing loans through 'extend and pretend' into 'zombie' loans.

He chose to put the real economy into a downward spiral by placing the burden of the excess debt on the real economy where it diverted capital needed for reinvestment, growth and supporting the social contract to debt service.

Update:
In his testimony, Bernanke also observed that

Fed didn't have a way to oversee the shadow banking system.

As regular readers know, the inability to see what is going on in shadow banking should have been a less than subtle hint that there was a need for transparency.