Policy success: Bankers carry on unabashed, unscathed and unashamed

In his Guardian column, Nick Cohen documents how since the beginning of the financial crisis bankers have carried on unabashed, unscathed and unashamed.

This is the direct result of the policy choices made by the global policy makers and financial regulators.  Specifically, they adopted the policy of failure containment and its corollary the Geithner Doctrine.

These policies are best expressed as the Japanese Model for handling a bank solvency led financial crisis under which bank book capital levels and banker bonuses are protected at all costs.  Yves Smith phrases it as: do nothing that will harm the profitability or reputation of big and/or politically connected banks.

To the extent that bankers have in fact carried on unabashed, unscathed and unashamed with their bonuses intact, except for a one year dip, the implementation of these policies has been very successful. So one can easily imagine why policy makers and financial regulators are expecting praise for their actions.

Unfortunately, it is the "protected at all costs" part of the Japanese Model that is proving problematic.

The problem is that by protecting banker bonuses, the burden of the excess debt in the financial system was placed on the real economy.  This burden has overwhelmed the real economy as predicted at the beginning of the financial crisis by your humble blogger.

The burden is in fact so large that despite massive fiscal and monetary stimulus the best that has been achieved is a Japan-style economic malaise (also known as on-going economic slump).

Regular readers know that there is in fact an easy way to end this economic malaise without resorting to central banks practicing new forms of money printing.  Simply adopt the Swedish Model and protect the real economy by using the banks as they were designed.

In a modern financial system with deposit guarantees and access to central bank funding, banks are designed to be able to absorb all the losses on the excess public and private debt in the financial system.  Banks can do this because the deposit guarantee effectively makes the taxpayers the banks' silent equity partner when they have low or negative book capital levels.

Of course, using the banks as they are designed results in bank book capital taking a hit, banker bonuses dropping precipitously and a shrinkage in bank consulting opportunities for current policy makers and financial regulators.

For most, that is a small price to pay to protect the real economy and preserve the social contract.  For policy makers and financial regulators, that is a price that to date they are unwilling to pay.

Conservatives, of all people, ought to have been horrified when the state used taxpayers' money to prop up lame-duck banks. Conservatives, who shout the loudest about scroungers living off the taxpayers, ought to have been the most concerned about sponging financiers.... 

In the 21st, honest conservatives might describe the public purse "as a vast source of corporate welfare for the moneyed classes"....

The right's folly lies in its inability to understand that bankers have not been bashed. Indeed, they have barely been slapped. The courts have jailed no one responsible for the crash. Instead of "a never-ending trial for financial war crimes", there have been no trials whatsoever. No one has sought to compensate the taxpayer by confiscating the bonuses taken in the bubble.... 

This palpable injustice allows me to summarise the coalition's failure to convince the public that "we are all in this together" in a paragraph.

The taxpayer injected about £65bn into RBS and HBOS in share capital. Those shares are currently showing a loss of £20bn. The overall cost to taxpayers is incalculably higher because we must now manage in a zombie economy with a crippled banking system that can't send credit to where it's needed. Yet rather than punish those responsible, the coalition has cut their taxes....

The parliamentary commission on banking standards' report on the collapse of HBOS, just published, has many virtues. Its greatest is that parliamentary privilege – a right to free speech Parliament will not extend to the rest of us – allows the commission to speak without authoritarian lawyers and judges blacking out the detail.

The commission's account of how HBOS's pre-tax losses reached £30bn breaks the bankers' mythology....

It was the same line Gordon Brown endlessly parroted. "A crisis that began in America" destroyed the British banking system. If it had not been for sub-prime loans in California and Bush's refusal to bail out Lehmans all would have been well. 

The banking commission, a strange but surprisingly intelligent group of MPs, peers and – only in England! – His Grace the Archbishop of Canterbury, takes the wishful thinking apart with admirable brutality. 

Lord Stevenson and his colleagues' version of events "represents a model of self-delusion", it says. HBOS suffered from a solvency, not a liquidity, crisis.... 

There is a more glaring fault. The banking commission condemns the FSA but, like the Tories and Labour, it will not recommend breaking up the banks by splitting their high street businesses from the investment business. Banks that were too big to fail and had to be bailed out by taxpayers in 2008 are still too big to fail in 2013. 

Grasp this point, and the complaints about "banker bashing" turn from the ridiculous into something more sinister. 

The banking lobby is so unscathed – so unbashed, unbattered and unbruised – it has the muscle to prevent an urgent and necessary reform and can act as if the crisis never happened.

Michael Pettis: When do we call it a solvency crisis

In a very interesting column, Michael Pettis looks at how there can be a bank solvency crisis going on for years before the banks and regulators are willing to publicly acknowledge that there is a bank solvency crisis.

The example that Mr. Pettis focuses on is the handling of loans to Less Developed Countries (LDC).

Regular readers know that your humble blogger has written about the LDC experience extensively.  The key takeaways were market participants knew that from a book value perspective the banks were insolvent, this did not matter and banks can operate for years while rebuilding low or negative book capital levels.

Why did market participants know the banks had negative book capital levels as a result of the LDC loans?

Because the banks disclosed the size of their exposures to each Less Developed Country.  By simply taking the price that the loans traded for in the market, market participants had a way of approximating the value of these exposures and what the true book capital level was for each bank.

Compare and contrast this with the current situation where banks do not disclose their exposures.

There is no way for market participants to know just how negative the true book capital levels are for each bank.

To take one possibly illuminating example, I started my trading career during the Latin American debt crisis, which officially began in August 1982. 

I joined the market in 1987, when bankers and policymakers were still assuring everyone that the problem Latin America was facing was a liquidity problem.

Nobody believed them nor because of disclosure of the LDC loans did anyone have to believe them.

I have referred to the handling of the LDC loans and the Savings & Loans as Fed Chairman Paul Volcker's regulatory legacy.  He believed in handling solvency issues behind closed doors.

This philosophy ultimately resulted in what I refer to as the policy of financial failure contagion and its corollary, the Geithner Doctrine (via Yves Smith:  do nothing that will harm the profits or reputations of big and/or politically connected banks).

This policy is built on the notion that financial contagion is minimized by hiding the truth behind closed doors.

As discussed above, this policy was absolutely the wrong conclusion to draw from the LDC loan experience.

The conclusions to have drawn are that markets understand that banks can operate with low or negative book capital levels and that markets can handle the truth.

As long as we could keep rolling loans over, they earnestly explained, the problem would eventually resolve itself at little to no relative cost (well, Latin America was struggling with unemployment, capital flight, hyperinflation and political turmoil, but I guess that doesn’t really count). 

It wasn’t until 1990 that the first formal debt forgiveness took place – known as the Mexican Brady Bond restructuring – and before the end of the decade nearly every country except Chile and Colombia had their own Brady bonds. 

Even those two countries, and all the others, had managed to obtain for themselves a significant amount of informal debt forgiveness through debt-equity swaps and debt repurchases at huge discounts from face value (some legal and some not quite legal). 

Why did it take so long for bankers and policymakers to recognize the truth – that this was not just a liquidity problem? 

Actually it didn’t. Most bankers knew by 1985-86 that the region was actually suffering from a generalized solvency problem, and among the big banks JP Morgan had been taking substantial provisions all along. 

No one could formally acknowledge the possibility of insolvency, however, because to have done so would have required that all of banks take much greater provisions than they already had. 

This would have created a problem. Of the top ten banks in America, only JP Morgan would not have been technically insolvent had the banks been forced to mark their LDC loan portfolios to market.

Mr. Pettis is confusing having negative book capital levels with being technically insolvent.

The banks all were technically insolvent as the book value of their liabilities exceeded the market value of their assets (the definition of technical insolvency).

Recognizing their losses would have had two impacts.  First, it would have in fact made the banks reported book capital levels negative.  Second and far more importantly, it would have hammered banker bonuses.  These bonuses couldn't be paid when banks have low or negative book capital levels.

In May 1987 Citibank, after many years of replenishing its capital, was able to announce suddenly and to the great surprise of the entire market that it had decided to take a huge amount of provisions against dodgy sovereign loans.

When it did so, Security Pacific became the poster bank for everyone knowing that its "true" book capital levels were massively negative.

However, everyone knew it would not be closed as it had a franchise that was capable of generating a significant amount of earnings even with a negative book capital level.

By 1989-90 the rest of the big American banks were also able to accept the write-offs without becoming technically insolvent. That is when everybody formally “discovered” that in fact the LDC debt crisis was a lot more than just a liquidity crisis.

No, this is when the regulators and bankers were willing to formally acknowledge the LDC debt crisis was a solvency crisis. It was well known by the market that it was a solvency crisis since 1982.

This is the key point. The American bankers weren’t stupid. They just could not formally acknowledge reality until they had built up sufficient capital through many years of high earnings – thanks in no small part to the help provided by the Fed in the form of distorted yield curves – to recognize the losses without becoming insolvent.

American bankers were not stupid.  They knew that formally acknowledging reality would end their lucrative bonuses.

This is exactly what has happened globally during our current bank solvency led financial crisis.  

And this matters to Europe. There is simply no way European banks, especially in Germany, can acknowledge the possibility of sovereign insolvency until they, too, have built up enough capital to absorb the losses. 

They have, unfortunately, been painfully slow to do so, even with yield-curve help from the ECB, and so I suspect that this is going to remain a “liquidity” problem for many more years. 

While it does, the debt-burdened countries of peripheral Europe are going to suffer a decade of weak growth, high unemployment, and contentious politics, all the while the debt growing faster than the economy.

Mr. Pettis re-iterates a series of points that your humble blogger has previously made.  These points boil down to two simple observations:

1. when bankers are allowed to pay themselves bonuses, banks cannot rebuild their book capital levels quickly; and
2. when banks are not required to recognize their losses on the excess debt in the financial system, the real economy and the borrowers suffer as a result.

Senator Sherrod Brown explains why banks must provide ultra transparency

In a must read speech on Too Big to Fail banks, US Senator Sherrod Brown explains why banks must provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Regular readers know that ultra transparency is the key to dealing with the TBTF banks.

History has taught us that we never see the next threat coming until it is too late.

Actually, some of us saw this threat coming and tried to a) warn policymakers about the threat and b) have transparency restored to all the opaque corners of the financial system so as to moderate the impact on the real economy when the financial crisis occurred.

That’ we passed the Dodd-Frank Act, which contains tools that regulators can use to rein in megabanks’ risk-taking.

The Dodd-Frank Act is based on the flaw notion that the combination of complex rules and regulatory oversight is superior to the combination of transparency and market discipline.

As the financial crisis showed, every area of the financial system that froze relied on the combination of complex rules and regulatory oversight (banks and the unsecured interbank lending market; structured finance).

The areas of the financial system that continued to function throughout the financial crisis without government intervention relied on the combination of transparency and market discipline (stock markets, non-financial corporate bond markets).

The Dodd-Frank Act embodies the policy of financial failure containment and its corollary, the Geithner Doctrine (nothing shall be done that hurts the profitability or reputation of big or politically connected banks).  This policy has been shown not to work and lead to the creation of the Too Big to Fail banks.

The alternative policy is financial failure prevention.  It is the policy on which our financial system is based and is embodied in the FDR Framework.  The FDR Framework combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

Financial failure prevention works because investors are responsible for losses on their investments and thus have an incentive to monitor their investments and exert discipline on management so that losses are avoided.

Unfortunately, many of those rules have stalled, and most will not take effect for years. 

Dodd-Frank was written by the big bank lobbyists for the benefit of the big banks.  By having multiple complex rules, the big banks guaranteed they could both delay the impact of any regulation and water down this impact through lobbying.

Dodd-Frank focuses on improving regulators’ ability to monitor risk and enhancing the actions that regulators can take if they believe that risk has grown too great. 

In the last five years alone we have seen faulty mortgage-related securities; foreclosure fraud; big losses from risky trading; money laundering; and Libor rate rigging. 

One of the myths behind Dodd-Frank is that the regulators did not have the ability to monitor what the banks were doing.

This is untrue.

Bank regulators have access to everything a bank does 24/7/365.  This access was granted in the 1930s when the US government started guaranteeing deposits.

As a practical matter, prior to the beginning of deposit insurance, all banks provided ultra transparency and therefore all market participants had the ability to monitor what the banks were doing. Disclosing their exposure details was a sign of a bank that could stand on its own two feet.

A second myth behind Dodd-Frank is that regulators will actually stop the banks from engaging in activities like foreclosure fraud, proprietary trading, money laundering, Libor rate rigging or selling fraudulent securities.

History shows that regulators will not do this.

History also shows that the only way to get banks to stop engaging in these types of activities is by requiring transparency.

Even in the halls of Congress, it is well known that sunshine is the best disinfectant.

Until Dodd-Frank’s rules take effect, the rest of us are standing idly by as megabanks take more risks that will eventually lead to near failure.

Even when the Dodd-Frank rules do take effect, the TBTF banks will continue to take excessive amounts of risk.

Why?

Because Dodd-Frank protects the opacity of the banks.

Only the regulators can see how risky the banks are and the regulators are not going to disclose the true level of risk to market participants out of fear about the strength and stability of the financial system.

Dodd-Frank is a boon to the TBTF banks as it prevents these or any other banks from being subject to market discipline.  With ultra transparency, the TBTF banks would see the cost of their funding linked to the risk the banks were taking (more risk would be met with a higher cost of funding).

With Dodd-Frank in place, this linkage doesn't happen and as a result, the TBTF's risk taking is subsidized as investors do not require a high enough return to compensate them for the risk being taken by the TBTF.

We shouldn’t tolerate business as usual, monitoring risk until we are once again near the brink of disaster; we should learn from our recent history and correct our mistakes by dealing with the problem head-on....   

How many more scandals will it take before we acknowledge that we can’t rely on regulators to prevent subprime lending, dangerous derivatives, risky proprietary trading, and even fraud and manipulation? 

Wall Street has been allowed to run wild for years. We simply cannot wait any longer for regulators to act. 

These institutions are too big to manage, they are too big to regulate, and they are surely still too big to fail. 

We cannot rely on the financial market to fix itself because the rules of competitive markets and creative destruction do not apply to the Wall Street megabanks.

Please re-read the highlighted text as Senator Brown has nicely summarized why we must bring ultra transparency to the TBTF banks.

It is only with ultra transparency that we can stop Wall Street from being allowed to run wild.  This solution was adopted in the 1930s after the last time Wall Street ran wild.

We know transparency works.

We know that it is opacity that causes instability in the financial system.

Your humble blogger has written numerous posts explaining why ultra transparency ends proprietary trading, ends manipulation of benchmark interest rates like Libor, and ends a reliance on financial regulators to act.

Your humble blogger has written numerous posts explaining why ultra transparency subjects the banks to the one institution that is bigger than they are:  the global financial market.  The global financial market is the only institution capable of exerting discipline on the TBTF banks.

Your humble blogger has written numerous posts explaining why the financial regulators' information monopoly prevents the TBTF from being subjected to the rules of competitive destruction and competition.

If market participants do not have access to all the useful, relevant information in an appropriate, timely manner so they can independently assess this information and make a fully informed investment decision, you cannot expect the banks to be subject to market discipline and the rules of competition.

Megabanks’ shareholders and creditors have no incentive to end “too big to fail” – they get paid out when banks are bailed out.

These shareholders and creditors would have an incentive to end "too big to fail" if the TBTF banks provided ultra transparency.  With ultra transparency, investors would have access to the information they need to make a fully informed investment decision.

With access to all the useful, relevant information in an appropriate, timely manner comes the responsibility for absorbing losses on an investment in the TBTF banks.

Right now, investors are not responsible for absorbing losses on their investment in the TBTF banks as they don't have access to all the useful, relevant information in an appropriate, timely manner.

In addition, investors are protected because financial regulators continue to make representations about the solvency and risk of the TBTF banks.  For example, Dodd-Frank requires the TBTF banks to undergo stress tests and the regulators report the results.

How can you expect an investor to absorb a solvency related loss when the investor does not have the information needed to assess solvency for themselves and the financial regulators are saying the bank is solvent?

This is the ultimate moral hazard.

A moral hazard that FDR was aware of and why he said that governments should never be in the business of offering an opinion on an investment.  Rather, governments were suppose to be responsible for ensuring that all the useful, relevant information was made available to all market participants in an appropriate, timely manner.

Taking the appropriate steps will lead to more mid-sized banks – not a few megabanks – creating competition, increasing lending, and providing incentives for banks to lend the right way....

The appropriate step is to require banks to provide ultra transparency.  The SEC could do this today as it already has the legislative authority.

What is lacking is a Congressional kick in the backside to get the SEC to require banks to provide ultra transparency.

Just about the only people who will not benefit from reining in these megabanks are a few Wall Street executives. 

Congress needs to take action now to prevent future economic collapse and future taxpayer-funded bailouts....  

The simple action is to require banks to provide ultra transparency.

Mr./Madame President, the American public doesn’t want us to wait until another crisis develops. 

They want us to ensure that Wall Street megabanks will never again monopolize our nation’s wealth or gamble away the American dream. 

To those who say that our work is done, I say that we passed seven financial reform laws in the eight years following the Great Depression.

These financial reform laws established the FDR Framework with its philosophy of disclosure and principle of caveat emptor.

We cannot restore Americans’ faith in the financial markets and in representative government until we ensure that taxpayers are not paying for Wall Street’s failures.

And the only way to do that is to return to the FDR Framework and make sure that all banks are subject to ultra transparency.

Geithner Doctrine worked as financial crisis just a 'blip' for bankers

Under the leadership of the US Treasury and Federal Reserve, prior to the current financial crisis global financial regulators abandon the policy of financial failure prevention that the global financial system is based on in favor of the policy of financial failure containment.

The policy of financial failure containment is embodies in its corollary, the Geithner Doctrine.  Under the Geithner Doctrine, as Yves Smith says, no action shall be taken that hurts the profitability or reputation of a bank that is too big to fail or politically connected.

Under the policy of financial failure containment and the Geithner Doctrine, at the beginning of financial crisis most western economies adopted the Japanese Model for handling a bank solvency led financial crisis.

Under the Japanese Model, bank book capital levels and banker bonuses were protected at all costs.

The Financial Times reports that it is mission accomplished when it comes to having protected banker bonuses.

At the same time, the cost to the global economy has been significant and is still rising.

As regular readers know, there is an alternative to the policy of financial failure containment, the Geithner Doctrine and the Japanese Model.  The alternative is the policy of financial failure prevention and the Swedish Model.

Under the Swedish Model, banks are required to recognize upfront the losses on the excess debt in the financial system.  By having the banks recognize these losses, the real economy is protected as it does not have to divert capital needed for reinvestment and growth to debt service.

Of course, under the Swedish Model, banker cash bonuses are limited until such time as the bank has rebuilt its book capital level through retain earnings.

The financial crisis has been “little more than a blip” for London bankers who were being paid more three years after it hit than before and were more likely to be employed than other workers, a report has found. 

The financial sector has proved remarkably resilient with wages in the City rising, while other workers saw pay fall between 2008 and 2011, according to research from the London School of Economics. 

Inequality before the crisis was driven by high pay in the financial sector and does not look set to stop, said Brian Bell of the Centre for Economic Performance, a co-author of the report. 

“The sector which in some sense caused the whole crisis is the sector which seems immune to almost any employment effect,” said Mr Bell. “Traders earning millions are in some sense not replaceable . . . so they have remarkable bargaining power within firms.”

Actually, requiring banks to provide ultra transparency and disclose their current global asset, liability and off-balance sheet exposure details would go a long ways to reducing the leverage of the traders.

Exposing their positions to other market participants would dramatically shrink the profitability of their bets as market participants trading against the bank would limit the upside of the bank's positions and maximize the downside.

With profits lowered and risk raised, banks would reduce the size, if not completely eliminate, the bets taken by traders.  The result is much less compensation for bank traders.

London’s finance workers took home 14.2 per cent more in salary and cash bonuses for 2011 than they did in 2008, compared with a 3.7 per cent rise – a real terms fall – for all other workers.

The top 10 per cent of bankers saw their wages rise by an average 8.6 per cent over the three years, more than the 2.3 per cent rise for the top decile of all workers. 

The report shows that a worker in the finance industry was still 2.2 per cent more likely to be employed than workers in other sectors....

Bottom line:  the policy of financial failure containment, the Geithner Doctrine and the Japanese Model have been wonderful for protecting banker pay.

And what does the real economy and the rest of society have to show for it?

Adoption of austerity policies and a rewriting of the social contract.

Two Labour MPs said the report showed that the financial sector – much of which was bailed out by the state – had not changed its ways. 

Lisa Nandy, MP for Wigan, said it was “business as usual” for parts of the banking industry and the government should “not be letting them get away with it”. 

“It demonstrates that finance executives and investment bankers have learnt nothing from the financial crisis,” she said. 

Paul Flynn, Labour MP for Newport East, said banks were part of a “dependency culture”. “It proves that the wages of sin are handsome,” he said.

Of course, this was the goal of the policy of financial failure containment, the Geithner Doctrine and the Japanese Model for handling a bank solvency led financial crisis.

Matt Taibbi discovers policy of financial failure contagion

In his typical eloquent prose, Matt Taibbi discovers the policy of financial failure containment and its corollary, the Geithner Doctrine (from Yves Smith, nothing should be done the hurts the profits or reputation of a bank that is either too big or politically connected), in his article on Too Big to Jail banks and bankers.

Mr. Taibbi discovered the policy when talking about both money laundering and the Libor interest rate manipulation.

In the same vein, there's only one thing worse than a totally corrupt bank: many corrupt banks. 

If the HSBC deal showed how much dastardly crap the state could tolerate from one bank, Breuer was back a week later to show that the government would go just as easy on banks that team up with other banks to perpetrate even bigger scandals. 

On December 19th, 2012, he announced that the Justice Department was essentially letting Swiss banking giant UBS off the hook for its part in what is likely the biggest financial scam of all time. 

The so-called LIBOR scandal, which is at the heart of the UBS settlement, makes Enron look like a parking violation. 

Many of the world's biggest banks, including Switzerland's UBS, Britain's Barclays and the Royal Bank of Scotland, got together and secretly conspired to manipulate the London Interbank Offered Rate, or LIBOR, which measures the rate at which banks lend to each other. 

Many, if not most, interest rates are pegged to LIBOR. The prices of hundreds of trillions of dollars of financial products are tied to LIBOR, everything from commercial loans to credit cards to mortgages to municipal bonds to swaps and currencies.... 

These are the world's biggest banks getting together every morning to essentially fix the price of money. Low LIBOR rates are an indicator that banks are strong and healthy. 

These banks were faking the results of their daily physicals. In banking terms, they were juicing. 

Two different types of manipulation took place. In 2008, during the heat of the global crash, banks artificially submitted low rates in order to present an image of financial soundness to the markets. But at other times over the course of years, individual traders schemed to move rates up or down in order to profit on individual trades. 

There is nobody anywhere growing weed strong enough to help the human mind grasp the enormity of this crime. It's a conspiracy so massive that the lawyers who are suing the banks are having an extremely difficult time figuring out how to calculate the damage. 

Here's how it works: Every morning, 16 of the world's largest banks submit numbers to a London­based panel indicating what interest rates they're charging other banks to borrow money and what they themselves are charged. The LIBOR panel then takes those 16 different interest rates, tosses out the four highest and the four lowest, and averages out the remaining eight to create that day's LIBOR rates – the basis for interest rates almost everywhere in the world. 

The fact that the LIBOR panel tosses out the four highest and lowest numbers every day is an important detail, because it means that it is difficult to artificially influence the final rate unless multiple banks are conspiring with each other. 

One bank lying its ass off and reporting that banks are lending money to each other basically for free doesn't move the needle much. To really be sure you're creating an artificially low or high interest rate, you need a bunch of banks on board – and it turns out that they were. 

For perhaps as far back as 20 years, banks have been submitting phony numbers, often in concert with other banks. 

They did it for a variety of reasons, but the big one, typically, is that a bank trader is holding some investment tied to LIBOR – bundles of currencies, municipal bonds, mortgages, whatever – that would earn more money if the interest rate was lower. 

So what would happen is, some schmuck trader at Bank X would call the LIBOR submitter and offer him cash, booze, a blow job or just a pat on the back to get him to submit a fake number that day. 

The scandal first blew up last year when the British megabank Barclays admitted to its part in the fixing of LIBOR rates. British regulators released a cache of disgusting e-mails showing traders from many different banks cheerfully monkeying around with your credit-card bills, your mortgage rates, your tax bill, your IRA account, etc., so that they could make out better on some sordid trade they had on that day. 

In one case, a trader from an unnamed bank sent an e-mail to a Barclays trader thanking him for helping to fix interest rates and promising a kickass bottle of bubbly for his efforts: 

"Dude. I owe you big time! Come over one day after work, and I'm opening a bottle of Bollinger." 

UBS was the next bank to confess, and its settlement – $1.5 billion in fines – was much the same, only the e-mails released were, if anything, more disgusting and damning. 

The British Financial Services Authority – equivalent to our SEC – discovered thousands of requests to fudge rates over a period of years involving dozens of different individuals and multiple banks. 

In many cases, the misdeeds were committed more or less openly, in writing, with traders and brokers baldly offering bribes in texts and e-mails with an obvious unconcern for punishment that later, sadly, proved justified. 

"I will fucking do one humongous deal with you," begged one UBS trader who wanted a broker to fix the rate. "I'll pay, you know, $50,000, $100,000." 

British regulators aren't hiding the size of the scandal. 

The UBS settlement demonstrated, without a doubt, that the LIBOR scandal involved more than just one or two banks, and probably involved hundreds of people at many of the world's largest and most prestigious financial institutions – in other words, a truly epic case of anti-competitive collusion that called into question whether the world's biggest banks are innovating a new, not-entirely capitalist form of high finance. 

"We have said there are five further institutions under investigation," says Christopher Hamilton of the FSA. "And there is a large number of individuals as well." (At press time, another bank, the Royal Bank of Scotland, also settled for LIBOR-related offenses.) 

This dovetailed with what Bob Diamond, the former head of Barclays, told the British Parliament the day after he stepped down last year. "There is an industrywide problem coming out now," he said. 

Michael Hausfeld, a famed class-action lawyer who is suing the banks over LIBOR on behalf of cities like Baltimore whose investments lost money when interest rates were lowered, says the public still hasn't grasped the importance of comments like Diamond's. "Diamond essentially said, 'This is an industrywide problem,'" Hausfeld says. "But nobody has defined what this is yet." 

Hausfeld's point – that Diamond's "industrywide problem" might be more than just a few guys messing with rates; it could be a systemic effort to pervert capitalism itself – underscores the extreme miscalculation of both recent no-prosecution deals.

At HSBC, the bank did more than avert its eyes to a few shady transactions. It repeatedly defied government orders as it made a conscious, years-long effort to completely stop discriminating between illegitimate and legitimate money. And when it somehow talked the U.S. government into crafting a settlement over these offenses with the lunatic aim of preserving the bank's license, it succeeded, finally, in making crime mainstream. 

UBS, meanwhile, was a similarly elemental case, in which the offenses­ didn't just violate the letter of the law – they threatened the integrity of the competitive system. If you're going to let hundreds of boozed-up bankers spend every morning sending goofball e-mails to each other, giving each other super­hero nicknames while they rigged the cost of money (spelling-challenged UBS traders dubbed themselves, among other things, "captain caos," the "three muscateers" and "Superman"), you might as well give up on capitalism entirely and just declare the 16 biggest banks in the world the International Bureau of Prices. 

Thus, in the space of just a few weeks, regulators in Britain and America teamed up to declare near-total surrender to both crime and monopoly. This was more than a couple of cases of letting rich guys walk. These were major policy decisions that will reverberate for the next generation. 

Even worse than the actual settlements was the explanation Breuer offered for them. "In the world today of large institutions, where much of the financial world is based on confidence," he said, "a right resolution is to ensure that counter-parties don't flee an institution, that jobs are not lost, that there's not some world economic event that's disproportionate to the resolution we want."

 ie, the policy of financial failure contagion and its corollary, the Geithner Doctrine.

In other words, Breuer is saying the banks have us by the balls, that the social cost of putting their executives in jail might end up being larger than the cost of letting them get away with, well, anything. 

This is bullshit, and exactly the opposite of the truth, but it's what our current government believes. 

From JonBenet to O.J. to Robert Blake, Americans have long understood that the rich get good lawyers and get off, while the poor suck eggs and do time. 

But this is something different. This is the government admitting to being afraid to prosecute the very powerful – something it never did even in the heydays of Al Capone or Pablo Escobar, something it didn't do even with Richard Nixon. And when you admit that some people are too important to prosecute, it's just a few short steps to the obvious corollary – that everybody else is unimportant enough to jail. 

An arrestable class and an unarrestable class. We always suspected it, now it's admitted. So what do we do?

This is why banks must be required to provide ultra transparency.  By making them disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, it subjects the banks to the discipline that national financial and judicial regulators are unwilling to do.

Specifically, it subjects them to market discipline.  Market discipline that has no time for banks that engage in money laundering or manipulating interest rates.

Elizabeth Warren discovers the policy of financial failure containment

In her first public session of the Senate Banking Committee, Senator Elizabeth Warren discovered the policy of financial failure containment and its corollary, the Geithner Doctrine (from Yves Smith, do nothing that hurts the profitability or reputation of a bank that is big and/or politically connected).

Senator Warren discovered the policy of financial failure containment as she tried to understand why no banker has gone to jail as a result of the frauds, including money laundering, that have been going on in the banking sector.

As reported by MarketWatch,

In her first hearing as a U.S. senator Thursday, Elizabeth Warren criticized federal regulators for settling civil cases with Wall Street banks instead of taking them to trial. 

“I want to note that there are district attorneys and U.S. attorneys who are out there everyday squeezing ordinary citizens on sometimes very thin grounds and taking them to trial to ‘make an example,’ as they put it,” she told bank regulators testifying at a Senate Banking Committee hearing. “I am really concerned that too-big-to-fail has become too-big-for-trial.”....

Warren acknowledged that trials are expensive but she insisted that if an agency is unwilling to go to trial it is because they are “too timid” or lack resources. She said that the consequence is that if large financial institutions can break the law and “drag in billions” in profits and settle, then they don’t have much incentive to follow the law. 

“Every time there is a settlement and not a trial, it means we didn’t have the days and days and days of testimony about what those financial institutions were up to,” Warren said....

Regular readers know that the Pecora Commission through its days and days of testimony set the stage for the implementation of the FDR Framework in the 1930s.

It is important to have this testimony as it highlights why transparency is needed in all the opaque corners of the financial system.

Warren asked bank regulators how tough they are and raised the question about when was the last time any regulator took a Wall Street bank to trial. 

“Anybody?” she asked.... 

Thomas Curry, the Comptroller of the Currency, which regulates national banks and thrifts, said the agency has not had to bring big banks to trial “as a practical matter” to achieve the regulator’s supervisory goals.

Please re-read the highlighted text as Mr. Curry is going to describe how the policy of financial failure containment and the Geithner Doctrine operate.

Curry added that the agency has had a fair number of consent orders “so we don’t have to bring people to a trial.” He said the primary motive of the agency’s enforcement actions is to identify the problem and demand a solution to it on an “on-going” basis.

And there we have the policy of financial failure containment.

Regulators find a problem and ask that banks stop.  If the banks don't stop because stopping would hurt their profitability, they ask again.  This cycle can continue indefinitely (see Matt Taibbi and his discussion of how HSBC continued to launder money despite repeated enforcement actions).

Big banks include J.P. Morgan Chase & Co. (NYSE:JPM) , Citigroup Inc. (NYSE:C)   and Goldman Sachs Group Inc. (NYSE:GS)

And here we have a list of the banks that the Geithner Doctrine applies to.

Securities and Exchange Commission Chairman Elisse Walter said that she believes the agency has a “very vigorous enforcement program” and that the commission looks at the distinction between what could be achieved in trial vs. what the SEC could obtain without a trial. 

An SEC spokesman said the agency is “fully prepared” to go to trial every time the commission files a lawsuit. However, he added that there is “no reason” under the SEC’s authority to delay justice and relief for investors when the agency can “get it all without a trial.”...

What could be achieved in a trial is that the bank's actions are made public and as a result of pushback, Congress takes legislative action so that if it happens again it is defined as illegal with strict penalties.

“As you know among our remedies are penalties, but the penalties we can receive are limited and we have asked for additional authority to raise penalties,” Walter said.

It is not the size of the penalty that is the issue, the issue is that Wall Street never has to say it was guilty.

By not having to say it is guilty, Wall Street is able to treat the penalties as a simple cost of doing business and violating the law for gain.

Last month Warren and Rep. Elijah Cummings, a Democrat from Maryland, sent a letter to Federal Reserve Chairman Ben Bernanke and Curry seeking documents about a series of mortgage settlements with large banks over foreclosure abuses stemming from the so-called robo-signing scandal. 

The Fed and the Office of the Comptroller of the Currency reached settlements last month with 13 big banks over the abuses. 

The two lawmakers sought the information to “identify the scope of the harms found” to establish “confidence in the sufficiency and integrity of the settlement”

Under the policy of financial failure containment and its corollary, the Geithner Doctrine, the settlement continued giving the big banks get out of jail free cards and pushing the losses from the banks' activities onto society.

"Unpunished and unreformed, the bankers have got away with it"

In his Guardian column, Phillip Inman notes that little has changed in the banking industry that brought on the financial crisis.

Of course, this was the explicit goal of the policy of financial failure containment and its corollary, the Geithner Doctrine (nothing must be done that will hurt the profit or reputation of any bank that is big and/or well-connected).

Unfortunately, much has changed outside the banking industry.  And all of this change has been for the worse.

The list of changes includes, but is not limited to:

• governments that are pursuing austerity policies and re-writing the social contract so that they can repay the debt taken on as a result of the financial crisis;

• savers that are having to cut back on current consumption so as to offset the loss of earnings on their savings caused by central banks pursuing zero interest rate and quantitative easing policies; and

• companies that are seeing their profitability hurt as competitors who should have gone out of business because they have too much debt are allowed to continue as a result of regulatory forbearance that lets banks turn these bad debts in to 'zombie loans'.

Regular readers know that your humble blogger has been saying since the beginning of the financial crisis that there is an alternative that ends the financial crisis and brings change to the banking industry without the negative changes to society and the real economy.

This alternative is the policy of financial failure prevention.  This policy is the foundation of the global financial system and is summarized by the FDR Framework.  The FDR Framework combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

Under the FDR Framework, investors have an incentive to use the information that is disclosed to independently assess the risk of any investment to make a fully informed investment decision as the investors are responsible for all losses on their investments.

The one exception where investors are not responsible for losses on their investment is bank deposits.

The FDR Administration recognized that it was necessary to have a banking system that functioned at all times to support the real economy.  The solution for achieving this was the combination of deposit insurance and access to central bank funding.

As I have repeatedly said, the combination of deposit insurance and access to central bank funding allows a bank to continue operating even when it has low or negative book capital levels.  A bank can do so because a) the taxpayers effectively become the bank's silent equity partners and b) anyone looking to withdraw their deposits can do so as the central bank provides the necessary liquidity.

Please note that even though depositors are protected this does not mean that investors in bank stock or unsecured debt are suppose to be protected.

In our current financial crisis, an argument could be made that these investors had to be protected as a result of the performance of the financial regulators.

First, the financial regulators did not fulfill their responsibility under the FDR Framework of ensuring that market participants had access to all the useful, relevant information about each bank in an appropriate, timely manner.  As the Bank of England's Andrew Haldane said, banks are 'black boxes'.

As a result, market participants could not independently assess the risk.

Second, the financial regulators made public announcements about both the risk and solvency of the banks both before and during the financial crisis (who can forget Tim Geithner's stress tests).

As a result of the regulators' public announcements, the financial regulators created a moral obligation to bailout the investors who relied on the regulators' risk assessment to make an investment (by the way,  FDR made the point very clearly that the government should not be in the business of offering an investment opinion because it would create this moral obligation to bailout the investors).

Finally by designing both the financial system and the banking system the way the FDR Administration did, a safety valve was created should the global financial system ever encounter a bank solvency led financial crisis.

The banks are the safety valve between the excess debt in the financial system and the real economy.  Because of their unique ability to operate with low or negative book capital levels, banks can absorb all the losses on the excess debt in the financial system and protect the real economy.

Of course, many changes occur in a bank that has low or negative book capital levels.  These changes include that cash compensation is dramatically lower until such time as the bank has retained sufficient earnings to rebuild its book capital levels.

Bottom line:  by pursuing a policy of financial failure containment and its corollary, the Geithner Doctrine, global policy makers didn't use the financial system as it was designed and instead of having the banks protect the real economy from the excess debt in the financial system, the policy makers but the burden of the excess debt in the financial system on the real economy.

Fortunately, policy makers could abandon the policy of financial failure containment and its corollary, the Geithner Doctrine, and use the financial system as it was designed.  This would lift the burden of the excess debt from the real economy and put the burden of the excess debt on the banks and banker bonuses.