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.

Regulators request recovery plans from TBTF banks that shows why regulators fail

Regulators have asked the Too Big to Fail banks to document how they would respond to a series of events that would trigger the need to raise capital without relying on a taxpayer funded bailout.

This request for useless documentation is the classic example of why tens of thousands of pages of complex regulations and regulatory oversight fail to protect the stability of the financial system as well as transparency and market discipline.

The world's top banks must spell out what would trigger capital raising and other steps to survive a crisis without needing taxpayer money, a global regulatory body said on Tuesday. 

The Financial Stability Board (FSB) published final guidance for lenders and supervisors listing "triggers" that would force a bank to consider action to shore up its capital, such as writing down its bonds.... 

Compared with a draft version put out to consultation, the FSB has given banks a bit more leeway, saying that hitting a trigger should not automatically require rescue action. 

The British Bankers' Association (BBA) had told the FSB that the word "trigger" implied the need for an automatic response. 

Instead, banks will have to say in advance what happens once a trigger is hit, such as how the issue will be escalated to a top executive or the bank's board....

Without requiring the banks to take immediate action and recapitalize themselves once a trigger is hit, how exactly does this documentation reduce the chances of a taxpayer funded bailout?

By backing off the need for an automatic response, the global financial regulators demonstrate just how captured they are by the TBTF banks.

"The aim of triggers in recovery planning is to enable firms to maintain or restore financial strength and viability before regulatory authorities see the need to intervene or enforce recovery measures," the FSB's new guidance said. 

Our current financial crisis established that global regulatory authorities won't "see" the need to intervene or enforce recovery measures before bailing out the TBTF banks is the only option.

A recent example of the global regulatory authorities' inability to "see" a problem within a bank was JP Morgan's London Whale trade.  None of the global regulators supervising JP Morgan identified the trade as a problem before it was written up by the press.

Knowing they will never "see" the problem before the global regulatory authorities consider a taxpayer funded bailout necessary, the global regulators have asked the banks to identify for the authorities triggers where the banks can take action that might make the bailout unnecessary.

Given how nicely the bankers have been treated in the current financial crisis (no interruption in bonus payments), what exactly is their incentive to find triggers and take actions after they are breached that would make a taxpayer funded bailout unnecessary?

"Firms should be required to provide supervisors and resolution authorities with an explanation of how the trigger calibrations were determined and an analysis that demonstrates that the triggers would be breached early enough to be effective." 

Triggers can include a credit rating downgrade, a fall in capital ratios, a run on deposits or being asked to post more collateral to back trades.

To summarize the intent of this complex regulation: its a good idea that a top executive or the bank's board should be notified if the bank has a credit rating downgrade, a fall in capital ratios, is asked to post more collateral to back its trades or has a run on its deposits.

FSA's Lord Turner: policymakers and regulators inherited "50 year long, large intellectual policy mistake"

In a must read Telegraph column, the FSA's Lord Turner attempts to place the blame for the failure of global policymakers and financial regulators to prevent and adopt a successful policy response to the global financial crisis on an over-reliance on markets.

Five years later, and as Lord Turner prepares to leave the FSA at the end of the month, few would have thought that the unprecedented events of that fateful year [2008] would still be reverberating throughout the developed economies.

For the record, your humble blogger publicly stated in late 2007 and throughout 2008 that without the right policy response, we would be facing a long-term Japan style economic malaise if not outright contraction.  This prediction has been borne out for the last 5 years as clearly, given the economic problems that we face today, the policymakers and financial regulators have not adopted the right policy response.

But, then again, who am I to be listened to on this matter.  After all, my track record includes predicting the financial crisis and subsequently predicting on this blog with the same degree of accuracy which policies were not going to work.

But hey, who cares about a track record when the entire economics profession continues to offer up recommendations despite having not predicted the financial crisis (my apologies to William White and his group at the BIS who did foresee the financial crisis).

In previous recessions, the route back to growth has been quicker. 

This time, a toxic mix of unsustainable levels of public debt and private-sector deleveraging has left the British economy in a long-term funk....

It is not the de-leveraging that has the economy in a funk.  It is the excess debt in the financial system and the policy responses to this excess debt that are causing the financial funk.

Banks are still in the dock. The City still feels friendless.

Oh please.  The City doesn't care about friends.  It is buying and selling policymakers left and right. Witness the UK government dashing off to Brussels to try to head off a regulation limiting banker bonuses.

Remuneration is still headline news.

As it should be given that the policy response that Lord Turner is so proud of was to protect banker bonuses at all costs.

New regulations on financial services are spewing out of Parliament, Europe and the Basel III process....

The number one lesson of the financial crisis is that the combination of complex rules and regulatory oversight does not prevent a financial crisis.

If it did, we would not have had a financial crisis and the banks would have avoided it.

“If you go back to March 2009, which is the point where all of us had gone through the crisis and were coming up for air and saying 'how do we put things right for the future?’ – if you look at all the forecasts, Bank of England, Treasury, the IFS [the Institute for Fiscal Studies], IMF, World Bank, they all suggested a much faster and more robust recovery of the developed-world economies than has actually occurred,” says Lord Turner. 

“I think that’s because we were slow to realise that once an economy has become overleveraged, once either corporates or households are over-leveraged, they will devote whatever disposable income they have to trying to get their balance sheets down, and therefore the demand for credit is depressed.”

Nice example of complete intellectual capture of a regulator by the bankers.  This is not surprising as Lord Turner is trying to defend the indefensible:  protecting banker bonuses and tearing up the social contract to pay for these bonuses.

The demand for credit is not depressed because of repayment of existing debt.

Demand for credit by business is depressed because of a lack of revenue growth.  Businesses simply don't borrow to expand when they don't see revenue growing.

Demand for credit by individuals is depressed because credit is now only provided to individuals who can actually afford the debt service payments.

And until the economy recovers, the financial crisis will cast its shadow over everything that happens....

The financial crisis will continue to make economic recovery impossible so long as policymakers and regulators refuse to require the banks to recognize upfront their losses on the excess public and private debt in the financial system.

Until this is done, the burden of the excess debt falls on the real economy where it diverts capital needed for growth, reinvestment and social programs to debt service and banker bonuses.

“I think we – as the authorities, central banks, regulators, those involved today – are the inheritors of a 50-year-long, large intellectual and policy mistake,” he says. 

“We allowed the banking system to run with much too high levels of leverage, inadequate levels of capital, and we ignored the development of leverage in the financial system and in the real economy. 

“And not only did we ignore it but we had a pretty overt intellectual philosophy that we could ignore it, because we knew the financial system was just a market like any other and whatever it did was bound to be for the good because that’s what markets are. 

“That was a huge mistake. 

“People just fall into the habit of believing that the system is stable. I think, unfortunately, there was the development of a set of intellectual ideas – efficient market hypothesis and rational expectation hypothesis – which provide an apparently sophisticated intellectual argument for why this whole system is safe.

I appreciate the fact that Lord Turner just said the economics profession is worthless and that economists should not be listened to.  It is hard to argue with this given that economists did not see the financial crisis coming and they were the ones promoting the large intellectual mistake.

However, by looking under the surface just a little, one can redeem the economics profession and discover what the real cause of the financial crisis was:  the assumption of transparency in a financial system that became dominated by opacity.

Adam Smith laid out the necessary condition for the invisible hand of the market to work properly:  buyer and seller must have access to all the useful, relevant information in an appropriate, timely manner so they can independently assess and make a fully informed decision.

Without transparency, the rest of economics professions set of intellectual ideas is not just worthless, but downright dangerous.  As shown by the economic crisis.

However, with transparency, the financial system actually works reasonably closely to how the economics profession thinks it should work.

“[But] I think the response to it, the emergency response in Autumn 2008, was very good and I’m proud to have been a part of that process.”

The response in Autumn 2008 and since could not have been worse from the perspective of the real economy, taxpayers and society.

On the other hand, it has been great for the bankers.

When he walked into the FSA, the organisation was already changing, desperately trying to catch up with a financial-services sector that had left it for dead, a sloth trying to catch up with a tiger. 

It wasn’t until the FSA’s own, reluctantly authored, RBS report of 2011 on the collapse of Fred Goodwin’s bank that Lord Turner fully realised how dysfunctional the system had become. 

“I was very surprised that, despite the fact that we had 3,000 people, the allocation on the direct supervision of RBS was five people,” he says. 

“I was more surprised the more I looked at the liquidity standards that we’d been applying and the capital standards we’d been applying. 

“I was surprised at the supervisory approach. I’d been on the board of a bank, I’d been involved in banks, I’d dealt with banks back in the 1980s and 1990s, and I, throughout that, had accepted the existing capital regime as a given, right? 

To his credit, Lord Turner acknowledges why the combination of complex rules and regulatory oversight doesn't work as a substitute for transparency and market discipline.

With transparency, all the market participants, including banking competitors, look at a bank and not just the limited resources available to a regulator.

“I had never gone back to basics and said, 'why do we allow banks to run with 30, 40, 50 times leverage?’. And neither had anybody else, funnily.”

It is not leverage that kills a bank.  It is the risk that a bank takes that kills a bank.

Talk about bank capital ratios misses the important point that the way to prevent a bank from imploding is by restraining its risk taking.

The way to restrain risk taking as JP Morgan's Jamie Dimon has demonstrated is by letting the market see the bank's current global asset, liability and off-balance sheet exposure details.

Why not? critics may scream – or, more precisely, there were some people warning of calamity, why weren’t they listened to? 

“Well, it’s partly the frog in the boiling water, isn’t it?” Lord Turner says. “It slowly happens over time. It doesn’t happen immediately so the frog doesn’t leap out. The frog dies.” And while the frog is slowly dying, everyone is living it up on the debt-fuelled proceeds.

My question is:  why aren't we listening to the people who warned of a calamity now?

As the Bank of England's Robert Jenkins said, it is amazing that policymakers and regulators turned to and still rely on the bankers who brought about the financial crisis.

In 2009, Lord Turner famously said that a lot of banking activity was “socially useless”, a phrase that became the standard around which many critics of the City gathered. Has his opinion changed? 

“Before the crisis, there was too much trading activity in unnecessarily complicated structured credits going on,” says Lord Turner. “We have seen a very significant shrinkage in some of the trading books of our major banks. 

“And I think, when all that deleveraging of trading books is completed, we will find that the real economy never needed this stuff in the first place, and in a sense we’re better off without it. 

“Secondly, I think if you look at Barclays’ decision to radically reduce the size of its tax structuring activity, that is an end of a socially useless activity.”

All of this would permanently go away if banks were required to provide ultra transparency.

Bankers prefer complex regulations governing their pay over providing transparency

Do you think that bankers would rather provide ultra transparency and disclose their current exposure details or try to get around complex regulations on bank pay?

Trick question.

Of course the bankers prefer complex regulations as they have an ability to influence how the regulations are drawn up so that their earnings are not interrupted.

The Guardian provided an example of the bankers' ability to influence how the regulations are drawn up.  It reports that

The Chancellor, George Osborne, goes to Brussels on Tuesday in what looks like a forlorn attempt to prevent the European Union from imposing swingeing curbs on bankers' bonuses in the City.

The bankers in London say jump and the Chancellor says how high.

It makes for great political theatre, but will have no impact on the bankers.

Regular readers know that the bankers won when it comes to their pay when they got the policymakers to focus on complex regulations to solve the problem.

The focus on complex regulations to solve the problem meant that more effective solutions were not considered.  Specifically, there was no consideration given to making the banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With ultra transparency, banker pay would dramatically decrease.

There are several reasons for this including

• The cost of funds to each bank would reflect the risks it took and therefore banks would lose the subsidy provided by the combination of financial regulators' information monopoly and their statements about the level of risk at each bank.

• Market participants could trade against proprietary bets in such a way as to minimize a bank's upside from taking a proprietary bet while maximizing its downside.

Capping banker bonuses is treating a symptom not cause of excessive risk taking by banks

In yet another display of treating the symptoms and not the cause of the problem, EU financial regulators have tentatively agreed to cap banker bonuses beginning in 2014.

The justification for capping bonuses is to limit risk taking by banks.

At best, capping bonuses is a one off solution for reducing risk taking.  The thinking behind why capping bonuses will work to reduce risk taking going as follows:  if bankers can earn less, then they have an incentive to take less risk and as a result they will take less risk.

Forgive your humble blogger for not having a lot of faith in this reasoning as its success if dependent on the combination of complex rules and regulatory oversight.

Don't kid yourself that the rules on banker pay are not going to be complex.  Bankers receive compensation in many different forms including base salary, short-term cash bonus, long-term cash bonus and stock.

Simply changing one component of banker compensation is not going to change their incentive to take risk.  Bankers will still take risk and privatize the gains while socializing the losses by simply changing where in their compensation they are awarded for taking risk.

Regular readers know that you humble blogger despises any solution that relies on the use of the combination of complex rules and regulatory oversight when there is a better, simpler alternative.

In this case, the better, simpler alternative is to stop focusing on banker pay and instead focus on limiting their ability to take risk.

The way to limit their ability to take risk is to require the banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants can assess the risk each bank is taking and adjust the amount and pricing of their exposure to each bank to reflect its risk.  When risk and cost of funds are linked, banks are subject to market discipline to reduce their risk profile.

For example, banks are subject to market discipline at the proprietary trading level.  When all market participants can see what a trader is gambling on, they can trade against the trader in such a way as to minimize the potential upside of the trade while maximizing the downside.  Market discipline acts to restrain, if not eliminate, proprietary trading.

"For the first time in the history of EU financial market regulation, we will cap bankers' bonuses," said the European Parliament's head negotiator, Austria's Othmar Karas, in a statement. 

"The essence is that from 2014, European banks will have to set aside more money to be more stable and concentrate on their core business, namely financing the real economy, that of small and medium-sized enterprises and jobs." 

The bonus cap was part of a package of financial laws hammered out between EU officials, the European Commission and representatives of the 27 member states in negotiations led by Ireland's Finance Minister Michael Noonan. 

The goal is to prevent bankers from taking excessive risks, which can shake the financial industry. 

"This overhaul of EU banking rules will make sure that banks in the future have enough capital, both in terms of quality and quantity, to withstand shocks," Noonan said. "This will ensure that taxpayers across Europe are protected into the future."

It is far from clear that capping banker bonuses will achieve this outcome.

What is clear is that requiring banks to provide ultra transparency would achieve this outcome.

Gary Gensler: 'Setting' Libor still not clean despite scandal

The BBC reports that Gary Gensler, head of the CFTC, sees a lot that much be done before 'setting' of Libor and other benchmark interest rates like Euribor and Tibor is done so that they cannot be manipulated.

Regular readers know that what must be done is that the banks must be required to provide ultra transparency so that these benchmark interest rates can be based off of actual transaction from a deep, liquid unsecured bank debt market.

Ultra transparency is the key to unfreezing and keeping unfrozen the interbank lending market as it provides the data that banks with deposits to lend need to assess the risk and solvency of banks looking to borrow.

Specifically, under ultra transparency banks disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Ultra transparency is also the key to basing benchmark interest rates off of actual transactions.  These transactions are disclosed by each bank.  Market participants can then determine which transactions to include in the benchmark interest rates.

Without ultra transparency, benchmark interest rates will still be subject to manipulation even if there are complex rules and regulatory oversight of setting process.

The way that the key Libor interest rate is set in the UK is still not clean and free of fraud, according to a top US regulator. 

"We have a lot more work to do," Gary Gensler, chairman of the Commodity Futures Trading Commission, told the BBC in London. 

He suggested that the rate was often "completely made up".....

Speaking of the scandal, Mr Gensler spoke of "pervasive rigging" and said authorities could not guarantee the rate is fraud-free, but refused to criticise the FSA or suggest that setting the rate should be moved to the US....

Please re-read the highlighted text again as Mr. Gensler has just confirmed what your humble blogger has been saying that the only way to guarantee that the benchmark interest rates are free of fraud is through ultra transparency.

Complex rules and regulatory oversight as suggested in the Wheatley Review will simply not guarantee an absence of fraud nor do they provide a reason for the market to trust the resulting benchmark interest rates.

So why did the Wheatley Review not publish your humble blogger's suggestion of ultra transparency and instead championed a combination of complex rules and regulatory oversight that will not work?

Mr Gensler compared the manipulation of rates to an estate agent trying to sell you a house. 

"They are trying to reference the price of the houses in the neighbourhood [when] there have been no transactions in the neighbourhood and furthermore, the agent is not willing to share the data and is often just making it all up," he said.

A problem that ultra transparency alone solves.

The BBA told the BBC it would not comment on Mr Gensler's comments but said: "The BBA has strongly stated the need for greater regulatory oversight of Libor". It added that it was working closely with the government and regulators to change the system. 

A government-commissioned review suggested taking the responsibility away from the BBA and placing it in the hands of an outside authority, such as a commercial body or an industry group.

This is an example of regulatory capture.

The British Banking Authority asked its regulator to do something that the combination of complex rules and regulatory oversight cannot accomplish.  Rather than respond by requiring ultra transparency, the regulatory response was to pursue a path that would allow the banks to continue manipulating the benchmark interest rates as before.

Jens Weidmann: "Monetary policy can only buy more time"

From a Telegraph article, Jens Weidmann, president of Deutsche Bundesbank, observed that it was "wrong and dangerous" to rely on the central banks because "monetary policy can only buy more time".

Please re-read the highlight text as Mr. Weidmann makes the very important point that monetary policy is not the right tool for fixing the problems that led to the financial crisis.

Japan has shown this to be true for the last 2+ decades.  The EU, UK and US have shown this to be true since the beginning of the financial crisis in 2007.

The question is 'using the time that the central banks buy at great expense, what needs to be done to resolve the financial crisis?'

Your humble blogger has laid out a blueprint for what needs to be done.  This includes adopting the Swedish Model and requiring the banks to recognize upfront the losses on all the excess public and private debt in the financial system.  In addition, there is a need for fiscal stimulus.

To date, our policymakers and financial regulators have not followed this blueprint.  Instead, they have managed to substantially increase the cost of the crisis by pursuing policies that have been shown to never end a bank solvency led financial crisis.

The global policymakers' and regulators' actions have worked out well for bankers, it has worked out badly for taxpayers and society.

"Central banks in recent years have been pulled into the role of a crisis manager. Some think that central banks are the only able ones. I consider this thinking wrong and dangerous," Mr Weidmann told Finnish newspaper Helsingin Sanomat in an interview. 

"The program can bring considerable risks to the monetary policy. Those risks now have to be limited and prevented," he was quoted as saying...

"Monetary policy can only buy more time. It is like a painkiller which will not erase the reasons but can cause risks and side effects," he said. 

He also warned against Europe depending on the ECB to supervise banks in the banking union. "That would mask the conflict of interest between the supervision task and monetary policy. I hope that the ECB would only serve as a helper," he said.

A conflict of interest that exists at the Fed and has lead to the Fed identifying with the banks/Wall Street and adopting the policies that the banks/Wall Street prefer (don't take my word for it, Professor Stiglitz made this observation in his recent speech in India).

Volcker and Ludwig: Relying on financial models to set loan-loss reserves is flawed

In their Wall Street Journal editorial, Paul Volcker and Eugene Ludwig praise the accounting board for adopting the idea that banks should reserve for losses expected over the life of the loan, but criticize the implementation because of its heavy reliance on financial models.

Actually, the real problem with the implementation is that it is subject to being gamed by bank management.

So long as banks are not required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details, bank management can play games whether the loan loss reserves are set based on financial models or 'experience and judgement'.

The reason that the reserves can be gamed is that in the absence of ultra transparency market participants have no way of independently assessing how closely the reserves for losses expected over the life of the loan actually tracks with how the bank's loans are actually performing.

For example, what are the reserves set aside for the 'zombie' loans that are the product of regulatory forbearance and the banks engaging in 'extend and pretend'?

The good news: The board recognizes that its existing rules on the Allocation for Loan and Lease Losses may have worsened the 2008 financial crisis. These rules limited bank reserves to those that are already "incurred." This all but ensures that banks' rainy day funds will be too skinny, particularly in periods when credit markets are under stress. 

Worse yet, limiting loss estimates to events that have already occurred makes the allowance for loan and lease losses procyclical—reported earnings are too high in good times and losses hit hardest in bad times.

The FASB's draft proposal to reform these rules incorporates what is known as the "Current Expected Credit Loss Model." It is meant to expand reserves to reflect losses that are expected over the life of the loan, and it is a big improvement over the existing regime. 

But as it stands, the proposal could create risks for the financial system.

Risks that can only be removed by requiring the banks to provide ultra transparency.

In an effort to ensure that everything is "auditable," the proposal ties the loan-loss reserve to what the accounting profession will decide is an acceptable "model." While the proposal is well-intentioned and makes clear that various models can be used, this model-driven approach is dangerous. 

Modeling by its very nature is backward looking. It would push bankers to address only risks that are readily and historically quantifiable. It would discourage them from acting on forward-looking but less well-defined risks, like broader economic trends, that can be just as damaging. 

A focus on modeling also unnecessarily favors large institutions. Banks with smaller loan books and more hands-on experience have some advantages when setting their reserves.... 

While we do believe it is critical to allow bankers to use their expertise in estimating losses for reserve purposes, we also believe it is critical that they disclose to regulators and the public both the methodology they employ to set reserves and the quarter-by-quarter decisions on reserves they actually make. That way investors can follow a bank's net revenue picture before and after loan reserves are set aside, and the methods they use to establish these reserves.

Disclosing how the reserves are set without providing ultra transparency is simply an invitation for the banks to game the system.

BoE's Robert Jenkins: Basel rules not up to the job

Reuters reports that Bank of England Financial Policy Committee member Robert Jenkins said that the Basel capital and liquidity requirements were not up to the job of protecting taxpayers.

Mr. Jenkins is simply confirming that the combination of complex rules and regulatory oversight doesn't work and is a wholly inadequate substitute for the combination of transparency and market discipline.

New global rules forcing banks to hold more capital and cash to shield taxpayers and make the financial system safer won't achieve their aim, a UK regulatory policymaker warned on Thursday. 

Robert Jenkins, a member of the Bank of England's Financial Policy Committee, said the Basel III accord, agreed by world leaders (G20) for implementation over six years from this month, does not go far enough. 

Basel III requires banks to more than triple the amount of capital they hold and have separate cash buffers so taxpayers are less likely to have to rescue them again should another financial crisis occur. 

"Will Basel III do the job? My personal opinion is that it won't," Jenkins told reporters. 

He said his view was echoed by a growing body of academics and others on the FPC such as Andrew Haldane, the Bank's director of financial stability. 

Haldane and other regulators such as Thomas Hoenig, vice-chairman of the U.S. Federal Deposit Insurance Corp, think the Basel accord is too complicated to work.

BoE's Andrew Haldane: have we solved 'TBTF'? No!

In an interesting article on VoxEU, the Bank of England's Andrew Haldane asks the question of have we solved the Too Big to Fail problem and answers with an emphatic 'no'.

Regular readers are not surprised by this answer as the only way to solve the TBTF problem is to require all banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

The reason ultra transparency solves the TBTF problem is it subjects the banks to market discipline.  Specifically, with this information, market participants can truly assess the risk of each bank and adjust their exposure accordingly.  The result is to link each bank's cost of funds to its risk.

Linking risk to each bank's cost of funds will put pressure on the banks to reduce their risk.  Pressure that banks will respond to by becoming smaller and more easily understood.  In short, market discipline will cause the TBTF to break themselves up into smaller units with less risk that the market places a higher value on (please note that this happened with corporate conglomerates).

Today, a bank's cost of funds is not related to its risk because the banks are in Mr. Haldane's words 'black boxes'.

Leading up to the financial crisis, market participants understood the banks were black boxes and turned to the financial regulators for insight into the risk of each bank.  The reason market participants turned to the financial regulators is they have a monopoly on all the useful, relevant information on each bank in an appropriate, timely manner.  Recall that the financial regulators have examiners at the banks 24/7/365.

One lesson from the financial crisis is that even if the examiners correctly assess the risk of each bank, the financial regulators will not communicate this risk to the market.  There are a number of reasons this occurs including political pressure and concerns over the safety and soundness of the financial system.

That financial regulators will not communicate the risk of each bank to the market has been shown time and time again with the bank stress tests.  We had banks throughout Europe collapse shortly after the financial regulators said they were well capitalized.  In the US, we had at least two banks who required a subsequent bailout.

It is interesting to note that besides the banks there is another part of the financial system that is Too Big to Fail:  the financial regulators.  Without ultra transparency, market participants are dependent on the financial regulators.  When the financial regulators fail, and they did because we had a bank solvency led financial crisis, the taxpayers bailed them out.

Not only that, but the policy responses since, like the Dodd-Frank Act, have increased the size and role of the financial regulators and made them even more TBTF.

Like the TBTF banks, financial regulators and their role is also cut down to size by requiring ultra transparency.  With ultra transparency, market participants can see if the financial regulators are doing what they are suppose to do.

Mr. Haldane's answer to the question of have we solved the TBTF problem:

No. 

That is not my pessimistic verdict; it is the market’s. Prior to the crisis, the 29 largest global banks benefitted from just over one notch of uplift from the ratings agencies due to expectations of state support. Today, those same global leviathans benefit from around three notches of implied support. Expectations of state support have risen threefold since the crisis began. 

This translates into a large implicit subsidy to the world’s biggest banks in the form of lower funding costs and higher profits. Prior to the crisis, this amounted to tens of billions of dollars each year. Today, it is hundreds of billions (Haldane 2012). In other words, if the market’s expectations are to be believed, the regulatory response to the crisis has not plugged the 'too-big-to-fail' sink.... 

What is certainly true is that, in the light of the crisis, regulation to quell the too-big-to-fail problem has come thick and (at least in regulatory terms) fast. This reform effort falls into roughly three categories: 

(a) Systemic surcharges: of additional capital levied on the world’s largest banks according to their size and connectivity. ... Last year, the Financial Stability Board (FSB) agreed a sliding scale of systemic surcharges for the world’s largest banks. The highest surcharge was set at 2.5% of capital. 

Yet therein lies the problem. Based on my estimates (Haldane 2012), a charge levied at this rate would leave the majority of the systemic externalities associated with the world’s biggest banks untouched. The reduction in default probabilities associated with lowering leverage by a percentage point or two would not offset the higher system-wide loss-given-default associated with the world’s largest banks. The systemic tax is being levied at rates which are too low...

If the banks were required to provide ultra transparency, there would be no need for complex rules like systemic surcharges.

Market participants could independently assess the banks' default probabilities, also known as risk.  The result would be the banks would be under pressure to reduce their risk as their cost of funds increases and makes much of their risk taking unprofitable.

As your humble blogger has said repeatedly, the combination of complex rules and regulatory oversight is an inferior substitute to transparency and market discipline.

(b) Resolution regimes: In principle, orderly resolution regimes for banks could lower the collateral costs of a big bank defaulting, thereby tackling at source these systemic externalities. .... A key component of these plans is the ability to impose losses on private creditors – so-called 'bail-in' – rather than have those losses borne by taxpayers. 

As with systemic surcharges, the issue here is not to so much the bail-in principle, but its application in practice. Bail-in, whether of big banks, sovereigns or companies, faces an acute time-consistency problem. Policymakers face a trade-off between placing losses on a narrow set of tax-payers today (bail-in) or spreading that risk across a wider set of tax-payers today and tomorrow (bail-out). 

A risk-averse, tax-smoothing government may tend towards the latter path – and historically has almost always done so, most notably in response to the present financial crisis. Next time may of course be different. But the market is sceptical.... 

As I have repeatedly said, the idea of bail-in completely misses how our financial systems were designed based on the FDR Framework.

Regular readers know that the FDR Framework combines the philosophy of disclosure with the principle of caveat emptor (buyer beware).

There is no need to be discussing bail-in or bail-out under the FDR Framework because market participants know under the principle of caveat emptor that they are responsible for losses on their exposures.

By definition under the FDR Framework, all unsecured debt and equity holders are subject to losses if a bank is insolvent and the financial regulators close it.

The reason these debt and equity holders will exert discipline on bank management to limit the risk of the bank is to avoid these losses.

Please note, the FDR Framework only holds true so long as the governments ensure that market participants have access to all the useful, relevant information in an appropriate, timely manner.  Given the financial regulators information monopoly, this is not currently true for banks.  Hence, the discussion of bail-in versus bail-out.  A discussion that is rendered moot by requiring banks to provide ultra transparency.

(c) Structural reform: One way of lessening that dilemma may be to act on the scale and structure of banking directly. Several recent regulatory reform initiatives have sought to do just that, notably the “Volcker rule” in the US, the 'Vickers proposals' in the UK and, most recently, the 'Liikanen plans' in Europe. While different in detail, each of these proposals shares a common objective: a degree of separation or segregation between investment and commercial banking activities. 

In principle, these ringfencing initiatives confer both ex-post (improved resolution) and ex-ante (improved risk management) benefits. Because they act on banking structure, they have a greater chance of proving time-consistent. While this is a clear step forward, those benefits are only as credible as the ringfence itself. The issue raised by some is whether, in practice, the ring-fence could prove permeable. Without care, today’s ring-fence could become tomorrow’s string vest. 

Again, ultra transparency addresses the issue of structural reform.  As I have previously said, regulation has two components:  the rule and the enforcement.

The Volcker Rule says that banks should not take proprietary bets.  By making the banks provide ultra transparency, market participants can assess the bank's positions and see if they are in compliance.

Oh, by the way, ultra transparency will also improves the banks' risk management.  Recall that market discipline has a bias towards banks taking less risk.

If each of these initiatives is necessary but none is individually or collectively sufficient to tackle too-big-to-fail, what is to be done? 

One solution might lie in strengthening these proposals. For example, re-sizing the capital surcharge, perhaps in line with quantitative estimates of the 'optimal' capital ratio (Miles et al (2012), Admati et al (2011)), would be one option for bearing down further on systemic externalities. 

Another more radical option, mooted recently by a number of commentators and policymakers, would be to place size limits on banks, either in relation to the financial system as a whole or, more coherently, relative to GDP (Hoenig (2012), Tarullo (2012)). 

Proposals of this type typically face two sets of criticism. 

The first, practical issue is how to calibrate an appropriate limit. ....

The second, empirical issue is whether size limits would erode the economies of scale and scope which might otherwise be associated with big banks....

What is to be done is to require the banks to provide ultra transparency.

Contrary to what the banking industry lobbyists say, there is no limit on transparency as there are a number of market participants who are capable of assessing the exposure details from the global banks (not the least of which are the competitor global banks).

Too-big-to-fail is far from gone. It is even more important it is not forgotten.

And it won't be gone until the banks are required to provide ultra transparency so that they can be subject to market discipline and forced to reign in their risks.

Why Wall Street thanks Tim Geithner for his service

In a must read Guardian column, Dean Baker credits Treasury Secretary Tim Geithner with the choice to pursue policies that were good only for banks and banker bonuses at the expense of the real economy, society and the social contract.

Regular readers know what Mr. Geithner pursued was 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.

This results in a series of polices like bailouts, zero interest rates, quantitative easing, austerity and failure to enforce securities laws that are bad for the real economy and society.

For example, the burden of servicing the excess debt is place on the real economy.  This diverts capital that is needed for reinvestment and growth to debt service.  This diversion triggers a negative self-reinforcing spiral for the real economy:  less capital leads to less demand which leads to even less capital...

As the real economy shrinks, so too does tax revenue.  As tax revenue drops, the call for austerity policies and changing the social contract to limit money spent on social programs which have acted as automatic stabilizers to the real economy grow.  As these policies are implemented and spending on social programs declines, this further harms the real economy and society.

From the perspective of the real economy, society and the social contract, the Japanese Model has never worked positively.  But this is not surprising as the goal of the Japanese Model is not positive for the real economy, society and the social contract.  The goal of the Japanese Model is to protect the banks and the bankers' ability to loot society.

Regular readers also know that there is an alternative to the Japanese Model that Tim Geithner had to lead a rejection of every day.  The alternative is the Swedish Model.  Under the Swedish Model, banks are required to recognize today all the losses on the excess debt in the financial system.

This protects the real economy as capital is not diverted to service the excess debt.  This protects society and the social contract as tax revenue can be used not to bailout the banks and pay for the debt incurred in bailing out the banks, but instead can be used to maintain and expand the social programs.

Finally, regular readers know that the global banking system is designed to support implementation of the Swedish Model.  Because of the combination of deposit insurance and access to central bank funding, banks can operate with low or negative book capital levels.

Deposit insurance effectively makes the taxpayers the banks' silent equity partner while they have low or negative book capital levels.  So the banks have time to rebuild their book capital levels after recognizing the losses.

Rebuilding the capital levels requires the banks to retain 100% of pre-banker bonus earnings until such time as the banks have achieved the book capital levels required by both financial regulators and market participants.

To keep the banks from gambling on redemption as they rebuild their book capital levels, the banks have to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  With this information, market participants can assess the risk each bank is taking and adjust both the amount and price of their exposure so that the bank's cost of funds reflects this risk.

Treasury Secretary Timothy Geithner's departure from the Obama administration invites comparisons with Klemens von Metternich. Metternich was the foreign minister of the Austrian empire who engineered the restoration of the old order and the suppression of democracy across Europe after the defeat of Napoleon. 

This was an impressive diplomatic feat – given the widespread popular contempt for Europe's monarchical regimes. In the same vein, protecting Wall Street from the financial and economic havoc they brought upon themselves and the country was an enormous accomplishment. 

During his tenure as head of the New York Fed and then as treasury secretary, most, if not all, of the major Wall Street banks would have collapsed if the government had not intervened to save them.... Had it not been for Geithner and his sidekicks, therefore, we would have been permanently rid of an incredibly bloated financial sector that haunts the economy like a horrible albatross. 

Along with the salvation of the Wall Street banks, Geithner also managed to restore their agenda of deficit reduction. 

Even though the economy is still down more than 9 million jobs from its full employment level, none of the important people in Washington is talking about measures that would hasten job creation. 

Instead, the focus is exclusively on deficit reduction, a process that is already slowing growth and putting even more people out of work. While lives are being ruined today by the weak economy, Geithner helped create a policy agenda where the focus of debate is the budget projections for 2022.... 

Nonetheless, the path laid out by Geithner's team virtually ensures that these distant budget targets will serve as a distraction from doing anything to help the economy now. 

There are two important points that should be quashed quickly in order to destroy any possible defense of Timothy Geithner. 

It is often asserted that we were lucky to escape a second Great Depression. This is nonsense. 

The first Great Depression was not simply the result of bad decisions made in the initial financial crisis. It was the result of ten years of failed policy. There is zero, nothing, nada that would have prevented the sort of massive stimulus that was eventually provided by the second world war from occurring in 1931, instead of 1941. We know how to recover from a financial collapse: the issue of whether we do so simply boils down to political will.... 

Correct, implementing the Swedish Model requires political will.  At the start of the current financial crisis, Iceland found the political will because it simply did not have the resources to adopt the Swedish Model.

Interestingly, even an imperfect adoption of the Swedish Model has left Iceland's economy far ahead of the EU, UK and US that adopted the Japanese Model in recovering from the bank solvency led financial crisis.

Finally, the claim that we made money on the bailouts is equally absurd. We lent money at interest rates that were far below what the market would have demanded.

Walter Bagehot, the father of modern central banking, said that the central banks should lend freely against good collateral at penalty rates of interest.  Clearly, the interest rates charged were not punitive.

Most of this money, plus interest, was paid back. But claiming that we thus made a profit would be like saying the government could make a profit by issuing 30-year mortgages at 1% interest. Sure, most of the loans would be repaid, with interest, but everyone would understand that this was an enormous subsidy to homeowners. 

The claim we made money on the bailouts is actually a distraction from the real issue that modern banks do not need to be bailed out in the first place.  Deposit insurance means the taxpayers are already the banks' silent equity partner.  A bailout is only in the interest of the bankers protecting their bonuses and continuing to loot society.

In short, the Geithner agenda was to allow the Wall Street banks to feed at the public trough until they were returned to their prior strength. Like Metternich, he largely succeeded. 

Please re-read the highlighted text as Mr. Baker nicely summarizes the Geithner agenda although he misses the crucial fact that letting Wall Street banks feed at the public trough until they return to their prior strength is effectively letting the bankers feed at the public trough through their bonuses.

Of course, democracy did eventually triumph in Europe. Let's hope that it doesn't take quite as long for that to happen here. 

Matt Taibbi: US government lied about health of large US banks

In a Rolling Stones article, Matt Taibbi discusses how the US government adopted the policy of lying about the health of the large US banks.  In doing so, he makes the case for why the only way to restore trust in the banks and end the moral hazard of Too Big to Fail is if the banks provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Regular readers are familiar with Yves Smith's Geithner Doctrine:

Nothing must be done that will hurt the profits or reputation of any bank that is pretty big or well-connected.

Mr. Taibbi sums up the result of implementing this doctrine:

It built a banking system that discriminates against community banks, makes Too Big to Fail banks even Too Bigger to Failier, increases risk, discourages sound business lending and punishes savings by making it even easier and more profitable to chase high-yield investments than to compete for small depositors. 

The bailout has also made lying on behalf of our biggest and most corrupt banks the official policy of the United States government. 

And if any one of those banks fails, it will cause another financial crisis, meaning we're essentially wedded to that policy for the rest of eternity – or at least until the markets call our bluff, which could happen any minute now.

In reaching this conclusion, Mr. Taibbi looks at how the US government handled the issue of reporting the true condition of the largest US banks since the beginning of the financial crisis.

In doing this, Mr. Taibbi shows why the financial regulators' information monopoly must be ended and banks must be required to provide ultra transparency.

The main reason banks didn't lend out bailout funds is actually pretty simple: Many of them needed the money just to survive.

Please recall that starting on August 9, 2007, the question asked globally was which banks are solvent and which banks are not.  This question could not be answered because the banks' current disclosure practices leave them, in the words of the Bank of England's Andrew Haldane, resembling 'black boxes'.

Which leads to another of the bailout's broken promises – that taxpayer money would only be handed out to "viable" banks.

Walter Bagehot, the father of modern central banking, said that the central bank's role as lender of last resort was to lend at high interest rates against good collateral to solvent banks.

What was obvious to all from the beginning of the financial crisis is that the global central banks were lending at low interest rates against even the most worthless collateral whether the banks were solvent or not for fear of financial contagion.

Regular readers know that the only way to end financial contagion is to require the banks to provide ultra transparency.  With this information, market participants can assess the risk of each bank and adjust their exposure to the banks to what they can afford to lose.  As a result, the collapse of one bank does not bring down the entire financial system.

Please re-read the preceding as this is the necessary condition for ending our current financial crisis.

Your humble blogger is not alone in calling for this.  See the article "What's inside America's Banks' based on this blog written by Frank Portnoy and Jesse Eisinger as well as Nassim Taleb's call for an anti-fragile system.

Soon after TARP passed, Paulson and other officials announced the guidelines for their unilaterally changed bailout plan. Congress had approved $700 billion to buy up toxic mortgages, but $250 billion of the money was now shifted to direct capital injections for banks.... 

This new let's-just-fork-over-cash portion of the bailout was called the Capital Purchase Program. Under the CPP, nine of America's largest banks – including Citi, Wells Fargo, Goldman, Morgan Stanley, Bank of America, State Street and Bank of New York Mellon – received $125 billion, or half of the funds being doled out. Since those nine firms accounted for 75 percent of all assets held in America's banks – $11 trillion – it made sense they would get the lion's share of the money. 

But in announcing the CPP, Paulson and Co. promised that they would only be stuffing cash into "healthy and viable" banks. This, at the core, was the entire justification for the bailout: That the huge infusion of taxpayer cash would not be used to rescue individual banks, but to kick-start the economy as a whole by helping healthy banks start lending again. 

This announcement marked the beginning of the legend that certain Wall Street banks only took the bailout money because they were forced to – they didn't need all those billions, you understand, they just did it for the good of the country. 

"We did not, at that point, need TARP," Chase chief Jamie Dimon later claimed, insisting that he only took the money "because we were asked to by the secretary of Treasury." Goldman chief Lloyd Blankfein similarly claimed that his bank never needed the money, and that he wouldn't have taken it if he'd known it was "this pregnant with potential for backlash." 

A joint statement by Paulson, Bernanke and FDIC chief Sheila Bair praised the nine leading banks as "healthy institutions" that were taking the cash only to "enhance the overall performance of the U.S. economy." 

But right after the bailouts began, soon-to-be Treasury Secretary Tim Geithner admitted to Barofsky, the inspector general, that he and his cohorts had picked the first nine bailout recipients because of their size, without bothering to assess their health and viability.

Paulson, meanwhile, later admitted that he had serious concerns about at least one of the nine firms he had publicly pronounced healthy. 

And in November 2009, Bernanke gave a closed-door interview to the Financial Crisis Inquiry Commission, the body charged with investigating the causes of the economic meltdown, in which he admitted that 12 of the 13 most prominent financial companies in America were on the brink of failure during the time of the initial bailouts.

On the inside, at least, almost everyone connected with the bailout knew that the top banks were in deep trouble. "It became obvious pretty much as soon as I took the job that these companies weren't really healthy and viable," says Barofsky, who stepped down as TARP inspector in 2011.

Please re-read the highlighted text as it confirms what your humble blogger has been saying since the beginning of the financial crisis that the financial regulators chose not to communicate to the market their true assessment of the solvency of the banks.

This is very important as the financial regulators have a monopoly on the information that market participants need to assess the solvency of each bank.  If the financial regulators misrepresent the banks' financial condition, there is no way for market participants to properly adjust both the price and amount of capital they provide to the banks.

More importantly, once the government started lying about the condition of the banks, everyone knew it.

How?

Please notice that the interbank lending market froze at the beginning of the financial crisis because banks with deposits to lend could not determine which banks were solvent and could repay the loans and which were not.

The interbank lending market is still frozen.

This is the banks' way of telling the market that they are still concerned with the solvency of other banks because they know that they too are hiding losses on and off their balance sheets.

This early episode would prove to be a crucial moment in the history of the bailout. It set the precedent of the government allowing unhealthy banks to not only call themselves healthy, but to get the government to endorse their claims. 

Projecting an image of soundness was, to the government, more important than disclosing the truth. Officials like Geithner and Paulson seemed to genuinely believe that the market's fears about corruption in the banking system was a bigger problem than the corruption itself. 

Time and again, they justified TARP as a move needed to "bolster confidence" in the system – and a key to that effort was keeping the banks' insolvency a secret. In doing so, they created a bizarre new two-tiered financial market, divided between those who knew the truth about how bad things were and those who did not....

Please re-read the highlighted text because not only are the banks fighting to maintain opacity so they can continue to gamble and engage in bad behavior like manipulating Libor, but the government has committed itself to maintaining opacity.

As you can imagine, this effectively undermines the US financial system as it is based on the FDR Framework and its combination of the philosophy of disclosure and the principle of caveat emptor (buyer beware).

The sweeping impact of these crucial decisions has never been fully appreciated. 

In the years preceding the bailouts, banks like Citi had been perpetuating a kind of fraud upon the public by pretending to be far healthier than they really were. In some cases, the fraud was outright, as in the case of Lehman Brothers, which was using an arcane accounting trick to book tens of billions of loans as revenues each quarter, making it look like it had more cash than it really did. 

In other cases, the fraud was more indirect, as in the case of Citi, which in 2007 paid out the third-highest dividend in America – $10.7 billion – despite the fact that it had lost $9.8 billion in the fourth quarter of that year alone. 

The whole financial sector, in fact, had taken on Ponzi-like characteristics, as many banks were hugely dependent on a continual influx of new money from things like sales of subprime mortgages to cover up massive future liabilities from toxic investments that, sooner or later, were going to come to the surface. 

Now, instead of using the bailouts as a clear-the-air moment, the government decided to double down on such fraud, awarding healthy ratings to these failing banks and even twisting its numerical audits and assessments to fit the cooked-up narrative. 

A major component of the original TARP bailout was a promise to ensure "full and accurate accounting" by conducting regular­ "stress tests" of the bailout recipients. 

When Geithner announced his stress-test plan in February 2009, a reporter instantly blasted him with an obvious and damning question: Doesn't the fact that you have to conduct these tests prove that bank regulators, who should already know plenty about banks' solvency, actually have no idea who is solvent and who isn't?

The government did wind up conducting regular stress tests of all the major bailout recipients, but the methodology proved to be such an obvious joke that it was even lampooned on Saturday Night Live. (In the skit, Geithner abandons a planned numerical score system because it would unfairly penalize bankers who were "not good at banking.")  

In 2009, just after the first round of tests was released, it came out that the Fed had allowed banks to literally rejigger the numbers to make their bottom lines look better. When the Fed found Bank of America had a $50 billion capital hole, for instance, the bank persuaded examiners to cut that number by more than $15 billion because of what it said were "errors made by examiners in the analysis." Citigroup got its number slashed from $35 billion to $5.5 billion when the bank pleaded with the Fed to give it credit for "pending transactions." 

Such meaningless parodies of oversight continue to this day. Earlier this year, Regions Financial Corp. – a company that had failed to pay back $3.5 billion in TARP loans – passed its stress test. A subsequent analysis by Bloomberg View found that Regions was effectively $525 million in the red. Nonetheless, the bank's CEO proclaimed that the stress test "demonstrates the strength of our company." Shortly after the test was concluded, the bank issued $900 million in stock and said it planned on using the cash to pay back some of the money it had borrowed under TARP. 

This episode underscores a key feature of the bailout: the government's decision to use lies as a form of monetary aid. State hands over taxpayer money to functionally insolvent bank; state gives regulatory thumbs up to said bank; bank uses that thumbs up to sell stock; bank pays cash back to state. What's critical here is not that investors actually buy the Fed's bullshit accounting – all they have to do is believe the government will backstop Regions either way, healthy or not. "Clearly, the Fed wanted it to attract new investors," observed Bloomberg, "and those who put fresh capital into Regions this week believe the government won't let it die." 

Through behavior like this, the government has turned the entire financial system into a kind of vast confidence game – a Ponzi-like scam in which the value of just about everything in the system is inflated because of the widespread belief that the government will step in to prevent losses.... 

They're building an economy based not on real accounting and real numbers, but on belief. 

The time has come to stop doubling down and build an economy based on real accounting and real numbers.

Price transparency brought to opaque swaps markets

Financial regulators, particularly the CFTC, are calling bringing price transparency to the opaque swaps markets a pivotal moment in the regulation of Wall Street.

Regular readers know that that there are two types of transparency:  valuation and price.  It is valuation transparency that is the important form of transparency.

As everyone knows, the investment cycle has three steps:  value the security; solicit a price for the security from Wall Street; and then make an investment management decision to buy, hold or sell the security.

Without valuation transparency, it is impossible to value the security and go through the investment process.

Without valuation transparency, the act of buying or selling the security is simply blindly betting.

So the question is, is there any reason to get excited about bringing price transparency to the opaque swaps market?

No.  In fact, price transparency makes the problems in this market worse.  Price transparency by itself suggests that the casino is somehow not just for gambling.

As discussed by Ben Protess in a NY Times Dealbook article,

After spending two years and millions of dollars to temper a regulatory crackdown, the world's biggest banks are now resigned to a wave of new oversight.

This assumes that the banks did not get exactly what they wanted.  Price transparency has not been the problem in the swaps market as buyers and sellers could always call multiple banks for quotes.

By New Year's Eve, 65 banks had registered their derivatives business with regulators and turned over heaps of real-time trading data to outside warehouses, fulfilling a central rule of the Obama administration's financial regulatory overhaul. 

Late on Wednesday, a warehouse also posted an early batch of data online, shining a rare spotlight on an opaque business that blew up in the 2008 financial crisis. 

The changes, regulators say, signal a pivotal moment in the fight over Wall Street regulation. 

Until now, regulators had little authority and little information to scrutinize the minutiae of derivatives trading, a vast market that totals more than $600 trillion.

Actually, the regulators have always had access to reams of information.  They simply had to ask for it from the banks as the regulators are entitled to know each bank's exposures.

"They are an historic change for the markets that will benefit the public and the economy at large," Gary Gensler, chairman of the Commodity Futures Trading Commission, the architect behind the derivatives overhaul, said in a statement....

Why?  What data will the public get that is useful for valuing these securities?

The new oversight is a major component of the Dodd-Frank Act, the Wall Street regulatory overhaul passed after the financial crisis. The law took particular aim at derivatives, which proved pernicious in the crisis. 

Banks had bought billions of dollars in derivatives as dubious insurance on mortgage-backed investments. 

When the investments soured, the American International Group lacked the capital to honor agreements with the banks, prompting a $180 billion government bailout of the giant insurance company.

So the important data is what each firm's exposure is.  After all, who cares what price the derivatives that blew up AIG were purchased/sold at.  What was relevant was AIG's exposure to losses if the sub-prime mortgage market blew up.

Does the data being disclosed to the market allow market participants to know what is currently on JP Morgan's or Goldman Sach's balance sheet and who their counter-parties are?

Hoping to prevent such calamities, lawmakers spelled out a plan in Dodd-Frank to require derivatives dealers to register with Mr. Gensler's agency. Under the law, the banks and hedge funds must also open up their trading books to regulators and the broader public.

So all market participants are going to be able to see each bank and hedge fund's trading book?

The oversight, carried out through new rules written at Mr. Gensler's agency, developed in fits and starts. At times, a plan that was supposed to kick in during 2011 seemed like it might never take effect. 

The delay was in part a result of an aggressive lobbying campaign on Wall Street, which dispatched lawyers and lobbyists to temper the overhaul. In turn, Mr. Gensler's agency conceded modest changes and postponed the oversight for several months.... 

Wall Street has been aggressively lobbying since before the Dodd-Frank Act was passed.  With the exception of the Volcker Rule and the Consumer Financial Protection Bureau, the act appears to have been written by the industry for the industry.

The banks must also turn over in real-time the data from their trading book.

 And what data from their trading book must be disclosed?

The disclosures, posted on the Web site of the Depository Trust and Clearing Corporation, a data warehouse, include the volume, time and price of each derivatives trade....

Data that is focused on price transparency and not valuation transparency.  Remember, part of valuation transparency is knowing what the exposure to losses is for the counter-party.

The spreadsheet, regulators say, presents the public with its first window into the swaps market. While the public is blocked from viewing the identity of the trader, regulators have access to that information.

This is a classic example of Wall Street protecting the opacity that it profits from.

The data that is being made available relates to price only.  This is of limited benefit as the last price could represent the price that the biggest fool was willing to buy or sell at.

To a buyer or seller who is willing to pick up the phone and call several firms, they can get all the price quotes they want.  Price disclosure simply saves them the hassle of making several calls.

The only market participants who have access to the identity of the trader, which is data needed for valuation, are the regulators.

Wall Street has nicely protected opacity in the swaps market by making it impossible for the market participants who need the valuation data to have access to the data they need by giving the regulators an information monopoly.  A monopoly that the regulators will be very reluctant to give up.

"Real-time reporting brings transparency to the formerly opaque swaps market," Mr. Gensler noted.

As currently being implemented, it only brings price transparency.  The regulators with their information monopoly are helping to keep the swaps market opaque from the perspective of valuation transparency.

Bankia's mom and pop investors turn to courts to get money back

Reuters reports that mom and pop Spanish investors have turned to the courts to get their money back based on Bankia having mis-represented an investment in its preferred stock as being covered by the Spanish deposit guarantee fund.

Retail investors have had to do this as the Spanish government has once again failed to protect them.

Spanish savers and pensioners who have seen their money wiped out by investing in state-rescued lender Bankia are likely to seek redress in court rather than wait for any official inquiry, which looks increasingly unlikely. 

About 350,000 stockholders will share the pain of the bank's European bailout, many of them bank clients who were sold the shares through an aggressive marketing campaign for its stock market flotation in 2011.... 

"Going to the courts and seeing if a judge can bring us justice is the only path left to us," said Maricarmen Olivares, whose parents lost 600,000 euros (490,509 pounds) they made from selling her father's car workshop by investing in Bankia preference shares. 

Neither of the two main political parties want to push for a full investigation into Bankia's demise, which could draw attention to their own role in a debacle that has driven Spain to the brink of an international rescue, commentators say. 

"Investigations work when a political party has something to gain over another. In this case, no-one has anything to gain," said Juan Carlos Rodriguez, of consultancy Analistas Socio Politicos. 

"I don't see the big parties investigating this because if there have been errors committed, they have been committed by both sides."

Please re-read the highlighted text again as it is not just the political parties in Spain that committed errors when it came to the nation's banking system, but also applies to the political parties in the other countries too.

For example, the Nyberg Report on the Irish Financial Crisis documented this occurred in Ireland.

The fact is that the rest of the countries in the Eurozone, the UK and the US were not immune to this problem and none of them has set up an investigation of the role of the political parties in the financial crisis.

The Socialist Party was in power when Bankia was formed in 2010 from an ill-matched combination of seven regional savings banks, a union that concentrated an unsustainable exposure to Spain's collapsed property sector. 

Immense political pressure from the then government forced Bankia executives to push ahead with an initial public offering in July 2011 as Spain sought to bring private capital into its banking system and avoid a European bailout. 

Then chairman, Rodrigo Rato, a former chief of the International Monetary Fund, had strong links to the centre-right Popular Party (PP) and was finance minister in a previous PP administration. 

A small political party, UPyD, forced the High Court in July to open an investigation into whether Rato, ousted when the bank was nationalised in May, and 32 other former board members are guilty of fraud, price-fixing or falsifying accounts....

 Oh what a tangled web we weave, when first we practice to deceive.

The probe centres around Bankia's stock market listing, the formation of the lender from the seven savings banks and the gaping capital shortfall revealed at the bank after the state takeover in May.... 

Bankia, alongside other Spanish banks, sold billions of euros of preference shares and subordinated debt to high street clients, many of whom say they were tricked into parting with their savings and are seeking compensation. 

The investigating magistrate is not including the mis-selling of preference shares - hybrid instruments that fall between a share and a bond - in the probe. 

Holders of preference shares at Bankia will incur losses of up to 46 percent as part of the European bailout, receiving shares rather than cash in exchange. 

"We won't see our money again, that's for sure. They'll give us shares, but shares with no value or credibility in a nationalised bank," said Olivares, who said she had heard nothing from the bank as to how much their losses would be. 

The losses each investor will have to take has yet to be decided, a Bankia spokesman said, adding that hybrid debt holders at all rescued banks had to take losses, not just at Bankia. 

A source close to the court investigation said there would certainly be scope for a separate wider probe into the mis-selling of preference shares, not just at Bankia, but throughout Spain's savings banks.

However, nobody seems to have started this court investigation.

Olivares, like many other small savers at Spain's state-rescued banks, claims her parents were sold the preference shares as a kind of high-interest savings account and that the bank staff did not explain the risks attached. 

The government is in the process of setting up an arbitration process to compensate Bankia clients who can prove that they were duped into buying preference shares, Economy Minister Luis de Guindos said last week.

I think the fundamental problem here is that all of the mom and pop investors trusted the bankers they were dealing with.  Why would they ever guess that their government would allow them to be sold an investment that put their money at risk in an insolvent bank without the bank being required to disclose it was insolvent?

But many ordinary Spaniards who lost their life savings through the Bankia rescue say this is not enough and they want answers as to what happened to their money. 

"We want justice, at least some kind of recognition that we were swindled," said Raimundo Guillen, a 50-year-old electricity station worker who put 30,000 euros in preference shares with Bankia under the impression they were a form of savings account.
"It's as if they've stolen your wallet - blatantly, with their face uncovered."