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Too Big to Bail
The Fed's Wall Street Dilemma
By Pam Martens
17/03/08 "Counterpunch" -- -
Americans learned two new truths last week from the Bush
Administration's version of Life's Little Instruction Book: if
you're a Wall Street miscreant you're thrown a lifeline; if
you're a Wall Street crime fighter you're thrown a land mine.
In the first effort, the Feds
effectively handed a Federal Reserve ATM card to JPMorgan to
funnel your tax dollars to the teetering Bear Stearns brokerage
firm to address counterparty risks that have been building for
at least 4 years as the Feds snoozed. Counterparty risk is the
trillions of dollars of insurance contracts (credit default
swaps and other derivatives) taken out by Wall Street firms on
each others (counterparty) bonds, bundled mortgage and
commercial debt (collateralized debt obligations). The firms
have used unregulated over-the-counter contracts to perform this
risk transfer alchemy and funded their own company, Markit Group
Ltd., to take the place of a regulated exchange for price
discovery.
In the second effort, the Feds
tapped the Department of Justice, Internal Revenue Service, U.S.
Attorney's office in New York, FBI, five federal judges and a
busy federal court to root out that Code Red threat to our
national security: consensual sex. The sex involved a
prostitution ring and Democratic New York State Governor, Eliot
Spitzer, who was savaged and forced to step down by an avenging
media mob abundantly fed with well placed leaks from a
suspiciously homogenous group called "anonymous law enforcement
officials." Governor Spitzer, in his former role as New York
State Attorney General, had taken the lead in rooting out Wall
Street crimes against small investors because the Federal
Reserve was preoccupied with lobbying to remove regulations on
Wall Street's crime factory.
As usual, the Feds handed the
bill to the governed with no thought to the will of the
governed.
While mainstream media called
the Bear Stearns bailout the first brokerage bailout since the
Great Depression, in truth it was the second in seven months.
The first brokerage bailout came
without all the media fanfare because it arrived not on the
wings of a public announcement but in five pages of
indecipherable Fed jargon addressed to the General Counsel of
Citigroup.
Here is the effective message
sent by the Federal Reserve to Citigroup in its letter of August
20, 2007: now that we have allowed you to become both too big to
fail and too big to bail by repealing the depression era
investor-protection law known as the Glass-Steagall Act at your
mere beckoning, we have to bend more rules to keep you afloat.
So, for example, the rule that says the Federal Reserve is not
allowed to lend to brokerages, just banks, from its discount
window can be tweaked for you by lending up to $25 billion to
you and then we'll let you lend it to your brokerage arm. The
Federal Reserve Act rule that says a bank can't loan more than
10% of its capital stock and surplus to its brokerage affiliate,
we'll let you go as high as about 30% and say it's in the public
interest.
By giving Citigroup an exemption
from Rule 23A of the Federal Reserve Act, by allowing it to
funnel up to $25 Billion from the Fed's discount window to its
brokerage clients who were getting hit with margin calls, the
Federal Reserve and Chairman Ben Bernanke telegraphed an
incredibly dangerous message to global markets: we're just as
unaccountable as Wall Street. The Federal Reserve as enabler
under Alan Greenspan created today's problem and today's Crony
Fed under Ben Bernanke is killing off what's left of U.S.
financial credibility. (I had barely finished typing these words
on Monday, March 17, 2008, when a news alert came across my
screen advising that the Federal Reserve was taking the
breathtaking step of making direct loans to all brokerage
firms which are primary dealers for Treasury securities.)
The Federal Reserve is stumbling
around in the dark and regularly bumping into the next bailout
because it stopped being an independent monetary force and
started taking its marching orders from Wall Street quite some
time ago.
Here's what Nancy Millar,
President at the time of the National Organization for Women in
New York City, presciently testified in writing to the
Securities and Exchange Commission in August 2001. (Ms. Millar
edited and signed this testimony while I and other Wall Street
activists provided input. This testimony is available in full on
the SEC's web site.)
We thank the Securities and
Exchange Commission for extending the comment period to
September 4, 2001 in the critical area of bank oversight now
that the lines between banks and brokerage firms have been
blurred with the repeal of the Glass-Steagall Act.
We believe that the comments
made in the letter dated June 29, 2001 from the Federal
Reserve, the Federal Deposit Insurance Corporation (FDIC)
and the Office of the Comptroller of the Currency should be
disregarded in their totality. The banks of America have
enough lobbyists and trade associations to argue their case
before the SEC. It is not the charter or mandate of these
three regulatory bodies to lobby on behalf of banks.
The body of evidence that
should dictate how the SEC must now proceed since Congress
saw fit to eliminate the critical protections afforded the
investing public in the Glass-Steagall Act, resides in the
tens of thousands of pages of transcripts of the Pujo
Committee hearings held in 1913 and the Pecora Committee
hearings of 1933 and 1934. Fancy promises from regulators
that banks functioning in the dual role as brokerage firms
can and will be self-policing is not what the SEC or
Congress should rely on. The well-developed history of
egregious abuses bestowed on the investing public prior to
the enactment of Glass-Steagall, and since its recent
repeal, is what the SEC and Congress must look to. To
believe that the dynamics of power and greed have been
materially altered in nine decades is to engage in naiveté
at the public's peril.
Our Nation's prosperity,
democracy and the productivity of its citizens demand a
level playing field to acquire and safeguard financial
assets. Society crumbles when assets achieved through years
of honest hard work can be fleeced by brokerage firms
masquerading as insured-deposit banks. It is the role of
federal regulators to maintain a level playing field through
stringent regulation.
We ask that the SEC
immediately impose the same regulations that govern outside
broker-dealers to securities' operations within banks. And,
we herewith ask Congress to reconsider the repeal of the
Glass-Steagall Act or be held accountable for the peril that
unfolds from this unwise and inadequately deliberated
decision.
If ever there was evidence that
America is now facing that peril, it was the most recent news
that the Bush administration's much touted "free and efficient
market" had priced Bear Stearns at $30 a share at the close of
trading on Friday, March 14, 2008 but on further examination of
its books over the weekend, it was valued at $2 a share and
absorbed by JPMorgan at that price.
Equally troubling is the growing
awareness among Wall Street veterans that neither the Federal
Reserve nor the U.S. Treasury comprehend was has happened here,
much less how to contain it. Here's what we heard from Hank
Paulson, the Treasury Secretary, last week:
"regulation needs to catch up
with innovation and help restore investor confidence but not go
so far as to create new problems, make our markets less
efficient or cut off credit to those who need it."
Innovation? Less efficient? Is
there anything at all that looks innovative or efficient about
Wall Street today? It is a seized up house of cards built on a
toxic formula of hubris, corruption and free market madness.
Before there is a complete
breakdown, Congress must quickly address the five key reasons we
have today's mess on our hands:
(1) Incentive: from
mortgage brokers paid higher fees to sell subprime loans rather
than prime loans, to stockbrokers paid dramatically higher fees
to sell mortgage-backed securities rather than U.S. Treasury
securities, to investment bankers paid dramatically higher fees
to package Collateralized Debt Obligations rather than issue
plain vanilla corporate bonds, Wall Street has been incentivized
to greed rather than honest service to investors.
(2) Artificial Demand:
The above outsized incentive produced a glut of unwanted and
unneeded product that had to be eventually hidden off Wall
Street's balance sheet in Structured Investment Vehicles (SIVs)
or dressed up to look like Commercial Paper and buried in mom
and pop money market funds. It is this glut and the lack of
transparency as to where else this toxic paper is hiding that is
creating the fear and panic on Wall Street.
(3) Counterparty Risk:
The regulators allowed Wall Street firms/banks to balloon their
asset base and pretend they were meeting capital adequacy tests
by buying "insurance" in the form of derivative contracts. There
was only one problem with these "hedging" techniques; the
counterparty in many cases was just another Wall Street firm or
an inadequately capitalized municipal bond insurer. Instead of
spreading risk, the risk was concentrated among the same
players.
(4) Glass-Steagall Act:
Congress was incentivized through Wall Street campaign financing
to throw reason and judgment out the window and repeal the only
law that stood between the country and another 1929. Glass-Steagall
must be restored; and public financing of federal campaigns is
the only means of restoring the will of the governed to
Washington.
Pam Martens
worked on Wall Street for 21 years; she has no securities
position, long or short, in any company mentioned in this
article. She writes on public interest issues from New
Hampshire. She can be reached at
pamk741@aol.com
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