Actions for Freedom

Conversations on more than 50 actions to expand freedom in the United States


Financial reform

How to take back the control that six major banks have had on national economic policy.

Members: 2
Latest Activity: Nov 12, 2010

What is the problem that needs to be corrected by financial reform?

For the recent status in Congress, click Congress fails to accomplish financial reform.
(See also So much for ending Too Big to Fail.)

The way to find the correct solution to a problem is to know as much as possible about the problem. You can't fix what you can't explain.
To achieve financial reform, we need:
First, to understand the causes of the economic collapse of 2008-2009,
Second, to review the actions taken by the government, particularly since the Lehman collapse in September 2008 to deal with the crisis,
Third, to ask whether this massive response was necessary,
Fourth, to look at the results of these actions,
Fifth, perhaps then we'll see what would be a solution.

First, the causes of the housing boom and bust were many and included the following:
(1) social policies to increase home ownership;
(2) government mandates to Fannie Mae and Freddie Mac to provide liquidity in the subprime secondary mortgage market;
(3) relaxation of lending standards;
(4) Federal Reserve actions to reduce the federal funds rate from 6.5% in 2000 to 1.0% in 2003 to 3.0% in 2005 when housing prices were 77% higher than in 2000;
(5) invention of mortgage-backed securities, collateralized debt obligations, credit default swaps, synthetic CDOs, etc. by the financial services industry to profit from these conditions;
(6) banks played rating agencies against each other to get AAA ratings on their products;
(7) lobbying success by major banks in avoiding regulation;
(8) In April 2009, Senator Richard Durbin said, "the banks ... are still the most powerful lobby on Capitol Hill. And they frankly own the place."
(8) the revolving door of senior executives moving between positions in banking, Treasury and the Federal Reserve;
(9) etc.

Second, we need to review certain actions taken by the government after Lehman Brothers collapsed in September 2008 to deal with the financial crisis.
(1) The Federal Reserve gave an $85 billion credit line to AIG to keep it from defaulting on credit default swaps it had guaranteed.
(2) On October 3, 2008 Congress passed the Troubled Asset Relief Program (TARP), which delegated to the Treasury Department the authority to buy $700 billion of toxic assets from financial institutions.
(3) On October 13, 2008 the heads of nine major banks were called to the Treasury Department. Each was given a term sheet to sell preferred shares to the government and told by Treasury Secretary Henry Paulson (former CEO of Goldman Sachs) to sign it. The CEO of Citigroup said, "This is very cheap capital!" Warren Buffett had recently invested in Goldman Sachs at 10% interest with options and the government was investing at 5% with fewer options. The government also said it would begin guaranteeing the debt issued by the banks! These were two very large gifts by taxpayers to the nine largest banks.
(4) Banks were able "to book huge revenues from trading and bookkeeping gains" because "the Federal Reserve purchased $1.5 trillion of longer-dated Treasury bonds and housing agency securities in less than a year." This also "gave a sharp boost to the price of bonds and other securities held by banks". (David Stockman, New York Times, January 20, 2010)

Third, was this massive response necessary?
The accepted wisdom from Republican and Democratic officials and most of the media is that we were on the verge of a massive breakdown in the economy in October 2008 after Lehman collapsed. More research is needed, but below are two views that agree and two that disagree on this question:
(1) President Obama simplified the cause and magnified the possible effect, saying "like when a lack of accountability on Wall Street nearly leads to a collapse of our entire economy." (University of Michigan commencement address, May 1, 2010)
(2) Mitt Romney writes that, "A cascade of bank collapses was on its way", because "Commercial paper ... one of the instruments in which many money market funds had invested" was affected. (Mitt Romney, page 127, "No Apology", St. Martin's Press, 2010) The Reserve Primary Fund, a major money market fund, had "broken the buck", causing a loss of confidence in other money market funds.
(3) Peter Wallison testified to Congress that, "[t]he Lehman example seems to demonstrate that even when a major institution fails at a time of profound market panic the actual systemic risks are minimal."
(4) John B. Taylor believes, "the problem was ... the failure of the government to articulate a clear, predictable strategy for lending and intervening into a financial sector". ("Ending Government Bailouts As We Know Them", Hoover Press, 2010, p 48) Taylor "conclude[s] that there is no clear operational definition and measure of systemic risk at this time." (p. 49)

Fourth, We need to look at the current results of our past actions,
The book "13 Bankers" by Simon Johnson and James Kwak has the best analysis I've seen of the causes of the breakdown, actions taken in response to the crisis, alternatives that could have been considered, some of the results of actions taken, and what should be done now. Here are some excerpts:
(1) There are now fewer banks and they are larger.
(2) "The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion." (p. 211, Mervyn King, head of the Bank of England)
(3) "The critical problem ... we've got to resolve is the too-big-to-fail-issue." (p. 210, Alan Greenspan, October 2009 speech)
(4) Large banks get a hidden subsidy from the government because bond investors lend money to the banks with government guarantees at 0.78 percent less than small banks, leading to "consolidation and concentration in the financial sector." (p. 205)
(5) Banks should "compete on the basis of products, price, and service rather than implicit government subsidies." (p. 219)
(6) Above $10 billion in assets, there are very few economies of scale in banking. (p. 212)
(7) "Corporations rely on syndicates of banks for major offerings of equity or debt." (p. 211)
(8) David Stockman wrote, by "fixing short term interest rates at near zero" the Fed is shrinking "the banks' cost of production -- their interest expense on depositor funds -- to the vanishing point." As a depositor, you are getting only a few cents of interest on your checking and savings accounts. Stockman said, "by supplying the banks with free deposit money (effectively, zero interest loans), the savers of America are taking a $250 billion annual haircut in lost interest income." (New York Times, January 20, 2010)

Fifth, What would be a solution to these issues?
Answer, Break up the banks by separating commercial banking from capital market activity.
This solution is described in the Discussion Forum below.

Discussion Forum

Volcker rule watered down in financial reform bill 1 Reply

"Paul Volcker is disappointed with the final version of the rule that bears his name.""As first envisioned, the Volcker rule would have banned banks from running private-equity and hedge funds, an…Continue

Started by Daniel Dyer. Last reply by Daniel Dyer Nov 12, 2010.

The Dodd-Frank financial regulation bill should be repealed

The Dodd-Frank financial regulation bill signed by President Obama July 15, 2010 requires 243 formal rule makings by 11 different federal agencies. "...Congress is inviting everyone interested in the…Continue

Started by Daniel Dyer Jul 19, 2010.

So much for ending Too Big to Fail.

Which do you believe, Moody’s Investor Services or the President?“Never again will the American taxpayer be held hostage by a bank that is 'too big to fail,'" (President Obama, January 21,…Continue

Started by Daniel Dyer Jun 7, 2010.

Congress fails to accomplish financial reform

The 2,319 page Dodd-Frank Financial Reform bill that emerged from the House-Senate committee and passed the House at the end of June 2010 guarantees future bailouts and fails to curb taxpayer-backed…Continue

Started by Daniel Dyer May 25, 2010.

Comment Wall


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Comment by Daniel Dyer on May 20, 2010 at 5:33pm
The Heritage Foundation Morning Bell topic on May 20, 2010 was "Dodd Bill is Just the Beginning of ‘Too Big to Fail’". I posted the following comment:

"You state that neither the Glass-Steagall regime nor the Volcker rule to restrict commercial banks from proprietary market trading would have prevented the 2008 financial crisis and therefore are not relevant to the current need for financial reform. Your reasoning appears to be based on the research report you published on February 22, 2010 by David C. John that the Volcker rule would not reduce financial risk. That report glossed over several issues: (1) using government-insured deposits to engage in capital market activity, (2) justifying bailouts in part to protect depositors, (3) the Fed’s giving banks free money at the expense of depositors (savers) by setting interest rates near zero, and (4) mis-allocating capital from productive investment in the economy into zero-sum growth speculation. What real financial reform does Heritage recommend, other than break up by the Volcker rule, to make the six largest banks tolerant to failure?"
Comment by Daniel Dyer on May 14, 2010 at 7:42am
"In 2007 and 2008, losses from risky proprietary trades in the major financial firms quickly decimated the availability of credit and seriously damaged the economy far beyond the concrete canyons where those bets were made." (Letter April 2010 from John S. Reed former CEO of Citigroiup to Sens. Jeff Merkley (D-Ore.) and Carl M. Levin (D-Mich.),, May 13, 2010 )
Comment by Daniel Dyer on May 8, 2010 at 4:46pm
Companies issuing stock want a syndicate of underwriters to get the stock distributed broadly to new shareholders.
Comment by Léa C. Park on May 8, 2010 at 12:59pm
I remember Glass-Steagall repeal proponents claiming that without repeal US banks would be at a considerable competitive disadvantage with large foreign banks who weren't similarly restricted. Do syndication possibilities available under a Volcker rule answer those arguments pretty well? Should we all be writing to Senators Markley & Levin, supporting their amendment to current financial reform bill?
Comment by Daniel Dyer on May 8, 2010 at 10:49am
The second Glass–Steagall Act (Banking Act of 1933) required that commercial banks and investment banks be entirely separate corporations, until this wall was removed by Gramm-Leach-Bliley (1999). Volcker's opinion is that certain investment banking functions, namely underwriting the issuance of stocks and bonds for client companies and even making a market in those stocks are not necessarily high risk activities. Hence, commercial banks could be allowed to continue to perform these functions. But the additional investment banking functions of proprietary trading in other securities; running hedge funds and equity funds; creating, selling, and trading proprietary securities (mortgage-backed securities, collateralized debt obligations, credit default swaps, synthetic CDOs, and other derivatives of underlying securities) are very risky, particularly when highly leveraged with high ratios of debt. Volcker uses the term "capital market activity" as a catchall to describe all these high risk activities. Since commercial banks have deposits guaranteed by the government and also have access to the Federal Bank favorable loan window, they should not be allowed to engage in high-risk "capital market activities". This means we need to break up the big banks by reinstating most, but not all, of the separation that existed under Glass-Steagall. Then none will be too big to fail. Syndicates will be able to meet the investment banking needs of even the largest clients. Competition in banking will thrive. The taxpayer will not be at risk.
Comment by Léa C. Park on May 7, 2010 at 9:38pm
Dan, this is definitely not my area of expertise, so I'll need some help here with terms, etc. Did the Glass-Steagall Act (1933), which was repealed in 1999, do what you're suggesting? Reading its wiki entry I see that it separated commercial banking from investment banking, as well as originating the Federal Deposit Insurance Corporation (which wasn't repealed in 1999). Is this the same thing as "separating commerical banking from capital market activity"?

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