I’m Tired Joey Boy, Van Morrison
There are a number of different takes on how much the Financial Crash of 2008 cost the average American. The New York Times ran a story on January 21, 2014, Recession’s True Cost Is Still Being Tallied, that pegs losses at a minimum of $20,000 per individual and as high as $120,000. The figure that I have the most confidence in, which I cited in a previous post, Hillary’s Albatross, and which falls pretty much in the middle of the NYT story’s range, is $58,000 per household (vs. per individual), which comports pretty well with my family’s own personal tally of loss.
But those estimates are based on the government’s official figures of the cost of the bail-out. The real cost to taxpayers exceeds $16.8 trillion dollars, according to the Special Inspector General for TARP, with $7.7 trillion of secret emergency lending only disclosed to the public after Congress forced a one-time audit of the Federal Reserve in November of 2011.
Regardless of how high the actual cost is to you and me, it’s far too high because it didn’t have to happen. It all came about as a result of the Big Banks playing Big Casino with their depositors’ money in the service of rampant greed. As the NYT article stated: “The portrait of loss, tentative as it is, suggests that even the most far-reaching measures might be justified to ensure it never happens again.”
But the Big Banks and the US Congress are taking precisely those actions necessary to ensure that it does happen again and that it will create an even worse financial disaster than the Crash of 2008. What’s more, it appears to be part of a plan.
A few weeks ago, on June 8, 2017, on a nearly party-line vote of 233-186 (with only one Republican opposed), the US Congress passed The Financial CHOICE Act of 2017 (HR 10), a bill that would roll back many of the protections of The Dodd–Frank Wall Street Reform and Consumer Protection Act. It was a very important event in the economic lives of nearly all Americans, but one which garnered very little coverage by the media or analysis by pundits, who were mesmerized by former FBI Director James Comey’s testimony to the Senate Intelligence Committee.
The 2017 Choice Act strips the federal government of its power to regulate risky behavior by the Big Banks, while simultaneously blocking it from managing a bank failure to prevent systemic damage. In short, the 2017 Choice Act is a major enabler for the Big Banks to profit handsomely from another financial disaster already in the making. A few of the changes the 2017 Choice Act calls for include:
♦ Repeal of Volcker Rule restrictions on speculative investments by banks;
♦ Eliminating the Orderly Liquidation Authority of the Federal Deposit Insurance Corporation (FDIC) and establishing new, self-directed provisions covering bankruptcy of large financial institutions with respect to winding-down failing banks; and
♦ Allowing certain banks self-exemption from regulatory standards if they maintain a certain ratio of capital to total assets and meet other requirements.
The Volker Rule is a federal regulation implemented in 2015 that prohibits a bank or any institution that owns a bank from engaging in proprietary trading, and from owning or investing in a hedge fund or private equity fund, and also limits the liabilities that the largest banks can hold. The Volker Rule prohibits banks from conducting investment activities using their depositors’ money. Its purpose is to prevent banks from engaging in the kind of risky investment strategies that were primary contributors to the financial meltdown. Among those speculative investments is derivatives trading, which earns nice profits for the bank but provides no direct benefit to depositors … investments that privatize profit and socialize risk in the event the bank should fail.
It’s important to understand that proprietary trading occurs when a bank invests money for its own direct gain. Banks engage in proprietary trading because it earns them profits far in excess of the small margins they make from processing trades on behalf of its customers and clients. Repeal of the Volker Rule would again allow the Big Banks to gamble on high-risk, high-reward investments and acquisitions using their depositors’ money without restriction.
It’s also important to understand that when a depositor puts money in a bank, they are legally transferring ownership of that money to the bank. What they get in return is essentially a promise of repayment (an IOU) with interest. Since repeal of the Glass-Steagall Act, which separated depositors’ money from money the bank could use for investments, both depositors’ funds and a banks’ funds go into a general pool that the banks can use for proprietary trading.
The Volker Rule currently allows banks to engage in market-making, underwriting, hedging, securities trading, and selling hedge funds and private equity funds unless the service or products offered create material conflicts of interest between the bank and depositors or creditors, or expose the bank to high-risk settlements, or may generate instability within the bank or within the overall U.S. financial system [emphasis mine]. Eliminating the Volker Rule would eliminate restrictions on high-risk trading and speculative investments, which would again allow the Big Banks to play Big Casino with your money. But it includes not just the money from private depositors: it also includes money from pension funds, bond-holders, and the general funds of local and state governments.
All this becomes really important in light of how much exposure the Big Banks currently have in derivatives obligations.
Derivatives are financial contracts with values derived from the behavior of something else – interest rates, mortgages, precious metals and other commodities, etc. In the same way as home-buyers take on mortgage debt with a fractional down payment and a contractual promise of repayment, derivatives traders only need to put up a small amount of cash to take on a large amount of debt. Unlike a mortgage loan, however, for which the property itself serves as collateral, and can be repossessed in the event of default, one derivative contract can serve as collateral for another derivative contract, which can serve as collateral for yet another derivative contract, in an unending interconnected web of inter-collateralized debt obligation, or what financial writer Ellen Hodgson Brown calls a “Web of Debt“. The result is the creation of a massive structure of derivative contracts supported by a relatively small amount of real money. The worldwide nominal value – also known as the “face value” – of derivative contracts tripled in the five years leading up to the Crash of 2008, at which time it was around $600-700 trillion according to the Bank for International Settlements (BIS). Since then, the total value of the derivatives market has actually grown quite a bit larger. Estimates in 2015 put the notional value of all derivative investments at $1.2 quadrillion, or more than 10 times the total GDP of all the nations on earth that year.
The most notorious kind of derivative contract is what’s known as a Collateralized Debt Obligation (or CDO). CDO’s are a Wall Street scam that collectively bundles the risk of default inherent in each of thousands of mortgages into financial “instruments,” which are then sold to investors under the fraudulent stamp of a AAA-rated security and which promise a guaranteed income stream based on the level of risk the buyer is willing to take on. A CDO is sliced into “tranches” (a French word meaning ‘a portion of something’), each representing a level of risk and expected return. Tranches act as discrete “baskets” of risk and reward that catch the cash flow of interest and principal payments within a given group of bundled mortgages. The higher the risk represented in a tranche, the higher the potential return. These risk-shifting contracts were peddled to greedy and unsuspecting institutional buyers like pension fund managers and municipalities as a sure-fire way to beat the Treasuries market.
CDO’s are still out there and the Big Banks are still buying and selling them, only now they’ve been renamed a Bespoke Tranche Opportunity (BTO), because, see, they’re custom-designed just for an individual investor’s desired outcomes, which makes them not be a CDO. Plus which, it just happens to be a legal workaround for provisions in the Dodd-Frank Act that restrict the kind of CDO’s that contributed to the financial meltdown. But it’s the same thing with a new coat of paint. It’s kind of like renaming metastatic cancer an Alternative Biogenesis Growth Opportunity and then running an office pool on the date your co-worker will die.
Now here’s where things start to get really hinky and broadly worrisome to a 10th Dan Paranoiac like myself. In 2005, the 109th Congress, having a GOP majority in the House and Senate under Bush2, passed the deceptively named Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). Far from protecting consumers, the act, among other things, made it more difficult for consumers to file for bankruptcy protection, exempted student loans altogether (lumping them in the same class of financial obligation as child support and criminal fines), and prioritized the settlement of banks’ derivatives obligations in the event of insolvency, ahead of all other claimants. So the Big Banks wanted to make sure that in the event a creditor went deeply horizontal they got their money first and the 109th Congress was happy to oblige.
It’s no surprise that student loan debt is a major concern for our elected representatives. Federal and private student loan debt surpassed credit card debt for the first time in 2010 and currently stands at $1.2 trillion. About 40 million Americans have student loan debt, the second-highest level of consumer debt behind mortgages. Nearly all of it is held by the federal government.
But student loan debt pales in comparison to the amount of derivatives debt held by just the top five largest US banks (JP Morgan Chase, Bank of America, Wells Fargo, Citigroup and Goldman Sachs), amounting to some $280 trillion, with Bank of America alone holding $50 trillion of derivative debt obligation with only $1 trillion in deposits. To put that number in perspective, the US Gross Domestic Product (GDP) in 2016 was $18.5 trillion. $280 trillion is more than 15 times the entire 2016 US GDP.
The top 10 US banks cumulatively hold around $10 trillion in deposits. About half of that total is deposits by large institutional customers exceeding the $250,000 deposit insurance provided by the FDIC. The other half is from depositors covered by FDIC insurance. But the FDIC only has some $67 billion currently on account to cover $61 trillion of insured US deposits, which isn’t sufficient to cover the insured depositors if even one of the Big Ten banks goes south. Furthermore, if one bank failure produces a cascade of failures – a systemic failure of the kind that nearly happened in the Crash of 2008 – all bets are off for anybody with money on deposit regardless of where you bank.
Ellen Brown explains: “The Dodd-Frank Act says we, the people, are no longer going to be responsible for the Big Banks when they collapse. It is not clear that the FDIC will be able to borrow from the Treasury, but even if they could, who is going to pay that money back? Let’s say they borrowed $1 trillion. Who is going to pay that $1 trillion dollars back? It will bankrupt all the small banks that had to contribute to this premium. They will say we’re raising your premium to everything you’ve got, basically. Little banks will go out of business, and who is going to survive? — the Big Banks. What we’re going to have left is five Big Banks and everybody else is going to be bankrupt.”
It gets worse. The 2017 Financial Choice Act follows hard on the heels of a decision 2-1/2 years ago in November of 2014 in Brisbane, Australia by the G-20’s Financial Stability Board (FSB) to allow large financial institutions (i.e., Big Banks) to liquidate their depositors’ cash accounts and convert them to unsecured creditor accounts, which would allow them to stay afloat in the event of a pending insolvency. Essentially, the FSB rules allow banks to absorb your money and provide you with an IOU in exchange. The IOU can be a fraction of the cash value absorbed. This was done in response to provisions in Dodd-Frank Act that forbid another bail-out of banks using taxpayer’s dollars. The EU followed suit with its own regulations restricting taxpayer bail-out of banks in the future. Instead, the G-20 FSB promulgated new rules that now provide the Big Banks with means to bail-out themselves by “bailing-in” your money. That includes not only individual depositor accounts but also pension funds, bonds, and government general fund accounts. “Unlike coins and paper bills, which cannot be written down or given a haircut,” says Jack Napier, a financial adviser who writes for ZeroHedge, bank deposits are now “… just part of commercial banks’ capital structure.” Hey Presto!– a whole new definition for moral hazard!
In effect, the G-20’s FSB made a judgment-call that a failing Big Bank’s survival is more important than your family’s financial survival, more important than retiree pension funds, and more important than the solvency of local and state governments. As signatories to an international agreement effected in 2010 at the G-20 Summit in Seoul, South Korea, the FSB rules have the weight of law for G-20 nations, who all agreed to the new rules. In effect, international bankers and finance ministers have imposed a treaty on US citizens that was not reviewed and vetted by Congress and is not in the best interests of the American people.
A real-world example of bail-in financing occurred four years ago in 2013 in Cyprus when uninsured depositors (defined as depositors with more than €100,000 on account) in the Bank of Cyprus lost nearly half the value of their deposits when the bank absorbed their capital and provided IOU’s in bank stock in return. The value of the bank stock IOU’s were a fraction of most depositors’ losses. However, that bank at least remained solvent and depositors retained some of their money. Insured depositor accounts in Laiki Bank were transferred to the Bank of Cyprus, while uninsured depositors were made shareholders of a “liquidation entity”, essentially an independent debt-holder in the Bank of Cyprus, when that bank failed.
Now consider that a financial bubble cannot be sustained indefinitely. We’re all supposed to act like it can, but really it can’t. At some point, it must collapse. When it does, those banks with the greatest exposure will be the ones most likely to face insolvency. Of course, the banks with the greatest exposure are the Big “too-big-to-fail” Banks. In order to prevent the whole financial system from cratering when a too-big-to-fail Big Bank fails, which could cause other banks to fail, which could cause the whole economy to crater, liquidation of a Big Bank facing insolvency has to be done in an orderly and efficient manner. That why it’s extremely troubling that the 2017 Financial Choice Act calls for elimination of the FDIC’s Orderly Liquidation Authority (OLA).
The OLA provides a receivership process to quickly and efficiently liquidate a large, complex financial institution facing insolvency. For purposes of the OLA, a large, complex financial institution includes those banks and other commercial entities with access to the Federal Reserve’s discount window, FDIC deposit guarantees, and other government-mandated financial safety nets. It includes all federally insured, deposit-accepting banks and the institutions that own those banks, as well as credit unions. In the event of a Big Bank failure, the OLA empowers the FDIC to assume oversight and managerial authority over the failed bank’s assets and liabilities and is given a 3- to 5-year window to complete the liquidation process.
OLA was created by Dodd-Frank in direct response to the Lehman Brothers collapse. The bankruptcy court in the Lehman case was required by law to focus narrowly on creditors’ claims against the bank. It lacked any statutory or regulatory basis to prevent collateral damage to other banks, to the financial system, or to the economy, from a “too-big-to-fail” bank in financial free-fall. The federal agencies, including the FDIC and Treasury, used the powers available to them to attempt to preserve broader financial stability, but those agencies also lacked a legal and regulatory authority for the kind of actions they needed to take. Eliminating the OLA strips the FDIC of regulatory authority to manage the aftermath of a Big Bank failure and throws the whole process back on the bankruptcy courts, which continue to lack the authority to do more than manage creditors’ claims and distribution of assets.
Lehman Brothers went belly-up in September, 2008, because it had enormous exposure to CDO’s that were backed by sub-prime and Adjustable Rate Mortgages (ARM’s). Interestingly, eleven months earlier, Lehman Brothers took a short position on sub-prime mortgage-backed CDO’s, essentially betting that the value of those securities would continue to fall, while hedging their own entire sub-prime mortgage portfolio. And in the interim period, in June 2008, Bank of America acquired Countrywide Financial, whose insolvency was an early harbinger of the coming housing market collapse. The same day that Lehman announced their short-and-hedge position – which was rewarded by investors with a one-day 3% bump in share value – Bear-Stearns announced that they were writing off $2.1 billion in losses from the plunging value of mortgage-backed CDO’s due to a trending increase in the number of defaults on sub-prime and ARM mortgages. Cynically, both JP Morgan Chase and Goldman Sachs worked with hedge funds to bet against toxic mortgages after the crash had begun and made money selling short on the financial catastrophe they helped to create. JP Morgan was fined $296.9 million and Goldman Sachs was fined $550 million for those actions. So it’s not like nobody saw the writing on the wall. Mene, Mene, Tekel, Upharsin.
Do you want to bet that they can see the writing on the wall today in BIG RED LETTERS. “If you want to get suspicious about this whole thing, I mean it looks like they set that all up,” Ellen Brown said in a YouTube interview. “They’re certainly preparing for something, because they know it [the derivatives bubble] can’t go on. It’s mathematically unsustainable.”
“The nation’s largest banks are a perversion of capitalism and a clear and present danger to the U.S. economy,” wrote Richard Fisher, President of the Federal Reserve Bank of Dallas in March, 2012. Or, as Matt Taibi put it in a January, 2013 Rolling Stone article Secrets and Lies of the Bailout, “It was all a lie – one of the biggest and most elaborate falsehoods ever sold to the American people. We were told that the taxpayer was stepping in – only temporarily, mind you – to prop up the economy and save the world from financial catastrophe. What we actually ended up doing was the exact opposite: committing American taxpayers to permanent, blind support of an ungovernable, unregulatable, hyper-concentrated new financial system that exacerbates the greed and inequality that caused the crash, and forces Wall Street banks like Goldman Sachs and Citigroup to increase risk rather than reduce it.”
Greed is blind and money never sleeps.
When Congress passed HR 10 on June 8th, House Speaker Paul Ryan called the 2017 Financial Choice Act “the crown jewel of this effort” to keep the GOP’s promise to cut onerous financial regulations in order to create jobs and foster economic growth. But is that the real intent – creating jobs and growing the economy? Or is the real intent to formalize a financial oligarchy that would control our economy and institutions of government for generations? There is no doubt that the act, should HR 10 become law, would strip away protections from individual depositors, small businesses, local governments, pensioners, and countless others who could see their financial assets legally taken from them in the event of another financial meltdown.
A fair number of prognosticators currently writing and blogging on the subject – including myself – believe that another meltdown will happen sooner rather than later.
From Mac Hall: FYI : CHOICE stands for Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs
Doesn’t that say it all “Hope investors send us campaign donations”
Tom Emmer was the lone Minnesotan to sponsor #HR10 but was joined by Erik Paulsen and Jason Lewis in voting for the legislation (all Democrats voted NO.)
It should be pointed out that the one Republican who voted NO issued a statement explaining why — it would be harmful to veterans. Why this was not a concern for Representatives Emmer, Lewis and Paulsen is something worthy of an election question.
Actually, there were a number of organizations that voiced concern (see the MN Political Roundtable review of Erik Paulsen’s claims of why this legislation was necessary — yep, they are outrageous.)