Zombie Glass–Steagall [Pseudo Glass-Steagall?]

by Glyn A. Holton, author and consultant with twenty years experience managing financial risk.

October 13, 2011
Zombie Glass-Steagall will soon be stalking the land.On Tuesday, the FDIC released proposed rules for implementing Section 619 of the Dodd-Frank Act—the so-called Volcker Rule. On Wednesday, the SEC did the same. This is a joint effort of the FDIC, Federal Reserve Board, SEC and OCC. Their—largely identical—proposed rules are based on a 79 page study released by Tim Geithner’s Department of Treasury in January 2011.

The Volcker Rule was, of course, an attempt to restore some of the safeguards that were lost in 1999, when Congress scrapped the 1933 Glass–Steagall Act’s separation of commercial and investment banking. In its original form—as Paul Volcker first proposed it in early 2009—the Volcker Rule would:

1. prohibit banks from engaging in proprietary trading, and


2. prohibit them from investing their own capital in hedge funds or similar speculative funds.
   

The first item is the crux of the rule. The second is a safeguard to prevent banks from indirectly speculating through a hedge fund or other entity. Volcker explained the rule’s intent as:

We ought to have some very large institutions whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the credit and financial system. Those institutions should not engage in highly risky entrepreneurial activity. Barack Obama ignored Volckers proposal for a year, but with frustration over his coddling of Wall street near a boil, on January 21, 2010, he publicly endorsed it. With Volcker gleaming by his side, he dubbed it the “Volcker Rule.”

The actual rule he sent to Congress was weak. Senators Jeff Merkley (Democrat of Oregon) and Carl Levin (Democrat of Michigan) strengthened it, and it was their version that made its way into the Dodd-Frank Act. The Treasury Department’s January report weakened it, proposing that, instead of prohibiting banks from investing in hedge funds, that they be allowed to invest up to 3% of their capital in them. The document just released by the FDIC embraces that proposal.

Volcker was unhappy with what happened to his rule, even before Treasury did their hatchet job. We should probably rename it. One possible name would be “Zombie Glass-Steagall”. The rule doesn’t bring any of Glass-Steagall back to life. At best, it disturbs the grave of Glass-Steagall. It makes Glass-Steagall not alive, but undead. And the 298 pages of proposed regulations just released by the FDIC are an abomination—onerous, convoluted and riddled with loopholes.I have always opposed Zombie Glass-Steagall in any form because, fundamentally, it is flawed. While Glass-Steagall prohibited commercial banks from trading certain instruements, Zombie Glass-Steagall prohibits only the proprietary trading of those instruments. Proprietary trading can be indistinguishable from trading related to market making, hedging, underwriting, price discovery, liquidity management, asset-liability matching or a host of other practices. If a trader wants to disguise proprietary trading as one off these, believe me, he can.

Let me give you an example. It is called “trading around order flow”. Suppose a bank makes markets in certain bonds. They are negative on a particular bond, so, when a client places an order to buy that bond, they sell it without purchasing an offsetting position in the same bond. Selling the bond was “market making” but, by doing nothing at all, the bank now has a proprietary short position in the bond. The mere fact that the bank has that short position doesn’t make this proprietary trading. The bank will tell you that it is ineficient to hedge positions transaction-by-transaction—that they look at their portfolio overall and hedge its net exposures. Fair enough, but analyzing whether a trading book is hedged can be devilishly difficult. The trading book might have tens of thousands of positions in equities, bonds, derivatives, repos, you name it. Do you remember the debate over whether Goldman Sachs had shorted the mortgage market heading into the 2008 crisis? They smugly claim they were market neutral. How do you argue with something like that? It is all posturing.

The proposed rules that the FDIC and SEC just released envision banks implementing elaborate reporting and compliance systems to help senior executives and regulators spot proprietary trading. Banks will also have to calculate and track five categories of metrics:

• Risk-management measurements – VaR, Stress VaR, VaR Exceedance, Risk Factor Sensitivities, and Risk and Position Limits;


• Source-of-revenue measurements – Comprehensive Profit and Loss, Portfolio Profit and Loss, Fee Income and Expense, Spread Profit and Loss, and Comprehensive Profit and Loss Attribution;


• Revenues-relative-to-risk measurements – Volatility of Comprehensive Profit and Loss, Volatility of Portfolio Profit and Loss, Comprehensive Profit and Loss to Volatility Ratio, Portfolio Profit and Loss to Volatility Ratio, Unprofitable Trading Days based on Comprehensive Profit and Loss, Unprofitable Trading Days based on Portfolio Profit and Loss, Skewness of Portfolio Profit and Loss, and Kurtosis of Portfolio Profit and Loss;
  Customer-facing activity measurements – Inventory Turnover, Inventory Aging, and Customer-facing Trade Ratio; and


• Payment of fees, commissions, and spreads measurements – Pay-to-Receive Spread Ratio.
  All this is staggeringly complex. Larger banks could spend millions of dollars a year complying with this mess. Smaller banks will receive exemptions from much of the reporting—Zombie Glass-Steagall isn’t intended for them.

What are regulators going to do with all the data they receive on the various metrics? No matter how much data there is, any determination on its meaning will be subjective. Regulatory agencies are under budgetary pressure, so it is not clear how they will afford additional enforcement. With Congress and the White House beholden to Wall Street, so are the heads of those regulatory agencies. How much career risk are their employees going to take to enforce Zombie Glass-Steagall? It isn’t going to happen.

What is really sad is the fact that the objectives of Zombie Glass-Steagall could easily be achieved by merely prohibiting banks from trading non-exempt instruments, as was the case under Glass-Steagall before it was repealed. That solution would be simple, inexpensive and objective. We didn’t need commercial banks trading mortgage-backed securities or credit default swaps prior to 1999. We don’t need them doing so now.

Don’t blame the FDIC, Federal Reserve Board, SEC or OCC for this mess. The regulators are doing the best they can with an impossible legislative mandate. It was Congress and the White House who imposed that mandate. Zombie Glass-Steagall will soon be stalking the land. Call your elective representatives and tell them to repeal the monster.

Matt Taibbi knows Glass-Steagall works!

The $2 Billion UBS Incident: 'Rogue Trader' My Ass
by Matt Taibbi, Rolling Stone

The news that a "rogue trader" (I hate that term – more on that in a moment) has soaked the Swiss banking giant UBS for $2 billion has rocked the international financial community and threatened to drive a stake through any chance Europe had of averting economic disaster. There is much hand-wringing in the financial press today as the UBS incident has reminded the whole world that all of the banks were almost certainly lying their asses off over the last three years, when they all pledged to pull back from risky prop trading. Here’s how the WSJ put it:

The Swiss banking giant has been struggling to rebuild trust after running up vast losses in the original financial crisis. Under Chief Executive Oswald Grubel, the bank claimed to have put in place new risk management practices, pulled back from proprietary trading and focused on a low-risk client-driven model.

All the troubled banks, remember, made similar promises in the wake of the financial crisis. In fact, some of them used the exact same language. Some will recall Goldman’s executive summary from earlier this year in which the bank pledged to respond to a "challenging period" in its history by making changes.

"We reviewed the governance, standards and practices of certain of our firmwide operating committees," the bank wrote, "to ensure their focus on client service, business standards and practices and reputational risk management."

But the reality is, the brains of investment bankers by nature are not wired for "client-based" thinking. This is the reason why the Glass-Steagall Act, which kept investment banks and commercial banks separate, was originally passed back in 1933: it just defies common sense to have professional gamblers in charge of stewarding commercial bank accounts.

Investment bankers do not see it as their jobs to tend to the dreary business of making sure Ma and Pa Main Street get their $8.03 in savings account interest every month. Nothing about traditional commercial banking – historically, the dullest of businesses, taking customer deposits and making conservative investments with them in search of a percentage point of profit here and there – turns them on.

In fact, investment bankers by nature have huge appetites for risk, and most of them take pride in being able to sleep at night even when their bets are going the wrong way. If you’re not a person who can doze through a two-hour foot massage while your client (which might be your own bank) is losing ten thousand dollars a minute on some exotic trade you’ve cooked up, then you won’t make it on today’s Wall Street.

Nonetheless, thanks to the Gramm-Leach-Bliley Act passed in 1998 with the help of Bob Rubin, Larry Summers, Bill Clinton, Alan Greenspan, Phil Gramm and a host of other short-sighted politicians, we now have a situation where trillions in federally-insured commercial bank deposits have been wedded at the end of a shotgun to exactly such career investment bankers from places like Salomon Brothers (now part of Citi), Merrill Lynch (Bank of America), Bear Stearns (Chase), and so on.

These marriages have been a disaster. The influx of i-banking types into the once-boring worlds of commercial bank accounts, home mortgages, and consumer credit has helped turn every part of the financial universe into a casino. That’s why I can’t stand the term "rogue trader," which is always tossed out there when some investment-banker asshole loses a billion dollars betting with someone else’s money.

They’re not "rogue" for the simple reason that making insanely irresponsible decisions with other peoples’ money is exactly the job description of a lot of people on Wall Street. Hell, they don’t call these guys "rogue traders" when they make a billion dollars gambling.

The only thing that differentiates a "rogue" trader like Barings villain Nick Leeson from a Lloyd Blankfein, Dick Fuld, John Thain, or someone like AIG’s Joe Cassano, is that those other guys are more senior and their lunatic, catastrophic decisions were authorized (and yes, I know that Cassano wasn’t an investment banker, technically – but he was in financial services).

In the financial press you're called a "rogue trader" if you're some overperspired 28 year-old newbie who bypasses internal audits and quality control to make a disastrous trade that could sink the company. But if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book.

In other words, "rogue traders" are treated like bad accidents and condemned everywhere from the front pages to Ewan McGregor films. But rogue companies are protected at every level of the regulatory structure and continually empowered by dergulatory legislation giving them access to our bank accounts.

There is a movement in the UK for a thing called “ringfencing” that would separate investment bankers from commercial bankers. Some people think this UBS incident will aid that movement, even though UBS can apparently absorb the loss without necessitating a bailout or endangering client accounts.

The U.S. missed its own chance for ringfencing when a proposal for a full repeal of Gramm-Leach-Bliley was routed during the Dodd-Frank negotiations.

That means we’re probably stuck here in the states with companies like Bank of America, JP Morgan Chase and Citigroup, giant commercial banks in charge of stewarding trillions in client bank accounts and consumer credit accounts who also behave like turbocharged gamblers via their investment banking arms.

Sooner or later, this is going to blow up in our faces, and it won't be one lower-level guy with a $2 billion loss we'll be swallowing. It'll be the CEO of another rogue firm like Lehman Brothers, and it'll cost us trillions, not billions.

Matt Taibbi: Corporate Tax Holiday in Debt Ceiling Deal: Where's the Uproar?

Have been meaning to write about this, but I’m increasingly amazed at the overall lack of an uproar about the possibility of the government approving another corporate tax repatriation holiday.

I’ve been in and out of DC a few times in recent weeks and one thing I keep hearing is that there is a growing, and real, possibility that a second “one-time tax holiday” will be approved for corporations as part of whatever sordid deal emerges from the debt-ceiling negotiations.

I passed it off as a bad joke when I first saw news of this a few weeks ago, when it was reported that Wall Street whipping boy Chuck Schumer was seriously considering the idea. Then I read later on that other Senators were jumping on the bandwagon, including North Carolina’s Kay Hagan.

This is what Hagan’s spokesperson said:

Senator Hagan is looking closely at any creative, short-term measures that can get bipartisan support and put people back to work. One such potential initiative is a well-crafted and temporary change to the tax code that encourages American companies to bring money home and put it towards capital, investment, and–most importantly–American jobs.

For those who don’t know about it, tax repatriation is one of the all-time long cons and also one of the most supremely evil achievements of the Washington lobbying community, which has perhaps told more shameless lies about this one topic than about any other in modern history – which is saying a lot, considering the many absurd things that are said and done by lobbyists in our nation’s capital.

Here’s how it works: the tax laws say that companies can avoid paying taxes as long as they keep their profits overseas. Whenever that money comes back to the U.S., the companies have to pay taxes on it.

Think of it as a gigantic global IRA. Companies that put their profits in the offshore IRA can leave them there indefinitely with no tax consequence. Then, when they cash out, they pay the tax.

Only there’s a catch. In 2004, the corporate lobby got together and major employers like Cisco and Apple and GE begged congress to give them a “one-time” tax holiday, arguing that they would use the savings to create jobs. Congress, shamefully, relented, and a tax holiday was declared. Now companies paid about 5 percent in taxes, instead of 35-40 percent.

Money streamed back into America. But the companies did not use the savings to create jobs. Instead, they mostly just turned it into executive bonuses and ate the extra cash. Some of those companies promising waves of new hires have already committed to massive layoffs..

It was bad enough when lobbyists managed to pull this trick off once, in 2004. But in one of the worst-kept secrets in Washington, companies immediately started to systematically “offshore” their profits right after the 2004 holiday with the expectation that somewhere down the road, and probably sooner rather than later, they would get another holiday.

Companies used dozens of fiendish methods to keep profits overseas, including such scams as “transfer pricing,” a technique in which profits are shifted to overseas subsidiaries. A typical example might involve a pharmaceutical company that licenses the rights or the patent to one of its more successful drugs to a foreign affiliate, which in turn manufactures the product and sells it back to the U.S. branch, thereby shifting the profits overseas.

Companies have been doing this for years, to incredible effect. Bloomberg’s Jesse Drucker estimated that Google all by itself has saved $3.1 billion in taxes in the past three years by shifting its profits overseas. Add that to the already rampant system of loopholes and what you have is a completely broken corporate tax system.

And the whole thing is predicated on that dirty little secret – the notion, long known to all would-be major corporate taxpayers, that there would come a day when there would be another tax holiday.

That time, they hope, is now. According to Drucker, lobbyists met with President Obama last December to ask for another holiday. And now the drumbeats are rolling on the Hill for a new holiday to be included in the debt-ceiling deal.

Senator Carl Levin of Michigan, the same Senator who produced the damning report of corruption on Wall Street, has been trying to fight the problem, introducing a measure that would prevent companies from accessing offshored money through correspondent accounts and branches of offshore banks.

Levin’s Permanent Subcommittee on Investigations has also been investigating how companies might use the cash they save from a tax holiday, surveying companies like DuPont, presumably to find out just how many of these firms really intend to create new jobs with their tax savings.

I’m shocked there isn’t more of an uproar about this. Could you imagine what the Tea Party would be saying right now if there was a law on the books that allowed immigrants to indefinitely avoid taxes on income sent back to family members in the old country, in Mexico and Venezuela and India?

Imagine the uproar if Barack Obama, in the middle of this historic revenue crunch and "We're so broke the world is going to end tomorrow!" debt-ceiling hystgeria, decided to declare a second “one-time tax holiday” for, say, unwed single mothers, or recipients of public assistance? Middle America would be running through the streets, firing shotguns out its truck window, waving chainsaws in mall lobbies, etc.

As it is, leading members of the Senate are seriously considering giving the most profitable companies in the world a total tax holiday as a reward for their last seven years of systematic tax avoidance. Hundreds of billions of potential tax dollars would disappear from the Treasury. And there isn’t a peep from anyone, anywhere, on this issue.

We’re seriously talking about defaulting on our debt, and cutting Medicare and Social Security, so that Google can keep paying its current 2.4 percent effective tax rate and GE, a company that received a $140 billion bailout en route to worldwide 2010 profits of $14 billion, can not only keep paying no taxes at all , but receive a $3.2 billion tax credit from the federal government. And nobody appears to give a shit. What the hell is wrong with people? Have we all lost our minds?

Buy, Buy American Pie!

Here's a video about just one of the effects of globalization. But, then, without any jobs, what does it matter??