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Thursday, February 11, 2010

Important Financial Regulation Nooz

Oh god damnit. Barack Obama's bank regulation thing. First Obamers rolled out a plan to tax big ole banks to recoup losses on TARP bail-out money. This is around $100bn and would be paid back over 10 years and would be easier on banks with large deposit bases. Fine. Except that:

1) TARP money did not go to just banks, even though they're the only ones who are being asked to pay the new tax.

2) Most banks that took TARP money have already paid the government back at a LARGE PROFIT TO THE GOVERNMENT. Did you know this?

And 3) some shit I can't remember.

Anyway, banks called bullshit on this and its the first time in awhile (history) that they've had a point. Still, it made them cry, and this is funny.

THEN, a few days later, oh man, Obamington rolled the big mother financial regulation thing no one saw coming. This is the Volcker Rule, after Paul Volcker, the 9ft-tall former Fed chairman who wears a blinking red light on his head so as not to be struck by low flying aircraft. The Volcker rule seeks to ban banks from proprietary trading, i.e. trading on their own account. Gambling with customer's money would be fine as long as the customers want to. Gambling with banks' own capital is not. The new rules would also impose limits on banks' size.

Egh. The good thing that can be said about this is that its big and disruptive. Something to shake banks out of their complacency. A modified Glass-Steagall, sort of. Whatever. BUT, if we're looking for actual solutions to actual problems revealed by the actual financial crisis that actually just happened, then I have no fucking idea what any of this is for. Let's review...

At the root of the financial crisis was basically a guess. A guess that people would not default on their mortgage payments in as big numbers as they turned out doing. For most other markets there is a huge statistical history where you can extrapolate all sorts of nerdly things to give you some sort of reasonable idea about where things will go or wont. As is made clear in this book here, banks simply had no idea what default rates for subprime mortgages would look like because there was no such history. So there it is. The guess.

From this guess a massive edifice of complex mortgage-backed securities was built. Banks securitized mortgages and sold them. Other banks bought and repackaged them into even more complex mortgage-backed securities and sold them again. Credit ratings agencies gave them AAA ratings, which means their likelihood of default was the same as the most stable of governments. How did they know this? They didn't.

At the same time trillions of dollars of credit insurance were written between banks on these same securities, and why not, since it was very cheap to do so, and the insurer was more than happy to, since the likelihood of default on AAA assets was by definition very low if not impossible. And since banks thought this effectively immunized them from any risk this only reinforced the process further.

Finally to lubricate this trade a fragile "shadow" banking system arose, with super short-term just-in-time financing and off-balance sheet vehicles with no capital requirements. And the minimal capital cushions banks were required to have under Basel II international banking regulations turned out to be wholly inadequate because those rules used, haha yes, ratings agencies to risk-weight certain assets, the shittiest of which were rated AAA.

Yea well, the guess was wrong. Even people who saw the housing bubble a mile away were shocked by the impact on the financial system. Losses once thought impossible happened daily. The financial system froze. America elected its first black Muslim communist president.

So do you see where the Volker rule fits into all of this? No you don't because IT FUCKING DOESN'T.

I just don't get it, man. Banning banks from proprietary trading, trying to maintain a core of safe banks that can't fail while pushing the risky stuff out into the ether seems to create more problems than it solves, and I'm not convinced it solves any. Goldman Sachs for example can trash its new banking charter to avoid the proposed regulations, but does anyone think this would stop Goldman from getting bailed out if necessary? So what's the point? This would needlessly tie down regulators who would be left bickering over what is proprietary trading and what isn't. That would be fine if that contributed to the financial crisis but Jesus fuck it didn't? Moreover there's no real evidence that size per se had anything to do with the likelihood of failure.

So I have no idea what's going on. At best the new proposals are irrelevant. This is like the financial regulation version of the response to 9/11. Yea, bin Laden attacked us WOO LET'S INVADE IRAQ. But at least we had an idea why George Bush wanted to invade Iraq (freedom). This Volcker rule is just baffling. I really want to believe that this had nothing to do with a certain naked Republican teabagging Ted Kennedy's headstone, but I'm having trouble finishing this sentence.

Fortunately much of the real work to strengthen the financial system is being done through the Basel Committee.

And I am getting way ahead of myself.

The Volcker rule still has to go through Congress where Ben Nelson will make it a tax cut for fetuses somehow.

update: I almost forgot. The Volcker rule also bans banks from investing in hedge funds and private equity, because golly we all know how many hedge funds and private equity companies had to be bailed out: 0.

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