Sunday, June 13, 2010

June 13, 2010 —

It's becoming increasingly clear that a number of finance world insiders are bracing for a near-term disaster of monumental proportions, unless a Glass-Steagall reorganization of the banks is implemented now. Among the voices for a breakup of the too-big-to-fail financial institutions are at least two regional Federal Reserve Bank presidents, a former International Monetary Fund chief economist, and New York University Stern School of Business Prof. Nuriel Roubini. One senior U.S. intelligence source confirmed this week that "there are significant numbers of people at the Fed, and even at the Treasury Department, who support a return to Glass-Steagall." He added that, if the ongoing House-Senate conference fails to produce a financial reform bill with real teeth, "the backlash could be overwhelming, and could be the driver for Glass-Steagall being implemented." He added that the Obama Administration, along with the top leadership of both the Democratic and Republican parties are oblivious to the "French Revolution alert"

It would appear that some of the recent attacks on TBTF ("too big to fail") are driven by the expectation that Wall Street and London will prevail on the House-Senate conference, and kill the Blanche Lincoln derivatives segment, and block any serious inclusion of Glass-Steagall. On a deeper level, some of these economists are bracing for another major financial blowout, very soon. This was the explicit message in two articles by former IMF chief economist Simon Johnson, circulated by Roubini Global Economics. On June 7, Johnson gave an extensive account of a June 3 speech by Richard Fisher, the President of the Dallas Fed, at the SW Graduate School of Banking, in which he declared that the TBTFs had to be broken up, and that no amount of regulation would work.

Fisher told the audience, "Regulators have, for the most part, tiptoed around these larger institutions [big banks]. Despite the damage they did, failing big banks were allowed to lumber on, with government support. It should come as no surprise that the industry is unfortunately evolving toward larger and larger bank size with financial resources concentrated in fewer and fewer hands... As a result of public policy, big banks have become indestructible. Big banks that took on high risks and generated unsustainable losses received a public benefit: TBTF ['too big to fail'] support. As a result, more conservative banks were denied the market share that would have been theirs if mismanaged big banks had been allowed to go out of business. In essence, conservative banks faced publicly backed competition."

Fisher added, "The system has become slanted not only toward bigness but also high risk," further warning, "We know from intuition and experience that any financial institution deemed TBTF will not be allowed to fail in the traditional sense. When such an institution becomes troubled, its creditors are protected in the name of market stability. The TBTF problem is exacerbated if the central bank and regulators view wiping out big bank shareholders as too disruptive, extending this measure of protection to ordinary equity holders." Fisher's ultimate conclusion: The TBTFs must be busted up.

Making good on his word, Fisher, on June 10, wrote to Sen. Blanche Lincoln (D-Ark.), endorsing her provision in the financial reform bill, prohibiting banks from engaging in proprietary trading in derivatives, and other similar activities. The Fisher letter was practically identical to the letter, sent the same day to Senator Lincoln, by Kansas City Fed President Thomas Hoenig.

In a second June 10th document, also circulated by Roubini, Simon Johnson warned that Wall Street was out to kill the Lincoln derivatives regulation, and that President Obama and the White House team, led by Larry Summers, are totally in lockstep with the mega-banks. "We will learn a great deal in the coming weeks, not just about the future stability of our financial system, but also for what President Obama really stands."

Nouriel Roubini, in a May 18 interview with TruthOut, was even more direct: "My view is that if banks are too big to fail, using higher capital charges and an insolvency regime is not going to work. If they're too big to fail, they're just too big, and they should be broken up.

"If they're too big to fail, they're also becoming too big to be saved, too big to be bailed out, and too big to be managed. No CEO can monitor the activities of thousands of separate profit and loss statements, and the activities of thousands of different bankers and traders. So that's one dimension. We must be capable of going beyond the Volcker Rule, which is essentially Glass-Steagall-Lite. We need to go all the way and implement the kind of restrictions between commercial banking and investment banking that existed under Glass-Steagall."

Asked why he was critical of the Volcker Rule, Roubini explained, "The Volcker Rule goes in the right direction, but in my view, the model of the financial supermarket where within one institution you have commercial banking, investment banking, underwriting of securities, market-making and dealing, proprietary trading, hedge fund activity, private equity activity, asset management, insurance—this model has been a disaster. The institution becomes too big to fail and too big to manage.

"It also creates massive conflicts of interest. If you look at the cases against Goldman Sachs and Morgan Stanley, leaving aside whether there was any fraud or illegal activity—that's for a court to decide—there is still a fundamental conflict of interest. These institutions are always on every side of every deal. That's an inherent conflict of interest that cannot be addressed with Chinese walls [internal company barriers between different aspects of its business]."