Tuesday, November 10, 2009
11 Page Summary of Senator Dodd's 1,136 Page Proposed Financial Reform Bill
A source on the Hill sent me the following summary of Senator Dodd's proposed financial reform bill.
My source notes:
The summary leaves out Sections 1201-1204, which contain serious changes to the Federal Reserve bank structures, transparency elements, and restrictions on 13(3).The full 1,136-page bill can be viewed at the bottom of this post.
Comments and observations are always welcome. Dodd said at the press conference that this is a discussion draft, and that there will be room for comments and feedback in the next few weeks. The markup will begin in the first week of December.
This is a fluid process and I encourage you to speak out now on the process, with as much specificity as possible.
I'm too busy to really read the summary, let alone the full bill. Please help me figure out what is good, bad or just plain missing, and then let's all phone our senators.
Here is the 11-page summary:
Senate Committee on Banking, Housing, and Urban Affairs, Chairman Chris Dodd (D-CT)
Contact: Kirstin Brost/Justine Sessions, 202-224-7391
Summary: Restoring American Financial Stability – Discussion Draft
Create a Sound Economic Foundation to Grow Jobs, Protect Consumers,
Rein in Wall Street, End Too Big to Fail, Prevent Another Financial Crisis
Over the past year, Americans have faced the worst financial crisis since the Great Depression. Millions have lost their jobs, businesses have failed, housing prices have dropped, and savings were wiped out.
The failures that led to this crisis require bold action. We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them. We must create a sound foundation to grow the economy and create jobs.
HIGHLIGHTS OF THE DISCUSSION DRAFT
Consumer Financial Protection Agency: Creates an independent watchdog to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, while prohibiting hidden fees, abusive terms, and deceptive practices.
Ends Too Big to Fail:
Prevents excessively large or complex financial companies from bringing down the economy by: creating a safe way to shut them down if they fail; imposing tough new capital and leverage requirements and requiring they write their own “funeral plans”; requiring industry to provide their own capital injections; updating the Fed’s lender of last resort authority to allow system-wide support but not prop up individual institutions; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.
Protects Against Systemic Risks: Creates an independent agency with a board of regulators to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the financial system. The agency could require companies that threaten the economy to divest some of their holdings.
Single Federal Bank Regulator: Eliminates the convoluted system of multiple federal bank regulators to increase accountability and end unnecessary overlap, conflicting regulation, and “charter shopping;” keeps in place the healthy dual banking system that governs community banks.
Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and director nominations.
Closes Loopholes in Regulation: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated - including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.
Protects Investors: Provides tough new rules for transparency and accountability from investment advisors, financial brokers and credit rating agencies to protect investors and businesses.
Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses. 2
INDEPENDENT CONSUMER FINANCIAL PROTECTION AGENCY
The Consumer Financial Protection Agency will have the sole job of protecting American consumers from fraud and abuse and will ensure people get the clear information they need on loans and other financial products from credit card companies, mortgage brokers, banks and others.
American consumers already have protections against faulty appliances, contaminated food, and dangerous toys.
With the creation of the Consumer Financial Protection Agency, they’ll finally have a watchdog to oversee financial products, giving Americans confidence that there is a system in place that works for them – not just big banks on Wall Street.
Why Change Is Needed: The economic crisis was driven by an across-the-board failure to protect consumers. When consumer protections are handled by regulators whose primary responsibility is to safeguard the profitability of the companies they regulate, consumer protections don’t get the attention they need. The result has been unfair, deceptive, and abusive practices being allowed to spread unchallenged, nearly bringing down the entire financial system.
The Federal Reserve is the primary consumer protection rule-writer, but it has repeatedly failed to act despite repeated demands from Congress. The Federal Trade Commission is responsible for consumer protections for non-bank finance companies, but lacks the authority and capacity to examine them.
The Consumer Financial
Protection Agency
• Consumer Protections in
• Independent: Led by a 5 member board with an independent director. The Chairman of the Financial Institutions Regulatory Administration will have a seat on the board.
• A Watchdog with Real Teeth: Unites rule-writing, supervision, and enforcement for consumer protection in a single, stand-alone agency with broad authority to investigate and react to abuses as they develop.
• Able to Act Fast: With this agency on the lookout for bad deals and schemes, consumers won’t have to wait for Congress to pass a law to be protected from bad business practices.
• Educates: Creates a new Office of Financial Literacy.
• Regulates Shadow Banking Industry: Levels the playing field for insured banks by regulating the shadow banking industry, such as mortgage brokers and payday lenders, for the 1st time and ensures that companies offering customers the same products receive the same regulatory treatment.
• Accountability: Makes one agency accountable for consumer protections. With many agencies sharing responsibility, it’s hard to know who is responsible for what, and easy for emerging problems that haven’t historically fallen under anyone’s purview, to fall through the cracks.
•
• Works with Bank Regulators: Coordinates with other regulators when examining banks to prevent undue regulatory burden.
• Bases Supervision on Risk: Focuses resources on companies that pose the biggest risk to consumers - mortgage bankers, brokers, finance companies and the largest institutions.
ADDRESSING SYSTEMIC RISKS: THE AGENCY FOR FINANCIAL STABILITY
One financial institution should never be capable of bringing down the entire American economy.
The newly created Agency for Financial Stability is an independent agency responsible for identifying, monitoring and addressing systemic risks posed by large, complex companies as well as products and activities that can spread risk across firms. It will discourage companies from getting too large by imposing burdens on them as they grow and give regulators the authority to break up large, complex companies if they pose a threat to the financial stability of the
Why Change is Needed: The economic crisis introduced a new term to our national vocabulary – systemic risk.
In July, Federal Reserve Governor Daniel Tarullo, testified that “Financial institutions are systemically important if the failure of the firm to meet its obligations to creditors and customers would have significant adverse consequences for the financial system and the broader economy.”
In short, in an interconnected global economy, it’s easy for some people’s problems to become everybody’s problems. The failures that brought down giant financial institutions last year also devastated the economic security of millions of Americans who did nothing wrong – their jobs, homes, retirement security, gone overnight because of Wall Street greed and regulatory failures.
The Agency for Financial Stability
• Strong and Independent: Governed by an independent chairman, appointed by the President and confirmed by the Senate, to provide insulation from political manipulation. The board will have 9 members including the federal financial regulators and two independent members. The board members' diverse areas of expertise will strengthen the board’s ability to identify and respond to emerging risks throughout the financial system.
• Tough to Get Too Big: Writes increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, imposing significant costs on companies that pose risks to the financial system.
• Break Up Large, Complex Companies: Gives the regulators the authority to break up large, complex companies if they pose a threat to the financial stability of the
• Close Gaps in Regulation: Identifies unregulated financial companies that pose systemic risk and assigns them to a federal regulator for supervision.
• Lean and Mean: Expected to be staffed with a highly sophisticated staff of economists, accountants, lawyers, former supervisors, and other specialists. With just rule writing authority and no direct supervision, the agency can remain small but effective.
• Make Risks Transparent: Collects and analyzes data to identify and monitor emerging risks to the economy and make this information public in periodic reports and testimony to Congress twice a year.
• Oversight of Important Market Utilities: The Agency for Financial Stability will identify systemically important clearing, payments, and settlements systems to be regulated by the Federal Reserve.
4
ENDING TOO BIG TO FAIL
Preventing another crisis where American taxpayers are forced to bail out financial firms requires strengthening big companies to better withstand stress, putting a price on excessive growth that matches the risks they pose to the financial system, and creating a way to shutdown big companies that fail without threatening the economy.
Why Change is Needed: As long as giant firms (and their creditors) believe the government will prop them up if they get into trouble, they only have incentive to get larger and take bigger risks, believing they will reap any rewards and leave taxpayers to foot the bill if things go wrong.
Since the crisis began, a number of institutions previously considered “too big to fail” have only grown bigger by acquiring failing companies, leaving our country with the same vulnerabilities that led to last year’s bailouts.
Limiting Large, Complex Companies and Preventing Future Bailouts
• Discourage Excessive Growth: Imposes increasingly strict standards for companies as they grow larger, more complex, or more interconnected, including heightened capital, leverage, and liquidity requirements, that ensure these companies have greater resources to deal with financial shocks.
• Require Companies Provide Their Own Capital Injections: Requires institutions to issue long-term hybrid debt securities that will provide them with capital during a systemic crisis so failing institutions can provide their own life support.
• Funeral Plans: Requires large, complex companies to periodically submit plans for their rapid and orderly shutdown should the company go under. Companies will be hit with higher capital requirements and subject to restrictions on growth and activity as well as required divestment if they fail to submit acceptable plans. Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails. Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.
• Orderly Shutdown: Creates a mechanism for the FDIC to unwind failing systemically significant financial companies through receivership, but not open assistance. Costs of unwinding these companies will ultimately be charged to financial firms with assets of over $10 billion, not to the taxpayers.
• Limit Federal Reserve Lending: Updates the Federal Reserve’s 13(3) lender of last resort authority to allow system-wide support for healthy institutions or systemically important market utilities during a major destabilizing event, but not to prop up individual institutions.
5
CREATING A SINGLE FEDERAL BANK REGULATOR:
THE FINANCIAL INSTITUTIONS REGULATORY ADMINISTRATION
The Financial Institutions Regulatory Administration will eliminate the alphabet soup of multiple bank regulators that has led to weak, confusing regulation where it’s easy for problems to fall through the cracks and difficult to know who is responsible.
Why Change is Needed: Today, we have a convoluted system of bank regulators created by historical accident. There are 4 federal banking agencies that oversee national and state banks and federal and state thrifts. The result has been charter shopping, where firms look around for the regulator that will go easiest on them and fee-funded regulators go easy on those they regulate in order to keep their business, as well as a mess of overlaps, redundancies, and blurred lines of responsibility.
Experts agree that no one would have designed a system that looked like this. For over 60 years, administrations of both parties, members of Congress across the political spectrum, commissions and scholars have proposed streamlining this irrational system. The Financial Institutions Regulatory Administration will finally achieve that goal.
The Financial Institutions Regulatory Administration
• Independent: Headed by an independent chairman appointed by the President and confirmed by the Senate, a Vice Chairman experienced in state banking regulation, and a board including the chairmen of the FDIC and the Federal Reserve and two other independent members. It will be funded primarily by assessments on the industry.
• Single Focused Agency: Combines the functions of the Office of the Comptroller of the Currency and the Office of Thrift Savings, the state bank supervisory functions of the Federal Deposit Insurance Corporation and the Federal Reserve, and the bank holding company supervision authority from the Federal Reserve.
• Dual Banking System: Preserves the dual banking system, leaving in place the state banking system that governs most of our nation’s community banks.
• Separate Community Bank Division: Establishes a separate division within the new regulator to regulate community banks given the different supervisory issues they pose.
• Eliminates Charter Shopping: Stops financial institutions from choosing the easiest regulator, and stops fee-funded regulators from going easy on those they regulate to keep their business.
• Increases Accountability: Having a single regulator will mean an identifiable agency is held responsible for shortcomings in the banking system.
• Speeds Action, Increases Efficiency: Ends slow, cumbersome, coordinated rulemaking that creates extra red tape and inconsistent enforcement of the same rules by agencies. Overlaps impose unnecessary costs on regulated institutions and their customers.
• Focuses the FDIC and the Federal Reserve: The FDIC will focus on its jobs as deposit insurer and resolver of failed institutions, retaining backup examination authority over troubled banks and gaining additional authority to accompany the new agency on examinations of healthy banks and holding companies to ensure it has sufficient information to perform its insurance functions. The Federal Reserve will focus on monetary policy without being distracted by responsibilities for bank oversight and consumer protections. The Federal Reserve will continue to play a key role in assessing financial stability and have guaranteed access to financial institutions and any needed information.
6
ADDRESSING SYSTEMIC RISKS POSED BY DERIVATIVES
Common sense safeguards will protect taxpayers against the need for future bailouts and buffer the financial system from excessive risk-taking. Over-the-counter derivatives will be regulated by the SEC and the CFTC, more will be cleared through centralized clearing houses and traded on exchanges, un-cleared swaps will be subject to margin and capital requirements, and all trades will be reported so that regulators can monitor risks in this large, complex market.
Why Change is Needed: The over-the-counter derivatives market has exploded in the last decade – from $91 trillion in 1998 to $592 trillion in 2008. During last year’s financial crisis, concerns about the ability of companies to make good on these contracts and the lack of transparency about what risks existed caused credit markets to freeze.
Investors were afraid to trade as Bear Stearns, AIG, and Lehman Brothers failed because any new transaction could expose them to more risk.
Over-the-counter derivatives are supposed to be contracts that protect businesses from risks, but they became a way for companies to make enormous bets with no regulatory oversight or rules and therefore exacerbated risks. Because the derivatives market was considered too big and too interconnected to fail, taxpayers had to foot the bill for Wall Street’s bad bets.
Those bad bets linked thousands of traders, creating a web in which one default threatened to produce a chain of corporate and economic failures worldwide. These interconnected trades, coupled with the lack of transparency about who held what, made unwinding the “too big to fail” institutions more costly to taxpayers.
Bringing Transparency and Accountability to the Derivatives Market
• Closes Regulatory Gaps: Provides the SEC and CFTC with authority to regulate over-the-counter derivatives so that irresponsible practices and excessive risk-taking can no longer escape regulatory oversight. Uses the Administration’s outline for a joint rulemaking process with the Agency for Financial Stability stepping in if the two agencies can’t agree.
• Central Clearing and Exchange Trading: Requires central clearing and exchange trading for derivatives that can be cleared and provides a role for both regulators and clearing houses to determine which contracts should be cleared. Requires the SEC and the CFTC to pre-approve contracts before clearing houses can clear them.
• Safeguards for Un-Cleared Trades: Requires traders post margin and capital on un-cleared trades in order to offset the greater risk they pose to the financial system and encourage more trading to take place in transparent, regulated markets.
• Market Transparency: Requires data collection and publication through clearing houses or swap repositories to improve market transparency and provide regulators important tools for monitoring and responding to risks.
7
HEDGE FUNDS
Hedge funds worth over $100 million will be required to register with the SEC as investment advisers and to disclose financial data needed to monitor systemic risk and protect investors.
Why Change is Needed:
Hedge funds are responsible for huge transfers of capital and risk, but generally operate outside the framework of the financial regulatory system, even as they have become increasingly interwoven with the rest of the country’s financial markets.
As a result, no regulator is currently able to collect information on the size and nature of these firms or calculate the risks they pose to the broader economy. The SEC is currently unable to examine private funds’ books and records or take sufficient action when it suspects fraud.
Raising Standards and Regulating Hedge Funds
• Fills Regulatory Gaps: Ends the “shadow” financial system in which hedge funds and other private pools of capital operate by requiring that they provide regulators with critical information.
• Register with the SEC: Requires hedge funds to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk. This data will be shared with the systemic risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity.
• Independent Custody of Client Assets: Requires investment advisers to use independent custodians for client assets to prevent Madoff-type frauds.
• Greater State Supervision: Raises the assets threshold for federal regulation of investment advisers from $25 million to $100 million, a move expected to increase the number of advisors under state supervision by 28%. States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.
INSURANCE
Office of National Insurance:
Creates a new office within the Treasury Department to monitor the insurance industry, coordinate international insurance issues, and requires a study on ways to modernize insurance regulation and provide Congress with recommendations.
Streamlines the regulation of surplus lines insurance and reinsurance through state-based reforms. 8
CREDIT RATING AGENCIES
Establishes a new Office of Credit Rating Agencies at the Securities and Exchange Commission to strengthen regulation of credit rating agencies. New rules for internal controls, independence, transparency and penalties for poor performance will address shortcomings and restore investor confidence in these ratings.
Why Change is Needed:
Rating agencies market themselves as providers of independent research and in-depth credit analysis. But in this crisis, instead of helping people better understand risk, they failed to warn people about risks hidden throughout layers of complex structures.
Flawed methodology, weak oversight by regulators, conflicts of interest, and a total lack of transparency contributed to a system in which AAA ratings were awarded to complex, unsafe asset-backed securities - adding to the housing bubble and magnifying the financial shock caused when the bubble burst. When investors no longer trusted these ratings during the credit crunch, they pulled back from lending money to municipalities and other borrowers.
New Requirements and Oversight of Credit Rating Agencies
• New Office, New Focus at SEC: Creates an Office of Credit Ratings at the SEC with its own compliance staff and the authority to fine agencies. The SEC is required to examine Nationally Recognized Statistical Ratings Organizations at least once a year and make key findings public.
• Disclosure: Requires Nationally Recognized Statistical Ratings Organizations to disclose their methodologies, their use of third parties for due diligence efforts, and their ratings track record.
• Independent Information: Requires agencies to consider information in their ratings that comes to their attention from a source other than the organizations being rated if they find it credible.
• Conflicts of Interest: Prohibits compliance officers from working on ratings, methodologies, or sales.
• Liability: Investors could bring private rights of action against ratings agencies for a knowing or reckless failure to investigate or to obtain analysis from an independent source.
• Right to Deregister: Gives the SEC the authority to deregister an agency for providing bad ratings over time.
• Education: Requires ratings analysts to pass qualifying exams and have continuing education.
9
EXECUTIVE COMPENSATION AND CORPORATE GOVERNANCE
Strengthening Shareholder Rights
Giving shareholders a say on pay and proxy access, ensuring the independence of compensation committees, and requiring public companies to set clawback policies to take back executive compensation based on inaccurate financial statements are important steps in reining in excessive executive pay and can help shift management’s focus from short-term profits to long-term growth and stability.
Why Change Is Needed: In this country, you are supposed to be rewarded for hard work.
But Wall Street has developed an out of control system of out of this world bonuses that rewards short term profits over the long term health and security of their firms.
Incentives for short-term gains likewise created incentives for executives to take big risks with excess leverage, threatening the stability of their companies and the economy as a whole.
Giving Shareholders a Say on Pay and Creating Greater Accountability
• Vote on Executive Pay and Golden Parachutes: Gives shareholders a say on pay with the right to a non-binding vote on executive pay and golden parachutes linked to corporate takeovers. This gives shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy.
• Nominating Directors: Gives shareholders proxy access to nominate directors. Providing shareholders a greater role in choosing directors can help shift management’s focus from short-term profits to long-term growth and stability.
• Independent Compensation Committees: Standards for listing on an exchange will require that compensation committees include only independent directors and have authority to hire compensation consultants in order to strengthen their independence from the executives they are rewarding or punishing.
• Clawbacks for Executives at Public Companies: Requires that public companies set policies to take back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards.
• SEC Review: Directs the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five-year period.
10
SEC AND IMPROVING INVESTOR PROTECTIONS
Every investor – from a hardworking American contributing to a union pension to a day trader to a retiree living off of their 401(k) – deserves better protections for their investments. Investors in securities will be better protected by improving the competence of the SEC, creating uniform standards for those providing customers investment advice, and giving investors the right to sue those who commit securities fraud.
Why Change Is Needed: The Madoff scandal demonstrated just how desperately the SEC is in need of reform. The SEC has failed to perform aggressive oversight and is unable to understand the very companies it is supposed to regulate. And investors have been used and abused by the very people who are supposed to be providing them with financial advice.
SEC and Beefed Up Investor Protections
• SEC Reforms: Mandates an annual assessment of the SEC’s internal supervisory controls and a biannual GAO study of SEC management.
• Uniform Standards for Advisors: Mandates uniform standards for anyone providing customers investment advice, eliminating different standards for broker‐dealers and investment advisers. Small investors should have uniform protections regardless of the title of the financial professional advising them has.
• Best Interest of the Client: Brokers who give investment advice will be held to the same fiduciary standard as investment advisers – they will be required to act in their clients’ best interest.
• Aiding and Abetting: Investors will be able to sue persons who help commit securities fraud.
• New Advocates for Investors: Creates the Investment Advisory Committee, a committee of investors to advise the SEC on its regulatory priorities and practices as well as the Office of Investor Advocate in the SEC, to identify areas where investors have significant problems dealing with the SEC and FINRA and provide them assistance.
• Funding: The self-funded SEC will no longer be subject to the annual appropriations process.
SECURITIZATION
Companies that sell products like mortgage-backed securities are required to retain a portion of the risk to ensure they won’t sell garbage to investors, because they have to keep some of it for themselves.
Why Change Is Needed:
Companies made risky investments, such as selling mortgages to people they knew could not afford to pay them, and then packaged those investments together, called asset-backed securities, and sold them to investors who didn’t understand the risk they were taking. For the company that made, packaged and sold the loan, it wasn’t important if the loans were never repaid as long as they were able to sell the loan at a profit before problems started. This led to the subprime mortgage mess that helped to bring down the economy.
Reducing Risks Posed by Securities
• Skin in the Game: Requires companies that sell products like mortgage-backed securities to retain at least 10% of the credit risk. That way if the investment doesn’t pan out, the company that made, packaged and sold the investment would lose out right along with the people they sold it to.
• Better Disclosure: Requires issuers disclose more information about the underlying assets and to analyze the quality of the underlying assets.
11
MUNICIPAL SECURITIES
Municipal securities will have better oversight through the registration of municipal advisers and increased investor representation on the Municipal Securities Rulemaking Board.
Why Change is Needed:
Financial advisers to municipal securities issuers have been involved in “pay-to-play” scandals and have recommended unsuitable derivatives for small municipalities, among other inappropriate actions, and are not currently regulated.
Better Oversight of Municipal Securities
• Registers Advisors and Brokers: Requires SEC registration for financial advisers, swap advisers, and investment brokers – unregulated intermediaries who play key roles in the municipal bond market.
• Regulates Advisors and Brokers: Subjects financial advisers, swap advisers, and investment brokers to rules issued by the Municipal Securities Rulemaking Board and enforced by the SEC or a designee.
• Puts Investors First on the MSRB Board: Gives investor and public representatives a majority on the MSRB to better protect investors in the municipal securities market where there has been less transparency than in corporate debt markets.
CREATING A 21st CENTURY WORKFORCE FOR 21st CENTURY REGULATORS
This bill will take a look at a key hurdle for creating competent regulatory agencies: competent staff.
Why Change is Needed: The new proposals will create three new agencies – the Financial Institutions Regulatory Administration, the Agency for Financial Stability and the Consumer Financial Protection Agency – each posing staffing challenges that will determine the regulators’ success or failure.
A Better Work Environment to Attract Better Staff: The bill will set up a panel to look at the staffing needs of the three new agencies based on the successful panel that helped the IRS to improve their hiring practices. The advisory panel will last only three years to see that these agencies are able to attract, cultivate, and retain competent staff qualified to regulate complex, 21st century financial institutions.
Sen. Chris Dodd's Proposed Financial Overhaul Bill -
Sovereign Credit Ratings: China Up ... UK, US, Japan and France In Question
I have previously written numerous articles documenting about sovereign credit ratings, asking whether the UK would lose its AAA rating, and pointing out that the credit rating agencies were playing games to avoid stripping the U.S., UK, Ireland and Spain of their AAA ratings.
Reuters notes today that the UK is in danger of losing its AAA rating:
Britain is most at risk among the big economies to lose its top-notch credit rating, while Japan faces a review of its rating if government debt issuance rises greatly, Fitch Ratings warned on Tuesday.
David Riley, Fitch's co-head of global sovereign ratings, told Reuters Television in an interview that Britain's AAA rating is more at risk than that of any of the four big economies with a top rating. The other AAA countries are the United States, Germany and France. His comments sent the pound down more than a cent to $1.6616.
"It's clear that the UK's ability to sustain large public fiscal deficits and a level of public debt without driving up interest rates and without putting sterling under significant pressure is much less than in the case of the U.S," he said.
"If there was another significant fiscal stimulus package in the UK, then UK rating would be at risk."
David Riley said Fitch is also concerned about France:
"We do have also some concerns in case of France ... We have seen significant deterioration in fiscal position in France. There is some pressure starting to build there."I've also asked whether the U.S. will lose its AAA rating. On October 22nd, Moody's warned that America's credit rating might be reduced if deficits are not reined in within 3-4 years:
"The AAA rating of the U.S. is not guaranteed," said Steven Hess, Moody's lead analyst for the United States said in an interview with Reuters Television. "So if they don't get the deficit down in the next 3-4 years to a sustainable level, then the rating will be in jeopardy."
Finally, Nouriel Roubini rounds up the latest rating news on China:
- Moody's upgraded China's ratings outlook to positive from stable on November 9, 2009, keeping the rating at A1 on expectations that the country's economic recovery is taking stronger hold with only modest effects on the government's finances. The agency cited possible asset price bubbles and the long-term effects of China's stimulus program as risks to its outlook. It also upgraded the ratings for seven Chinese banks, a sector that some analysts worry may be hit with a surge in non-performing loans following this year's sharp credit growth...
- In early November, James McCormack of Fitch called the Chinese property market and banks "a sovereign rating weakness" given that the property bubble posed asset quality concerns...
- S&P affirmed its A+ long-term rating on August 18, 2009. China's modest debt level, strong external asset position and economic growth potential "outweigh sizable contingent liabilities in the banking system that could materialize should an extended economic slowdown play out."
- S&P raised the rating on China's long-term government bonds to A+ in July 2008, the fifth highest grade (short-term debt was raised to A-1+, the highest level and Hong Kong was upgraded to AA+). This move brought S&P in line with Moody's and Fitch ratings of Chinese debt...
- As of October 2009, credit default swaps on Chinese debt were cheaper than those for other countries with the same credit rating, signaling that its credit rating could be upgraded. This is an improvement from 2008, and reflects China's faster economic recovery. But the rating agencies argue that the large fiscal stimulus liabilities have offset China's strengthening position elsewhere. (Bloomberg, 10/16/09)
- China's foreign debt was US$360.6 billion in June 2009, down 3.8% from the end of 2008 and much lower than its foreign exchange reserves (US$2.13 trillion at end of Q2 2009). China's total foreign debt increased US$23.9 billion in Q2 over Q1 2009. Short term debt rose 12% in Q2 to US$194.4 billion, and accounted for 53.9% China's total foreign debt stock at the end of June, up from 51.5% at the end of Q1. (Reuters, 10/13/09)...
- Reuters: Official debt-to-GDP ratio was 17.7% at end of 2008, but this may be closer to 60% once local government debt, backstopped bank loans and bad assets are included. This is still below the U.S. level and not explosive, but stimulus spending by local governments and loans from state-owned banks may push the 2009 fiscal deficit up to 10% of GDP. (7/27/09)
- Citi: Although the Reuters calculation may be true, it is not correct to compare this debt load to that of the U.S. because calculating contingent liabilities is fraught with inaccuracy. Also, Chinese government is much stronger on the assets side of the balance sheet than the U.S. Estimates of around 8% of GDP may understate the government's assets because it has significant influence over state-owned enterprises. (8/6/09)
- World Bank: ...the fiscal surplus exceeded 0.7% of GDP in 2007. (Quarterly Update, June 2008)
- Michael Pettis, Peking University: " Despite hidden spending that may show up as contingent liabilities later on, it is the banking system not external debt that is most worrisome for Chinese economic prospects as it has accumulated so much in the way of foreign currency reserves that it will have little difficulty in repaying its very limited foreign-currency external obligations." (July 2008)
Vitaliy Katsenelson argues that while China has been blowing a huge bubble in lending, the government may have enough of a surplus to pull it off - at least for a couple of years (especially given that the banks are controlled by the government).But - at some point in the future - the bubble in bad loans will likely burst.
I will continue to follow on-the-ground China experts such as Pettis for updates.
Monday, November 9, 2009
The Fed's Lame Defense of Too Big To Fail
Federal Reserve Governor Daniel Tarullo argues that we should not break up the too big to fails or reimpose Glass-Steagall because:
Financial institutions that experienced so many problems -- such as Bear Stearns and Lehman Brothers, which did not have commercial banking operations -- would still have posed a "too big to fail" threat had commercial banks been prohibited from owning investment banks prior to the crisis.
He also said that commercial banks without investment-banking issues have, in the past, had serious difficulties as well. "Some very large institutions have in the past encountered serious difficulties through risky lending alone."
That's like arguing that nuclear power plants shouldn't be regulated as to how close they are to earthquake faults because some plants failed because their concrete containment dome wasn't thick enough.
Giant banks become dangerous to the entire economy if one or more of the following occur:
(1) They are too big;
(2) They speculate too much, especially if they are speculating with deposits gained through normal depository banking functions (the whole dynamic Glass-Steagall was enacted to stop); or
(3) They focus too much of their investments in credit default swaps or other instruments which allow massive looting.Nuclear plants must be sited away from earthquake faults and their containment domes have to be thick enough. Similarly, all 3 of the giant banks problems must be addressed. The TBTFs should be broken up (see this and this). Glass-Steagall should be reimposed. And risky investments which encourage looting and which generally destabilize the system should be reined in.
Note: Sure, higher capital and liquidity requirements - as suggested by Tarullo - would be helpful. But unless the real core risks are addressed, they won't be nearly enough.
Two Senior IEA Officials: Oil Reserves Have Intentionally Been Overstated to Prevent Panic Buying . . . Peak Oil is Real
As I have previously noted, the world's top energy economist - the International Energy Agency's Dr. Fatih Birol - has previously predicted that we will have peak oil by 2020.
And I have previously disclosed that an insider told me we already have peak oil.
Now, an article in the Guardian states that official oil estimates have been intentionally inflated to prevent panic:
The world is much closer to running out of oil than official estimates admit, according to a whistleblower at the International Energy Agency who claims it has been deliberately underplaying a looming shortage for fear of triggering panic buying.
The senior official claims the US has played an influential role in encouraging the watchdog to underplay the rate of decline from existing oil fields while overplaying the chances of finding new reserves.
The allegations raise serious questions about the accuracy of the organisation's latest World Energy Outlook on oil demand and supply to be published tomorrow – which is used by the British and many other governments to help guide their wider energy and climate change policies...
Now the "peak oil" theory is gaining support at the heart of the global energy establishment. "The IEA in 2005 was predicting oil supplies could rise as high as 120m barrels a day by 2030 although it was forced to reduce this gradually ..."The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this.
"Many inside the organisation believe that maintaining oil supplies at even 90m to 95m barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further. And the Americans fear the end of oil supremacy because it would threaten their power over access to oil resources," he added.
A second senior IEA source, who has now left but was also unwilling to give his name, said a key rule at the organisation was that it was "imperative not to anger the Americans" but the fact was that there was not as much oil in the world as had been admitted. "We have [already] entered the 'peak oil' zone. I think that the situation is really bad," he added....
The World Energy Outlook is produced annually under the control of the IEA's chief economist, Fatih Birol, who has defended the projections from earlier outside attack. Peak oil critics have often questioned the IEA figures.But now IEA sources who have contacted the Guardian say that Birol has increasingly been facing questions about the figures inside the organisation.
Matt Simmons, a respected oil industry expert, has long questioned the decline rates and oil statistics provided by Saudi Arabia on its own fields. He has raised questions about whether peak oil is much closer than many have accepted.
Can Technical Indicators Still Work When High Frequency Trading Dominates the Market?
In July, I pointed out that high-frequency trading is distorting the market, and that - at least on some days - many more high-frequency trades occur than normal trades by human investors.
Friday, I quoted Senator Ted Kaufman:
The chief executive of one of the country's biggest block trading dark pools was quoted two weeks ago as saying that the amount of money devoted to high-frequency trading could "quintuple between this year and next."I know that technical market systems such as Elliot Wave are supposed to work no matter what is going on. And I know that people program the computers used for high -frequency trading.
But given the massive distortions by hft, dark pools and other shenanigans, and the speed with which things can happen in this volatile market, can Elliot Wave and other predictive systems still work?
I look forward to comments one way or the other from technical traders who are more knowledgeable than me on this subject.
Don't Blame Capitalism for Wall Street's Corruption and Lawlessness
When Mahatma Gandhi was asked what he thought about Western civilization, he answered:
I think it would be a good idea.I feel the same way about free market capitalism.
It would be a good idea, but it is not what we have now. Instead, we have either socialism, fascism or a type of looting.
If people want to criticize capitalism and propose an alternative, that is fine . . . but only if they understand what free market capitalism is and acknowledge that America has not practiced free market capitalism for some time.
I'm not talking about Michael Moore's latest movie. I'm talking about worldwide opinion.
Specifically, a poll conducted by the BBC shows that the vast majority of people worldwide say that capitalism is not working.
The poll shows that:
Nearly a quarter -- 23 percent -- said the system is "fatally flawed."
RawStory describes the poll by saying:
Worldwide poll: Vast majority say capitalism not working...
Dissatisfaction with capitalism is widespread around the globe 20 years after the fall of the Berlin Wall that heralded the demise of European communism, a poll released Monday showed...
A bare majority, 51 percent, believed its problems can be solved with more regulation and reform, the poll said.
People pointing to the Western economies and saying that capitalism doesn't work is as incorrect as pointing to Stalin's murder of millions of innocent people and blaming it on socialism. Without the government's creation of the too big to fail banks, Fed's intervention in interest rates and the markets, government-created moral hazard emboldening casino-style speculation, corruption of government officials, creation of a system of government-sponsored rating agencies which had at its core a model of bribery, and other government-induced distortions of the free market, things wouldn't have gotten nearly as bad.
As Justice Louis Brandeis said:
In a government of laws, the existence of the government will be imperiled if it fails to observe the law scrupulously. Our government is the potent, the omnipotent teacher. For good or ill, it teaches the whole people by its example. If government becomes a lawbreaker it breeds contempt for law: it invites every man to become a law unto himself. It invites anarchy.If there has been lawlessness and corruption among Wall Street players, it was partially simply modeling the lawlessness and corruption of the Executive Branch and Congress members. I've written elsewhere about how the government lied by saying Saddam had weapons of mass destruction and was behind 9/11 (when he didn't and wasn't), that we don't torture (when we did), that we don't spy on Americans (when we did), etc. Just like kids model what their parents do as well as what they say, Wall Street modeled the unlawful and corrupt actions of our government employees.
Being against capitalism because of the mess we've gotten in would be like Gandhi saying that he is against Western civilization because of the way the British behaved towards India.
Note 1: I am not anti-regulation. I believe we need laws like Glass-Steagall, antitrust laws, fraud laws and other laws to ensure a level playing field. You can't have a football game without rules designed to keep the game fair. Same with capitalism.
Note 2: Maybe somebody can convince me that something else is a better system. I am open to listening to alternatives. But - to date - I have never heard of a better economic system than free market capitalism ... but if and only if it is truly free.
Sunday, November 8, 2009
Big Bankers Say They're Doing God's Work ... Are They Right?
Preface: If you are a Christian or Jew, the importance of the Bible is probably obvious. If you are not, please consider passing this essay on to people of those faiths who you know.
If you are an atheist and believe that religion is crazy, please remember that some 85% of the American population identifies itself as Christian and millions more identify themselves as Jewish, and that most people make decisions and process information based on their beliefs and emotions.
The head of Barclays also recently told his congregation that banking as practiced by his company was not antithetical to Christian principles.
And Enron's CEO previously said "We are the good guys - we are on the side of angels."
Are they right? Is big banking as practiced by the giant banks in harmony with Christian principles?
Do Justice
Initially, the Bible does not counsel us to ignore the breaking of laws by the the powerful.
In fact, the Bible mentions justice over 200 times -- more than just about any other topic. The Bible asks us to do justice and to stand up to ANYONE -- including the rich or powerful -- who do injustice or oppress the people.
There have been widespread, credible allegations that Goldman Sachs and other giant banks have broken the law (see this, for example).
Indeed, one of the first things God asks of us is to do justice:
He has told you, O man, what is good; and what does the Lord require of you but to do justice, and to love kindness, and to walk humbly with your God? (Micah 6:8)While many churches and synagogues have become obsessed with other issues, many have arguably ignored this most important of God's demands of us. As pointed out by a leading Christian ministry, which rescues underage girls trapped as sex slaves in third world countries:
In Scripture there is a constant call to seek justice. Jesus got upset at the Pharisees because they neglected the weightier matters of the law, which He defined as justice and the love of God . . . Isaiah 58 complains about the fact that while the people of God are praying and praying and praying, they are not doing anything about the injustice.Should Christians just pray for justice and leave the rest to God?
That's not what the Bible asks us to do. Instead, Hebrews 11:33 tells us that we are God's hands for dispensing justice, and God uses us to "administer justice."
We have to "walk our talk" and put our prayers into action.
God demands that we do everything in our power to act as "God's hands" in bringing justice. And as Saint Augustine reminds us, "Charity is no substitute for justice withheld."
Please reflect on the following Scripture:
The Lord looked and was displeased that there was no justice. He saw that there was no one, He was appalled that there was no one to intervene. (Isaiah 59:15-16)This is the only place in the Bible where the word "appalled" is used for the way God feels -- in other words, the only thing which we know God is appalled by is if people are not doing justice.
There are hundreds of other references to justice in the Bible, including:
- Blessed are they who maintain justice . . . . (Psalm 106:3)
- This is what the LORD says: Maintain justice and do what is right . . . . (Isiah 56:1)
- This is what the LORD says: Do what is just and right. (Jeremiah 22:3,13-17)
- Follow justice and justice alone. (Deuteronomy 16:19, 20)
- For the LORD is righteous, he loves justice . . . . (Job 11:5,7)
- Learn to do right! Seek justice . . . . (Isaiah 1:17)
Manipulating Money
Moreover, there have been credible allegations that Goldman Sachs and other giant banks manipulate the currency and other markets.
As Ron Paul notes, the Bible forbids altering the quality of money (which, at the time and place, was entirely in the form of coins):
Even the Bible is clear that altering the quality of money is an immoral act. We are instructed to follow the rules of "just weights and measures." "You shall do no injustice in judgment, in measurement of length, weight, or volume. You shall have just balances, just weights, a just ephah, and a just hin" (Leviticus 19:35-36). "Diverse weights are an abomination to the LORD, and a false balance is not good" (Proverbs 20:23). The general principle can be summed as "You shall not steal."
Dishonest scales are an abomination to the LORD, but a just weight is His delight.So to the extent that the giant banks have engaged in any dishonest acts or the manipulation of currencies, they are violating scripture.
Of course, any bankers who charge usurious interest rates should remember the little story about Jesus turning over the money changers' tables.
Oppression of the Poor
Finally, the Bible condemns oppression of the poor for the benefit of the affluent:
He that oppresses the poor to increase his riches, and he that gives to the rich, shall surely come to want. (Proverbs 22:16)To the extent that the giant banks have oppressed the poor to increase their riches, they are violating scripture.
One Reason that the Stock Market is Rising While Unemployment is Soaring
Daniel Gross points out that part of the reason that the American stock markets are going up even though unemployment is rising and the real economy suffering is because multinational corporations headquartered in the U.S. are experiencing strong sales abroad:
Here's a puzzle: The stock markets are doing very well, yet the performance of the underlying economy doesn't seem to justify optimism. The buoyant S&P 500 has risen 53 percent since the March bottom. And while the economy expanded at a 3.5 percent rate in the third quarter, unemployment is high, incomes are stagnant, and consumers are shaky...
It could be that the notion the stock market is an accurate gauge of the domestic economy's temperature is outdated.
The Dow, the S&P 500, and the NASDAQ are primarily indices of large U.S.-based companies, not main street businesses: more Davos than Chamber of Commerce. These increasingly cosmopolitan firms have been busy globalizing and expanding their operations overseas. In 2006, according to Standard & Poor's, 238 members of the S&P 500 broke out revenues between U.S. and non-U.S. sales. These companies notched about 43.6 percent of sales outside the United States. For large companies that had already saturated the U.S. market, the home market was something of an afterthought. In the second quarter of 2007, 66 percent of Coca-Cola's beverage business came from outside North America.
And thanks to the long recession, demand for products and services of all types in the United States has shrunk even since 2006. Yes, the global economy in 2008 experienced its first year of shrinkage since World War II. But growth has resumed, and in some places—Peru, China, India—it never stopped. As a result, the globe's economic geography has continued to change, with the United States accounting for a smaller chunk of global output and demand each year. For much of the past two years, virtually all growth in economic activity has taken place outside America's borders. As a result, U.S.-based companies are becoming even more reliant on non-U.S. customers and operations for sales... in two years, big companies' proportion of sales coming from outside the United States rose 9.8 percent. It's likely the 2009 figure will be something very close to 50 percent.
Don't American Workers Win?
The fact that companies based in America are raking in profits from sales abroad is good for American workers, right?
No.
Gross points out that American workers don't benefit because a lot of the goods sold abroad by American multinationals are made abroad:
If companies participated in foreign markets primarily by exporting U.S.-made goods, this shift would be good news for the U.S. economy and workers. But that's not how it works. In fact, in the months after the global credit meltdown, U.S. exports plummeted. They bottomed in April, at $120.6 billion, and though they have been rising, the August 2009 total is still 20 percent below the August 2008 total. Globalization is changing the way we do business. It's not a matter of U.S. companies exporting goods—burgers, soda, cars, software—made in the United States to Beijing but rather, making goods overseas and selling them overseas...
"Based on a Russian fairy tale and produced in Russia using local talent, the film is the latest step in Disney's broad push into local language production," the FT reports. As Disney CEO Robert Iger put it: "We would not be able to grow the Disney brand … if we just created product in the US and exported it to the rest of the world." If Book of Masters succeeds, it will be good for Disney's American shareholders but won't do a whole lot of good for its U.S.-based employees. Or consider American icon General Motors. GM's sales in China are rocking. In the first nine months, the company sold 1.3 million cars in China, including more than 181,000 in September. By contrast, GM in the United States in the first nine months sold 1.5 million cars in the United States, down 36.4 percent from the year before. And in September, GM sold just 156,673 cars in the United States. That growth in China is good for GM's shareholders and for some of its executives. But since most of the cars sold in China are produced there, with parts produced by suppliers in China, rising sales in the Middle Kingdom won't translate into jobs for unionized workers in the Middle West.
The rising U.S. stock market and a weak, slow-growing U.S. consumer sector aren't really in contradiction. Given the large-scale trends transforming the global economy—and the role of large U.S. companies in it—it may be possible to have a sustainable rally in American stocks without a sustainable rally by American consumers.
Don't Multinationals Pay A Lot in Taxes?
Well, at least the multinationals are paying a good chunk of taxes into the American economy, right?
Not exactly.
The Washington Post notes:
About two-thirds of corporations operating in the United States did not pay taxes annually from 1998 to 2005, according to a new report scheduled to be made public today from the U.S. Government Accountability Office...
In 2005, about 28 percent of large corporations paid no taxes...
Dorgan and Sen. Carl M. Levin (D-Mich.) requested the report out of concern that some corporations were using "transfer pricing" to reduce their tax bills. The practice allows multi-national companies to transfer goods and assets between internal divisions so they can record income in a jurisdiction with low tax rates...
[Senator] Levin said: "This report makes clear that too many corporations are using tax trickery to send their profits overseas and avoid paying their fair share in the United States."
Indeed, as Pulitzer prize winning journalist David Cay Johnston documents, American multinationals pay much less in taxes than they should because they use a widespread variety of tax-avoidance scams and schemes, including:
- Selling valuable assets of the American companies to foreign subsidiaries based in tax havens for next to nothing, so that those valuable assets can be taxed at much lower foreign rates
- Pretending that costs were spent in the United States, so that the companies can count them as costs or deductions in the U.S. and pay less taxes to the American government
- Booking profits as if they occurred in the subsidiary's tax haven countries, so that taxes paid on profits are at the much lower safe haven rate
- Working out sweetheart deals with certain foreign governments, so that the companies can pretend they paid more in foreign taxes than they actually did, to obtain higher U.S. tax credits than are warranted
- Pretending they are headquartered in tax havens like Bermuda, the Cayman Islands or Panama, so that they can enjoy all of the benefits of actually being based in America (including the use of American law and the court system, listing on the Dow, etc.), with the tax benefits associated with having a principal address in a sunny tax haven.
- And myriad other scams
As Johnston documents, the American economy is hurt by the massive underpayment of taxes by the huge multinationals.
"I've Always Been Convinced that the Exchange Stabilization Fund is Involved in Stock [and] Commodity Transactions by Manipulating Price"
I'm reading Ron Paul's book "End the Fed", which is chock full of good quotes.
This one caught my eye:
I've always been convinced that the Exchange Stabilization Fund is involved in stock, commodity, and currency transactions by manipulating price.For more on the Exchange Stabilization Fund, see this, this and this.
As part of the ignored President’s Working Group on Financial Markets (Plunge Protection Team), the Treasury, along with the Fed, SEC, and CFTC, will continue to rescue the market any way possible. Unfortunately, it’s more like that its powers will be used to bail out friends at the expense of the rest of us.
For more on the Plunge Protection Team, see this, this and this.
And don't forget that the largest derivatives holders use their Counterparty Risk Management Policy Group (CRMPG) to literally collude - exchange secret information and formulate coordinated mutually beneficial actions - all with the government's blessings.
Saturday, November 7, 2009
Citigroup is ALREADY Being Broken Up ... But Not Enough
MarketWatch points out that Citigroup is actually already being broken up:
Citigroup Inc.... is already being broken up under part-ownership by the government, [Richard] Bove and other analysts say...
Citigroup, roughly a third owned by the government, is already being broken up, giving investors a preview of how other large financial institutions may be shrunk in future.
"The break-up of some of the banks has already occurred," Bove said. "Citigroup doesn't really exist anymore."
Late Thursday, the company unveiled plans for an IPO of its Primerica business, which sells life insurance, mutual funds, variable annuities and other financial products.
Citigroup sold its Smith Barney brokerage business to Morgan Stanley earlier this year and had already jettisoned most of its insurance operations.
Other businesses sold include its money-management arm, retail bank networks in Germany and Puerto Rico, brokerage, banking and consumer finance operations in Japan, Diner's Club and other credit card portfolios, payment processing businesses in the U.S., India and Brazil, and a controversial energy-trading unit called Phibro.Businesses that remain on the block include Commercial Credit, The Associates, most of its mortgage, auto and student-loan portfolios and possibly its Mexican bank, Bove said.
Citigroup had $2.4 trillion in assets in September 2007 and this has declined to $1.9 trillion in two years, the analyst noted.
Citigroup has housed all the businesses it doesn't want in Citi Holdings, while the operations it wants to keep are in Citicorp.
The remaining institution will have roughly $1 trillion in assets, with a leading credit-card business, a large retail bank in New York, a medium-sized retail bank in California, a clutch of small private banks globally and a top payment-processing and lending business, Bove said.
"The Treasury Secretary and numerous other bank regulators have spoken repeatedly about the need to gain the power to liquidate companies that pose systemic risks," the analyst wrote in a recent note to investors. "Citigroup is the laboratory experiment to show how it can be done."
I applaud peeling off divisions of the TBTFs. But unless Glass-Steagall is restored, and the overall size of the banks reduced significantly, they still pose a gigantic and very real risk to the economy.
Indeed, the MarketWatch article goes on to quote Economist Henry Kaufman (a former Salomon Brothers executive who was on the board of Lehman Brothers) and Simon Johnson saying the same thing:
The firms would probably still be too big to fail, Kaufman said, adding that the only way to change this is to shrink the firms and limit many of their activities...
Simon Johnson, an MIT professor and former chief economist at the International Monetary Fund, reckons there should be caps of roughly $100 billion on the assets of financial institutions and "serious criminal consequences" if firms are caught trying to get around such limits.Bove things that B of A will be next:
Bank of America, which has also received a lot of government support, is the next candidate to be broken up, Bove said.
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