Recent events support financial regulation reform

In a fortuitous turn of events the SEC has decided to make a public announcement of a legal action based on things they have known about for at least a year in the Goldman Sachs case. Sure they had to study the case and try and convince themselves it might be winnable. It took some time, I'm sure. We can't help but notice how helpful for the progress of the party in power it is to put out some bluster on this right about now, while the financial reform legislation is about to come up for a vote in the Senate. That should be a good thing even if the SEC decided the case really is not winnable. It at least yields something useful from the time they have put in on this up to now. It may be all we really ever get out of it. A bunch of lawyers are sure to do well with it, but as for the rest of us I'm not so sure. I predict that when all is said in done many years hence the Status Quo will be largely undisturbed.

You see, my cynical alter ego knows that the rich will continue to get richer and that this is probably just another PR stunt that admittedly does involve some pain and even some financial loss for one of the great representatives of the rich. But the net effect will not be that the rich actually lose anything, they will just appear to lose for a while for political reasons. The banks are still being given cheap money to speculate with in the financial markets by the Fed on a huge scale. We have been funding what amounts to a dollar carry trade with the 0-0.25% money available at the Feds discount window. This normally happens on a smaller scale and at a somewhat higher interest rate, but since the banks have needed bailing out the size of the operation has been increased. If you pay any attention to the quarterly earnings reports you know that banks are reporting record profits, but it is all coming from their trading desks. They are still taking huge losses on the traditional banking business of making loans. Goldman Sachs is making a killing during this Great Recession. Of course, they don't really make loans, they are just a bank holding company so they can qualify for the Feds cheap money.

One thing to realize is that even in "normal" times, the manipulation of interest rates by the Fed serves to keep rates lower than historical norms during free market periods of our history. This has the effect of overstimulating the economy, of favoring investment in interest rate sensitive industries, and of providing relative economic advantage to the large entities which can deal with the Fed directly. It inherently favors big business over small, and leads to what otherwise would be unrealistically cheap products being produced in large quantity, which in turn leads to over consumption, and the associated higher levels of waste/pollution as a side effect. Put more simply, this type of economic management just leads to Too Much Stuff. With too much emphasis on activities that require low interest rates and/or high levels of liquidity for profitability we are more vulnerable to large scale business contractions and layoffs when interest rates rise or the Fed otherwise tightens liquidity conditions. And over all, the value of the dollar declines. It is less noticeable while the price of stuff doesn't rise, or even falls, due to the scale of production, but it does happen, is happening. The rich don't mind that we play this game because this form of economic management provides them with so many nice investment opportunities that it makes up for the decline in the value of the dollar.

Now you are privy to what my cynical alter ego knows. The people who are winning this game aren't interested in changing it in any material way. We ordinary citizens will have to get up very early, as they say, to stay on top of this and see to it that we get more than just the appearance of meaningful rule changes. We will have to know the rest of the story, including about the role of the Fed, and the NY Fed in particular, in how this game is played. I mean, is it reasonable to believe that when a body run by the elite of the banking industry is charged with regulating the banking industry that there isn't going to be just a bit of a bias in favor of their industry? Those favors can take many forms, many of which only financial experts could understand. But if we don't even take the initiative to find out what they are up to, then what chance do we have of understanding?

To that end we have been lobbying the local political party organizations to come out in support of the bills in Congress which call for the first real audit of the Federal Reserve. It has been a long time since any substantive changes have been made to the Federal Reserve system, since the 1930's for the most part. Since we have just come through what is said to have been an even larger financial crisis, this is an appropriate time to re-assess the role of this organization. Congress created it, and Congress can change it. In fact, doesn't Congress have a responsibility to ensure that it's creation serves the People's interests? A proper audit would be a good start on executing that responsibility.

I am very pleased to be able to say that we have made some progress towards our goal, at least in King County. The King County Democrats have passed a resolution in support of a Federal Reserve audit, (read it here) and we think the King County GOP will as well. The larger test comes in June at the State conventions. Stay tuned, stay energized. This is the real deal.

Report from Lehman Bankruptcy Examiner Implicates NY Fed

Mike Whitney, a Washington State local, posted an article on CounterPunch.org yesterday describing the findings of the report by the court appointed bankruptcy examiner in the Lehman Brothers case. As you may recall, the failure of Lehman Brother precipitated the climax of the Financial Crisis in 2008. Here is an excerpt, which draws heavily on Yves Smith's analysis presented on Naked Capitalism (recommended at left) last Friday:

"Geithner and Bernanke's Possibly Criminal Roles

Lehman Brothers Scandal Rocks the Fed

By MIKE WHITNEY

After a year-long investigation, court-appointed bank examiner Anton Valukas has produced a deadly 2,200 page report which details the activities that led to the Lehman Brothers bankruptcy. The report is a keg of dynamite. The question now is whether anyone in government has the nerve to light the fuse. Valukas provides powerful evidence that Lehman executives were involved in “balance sheet manipulation” by implementing an arcane accounting procedure called “Repo 105” which masked the bank's true financial condition from investors and regulators.

According to Valukas, Lehman was “Unable to find a United States law firm that would provide it with an opinion letter permitting the true sale accounting treatment" using Repo 105. So, Lehman executives went outside of the country in an effort to enlist the support of a London law firm that would approve the procedure.

It is impossible to overstate the significance of Valugas's findings. The report exposes the opaque but central role of the repo market which provides essential short-term loans for financial institutions. (Lehman used repos to conceal the full extent of its collapse, by dint of the amount of leverage it was using, meaning the pitiful asset anchor tethered to a vast zeppelin of debt) More importantly, it shows the cozy and, very probably criminal relationship between the country's main regulatory bodies and the Wall Street behemoths. The activities of the New York Fed (NYFRB), which at the time was headed by Timothy Geithner, is particularly suspect in this regard. The report should trigger an immediate Congressional investigation, probing the whole affair and most importantly the role of the Fed.

Naked Capitalism's Yves Smith, who has apparently sifted through all 2,200 pages of the report, has done some first-rate analysis of the details. Here's an excerpt from her Friday posting:

"Quite a few observers... have been stunned and frustrated at the refusal to investigate what was almost certain accounting fraud at Lehman. ....The unraveling isn’t merely implicating Fuld (Lehman’s CEO) and his recent succession of CFOs, or its accounting firm, Ernst & Young, as might be expected. It also emerges that the NY Fed, and thus Timothy Geithner, were at a minimum massively derelict in the performance of their duties, and may well be culpable in aiding and abettingLehman in accounting fraud and Sarbox violations....

“We need to demand an immediate release of the e-mails, phone records, and meeting notes from the NY Fed and key Lehman principals regarding the NY Fed’s review of Lehman’s solvency. If, as things appear now, Lehman was allowed by the Fed’s inaction to remain in business, when the Fed should have insisted on a wind-down .....

“…at a minimum, the NY Fed helped perpetuate a fraud on investors and counterparties. This pattern further suggests the Fed, which by its charter is tasked to promote the safety and soundness of the banking system, instead, via its collusion with Lehman management, operated to protect particular actors to the detriment of the public at large.

“And most important, it says that the NY Fed, and likely Geithner himself, undermined, perhaps even violated, laws designed to protect investors and markets. If so, he is not fit to be Treasury secretary or hold any office related to financial supervision and should resign immediately." (Naked Capitalism)

Repeat: "Accounting fraud", "collusion", "aiding and abetting." This is strong language from a woman who spent more than 25 years in the financial services industry, alternately working at Goldman Sachs, McKinsey & Co., and Sumitomo Bank. Smith typically chooses her words carefully and is not easily given to hyperbole. Yves Smith again: "Here is the part of the report that discussed how the Fed aided and abetted Lehman misconduct:"

Read the rest at http://www.counterpunch.org/whitney03152010.html

If you weren't convinced before that we should subject the Federal Reserve to a real audit for once...

The NY Fed branch is primarily implicated in shady dealings in this case. That branch has a long history of shady dealings. Try this - look up Benjamin Strong on the NY Fed web page.

http://www.newyorkfed.org/aboutthefed/BStrongbio.html

There is a very brief biographical sketch there. So brief and bland as to be nearly pointless. They certainly don't seem very interested in owning up to what this guy really represents. The reality is that Mr. Strong was at the meeting of a group of influential individuals who ginned up the idea of creating a Federal Reserve in the first place back in 1910, the famous Jekyll Island meeting. Then he became the first head of the NY Fed, where he proceeded to bend the rules to the breaking point and had a hand in causing the Great Depression. I leave it to you, dear reader, to do a search for information on Benjamin Strong and his counterpart at the Bank of England, Montagu Norman and learn something about this under your own steam.

The fact that there were 12 Federal Reserve districts, which were intended to prevent the concentration of power in NY City, made no difference then, and it still doesn't seem to make any difference now, 100 years later. At least the outline of the financial reform bill being discussed in the Senate now includes the idea of having the head of the NY Fed being appointed by the President. That is something at least. I'm not sure how much of a difference it will really make given the way politics works, but at least it acknowledges the problem.

Democratic 3/14 LD Caucus results, any reports folks?

Last week the Citizens Platform Committee ran ads on 3 radio stations in the Seattle Metro Area in the days leading up to Sunday, 3/14/2010. Then volunteers distributed printed copies of Federal Reserve Transparency resolutions to people attending the caucuses. At this point we do not know how many people managed to propose a motion to adopt the resolution, and whether or not the motions passed. If you can make a report about your caucus, please tell your story in a comment after this post. Inquiring minds want to know ;-)

A proposal for a Financial Regulation Reform Resolution

We are presenting here a suggested one page resolution supporting passage of Fair and Effective Financial Regulation Reform by Congress. The language is intentionally general since it is the principles which are the important thing in this case. You can modify the text as you wish. The important thing is to let our representatives know we are paying attention to this issue and expect real reform to emerge from Congress.
You can help develop this proposed resolution further by leaving comments, below.

Resolution Supporting Fair and Effective Financial Regulation


Whereas, the Democrats of the _____ Legislative District of Washington State believe that honest stewardship of the public money and credit is essential to social justice; and


Whereas, the Democrats of the ______ Legislative District of Washington State believe that money placed on deposit in a bank is the property of the account holder, not a capital pool for speculation by the bank, and the bank has a fiduciary responsibility to the account holders first and foremost, and that this relationship is essential to a stable, sustainable, financial system.

Further, we believe that the same principles of ownership and fiduciary responsibility of managers to account holders applies to money placed by citizens into other investing/savings vehicles which are not directly managed by the account holder, such as 401K and IRA plans, especially as participation is not entirely voluntary in many cases.

Therefore we believe that, at a minimum, the following 4 principles should be upheld in any Financial Regulation Reform passed by Congress:
1.) Full implementation of the “Volcker Rule” preventing retail banks from speculating in the financial markets with depositors funds.
2.) All investment companies that operate in public markets, including insurers, investment banks, hedge funds, banks, trusts, etc., should be subject to minimum capital requirements in order to keep financial leverage to within reasonable limits.
3.) The currently unregulated derivatives should be traded in transparent markets and participants should be required to maintain adequate capital reserves to cover their positions.
4.) The use of short term funding by investment companies that operate in public markets, including insurers, investment banks, hedge funds, banks, trusts, etc., should be subject to capital charges to reflect the higher risks involved in maintaining such investments.



Now therefore, on this the ___ Day of __________, in the year 20__, be it:



Resolved, that the Democrats of the ___ Legislative District of Washington State call upon the United States Congress to pass Financial Regulatory Reform Legislation that adheres to the above stated principles.
Be it further resolved that this resolution be transmitted to the Members of Congress representing the State of Washington.

Financial Regulation Reform Resolution Pt. 1

There is already a bill pending in the Senate to bring transparency to the activities of the Federal Reserve, the Federal Reserve Sunshine Act, S604. All that bill needs is the backing of more Senators, who are of course majority Democrats. The Federal Reserve tends to be overwhelmingly influenced by the NY Fed branch which holds over half the assets of the entire 12-region Federal Reserve System. You can bet they have friendly relations with the major Wall Street firms. You can bet their friends get somewhat preferential treatment when push comes to shove. There is a lot you can read about this on blogs like baselinescenario.com, co-founded by the ex-chief economist at the International Monetary Fund, Simon Johnson. And you have a ready-made resolution you can download and take to a caucus.

A bill to overhaul our system of financial regulations is still a ways from being written. So far it looks like Financial Industry lobbyists are getting plenty of access to their Senators and Congressmen. Us folks back home are not being heard on this issue. We need to get the attention of Congress, especially of the majority Democrats in the Senate, if we expect to get a fair shake in this process. You can write letters to your representatives, which is always worth doing, but we will get more serious consideration if the parties pass resolutions directing their representatives to include certain goals in the legislation. These are also good platform issues.

Financial regulation is a pretty technical topic, one that most people would not claim to understand. We have tried to present some background information on www.citizensplatformcommittee.org to get you started thinking about this. There are some basic points average people can understand. The so-called Volcker Rule is one of these. That proposed rule would prohibit retail banks from speculating in the markets with their money, which is to say our savings. I consider that a good idea. However, that by itself would not have prevented the financial crisis we are still suffering through. Most knowledgeable observers would agree that there was far too much leverage being used by trading firms, and that includes banks these days. Most observers also agree that the markets for securitized assets like those sub-prime mortgages packaged as CDOs and other assorted derivatives is not transparent and does not have any formal capital requirements.

Transparency and minimum capital requirements are accepted rules in the stock and bond markets where we ordinary folks keep our retirement savings in our 401Ks and IRAs. But those rules did not prevent us from losing roughly half our nest eggs during the credit crisis. That is because the same firms that hold large amounts of those "conservative" stock and bond investments were loosing HUGE sums in the unregulated derivatives markets and cash had to be raised from somewhere to cover the losses. They had to sell their stocks, among other things, and the value of their own shares fell dramatically, which did even more damage to the Mutual Funds so much of our retirement savings are invested in. It should be common sense that we need similar transparency and capital requirements for the currently unregulated parts of the financial industry so it can't drag the rest of us down like that again.

These points can provide the basis for a simple resolution calling for fair and effective financial regulation reform.

Caucus Resolutions Better than Letters to Congressmen

You probably remember the uproar that Henry Paulson's original TARP proposal created in the country. I remember a statement by a recently elected member of Congress that passing the TARP bailout was the hardest vote they had ever faced. The phone lines and e-mail in-boxes of Congress were burning up and bursting. This new Congress member said the letters and calls were running 50-50 - 50% No, and 50% HELL NO! But the majority voted for it anyway. Well, OK, we can excuse them for being scared to death of setting off the next Great Depression. Still, it makes you wonder if letters and phone calls are really taken seriously by our representatives in the political process.

Fortunately there is another way of communicating our wishes to our political representatives. Folks, it is time to start flexing this neglected muscle. In our state, Washington, the Democratic Party is holding legislative district caucuses in about a week. Anyone who has not participated in the process of another party can join in the fun. You don't have to have been to a caucus before or have been elected PCO or anything else to attend. All you need is to be a concerned citizen. By participating in the caucus you will provide input to the selection of candidates and the creation of the party platform those candidates will be expected to follow. The platform proposals and resolutions that come out of the caucus will be seen by the currently serving Democratic politicians as a direct read of the minds of the voting public, their voting public. The resolutions from the caucus are considered to be from the "party faithful" and will carry more weight than letters from the anonymous masses, and they are expected to heed these resolutions by the party rules. Best of all, you only need one other person to second your motion to bring a resolution up for discussion and vote.

Right now most of the Democrats in the US Senate, in particular, don't seem convinced that the American people really want effective financial regulation reform. They don't seem convinced that we are concerned about the self-serving behavior of our Central Bankers in New York. You may have noticed that when we bailed out General Motors the company was downsized and some heads rolled. What about the banks we bailed out? Are they smaller now? Did any CEOs get put out to pasture? No, the "too big to fail" banks are mostly bigger and more powerful now and their lobbyists are standing in the way of any meaningful regulatory reform legislation in the Senate. We need to let the politicians in office now KNOW we are watching and expecting them to do the right thing.