Before the Election was Over, Wall Street won

Before the campaign contributors lavished billions of dollars on their favorite candidate; and long after they toast their winner or drink to forget their loser, Wall Street was already primed to continue its reign over the economy.

For, after three debates (well, four), when it comes to banking, finance, and the ongoing subsidization of Wall Street, both presidential candidates and their parties’ attitudes toward the banking sector is similar  – i.e. it must be preserved – as is – at all costs, rhetoric to the contrary, aside.

Obama hasn’t brought ‘sweeping reform’ upon the Establishment Banks, nor does Romney need to exude deregulatory babble, because nothing structurally substantive has been done to harness the biggest banks of the financial sector, enabled, as they are, by entities from the SEC to the Fed to the Treasury Department to the White House.

In addition, though much is made of each candidates' tax plans, and the related math that doesn’t add up (for both presidential candidates), the bottom line is, Obama hasn’t explained exactly WHY there’s $5 trillion more in debt during his presidency, nor has Romney explained HOW to get a $5 trillion savings. 

For the record, both missed, or don’t get, that nearly 32% of that Treasury debt is reserved (in excess) at the Fed, floating the banking system that supposedly doesn’t need help. The ‘worst economic period since the Great Depression’ barely produced a short-fall of  an approximate average of $200 billion in personal and corporate tax revenues per year, according to federal data.)

Consider that the amount of tax revenue since 2008, has dropped for individual income contributions from $1.15 trillion in 2008 to $915 billion in 2009, to $899 billion in 2010, then risen to $1.1 trillion in 2011. Corporate tax contributions have dropped (by more of course) from $304 billion in 2008 to $138 billion in 2009 to $191 billion in 2010, to $181 billion in 2011. Thus, at most, we can consider to have lost $420 billion in individual revenue and $402 billion in corporate revenue, or $822 billion from 2009 on. The Fed has, in addition, held on average of $1.6 trillion Treasuries in excess reserves. That, plus $822 billion equals $2.42 trillion, add on the other $900 billion of Fed held mortgage securities, and you get $3.32 trillion, NOT $5 trillion, and most to float banks.

The most consistent political platform is that big finance trumps main street economics, and the needs of the banking sector trump those of the population.  We have a national policy condoning zero-interest-rate policy (ZIRP) as somehow job-creative. (Fed Funds rates dropped to 0% by the end of 2008, where they have remained since.)

We are left with a regulatory policy of pretend. Rather than re-instating Glass-Steagall to divide commercial from investment banking and insurance activity, thereby removing the platform of government (or public) supported speculation and expansion, props leaders that pretend linguistic tweaks are a match for financial might. We have no leader that will take on Jamie Dimon, Chairman of the country’s largest bank, JPM Chase, who can devote 15% of the capital of JPM Chase, which remains backstopped by customer deposit insurance, to bet on the direction of potential corporate defaults, and slide by two Congressional investigations like walks in the park.

Pillars of Collusion

A few months ago, Paul Craig Roberts and I co-wrote an article about the LIBOR scandal; the crux of which, was lost on most of the media. That is; the banks, the Fed, and the Treasury Department knew banks were manipulating rates lower to artificially support the prices of hemorrhaging assets and debt securities. But no one in  Washington complained, because they were in on it; because it made the over-arching problem of debt-manufacturing and bloating the Fed’s balance sheet to subsidize a banking industry at the expense of national economic health, evaporate in the ether of delusion.

In the same vein, the Fed announced QE3, the unlimited version – the Fed would buy $40 billion a month of mortgage-backed securities from banks. Why – if the recession is supposedly over and the housing market has supposedly bottomed out – would this be necessary? 

Simple. If the Fed is buying securities, it’s because the banks can’t sell them anywhere else. And because  banks still need to get rid of these mortgage assets, they won't lend again or refinance loans at faster rates, thereby sharing their advantage for cheaper money, as anyone trying to even refinance a mortgage has discovered. Thus, Banks simply aren’t ‘healthy’, not withstanding their $1.53 trillion of excess reserves (earning interest), and nearly $900 billion in mortgage backed securities parked at the Fed. The open-ended QE program is merely perpetuating the illusion that as long as bank assets get marked higher (through artificial buyers, zero percent interest rates, or not having to mark them to market), everything is fine.

Meanwhile, Washington coddles and subsidizes the biggest banks - not to encourage lending, not to encourage saving, and  not to better the country, but to contain harsh truths about how badly banks played, and are still playing, the nation.

The SEC’s Role

According to the SEC’s own report card on “Enforcement Actions: Addressing Misconduct that led to or arose from the Financial Crisis”: the SEC has levied charges against 112 entities and individuals, of which 55 were CEOs, CFOs, and other Senior Corporate Officers.

In terms of fines; the SEC ‘ordered or agreed to’ $1.4 billion of penalties, $460 million of disgorgement and prejudgment interest, and $355 million of “Additional Monetary Relief Obtained for Harmed Investors. That’s a  grand total of $2.2 billion of fines. (The Department of Justice dismissed additional charges or punitive moves.)

Goldman, Sachs received the largest  fine, of $550 million, taking no responsibility (in SEC-speak, “neither confirming nor denying’ any wrongdoing) for packaging CDOs on behalf of one client, which supported their prevailing trading position, and pushing them on investors without disclosing that information, which would have materially changed pricing and attractiveness. (The DOJ found nothing else to charge Goldman with, apparently not considering misleading investors, fraud.)

Obama-appointed SEC head, Mary Shapiro, originally settled with Bank of America for a friendly $34 million, until Judge Rakoff quintupled the fine to $150 million, for misleading shareholders during its Fed-approved, Treasury department pushed, acquisition of Merrill Lynch, regarding bonus compensation. (Merrill’s $3.6 billion of  bonuses were paid before the year-end of 2008, while TARP and other subsidies were utilized). Still embroiled in ongoing lawsuits related to its Countrywide acquisition, Bank of America agreed to an additional $601.5 million in one non-SEC settlement, and $2.43 billion in another relating to those Merrill bonuses. Likewise, Wells Fargo agreed to pay $590 million for its fall-2008 acquisition of Wachovia’s foul loans and securities. These are small prices to pay to grow your asset and customer base.

Citigroup agreed to pay $285 million to the SEC to settle charges of misleading investors and betting against them, in the sale of one (one!) $1 billion CDO. Judge Rakoff rejected the settlement, but Citigroup is appealing. So is its friend, the SEC.  Outside of that, Citigroup agreed to an additional $590 million to settle a shareholder CDO lawsuit, denying wrongdoing.

JPM Chase agreed to a $153.5 million SEC fine relating to one (one!) CDO. Outside of Washington, it agreed to a $100 million settlement for hiking credit card fees, and a $150 million settlement for a lawsuit filed by the American Federation of Television and Radio Artists retirement fund and other investors, over losses from its purchase of  JPM’s Sigma Finance Hedge Fund, when it used to be rated ‘AAA.’

There you have it. No one did anything wrong. The total of $2.2 billion in SEC fines, and about $4.4 billion in outside lawsuits is paltry. Consider that for the same period (since 2007), total Wall Street bonuses topped $679 billion, or nearly 309 times as much as the SEC fines, and 154 times as much as all the settlements.

The SEC & Dodd Frank Dance

The SEC embarked upon 90 actions, divided into 15 categories, related to the Dodd-Frank Act that amount to proposing or adopting rules with loopholes galore, and creating reports that summarize things we know. Some of the obvious categories, like asset backed related products or derivatives, don’t even include CDOs, which got the lion’s share of SEC fines and DOJ indifference.

Rather than tightening regulations on the most egregious financial product culprits; insurance swaps, such as the credit default swaps imbedded in CDOs, the SEC loosened them. It did so by approving an order making many of the Exchange Act requirements not applicable to security-based swaps. In one new post-Dodd-Frank order, it stated, a “product will not be considered a swap or security-based swap if ,,, it falls within the category of…insurance, including against default on individual residential mortgages.” Thus, credit default swaps, considered insurance since their inception, warrant no special attention in the grand land of sweeping reform.

The credit ratings category includes 20 items proposed, requested, or adopted. Under things accomplished, the SEC gave a report to Congress that basically says that the majority of rating agency business is paid for by issuers (which we knew), and proclaims (I kid you not) that a security is rated “investment grade” if it is rated “investment grade” by at least one rating agency. Further inspection of SEC self-labeled accomplishments provides no more confidence, that anything has, or will, change for the safer.

The White House & Congress

Yet, the Obama White House wants us to believe that Dodd-Frank was ‘sweeping reform.’ Romney and the Republicans are up and arms over it, simply because it exists and sounds like regulation, and Democrats defensively portray its effectiveness.

Ignore them both and ask yourself the relevant questions. Are the big banks bigger? Yes. Can they still make markets and keep crappy securities on their books, as long as they want, while formulating them into more complicated securities, buoyed by QE measures and ZIRP? Yes. Do they have to evaluate their positions in real world terms so we know what’s really going on? No.

Then, there’s the Volcker Rule  which equates spinning off private equity desks or moving them into asset management arms, with regulatory progress. If it could be fashioned to prohibit all speculative trading or connected securities creation on the backbone of FDIC-insured deposits, it might work, but then you’d have Glass-Steagall, which is the only form of regulatoin that will truly protect us from banking-spawned crisis.

Meanwhile, banks can still make markets and trade in everything they were doing before as long as they say it’s on behalf of a client. This was the entire problem during the pre-crisis period. The implosion of piles of toxic assets based on shaky loans or other assets didn’t result from  private equity trading or even from isolating trading of any bank’s own books (except in cases like that of Bear Stearns’ hedge funds), but from federally subsidized, highly risky, ridiculously leveraged, assets engineered under the guise of 'bespoke' customer requests or market making related ‘demand.’ 

When the Banking Act was passed in 1933, even Republican millionaire bankers, like the head of Chase, Winthrop Aldrich, understood that reducing systemic risk might even help them in the long run, and publicly supported it. Today, Jamie Dimon shuns all forms of separation or regulation, and neither political party dares interfere.

But things worked out for Dimon. JPM Chase’s board (of which he is Chairman) approved his $23 million 2011 compensation package (the top bank CEO package), despite disclosure of a $2 billion (now about $6 billion) loss in the infamous Whale Trade. He banked $20.8 million in 2010, the highest paid bank CEO that year, too. In 2009, Dimon made $1.32 million, publicly, but really bagged $16 million worth of stock and options. He made $19.7 million in total compensation for 2008, and $34 million for 2007. Still a New York Fed, Class A director, he’s proven himself to be untouchable.

Yet, the kinds of deals that were so problematic are creeping back. According to Asset Backed Alert, JPM Chase was the top asset-baked security (ABS) issuer for the first half of 2012, lead managing $66 billion of US ABS deals.

In addition, according to Asset Back Alert, US public ABS deal volume rose 92.8% for the second half of 2012 vs. 2011, while issuance of US prime MBS (high quality deals) fell 50.6%. Overall CDO issuance rose 50.2%. (Citigroup is the lead issuer (up 552%.))

ZIRP’s  hidden losses

According to a comprehensive analysis of data compiled from regulatory documents by  Bill Moreland and his team at my new favorite website, www.bankregdata.com, some really scary numbers pop out. Here’s the kicker: ZIRP costs citizens and disproportionately helps the biggest banks, by about $120 billion a year.

Between 2005 and 2007, US commercial banks held approximately $6.97 trillion of interest bearing customer deposits. During the past two quarters, they held an average of $7.31 trillion. During that first period, when fed funds rates averaged 4.5%, banks paid their customers an average of $39.6 billion of interest per quarter. More recently, with ZIRP, they paid an average of $8.9 billion in interest per quarter, or nearly 77% LESS. In dollar terms - that’s about $30.7 billion less per quarter, or $123 billion less per year.

Since ZIRP kicked into gear in 2008, banks have saved nearly $486 billion in interest payments. Average salary and compensation increased by approximately 23%. Dividend payments declined by 14.05%.

The biggest banks are the biggest takers. Consider JPM Chase’s cut. Although its deposits disproportionately increased by 46% from 2007 (pre ZIRP and helped by the acquisition of Washington Mutual) to 2012, its interest expenses declined by nearly 89%. From 2004 to 2007, Chase paid out $34.4 billion in interest to its deposit customers. From 2008 to mid-2012, it paid out $3.4 billion. JPM Chase’s ratio of interest paid to deposits of .27% is the lowest of the big four banks, that on average pay less than smaller banks anyway.

The percentage of JPM Chase’s assets comprised of loans and leases is lower at 36.04% compared to its peers’ percentage of 52.4%. Its trading portion of assets is higher, as 14.78% vs. 6.88% for its peers, and 4.23% for all banks.

Looking Ahead

To recap: savers, borrowers, and the economy are still losing money due to the preservation of the illusion of bank health. More critically, the big banks grew through acquisitions and the ongoing closures of smaller local banks that provided better banking terms to citizens.  The big banks have more assets and deposits, on which they are over-valuing prices, and paying less interest than before, due to a combination of Fed and Treasury blessed mergers in late 2008, QE and ZIRP. Yet, we’re supposed to believe this situation will somehow manifest a more solid and productive economy.  

Meanwhile, past faulty securities and  loans will fester until their transfer to the Fed is complete or they mature, while new ones take their place. This will inevitably lead to more of a clampdown on loans for productive purposes and further economic degradation and instability. Financial policy trumps economic policy. Banks trump citizens, and absent severe reconstruction of the banking system, the cycle will absolutely, unequivocally continue.

The Real Libor Scandal by Paul Craig Robert & Nomi Prins

(Note: I was deeply honored to have been asked to be a co-author on this piece by Paul Craig Roberts)

According to news reports, UK banks fixed the London interbank borrowing rate (Libor) with the complicity of the Bank of England (UK central bank) at a low rate in order to obtain a cheap borrowing cost. The way this scandal is playing out is that the banks benefitted from borrowing at these low rates. Whereas this is true, it also strikes us as simplistic and as a diversion from the deeper, darker scandal.

Banks are not the only beneficiaries of lower Libor rates. Debtors (and investors) whose floating or variable rate loans are pegged in some way to Libor also benefit. One could argue that by fixing the rate low, the banks were cheating themselves out of interest income, because the effect of the low Libor rate is to lower the interest rate on customer loans, such as variable rate mortgages that banks possess in their portfolios. But the banks did not fix the Libor rate with their customers in mind. Instead, the fixed Libor rate enabled them to improve their balance sheets, as well as help to perpetuate the regime of low interest rates. The last thing the banks want is a rise in interest rates that would drive down the values of their holdings and reveal large losses masked by rigged interest rates.

Indicative of greater deceit and a larger scandal than simply borrowing from one another at lower rates, banks gained far more from the rise in the prices, or higher evaluations of floating rate financial instruments (such as CDOs), that resulted from lower Libor rates. As prices of debt instruments all tend to move in the same direction, and in the opposite direction from interest rates (low interest rates mean high bond prices, and vice versa), the effect of lower Libor rates is to prop up the prices of bonds, asset-backed financial instruments, and other "securities." The end result is that the banks' balance sheets look healthier than they really are.

On the losing side of the scandal are purchasers of interest rate swaps, savers who receive less interest on their accounts, and ultimately all bond holders when the bond bubble pops and prices collapse.

We think we can conclude that Libor rates were manipulated lower as a means to bolster the prices of bonds and asset-backed securities. In the UK, as in the US, the interest rate on government bonds is less than the rate of inflation. The UK inflation rate is about 2.8%, and the interest rate on 20-year government bonds is 2.5%. Also, in the UK, as in the US, the government debt to GDP ratio is rising. Currently the ratio in the UK is about double its average during the 1980-2011 period.

The question is, why do investors purchase long term bonds, which pay less than the rate of inflation, from governments whose debt is rising as a share of GDP? One might think that investors would understand that they are losing money and sell the bonds, thus lowering their price and raising the interest rate.

Why isn’t this happening?

PCR’s June 5 column, “Collapse at Hand,” explained that despite the negative interest rate, investors were making capital gains from their Treasury bond holdings, because the prices were rising as interest rates were pushed lower. 

What was pushing the interest rates lower?

The answer is even clearer now. First, as PCR noted, Wall Street has been selling huge amounts of interest rate swaps, essentially a way of shorting interest rates and driving them down. Thus, causing bond prices to rise.

Secondly, fixing Libor at lower rates has the same effect. Lower UK interest rates on government bonds drive up their prices.

In other words, we would argue that the bailed-out banks in the US and UK are returning the favor that they received from the bailouts and from the Fed and Bank of England’s low rate policy by rigging government bond prices, thus propping up a government bond market that would otherwise, one would think, be driven down by the abundance of new debt and monetization of this debt, or some part of it.

How long can the government bond bubble be sustained? How negative can interest rates be driven?

Can a declining economy offset the impact on inflation of debt creation and its monetization, with the result that inflation falls to zero, thus making the low interest rates on government bonds positive?

According to his public statements, zero inflation is not the goal of the Federal Reserve chairman. He believes that some inflation is a spur to economic growth, and he has said that his target is 2% inflation. At current bond prices, that means a continuation of negative interest rates.

The latest news completes the picture of banks and central banks manipulating interest rates in order to prop up the prices of bonds and other debt instruments. We have learned that the Fed has been aware of Libor manipulation (and thus apparently supportive of it) since 2008. Thus, the circle of complicity is closed. The motives of the Fed, Bank of England, US and UK banks are aligned, their policies mutually reinforcing and beneficial. The Libor fixing is another indication of this collusion.

Unless bond prices can continue to rise as new debt is issued, the era of rigged bond prices might be drawing to an end. It would seem to be only a matter of time before the bond bubble bursts.

JPM Chase Chairman, Jamie Dimon, the Whale Man, and Glass-Steagall

It was fitting that while President Obama and his Hollywood apostles broke fundraising records at a sumptuous $40,000 per plate dinner at George Clooney’s place, word of JPM Chase’s ‘mistake’ rippled through the news. Not long ago, Dimon’s name was batted about to become Treasury Secretary.  But as lines are drawn and pundits take sides in the Jamie Dimon ego deflation saga – or, as I see it - why big banks should be made smaller and then, broken up into commercial vs. speculative components ala Glass Steagall – it’s important to look beyond the size of the $2 billion dollar (and counting) beached whale of a trading loss.

Yes, $2 billion in the scheme of JPM Chase’s book and quarterly earnings is tiny, a ‘trading blip’ as it’s been called by some business press. But that’s not a mitigating factor in what it represents. In this era dominated by a few consolidated and complex banks, the very fact that it’s a relatively small loss IS the red flag. 

First - because the loss could (and will) grow. Second, because even if it doesn’t, it’s a blatant example of a big bank incurring un-due risk within barely regulated, highly correlated financial markets. It only takes another Paulson hedge fund, or a trading desk at Goldman Sachs, to short the hell out of the corporates that JPM Chase is synthetically long, or take whatever the other side really is, to create a liquidity crisis that will further screw those least able to access credit – individuals, small businesses, and productive capital users.

We know this. We’ve seen this. We're in this. There’s no such thing as an isolated trading loss anymore. And yet Jamie Dimon, seated atop the most powerful bank in the world, has smugly led the charge to adamantly oppose any moves to alter the banking framework that allows him, or any bank, to call a bet - a hedge or client position or market-making maneuver  - with central bank, government official, and regulatory impunity.

Flashback to the unimaginable in 1933

It’s 1933 and the country has undergone several years of painful Depression following the 1920s speculation that crashed in the fall of 1929. Investigations into the bank related causes began under Republican President, Herbert Hoover and continued under Democratic President, FDR.

Okay, that’s pretty common knowledge. But, here’s something that isn’t: of all the giant banks operating their trusts schemes and taking advantage of off-book deals, and international bets in the late 1920s, it was an incoming head of Chase (replacing Al Wiggins who shorted Chase stock in a network of fraud) that advocated for Glass-Steagall. Indeed, despite all pedigree to the opposite (his father was Senator Nelson Aldrich architect of the Federal Reserve and brother-in-law, John D. Rockefeller), Chase Chair, Winthrop Aldrich, took to the front pages of the New York Times in March, 1933 to pitch decisive separation of commercial and speculative activity arguments.  Fellow bankers hated him.

His motives weren’t totally altruistic to be sure, but somewhere in his calculation that Chase would survive a separation of activities and emerge stronger than rival, Morgan Bank, was an awareness that something more – permanent – had to be put in place if only to save the banking industry from future confidence breaches and loss. It turned out he was right. And wrong. (much more on that in my next book, research still ongoing.)

Financial history has a sense of irony. JPM Chase was the post-Glass-Steagall repeal marriage, 66 years in the making, of  Morgan Bank and Chase. Today, it is the largest bank in America, possessing greater control of the nation’s cash than any other bank.  It also has the largest derivatives exposure ($70 trillion) including nearly $6 trillion worth of credit derivatives. 

It is the size of a bank holding company’s deposits that dictates the extent of the risk it takes, risk ‘models’ not withstanding: the more deposits, the more risk, the more potential loss. JPM Chase is not alone in using its position as deposit taker to increase speculation, but it has more to play with.

And the more access to other people’s money, the greater the gambling incentive. The largest banks hold deposits (our deposits) hostage in the global game of financial warfare. Related access to capital and bailouts are enabling weaponry in the fight for worldwide insitutional supremacy.

The Alleged Hedge

Now, consider JPM Chase’s alleged ‘hedge’ itself; a trading position taken in the London department, the chief investment office,  set up to allegedly protect the bank’s overall book and ‘invest’ its excess capital.  Any investment is a bet. A hedge is supposed to mitigate loss if the bet fails. An investment is not a hedge.

Let’s pretend for a moment that banks were about simple conventional - banking – taking deposits and making loans. In that context, it would be nonsensical to hedge loan risk by pouring on more loan risk, or put out a fire by pouring fuel on its flames.

In other words, if a bank lends money to, say Boeing, it accepts a rate, in return,  more or less related to its assessment of the risk involved in getting its money back, which translates into an interest payment. To hedge that payment, a bank could purchase ‘insurance’ or ‘protection’ from a counterparty solvent enough to make good on any shortfall in Boeing’s ability to pay its interest, or in the event of an Boeing default.  What is not a hedge for the loan, is further exposure to the risk that Boeing could default.  Yet, in a more complex manner, that’s exactly what happened here.

By engaging in a trade that tied up 15% of its assets, or $350 billion, no matter what label that trade received, the Whale man and his managers (leading up to Jamie Dimon), went long credit risk by shorting an index of synthetic credits, thereby placing the bank in the position of paying out, or losing money, if those credits deteriorate. In effect, and super-simplistically, it doubled down. In its more complex form, the firm took a short position in an index of credit default swaps representing 125 North American investment grade corporations (including Boeing), called the CDX.NA.IG.9. The index reference of underlying corporates has been diving in price, hence the loss - and mounting loss to JPM.

Deception and Delusion

Going long the corporate credit market while still immersed in the fallout of having been long the European sovereign and US real estate market, demonstrates the same cluelessness about the economy and financial system prevalent in the media and in Washington every time the words ‘slow recovery’ rather than something to the effect of ‘prolonged, continued, enduring depression’ are uttered.

In such a charade, why wouldn’t JPM Chase, a bank existing on an array of federal largesse, and Jamie Dimon who was re-voted to Class A NY Fed Director, the position he held during the 2008 crisis, in early 2010 – rubber stamp a bet that corporate economic health is a foregone conclusion.

It was under that same misplaced, other people’s money optimism and hubris that MF Global stole (or for the apologists, ‘mistakenly took’) $1.6 billion of its segregated customers' money to stay in a bad bet. Former MF Global CEO, the ‘honorable’ Jon Corzine’s bet was that certain European sovereign credits would improve. Only they didn’t. Not in time for his margins to hold out.

It’s more than ironic, that JPM Chase, the bank still entangled with MF Global customer money, took the same bet, albeit with different credits and is trying to pawn it off as an ‘egregious’ mistake, a blip on the radar of an otherwise pristinely risk-managed bank.

It’s also supremely annoying that Dimon is right about something, that the Volcker Rule wouldn’t necessarily apply to this ‘hedge.’ There’s nothing particularly wrong with the Volcker Rule; it will mitigate some fraction of risk, though given the SEC and Fed’s inability to understand what risk is, it’s unlikely they’ll take the mental leap to segment trades as mitigating it, or not. Yet, the Volcker Rule will not change one fundamental pillar of global systemic risk – as long as banks are not segregated ala Glass Steagall along deposit-taking  / loan-making vs. speculation lines, they will have access to capital to burn. And burn it they will.