Saturday, April 16, 2016

Along came Phil

Gramm, former Senator from the state of Texas to set a few facts straight in the Wall Street Journal about the cause of the financial crisis. I.e., it wasn't deregulation of the banking system;
Regulators also eroded the safety of the financial system by pressuring banks to make subprime loans in order to increase homeownership. After eight years of vilification and government extortion of bank assets, often for carrying out government mandates, it is increasingly clear that banks were more scapegoats than villains in the subprime crisis.
Similarly, the charge that banks had been deregulated before the crisis is a myth. From 1980 to 2007 four major banking laws—the Competitive Equality Banking Act (1987), the Financial Institutions, Reform, Recovery and Enforcement Act (1989), the Federal Deposit Insurance Corporation Improvement Act (1991), and Sarbanes-Oxley (2002)—undeniably increased bank regulations and reporting requirements. The charge that financial regulation had been dismantled rests almost solely on the disputed effects of the 1999 Gramm-Leach-Bliley Act (GLBA).
Prior to GLBA, the decades-old Glass-Steagall Act prohibited deposit-taking, commercial banks from engaging in securities trading. GLBA, which was signed into law by President Bill Clinton, allowed highly regulated financial-services holding companies to compete in banking, insurance and the securities business. But each activity was still required to operate separately and remained subject to the regulations and capital requirements that existed before GLBA. A bank operating within a holding company was still subject to Glass-Steagall (which was not repealed by GLBA)—but Glass-Steagall never banned banks from holding mortgages or mortgage-backed securities in the first place.
Bolds by HSIB in the above. As faithful readers here know, GLBA only repealed two provisions (of 34 original ones) of the Banking Reform Act of 1933 (AKA Glass-Steagall). And the two repealed were numbers 20 and 32--affiliations provisions that had prevented a holding company from owning separately both a commercial and an investment bank--not the actual provisions (16 and 21) defining and separating institutions that offer checking accounts from those underwriting corporate securities.

IOW, Bernie Sanders and his ilk are just flat out wrong to assert otherwise. Also, Sanders is wrong about the dangers of big banks, because elsewhere in his excellent piece, Gramm points out that the large banks were the ones that didn't need bailing out by TARP, because they were better capitalized. It was smaller banks that wouldn't have survived without the actions of Hank Paulsen, Ben Bernanke and Tim Geithner.
The subprime crisis was largely the product of government policy to promote housing ownership and regulators who chose to promote that social policy over their traditional mission of guaranteeing safety and soundness. But blaming the financial crisis on reckless bankers and deregulation made it possible for the Obama administration to seize effective control of the financial system and put government bureaucrats in the corporate boardrooms of many of the most significant U.S. banks and insurance companies.
Again, our bold in the above paragraph.

Thursday, February 18, 2016

EuroCoCo, Guy

We again interrupt our blogging hiatus, for another update on banking regulation.

Tuesday, at the Brookings Institution, about 30 minutes into this discussion, retired Fed Board of Governor's member Donald Kohn tells Minneapolis Fed President Neel Kashkari, pretty much what Bentley University macroeconomist Scott Sumner concluded last November: That had contingent convertible bonds, with an explicitly defined trigger been in place years before 2008, the financial crisis may well have been averted.

Kohn's reasoning was that back then the conversion to equity of the long term bonds (CoCos) in the capital structure of stressed firms (such as Bear Stearns and Lehman Bros) would have protected the short term bond holders from runs: That's where the danger was. He then goes on to point to the CoCos in Europe (where such bonds are already in place), as an example. He believes that developments in the last few weeks show that markets believe that the threat of conversion from debt to equity is now affecting bond prices and is evidence that bank regulators are alert to possible stress in the banking system. That they will allow the stressed financial institutions to be automatically recapitalized. I.e., CoCos will work as advertised as canaries in the coal mine, and avert a repeat of the disaster of 2008-09.

Of course, European bank managers aren't happy that they're being disciplined by markets (and regulators):
...investors have indeed flipped out with concern about Cocos after the German lender Deutsche Bank was forced to reassure investors it could meet interest, or coupon, payments on its Coco bonds. 
The move has stoked fears that something is rotten at the heart of the European banking sector and led many to question why Cocos – considered a silver bullet solution – have melted like their chocolate breakfast cereal namesake in the face of market turmoil.

Which is what Charles Calomiris reported was their reaction when CoCos were authorized by the  1999 legislation known as Gramm, Leach Bliley:
I would establish a minimum uninsured debt requirement for large banks in the form of subordinated debt, known as contingent capital certificates, or "CoCos." The CoCos would automatically convert to equity based on predetermined market triggers, which would be very dilutive to pre-existing shareholders. One banker who understood my proposal for CoCo's said, "You are putting an electric fence behind me."
It's a feature...not a bug, guys.

Well, back to hiatusing.