Why Cheaters Prosper

Just Ask a Banker

by MIKE WHITNEY

 

Now there’s something you don’t see every day.

If I told you that the Wall Street Journal ran no less than 3 articles in the last week promoting more regulations, you’d think I was crazy. But it’s true. And, for once, the WSJ is right.

Last week, the Securities and Exchange Commission (SEC) voted down a proposal for rule changes that would have helped to avoid another financial meltdown like 2008. The vote was 3 to 2 and– as the editors of the WSJ opined– it illustrates the degree to which government regulators are captured by the industry.

“Captured”? Industry “slaves” is more like it.

Here’s the story: When Lehman Brothers failed in September 2008, there was a run on Reserve Primary Fund, a money market mutual fund that had a paltry 1.2% of its $63 billion in Lehman financial assets. Even so, when Primary “broke the buck” (and could no longer pay back its investors 100 cents on the dollar) panic spread through the market triggering a bank run. Prime money-market funds lost $310 billion or 15%  in less than a week. The panic put stocks into a nosedive which didn’t stop until the Fed extended a blanket taxpayer-funded guarantee on all money market funds.

Four years have passed since the money markets blew up and still nothing has been done to fix the problem, which means that it’s only a matter of time until the next meltdown.

Now, there are a couple of very easy ways to make the system safe again. Either the SEC can require the funds to have enough ready cash on hand to pay investors off “in full” if they want their money back on short notice or financial institutions can explain to investors that there are risks involved when they put their money into money market mutual fund accounts. (and that the value of their investment can go up or down) These aren’t FDIC-guaranteed depository accounts, even though everyone seems to think they are.

Both of these are straightforward solutions that would remedy the situation and assure that the financial system would not suffer another massive heart attack if one of these funds were to dip below 100 cents per dollar.

So why did 3 of the 5 SEC board members vote the measures down?

Well, because the banks don’t want to hold any additional capital to pay off investors in the event of a run. And, because the banks don’t want investors to know that they are actually taking a risk by putting their money in money market mutual funds. (They want to preserve the illusion that these are standard-issue checking-savings accounts) And, finally, because the banks know that if the system goes haywire again, the Fed and US Treasury will ride to rescue with more taxpayer-backed bailouts. So, why would they want to pay when Uncle Sam will cover their losses anyway? That’s how the banks see it.

Here’s a little more background from the Wall Street Journal:

“The industry notes that only two funds have ever broken the buck—and argues this is much ado about nothing. Yet that doesn’t mean other funds didn’t come close. A Boston Fed study—unchallenged by the industry—found “frequent and significant” cases in which companies that sponsor money funds had to bail them out. At least $4.4 billion was provided between 2007 and 2011 to at least 78 funds.”….

…the Treasury’s Office of Financial Research found that in April 2012—after those SEC changes had been implemented—there were 105 money-market funds with combined assets of more than $1 trillion that were at risk of breaking the buck if any of the top 20 outfits in which they invested defaulted. Of those, 14 were at risk of breaking the buck if any of the top 30 outfits in which they invested did so.

In ordinary times, that may be OK. In a crisis, it spells trouble, particularly since the funds tend to invest in the same securities.” (“SEC Can’t Agree on a Fix For Money-Market Funds”, David Wessel, Wall Street Journal)

So the idea that “only two funds have ever broken the buck” is pure baloney. These funds get into trouble all the time, which is why they need to be fixed, so the banks that run them provide the resources necessary to make them safe. At present, the financial institutions are getting a free ride, which is to say, they are recipients of an implicit government subsidy by virtue of the fact that the Fed will be forced to backstop their crappy mutual fund if the there’s another panic. That’s free insurance and, in 2008, it cost taxpayers a bundle.

This whole money market fracas is just like the regulatory issues surrounding securitization, which is the bundling of loans into securities.  Dodd-Frank is supposed to require originators of these garbage products to retain a portion of them for their own accounts. It’s called “risk retention” and it’s no different than an insurance company being required to keep some money on hand in case your bloody house burns down.

Fair enough? Well, of course, the banks don’t want to have skin in the game, not unless it’s your skin or my skin. So, they are fighting risk retention tooth and nail.

And they’re probably going to win that fight, too, because in the good old USA, cheaters always prosper. Just ask a banker.

Why We Don't Let Foxes in the Henhouse

Regulatory Capture
By DAVID MACARAY

"The Commission is, or can be made, of great use to the railroads. It satisfies the popular clamor for government supervision of the railroads, while, at the same time, that supervision is almost entirely nominal.” [italics added]

—Richard Olney, U.S. Attorney General, referring to the ICC (Interstate Commerce Commission), circa 1889.

"If the government is to tell big business men how to run their business, then don't you see that big business men have to get closer to the government even than they are now? Don't you see that they must capture the government in order not to be restrained too much by it? Must capture the government? They have already captured it.” [italics added]

—Woodrow Wilson, 1913

Regulatory Capture is defined as the phenomenon where “….a regulatory agency created to act in the public interest instead advances the commercial or special interests that dominate the industry or sector it is charged with regulating. [It] is a form of government failure, as it can act as an encouragement for large firms to produce ‘negative externality.’ The agencies are called Captured Agencies.”

It’s common knowledge that tobacco companies once enlisted shady doctors to deny the link between smoking and lung cancer, that corporations hire ex-IRS employees to advise them on how to avoid paying taxes, that coal mine companies have put mining safety regulators on their payrolls to grease the skids, and that ex-congressmen drool at the prospect of becoming top-dollar lobbyists.

Therefore, it shouldn’t come as any great surprise that Wall Street investment firms continue to hire government financial regulators to help them game the system.

And it’s not simply a matter of hiring these ex-regulators to assist in circumventing federal law. As devious and sleazy as that practice has become, what’s even more alarming is the conflict-of-interest charges leveled against regulators accused of lying, falsifying data, and “looking the other way” as a condition of future employment. But again, why would that shock anyone?

The relationship between financial institutions and the agencies established to regulate them has become so ridiculously cozy, so maggoty, that the Securities and Exchange Commission (SEC) is now regarded as the Oversight Fairy’s notion of an elaborate prank. The list of SEC officials who have left the Commission for highly lucrative jobs in the private sector is long and impressive (Linda Thomsen, Richard Walker, Bob Khuzami, Arthur Levitt, Gary Lynch, et al).

So what’s the remedy? How can we maintain the integrity of the agencies? It can’t simply be a matter of paying higher salaries to these agency people, because corporations will always be able to offer more—just as the drug cartels will never be outbid by the Mexican government. It’s no contest.

What needs to be done is to impose time restraints on changing teams. We need to regulate the regulators. Anyone who wishes to take a regulatory job with a Civil Service agency (which—let’s not forget—offers decent wages and benefits) must not be allowed to work for a private company within that same industry for a period of, say, seven years after leaving.

If that seems too harsh, or if it violates one’s finely tuned libertarian sensibilities, then so be it. If you can’t handle these restrictions going in, don’t work for the government. The Peace Corps had a rule where ex-volunteers couldn’t engage in military intelligence for a period of five years following our leaving the host country. It was part of the Peace Corps charter.

When you take a federal job, you are, in principle, promising to serve the citizens of the United States. These jobs should not be used as a springboard to higher paying positions within the industry you’re regulating, nor should they result in the very citizens you were empowered to serve being taken advantage of by your change of allegiance. It’s a covenant that any enlightened fourth-grader would understand.