Remembering a day that was too big to forget

Posted on March 5, 2016September 25, 2019 by j.giglio

This month marks the anniversary of the collapse of Bear Stearns, once Wall Street’s fifth-largest investment bank. The demise of the 85-year old institution signaled the real start of the 2008-2009 financial crisis. Eight years later, we can only hope our leaders learned something from the experience.

The collapse and Bear’s subsequent bailout by the Federal Reserve, with the support of the Treasury Department and JPMorgan Chase sent shockwaves throughout the financial system. Bear’s incredibly rapid demise raised serious questions about the banking industry’s use of leverage, inadequate oversight of commercial and investment banks, and the role of the Fed and other regulators in preventing the failure of major financial institutions.

Late on Sunday afternoon, March 16, 2008, Bear’s board of directors accepted JPMorgan Chase’s offer to purchase the company. Less than 18 months after its stock was trading at an all-time high of $172.61 a share, Bear Stearns had little choice but to accept the humiliating offer of $2 a share.

JPMorgan Chase later raised the bid to $10 per share and the Fed provided $30 billion in collateral guarantees to facilitate the deal. The Fed considered Bear too large and too interconnected to fail and saw no choice but to arrange a bailout to prevent a global market crisis. It was hoped that the Bear rescue would nip the problem in the bud and avoid the damage to the larger financial world that many policymakers thought would result from the failure of a major investment bank.

The precise nature of the transaction seemed unclear, but the Fed appeared to be accepting responsibility for the toxic, illiquid assets on Bear’s balance sheet if their eventual liquidation resulted in a loss. In this sense, it appeared that the Fed became the residual owner of these securities and put the federal taxpayer on the hook for Bear’s reckless risk taking activities. Some believe that this action exceeded the Fed’s power.

The first sign of trouble at Bear was the July 2007 collapse of two of its hedge funds. The funds had invested heavily in collateralized debt obligations backed by subprime mortgages, and their failure alerted the rest of the financial system to this contagion.

The hedge funds’ collapse also raised concerns about the firm’s own exposure to mortgage-related securities. It damaged the firm’s reputation, weakened its finances and served as the precursor to Bear’s ultimate collapse. Within a year “the plumbing had stopped working” and credit ceased to flow through the financial system.

Hopes that a global financial crisis could be averted proved misplaced just six months later when Lehman Brothers, another bank that was heavily involved in the mortgage business and was even larger than Bear filed for Chapter 11 bankruptcy on September 15, 2008. The public backlash against the Bear bailout made rescuing the 158 year-old Lehman Brothers politically untenable, especially just weeks before a hotly contested presidential election.

The 2008-2009 financial crisis proved to be the most expensive in history. On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank), one of the most sweeping financial reforms in U.S. history.

The law’s stated aim is to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.” Essentially, Congress’s intent was to reduce system-wide risk and to prevent another financial collapse.

Let’s hope policy makers actually learned enough about how the economy and the financial system fit together from the 2008-2009 financial crisis to avoid future learning experiences. They would be well advised to recall the words of that prolific author, anonymous, who said, “The past is prologue: but which past?”

originally published: March 5, 2016

Corporations’ interest vs. the public interest

Posted on October 10, 2015September 25, 2019 by j.giglio

There is much truth to the cliche that politicians are primarily interested in getting re-elected. To achieve this goal they cater to the small group of voters who are paying attention to the details of the legislative process – and often looking to cook up a raiding party on the public interest to promote their own goals.

Take a provision tucked into the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank), one of the most sweeping financial reform bills in U.S. history, which President Obama signed into law in 2010. Dodd-Frank demonstrates that policy making is dominated by powerful businesses and other well-organized special interests.

In the aftermath of the historic bailout of the financial system and major banking houses in 2008 and 2009, which precipitated the worst economic downturn since the Great Depression, the financial industry fell under intense criticism and scrutiny. The omnibus 2,300-page bill was passed in response to this financial and economic crisis.

Its stated aim was to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purpose.” It was supposed to reduce system-wide risk and prevent a financial collapse like the one in 2008.

While the law did not lay a hand on Fannie and Freddie Mac, major players in the 1997-2007 housing bubble and the subsequent financial crisis, it did address the subject of “conflict minerals” that was promoted by certain non-governmental organizations supported by celebrities such as George Clooney and Brad Pitt.

These activists lobbied Congress and got them to state that the exploitation and trade of certain conflict minerals was fueling a humanitarian crisis in the Democratic Republic of the Congo that warranted the imposition of disclosure requirements.

The NGOs argued that profits from conflict minerals have helped fund the conflict between rebel militias and government troops in Congo that has claimed millions of lives and resulted in widespread human rights abuses, including violence against women and the conscription of children as soldiers.

The conflict minerals are tantalum, tin, tungsten, and gold, which are used in many industries. Tungsten, for example, is used in the screens of cellphones and tin is used to solder circuit boards.

Congress directed the Securities and Exchange Commission to promulgate a rule requiring thousands of publicly traded U.S. companies to investigate whether they or any of their suppliers use minerals mined in the conflict-ridden parts of Congo and to annually disclose the origins of conflict minerals necessary to its operations if the minerals originate from Congo or an adjoining country.

Supporters of the Dodd-Frank conflict minerals provision and of the SEC implementing rule argue that such disclosures reduce the violence involved with the mining of conflict minerals. Opponents argue that they are burdensome and costly to administer.

Combating brutal human rights abuses in the Congo is surely a good idea, but is a Wall Street Reform bill the appropriate place to do it? And is the SEC the right entity to implement the law?

And what are the boundaries of corporate social responsibility? How much responsibility does a firm have for its supply chain? Are there alternative and transparent approaches to dealing with the issue of conflict minerals? Corporations cannot be asked to solve all the world’s problems.

The financial industry was widely criticized for its intense lobbying efforts to shape Dodd-Frank’s legislative and rule making process. But they were not the only ones to convince lawmakers eager to curry favor with powerful special interests to include provisions in the legislation that promote their own rather than the public interest.

Originally Published: October 10, 2015

Dancing on the edge of absurdity

Posted on October 25, 2014September 25, 2019 by j.giglio

There can be little doubt that one of the causes of the 2008 financial crisis was diminished regulatory control , the seeds of which were sown during the three preceding decades.

Recent legislation re-regulates financial markets, but attracting the best and brightest to regulatory jobs is proving to be a major challenge. The congressionally authorized Financial Industry Regulatory Authority, a not-for-profit self-regulator, may offer a solution to the problem.

Beginning with the Carter administration and accelerating during Reagan’s presidency, the banking industry, among others, was steadily deregulated. Not only were leveraging requirements continually lowered but watchdog organizations such as the Securities and Exchange Commission were weakened both by legislation and the appointment of free-market advocates.

Successive administrations were enthusiastic advocates of deregulation. The dominant economic paradigm was that markets are efficient and inherently maximize welfare and work best when managed least. Moreover, with free-market advocates in charge of regulatory agencies such as the SEC, many existing laws were ignored or rarely enforced.

For example, observers repeatedly warned the Securities and Exchange Commission about suspected irregularities at Bernard Madoff’s investment firm, which was later revealed to be a multi-billion dollar Ponzi scheme. In spite of several warnings, no serious investigation was undertaken until after the firm’s spectacular collapse.

One reason offered for poor financial regulation is that government agencies are seriously disadvantaged when it comes to attracting the best and the brightest. The salaries of elected officials tend to impose an artificial ceiling on how much public employees can be paid. Even though these ceilings ignore marketplace realities, elected officials are reluctant to raise them by advocating higher salaries for themselves because it looks bad to voters.

Consequently, Americans are told that many government regulatory agencies lack the talent to regulate financial markets because they can’t pay the going rate for good people. Thus, the regulatory agencies’ best and the brightest flock to higher-paying jobs with firms they regulate. This leaves the public to complain that our regulatory agencies are less effective than they need to be.

But not all regulators are underpaid. According to the Bond Buyer ‘s annual salary survey of 21 industry regulatory groups, compensation for the chairman and CEO of Financial Industry Regulatory Authority , which oversees the 4,100 securities firms and over 636,000 stockbrokers in the United States, was $2.63 million in 2013.

The perks aren’t bad either, he receives $20,000 annually for admission fees, dues, and house charges to one club each in the Big Apple and Washington, and up to $20,000 annually for personal finance and tax counseling, as well as spousal travel for certain business-related events. Financial Industry Regulatory Authority also paid four of its top executives more than $1 million in 2013. These folks can spend more for one dinner than the average American -whose wages have been flat for decades – spends on a vacation.

Let’s put these salaries in perspective: The President earns $400,000 annually. Janet Yellen, the chair of the Federal Reserve who has sway over the entire world economy as opposed to just American stockbrokers, earns $201,700. Securities and Exchange Commission Chair Mary Jo White makes $165,300. White’s predecessor at the SEC, Mary Shapiro, was fresh from running Financial Industry Regulatory Authority, which gave her a $9 million severance to ease the pain of a low government salary.

These are clearly difficult times for national financial regulators. They are challenged with implementing hideously complicated Dodd-Frank legislation that is supposed to safeguard and stabilize the financial system to avoid another financial crisis.

At 2,319 pages, the Dodd-Frank Act is the most far-reaching financial regulatory undertaking since the 1930s, requiring regulatory agencies that had been withering to enact 447 rules and complete 63 reports and 59 studies within tight congressional deadlines.

It may be at the edge of absurdity, but just maybe the best way to attract the best and the brightest would be to expand the number of one-percenters by outsourcing all regulation to not-for-profit entities such as Financial Industry Regulatory Authority.

originally published: October 25, 2014

Dancing on the edge of absurdity

Posted on October 25, 2014September 25, 2019 by j.giglio

There can be little doubt that one of the causes of the 2008 financial crisis was diminished regulatory control , the seeds of which were sown during the three preceding decades.

Consequently, Americans are told that many government regulatory agencies lack the talent to regulate financial markets because they can’t pay the going rate for good people. Thus, the regulatory agencies best and the brightest flock to higher-paying jobs with firms they regulate. This leaves the public to complain that our regulatory agencies are less effective than they need to be.

originally published: October 25, 2014

‘Caveat Emptor’ no help to investors

Posted on August 31, 2013September 25, 2019 by j.giglio

In the wake of the 2008 financial crisis, the conventional wisdom is that financial markets need to be more tightly regulated. That is certainly true, but the problem is as much about who is doing the regulating as it is about the regulations themselves.

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act represents America’s biggest financial regulatory reform since the Great Depression, but its success will ultimately depend on having competent and honest regulators who cannot be compromised by lucrative employment opportunities dangled by the regulated.

The dominant global financial players’ failure to rein in their greed set the stage for the last economic crisis, and it was hardly the first time; under-regulated markets went on a murderous rampage.

Common-sense regulation ensures that a buyer can be confident that the item being purchased possesses all the advantages the seller claims, and that any disadvantages are clearly identified. This allows the buyer to make a rational decision about whether the item is actually worth the price. Many libertarians assume sellers will always inform the buyer of pertinent factual information because the seller knows that economic success ultimately depends on a reputation among potential buyers.

At the other extreme is the idea that sellers are inherently Times Square shell-game scammers who can’t be trusted to provide clear, honest, information about their products’ advantages and disadvantages, so the buyer must accept sole responsibility for obtaining all necessary information about whatever products he or she may purchase. This is the spirit behind the popular Latin phrase: “caveat emptor,” or “let the buyer beware.” Responsibility for regulating private firms rests with government agencies staffed by highly qualified managers and analysts who regard “public service” as the noblest of callings and their surest path to heaven. ·There are at least two real-world problems with this concept.

The first is that it depends on a large supply of trust fund babies to staff these government agencies free to devote their professional lives to “public service.” Sadly, the supply is nowhere near sufficient. Most of the intelligent and well-educated people they require emerge from graduate school burdened by crushing student loan debt that forces them to opt for the most lucrative job they can find.

The second problem flows naturally from the first. Many gifted, well-educated, young people see government regulatory agency job as stepping stones to lucrative private sector careers. They can develop useful contacts with key players with the firms they are supposed to regulate and impress the contacts that their “hearts are in the right place” as far as the regulated firm is concerned.

So it’s scarcely a surprise that there’s a parade of people marching back and forth between lavish private sector executive suites and the basic steel-desk offices of agencies like the Securities and Exchange Commission.

If we want federal regulatory agencies that prevent financial debacles, we have to end close the revolving door.

To make that work, we will need to address the economic concerns of gifted but highly indebted people. We could pay them much higher salaries for government jobs or subsidize their student loan burdens in return for their committing to careers in public service. Perhaps we could make up some of the difference with generous pensions, health benefits, and perhaps even offer them college scholarship for their children.

It’s awfully hard to be serious about regarding financial markets when you need a program to tell the regulators from the regulated.

originally published: August 31, 2013