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The biggest problem facing investors today is that “the rules” of the game change almost every year.
What I mean is that any basic rule investors took for granted could be thrown out the window. Indeed, in the last five years we’ve seen:
1) Accounting standards at financial institutions suspended.
2) Capital requirements for banks (Basel III) postponed multiple times.
3) Fraud go unpunished.
4) Obvious insider trading amongst political officials and banking insiders.
5) Central bankers openly admit that they will lie to investors.
Why are so many laws and rules being thrown out?
The Powers That Be are committed to propping the system up by any means possible.
Spain’s banking system, by any reasonable analysis, is totally bankrupt.
The reason for this is that Spanish banks are all packed to the brim with garbage assets (mortgage loans and Spanish Government bonds… which aren’t worth the paper they’re printed on).
Consider the story of Bankia.
Bankia was formed by merging seven bankrupt regional Spanish banks in 2010.
The new bank was funded by Spain’s Government rescue fund… which received “preference shares” in return for over €4 billion (from taxpayers).
These preference shares were shares that a) yielded 7.75% and b) would get paid before ordinary investors if Bankia failed again. So right away, the Spanish Government was taking taxpayer money to give itself preferential treatment over ordinary investors.
Indeed, those investors who owned shares in the seven banks that merged to form Bankia lost their shirts. They were wiped out and lost everything.
Bankia was then taken public in 2011. Spanish investment bankers convinced the Spanish public that the bank was a fantastic investment. Over 98% of the shares were sold to Spanish investors.
One year later, Bankia was bankrupt again, and required the single largest bailout in Spain’s history: €19 billion. Spain took over the bank and Bankia shares were frozen on the market (meaning you couldn’t sell them if you wanted to).
When the bailout took place, Bankia shareholders were all but wiped out, forced to take huge losses as part of the deal. The vast majority of them were individual investors (the bank currently faces a lawsuit for over 140,000 claims of mis-selling shares).
So that’s two wipeouts in as many years.
The bank was taken public a year a second time later in May 2013. Once again Bankia shares promptly collapsed, losing 80% of their value in a matter of days. And once again, it was ordinary investors who got destroyed.
Indeed, things were so awful that a police officer stabbed a Bankia banker who sold him over €300,000 worth of shares (the banker had convinced him it was a great investment).
Which brings us to today.
Bankia remains completely bankrupt. But its executives and the Spanish Government continue to claim that things are improving and that the bank is on the up and up. Indeed, just a few weeks ago, the Wall Street Journal wrote an article titled “Investors Show Interest in Bankia.”
The story featured a quote from Spain’s Finance Minister that, “… it is logical. The perception of Spain has improved and Banki has improved a lot.”
Bear in mind, this is a bank that has wiped out investors THREE times in the last THREE YEARS. So that’s three different rounds of individual investors being told that Bankia was a great investment and losing everything.
Every single one of these wipeouts was preceded by both bankers and Spanish Government officials claiming that “everything had been fixed” and that Bankia was a success story.
And now the Spanish Government is trying to convince them to line up for a fourth round.
This kind of fraud and lawlessness is unbelievable to me. But it is indeed how the world works today. Those who have power will do anything they can to retain it. This includes, lying, cheating, and stealing.
And while certain items relating to this story are unique, the morals to Bankia’s tale can be broadly applied across the board to the economy/ financial today.
Those morals are:
1) Those in charge of regulating the system will lie, cheat and steal rather than be honest to those who they are meant to protect (individual investors)
2) Any financial problem that surfaces will be dealt with via fraud or lies rather than taking a hit. This will include short selling bans, stocks being frozen, bail-ins, and worse.
3) When the inevitable collapse finally does hit, it will be individual investors and the general public who get screwed.
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Phoenix Capital Research
The so-called Volker Rule for policing (ha!) banking practices, approved by a huddle of federal regulating agency chiefs last week, is the latest joke that America has played on itself in what is becoming the greatest national self-punking exercise in world history.
First of all (and there’s a lot of all), this rule comes in the form of nearly 1,000 pages of incomprehensible legalese embedded in what was already a morbidly obese Dodd-Frank Wall Street Reform (ha!) and Consumer Protection (ha!) Act of 2012 that clocked in at 2000 pages, not counting the immense rafts of mandated interpretations and adumbrations, of which the new Volker Rule is but one. These additions were required because the Dodd-Frank Act itself did not really spell out the particulars of enforcement but rather left it to the regulatory agencies to construct the rules — which they did with “help” of lobbyist-lawyers furnished by the banks themselves. That is, the lobbyists actually wrote the rules for Dodd-Frank and everything in it, which means the banks wrote the rules. Does this strain your credulity? Well, this is the kind of nation we have become: anything goes and nothing matters. There really is no rule of law, just pretense.
The Volker Rule was a lame gesture toward restoring the heart of the Glass-Steagall provisions of the Banking Act of 1933, which were repealed in 1999 in a cynical effort led by Wall Street uber-grifter Robert Rubin and his sidekick Larry Summers, who served serially as US Treasury Secretaries under Bill Clinton. Glass Steagall was passed in Congress following revelations of gross misconduct among bankers leading up to the stock market crash of 1929. The main thrust of Glass Steagall was to mandate the separation of commercial banking (deposit accounts + lending) from investment banking (underwriting and trading in securities). The idea was to prevent banks from using money in customer deposit accounts to gamble in stocks and other speculative instruments. This rule was designed to work hand-in-hand with the Federal Deposit Insurance Corporation (FDIC), also created in 1933, to backstop the accounts of ordinary citizens in commercial banks. The initial backstop limits were very modest: $2,500 at inception, and didn’t rise above $40,000 until 1980. Investment banks, on the other hand, were not backstopped at all under Glass-Steagall, since their activities were construed as a form of high-toned gambling.
The Glass Steagall Act of 1933 was about 35 pages long, written in language that was precise, clear, and succinct. It worked for 66 years. Banking during those years was a pretty boring business, commercial banking especially. It operated on the 3-6-3 principle — pay 3 percent interest on deposits, lend at 6 percent, and be out on the golf course at 3 p.m. Bankers made a nice living but nothing like the obscene racketeering profits engineered by the looting operations of today. Before 1980, the finance sector of the economy was about 5 percent of all activity. Its purpose was to allocate precious capital to new productive ventures.
As American manufacturing was surrendered to other countries, there were fewer productive ventures for capital to be directed into. What remained was real estate development (a.k.a. suburban sprawl) and finance, which was the enabler of it. Finance ballooned to 40 percent of the US economy and the American landscape got trashed. The computer revolution of the 1990s stimulated tremendous “innovation” in financial activities. Much of that innovation turned out to be new species of swindles and frauds. Now you understand the history of the so-called “housing bubble” and the crash of 2008. The US never recovered from it, and all the rescue attempts in the form of bail-outs, quantitative easing, zero interest rates, have turned into rackets aimed at papering-over this national failure to thrive. It is all ultimately linked to the larger story of industrialism and its relationship with the unique, finite, fossil fuel resources that the human race got cheaply for a few hundred years. That story is now winding down and we refuse to pay attention to the reality of it.
The absurdity of Dodd-Frank and the Volker Rule in the face of that is just another symptom of that tragic inattention. The baroque prolixity of these statutes must have been fun for the lawyers to construct — thousands of pages of incantatory nonsense aimed at confounding any attempt to enforce decent conduct among bankers and their supposed regulators — but it does nothing to really help us move into the next phase of history.
The bankers have written the most integral rule that would reform their business practices and President Obama is showing his support.
Obama has released a written statement supporting the new Volcker Rule that will make “sure big banks can’t make risky bets with their customer’s deposits.”
Obama said: “Our financial system will be safer and the American people are more secure because we fought to include this protection in the law.”
Speaking about the crash of 2008, Obama admonished the banks for “fueling a punishing recession on Main Street that ultimately cost millions of jobs and hurt families across the country.”
As part of the economic repair of our country, the president said that financial “rules that reward sound financial practices allow honest innovation and strengthen the financial system’s ability to support job creation and durable economic growth.”
Obama said that the Volcker Rule will make “it illegal for firms to use government-insured money to make speculative bets that threaten the entire financial system, and demand a new era of accountability from CEOs who must sign off on their firm’s practices.”
This new rule will ensure that ‘our financial system will be safer.”
Experts say that the new Volcker Rule glosses over the fact that it was “trading mishaps” that were the “root cause of the financial crisis.”
Because of this, “the rule doesn’t go far enough . . . prohibition [will] draw a line, making it clear that banks’ business is about lending not investing.”
The Volcker Rule, within the Dodd-Frank law, is now being used by the president as a public relations ploy to give Americans a semblance ofgovernment oversight and the reining in of “risk taking after the financial crisis.”
The new Volcker Rule was created by the banks and is “the rule that the banks wanted.”
The 2011 draft of the Volcker Rule was leaked by the American Banker Association (ABA).
Rob Tooney, associate general counsel at the Financial Securities Industry and Financial Markets Association (FSIFMA) said : “Our concern is that whatever the final rule is that it doesn’t harm the markets’ overall liquidity. The short answer is we don’t know yet.”
The new rule was reported “far more restrictive than previously expected” and now that the banks have taken over the writing of the document, they feel more comfortable in supporting its passage.
Ben Bernanke, chairman of the Federal Reserve Bank (FRB) said at a central bank meeting this week: “Getting to this vote has taken longer than we would have liked, but five agencies have had to work together to grapple with a large number of difficult issues and respond to extensive public comments.”
In 2010, Alan Blinder, economist of Princeton stated of the burgeoning Dodd-Frank law in an op-ed piece : “It is devilishly difficult to draw bright lines between proprietary trading and trading, hedging, and market-making on behalf of clients.”
Paul Volcker said he was “disappointed with how the rule was turning out” and that he “didn’t expect the proposal to be diluted so much, said a person with knowledge of his views. He’s content with language that bans banks from trading with their own capital, the person said.”
The Dodd-Frank Law was signed that same year.
Volcker contended that the rule should have “clear concise definitions, firmly worded prohibitions, and specificity in describing the permissible activities will be of prime importance for the regulators as they implement and enforce this law.”
In 2011, Senator Carl Levin co-sponsored the Volcker Rule and spoke toCongress about the importance of the regulation: “The Volcker Rule is essential to protect taxpayers from banks’ excessive financial risk-taking, conflicts of interest, and from the resulting billion-dollar bailouts. I look forward to reviewing the proposed rule and hope the regulators reject efforts to weaken the law.”
In early 2012, Jamie Dimon, chief executive of JP Morgan Chase & Co, brazenly told media : “If you want to be trading, you have to have a lawyer and a psychiatrist sitting next to you determining what was your intent every time you did something.”
In another interview, Dimon said of Volcker: “Paul Volcker, by his own admission, has said he doesn’t understand capital markets. Honestly, he has proven that to me.”
Lawrence Fink, chief executive of BlackRock commented : “We are not in support of it. We sent the letter as a firm. It’s very hard for me to understand how to navigate the Volcker Rule. What is proprietary trading? What is flow trading? It’s going to be very definitional.”
Volcker responded to critics, saying: “A lot of the criticism is over the complexity of the thing and, essentially it’s down to a lot of details. But the basic rule, of course, is incorporated in the law. And I think when you get all finished with this Sturm und Drang in the Congress now, I think you’re going to have a reasonable interpretation of a law and an interpretation that can be reasonably followed by the banks and enforced by the regulators.”
This past summer, Jacob Lew, secretary of the US Treasury, warned of a year’s end deadline on the Volcker Rule.
Lew said: “I want to mention that the Volcker Rule is particularly important, and I will continue to push for swift completion of a rule that keeps faith with the intent of the statute and the president’s vision.”
By Marc Faber
As a distant but interested observer of history and investment markets I am fascinated how major events that arose from longer-term trends are often explained by short-term causes. The First World War is explained as a consequence of the assassination of Archduke Franz Ferdinand, heir to the Austrian-Hungarian throne; the Depression in the 1930s as a result of the tight monetary policies of the Fed; the Second World War as having been caused by Hitler; and the Vietnam War as a result of the communist threat.
Similarly, the disinflation that followed after 1980 is attributed to Paul Volcker’s tight monetary policies. The 1987 stock market crash is blamed on portfolio insurance. And the Asian Crisis and the stock market crash of 1997 are attributed to foreigners attacking the Thai Baht (Thailand’s currency). A closer analysis of all these events, however, shows that their causes were far more complex and that there was always some “inevitability” at play.
Take the 1987 stock market crash. By the summer of 1987, the stock market had become extremely overbought and a correction was due regardless of how bright the future looked. Between the August 1987 high and the October 1987 low, the Dow Jones declined by 41%. As we all know, the Dow rose for another 20 years, to reach a high of 14,198 in October of 2007.
These swings remind us that we can have huge corrections within longer term trends. The Asian Crisis of 1997-98 is also interesting because it occurred long after Asian macroeconomic fundamentals had begun to deteriorate. Not surprisingly, the eternally optimistic Asian analysts, fund managers , and strategists remained positive about the Asian markets right up until disaster struck in 1997.
But even to the most casual observer it should have been obvious that something wasn’t quite right. The Nikkei Index and the Taiwan stock market had peaked out in 1990 and thereafter trended down or sidewards, while most other stock markets in Asia topped out in 1994. In fact, the Thailand SET Index was already down by 60% from its 1994 high when the Asian financial crisis sent the Thai Baht tumbling by 50% within a few months. That waked the perpetually over-confident bullish analyst and media crowd from their slumber of complacency.
I agree with the late Charles Kindleberger, who commented that “financial crises are associated with the peaks of business cycles”, and that financial crisis “is the culmination of a period of expansion and leads to downturn”. However, I also side with J.R. Hicks, who maintained that “really catastrophic depression” is likely to occur “when there is profound monetary instability — when the rot in the monetary system goes very deep”.
Simply put, a financial crisis doesn’t happen accidentally, but follows after a prolonged period of excesses (expansionary monetary policies and/or fiscal policies leading to excessive credit growth and excessive speculation). The problem lies in timing the onset of the crisis. Usually, as was the case in Asia in the 1990s, macroeconomic conditions deteriorate long before the onset of the crisis. However, expansionary monetary policies and excessive debt growth can extend the life of the business expansion for a very long time.
In the case of Asia, macroeconomic conditions began to deteriorate in 1988 when Asian countries’ trade and current account surpluses turned down. They then went negative in 1990. The economic expansion, however, continued — financed largely by excessive foreign borrowings. As a result, by the late 1990s, dead ahead of the 1997-98 crisis, the Asian bears were being totally discredited by the bullish crowd and their views were largely ignored.
While Asians were not quite so gullible as to believe that “the overall level of debt makes no difference … one person’s liability is another person’s asset” (as Paul Krugman has said), they advanced numerous other arguments in favour of Asia’s continuous economic expansion and to explain why Asia would never experience the kind of “tequila crisis” Mexico had encountered at the end of 1994, when the Mexican Peso collapsed by more than 50% within a few months.
In 1994, the Fed increased the Fed Fund Rate from 3% to nearly 6%. This led to a rout in the bond market. Ten-Year Treasury Note yields rose from less than 5.5% at the end of 1993 to over 8% in November 1994. In turn, the emerging market bond and stock markets collapsed. In 1994, it became obvious that the emerging economies were cooling down and that the world was headed towards a major economic slowdown, or even a recession.
But when President Clinton decided to bail out Mexico, over Congress’s opposition but with the support of Republican leaders Newt Gingrich and Bob Dole, and tapped an obscure Treasury fund to lend Mexico more than$20 billion, the markets stabilized. Loans made by the US Treasury, the International Monetary Fund and the Bank for International Settlements totalled almost $50 billion.
However, the bailout attracted criticism. Former co-chairman of Goldman Sachs, US Treasury Secretary Robert Rubin used funds to bail out Mexican bonds of which Goldman Sachs was an underwriter and in which it owned positions valued at about $5 billion.
At this point I am not interested in discussing the merits or failures of the Mexican bailout of 1994. (Regular readers will know my critical stance on any form of bailout.) However, the consequences of the bailout were that bonds and equities soared. In particular, after 1994, emerging market bonds and loans performed superbly — that is, until the Asian Crisis in 1997. Clearly, the cost to the global economy was in the form of moral hazard because investors were emboldened by the bailout and piled into emerging market credits of even lower quality.
Above, I mentioned that, by 1994, it had become obvious that the emerging economies were cooling down and that the world was headed towards a meaningful economic slowdown or even a recession. But the bailout of Mexico prolonged the economic expansion in emerging economies by making available foreign capital with which to finance their trade and current account deficits. At the same time, it led to a far more serious crisis in Asia in 1997 and in Russia and the U.S. (LTCM) in 1998.
So, the lesson I learned from the Asian Crisis was that it was devastating because, given the natural business cycle, Asia should already have turned down in 1994. But because of the bailout of Mexico, Asia’s expansion was prolonged through the availability of foreign credits.
This debt financing in foreign currencies created a colossal mismatch of assets and liabilities. Assets that served as collateral for loans were in local currencies, whereas liabilities were denominated in foreign currencies. This mismatch exacerbated the Asian Crisis when the currencies began to weaken, because it induced local businesses to convert local currencies into dollars as fast as they could for the purpose of hedging their foreign exchange risks.
In turn, the weakening of the Asian currencies reduced the value of the collateral, because local assets fall in value not only in local currency terms but even more so in US dollar terms. This led locals and foreigners to liquidate their foreign loans, bonds and local equities. So, whereas the Indonesian stock market declined by “only” 65% between its 1997 high and 1998 low, it fell by 92% in US dollar terms because of the collapse of their currency, the Rupiah.
As an aside, the US enjoys a huge advantage by having the ability to borrow in US dollars against US dollar assets, which doesn’t lead to a mismatch of assets and liabilities. So, maybe Krugman’s economic painkillers, which provided only temporary relief of the symptoms of economic illness, worked for a while in the case of Mexico, but they created a huge problem for Asia in 1997.
Similarly, the housing bubble that Krugman advocated in 2001 relieved temporarily some of the symptoms of the economic malaise but then led to the vicious 2008 crisis. Therefore, it would appear that, more often than not, bailouts create larger problems down the road, and that the authorities should use them only very rarely and with great caution.
- Volcker: Fed will ‘fall short’ (money.cnn.com)
- Volcker Cautions Federal Reserve May ‘Fall Short’ – Bloomberg (bloomberg.com)
- Volcker warns on limits of U.S. easy money (theglobeandmail.com)
- Volcker Sets Up Center to Examine Trust in Government – Bloomberg (bloomberg.com)
- Volcker: Fed should focus on containing inflation (usatoday.com)
- Eric: Volcker: Government Makes Up 35% Of GDP, Mortgage Markets Are Now A State ‘Subsidiary’ – Forbes (forbes.com)
- Former Fed Chairman Volcker Wants to Rebuild Public’s Faith in Government (wnyc.org)