A Looming Financial Crisis? | A Conversation On Unregulated Derivatives

once upon a time in the United States people believed that they had a society and they believed that we should construct the rules where essentially the refs don't work for one team or the other that's ethic that sensibility certainly has come in to how I say come to be tested at various times in our history but probably never more fiercely and visibly as in two thousand seven and eight many people now attribute the discord that manifest as Occupy Wall Street on the left or the tea party on the right it's not just related to the financial sector but as a deterioration in the faith legitimacy and Trust in American governance all together that loss of faith if it be true puts America at a huge disadvantage in terms of its ability to evolve and transform I think it's interesting to be here at Scandinavia house because the last time I had breakfast here was with a group of people from Sweden who said to me the American model of fierce deregulation was always said to be the growth model but now we in Sweden don't fear the robots anymore because we know how to make transformations where our children retain their education their healthcare we retain our pensions maternity and paternity leave and job retraining so we're happy to embrace new productivity and we see America getting bogged down in despondency whether related to globalization or related to technology so I think before us now we have a tremendous number of challenges and we are say burdens with the need to regenerate faith and trust in our social systems so we go back to that what you might call that that deep wound of 2008 and the gentleman here with me are all how he's saying more than experts in this realm starting down at the end the moderator today Dennis Kelleher who worked with Senator Dorgan in the leadership office during the dodd-frank legislation and in recent years runs an extraordinary organization called better markets I'd encourage you to read Steven Brill new book because Denis is featured as one of the good guys who's trying to turn things around Tom Hoenig you've always been trying to turn direction whether at the Kansas City Fed or more recently at the FDIC and I know you've had some serious commentary on Michael Green burgers work and I would say a new glass-steagall and things of the sort Michael our speaker normally a commissioner at the CFTC and been a good friend of mine we work very closely through all of the dodd-frank work when I was at the Roosevelt Institute in their global finance project and last and certainly not least we have Chairman Paul Volcker who I thought weighed in tremendously to the point where how would I put it even the industry started to attack you Soros says sometimes you got to be happy who your enemies are so chairman Volcker I'm really grateful that she made it to see us and continue the energy and I know the Volcker alliance we've worked with it I knit on a numerous occasions is doing excellent work and I encourage you all to stay tuned to what they have been and continue to develop not just in the financial sector but related to good governance everywhere so with that let me turn it over to Dennis and carry it from here well good morning everybody and thanks Rob and thanks to inet not just for kind of generically everything that they do but for their steadfast commitment to paying attention to issues no matter how complex if they're important and what we're doing here and talking about really one of the most important things in financial reform in the financial sector which is derivatives and the cross-border implications of derivatives now it's not going to make a headline and it doesn't fit in a tweet but it's a heck of a lot more important and Michael's going to go through his paper but I wanted say to start first of all you know derivative the crash as everybody here knows had a lot of different causes but nobody can deny that derivatives were at the core of causing the crash derivatives were time bombs laid throughout the financial system and at the same time they were a conveyor belt that delivered those time bombs throughout the global financial system and what this paper really is about is how that happened in Oh for five six seven eight boom the time bombs explode throughout the world the conveyor belt worked unfortunately and essentially this paper talks about how that conveyor belt has been rebuilt by subterfuge by an industry committed to evading the most sensible modest and fundamentally necessary protections and so Michael who you should it's a it's not that long of a paper it's a hundred pages and I'd encourage you to read it because it gives you the broad sweep it puts it in context it's actually said in English you can actually understand it even if you're not a derivatives professional which most people are not thank God right so with that really one of the nation's most experienced knowledgeable and articulate experts on the CFTC derivatives and the cross-border implications Michaels going to run us through the highlights of the paper and then we're going to have a discussion about it okay it's okay I'm gonna use the podium [Music] well thank you very much as Rob said Rob Tom Ferguson who is my editor and prouder through this entire thing unfortunately he couldn't be here today we started working together right after the meltdown sorry I am in DC Rob was in New York Tom at that point was in Boston but we saw each other a lot Tom Rob I net have done wonderful work and I'm indebted to them they funded this paper Denis is one of the top market advocates for the good guys and better markets has just done a fabulous job I'm honored to have mr. Volker mr. Koenig here today to comment on the paper when I walked in somebody was thumbing through the paper and said this is over a hundred pages actually it's 110 pages all I would like to say in preface is I worked very hard on a ten page introduction in summary that tells you really everything I think you need to know and cross-references back to the substantive discussion in the paper we also have a blog up there's an abstract but it is a complicated subject made more complicated by the attempt to dodge the regulatory scheme that was put in place by dodd-frank let me just and by the way I'm going to go pretty fast I've only got a limited amount of time but I'll be here I'm happy to talk to anybody at length today or in the future you can find me at the I'm at the University of Maryland School of Law you can find me on the website okay so it's part of the popular culture now thanks to Michael Lewis's book the big short and recently thanks to the Pope who has warned about the dangers of derivatives we recently the dangers of derivatives and especially credit default swaps so if you've read the big short or seen the movie seen the movie because bus husbands holiday the the essential thesis of Lewis's book which is done outside of any legal context the lays out the problem is that the big Shorter's were desperate they knew in 2005-2006 that the market mortgage market would fail and they wanted to be able to short the market and with the help of Goldman Sachs and some others they got permission from the International Swaps and Derivatives Association to to buy and create whether what we're called naked credit default swaps what are those credit default swaps are essentially insurance on an investment that you have an interest in they don't call it insurance because insurance is regulated by the states so originally some insurance companies for the insurance contracts and the bank said no no you can't do that we'd be regulated by the states but essentially they wanted to select tranches of mortgages that they did not own and bet that those mortgages would fail how did they do that they entered into a swap agreement with those that were foolish enough in 2006-2007 to be giving insurance on those mortgages so they hand-picked the mortgages they thought would fail and then with a small insurance premium could recover a hundred percent of the value of the mortgage they did not own and if you read the big short or saw the movie you know they collected big time and in fact because they were betting on mortgages feeling some houses had nine bets on them by outsider side bets that those mortgages would fail there were three to four times as naked credit default swaps as there were credit default swaps these people recovered billions in fact the problem became because credit default swaps were deregulated by virtue of a 2000 law that we got handed to us by Phil Gramm and the Senate supporting supported by Larry Summers secretary of the Treasury credit default swaps in 2000 were put outside the boundaries of law they were unknown financial regulators had no idea what was going on they were not capitalized there were no anti-fraud protections and it came as a great shock to Messrs Bernanke and Paulson and others when Lehman failed and right after to have AIG present itself saying it was 80 billion in the hole later became a hundred billion because they had issued the swaps nobody knew about it there were no capital reserves there were no anti-fraud provisions and the shortfall essentially to pay off the winners of those bets had to be funded by the United States taxpayer now I'm not saying it's the only cause but it was a very big cause in 2010 dodd-frank has passed its number-one goal is that the United States taxpayer should never again be put in the position of having to bail out the world's largest bank to the tune of trillions of dollars in aid of that goal dodd-frank set up a regulatory regime for swaps they had to be reported they had to be cleared they had to be exchange-traded there had to be capital set aside they were collateralized and there were a lot of anti-competitive things that were stopped where banks were trying to control the market to the detriment of everyone else so that was 2010 three years the CFTC Commodity Futures Trading Commission is the principal regulatory agency over a three year period they promulgate 67 substantive rules to implement the statute but then they're confronted with the issue what happens to swaps that get traded outside the United States AIG financial products the company that lost all that money was a London subsidiary later the so-called London rogue who lost six point two million dollars for JPMorgan Chase on his own was a London branch of JPMorgan Chase the key senators specifically said we've got problems with what especially the big US banks are doing abroad dodd-frank must in certain circumstances apply to swaps outside the United States who's what swaps in and this is what the statute provides if a swap could add a swaps trading could adversely affect the US economy it should be regulated by dodd-frank if the swap is a ruse conducting it in a foreign location to avoid dodd-frank it should be covered by dodd-frank now I quickly want to say that my focus here is not on everyone my focus is on the four big US bank holding company swap dealers who control ninety percent of the United States market as far as I'm concerned if they can be prevented from collapse I have little worried about other financial institutions the banks through their trade organization the United the financial swaps Derivatives Association International is the did the following in July 2013 the CFTC and a very complicated quote guidance close quote made one point clear if a subsidiary of a US person or US bank holding company is guaranteed by the bank that if the subsidiary fails the bank holding company will stand behind its obligations dodd-frank applies even though it's foreign from 1992 to that point in time all US bank holding companies swap dealers were guaranteed by their parents they had to be guaranteed because as the market was developing nobody would have done business with the subsidiaries unless they knew that the parent was standing behind it by 2013 everyone knows or at least believes that these banks are too big to fail what do I mean by that that if they collapse the US taxpayer will likely be called upon again to be on the map that as a study I cite by Tom Ferguson I Nets research director that too-big-to-fail concept is embedded in the stock price of those big banks July 2013 the CFTC says their subsidiaries guaranteed it's covered August 2013 under cover of darkness with no public announcement the International Swaps gurus association gives its members including these four banks language to be guaranteed their subsidiaries that had never been done before now you might ask who will do business with adi guaranteed subsidiary well the answer is the real guarantee is by you the United States taxpayer the expectation is if the bank holding company fails because bad practices by its subsidiary even though the subsidiary may not be legally guaranteed that the bank will be rescued or the thinking was if we don't rescue these banks we will confront the second Great Depression this it took a while for the CFTC to know that the banks were doing this keep the guarantee process they they did notice the u.s. swaps were suddenly moving outside the United States market to foreign moat mark it's mostly the European Union to shorten the story in October 2016 over three years after the D guarantee loophole was established the CFTC proposed a rule that would have closed this they said this guaranteed the guarantee stuff is fiction what we worry about is is the subsidiary on the consolidated books the swaps trading on the consolidated books of the bank holding company if it is and most are then the subsidiaries must follow dodd-frank wherever in the world it does business again these are for US bank holding companies they are headquartered in the United States their principal place of business is in the United States they've already been bailed out by US taxpayers they've been deemed to be systemic ly risky by the banking regulators and they've engineered what I call the de guarantee loophole there are other loopholes one quick one I would just notice in October 2016 the CFTC discovered that these banks were executing the swaps in Wall Street it's called the a any assigned ago she eight executed in Wall Street and then after completed execution sending them off to foreign subsidiaries and the CFTC said that's not right and they wanted to put an end to it suffice it to say with the election of Donald Trump and a Trump CFTC that proposed rule to make a proposal final rule you have to go a lot through a lot of procedures it can't be done instantly if it's done in a year it's fast so the October 2016 proposed rule to end the D aren t loophole and the a.m. elope loophole was never finalized by the time President Trump was inaugurated as you know the entire thinking of the Trump economic financial infrastructure is to rollback dodd-frank to to accommodate the big banks so it's never going to be fixed in the absence of some extraordinary action to be taking place the paper says there is a remedy available it's not going to be the CFTC it's certainly not going to be the republican-controlled Congress who will fix this but the commodities Act gives state attorney generals and state financial regulators the right to go into federal court to sue over violations that they can show will have an adverse impact on the citizens of the state that's great the one problem is as I say in the paper and senator Dodd said this in spades the understanding of the swaps market somewhat dated by Michael Lewis somewhat aided by the Pope is not very good it is the least understand understood of all the financial markets not because it's so complicated but because everything has a confusing name associated with it a naked credit default swap which is really insurance on property or for assets that you don't own you can't call it insurance because it would be regulated so it's a naked credit default swap collateralized debt obligations asset backed securities the biggest problem we have in getting state attorney generals to do this who by the way in other fields have been very aggressive in the financial sector is a lack of understanding and my hope is that the paper will provide them and others with the fundamental tool to understand what's going on here it for big bank holding companies putting their trading abroad dodd-frank applies under dodd-frank if that trading could adversely impact the US economy well we've seen that movie already moreover if it's a ruse to get out of dodd-frank dodd-frank applies is this a ruse when you're executing the swap in the United States and after execution is completed sending it off to a foreign subsidiary basically to just take advantage of the big guaranty loophole if that isn't a ruse I don't know what is this can and should be fixed unfortunately we're at the mercy of state attorneys general and I think that's our mission to work with them to have them bring lawsuits that would declare this as it really is a plain violation of the plain language of the extraterritorial provision in dodd-frank thank you well thank you Michael for that overview I thought I'd start with you one of the things that seems to echo throughout this paper is it seems like back to the future it seems like go back to oh four five and six where international regulatory arbitrage was happening where the biggest global banks were searching the world for the lightest touch regulation and London were actually bragged about having light touch regulation and it can't be a coincidence that many of the derivatives problems US banks have had happen to happen in London and it's a wild coincidence and we have banks today doing essentially the same thing of where they're moving their high-risk dangerous act derivatives activities overseas and one of their primary arguments as you know Paul cause you've heard it for years is that in order for us the banks to maintain their global competitiveness or their leadership and financial products they have to go and search the globe and go where the lightest touch as a Prudential regulator for so long how did you how do you think through that argument and what do you think of that argument and complicated we'll look I don't know what I can bring to this little meeting Rob adequately described what's been going wrong you have a very detailed explanation here one aspect I happen to be 90 years old he do a little subtraction I started out in banking 70 years ago and I've been in and out of banking and government for 70 years what strikes me is I've seen it all before I over and over and then in different degrees of complication and it has got indeed more complicated you've listened to Michael Hughes you can realize down in the woods how how complicated is you talk about this international competition I could remember back you know wasn't so long ago where American banks couldn't even branch outside their own state much less become huge international institutions and I couldn't remember testifying once isn't this terrible American banks can't survive they have these big overseas banks like the Deutsche Bank a farm example of beauty in banking operating around the world and here we are for those Japanese banks what's so big and powerful we can't deal with them I you know I said I don't care how big the banks works I just wonder I worry about how good they are I didn't worry enough about how a good deal well now all those restraints is long and it's gotten more more complicated but the the underlying concerns in many ways pretty much the same how we go from ricochet from one banking crisis to another I don't know if I in my old days I don't know why I couldn't smile as if I de memoire and at this point when his practice finished I wonder why I did this is chapter one chapter two repeats chapter one is chapter and it's a complicated world the International Cooperation I think among central banks and governments has actually gotten better not worse we never had a big effort to get international capital rules in the 1980s that was a big initiative at the time we're still not happy with same old debates should it be a leverage ratio should be risk-based we fought all that battle in 1980s were fighting it again now and you know we end up with both witches it's fine but you know what's different put it quite simply you know Washington DC as late as the 1970s Washington had one considered four-star hotel one it had one restaurant I was considered a top-class French restaurant it had a few lobbyists around it did not have until the 70s an out-of-town law firm in Washington now those little local law firms prestigious it used to be on one floor and an office building and then you know in the 1980s he got to be two floors one of my best friends and come with me a long time became a lawyer and big national law firm right across the street from the Treasury he expanded into two floors ten years later they bought an office building ten years after that they bought another office building one law firm two office buildings how many law firms over now too many how many fancy hotels are there in Washington DC you can't count them anymore who are two were the four most richest counties in the United States but per capita income outside Washington DC what are those people doing like how many tickets what are they doing it we've got an industry generating hundreds of millions of dollars of lobbying and you know you need some lobbying you need some truth-telling but one does it become just so outrageous and the campaign expenditures are so great and looms the Lord for the congressmen that they're susceptible to any little visit from a friendly [Music] lobbyist who before he says yes I do remember when your next fundraiser is I'll get lost subject here again I think I'm on subject that you were talking about derivatives another big deal autumns it from nothing invented all of the existence twenty years ago just since sometimes writers let me raise a question about so-called vocal role you know that is yes it says you're getting government subsidized directly or indirectly you shouldn't be doing a lot of speculation what did I read a couple of years ago this one really hurt me a little bit American Bankers Association that's a big deal in Washington 20 years ago there wasn't even in Washington American Bankers Association was in New York and now they're all in Washington what I read this concern me statement rather than solving problems the vocal role has created problems okay how it is operated to impede the efficient operation of the financial system oh it drives banks away from providing services valued by their customers but maybe Wells Fargo out there it reduces competition and affected markets not quite sure what markets they're talking about no but what really heard it is an overall drag on the economy a little bit I know that my little role would be an overall drag on the economy Jesus we've got unemployment on the 4% now if we didn't have the Volcker rule maybe be 2 percent one and a half percent we've only had 10 years of uninterrupted expansion we have loans rising faster than their GDP you've got small loans going up faster than big lungs I mean you know and I really got upset by reading all this stuff I opened up the for their time yesterday be good line US banks poised to hand out one hundred and seventy billion dollars handout one hundred and seventy eight billion dollars because they're suffering because of the possible how can they possibly do it dividends and buybacks exceed profits I pick up the New York Times this morning and I got to read something headline will we ever drain the swamp and it talks at the column op-ed piece about the advisory business about lobbying hundreds of millions dollars spent on lobbying now what do we do about it I don't know but I do think things have gotten more complicated because of Technology it's harder the deal with but what strikes me and going back over 270 years and you could look back wall there how much some of the complaints that were apparent than are apparent today and one that stands out is why do we have five regulatory agencies overseeing the banking system I had great complaints about it seventy years ago competition in laxity unwillingness to press banks another financial institution for fear that the other agency will you know which one that typically is at the bench will go ahead and not insist banking regulation is a very tough business and you can't compress it into rules hundreds of pages long which try to cover every pie of all detail of what could go wrong it's not just a problem of making regulations a problem with the county and a lot of other things and if you don't have a strong regulatory system to deal with another common sense kind of way you're in trouble then what struck me is that that was a problem seventy years ago and so far you read mr. tightness books about the crisis read mr. Bernanke read mr. Paulson Republican Democrat neutral all complaining about the this regulatory system is still in place and getting worse but its overlaps and and inconsistencies and failures to deal with some problems I've been there you know about either criticize well we tough enough regulator when I was there I thought you're being tougher one tough enough how do we deal with this problem which is the governance problem and she laid it to the broader governance problem that I was talking about but it is a very real problem and it's going to take a lot of effort to carry through this you know there's no I'll talk about this focal ball I tried to set away from all this I'm too old all the rest but you had this bill the past month or two ago and now you've got this proposed regulation I am told you can make a very good case both are desirable both are an effort to simplifying god-knows-who could use some simplification to what degree and this is unknown is it going to become a vehicle for weakening the substance weakening the core if it's simplification great this is a subterfuge and opening the way to looting the core is just one little example he's relatively little and the whole scheme of things but an example of how difficult it is to get coherent effective disciplined regulation against an overpowering ly different environment in terms of the money and resources spent on finance in the electoral process and in the lobbying world I think this is a huge challenge to the country you know I can think of the imaginative ways of dealing with it what chance they do have a success is another question so let me I'll stop and moding and well thanks Paul you know but we'll give you a quick short answer you know DC has because is now in the loophole creation and exploitation business and you've well talked about that and you bit your question was what do we do about it well what I would say is there's some obvious things to do about it and one is to support those who fight back i net better markets Reed Steve grills new book called tailspin that highlights 10 different organizations that are fighting back to try and provide a counterweight to the money and power special-interest uphill battle but they don't get anywhere near the support that the industry gets for all the obvious reasons so short plug but I'll move on Michael ended is talk by talking about a lack of understanding of derivatives due to what I call industry created complexity they use it as an intimidation weapon they use them against the regulators against knowledgeable people in the general public but part of the problem of lack of understanding is they're also in the active concealment business one of the benefits protocol benefits of moving derivatives overseas is they don't have the dodd-frank reporting requirement so you don't even have the information to try and understand it Thomas a regulator for me many years and a warrior for sensible modest regulation both so that the public can be informed and the regulator's can be informed and do their job what what's your take on Michaels thesis well let me let me start by saying Michaels paper is about more than an obscure a footnote that allows them to move this stuff it's it's a history of the industry's lobbying practice of removing their barriers to the pursuit of increasing risk backed by taxpayers and so when you go through the history and you see it in the 90s where the efforts were to at least get some sense of what was going on with the derivatives book it was batted back by not only the industry but some of the regulator's and what we've done is now we've carried that forward people say what crisis the traders today remember it's 10 years ago things are great so you leave it behind and so what you're finding yourself with today is a well subsidized industry too big to fail is a huge subsidy it allows you to take on marginal risk young what you would otherwise take because your counterparty your creditor if you will is confident that you'll be bailed out and that is a huge competitive advantage for these particular players and that's why they're going to fight any kind of rule that restricts that and one of my points is if the public or if the counterparty or the creditor truly believed that this institution would be allowed to fail a lot of this activity would shrink because they're not going to put up with no capital they're not going to put up with opaque positions in derivatives around the world they're going to insist on knowing things and we've left that behind and I think when Michael's paper did is is show this gap between what was intended in dodd-frank and the Volcker Rule and what is accomplished and until you changed the subsidy and the too-big-to-fail problem and you're not going to get the too-big-to-fail problem solved through more regulation that's why for years I've said we it's not just simplify the rules it's simplified the industry these large is it because they're universal banks you cannot be a broker-dealer independent and compete successfully with a universal bank you just don't have a subsidy they have so we'll see that grind away as we did earlier so it's a it's a real issue and the real problem is how do you get these institutions in a position to be allowed to fail not all at once but allowed to fail and that with confidence and until you do that you find a footnote you play the footnote the the regulator is slow to react so it's already outside to reach you'll see that over and over again and the pall point it may be a little bit off-topic but it's not really when you come to the rate the Volcker rule designed to say simply you cannot gamble with deposit insured funds and a backstop of liquidity that is almost infinite in its availability you you you cannot do that and now we have in the implementation was made far more complicated than it needs to be my point then and I think Paul's was thou shalt not engage in this activity if we have strong supervision we will test you and if you are we will find you or you will be held accountable for it and what I've and what is in this even this revised proposal is and your CEO has to attest to this fact but when you read the proposal it's kind of an example of what we saw here with this obscure footnote when you read the proposal that's about there it is for pages long it is as complex as the rule it has 300 plus questions that are pardon my words designed I think to raise the possibility of repealing vocre not simplifying and those are all things that that we have to be aware of and and to finally the ballpoint I've been only in Washington six years and I'm going back to Kansas City but my point is when I when I looked at the Capitol and it's a beautiful place and I said it's now an ant hill not a hill because all the lobbyists and Allegan are so swarming around that that that mountain you have a sense of why these things are increasingly complicated and easily gained and the complexity is designed for the gaming of the system so I have real concerns about how we'll do this and and what we end up with is a new crisis I don't know when I'm not predicting one but when you put six hundred trillion dollars of derivatives and you don't know what's in them and you don't know how much of it is you know when you're netting all kinds of one swap against another that they're completely different you are asking for trouble because you are ignorant and then in what's going on and that's a prescription for trouble only in Washington DC which some bunch of regulators proposed a rule that's 400 pages long and shamelessly claim that it's to simplify a 700 page prior rule so Michael you know you went over a lot of really interesting things in the paper and again I'd encourage you all to read it but one of them I thought you spelled out well and is really important and should offend everybody's sense of rightness here which is the concept of substitute of compliance so the CFTC basically made up this thing where if foreign jurisdictions say that they're going to regulate the foreign activities of US banks in their jurisdiction like we regulate them then all fine we'll let them regulate them and so but to me it sounds like a we're outsourcing the protection of US taxpayers to foreign regulators and those foreign rate actually have an unbroken record of failure so I'm curious why that is and I hope you weave it in but Sharon Bowen who is a fantastic former commissioner of the CFTC did an excellent job and a dissent on a vote that was very important detailing how crazy this is so when I talk about my brilliant insight here I'm now properly crediting Sharon but if you want to talk about that maybe you should think that people can understand why at least if the US regulators supposed to do something they feel there's at least a theoretical possibility of dragging off the Congress put it in a name in the paper but if it's somebody in Paris or Brussels you know the reach of the US accountability system such as it is doesn't exist yes I'm happy to talk about that I just would want to say two things I don't think in my talk I emphasized that the International Swaps Derivatives Association for their authority for the D guarantee loophole relies on footnote 536 of an 80 page single-spaced triple column document put up at the CFTC that had 662 footnotes so this salt arrives as the commentators have said from reading a footnote that really doesn't doesn't give the support for this dramatic dramatic loophole secondly even if a subsidiary is guaranteed even if a subsidiary is otherwise under dodd-frank the CFTC created out of whole cloth a further exemption and that is the any number of stakeholders can apply to the CFTC for something called substituted compliance so if you are guaranteed you're covered by dodd-frank but under a wholly made-up doctrine by the CFTC the bank the country almost anybody can apply to have the foreign governments rule substitute for dodd-frank the as was said Commissioner BOM Bowen wrote a phenominal which I quote extensively dissent to using a Japanese rule to substitute for a dodd-frank rule showing that it's it's a Potemkin village of regulation the other big substituted regulation is the European Union and all I can say is look at the AG bank my junk is in the hands of the great regulators of the European Union as was Northern Rock as was HSBC as was the London LIBOR problem as was the money laundering by HSBC so essentially what happened is the European Union said to the CFT there was a trade war they said look if you're gonna apply dodd-frank when you're US companies do business and are in our jurisdiction when they do business in our jurisdiction and are regulated by us we're going to regulate them out of existence so if you want to help your banks you better use our regulation as it is without all the drama of making it harder for US banks and it was essentially a trade war and the CFTC in getting substituted compliance the EU was clear they were conceding something to get out of what they thought was a trade war with the EU and as I said Commissioner Rowan's dissent and the Japanese substitute of compliance says it all but again if the purpose of dodd-frank is to regulate so as to avoid the US taxpayer bailing out to the tune of trillions of dollars not just US banks but foreign banks let's say there is a collapse of a big US bank holding company because it was regulated by the European Union what is the average person going to say in when they're explained as the bailout progresses oh we tried to take care of this we gave it to the European Union to regulate Citibank JP Morgan Chase Goldman Sachs and Bank of America it just makes no sense but as the economy seems to be booming there's as I say my paper there's a lot of writing by very respected people saying indebtedness consumer indebtedness is mounting to the extent that mortgage indebtedness happened in 2007-2008 defaults on cansado loans student loans credit card debt are skyrocketing banks are losing a lot of money out of this oh and by the way all this indebtedness has the very same financial engineering that surrounded mortgages in 2007 asset backed securities collateralized debt obligations credit default swaps and yes naked credit default swaps in other words people are betting that student loans auto loans credit card debt will not be paid off even though they are not extending the debt the final thing would i would say is the good news in all this is I think we really took a turn for the worse by bringing in the Trump deregulatory philosophy the tea party got started as opposition to u.s. bank bailouts progressives are opposed to us bank bailouts there was this sort of quasi deregulatory bill passed as to 155 I talked about it in my paper it was for small banks banks no more than 250 billion in assets that sounds like a lot JPMorgan has 2.5 billion and tritium assets I'm sorry you lose track of the dollars JPMorgan and City said oh this is for banks up to 250 we want to take advantage of this the outcry against that was overwhelming shareholders meetings of city people were getting up saying don't put yourself and my money in the position we were back in 2007 2008 even the conservative Republican senators who supported the modest fee regulatory loophole said we are not going to pass legislation that deregulates the biggest US banks the problem is we do not have a spokesperson in power to be able to take advantage of that bias against the regulation and certainly not in this administration but I as I said I think the immediate way out of this is to get state attorney generals to bring lawsuits they can do so under the Commodity Act but in the long run I think regulating big banks does resonate politically we just need a spokesperson for it well before I hand it over to rob for the qat I want to say terrific discussion about a really important topic but it's important to keep in mind that what we're talking about is derivatives regulation of the CFTC the same type of loophole loophole creation and exploitation and deregulation is happening at the Fed with capital liquidity counterparty etc the same thing is happening at the SEC in various areas and at the OCC and at the CFPB we're interesting Lee the Acting Director said you know when I was in Congress if you are lobbyists and you gave me money I'd see you and if you were not a lobbyist if you were lobbyists and you didn't give me money I wouldn't see you so this is actually just one pshhh of a much broader picture of massive deregulation that's happening across the board throughout the financial industry in Washington DC today so thank you all for that and Rob will lead the QA C start with Dale I did the notional amount metrics relative to the metrics before the crisis and Tom Dan trullo before he left us really Washington you know view viewed the adjustment of regulatory bank regulatory regime as between the US and Europe as an evolving process and he was willing to give them some time I think he said that back in 20 14 or 15 but whatever happened to the notion of aligning the regulatory regime so we is that just flown off the table at this point Michael if I can just quickly say that I have a history of the European Union in the g20 2008 they say let's hold hands we're all gonna regulate derivatives here are our principles only two countries adopted those principles the United States and arguably Japan as that we move further away from the crisis the European regulators were captured they have not put in place dodd-frank alike principles and the thesis is 2008 was a once in lifetime experience and it'll never happen again so who who cares and with chairman Powell telling us and I he has basis for saying that we're in an economic boom that's fine but Steven Pearlstein just wrote a long column for the Washington Post I talked about student debt credit card debt auto loan debts he points out that the big corporations have extended themselves by borrowing to buy back their stocks he sees that so there's a lot out there as people have said I'm not saying I predicted crisis but we are not in a utopian economic situation the Europeans look don't you bank the Italian banks the Spanish banks the Portugal banks the British banks are all in serious problems they're readying bailouts already for those various banks do we want to give those people the substituted compliance responsibilities in our our run a regulatory scheme dan what was your first question yeah well that's a great question there was an article published by Reuters which I cite in my paper in 2015 by a man by a man named Levinson and he estimates that 95 percent of certain swap lines have left the United States and gone abroad mostly to Europe now lately that calculus has been a attacked as not being accurate but look when you're dealing with 600 trillion dollars you don't have to show 95 percent is exposed one bank recently said well we're only operating 5% of our swaps outside of dodd-frank well 5% of 600 trillion dollars that's a lot of money JP Morgan Chase one rogue trader in 2012 lost 6.2 billion dollars now JPMorgan Chase has two preserves that could cover that but a lot of financial institutions don't and what if it wasn't just one trader in London what if it was a bunch the metrics are hard to come by because of a lack of transparency if you're getting out of the reporting requirements of dodd-frank it becomes difficult to get precise information interestingly the Bank of England just said their observation of the swaps market it's a lot of swaps are moving out of the United States into the European Union but we can't get metrics what we need is to have somebody with subpoena power to get the information the CFTC would not have tried to close this loophole in October 2016 if they didn't think they were losing regulatory control over the swaps market okay but I'd like to do is take about four questions I see one two three four to start with the lady over here and then work your way around thank you my name is Lucy Komisar I'm a journalist to what extent does the movement of these derivatives into Europe relate to rehypothecation is this a part of rehypothecation is is it parallel to rehab publication this reminds me that the course I took in law school that dealt with reiha publication and I think I failed so I'm not in a position to answer your question I would tell you that is probably not related to rehypothecation it's more of moving the activity actually out into a subsidiary in a foreign country where RIA politician is taking the collateral and using again to lever up a little bit further so it's it's it's a different kind of risk the moving across is if you move if you if your arbitrage in the regulatory framework and move me from a stricter to a less strict which is what that footnote began motion on that's one level of risk and it does mean increased leverage perhaps it does mean less transparency it does mean easier margin requirements so you do have risk the reification says well I have this collateral at sitting here I got to use it so I I borrow against it again using someone else's and that's why you have the very rapid row down [Music] [Music] that's that's the arbitrage of the regulatory framework so you move it from one jurisdiction to another to get a better deal and that's what goes on there with the reification process yeah and we did we did we did limit in the US I bought the reallocation abilities of some of these firms to the to the betterment of the financial stability issue in the United States why don't we go through and ask the three questions and then the pale how can't take with that and then we'll have to I just wanted to ask the panel so about three weeks ago a story came out at the goldman sachs equity derivatives desk and one day in february 5th of earlier this year made 200 million dollars now it's hard to say that that was market making operations and was in proprietary trade and what i found it i love to get the just the response from the panel what would you what he thought of that but the story literally lasted a day and then we just moved on and boy those guys at goldman sachs are really smart and we just moved on and this was done with derivatives it's a lot of it was derivatives equity derivatives specifically the the VIX and volatility derivatives so it seems as though businesses going on as usual but if you have any any insight or any of any you know just reaction to that I want to take it slightly different different technics I share the concern and a lot of it is taking advantage of government guarantees we try to write regulations to avoid the exploitation of government guarantees but it's a government character in the first place kind of allow for the exploitation of my wandering at the time hasn't come to why do you need banks there's enough expansion of credit from all kinds of sources that if the Federal Reserve people just buy those directly involved in theory if they wanted to invest in something that never ate it would be just like a neutral factor without any underlying guarantee and I think if we took away that you doesn't guarantee we will solve and wondering if there's enough credits available well they answer some of the questions as they've come up hoping that this can be corrected by increased capital I think given the the direction today a decrease in capital over overall is just it's not going to happen I think chairman Volcker and vice chair honi could answer that more directly I did want to say something because chairman Volcker is here about the Volcker Rule that is very important it isn't directly affected by what I've discussed because I don't think the banks have been able to use shuttling money to Europe to get out of the Volcker Rule but the point that's important and what I want to emphasize as part of Chairman Volkers thesis when he first of all the Volcker Rule I think all of us would agree was a very very important recommendation when chairman Volcker proposed it to President Obama it was contained in the three-page letter jumping over the history there are five different regulators who have to promulgate a Volcker Rule those rules are hundreds and hundreds of pages long the new effort to redo them is quote to simplify them now reduces it to another several hundred pages but chairman Volcker has said something very very important he has said that the Boca rule could be four pages long you just outlined the prohibition and then you have the CEO and the boards be liable for its violation too much of what we're doing and I think this comes out of the fact as Senator Dodd made clear Congress didn't know what it was doing when it passed dodd-frank so every time they had a corrective they said to the agencies you promulgate rules which is a very long complicated process that invites the participation of lobbyists in trying to limit the rule the vocal rule and the extraterritorial rule if you're swap trades are going to have a serious adverse impact on the US economy if they go wrong you don't need an 80-page guidance on that the more traditional form of regulation was here's the rule if you violate it you're in trouble now go out and figure out what it is not as I think chairman Volcker said and maybe vice-chairman honing not to write a rule that looks for every conceivable option in terms of applying the rule and in that process giving the bank's leeway because you know a rulemaking you have to file comments if you want influence filing comments is expensive Dennis I and others have filed comments but we don't have limitless resources the banks do and also they're in lobbying the commissioners of the CFTC that's public information so many simple prohibitions in dodd-frank should have just been left as prohibitions and you keep kill somebody you don't go through a rulemaking to say what is killing or any other crime there's no rule making the rule makings are just draining the life out of dodd-frank can come in a couple starting with the last that I agree that one of the things that's happened are the enormous subsidies that come through the implied and explicit guarantees from the government in fact that's one of the reasons I think Washington is growing so quickly because we're not subjecting ourselves to the market as much we are relying on Washington for favors and that changes the dynamics and the risk appetite and we're seeing that so that's why you have to get this idea of too big to fail back off or this will only grow I'm convinced to that and and I'm not optimistic but at least we ought to keep fighting at and one of the that brings us to the second point capital now there's a foul knots out there's dozens of capital measures that we use and I've been a strong proponent of a simple tangible leverage ratio because it tells me how much money I can lose before I'm broke that's what the market wants to know that's what I want to know so if I can see what you're doing at risk I know how much leeway you have and we've we've completely moved away from that we have this very complicated risk weighted system that is confuses everyone so we need to simplify and the most systemically important institutions in the world are the least well capitalized I mean a little community bank in western Kansas has more capital $4 of assets than the largest banks the United States now whether that's good or bad we might debate but at least talk about the same thing and I think that is a real issue because the idea now is if you have the guarantee lever up because you you more easily increase your ROI the bonuses come in so that will be a constant problem as long as you have this explicit and implied guarantee I want to them very comment on your on the cooperation everyone wants to cooperate except for their special case and the Bank of International Settlements and I have a lot of respect for you have this the supervision committee that various countries come in try and come to an agreement but behind that is every countries shall we say anchor instant and even in the building the capper ratios whether it was risk-weighted or otherwise leverage ratio afterwards it's easy to say yeah we need more capital but but and so then that they've got the cooperation of the discussion kind of weakens at that point so it's it's always local interest first and that will always be the case which is why the cross-border issues will we haven't begun to solve those ring-fencing will be the call of the day if we have another crisis so cooperation is important I always want to keep striving and in today's dynamics and world I don't think we're headed that way we're headed the other way we'll see what happens thank you so fascinating that people talk about capital they say how much and what type nobody ever says well what against what what is how much or how little so if you look at the data done on the crash of oh seven oh eight oh nine the first question should be what was the capital shortfall that US taxpayers had to bail fill in right what was that well it appears because there has not been any robust comprehensive analysis of north of twenty percent was the capital shortfall when you look at it that's after being back stopped by The Full Faith and Credit of the United States the shortfalls about twenty two percent or something and we're talking we're arguing about what are the capital levels at the biggest banks well today they're using capital leverage tangible right they're about six and a half percent six and a half right and in Europe it's 200 basis points less theoretically whether a crisis less than a third great worse than it was before so well you have to remember yes let's say it's six percent it's not six percent that you can lose you can lose only a fraction that before people become absolutely paralyzed and the liquidity crisis emerges and that's when everything runs and that's the real danger that we face right you know oh they do all the time well there's somebody from the Fed I don't remember his name but somebody when somebody was making that argument back in 2010 and 2012 somebody said well you know two times zero you know I mean double the doubling was always comforting it somebody said well why don't you triple it well we'd better tie up I thinking of the old Billy Preston song nothing from nothing equals I think there are a lot of themes here today first of all we have four very experienced extraordinary people who've done a lot of public service here and as we're trying to manage in our society this question of legitimacy and Trust and representation in a complex domain I'm reminded of John Kenneth Galbraith statement you should all read this book it's called the short history of financial euphoria about a hundred pages and it's fantastic for the how did I say the farce that our society repeatedly returns to and he says for practical purposes the financial memory should be assumed to last at a maximum no more than 20 years this is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind and so here we are at halftime we have these diligent public servants reminding us not to relinquish and I not to relinquish what you might call awareness stay vigilant and there are two things on this I don't know how much you know about the structure blues music but it got it goes like this I have no idea what to do I have no idea what to do let's get back to work [Laughter] [Laughter] so there's there's kind of two variations in blues music one of its typify by the song trouble in mind trouble in mind I'm blue but I won't be blue always because the Sun gonna shine again in my back door someday that in your spirit you keep drawing keeps there's a newer variation and I found a song that I think particularly pertains to one of our panelists and it's goes like this and I love you dear but just how long can I keep singing that same old song and I love you dear but just how long can I keep singing that same old song I'm going back to Kansas City [Laughter]

Channel: New Economic Thinking

Views: 11,400

Rating: 4.8208957 out of 5

Keywords:

Id: xT-tie8sFog

Length: 75min 29sec (4529 seconds)

Published: Wed Jul 11 2018

Reddit Comments

[u/pacg]

This is still going on? Frontline covered this several years ago, show warnings went unheeded. Oh boy.

[u/ahandreachesout]

This is fucking insane.

[u/EasternEuropeSlave]

Free market ladies and gentlemen.