This blog
has long argued against the non-transparent and highly
subsidized derivatives activities of the megabanks while also
recognizing the legitimate
role of derivatives in
facilitating risk management. Most recently, I suggested that any financial
losses arising from turmoil in Greece, Russia or the global oil collapse could
land in surprising places thanks to the derivatives
markets.
Derivatives
allow megabanks to sell their government backing to
third parties for a lower price than what would be implied by the third party
simply investing in government bonds. The megabanks under-price the risk of
their derivatives transactions because ultimately the US taxpayer (and by extension
the economy as a whole) bears the costs not executives at the megabanks who
make millions no matter
what.
Recently,
the megabanks used their prodigious
political power to
short-circuit the efforts of lawmakers to curb the derivatives activities of
the megabanks under the Dodd-Frank Act. The megabanks managed to insert a
provision in an omnibus
funding bill that effectively
repealed the Dodd-Frank mandate that federally insured banks "push-out"
their riskiest derivatives activities to other megabank affiliates. Due to their express federal insurance the bank subsidiaries
enjoy higher credit ratings than the megabanks as a whole.
This
stealth repeal of part of Dodd-Frank means that the banks now offer a safer,
less risky derivatives product to their counterparties. That, in turn, means more
pricing power, greater megabank profits and higher bonus payments to senior
management.
Some megabank
apologists suggest that this all matters little or that it is all
about technical rules beyond comprehension. Do not buy that sanguine story.
Essentially this dispute is about whether the riskiest derivatives--including
credit default swaps (CDS) like those that sank AIG in 2008--can be housed in
federally insured depository institutions. Huge sums are at stake. Jamie
Dimon himself lobbied for this partial repeal of Dodd-Frank. Citigroup
apparently drafted the bill. According to the Vice Chairman of the FDIC:
"There is about $10.4 trillion in notional CDS exposure
that would have been subject to the push-out, and one insured bank owns $4.6
trillion of that exposure. That is three times the amount of notional CDS AIG
had when it was bailed out at a cost of $85 billion." In other words, the very derivatives (credit
default swaps) that figured so prominently in the 2008 financial
collapse are subject to this partial repeal, but in far greater amounts.
Government subsidies like those available to insured
depository institutions should not extend to support risky derivatives
transactions. The only logic behind this partial repeal is for megabank CEOs to
garner excess compensation for taking on too much risk and the raw political
power that the megabanks now hold in Washington.
Given the incestuous relationship of derivatives
traders (a
small number of global
banks dominate the market) why did this regulatory indulgence make it to the
top of their agenda now? Do the megabanks know something about their exposure
to Greece, Russia, and the oil collapse that makes federal backing of their
riskiest derivatives particularly urgent?
Steve, this repeal feels sneaky and "manufactured." Was there any opposition in Congress? Or within the Obama administration?
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