TBTF and the $7 Trillion Question

The Wall Street Journal ran a disturbing story this weekend. The story featured Thomas Hoenig, President of the Federal Reserve Bank of Kansas City. He adds yet another angle on Dodd-Frank and the TBTF problem.

According to Hoenig, a handful of megabanks hold over $7 trillion in derivatives exposure--a number that dwarfs all other sectors combined. Hoenig argues that the concentrated nature of this exposure means that the megabanks cannot be permitted to fail because the failure of one would still cause the entire financial sector to collapse as each bank would have to write off the amount owed by other banks under derivative agreements.

"Mr. Hoenig doesn't buy the idea that better supervision, higher capital levels and powers granted by the Dodd-Frank Act to wind down a tottering institution will take care of the too-big-to-fail problem. The biggest firms, he noted, can't be wound down because 'there are too many connections that will bring down other institutions.'"

I have long argued that Dodd-Frank did not end TBTF, but instead institutionalized it. Hoenig highlights another reason why that is so. The only remaining question revolves around the behavior of the derivatives markets if oil surges, prompting a nasty bout of stagflation that could well cause losses to the financial system that feed into the derivatives markets and land who knows where.

The Politics of the Financial Market Crisis

In May of 2009, the Fraud Enforcement and Recovery Act (FERA) was signed into law. The bill created the Financial Crisis Inquiry Commission, a panel of 5 Democrats, 1 Independent, and 4 Republicans whose task was to “examine the causes, domestic and global, of the current financial and economic crisis in the United States” and to issue a bipartisan report by December 15, 2010. As was previously noted on this blog, the official 545 page report was delayed and just recently released on January 28, 2011.

The FCIC’s investigations were marred with partisan bickering, finger-pointing and infighting, highlighted by the votes cast by the commission’s 4 Republican members during December 2010 to ban the words “deregulation,” “shadow banking,” “interconnection” and amazingly, “Wall Street," from the final report. After being voted down 6 to 4 on banning "Wall Street" from the final report, the Republican commissioners defected from the FCIC and issued their own 9 page dissenting report on December 15, 2010 (which does not include the terms "deregulation," "Wall Street," and "shadow banking"). The Republicans have since complained about the commission’s leadership and management, claiming they were often kept in the dark about witness interviews and other important information.

The Republican report, originally issued on December 15, 2010, details the large housing bubble and government sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac’s “contributions to declining lending standards,” and the Community Reinvestment Act’s role in the meltdown by “mandate[ing] the extension of credit to high-risk borrowers,” all in stark, partisan contrast to the official report’s conclusions released on January 28, 2011. One possible aim of the defecting Republican commissioner's dissent was to attempt to undermine the official report by discrediting it as hyper-partisan. Following the release of the official FCIC report, three of the Republican commissioner's dissented anew, while the fourth attempted to place blame for the entirety of the financial market meltdown on governmental social engineering. This Republican attention grab “makes it easy to chalk this up as just another chapter in the divisive politics in Washington,” commented one law professor. Another financial market scholar added, “The most likely outcome seems to be that this report gets put on a shelf to collect dust.”

Strangely, the official FCIC report may end up doing little more than collect dust. Because the Dodd-Frank Act was passed before the FCIC report was completed, new legislation was passed before official word was delivered as to the causes and underlying failures of the crisis. Now that the badly flawed Dodd-Frank Act is law, there seems to be little political will to carefully consider the FCIC official report in order to consider new regulation or necessary legislation. As to whether the Dodd-Frank Act will do anything to prevent a future meltdown, several commentators at various symposia believe that it most definitively will not.

Racially hostile work environments

Approximately 250 African American workers are suing Turner Industries Group LLC, a large industrial construction company based in Baton Rouge, Louisiana. The workers allege that they have been forced to work in a racially hostile work environment. They complain about the use of racist epithets, nooses in the workplace, and discriminatory employment practices relating to promotion and pay.

Turner Industries denies the allegations even though The Equal Employment Opportunity Commission issued a “reasonable cause” finding against the company, and even though the company settled similar allegations made by several workers at its plant in Paris, Texas.

James Vagnini, a partner at Valli, Kane & Vagnini, is representing the plaintiffs. According to Vagnini, some members of the community believe that Turner Industries’ treatment of its employees is a private matter since Turner is a closely-held private limited liability company. But Turner Industries was formed under state limited liability company law. The fact that the Turner family enjoys limited liability because the state law allows them to do business this way makes this very much a public matter.

Joint Meeting of the Southeast/Southwest and Mid-West People of Color Legal Scholarship Conferences

Nova Southeastern University Shepard Broad Law Center in Fort Lauderdale, Florida, will be hosting the 2011 Joint Southeast/Southwest and Mid-West People of Color Legal Scholarship Conference from March 31st through April 3rd. The theme or title for this years conference is "The Role of the Lawyer in Fostering Social, Political, and Economic Equality." The conference will include a New Law Teachers Pipeline Program sponsored by the Society of American Law Teachers (SALT) and an alumni reception for southeast Florida. Nova Southern University Shepard Broad Law Center and John Marshall School of Law (Chicago) are co-sponsors of the conference. You may access information about the conference at the following link: http://seswpocc.org/

The Rise of American Market-Driven Education System in the United Kingdom, But Interestingly Not In Germany

In December I traveled a few hours, well perhaps a little more than a few hours, to a lovely city in Lower Saxony, Germany—Osnabruck, to teach U.S. corporate law to German law students at Universitat Osnabruck. The students were eager to learn about the U.S. common law legal system, and agreed to enhance their German civil code legal education by adding an English common law component including studying certain aspects of British and U.S. laws. The program is part of Universat Osnabruck’s extensive commercial law program that exposes students to laws of jurisdiction throughout the European Union and North America. The program also provides fairly impressive transnational externship placements with public and private institutions as a requisite part of the law curriculum. As a result, the laws students receive doctrinal theory as well as real world practical experience. Universat Osnabruck has been operating on this model for approximately the last ten years. In addition, the law school offers an extensive comparative law summer program with partners in Europe, Canada, and the American Institute. Viva German law schools!

The commercial law program is really quite well run by Prof. Dr. Martin Schmidt-Kessel, a German attorney, who has spent some time in New York working at Rogers & Wells in the heyday of the technology stock explosion just prior to the industry’s implosion. Lecturer Matt LeMieux, an American attorney, former ACLU litigator, who has been living in Germany for the past five years all for the love of German culture, is an integral component in securing American law professors to make the journey to Osnabruck. They are an interesting legal team and offer a wealth of American ideology and legal know-how to aspiring German law students. The German law students are an industrious lot. After all, it takes a special type of law student to not only study a foreign jurisdiction’s laws but to do it in a foreign language. The class is taught you guessed it—in English. The students’ primary language is German. I would have loved to have taught the class in French, but some well meanings folks may have thought it rather odd that an American law professor was teaching U.S. corporate law in French. Oh, well c’est la vie.

It is from this perspective that I was surprised to read about the student protest turn riot in London over the increase in student tuition and fees. Nothing in the German law students’ reaction indicated that anything was amiss. There were no student riots in Germany. No outrage expressed in the local German news coverage. I didn’t even hear German student raise their voices in anger, in solidarity with their British cohorts. When I raised the issue in class, I was hoping for a robust discussion on American capitalism, market driven decision-making, and the violation of the public trust. After all isn’t Germany the land of Karl Marx and Martin Luther? Viva the sinful proletariat, and the dutifully religious common working man and woman! The students simply stared at me. Finally, a brave student shared that German students “do not pay very much for their legal education and the costs in America for education is way too much. Then the American students have a BIG debt. How do American student repay their loans when they cannot find a job,” he asked? Interesting. I had crossed the Atlantic to teach U.S. corporate law to German students, and here I was being lectured by German students about the market-driven U.S. legal education system, which ladens recent graduates with a huge debt burden that probably take years to repay, if at all.


After class, I inquired as to how much do German students pay for their legal education. “Approximately, 600 Euros, “I was told. “For books,” I confirmed. “No for one year’s tuition.” “What! At the current currency exchange rate that is less than $1,000 American dollars,” I stammered. As I continued discussing the issue with a number of Germans, an intriguing philosophy began to develop, in essence--the German Government believes that Germans should be well educated in order for Germany to remain a competitive commercial and manufacturing powerhouse on the international scene. As such, the German Government heavily subsidizes the education system –at the undergraduate and graduate levels to encourage Germans to attend university. It seems to have worked pretty well when we compare Germany’s literacy rate, employment rate, college-graduate rate, commercial preeminence, et cetera. The Germans are not only competitive; they are arguably in certain sectors doing remarkably better than us market-driven Americans. Perhaps it is time that we Americans rethink our market-driven education system, and learn a few lessons from our German colleagues across the Atlantic.

Lydie Nadia Cabrera Pierre-Louis

More on the FCIC Report

As Professor cummings noted the FCIC report has been released. Initial reactions to the report can be found here, here, here. Reaction to the rebuttals to the report can be found here. If you have been reading the Corporate Justice Blog, you won't be surprised at the findings of the committee. If you have been following the passage of the Dodd-Frank financial reform bill many of these findings were addressed, even if the sufficiency of some of those measures might remain in question. The commission found:

There was an explosion in risky sub-prime lending and securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term “repo” lending markets, among many other red lags. Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner.

What is more telling about the report is what the commission found were not causes of the financial collapse. These causes, having been used by conservatives to advance their free market and deregulation prerogatives, have NOT found a welcome home with the commission. Here are some examples:

1) Fannie Mae and Freddie Mac were the cause of the financial crisis. The commission writes, "We conclude that these two entities contributed to the crisis, but were not a primary cause. Importantly, GSE mortgage securities essentially maintained their value throughout the crisis and did not contribute to the significant financial firm losses that were central to the financial crisis. " The commission goes on to say that rather than leaders in the sub-prime market that the GSEs were followers and that the delinquency rates on sub-prime loans purchased by the GSEs was less than other financial firms. While certainly the GSEs were not innocent in the crisis, as this blog has noted the performance of Fannie Mae and Freddie Mac were much more a symptom than the illness that was the financial crisis.

2) The Community Reinvestment Act played a role in the financial crisis. The commission finds "the CRA was not a signiicant factor in subprime lending or the crisis. Many subprime lenders were not subject to the CRA. Research indicates only 6% of high-cost loans—a proxy for subprime loans—had any connection to the law. Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made in the same neighborhoods by independent mortgage originators not subject to the law." While the commission goes on to question the national priority of homeownership, one President George W. Bush called the "American Dream," it doesn't place the blame on poor Americans looking for help entering the middle class.

3) The deficit. One of the now popular conservative arguments, and one that has enveloped the mainstream media, is that the deficit is the cause of our economic problems. Unsurprisingly, the deficit does not receive a mention in the commission's report. While many conservative leaders propose harsh austerity measures, they fail to note that these very measures in the United Kingdom have them headed towards a double dip recession, while the stimulative measures initiated by President Obama has the US on a slow but steady course of growth.

4) Excessive regulation and failure to let the free market work was the cause of the crisis. One thing you have undoubtedly heard is that "uncertainty" and "hostility" towards business is the reason that the economy fails to grow. The commission found, "The sentries were not at their posts, in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of inancial institutions to effectively police themselves. More than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry at every turn, had stripped away key safeguards, which could have helped avoid catastrophe." The commission has harsh words for those who believe that just letting the free market work is an acceptable strategy for a functioning economy. The belief of those on Wall Street that they were "market makers" and "wealth creators" who had found ways to remove all risk from their transactions and could "beat the market" has ended up to be unfounded. This culture remains on Wall Street and is the reasoning behind the still excessive bonuses received on Wall Street.

Financial Crisis Inquiry Commission Report

The Financial Crisis Inquiry Commission, formed by a 2009 Congressional enactment, has at last issued its final report, despite a fractured and divided committee. Charged with examining the underlying causes of the financial market crisis of 2008, the bipartisan FCIC spent hundreds of hours interviewing dozens of market actors and poured over thousands of pages of reports with the end goal to provide a comprehensive picture of the root causes of the market collapse of 2008. In its 545 page book-report, the FCIC concluded that the crisis was "avoidable" and that "warning signs" had developed years prior to the meltdown.

According to the Wall Street Journal, the report found that:

"Twelve of the 13 largest U.S. financial institutions 'were at risk of failure' at the depth of the 2008 financial crisis, while at least 50 hedge funds tried to capitalize on it, according to a report released Thursday [January 27, 2011] by a U.S. panel investigating how the financial system unraveled."

In several future posts, the Corporate Justice Blog will drill down into the report, examine the contentious nature of the bipartisan committee debate, and discuss the defecting committee members separate report filed last month, December 15, 2010, by the Republican Commissioners of the FCIC styled the "Financial Crisis Primer."

From Wall Street to Main Street Symposium

On Thursday and Friday, January 27th and 28th, 2011, the Chapman Law Review will host its annual symposium "From Wall Street to Main Street: The Future of Financial Regulation." The symposium will analyze the Dodd-Frank Financial Reform Act as speakers and panelists will describe various provisions of Dodd-Frank and opine on the potential that this new financial industry regulation will be successful. A cutting edge group of legal scholars, regulators, practitioners, and bankers will tackle the financial market crisis of 2008 from a variety of perspectives through the lens of the new Dodd-Frank regulation.

The event will be podcast live. Go here, and scroll down to "webcasts." Further, each panel has its own weblink as indicated below:

Panel I: Into the Bog: An Introduction to Dodd-Frank

Panel II: Congress Punts; Administrative Agencies Receive; Welcome to a Decade of Rulemaking

Keynote: Steven Schwarcz: Ex Ante Versus Ex Post Approaches to Financial Regulation

Panel III: The Return of the Rating Agencies: Rerun or Redemption?

Panel IV: Who's the Boss: Re-writing the Rules of Corporate Governance

Rhetoric Matters. . .

People should take responsibility for their words and this prophetic video should be watched by anyone participating in public discourse:


The bottom line is that demonizing people simply is not costless. In the final analysis we are all citizens of this great nation and while we may disagree on policy we should be mindful of the powerful ties that bind us together. When we were attacked on 9/11 the terrorists drew no distinction between conservatives and liberals. Both Democrats and Republicans stormed Omaha Beach. We Americans are all on the same side.

From Wall Street to Main Street Symposium

The Chapman University School of Law and the Chapman Law Review will host a Symposium on Thursday and Friday, January 27th and 28th, 2011 entitled "From Wall Street to Main Street: The Future of Financial Regulation." The Symposium aims to examine the Dodd-Frank Wall Street Reform and Consumer Protection Act featuring keynote speaker Professor Steven Schwarcz and panels focused on deciphering the content and implications of new Wall Street regulations.

Corporate Justice Blog contributors Steven Ramirez, Jill Barclift and andré douglas pond cummings are among the participants that will appear on panels scheduled for 1.28.11 including (a) Into the Bog: An Introduction to Dodd-Frank; (b) Congress Punts; Administrative Agencies Receive; Welcome to a Decade of Rulemaking; (c) The Return of the Rating Agencies: Rerun or Redemption?; and (d) Who's the Boss: Re-writing the Rules of Corporate Governance.

The Symposium promises to be a cutting edge event. For more information and registration instructions, click here. Wall Street reform is something that this blog has and will examine surgically in coming weeks and months.

Merry Christmas to All, with a Special Wish to the Least Fortunate Among Us

Christianity as practiced in too much of the USA really has me baffled these days. Where is the outrage among the hundreds of millions of Christians regarding the 99ers and the 9/11 first responders?

The 99ers are the millions left out of the extension of unemployment benefits and are now facing unemployment with zero aid after exhausting 99 weeks of benefits. The 9/11 first responders are those who were left ill after rushing to the WTC to save lives or otherwise help. They now face crushing health care costs. There are now bills pending to resolve these issues, and I urge anyone with a GOP Senator to contact that Senator and urge passage of these bills.

Much has passed recently during this lame duck session of Congress. Perhaps the most costly and high profile action was the extension of the Bush tax cuts to even the very wealthy--at a total cost of $858 billion. The cuts for those making more than $250,000 will cost $75 billion and will have little stimulative impact.

It is truly morally corrupt and deeply anti-Christian to shower massive wealth on the already wealthy while leaving the most unfortunate among us literally out in the cold this Christmas.

I attended St. Isaac Jogues grammar school and graduated from Our Lady of Perpetual Help. The most vivid lesson from that Christian schooling in my mind is: "That which you do to the least of my brothers, you do unto to me." Somewhere American Christianity seems to have lost that fundamental teaching, at least for too many. I sometimes think that too many Christians in the USA think this is a part of the Sermon on the Mount: "Blessed are the tax cutters, for they shall inherit millions tax free."

So, Merry Christmas to all--and if you wish to help the most unfortunate among us this holiday season I recommend food pantries and a letter to your representatives.

Reversing Field: Examining Commercialization, Labor, Gender, and Race in 21st Century Sports Law

A new book has just been released called "Reversing Field: Examining Commercialization, Labor, Gender and Race in 21st Century Sports Law." Edited by andré douglas pond cummings and Anne Marie Lofaso, this book interrogates the "dark side" of sports, focusing on the commercialization of collegiate athletics and the exploitation of college athletes, as well as issues of racism, sexism and discrimination in professional and collegiate sports.

Per the frontmatter: "Reversing Field invites students, professionals, and enthusiasts of sport – whether law, management and marketing, or the game itself – to explore the legal issues and regulations surrounding collegiate and professional athletics in the United States. This theoretical and methodological interrogation of sports law openly addresses race, labor, gender, and the commercialization of sports, while offering solutions to the disruptions that threaten its very foundation during an era of increased media scrutiny and consumerism. In over thirty chapters, academics, practitioners, and critics vigorously confront and debate matters such as the Arms Race, gender bias, racism, the Rooney Rule, and steroid use, offering new thought and resolution to the vexing legal issues that confront sports in the 21^st century."

Successful Partnerships

The Economist has recently published a short piece examining the ingredients of successful business partnerings. In describing successful partnerings, like those of Warren Buffet and Charlie Munger (Berkshire Hathaway); Michael Eisner and Frank Wells (Disney); and Bill Gates and Paul Allen/Steve Ballmer (Microsoft), the article describes characteristics of successful business partnerings as follows:

"Partners need to be able to trust each other absolutely. . . . Partners also need to possess a delicate balance between similarities and differences. A striking number of successful partners combine similar backgrounds with very different attitudes to fame."

The Economist focuses on one surprising business combination that has worked for more than forty years -- that of Mick Jagger and Keith Richards. To read more about the successful Rolling Stones combination of Jagger and Richards, check out the article here.

Shutting Down the Big Banks

Economists William Black and Randall Wray argue that several big banks should be foreclosed on, starting with Bank of America, for engaging in a pattern of criminal fraudulent behavior first in its mortgage lending practices and now in the foreclosure processes. To read how and why Black and Wray believe that Bank of America should be forced into receivership see:

Foreclose on the Foreclosure Fraudsters, Part I: Put Bank of America in Receivership; and

Foreclose on the Foreclosure Fraudsters, Part II: Spurious Arguments Against Holding the Fraudsters Accountable

If Bank of America and other Wall Street banks had been taken over in 2009 when they were nearly insolvent and desperate for a lifeline, everything would be much different now both on Wall Street and on Main Street. Instead, the big banks have continued "rewarding" their executives with enormous bonuses as they continue to be silently buoyed by the Fed.

Are the Megabanks Insolvent?

Three trillion dollars in uninsured mortgage exposure? Nine hundred billion in home equity loans (probably better termed no-equity loans)? Plus, 1.7 trillion dollars in suspect commercial loans? "The collateral for these loans is definitely worth less than the loan balance." What a nightmare.

Add in any realistic valuation adjustments for MERS related losses, lost note losses, and the fact that residential real estate sales are still declining and it gets really hard to see how the banking sector can be fully solvent.

The Obama administration needs to do new stress tests, with a specific focus on foreclosure fiasco issues, and then assess which banks are viable and which ones are not. Those that are not viable must be shuttered immediately--before they can do more damage or become even more insolvent.