Systemically Important Financial Institutions

What do you think this phrase means? Yup, the biggest of the big boy financial institutions… including the next batch of “too big to fail monoliths.” These mega-babies have the ability to borrow cheap money from the Federal Reserve – because they are federally insured commercial banks – and have trading desks that create, buy and sell equity and debt instruments, inventing new secondary markets (so-called derivatives) with virtually no oversight. The law once prevented these various financial functions from being performed within the same institution, but then President Bill Clinton signed a bill to permit them all to merge into a single entity. And boy did they?! These bad boys float debt instruments and bundled assets, often requiring a rating by one of our nation’s sterling credit rating agencies in order to justify the market . Yes, the same credit rating agencies that believed bundles of subprime mortgages deserved A or better ratings. Oh and these behemoths – the ones that the rating agencies need as clients to survive – are also the ones to pick those agencies in the first place.

Sure, there are a few new regulations, debt-to-equity ratios are more carefully regulated, cash reserves are monitored, bailed out banks have restrictions on some executive compensation, etc. But even implementing rule-making under significant sections of the lobbied-to-death Dodd-Frank legislation, mostly too little too late, is being delayed, especially in market segments that played a major role in the big fall. This is particularly true with proposed rules wrapped around derivatives (where people trade based on economic values that occur in other tradable instruments or bundles of such instruments as opposed to dealing directly in them), including “swaps” (where one party with a risk-oriented right to income sells that right to another party who has a willingness to assume that risk for a le sser cost) and “credit default swaps” (literally a form of credit default insurance): “[On June 29^th,] the SEC … proposed new standards of conduct for banks and other firms that deal in complex financial instruments known as ‘swaps.’

“The proposed rules are part of the government’s push to impose order on the vast but historically unregulated trade in derivatives, an often lucrative but risky business… The SEC has jurisdiction over swaps tied to securities. The Commodity Futures Trading Commission has authority over others and has proposed parallel standards… Both agencies have fallen behind s chedule in writing a host of rules about derivatives and have given the industry a temporary reprieve from some of the Dodd-Frank requirements.” Washington Post, June 29^th. What??!!

For the most part, very little has changed, except that the surviving big boys absorbed the failed big boys and got bigger. Oh sure, some of them are bracing for the obvious downturn as the government heads toward an economy-contracting austerity program. Goldman Sachs even announced [on June 29^th] 230 intended lay-offs in New York, but these fat dudes are in no danger of succumbing to the economic mess they fomented. Wall St. even got the Federal Reserve to buy a whole pile of questionable bundles of debt off their books (their mistakes!); the euphemism was “quantative easing.” The Fed is clearly under-capitalized… er… well… except they do have the ability to increase the money supply (the modern equivalent of printing money). When foreign buyers aren’t buying U.S. treasuries, the Fed steps in and makes the purchase, with phantom money they have just manufactured.

The governmental bailout was intended to increase the flow of credit, for middle level and ordinary businesses. That just didn’t happen, but hording and using money to buy up little companies did. Credit is tight unless you are a very big economic player. These institutions are so big that they are hard to control or even understand. So big that senior managers can embezzle millions, and it is often dumb luck that such crimes are discovered: “Gary Foster toiled away as a mid-level accountant in Citigroup’s Long Island City back office, collecting around a $100,000 paycheck last year… But federal prosecutors claim Mr. Foster gave himself a bonus fit for a star investment banker by embezzling more than $19.2 million from Citi before its auditors picked up on the scheme… In this case, it took nearly a year after the claimed embezzlement began before Citigroup’s internal auditors uncovered that millions of dollars were missing.

“According to the complaint, Mr. Foster transferred the money from various Citigroup corporate accounts to his own bank account at JPMorgan Chase late last year. From July to December 2010, he moved about $900,000 from Citigroup’s interest expense account and about $14.4 million from Citigroup’s debt adjustment account to the bank’s main cash account. Then, on eight separate occasions, he wired the money to a personal account at Chase.” New York Times, June 27^th. His own personal bank accounts?! As I said, “dumb” luck.

Federal Reserve Bank of Kansas City President Thomas Hoenig is profoundly skeptical of the minimal financial reform efforts taken by the federal government (mostly under the watered-down Dodd-Frank bill). Indeed, administration efforts have stymied at every turn by well-healed Wall St. lobbyists, political action committees funded by financial institutions (literally unchecked under the horrific Citizens United Supreme Court decision), lurking campaign contributors making the connection between getting enough money to run and being friendly to Wall St. very clear, and smart lawyers and accountants finding all the loopholes necessary to render much of this purported regulation ineffective. Hoenig has been blunt in his criticisms: “‘The Dodd-Frank reforms have all been introduced before, but financial markets skirted them,’ he continued. ‘Supervisory authority existed, but it was used lightly because of political pressure and the mis-perceptions that free markets, with generous public support, could self-regulate.’…

“Regulators will lack the will to wind down failing companies deemed systemically important financial institutions, or SIFIs, Hoenig said. The power to force large firms into liquidation was the centerpiece of the Obama administration's plan to reform the financial system in the wake of the crisis and Great Recession.

“‘I just can't imagine it working,’ Hoenig said. Speaking of the difficulty of forcing a large, complex firm like Citigroup or Goldman Sachs into bankruptcy-like proceedings, the Midwesterner admitted that if he were the one ultimately making the decision, ‘I would be inclined to bail them out.’… ‘One of the difficulties in terms of supervision of these SIFIs is they are so horribly complex their directors don't understand it, their management don’t understand it, and the supervisors certainly can't deal with all the issues,’ Hoenig said.” Huffington Post, June 28^th. The inmates are still running the prison, and if you think this seemingly never-ending litany of financial catastrophes will never happen again, that the global powers have reined in a system that was rife with abuse, think again. They’re baaaaaack!

I’m Peter Dekom, and as we stare down the barrel of the double-dip of our recession, we really need to remember where it all started, and why it most certainly can happen again.