America's Big Banks, America's Financial Vietnam

October 3rd, 2011 By Peter G. Miller

Three years ago the most-powerful institutions in America were the nation's largest banks and brokerages, Wall Street for short. While millions of people were losing their homes, their jobs and their savings, the nation's elite extracted a $700 billion line-of-credit from Uncle Sam.

Now Wall Street is our financial Vietnam. It's broken. The old cures and postponements won't work. Everyone knows it.

"High risk mortgage lending and shortcomings in consumer protections for mortgage borrowers were among the most important underlying causes of the housing bubble and the financial crisis that resulted," according to Sheila Bair, past chairman of the FDIC. "Not only did the proliferation of high-risk sub-prime and non-traditional mortgage products help to push home prices up during the boom, but excessive reliance on foreclosure as a remedy to default have helped to push home prices down since the peak of the market over four years ago."

No longer are huge financial corporations seen as too big to blame - nor as too big to fail. In fact, some have even embraced the idea of a voluntary bankruptcy.
Stock values for the financial sector are in the dumper. Shareholder equity worth hundreds of billions of dollars has been destroyed.

The value of savings has been demolished with interest rates at record lows. Those who had played by the rules and put away for retirement now find themselves with pension cash that generates only tiny dribbles of income and surely less than the rate of inflation. In effect, savers are losing buying power. Many who were once financially comfortable are comfortable no more. Government, corporate and private pension plans have all been decimated.

According to the FDIC the banking industry had profits of $28.8 billion in the second quarter - after reducing reserves for loan losses by $21.5 billion when compared with a year earlier.

Large and growing demonstrations are taking place in New York, Seattle, Boston and Washington. Groups such as Occupy Wall Street, Occupy Together.org, Occupy DC and TakeBackBoston are rising with the speed of Twitter, texting, Facebook and Google.

A huge march for jobs and justice is scheduled for October 15th in Washington. Major unions and other organizations will be involved, according to the National Action Network.

Sweetheart deals between banks and regulators are falling through. The Federal Housing Finance Agency is now suing 17 major banks and servicers, alleging that mortgages worth nearly $200 billion were sold to Fannie Mae and Freddie Mac through "negligent misrepresentation."

An effort to paste together a $20 billion robo-signing settlement between several major banks and the nation's 50 attorneys general is on the rocks. Several state AGs - including New York's Eric Schneiderman and California's Kamala Harris - oppose a general settlement which would allow banks and servicers to avoid further mortgage and securities investigations.

Michael Hudson, author of The Monster: How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America - and Spawned a Global Crisis, alleges that lenders have "protected fraudsters by silencing whistleblowers" in his new two-part series, The Great Mortgage Cover-Up.

The real size of the 2008 bailout is beginning to be understood. It wasn't just a $700 billion line-of-credit, it was also secret funding worth $1.2 trillion according to Bloomberg News. "The largest borrower, Morgan Stanley (MS), got as much as $107.3 billion, while Citigroup took $99.5 billion and Bank of America $91.4 billion," says Bloomberg, which had to sue to get the information. Across the country foreclosures have slowed, not because there are more jobs or better times but because the electronic sale and transfer of mortgage notes is widely regarded as unreliable. As the Maine Supreme Court explained to one lender, their documentation was "inherently untrustworthy."

Gutting Regulation
In even in past periods when unemployment has been high there was no mortgage meltdown that compares with what we have seen since 2007, the year home prices peaked.
So what happened?

The presidency of George W. Bush was powered in large measure by an effort to reduce both taxes and government regulation. The compassionate conservatism he promised - whatever that was - quickly was replaced with the thinking of Ayn Rand.

"When I say 'capitalism,'" said Rand, "I mean a full, pure, uncontrolled, unregulated laissez-faire capitalism - with a separation of state and economics, in the same way and for the same reasons as the separation of state and church."
Indeed, officials from five financial regulatory agencies told reporters in 2003 they were going to "identify and eliminate outdated, unnecessary or unduly burdensome regulations imposed on insured depository institutions." To make sure no one misunderstood, four of the regulators stood around a pile of paperwork with pruning shears. The fifth, James Gilleran with the Office of Thrift Supervision, posed with a chainsaw.

The Securities and Exchange Commission decided in 2004 that 11 major banks and brokerages could have more liberal reserve requirements than competitors. The SEC said "the 11 firms we expect to apply under the rule amendments could realize a total reduction in haircuts of approximately $13 billion. We estimate that they will realize a total annual benefit of approximately $26 million (.2% * $13 billion - $26 million)."

How nice to give selected corporations a $26 million advantage. That sure sounds like a case of the government picking marketplace winners.

In fact, according to The New York Times, much more that $26 million was involved.

"The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments."

Federal Monopoly
In 2004, one major bank regulator, the Office of the Comptroller of the Currency (OCC), simply ruled that state regulators had no right to oversee national banks in any meaningful way. According to Eliot Spitzer, then the attorney general of New York:

"The OCC today issued two regulations designed to protect national banks at the expense of consumers."

"One regulation would broadly pre-empt all state laws against national banks, including predatory lending laws, leaving only narrow exceptions for contracts, debt collection, acquisition and transfer of property, taxation, criminal, zoning and tort laws."

"The other regulation would confer upon the OCC exclusive jurisdiction over national banks, and specifically exclude state attorneys general from enforcing consumer protection laws against national banks."

"Together, the two regulations would prevent the states from enacting or enforcing almost any law against national banks, including consumer protection laws of general applicability that apply to every other business in the state."

"These regulations would also result in an unprecedented expansion of the OCC's powers, while at the same time shielding the banks from state enforcement officials charged with protecting their citizens from fraudulent and illegal conduct."

"The OCC regulations are opposed by a bi-partisan coalition of state officials. In fact, all 50 state attorneys general have submitted comments to the OCC opposing this action. The attorneys general have noted that OCC devotes the vast majority of its time and resources to monitoring the safety and soundness of financial institutions, and does not have the states' experience, expertise, resources or record in addressing consumer protection issues." Spitzer was exactly right.

The truth is that the mortgage meltdown was entirely preventable. The Federal Reserve, under the Home Ownership and Equity Protection Act, has the unilateral right to ban mortgages and mortgage activities which it defines as "unfair and deceptive acts or practices." Under the chairmanship of Alan Greenspan - a long-time Rand devotee - the Fed never used its power to stop option ARMs, interest-only mortgages or no-doc loan applications.

Think about it:
If the mortgages were good then the mortgage-backed securities (MBS) would be good. If the mortgage-backed securities were good then the banks and brokerages would not have massive losses, mortgage investors would be whole, the companies that "enhanced" (insured) mortgage-backed securities would be profitable, and people across the country would not be losing their homes because they financed with "non-traditional" loan products that included surprise terms, prepayment penalties and huge monthly cost increases. And if the housing sector was okay then home prices might well be stable and many of the job losses we have today would never have happened.

There's little doubt that many will discount the marches and tweets now growing in volume and fervour. That's a mistake. In the same way that the Vietnam war became unsustainable as political support waned, that's now happening with the policies, tax breaks and favours for big banks, big brokerages and big corporations. It's our new financial Vietnam and like the first one it has cost great treasure, weakened our economy, hurt our national interests and devastated the social contract.

"There's class warfare, all right," Warren Buffett told the New York Times, "but it's my class, the rich class, that's making war, and we're winning."

I disagree. It's not the "rich" it's the greedy. There are a lot of rich people - including Buffett, Bill Gates and even JPMorgan Chase CEO Jamie Dimon - who understand that higher taxes are a cheap price to pay for social consensus.

It's also in a large sense not a left-versus-right or conservative-versus-liberal debate. Rather there's a growing understanding that Albert Einstein was right when he said "the thinking it took to get us into this mess is not the same thinking that is going to get us out of it."

Moreover, it's hard to see that there are many winners. If you don't believe it just look at the Bank of America - it's downsizing and planning to lay-off 30,000 workers.
There is an answer. Big financial institutions need to be smaller so there's less risk to us all. Repeal the Gramm-Leach-Bliley Financial Services Modernization Act and bring back Glass-Steagall, a 1933 law which said that a bank could make loans and collect deposits or it could raise money and sell securities - but not both. Require financial institutions to have a 5 percent cash reserve for every derivative they buy, sell, finance or insure - for themselves, for others or for a subsidiary. Limit the size of depository institutions to $100 billion in assets. Limit the size of branch networks to a maximum of ten states. Prohibit commercial banks from selling insurance or annuities. Limit ATM charges to $1. Allow state bank regulators to define predatory loans and enforce their definitions even when national banks, thrifts and credit unions are involved.
The list goes on but the point is obvious: A financial institution which can undermine the entire economy of the United States is not just too big to fail, it's also too big to regulate and too big to exist.
Financial holding companies can divest divisions and subsidiaries until they're right-sized, downsized, focused, leaner, more efficient and more profitable; a better deal for customers, clients, employees and shareholders. The businesses that are sold off can keep their employees and function independently - and sink or swim on their own without needing or expecting a taxpayer bailout.

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