Financial Stability Bill: Loopholes Destabilize It

One wonders about this 1136-page behemoth......

First, some general observations:

• It does not ban off-balance sheet exposures. Why not, given their history both in ENRON's collapse and the panic of 2008? How many times do we have to see these entities abused for the explicit purpose of hiding risk?
  
• It draws a distinction between "regular" and "too big to fail" companies, putting the second into a putative "more supervised" bucket.
  
• It lists requirements that allegedly already exist - including for capital, leverage and "prompt corrective action." But nowhere in the proposed Title does it appear to contain either civil or criminal penalties for the new agency if it fails to discharge its responsibilities. As we have repeatedly seen under existing "Prompt Corrective Action" you can have all the laws you want but if nobody will enforce them they are meaningless.
  
• The contingent capital - that is, hybrid debt that is automatically convertible to equity upon failure to meet a standard set by the agency - sounds good. But is it good? Well, maybe. More on that later.
  
• It does not appear that this act prevents "large" companies from restructuring as a group of bank holding companies to evade supervision. I may have missed it, but if there is a clause or title in there that prevents cross-ownership evasion (by treating any such cross-ownership as one firm for the purpose of classification) I didn't see it.
  
• The leverage limits specified in the act (the "floor", p56) is ridiculously low. 2% capital in tangible equity? That's 50:1 leverage! What are these people smoking? Remember - Bear and Lehman both failed at about 30:1. Prudential eh? Like hell. Realize that with a 2% tangible equity floor a mere 2% loss on assets results in bankruptcy. How many times have we seen traded securities lose 2% or more in a single day? Many. How does one call this "prudential"?
  
• Credit exposure: There goes the need for "23A" exemptions. The putative limit of affiliated and unaffiliated firms is 10% to any single firm, although The Fed has handed out exemptions to that limit like candy on Halloween. This bill puts a 25% limit (!) on unaffiliated credit exposure - a more than doubling of the previous limits. This is a tightening of risk controls? Like hell. In addition allowing more than ten times the credit exposure to an entity than the equity capital requirement is asinine - this would theoretically allow a single counterparty failure to wipe out the firm's capital by that same ten times! A firm should not be allowed to have more exposure to a given counterparty than its equity cushion to prevent any single failure from cascading through to the regulated entity and taking it out.
  
• The putative "resolution authority" allows the assumption of literally any risk, putative "asset" or liability of a failing firm with the full faith and credit of The United States. This is effectively the provision of a blanket guarantee of any large financial firm's assets and liabilities by The US Federal Government. I thought we were getting rid of moral hazard (or is that "mortal hazard" - to the government?)
  
• The putative "resolution authority" creates an explicit right to do what The Administration did with GM, Chrysler and others - to insert the government in front of Senior Creditors. Over the last year or so the sanctity of the capital structure has been essentially destroyed - this act makes that destruction a matter of formal federal law. Blech.
  
• The putative "resolution authority" specifically bars judicial review for those creditors who claim they were screwed by the imposition of modified claim priority. This codifies in black letter Federal Law what was done to Chrysler and GM bondholders.
  
• Ridiculous shortening of statutes of limitations. There are peppered all over this legislation unbelievably short periods of time to file claims, from 30 to 90 days - dramatically shortening the time to bring suits. This appears to be intentionally designed to limit the ability of those who believe they were abused by these processes to obtain judicial relief.
  
• The supposed "strengthening" of regulation of OTC derivatives contains a very important weasel provision on page 385. Specifically, it says ".... MAY jointly prescribe rules defining the term "swap" or "security-based swap" to include transactions that have been structured to evade this title." Note the word MAY. It is not SHALL, meaning that just as has occurred to date, the CFTC and SEC can willfully and intentionally allow firms to evade all of these "reforms" - and you can bet they will, since this is entirely within their discretion. Oh, and the byzantine definition of these products has enough holes to drive a truck through - sideways.
  
• This act specifically preempts state "bucket shop" laws relating to swaps and OTC derivatives. This is a serious problem folks - the issue with "bucket shops" is that the putative "dealer" isn't really dealing at all - you're betting against him and he controls the bid and offer, thereby making it trivially easy to guarantee that you lose. While there hasn't been much in the way of attention paid to this, I am deeply troubled by inclusion of explicit federal preemption of these laws - who in the financial industry wants to be able to evade these important protections in state law, and why?

This act effectively transfers and consolidates the OCC and OTS into this new agency, deleting them. There may be some good that comes from this, in that OCC and OTS have been accused of both malfeasance and misfeasance - and in the case of OTS, specific allegations of conspiracy to cook the books (e.g. Indymac) have been made. Nor is this a new problem - it featured prominently in the S&L crisis as well with some of the same actors. But putting a different name on the door doesn't change the agency. What's missing here is the same thing that has been missing up until now - an "or else" putting criminal and/or civil penalties into the law so that those who have or do commit this sort of accounting fraud can and will face the music.

Contingent capital sounds like a great idea, and it might even be a great idea. But who had the idea to set the bar on leverage at 50:1 (a 2% equity requirement)? That's insane. What's wrong with the former 12:1 standard? Oh, I know, these so-called "too big to fail" companies can't make as much money. I thought the purpose of this act was to impose stronger leverage limits and prudential regulation, not loosen standards further? Why are we going from 40:1 (today) to 50:1 (in this act) if that is the case?

There is a fair bit to like in this act. The explicit statement of support for state laws in the consumer protection realm that are stronger than federal protections is one of these areas. The abolishment of "venue shopping" when it comes to regulators (e.g. OCC .vs. OTS) is long overdue.

But the above bullet points are troubling, and this act reeks of having intentional loopholes written into it via obfuscation, along with no statutory demand that the new FIRA agency actually stomp on such abusers. There are too many "mays", not enough "shalls", and an absolute lack of "or else's" - making this one of those acts that says more by its absence than presence.

Add to that the further loosening of leverage limits and you have what is obviously a lobbyist-written "bill" that totals 1136 pages primarily as a means to dissuade anyone from reading it.

Well, it didn't stop me.... and what I see in there, despite the gloss of some improvements (especially in consumer protection) is a big fat stinking piece of used dog food when it comes to financial stability and prudent regulation.

Comments

[PainfullyAware]

When You Can Create Money Out Of Thin Air You Can Buy Governments.

Thanks For The Summary Of The Tools Of "Future Doom".

Things are being so "Abused" in the "Funny Money System" that when it finally Implodes only "Hard/Tangible" Assets will suffice for "Exchange".

The Circus Continues => Down With Clowns !!!

2009 Nov 17 07:39 PM

[artkarl]

Well, we all know which private sector spends the most on lobbying.
Obviously, we're at the point in most every area of endeavor where we collectively act like pigs.
This behavior will hurt in every way, eventually, and all the assets in the world won't protect you from harm.
-Karl Krachenberg

2009 Nov 17 08:10 PM