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Bo Peng
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I run a fund based on automated trading and technical analysis. But my favorite pastime is thinking and talking about political economy. I guess I'm George Soros. Writing helps clarifying my thinking. All opinion expressed here is mine, wholly mine, nobody's but mine. And all trading/investment... More
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  • Reform Is Toothless Without Re-enacting Glass-Steagall 0 comments
    May 19, 2010 1:27 AM

    Frankly, both sides of the debate on financial regulatory reform have sickened me. On one hand, we have the populist cheapshots pitting Wall St against Main St (how many people live on Main St, really?). On the other hand, we have politicians, from both parties and stuffed with bank lobby money, making all kinds of lame excuses to water down reform. Finally, after I read that Volcker Rule, which I think is the very least a sensible society should do, was fading into the fringes, I just tuned out the whole debate in disgust.

    But the Dylan Ratigan's ranting video got my attention, and the debate on Capitol Hill apparently has gotten quite interesting over the last few days. So I'll pitch in my two cents.

    1. Bailout = massive wealth transfer from the responsible/honest to the irresponsible/dishonest.


    The Great Bailout of 08 has been transferring a great deal of wealth from tax payers, present and future, to the few TBTF banks, and from those who save and abide by financial responsibility to those who flipped houses, maxed out home equities to spend on vacations and $20k barbecue grills, and simply refused to pay their mortgages. The ongoing European bailout will be transferring wealth from all EU citizens, who will suffer more than if insolvent sovereigns were let default, to banks holding PIIGS bonds.

    This is the greatest injustice forced upon the greatest number of people at least since the fall of communism in USSR and China. I used to think it couldn't get worse than Bush's Iraq War. Now it looks so harmless in comparison.

    I have been adamantly against the bailout since the very beginning. It was clear to me that some people used fear to jam the otherwise transparent scam down our collective throat. In retrospect, as long as the government assured some temporary liquidity, some banks would've failed and some would've survived, and today at least we wouldn't have the mockery of trading that never lost a single day for a quarter. Come on, people, the banks have shown you what a scam they've been running with this impossible feat.

    I had been working in investment banks for 15 years until recently, still have many personal friends in the industry. But the no-trading-loss story took away the last shred of empathy I have left for the industry. Whereas the Street used to have the brightest, hardest working people, over the past years it has degraded into a dump of tunnel-visioned executives, mediocre middle-management bureaucrats, and a few remaining good people drawn out in a vast swamp of idiots. A lot of Wall St traders today are not smart; they just have exclusive, unfair privilege. The executives are not smart. They're outright stupid. How else would they allow their trading desks to have no loss day in a quarter in this political environment? A master criminal at least deserves respect for his canning even in prison. Stupid criminals deserve prison period.

    We still need banks, of course, and the brightest and hardest working people to work for banks. But now Wall St has become a social parasite.

    2. It will not kill the market if derivatives trading cannot access free financing from depositors and tax payers. It will help preventing future bubbles.

    We used to do it in the 90's, OK? We went to repo market with single-A rating, and we made money, honest money. We didn't borrow free money from Fed window and then turn around lend it to Uncle Sam for 3%, and then use the treasuries as collateral back at the Fed window ad naseum until we get sick of the sheer boredom of repetition. We didn't take deposits for free and lever up 30, 40 times to take on naked positions. We executed client orders and actually hedged.

    Cutting off the free funding scam will of course raise cost of legitimate hedging. But that's what it should be. Wasn't the bubble partly caused by credit that had been too cheap? Wasn't the sky-high leverage partly caused by funding that had been too cheap? You don't need any hard cap on leverage. The number, whatever it is, is pulled out of ass anyway. Raise funding cost and leverage will promptly come down.

    3. Glass-Steagall will not kill banking. It will make banking healthier.

    I still vividly remember the day when I heard Glass-Steagall was thrown away. I knew little about banking back then. But I thought "wow, this is a new era and something doesn't smell right."

    The combination makes perfect sense, to banks. Commercial bank umbrella provides investment bankers better credit rating (lower funding cost and higher fee), bigger balance sheet (to take on risky positions based on deposits and access to Fed windows), and much greater client base (more, bigger suckers to prey on). Investment bank umbrella provides commercial bankers much greater freedom in seeking profit and gaining prestige. Commercial bankers used be looked down upon by investment bankers, from receptionists to CEOs. Now they can be part of the elite, cool.

    Now I know where the stench came from. Combining investment banking with commercial banking is the single biggest regulatory arbitrage and public rip-off ever in human history. I made the case back in early 09 and will not repeat the points here, just dwell on one point I didn't focus on: international competitiveness.

    Glass-Steagall was the culmination of the lesson learned through great pain and sacrifice in Great Depression. It was taken down on the premise of competition from European banks. But European banks back then, mostly German banks, had a reason not to separate commercial banking from investment banking. The German corporate legal system and banking system are such that bond holders have much more power over corporate governance than in the Anglo-Saxon system. Bond holders are by nature conservative while stockholders are more speculative. As such, European investment banking had been very conservative in nature compared to the cut-throat Wall St of private partnerships. Coupled with big corporate bureaucracy and antiquated technological infrastructure, they were dinosaurs and never posed a real threat. But they provided a convenient excuse. Buy some shithead congressmen and stuff a few buddies into the administration and, voila, welcome to the fun new world of free funding.

    Of course, European banks would've been as dead boring and rock solid today as Canadian ones if it hadn't been for Basel II. Basel II, the biggest joke and disaster in the history of financial regulation, took mathematical models, threw away all the warnings from quants, ignored all the simplifying assumptions, and pretended they're reality. Were all the regulators stupid? No, of course not. It's just too perfect an excuse, just like "unfair competitive advantage of European banks" for abandoning Glass-Steagall, "al Qaeda link" for invading Iraq, or TBTF. Stupid, but perfect.

    Well, look where European banks are today. Santander is still acquiring and expanding. Even Douglas Adams, when he wrote that the babel fish, by eliminating all possibilities of misunderstanding, was single-handedly responsible for unprecendented violence and bloodshed throughout the Galalxy, could not have been so cynical as to imagine this.

    No amount of regulatory duct-tape can mend the structural defect of investment banking combined with commercial banking. And, once the two are separated, the systemic conflict of interest is gone. Prop traders can go on their merry ways of trading and speculating without endangering public money. Market makers will have to serve their clients because now their private partner bosses' asses, not just their next bonus checks, are on the line. Commercial banks won't even have the incentive to securitize their mortgage loans because there's nothing they could do with the freed-up money.

    Way back when CDOs were the New Thing, I asked a friend, who was high up in WaMu's mortgage business, whether they would be interested in using such tools. He was flat out not interested: "We have enough capital and don't want the leverage and risk." Yes, WaMu, a highly conservative, prudent, solid financial institution that it once was.

    Greed is good. But what have been happening in the financial sector and financial regulation ever since the abandonment of Glass-Steagall are way beyond greed. It's insanity and stupidity.



    Disclosure: None

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