Friday, April 13, 2012

“Forewarned is Forearmed”

Sydney M. Williams

Thought of the Day
“Forewarned is Forearmed”
April 13, 2012

The biggest problem with Dodd-Frank is that it protects those who caused the credit collapse – consumers who borrowed more than they should, banks and government employees, like Senator Chris Dodd and Representative Barney Frank – but not its victims, the taxpayers. The reasons are straightforward: populist politics garner votes, banks provide funds for campaigns and who wants to blame themselves? Taxpayers, increasingly, are left without representation. In today’s world, most members of Congress serve without limit in “safe” districts. And government spends money (consider the Obama’s vacations, Charlie Rangel’s beach villa, or the GSA’s weekend in Las Vegas!) with little respect for its source.

While the origin of the credit meltdown has many fathers, regulation should be designed to protect taxpayers against a future occurrence, not to shelter those who strayed. How many of us, as children, were warned not to touch a hot stove? Like many, I learned the hard way! Without fear of punishment, what prevents a consumer from taking on more debt than is affordable, or what prevents a bank from trading risky securities for its own account? TARP (taxpayers) bailed out the biggest banks, including the sanctimonious Goldman Sachs and the equally supercilious J.P. Morgan Chase.

Two recent examples serve to make the point of taxpayers continuing to be at risk: Since 2005, no students’ loans have been dischargeable in bankruptcy. While that put the onus on student borrowers, it allowed lenders to offer lower interest rates. Student loans now exceed a trillion dollars, more than credit card debt. Last year three Democratic Senators joined four Democratic Representatives in introducing legislation that would restore the bankruptcy law as it pertains to privately issued student loans. Under the proposal, federal loans would continue to be protected, as they have been since 1978. The consequences of such a bill are obvious. Private lenders, faced with the possibility that their loans would be discharged in bankruptcy, would be forced to re-price those loans, effectively putting them out of business; that would leave student loans the monopoly of the federal government.

Perhaps student loans should be dischargeable in bankruptcy? That is a debate worth having, keeping in mind, it is our – the taxpayers – money. But with government remaining in the business, the benefits of bankruptcy – greater scrutiny on the part of lenders, pressure on colleges to keep costs down, and the ability to discharge an onerous debt in the case of severe financial plight – would be lost, as private lenders would be forced out of business. Given the exorbitant price of a college education, delinquencies (if not defaults) would persist, with the extra costs borne by taxpayers, not the students. The hot stove theory would not apply.

The second example relates to banks, with the derivative positions built by Bruno Iksil of J.P. Morgan Chase serving as an exemplary case. Mr. Iksil is known as the “London whale” for the size of his positions, estimated to be $350 billion at the end of last year. To put that number in perspective, on December 31, 2011 the bank’s total assets were $2.27 trillion and shareholders equity was $183.57 billion. Mr. Iksil’s positions were roughly twice shareholder’s equity and represented about 15% of total assets. At issue: were the positions hedges, or was he speculating? Jamie Dimon, who has been a vociferous foe of Dodd-Frank and the Volcker Rule that prohibits a bank trading for its own account, claims that the trades were part of a hedging strategy. The debate, or argument, highlights a flaw in the Volcker Rule – differentiating between the two – hedging and speculating. In Wednesday’s Wall Street Journal, Peter Wallinson of the American Enterprise Institute made an eloquent and convincing argument as to why the Volcker Rule is flawed. In testimony before Congress, when asked to define the line between hedging and speculating, Mr. Volcker was unable to do so. He responded that it’s like pornography. “You know it when you see it.” That may be true for old time bankers, but, as Mr. Wallinson notes, it won’t work for bank lawyers.

Since Dodd-Frank went into effect, big banks have become even bigger. At the time of the crisis, three and a half years ago, the ten largest banks controlled 55% of all bank assets. Today, the ten largest banks control 77% of all assets. The risk of ‘too big to fail’ still exists and, as Dallas Federal Reserve President Richard Fisher has been speaking out, the risks today are larger than ever. The only answer, apart from nationalizing the banking industry (which would only heighten the risk to all of us), is to curtail their size. The simplest way, it seems to me, would be to reinstate Glass-Steagall.

Every dime the government spends, whether it is on a boondoggle for GSA employees, a vacation for the first lady, building a bridge, or educating a child comes from taxpayers. The American people, in general, are enormously generous, rarely questioning the wisdom of any expense, regardless of how frivolous. But the problem is that we are becoming a single nation divided between those who pay federal income taxes and those who do not – providers and takers. Roger Ainsley once said he could see the country split between a government party and a freedom party. Currently, about half the citizens of the country pay no federal income taxes. Of the half that do, a mere five percent pay more than half of all federal income taxes. When the nation was formed, a voting requirement was ownership of property. No one wants to return to such feudal prerequisites, but neither should we have system where those who pay no federal income tax determine how tax dollars, provided by the other half, are spent. That becomes a road to Athens.

Three and a half years after the near collapse of the credit system, the lessons of that time seemed not to have been learned. When I think back on those harrowing days, my spine tingles. Saving the system, during the fall of 2008, was government at its best. (Of course, government at its worst, had been part of the cause.) While Mr. Obama talks about the terrible situation he inherited, it would have been far worse had not the Bush administration responded the way they did in September and October of 2008. Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke saved the day, with an assist from Tim Geithner, then President of the N.Y. Fed. By the end of December of that year credit markets, while not normal, were no longer in panic stage.

Both Goldman Sachs and J/P. Morgan Chase weathered the storm and are today bigger and stronger than ever. But the arrogance of their leaders is incredible. Had it not been for the Fed and the Treasury, acting in concert as they did, there is every reason to believe that neither bank would have survived. Instead of expressing appreciation, or contrition, both have decided that bigger is still better. Whatever gains will be made will be theirs. The risk falls on our shoulders – the taxpayers. Dodd-Frank has not protected those who underwrote the liabilities of those who created the crisis in the first place. Forewarned is forearmed.

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