Must-read investigative report highlights Wall Street’s taxpayer-backed too-big-to-fail banks latest lobbying to avoid key financial reforms designed to protect U.S. taxpayers from having to bail out Wall Street again: Reuters’ Charles Levinson has written a must-read investigative report on Wall Street’s latest scheme to avoid critically important financial reforms: change a few words in their derivatives contracts and pretend that they are not guaranteeing their overseas affiliates. Wall Street’s handful of biggest banks merely erase/delete the word “guarantee” from one or more of their foreign affiliates and then claim/pretend it is not guaranteed by the gigantic U.S.-based parent bank (backed by U.S. taxpayers) and, voila, their trades are not subject to U.S. regulations. (BTW, these activities really only involve Wall Street’s four biggest banks – JPMorgan Chase, Citigroup, Goldman Sachs and Morgan Stanley – which control more than 90% of all the derivatives trading in the U.S.)
This scheme (which we discuss in this fact sheet) is called “de-guaranteeing,” but it is really just a form-over-substance loophole that allows the largest financial institutions in the U.S. to get “light touch” regulation overseas. Why? Because merely deleting the word “guarantee” does not mean that the foreign affiliates are not guaranteed or, as we at Better Markets call it, de facto guaranteed by the U.S. bank. Why? Because the U.S.-based bank directs its customers, clients and counterparties to its purportedly non-guaranteed affiliate overseas which always not coincidentally uses the same name as the U.S. bank.
Those customers, clients and counterparties understand they are doing business – albeit indirectly – with the U.S. bank and expect the U.S. bank to stand behind the foreign affiliate regardless of a deleted word. More importantly, the U.S. bank will have to stand behind the foreign affiliate (i.e., guarantee it) if it gets into trouble because the U.S. bank has directed its customers, clients, and counterparties to the foreign affiliate and will suffer serious – if not lethal – reputational damage in the markets if the U.S. bank failed to de facto guarantee its foreign affiliate in trouble.
This is a really serious issue, not a theoretical matter or theoretical risk to U.S. taxpayers. There are numerous examples of where Wall Street banks and other U.S. financial institutions have shipped their business overseas, but the risk and costs have come back to the U.S. taxpayer. (Oh, and by the way, when the U.S. banks ship their derivatives trades overseas, they also ship U.S. jobs overseas and the revenue and taxes generated by those jobs. Thus, U.S. taxpayers pay in two big ways: first they lose jobs and revenue, then they have to bail out the bank when their overseas affiliates – explicitly guaranteed or not – blow up and drag down the U.S. parent company.)
For example, this is exactly what Citigroup did in the middle of the 2008 financial crisis when it took $59 billion in assets back onto its balance sheet from non-guaranteed so-called “bankruptcy remote” SIVs that it had created and sponsored years before. Citi had absolutely no legal obligation to do it, but, to avoid asset fire sales and reputational damage, it nonetheless “had to” take the impaired assets back at 100 cents on the dollar. Citi had to then write down the values which reduced Citi’s capital and contributed to the creditor run on the bank. The result? Citi had a liquidity crisis and was insolvent, ultimately requiring more than three bail outs to prevent its collapse into bankruptcy. Those government and U.S. taxpayer bailouts to Citi totaled almost $500 billion, more than any other single institution (and Citi remains the only too-big-to-fail U.S. bank that did not repay the taxpayer TARP funds it received).
Citi isn’t the only example. There are lots of them. Remember AIG? It was a gigantic insurance company based in New York, but did its credit default swaps (CDS) gambling in “light touch” London in the years leading up to the financial crisis. But who was left on the hook to bail out AIG when its London CDS operations blew up and kick-started the financial crash? U.S. taxpayers and the U.S. government, which ended up having to provide $185 billion in a series of bailouts. (Bear Stearns and Lehman Brothers are two other prominent examples of using overseas affiliates to avoid U.S. regulation.)
Better Markets has been fighting Wall Street on this evasive, if not fraudulent, gambit for years. Much of our work, including the presentation we used in meetings with the Chairs, Commissioners and staff of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), can be found on our website here. As the Levinson investigative report points out, so far the CFTC and the SEC have failed to protect taxpayers as the law requires. Wall Street’s four biggest and most dangerous banks have exploited the loophole and the regulators have not stopped them. U.S. taxpayers remain at grave risk from hundreds of trillions of mostly unregulated derivatives trading overseas by U.S. bank affiliates.
However Better Market has proposed a relative simple, market-based solution to this loophole called the “de facto guarantee test,” which would enable regulators to determine which foreign affiliates are genuinely non-guaranteed and which ones are de facto guaranteed and pose an unacceptable risk to U.S. taxpayers that the law requires the CFTC and SEC to regulate. It is time for the CFTC and the SEC to adopt the de facto guarantee test and only allow genuinely non-guaranteed foreign affiliates to avoid U.S. laws and regulations.
New research shows once again that the costs of the 2008 financial crash have been devastating to American families and that those crippling costs continue to cause economic wreckage across the country: A new National Bureau of Economic Research working paper by Henry Farber, Job Loss in the Great Recession and its Aftermath: U.S. Evidence from the Displaced Workers Survey, outlines how, “[t]he Great Recession from December 2007 to June 2009 is associated with a dramatic weakening of the labor market from which, by some measures, it has not completely recovered.” As NBER summarized:
“Of the workers who lost full-time jobs between 2007 and 2009, Farber reports only about 50 percent were employed in January 2010 and only about 75 percent of those were re-employed in full-time jobs. This means only about 35 to 40 percent of those in the DWS (Displaced Worker Survey) who reported losing a job in 2007-09 were employed full-time in January 2010. This was by far the worst post-displacement employment experience of the 1981-2014 period.
“The adverse employment experience of job losers has also been persistent. While both overall employment rates and full-time employment rates began to improve in 2009, even those who lost jobs between 2011 and 2013 had very low re-employment rates and, by historical standards, very low full-time employment rates. In addition, the data show substantial weekly earnings declines even for those who did find work, although these earnings losses were not especially large by historical standards….
“Farber concludes that the costs of job losses in the Great Recession were unusually severe and remain substantial years later. Most importantly, workers laid off in the Great Recession and its aftermath have been much less successful at finding new jobs, particularly full-time jobs, than those laid off in earlier periods. The findings suggest that job loss since the Great Recession has had severe adverse consequences for employment and earnings.”
This should really surprise no one because the 2008 financial crash was the worst since the Great Crash of 1929 and the economic catastrophe it caused was the worst since the Great Depression of the 1930s. In addition to the latest research, Better Markets detailed this in its recent Cost of the Crisis report showing tens of millions of Americans from coast to coast have suffered and continue to suffer, including millions of American families still struggling with lost jobs, homes, savings and security. This is going to cost the United States more than $20 trillion in lost GDP.
In just one example that relates to the new NBER research, the number of unemployed and under-employed Americans (forced to work part time because they couldn’t find full time work, the so-called U-6 rate) peaked for five out of seven months between October 2009 and April of 2010 at 17.5%, which is almost 27 million individual Americans:
In addition, many of those 27 million Americans were heads of households, which means that the impact of just this one cost of the crisis touched more than 50 million Americans.
Reflecting the depth and breadth of the damage from the 2008 financial crash, since the recession officially ended in June 2009, growth has averaged only around 2%, which is low by historic standards and inflated by extraordinary monetary policies by the Fed. That means that many Americans still can’t find good work, start a business, pay their debts, or save for college and retirement.
This is yet another reminder that Wall Street’s too-big-to-fail banks must be carefully regulated to prevent their reckless trading and investments from endangering the country’s financial system and economy as well as Americans’ standard of living. That’s why it’s critically important that the Dodd-Frank financial reform law is fully implemented and aggressively policed as soon as possible, as strongly as possible, and as thoroughly as possible. The American people cannot afford another devastating financial crash.
Better Markets in the News:
Three Regulatory Takeaways from Monday’s Stock Market Drop: American Banker by John Heltman 8/24/2015
Greenspan’s capital idea for cutting back on banking angst: Financial Times by Jonathan Ford 8/23/2015
What’s Wrong With Advisers Putting the Client First?: The Wall Street Journal 8/22/2015
Why ‘Too Big to Jail’ Is Still a Matter of Debate: American Banker by John Heltman 8/21/2015
News You Don’t Want to Miss:
Judge dismisses HFT case against Barclays and US exchanges: Financial Times by Ben McLannahan 8/26/2015
Market Turmoil Prompts New Speculation on the Fed’s Timetable: The New York Times by Benyamin Appelbaum 8/26/2015
Who’s the Boss? You or Your Broker?: The Wall Street Journal by Jason Zweig 8/21/2015