Financial Reform Newsletter: Jan 25 2019

JP Morgan’s Jamie Dimon and Better Markets’ Dennis Kelleher Agree on Leveraged Risks 
We have been concerned for some time about rising financial risks in the shadow banking system and the failure of Trump’s regulators to take appropriate action from the Fed and the SEC to the OCC and FSOC. So-called leveraged loans have been getting a lot of attention lately and standout LA Times reporter Jim Puzzanghera had an important lengthy analysis that highlighted the risks in this market, quoting the concerns and observations of both JP Morgan Chase’s CEO, Jamie Dimon, and Better Markets’ CEO, Dennis Kelleher.

The entire article is worth reading – “Remember the subprime mortgage mess? $1.2 trillion risky corporate debt is flashing similar warnings signs” – but Dimon’s comments are particularly noteworthy: while “dismissing concerns that the leveraged loan market represents a potential ‘systemic risk,’ [he] warned that there could be problems for some lenders outside the conventional banking system. ‘Someone is going to get hurt here,’ … referring to leveraged loan losses if a recession hits.”

While we disagree with him and see potential systemic risks, even if his more limited view is right there are real problems coming. First, remember that Bear Stearns and Lehman Brothers were “lenders outside of the conventional banking system” and we all know how that ended. Second, because FSOC is charged with monitoring activities “outside of the conventional banking system” and the Trump administration has all but shut it down, we are likely to once again be surprised by an AIG-like explosion. Third, because of interconnectedness, feedback loops and transmissions mechanisms, “someone” getting “hurt” is likely to have impact far beyond the “lenders outside of the conventional banking system.” Fourth, often the source of credit and liquidity to “lenders outside the conventional banking system” are the “conventional banking system,” which also happened in 2008.

As Dennis Kelleher said, “When you’re this late in the business cycle, you pretty much already lent to every creditworthy borrower. The real question is, how much lending do you want to give to marginal, non-creditworthy borrowers?” Driving this point home is the fact that “total outstanding leveraged loans had overtaken junk bonds ‘to cement their status as the go-to financing source for speculative grade companies.’”

Compounding this, borrower protections and underwriting standards are plummeting, Mr. Kelleher noted: “You have the leveraged loan market growing at a very rapid clip at the same time the standards are dropping. The leveraged loan market is flashing red warning signs all over the place.”

That’s why we’re less optimistic than Mr. Dimon and, as Mr. Kelleher said, “the leveraged loan market should cause significant alarm by anyone concerned about financial stability and the inevitable [coming] economic downturn. You put all these pieces together, it’s a witches brew” of trouble.” 

BTW, don’t be too surprised that Jamie Dimon and Dennis Kelleher are agreeing. It happens more than most think, including, for example, when Mr. Kelleher agreed with Mr. Dimon, Treasury Secretary Mnuchin and The Clearing House on the OLA failsafe, as we discussed previously here.

We’re Fighting to Protect Your Right to Have Your Day in Court When You’re Ripped Off 
Fighting for the right for all Americans to have their day in court, Better Markets joined lots of other advocacy groups in a letter to SEC Chairman Jay Clayton, urging him to reject a pending attempt to take away shareholders’ rights to recovery when ripped off and to force them into secret, biased arbitration proceedings where they almost always lose.

A Johnson & Johnson “shareholder” (who just happens to have headed an “independent” committee established by the Chamber of Commerce) is pushing for such a resolution to be considered at the company’s upcoming shareholder meeting this Spring. In the past, the SEC has repeatedly rejected such maneuvers because if adopted, they would in effect force shareholders to lose the protections of the federal securities laws. This time around, it’s not so clear how the SEC will react.

What is clear, however, is that forcing arbitration on shareholders, consumers, or investors is a terrible idea. Arbitration is biased, expensive, unfair and secretive. Ask yourself, if it was so great, why would it have to be forced on shareholders?

It also amounts to de facto immunity for corporate fraud, and it will undermine confidence in the integrity of the securities markets, on which many Americans rely to save for a college education, a better standard of living, or a secure retirement. 

• It’s unfair, because the deck is stacked against investors and consumers in arbitration. There is no judge or jury, only a panel typically comprised of people who worked for years in the industry. The facts show that victims of fraud and abuse who seek justice in arbitration against large banks, brokers, and other firms, almost always receive little or no relief. And there is virtually no right to appeal even a shockingly bad decision.
• It’s not transparent, because unlike cases tried in court, arbitrations are conducted in secret, and panels aren’t even required to provide an explanation of how they arrived at their decision under the facts or the law.
• Because ripped off shareholders have to go alone against the well-funded corporation and hire their own lawyers out of their own pockets, almost no one files for arbitration because the losses usually don’t justify it; the costs are high; and the outcome is at best uncertain and, more likely, almost certainly adverse to the individual.  Companies thus avoid liability and keep the ill-gotten money they took from their customers and clients, usually representing huge sums of money in the aggregate. Ultimately, when investors realize they have no meaningful remedy if they are ripped off, they result will be that they won’t be so ready to invest their money to the stock market.

The Joint Letter also makes the case for the SEC to at least address the issue at the Commission level through an open and deliberative process. This is, at a minimum, what Chairman Clayton has promised to deliver in the past when it comes to possible forced arbitration in initial public offerings. If the SEC changes its longstanding policy and permits the forced arbitration resolution to go forward with just a secretive staff-level approval, it will betray its core commitments both to investor protection and to transparency in government.

The Road to the White House Goes Through Main Street, Not Wall Street
As we wrote about recently, one of the most important ways to judge the 2020 candidates is not by their campaign trail rhetoric, but by their actions.

What then should we make of the news that several potential Democratic candidates for the White House are all traveling to Wall Street, apparently to line up support and money before deciding to run? Senators Cory Booker, Kamala Harris, and Kirsten Gillibrand have all been reaching out to Wall Street executives, reportedly to solicit donations, fundraising support, and other assistance as they each gauge whether or not to formally enter the 2020 Presidential race. It is also important to note that Wall Street has previously supported all three candidates in their Senate races.

The relevant factor here is that all of these potential candidates see soliciting Wall Street as a necessary and important early step. Contrast that with other candidates who have focused instead on traveling to early primary and caucus states and spent their time meeting with voters and talking about issues that impact their lives. They are also devoting lots of effort to raising money from small donors rather than special interest millionaires and billionaires, who have already too often corrupted the law, policy and rulemaking process.

Without a clear, concrete record of standing up to Wall Street’s special interests, campaign rhetoric about standing up for Main Street should be viewed skeptically by those meeting in secret with Wall Street.  At a minimum, those candidates should publicly detail all meetings and discussions with Wall Street executives and bankers as well as the topics they discussed.

The road to the White House should put Main Street’s interests first, not Wall Street’s interests.

More Proof That Banks Are in Strong Shape and That Financial Protection Rules Are Working
Despite their protests that more and more deregulation is needed to ensure their strength, it was reported that for the first time since the years before the 2008 financial crisis, there was not a single bank failure in the United States last year.

Reaffirming the overall strength of the financial system, the absence of any bank failures last year stands in contrast to 2010, when postcrisis failures reached a peak of 157. Indeed, one of the main reasons for the strong performance was the post-crisis financial protection rules that have bolstered capital and liquidity requirements, thus making banks comparatively safer.

All of this though should be taken with a grain of salt, as many of the critical financial protection rules put in place to strengthen our financial system have either been weakened or eliminated by the Trump administration. So, while the financial system and the banks appear to be strong on the surface, the pillars providing that strength are broadly and quickly being eroded.

The real test will come this year and the next year as more and more elements of S. 2155, the bank deregulation bill passed in the middle of 2017, are put in place. As the rules get weaker, thanks to this legislation and the deregulatory agenda of Trump officials, the financial system they are supposed to protect will undoubtedly start to show signs of stress and/or instability. By then, it’ll be too late, and the country may find itself plunging into another financial crisis while too many are still recovering from the last one.

Jack Bogle: A Main Street Hero, Tireless Advocate for the Small Investor, Fighter for Consumers, and Conscience of the Financial Industry 
John (Jack) Bogle, the founder and former chairman of the Vanguard Group, who made a name for himself introducing millions of Americans to an easier and low-cost approach to investing, passed away last week.

Jack’s enduring legacy will not be a vast fortune, multiple houses, or any of the other usual trappings of the ultra-wealthy. Instead it will be his innovative index funds and tireless effort to make it easier and cost less for tens of millions of hardworking Americans to invest in the stock market and achieve the American Dream.

As the founder and longtime chairman of the Vanguard Group, Jack was a pioneer in creating low-cost, low fee mutual funds tied to market indexes. Freeing everyday Americans from relentless and usually empty broker sales pitches, he enabled tens of millions of people to get the benefit of compound returns while avoiding the tyranny of fees. That allowed investors to build wealth, buy a home, send a child to college, and to enjoy a safe and secure retirement.

Finally, he was also the conscience of the financial industry because of his steadfast belief that the industry had a special duty to be stewards of their clients’ money. To that end, he believed that the clients’ interests must be first, evidenced by his support of the fiduciary duty rule. Putting the client first was his guiding principal.