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Why the “Dodd-Frank Wall Street Reform and Consumer Protection Act” won’t Reshape Wall Street’s Biggest Banks or Prevent another Crisis

By : Ziad K. Abdelnour| 30 July 2010
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As mentioned time and time again to our clients worldwide, we at Blackhawk never supported bailouts but rather believe it would be much better to let bailed out companies fail, rather than wait for a number of them to happen all at once. The system can indeed recover from bankruptcies as it always did throughout history.

South Korea went through this in the late 1990s. They didn’t have anyone to bail them out, and they had to go through the pain. Sweden did it in the early 1990s, Mexico did it, Russia did it. The list goes on and on. Competent people take over the assets from incompetent people and rebuild from a solid base. Survival of the fittest and Darwinism at its best. After all, this is what capitalism is all about.

In retrospect, it is a fact today that the $700 billion dollar TARP bailout was a massive bait and switch. The government said it was doing it to soak up toxic assets, and then switched to saying it was needed to free up lending. It didn’t do either.

It is clear by now that all what the bailout money did was lining the pockets of the wealthy, instead of helping to stabilize the economy or even the companies receiving the bailouts.

Bailout money was clearly used to subsidize companies run by idiots, allowing the bankers to receive fat bonuses, to redecorate their offices, and to buy gold toilets and prostitutes.

A lot of the bailout money went to the failing companies’ shareholders. Indeed, the true purpose of the bank rescue plans was a massive redistribution of wealth to the bank shareholders and their top executives.

The Treasury Department encouraged banks to use the bailout money to buy their competitors, and pushed through an amendment to the tax laws which rewards mergers in the banking industry (this has caused a lot of companies to bite off more than they can chew, destabilizing the acquiring companies)

And tens of billions of bailout dollars merely passed through A.I.G. to its derivatives trading partners. In other words, through a little game-playing by the Fed, taxpayer money went straight into the pockets of investors in AIG’s credit default swaps and is not even really stabilizing AIG.

But the TARP bailout is peanuts compared to the numerous other bailouts the government has given to the giant banks.

And I’m not referring to the $23 billion in bailouts, loans, guarantees and other known shenanigans that the special inspector general for the TARP program mentions in here. I am talking about more covert types of bailouts…..like guaranteeing a Fat Spread on Interest Rates.

Well, as you may or may not know, the trading profits of the Street is just another way of measuring the subsidy the Fed is giving to the banks; basically a transfer from savers to banks.

Check out for a change the latest quarterly reports from the big Wall Street banks that reveal a startling fact: None of the big four banks had a single day in the quarter in which they lost money trading.

For the 63 straight trading days in Q1, in other words, Goldman Sachs (GS), JP Morgan (JPM), Bank of America (BAC), and Citigroup (C) made money trading for their own accounts.

Trading, of course, is supposed to be a risky business: You win some, you lose some. That’s how traders justify their gargantuan bonuses–their jobs are so risky that they deserve to be paid millions for protecting their firms’ precious capital. (Of course, the only thing that happens if traders fail to protect that capital is that taxpayers bail out the bank and the traders are paid huge “retention” bonuses to prevent them from leaving to trade somewhere else, but that’s a different story).

But these days, trading isn’t risky at all. In fact, it’s safer than walking down the street.

Why?

Because the US government is lending money to the big banks at near-zero interest rates. And the banks are then turning around and lending that money back to the US government at 3%-4% interest rates, making 3%+ on the spread.

What’s more, the banks are leveraging this trade, borrowing at least $10 for every $1 of equity capital they have, to increase the size of their bets. Which means the banks can turn relatively small amounts of equity into huge profits–by borrowing from the taxpayer and then lending back to the taxpayer.

The government’s zero-interest-rate policy, in other words, is the biggest Wall Street subsidy yet. So far, it has done little to increase the supply of credit in the real economy. But it has hosed responsible people who lived within their means and are now earning next-to-nothing on their savings. It has also allowed the big Wall Street banks to print money to offset all the dumb bets that brought the financial system to the brink of collapse two years ago. And it has fattened Wall Street bonus pools to record levels again.

To get a clear picture of what is going on in here, ignore the intermediate steps (borrowing money from the Fed, investing in Treasuries), as they are riskless, and it immediately becomes clear that this is merely a direct payment from the Fed to the banking executives…for nothing.

No nifty new tech product has been created. No illness has been treated. No teacher has figured out how to get a third-grader to understand fractions. No singer’s voice has entertained a packed stadium. No batter has hit a walk-off double. No “risk” has even been “managed”, the current mantra for what big banks do that is so goddamned important that according to the Goldman Sachs megalomaniac Lloyd Blankfein, his firm is doing “God’s work”.

Nor has any credit been extended to allow the real value-producers to meet payroll, to reserve a stadium, to purchase capital equipment, to hire employees. Nothing.

We at Blackhawk have always believed it is high time for Congress to put an immediate halt to this practice. Banks should have to show that the money they are borrowing from the Fed is to provide credit to businesses, or consumers, or homeowners. Not a penny should be allowed to be used to purchase Treasuries. Otherwise, the Fed window should be slammed shut on their fingers. And stiff criminal penalties should be enacted for those banks that mislead the Fed about the destination of the money they are borrowing.

There is another type of guaranteed spread that allows the giant banks to make money hand over fist. Specifically, the Fed pays the big banks interest to borrow money at no interest and then keeps money parked at the Fed itself. (The Fed is intentionally doing this for the express purpose of preventing too much money from being lent out to Main Street).

The giant banks are receiving many other covert bailouts and subsidies as well.

Initially, the fact that the giant banks are “too big to fail” encourages them to take huge, risky gambles that they would not otherwise take. If they win, they make big bucks. If they lose, they know the government will just bail them out. Cool gambling subsidy; don’t you think so?.

The very size of the “too big to fail” also decreases the ability of the smaller banks to compete. And – since the government itself helped make the giants even bigger – that is also a subsidy to the big boys.

The monopoly power given to the big banks (technically an ” oligopoly”) is a subsidy in other ways as well. Get the picture?

The giants (especially Goldman Sachs) have also used high-frequency program trading which not only distorted the markets – making up more than 70% of stock trades – but which also let the program trading giants take a sneak peak at what the real (aka “human”) traders are buying and selling, and then trade on the insider information. In my dictionary, this is front running, which is illegal; but it is a lot bigger than garden variety front running, because the program traders are not only trading based on inside knowledge of what their own clients are doing, they are also trading based on knowledge of what all other traders are doing).

The government’s failure to rein in derivatives or break up the giant banks also constitute enormous subsidies, as it allows the giants to make huge sums by keeping the true price points of their derivatives secret.

The PPIP program – which was supposed to reduce the toxic assets held by banks – actually increased them, and just let the banks make a quick buck.

In addition, the government suspended mark-to-market valuation of the toxic assets held by the giant banks, and is allowing the banks to value the assets at whatever price they desire. This constitutes a huge giveaway to the big banks.

By allowing banks to legally disregard mark-to-market accounting rules, our government allows banks to maintain investment grade ratings.

By maintaining investment grade ratings, banks attract institutional funds. That would be the insurance and pension funds money that is contributed by the citizen.

As institutional money pours in, the stock price is propped up ….

Bottom Line:

These are just a few of the secret bailouts programs the government is giving to the giant banks. There are many other bailout programs as well. If these bailouts and subsidies are added up, they amount to many tens – or perhaps even hundreds – of trillions of dollars.

And then there is the cost of debasing the currency in order to print money to fund these bailouts.

At the end of the day, I am afraid the cost to the American citizen in less valuable dollars will be truly staggering and the overwhelming majority of the American public has no clue of what is going on out there.

So for all who are impressed with how the Obama Administration has turned the tide, I am afraid the recent passing of the “Dodd-Frank Wall Street Reform and Consumer Protection Act” http://www.weil.com/files/upload/Weil%20Dodd-Frank%20Overview.pdf won’t fundamentally reshape Wall Street’s biggest banks or prevent another crisis.

Nothing has really changed as our government is continuing to strengthen the parasite and poison the real economy. As to Congress, it is still continuing to pimp out the American people to Johns who have insatiable lusts and totally misplaced egos.

So next time you elect your representative, know the facts before embarking into oblivion.

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

Comments

  1. Jeffrey L. NelsonJeffrey L. Nelson

    A few minutes ago,for the fourth or fifth time, I again read this blog writing. Many of your comments have been running around in my head for several months. I do think that when too much power and wealth is placed in the hands of too few, the economy weakens and nearly all will feel some pain. Thanks for your writings.

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