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July 20, 2010

Reform Legislation Does Little to Address Systemic Faults in Banking


Congress passed the final version of financial reform legislation this past Friday, July 15, and President Barack Obama will sign the bill into law within days. The effect of the legislation on the industry will be relatively modest, as most agree that the new body of law will do relatively little to reduce systemic risk in our banking industry or cut banking industry profits. Ironically, on the same day, Goldman Sachs, admitting that it made "mistakes," agreed to pay $550 million in a settlement with the SEC over alleged charges that it sold mortgage securities it knew would fail. Are we now to believe that our financial system will never again cause a global meltdown as it did before?

Buckle your seatbelts. The ride will not be any less bumpy because nothing was done to eliminate the present incentive structures that encouraged bad behavior in the first place. The current world of difficult credit, excessive layers of banking transaction fees, and mortgage-backed securities are the ultimate result of years of misplaced incentives and unbridled greed. The general malaise is not specific to just a few banks. The problems developed over the past thirty years, are systemic and run through the entire banking system.

Back in the 80’s, our traditional banking system was struggling with competition on all fronts from insurance, telecom and investment banking companies. The best minds in the nation deduced a major strategic flaw in how banks funded their ongoing operations. Banks take deposits, and then loan the money to businesses and individuals. The practice in those days was to cover the majority of banking costs with margins added to their loans. A better approach would be to create numerous streams of new transaction fees. These would take the pressure off loans and allow margins to be competitive.

All banks were quick to adopt the new revenue strategy. It spread through every department of the bank from credit cards to foreign exchange trading. In order to encourage the new practice, bonuses were also tied to transaction fees collected, a critical mistake. Incentives work. The resulting behavior, however, may not be what was intended. Up to that point, bonuses in banks tended to be discretionary and moderate when compared to other industries. The allure of large bonus payouts catapulted banking to new levels of performance.

Banks had always coveted the exorbitant fees collected by their “cousins” in the investment banking industry, but the Glass-Steagall Act blocked access to this lucrative capital raising business. The Act, passed during the Great Depression, was created to prevent both styles of banking from destroying one another. Merchant banks, as they were called at the time, helped companies raise capital, but took no deposits. Traditional banks took deposits and made loans. In 1999, a Republican Congress removed the prohibitions of the Act altogether.

Greater competition ensued, at first believed to be a good thing. However, investment banks were pressured to invent and sell more complex securitization schemes to generate entirely new revenue streams. Banks became mortgage paper generators, charging high mortgage origination fees and then assigning the paper, much without income verification, to investment pools. Investment banks then marketed shares in the pools to pension funds and governments as “AAA” investment grade securities. Everyone made large bonuses. Everyone was happy, until the real estate “bubble” burst, and “toxic assets” became a new term in daily news headlines.

The debacle that followed is well documented. Many believe Glass-Steagall should have been re-instated, but members of Congress thought otherwise. The new reform bill does place new limits on specific types of revenue, but basically, it is business as usual. These banking trends took years to reach their “tipping point” and will take many more years to reverse. Traditional banks were intended to take risks and make loans, not generate fee income alone. Banks need to be Banks again.

11 comments:

  1. Everything is a farce...look at this...first Paulson, now Geithner ...either way, no change..just busines as usual....this is like money allocated to the Haitian Crisis that never makes it to the people...just to accounts allocated for "family and friends of"...they must really think we're all dumb asses!



    More than 40 pct. leave Obama mortgage-aid program
    The more than 100 participating mortgage companies get taxpayer incentives to reduce payments. But as of mid-May only $132 million has been spent out of a potential $75 billion, according to the Government Accountability Office.

    http://tinyurl.com/2d8mzqp

    ReplyDelete
  2. Let's see what happens with this...


    Elizabeth Warren, The Next Brooksley Born?

    Geithner plays the role of Rubin

    Now Tim Geithner, Rubin’s protege, is trying to block the appointment of Elizabeth Warren as head of the new Consumer Financial Protection Bureau.
    http://www.bearishnews.com/post/3391

    ReplyDelete
  3. This should happen to everyone in DC...oops I forgot the plundering has left them flush!

    Economic Pain

    http://www.swarmusa.com/vb4/showthread.php/2661-Economic-Pain

    ReplyDelete
  4. Everyone wants working families to go on austerity so this can continue? Then we'll be stuck with their pensions? No wonder stimulus won't work..its going to a few people...

    Whatever happened to just say no?


    California Official's $800,000 Salary in City of 38,000 Triggers Protests

    Hundreds of residents of one of the poorest municipalities in Los Angeles County shouted in protest last night as tensions rose over a report that the city’s manager earns an annual salary of almost $800,000.

    An overflow crowd packed a City Council meeting in Bell, a mostly Hispanic city of 38,000 about 10 miles (16 kilometers) southeast of Los Angeles, to call for the resignation of Mayor Oscar Hernandez and other city officials. Residents left standing outside the chamber banged on the doors and shouted “fuera,” or “get out” in Spanish.
    http://tinyurl.com/2d888pz

    ReplyDelete
  5. So Obama supports Geithner...then he's okay with this? 2 parties same team



    Bailout watchdog calls mortgage programs a bust
    Bailout watchdog says Treasury's $50 billion mortgage programs did little to stem foreclosure



    Special inspector general for the financial bailouts Neil Barofsky says the program has not "put an appreciable dent in foreclosure filings."


    He says the Treasury Department has ignored earlier demands that it set clearer goals for the program.



    http://tinyurl.com/3xn72rk

    ReplyDelete
  6. CHANGE WE CAN BELIEVE IN OR DIE OF?
    KEEP THOSE BLOATED PENSIONS..PAY THOSE BONUSES..
    SAVE THE BANKS...THIS SHOULD HAPPEN TO EVERYONE IN POLITICS!

    Cuts in Home Care Put Elderly and Disabled at Risk

    Since the start of the recession, at least 25 states and the District of Columbia have curtailed programs that include meal deliveries, housekeeping aid and assistance for family caregivers, according to the Center on Budget and Policy Priorities, a research organization. That threatens to reverse a long-term trend of enabling people to stay in their homes longer.

    http://www.nytimes.com/2010/07/21/us/21aging.html

    ReplyDelete
  7. They refuse to clean up their act....


    Personal Strategies against a Government Policy Sponsoring Destitution

    http://tinyurl.com/324ass7

    ReplyDelete
  8. Friday, July 23, 2010
    How HAMP Makes Elizabeth Warren The Only Choice For Consumer Protection » New Deal 2.0

    Crossposted from New Deal 2.0.

    By Mike Konczal, a Fellow at the Roosevelt Institute.

    No one else has been a stronger advocate for public disclosure. There’s a debate going on about who should be nominated to run the Consumer Financial Protection Bureau at the Federal Reserve. One side says Elizabeth Warren, while another says someone from Treasury, likely Michael Barr. At a quick glance you might not see a big difference. As Felix notes, Michael Barr is very strong on consumer finance. But I think Warren would be a far superior choice. There are many reasons why, but I want to discuss a very specific one here that distinguishes her from anyone in Treasury. The biggest: she is a strong critic of HAMP, Treasury’s largest intervention into the massive foreclosure crisis hitting millions of regular Americans, and she demands accountability on behalf of the people.


    http://tinyurl.com/2ccy6hw

    ReplyDelete
  9. Disappearing Middle Class: Bilingual Ph.D. Accepts Rent Money From Church

    Ortiz lives in Las Vegas, Nevada, where the unemployment rate is currently the highest in the country. She says that while people often think of higher education jobs as being in a different category than most others, like construction or health care, she has experienced the same frustrations applying in her field as anyone else.

    "You go through the trouble of applying, people know you, people recommended you, you're looking forward to the interview. Then a few days later, they send you an email saying, 'I'm sorry, but because of budget cuts, we're suspending the search.' It's no longer frustrating, its enraging! Why do they advertise these positions in first place, if they don't really exist?" she said.

    http://www.huffingtonpost.com/2010/07/23/disappearing-middle-class_n_656941.html

    ReplyDelete
  10. Invasion of the Apparatchik

    http://tinyurl.com/27w3d2n

    ReplyDelete
  11. Monday, July 26, 2010
    [Video] Dateline NBC: America's Increasing Ranks of Poor


    NBC's Ann Curry travels to Ohio where the hardworking poor, with deep traditions in mining, manufacturing and military service, are increasingly seen in food pantry lines ashamed and angry.

    http://tinyurl.com/2e92cxb

    ReplyDelete