May 13, 2010

Reg Reform : What fresh hell is this?

Sen. Lincoln's bill to spin off derivatives businesses of the banks survived yesterday, despite the efforts of Saxby Chambliss and the Republicans. Obviously, there are going to be some modifications to this proposal, probably something that allows the banks to keep derivative trading as part of the bank. What's making me happy is that the central thrust... exchange clearing, collateral requirements and some real transparency... will likely remain intact which does exactly what the market needs, create a stable insurance market for financial products. While the banks profitability will be reduced somewhat (they've been raping clients on derivative trades for decades on the open and the close), this will create a much bigger more stable market that will ultimately end up serving all participants well. Frankly, that's what makes the Republican argument so silly...

In floor debate, Mrs. Lincoln defended her tough rules. “The Chambliss amendment does not meet the test of what our markets require,” she said. “It is a stark reminder that if we do not act boldly in the face of the near collapse of our economy, tragic Wall Street abuses and abysmal regulatory failures, we will all suffer the consequences.”

Mr. Chambliss, echoing arguments from some bankers, warned that the legislation would harm businesses and drive derivatives trading to overseas markets outside the reach of American regulators.

“Our approach on transparency, on clearing, on end users, on capital requirements and on trading mandates are much more appropriate, much more reasonable, much more business-friendly,” he said. “My amendment will ensure that Main Street businesses will still be able to appropriately use derivatives in hedging their daily business risks.”

Sure. As an American business, I'm totally going to go set up a trade to hedge my risk on something with an unregulated (possibly undercapitalized) foreign bank and which I will only be able to settle with that bank. I will also be fine with the bank posting no collateral. Sen. Chambliss, that's just fucking retarded. Of course I won't; I'll enter the trade transparently, I'll know my counterparty has posted collateral and I know I can settle with an alternate party if needed. This argument is just bone headed dumb because it's like insurance... would you rather buy insurance from a respectable company that has an agent with a local office or from some guy in a conversion van in the parking lot at HEB representing a company that's overseas?

Sen. Lincoln deserves a ton of support based on this... what she's proposing would have stopped the collapse of AIG and saved tax payers $180 billion. Sure, the FP division was effectively unregulated, but with these regs, they wouldn't have been able to so egregiously cut their own throats.

There was a minor bit of comedy, courtesy of Republican Senator Brownback

In an unusually aggressive foray into the Senate floor debate on Wednesday, President Obama issued a statement in opposition to another Republican amendment, by Senator Sam Brownback of Kansas, that would exempt auto dealers from coming under the purview of a proposed new Consumer Financial Protection Bureau.

REALLY?!?! You want to exempt used car dealers? Is it because everyone knows they're paragons of integrity and excellent business ethics?

In his statement, Mr. Obama said the amendment would create a “special loophole for auto dealer-lenders” that “would carve out a special exemption for these lenders that would allow them to inflate rates, insert hidden fees into the fine print of paperwork and include expensive add-ons that catch purchasers by surprise.”

Thank you, Mr. President.

Todd Hill over a BOR has been interning with the Financial Services Roundtable and he's had some fun learning about the industry and reg reform. I think he's also come away with an appreciation for just how many different ways we can slice and dice an asset. He's done a series on reg reform (here and here) that's worth checking out as a primer ( I know I sometimes don't explain things too clearly). I wanted to just mention one thing with regard to Too Big to Fail (TBTF)...

While I think the asset caps are a good idea, there's a misconception regarding TBTF that somehow you can allow firms with smaller balance sheets to go into bankruptcy without negative effects on the rest of the banking system. That's false. The problem in 2008 wasn't that Bear Stearns or Lehman were too big to fail, it was that their failure would have had serious impacts across the board because of two big issues that are unlikely to change with any regulatory reform...

1) Derivative risk...both wrote a ton of derivative business and both had a lot of derivatives written on them with specific triggers related to credit events.
2) Mark to Market... when all banks are carrying the same or similar assets, if one large bank goes into an uncontrolled bankruptcy (where it must be liquidated rapidly), those assets will be selling at distressed prices. However, because of mark to market, those firesale prices become the market clearing price and everyone must change the valuation used for accounting purposes of the same or similar assets on their books. Suddenly, from just the collapse of one firm, you have gigantic holes in the balance sheets of 20 firms.

It's the second one that's a real killer, one of the reasons I really liked the bank funded workout fund since it could be used to effect an orderly dismantling of a firm. It's also one of the reasons we need a long term solution to FAS 157 that creates a concrete valuation model for illiquid or distressed assets based on performance and cashflow.

Until we get a real handle on accounting issues, TBTF is going to continue to haunt us.

Posted by mcblogger at May 13, 2010 12:12 PM

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