If Trump Eliminates This Part Of Dodd-Frank, He Will Make Recessions Great Again
Bank Deregulation All Over Again
The next economic downturn is coming. Economies go up and down. It’s a question of whether we can lessen the downturn and avoid a crash. Who wants another Great Depression? Or another Great Recession like the one in 2008? Intrepid investor Warren Buffett warned the shareholders of his Berkshire Hathaway, as early as 2014, that one is coming and it would be a major financial discontinuity — which sci-fi buffs will understand as an ELE (Extinction Level Event).
One of the many Trump policies that are going to bring that prediction about harder and faster than it otherwise would — and with surgical precision — is his Choice Act. It targets that part of the Dodd-Frank Act called the Volcker Rule. This rule was crafted to stop banks from speculating in risky investments. If they lose, their creditors— the wealthy hedge and equity funds— can seize any and all bank assets including our deposit money.
Michael Lewis in his The Big Short gives us the clearest example of a major reason why banks were brought to the brink of bankruptcy in 2008. His antiheroes bet with the banks that the housing market would tank. The banks took the bet.
We all know the result….
Why The Volcker Rule Was Established
These guys were little fish. The banks made similar but bigger bets with bigger sharks. There were multi-billions on the table, and the banks did not set aside any reserves to pay if they lost.
It’s like one of us going into a casino and writing a check for $1 million to buy chips with no money in our bank account. Whoever would be foolish enough to do such a thing might find themselves at the bottom of a river wearing a new pair of cement shoes.
Yet, that is what the bankers did!
Forget the cement shoes, these banker bandits, who brought stupidity to a new level, rewarded themselves with salaries and bonuses 300 times what the average worker gets.
Note this neat little legal point: when we deposit our money in banks, they don’t have to hold it in trust for us. They can use it any way they please. They can put it at risk by taking wild, irresponsible bets — and they do. It was a regular way that banks were permitted to do business prior to 2008.
In his recent book Other People’s Money: The Real Business Of Finance, British economist, John Kay, confirms that the banking model has radically changed. About 90% of what bankers do is trading for their personal profit.
Because the banks owed multi-billions to the counterparties to their housing market bet, the happy creditors could seize any and all bank assets to satisfy the debt. Our deposit money was the low hanging fruit — easy pickin’s! Easier than having to wait for the sale of a bank building. In an insolvency situation, its creditors’ choice.
Just think of your own situation. If you owed money and a creditor got a judgment against you, and you had: money in a bank account, a car, and a house, the creditor would seize the money in your bank account first. Why go to the trouble of having to seize and sell your car.
Suddenly and without warning, all deposit money in all major banks throughout all the country could be seized — and all at once.
Yes, there was deposit insurance, but that assumed only the risk of a bank here or a bank there going bankrupt.
Let’s be clear: The banks were not acting on behalf of clients but were betting for themselves on the housing market. This is called proprietary trading or prop trading for short. The banks are trading as if they are the owners of our deposit money. The profits are vacuumed up in those obscene executive salaries.
A Ticking Time Bomb
A main factor that contributed to the 2008 crisis still plagues us today. A little demystifying is needed to explain why. Betting on the housing market is one kind of a derivative. The daunting term ‘derivative’ simply means that the investment has no money value in and of itself, but derives its value by reference to the value of something else.
The bets on the housing market were obscured under the term, “Credit Default Swap.”
The home owners had borrowed to buy a home, hence they had bought on credit. There was a risk that the homeowners would default on these loans. The bet supposedly “swapped” the risk of default. In fact, there was no swap. The bet created a new risk entirely out of nothing.
Credit Default Swap bets were made in the completely unregulated arena aptly called the dark or shadow market — an unregulated market where no one, not even the banks knew the totality of what was going on.
In 2002, at a shareholders meeting of Berkshire Hathaway, the Oracle of Omaha had described derivatives, especially credit default swaps, as “financial weapons of mass destruction”.
No one listened.
At his company’s 2016 meeting, Buffett said he still could not understand bank financial statements because of the massive derivative positions. He pronounced them “time bombs.”
Buffet was not alone in his predictions of coming doom. Law and finance professor Frank Partnoy teamed up with journalist Jesse Eisenger to review the financial statements of America’s most conservative bank, Wells Fargo. (Doesn’t the mere mention of the name raise an image of a stagecoach racing over the plains with a shot gun guard protecting a strong box full of money?)
They sounded the same dire warnings as Buffett. There are massive risky derivatives, probably of a trillion dollars, on the statements. These are the same type and the same amount of risky investments that caused the downfall of the banks pre 2008 and will, in all probability, cause another and more severe financial crisis. Our system will not survive another hit of the same magnitude…
The banker lobby had successfully delayed full implementation of the Volcker Rule until 2017. The workers’ new champion, Donald Trump, passed his Choice Act in the nick of time to save the bankers’ big bonuses.
The Volcker Rule would have put some (not nearly enough) reins on bank participation in the gambling world of the dark markets. Now banks are back in the casino business.
And we know how well Trump can manage a casino!