Thursday, March 20, 2008

Hey Bernanke—Deregulation is Killing US

Fed Enters Securities Underwriting Business

On Sunday night March 16, 2008 the Federal Reserve made a major advance for financial liberalization and deregulation when it opened up the Fed window to investment banks. For the first time securities underwriters could now borrow at the same advantageous rate as banks from the Fed. Unfortunately it has been deregulation and measures such as this that have helped create the mess we are in.

Is the Fed is going to underwrite the stock market?

The idea of the Fed lending money to investment bank reinforces decade’s long rumors that the Fed has been buying S +P 500 (stock index futures) to selectively prop up the stock market at times of crisis. By buying stocks the Fed is defying the basic tenet that markets are self-correcting and should be left to their own devices.

By creating a special borrowing window for underwriters it is clear that the Fed has stepped up its involved in the stock market and may take on a role similar to the Japanese Postal Savings System who is rumored to have bought hundreds of billions of dollars(if not trillions) of worthless securities during the Nikkei’s decline. The unfortunate thing is that we will never know what the Fed does because it is basically an organization independent of the checks and balances of the democratic process. It is also highly secretive.

We do know that deregulation fuels speculation.

Take for example how banks exploited their lines of credit with the Fed when they were allowed to underwrite securities with the passage of Gramm Leach Biley Act (GLB) in 1999. GLB overturned Glass-Stegal and other laws created during the Great Depression to protect the public. The passage of GLB was a monumental step forward in the process of financial deregulation.

Andrew Bary in “Truth in Lending?: Wall Street Rivals say big banks use cut-rate loan commitments to snag underwriting business”, Barrons; May 28, 2001; notes how banks were using their ability to borrow cheaply from the Fed window to buy away business from investment banks. They did this by taking advantage of the Fed window and offering cut rate lines of credit, below what investment banks could offer to corporations. They then made access to these lines contingent upon underwriting business. Arguably they were using the Fed as their guarantor in speculation:
""The commercial banks have been aggressive in using bundled pricing and below-market pricing in some instances to win business,' says Henry McVay, brokerage analyst at Morgan Stanley,"
Not surprisingly the banks went hog wild and took on inordinate amounts of risk. Remember banks know all to well that if hard times hit the Fed will bail them out:
“In his report, Mayo (banking analyst at Prudential Securities) writes investors are underestimating the risks posed by the industry's $4.7 trillion in credit lines and other contingent liabilities because banks aren't reserving adequately…. Mayo argues that banks haven't reserved adequately for credit lines and other contingent loans. "The risks related to this issue are underappreciated,' he told Barrons. In the report, "Shh! Banks' contingent Liabilities Have Tripled in the past Decade," Mayo notes that off-balance-sheet exposure has exploded to $4.7 trillion form $1.5 trillion a decade ago and now equals 30% of total bank loans."
We must ask how much of the current financial malaise is tied to commercial banks that aggressively pursued underwriting business with enticing lines of credit after the passage of GLB? Secondly, what kind of maelstrom can we expect from investment banks now that they have access to the Fed’s window?

Deregulation—Birth Mother of Sub prime/predatory loans

Before complaining and worrying about the effect of the sub-prime market and predatory loans in our current financial crisis we need to go back and look to see what led to their creation. Before the 1990’s the sub-prime market was almost nonexistent. Fringe banking consisted of a few pawnshops in communities across the country. However, that all changed when financial deregulation began with Reagan and accelerated dramatically under Clinton. Overseeing this process was Fed Head Alan Greenspan who cared little for the poor or protecting them as Martin Mayer (The Fed) notes;
"Discrimination against low-income people in lending operations was a subject guaranteed of be of no interest to the Federal Reserve System. The fed could never be the agency of choice for a program to compel banks to invest in the ghetto." page 289
Banks deserted inner cities and diversified away from traditional businesses such as making home loans. One can only assume that the Greenspan Fed ignored the Community Reinvestment act and the Humphrey Hawkins Act meant to help the less well to do.

Greenspan a big devotee of financial innovation did all in his power to facilitate the growth of derivatives ( from almost zero in 1973 to $516 Trillion as of June 2007; For the poor this meant financial innovation rushed in to meet the void left by banks that had abandoned them. Hucksters developed creative measures to circumvent usury laws to take advantage of the poor. A host of snares were developed; predatory loans, pay day loans, auto title loans, check cashing stores, rent to own stores and whole lot more. The sub-prime market grew exponentially to fund all of them.

We must ask ourselves—had the Fed done its job would their even be a sub-prime market? Predatory loans? Pay day loans? While we may not have sold the poor for a pair of sandals we have financially indentured them to line the pockets of the rich. ( To learn about Fringe banking go to: )

Deregulation is the problem

By creating a special window for investment banks on Sunday night the Federal Reserve moved one step closer to becoming an appendage of the market and giant corporations. The problem is that the market and corporations have unbounded greed and as history tells us gluttons eventually devour themselves in their own avarice.

We continue to be in a full fledged financial markets meltdown. More financial deregulation only exasperates the problem. We will see a respite here, a bear market rally there, but ultimately the end is nigh!

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