One
of the few rebellious Fed heads, Richmond Fed President Jeffrey
Lacker, fired another salvo when he was testifying at the House
Judiciary Committee’s hearing.
And he hit Wall Street risks that are wrapping their growing
tentacles ever more tightly around the economy and taxpayers.
The
hearing, according to Chairman Bob
Goodlatte, would examine whether the Bankruptcy Code is “best
equipped” to deal with the insolvency of large banks, such as the
“unusual level of speed” needed for their “efficient and
orderly resolution,” and the “unique threats” their collapse
would pose to the “broader stability of the economy.”
Lacker
was on his turf. For years, he has spoken out against QE. Earlier
this year, he committed heresy by admitting that “labor market
conditions are affected by a wide variety of factors outside
a central bank’s control“; he’d yanked away the Fed’s fig
leaf for its QE and zero-interest-rate policies. And in June 2012,
before QE3 had appeared on the horizon, he’dstunned
his listeners when he said, “Monetary policy doesn’t
have a lot of capability right now for enhancing growth.” He
dissented at the FOMC meetings in 2012 when he last was a voting
member. His concerns were confirmed by QE3’s subsequent failure to
budge the economy, though it inflated glorious assets bubbles all
around.
Now,
in his prepared
remarks, he told the Committee that the Bankruptcy Code should be
tweaked to make it “feasible to resolve failing financial firms in
bankruptcy.” The financial crises showed “glaring deficiencies”
in the way “distress and insolvency” of big banks are handled, he
said. Meaning, they were all bailed out by the Fed and to a much
smaller extent by TARP, when there should have been a system in place
to wind the failing ones down in bankruptcy. The bailout of investors
has created, he said, “two mutually reinforcing expectations”:
First, many financial institution creditors feel protected by an implicit government commitment of support should the institution face financial distress. This belief dampens creditors’ attention to risk and makes debt financing artificially cheap for borrowing firms, leading to excessive leverage.
This belief also encourages the riskiest types
of borrowing, “such as short-term wholesale funding,” that could
evaporate at a moment’s notice and leave banks and other companies
high and dry, which is what had happened during the financial crisis.
And these types of funding then “prompt the need” for an implicit
government or Fed “protection,” he said.
Second, policymakers may well worry that if a large financial firm with a high reliance on short-term funding were to file for bankruptcy under the U.S. bankruptcy code, it would result in undesirable effects on counterparties, financial markets, and economic activity. This expectation induces policymakers to intervene in ways that allow short-term creditors to escape losses, such as through central bank lending or public sector capital injections. This reinforces creditors’ expectations of support and firms’ incentives to grow large and rely on short-term funding, resulting in more financial fragility and more rescues.
He cited the Richmond Fed’s research into how
expectations of creditor bailouts – the implicit guarantees –
have grown over time.
In
its 2013
estimate, using 2011 data, the Richmond Fed found that there were
$44.5 trillion in total liabilities in the financial system, such as
bank deposits and bonds. Of them, $10.6 trillion (23.8%) carried
explicit guarantees, such as FDIC deposit insurance. And a stunning
$14.83 trillion (33.4%) carried implicit guarantees. Unlike FDIC
insurance, these guarantees are issued for free to the beneficiary,
and when they come due during a bailout, all Americans are forced to
pay, through either government or Fed action, to protect the wealth
of the creditors. These implicit guarantees in 2011 amounted to 97%
of GDP!
They
have done nothing but balloon. The Richmond Fed’s first
estimate, using 1999 data, found that implicit guarantees
amounted to $3.4 trillion (18% of the liabilities in the financial
system). A mere 27.6% of GDP. Another screaming data point – as if
we needed anymore – in how Wall Street’s risks have been wrapping
their ever larger tentacles around the US economy and the taxpayer.
How could this happen? How could these
expectations of creditor bailouts balloon so fast so much? Who
encouraged it? Well, the Fed and the government. “Through gradual
accretion of precedents,” Lacker explained. One bailout followed by
a bigger one, followed by an even bigger one, etc., followed by the
massive bailouts during the financial crisis. It has been going on
for four decades, he said.
While
these implicit guarantees have altered risk-taking on Wall Street,
banks have become fewer and bigger. In the mid-1980s, there were over
18,000 federally insured banks. Now there are 6,891. Of the goners,
17% collapsed; the rest were mergers and consolidations, based on
FDIC data cited by the Wall
Street Journal.
Of the survivors, 98.6% are banks with $10
billion or less in assets that control 12% of all assets in the
banking industry. Then there are 70 regional banks with up to $250
billion in assets. They make up 1.2% of all banks but control 19% of
all bank assets. Should any of them fail, it would entail
private-sector losses and ownership changes with minimal governmental
intervention. And then there are 12 megabanks – 0.17% of all banks
that control 69% of the banking assets!
Their
“owners, managers, and customers believe themselves to be exempt
from the processes of bankruptcy and creative destruction,” Dallas
Fed President Richard Fisher pointed out when he once
again vituperated
against TBTF banks that, as “everyone and their sister
knows,” were “at the epicenter” of the financial crisis. They
“capture the financial upside” of their bets but are bailed out
when things go wrong, “in violation of one of the basic tenets of
market capitalism.”
While Chairman Bob Goodlatte bent over
backwards to address ostensibly the collapse “of large and small
financial institutions,” everyone knew he was talking about just 12
banks, the only banks in the country exempt from the Bankruptcy Code.
Their bondholders are benefiting, free of charge, from implicit
guarantees in the size of America’s GDP. These guarantees have
encouraged banks, aided and abetted by the Fed, to pile on mountains
of risk as if the financial crisis had never happened.
Bu
it has done nothing for the real economy, a rather drab place, where
consumers try to make ends meet as they entered the holiday shopping
season with shootings, stabbings, tramplings, fights, pepper
sprayings…. “Only in America people trample each other for sales
exactly one day after being thankful for what they already have,” a
tweet explained. But it’s been tough for retailers too.
Read…. Strung-out
Consumers, Desperate Retailers, Crummy Sales
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