The capitalist version of the Golden Rule goes something like this, “He who has the gold, makes the rules.” This is exactly what we are seeing with the implementation of the Dodd – Frank Act. The financial institutions have the resources to stall, drag, markup, and negotiate on every one of the 243 rules, 67 studies and 22 periodic reports the Act contains. The most recent markup session was a classic example of, “The Golden Rule” at work. The House Agricultural Committee’s recent markup session included bills to gut the most important parts of the Dodd – Frank Act. The committee invited 5 individuals to discuss these matters, four from the financial industry and one person from the private sector, Wallace Turbeville of the Americans for Financial Reform.
The timing of this session was critical as it came right on the heels of the London Whale testimony before the Senate Permanent Subcommittee on Investigations. The London whale was the JP Morgan (JPM) trader who accumulated an outsize losing position, at one point reaching a negative value of more than $150 billion dollars before finally paring the reported loss to just over $6 billion. The crucial point here is that JP Morgan lied about the debt from beginning to end and was able to transfer funds internationally among its branches to hide the loss. One of Dodd – Franks’ most important pieces is, “extraterritoriality.”
Extraterritoriality is what is supposed to protect the American financial system from a meltdown somewhere else on the globe. This act would ensure that American firms who hold risk outside of the U.S. must still use our reporting standards. This is the loophole JP Morgan used to hide the losses of the London Whale for so long. This piece of legislation also increases transparency by creating a public swaps global clearinghouse so that the vast majority of these can be readily monitored. This is a good thing. However, this would hurt the financial industry’s profits through more reporting man-hours as well as additional execution, clearing and margin requirements.
The next major challenge with the implementation of the Dodd Frank Act is the, “Bank Derivatives Subsidiaries.” This is intended to eliminate, “too big to fail.” The financial industry is having a hard time coming to grips with the notion that it may have to separate its trading and banking operations. Dodd-Frank got this right. Investment firms should be investment firms and banks should be banks. It’s one thing for a bank to loan out excess deposits. It’s quite a different matter when the bank is using your excess deposits to trade European debt markets, crude oil or any other trade the bank would like to initiate with your funds. Just a few years post crisis and the banks already want us to allow access to taxpayer funds to cover their losses. Trading becomes a pretty easy game when the taxpayer money is there to cover the losers.
These are the two primary points of contention with several others falling under the umbrella of the previous two paragraphs like, “Business Risk Mitigation and Price Stabilization Act.” This is a margin act. When a product is hedged, there is still risk for the financial institution. Therefore, the Dodd-Frank stipulation that the financial entity engaged in the hedge transaction should keep sufficient margin on hand to cover market movement. This splits the previous points if the trading entities are spun off from the banking sector as well as creating a trading entity that can be monitored while assuring client funds in the banking side of the business remain safe.
The era of, “too big to fail” must come to an end. Individuals who put their money in banks deserve to know that it’s safe. There was a time when customers worried that their money may be stolen by crooks robbing the bank. I doubt anyone ever thought of the crooks in the bank stealing their money. The financial industry must undergo a paradigm shift in this respect and realize that they cannot be all things to all people and therefore must choose between investment banking and customer banking. Dodd-Frank implementation is a daunting task. Current estimates are that somewhere between one quarter and one half of it has been put into place. If the finance industry has its way, that’s as far as it will go and the people with the gold will have arranged the rules to suit themselves once more.