What We Need Is More Trusts In Banks

Not more banks that say trust us.

By Melvin J. Howard 

After reading Bloomberg article Secret Fed Loans Gave Banks $13Billion 

Only backs up my long held suspicion that in this day and age robber barons still exits and monopoly is not just a board game. And that maybe the solution lies in the people creating their own monetary and trade systems and weaning themselves away from dependence on the very risky, and destructive global financial system we have today. Really why continue to trust in, and be a part of, a system that works against us? Should the current global financial system collapse tomorrow the world would have no back-up mechanism for continuing trade, and in all likelihood the resulting confusion and collapse of order would result in massive catastrophe, maybe worse than Germany in the 1930s, and on a global scale. The risk of global financial collapse continues to increase with increasing income inequality. This leads to an increasing amount of financial activity being driven by those who have so much excess money that the bulk of their transactions are speculative. This inequality and these risks increase with each publicly funded bailout, which then further increases income and wealth gaps. And so the cycle continues, with this positive feedback built in to make the whole system more and more unstable. Those who are currently actively involved in setting up alternative economies are in a way actively hedging their bets that the dominant system will eventually fail.

However that being said, setting up alternative financial and economic systems in a meaningful way will take a lot of time and effort. The existing global financial order will be with us until it either collapses or people come up with an alternative, or both. In this time it's important for activists to challenge the financial world on their trend towards increasing speculation and reliance on cures for financial crises. Along this line of thinking it might be more fruitful to work towards reducing the need for IMF bailouts, rather than just worry about them once they already exists. That is maybe people should also be focused on prevention as well as the specific nature of the cure. Otherwise increasing speculative activity may end up increasing the frequency and severity of IMF bailouts.

One of the best means of prevention of financial crises (and therefore IMF bailouts) is stricter supervision of banks and other financial services companies, so that they don’t make too many risky bets that destabilize the markets. This is in the best public interests of a public that depends on stability of the banking system, and doesn’t have an alternative monetary system to fall back on. One would think that bank supervision would be done under the guise of a government body so that there could be some democratic accountability of the supervisor, and some representation of the public’s interests. Think again Under the Gramm-Leach-Bliley Financial Services Reform Act of 1999 the regulator of all bank holding companies in the U.S. is the Federal Reserve. They are also the supervisory body, which will monitor banks risk taking activities and their associated capital buffers under the new Basel Capital Accord. As we know the Federal Reserve is 100% owned by the private banking industry. So the banks seem to be supervising themselves!

This doesn’t bode well for the idea of getting banks to behave better with respect to risk taking. Apart from the issue of ownership, the conflicts of interest with respect to the "central bank" of a country also supervising the banks are so profound that no other major industrialized nation has dared to do it. In most other countries the central bank the driver of monetary policy - and the bank supervisor - trying to make sure the financial system is safe - are two entirely different bodies.

One the one hand, the Fed, when it wants to increase the money supply would encourage banks to take more risks to achieve this monetary goal. For example , the president of the Federal Reserve Bank in New York let’s call him Mr. XXXX might comment in the midst of the worry about the European crisis, "The Fed": "If you’re a banker, go out and lend you don’t have to cross every i and dot every t. If you’re a bank supervisor, don’t criticize your banks for making loans, even if they’re loans you might not have approved just a little while ago." He would be speaking there as a key player in monetary policy, not as a supervisor who should be concerned about risks in the financial system. Mr XXXX, as the head of the New York Fed is also vice-chair of the Fed's Open Market Committee, responsible for the creation of base money you know magic money out of thin air, not only is Mr. XXXX now responsible for supervising the activities and capital levels of the New York area banks, he is now also the chair of the Basel Committee on Bank Capital requirements! In many cases his role as central banker (and driver of monetary policy) will conflict with his role as both supervisor of banks and chair of this capital committee both of which SHOULD be representing the publics interests in bank risk taking.

When Alan Greenspan was, the Governor of the Federal Reserve Board, that overseas all the Federal Reserve Banks, said in his bid for being the bank regulator of choice, that regulation by a separate government body (such as the Office of the Comptroller of the Currency) devoted only to managing safety and soundness of the banking system would "inevitably have a long term bias against risk taking and innovation". He forgot to mention that these risks are usually born by the public, so that such a focus of a supervisor would be quite appropriate. Unfortunately, often masters of the universe forget that there is a public to worry about. That is, until a public bailout is needed of course.

The conflicts of interest and evidence of the "fox guarding the hen house" does not stop there. The Board of the Federal Reserve Bank of New York always has the biggest New York bankers on it. So it is not surprising that the, past CEO’s of Citgroup is on the Board of the Federal Reserve Bank of New York. The Federal Reserve Bank of New York is the Supervisor of CitiGroup! As noted, the president of the NY Fed is also the chair of the Basel Committee setting capital requirements that are supposed to protect the public from banks taking excessive risks for excessive profits. So the supervisors and the supervised are pretty much one and the same.

The latest draft of the Basel Accord in coming up with capital (i.e. safety) requirements. Evidently ticked off the American bankers and they were starting to get pissed-off at some of the conservatism and safety margins proposed by the European supervisors. So they thought they better step in and take over.

The change at the helm will probably bode well for the big bankers whose comments on the proposed accords can be pretty much summed up as tantrums  about how the proposed capital (or safety) levels were just too high and how this would eat into their profit margins. It is especially illustrative to look at Citigroups comments in the past since, as noted, the Federal Reserve Bank of NY, whose president once chaired Basel, supervises Citigroup and on whose board CitiGroup has representation. In this way it could be construed that, unless pressure is applied otherwise, CitiGroups desire for holding less capital, and making the financial system more volatile and risky will become a reality. The following is a quote from the response by Jay Fishman, past COO of Citigroup at the time to the new proposed Basel Capital requirements for banks:

"We urge the Committee to keep in mind that although capital has an important role to play in assuring safety and soundness by supporting a banking organizations assets, it has a significant opportunity cost". This means lower profits. This "would effectively translate into higher costs to users of funds and/or lower returns to investors in organizations subject to the New Accord". He goes on to say that this would end up "reducing competition and choice for customers of banks". This is rather laughable now given that the multitude of recent acquisitions of banks that have gotten bigger since the crisis. All across the world this has done more to reduce competition and choice that any capital requirement could.

Furthermore in appealing to competition, that bastion of the free markets, Mr Fishman forgets to point out that his organization is a primary beneficiary of the IMF bailout mechanism, which is more of a threat to competition and free markets than any supervisor could dream up.

Mr. Fishman, in his letter, calls for capital requirements to be primarily set by the banks themselves, especially those "sophisticated banks" with "sophisticated risk management techniques". Fishman forgets to point out that these fancy risk management models failed completely to manage the risks of their bets in Mexico, Asia, Latin America and Russia during the 1990s. Finally he argues that the increased disclosure requirements of the proposed new Basel Accord will increase the costs to banks, and only serve to confuse everybody.

The comments of a bank that has the highest degree of moral hazard posed by the Bretton Woods institutions, and hence the biggest incentive to take excessive financial risk, must surely be taken with a grain of salt. However without the involvement of the NGOs and other organizations fighting these institutions the new Basel Accords and associated capital requirements will go through with exactly what the banks want. That is - more profits through higher financial risk taking that will only serve to increase the frequency and severity of publicly funded bailouts and further compound the transfer of wealth from the poor to the rich. If you look at history this has always led to the destruction of empires society can no longer afford to ignore income and wealth inequalities for if we do we do so at our own peril.