Joshua Rosner

 

Recent Posts by Joshua Rosner

  • Has the New York Fed been serving the public trust? Has Geithner?

    Feb 4, 2010Joshua Rosner

    money-question-150Questions about Geithner's role in the bailouts as NY Fed president continue to swirl.

    money-question-150Questions about Geithner's role in the bailouts as NY Fed president continue to swirl.

    In Geithner's AIG testimony before the House Oversight Committee, the Secretary again tried to sell the notion that ‘if we didn't act then, millions more would have lost their jobs and thousands of factories would have closed'. Even if this were true, why did they have to pay these counterparties one hundred cents on the dollar? The answer may be because, as President of the New York Fed, the counterparties you paid out on AIG owned your company.

    To simply say "we had to" is an oversimplification and a partial story. Those of us who saw the crisis coming and recognized the fragility of the system before the Fed or Treasury disagree with the "we had to act" line, but the story is actually larger than that, and predates the unfolding of the crisis. The full story puts Tim Geithner and Larry Summers dead center in creating the environment that drove us to crisis.

    Secretary Geithner can keep repeating his assertion he has worked in public service his whole life. Never mind that this calls into question his tangible market experience, this claim begs the question: How does he define working in the public service?

    Geithner's last job, as the President of the New York Fed highlights that question. The NY Fed's most important jobs, arguably, are safety and soundness supervision and capital market supervision. Success in carrying out those responsibilities should be the basic litmus test for the measuring how well the NY Fed is serving the public trust. In these roles it is supposed to examine, regulate and oversee the Federal Reserve regulated bank holding companies in the NY Fed's region, the largest bank holding companies in the country, many of which were AIG's counterparties.

    The New York Fed is not government-owned. Most people fail to recognize this fact. Simply, the Federal Reserve Board (responsible for monetary policy, with a dual mandate of full employment and price stability) is an independent part of the federal government, while the New York Fed is a shareholder-owned or private corporation. In other words, where the Federal Reserve Board is www.frb.gov, the District Bank is www.newyorkfed.org. Historically, the New York Fed has been among the most profitable shareholder-owned corporations in the world. Yet it keeps the details of its shareholders' ownership information private. What we do know is that its owners include precisely those institutions it is tasked to regulate and supervise and those is has obviously failed to adequately supervise. Unlike the other District Banks of the Federal Reserve system, which have overseen their banks quite well, the New York Fed's concentration of the largest banks, coupled with its unique role of managing the market operations of the entire Fed system, has built a culture where it sees itself as a market participant and peer to those firms it regulates.

    The President of the NY Fed is chosen by, paid by and reports to the private shareholders of that private institution. Only three of the nine Directors of the Board of the New York Fed are chosen by the Federal Reserve Board and, until this year, the NY Fed's Chair -- chosen by the Federal Reserve Board in Washington -- was a former Chairman of Goldman Sachs who still sits on Goldman's Board.

    We do not know the full roster of shareholders, but the list of the NY Fed's Board and management group is particularly interesting, reading like a Who's Who of sell-side financial corporations that the taxpayer has bailed out and whose systemic riskiness Washington would rather take indirect and half measures to address rather than take a head-on approach of resolving.

    In truth, Geithner's ineffectiveness in his role at NY Fed President and his current political posturing -- without any policy substance to directly address too-big-to-fail or the Fed's flawed powers to bailout firms -- seems to have resulted from design rather than accident. After all, in a previous "public service" role, Geithner was the lead negotiator for the WTO's General Agreement on Tarrifs and Trade for financial services. In this role, Geithner reported to Larry Summers, who in turn reported to Secretary of Treasury Robert Rubin. In 1998, this team won the banks EVERYTHING they requested from that treaty. From open access to new markets to unrestricted growth in equity and credit derivatives, they opened the door to rapid and deregulated growth of the large multinational banks, allowing them to become "too big to fail". Moreover, the terms of the agreement has made it almost impossible to put the "too big to fail" genie back in the bottle without running afoul of rules of this international agreement. That was the work of Geithner as "public servant".

    It appears that his reward for this work was nomination to run the privately owned NY Fed. The nomination was orchestrated by many of those same banks that own the NY Fed and for whom he delivered on that GATT (General Agreement on Tariffs and Trade) "Understanding on Commitments in Financial Service" (an international agreement, won by arm-twisting, that led to global deregulation of the fnancial services industry and encouraged the largest firms to enter new business lines and new financialmarkets without resistance).

    I expect documents to come to light that will show that Geithner and Summers did the WTO negotiations on behalf of the industry and viewed the completion as a 'deliverable' to their financial constituents. How can Obama say, while Summers and Geithner are his team, "if the banks want a fight, I am ready to fight them"?

    Geithner's comment from January 1998 demonstrates that he was working on behalf of the industry and not necessarily the public:

    "Second, we, I think, established -- I hope you agree, Bob -- very effective cooperation with the U.S. financial community, both in defining priorities, and more importantly in some ways... mobilizing a coordinated approach with other globally active financial institutions in other jurisdictions...Fourth, we worked very closely with the international financial institutions so that they made a very strong, compelling analytical case for the benefits of liberalization, so that they built specific conditions into programs where that was appropriate, and so that they provided technical support and technical assistance to countries who were trying to find the right path of liberalization in an environment of considerable financial stress... the agreement establishes quite substantial new opportunities for access to these rapidly growing markets, with substantial increases in the equity thresholds open to foreign firms... the agreement provides protection for the substantial existing presence of U.S. financial institutions from the threat of future discrimination or future protection. And this is not a static commitment. It means that they can participate fully in the growth of these markets as they evolve further".

    I expect more damning statements of Geithner and Summers using the office of the Treasury to work on behalf of the bankers.

    So how did this WTO process to liberalize the global financial regulatory structure begin? Well, according to the "Financial Services and the GATS 2000 Round" report:

    "In 1975 Pan American, which was still there, and American International Group (AIG) took a shot at trade in services. In 1979, I was in New York with the American Express Company and was in charge of strategic planning and acquisitions. We were having problems, which we now call market access problems (we did not have this kind of terminology at that time), in thirty or forty countries. We had no remedy under the trade laws or under the General Agreement on Tariffs and Trade (GATT), which only covered goods.

    To make a long story short, we decided that we would have to change that, which meant starting a new round of trade negotiations including services. My boss, Jim Robinson, chief executive officer (CEO) of American Express, asked me to start a new trade round as soon as possible. He asked, 'How long will it take?' I said, 'I don't know, ten years maybe. I don't know. I have never done it. I am just reading this book by Ken Dam called the GATT.' He said, 'Well, do it as soon as you can.' I said, 'I need some money.' He said, 'Don't worry about money. This is so important, you will have an unlimited budget." If there was one phrase that really pushed trade and services, that was it. We put a person in Brussels, a person in Tokyo, two or three people in Washington, three people in New York, and so forth.

    We enlisted the aid, which was really important, of Citicorp and also AIG. John Reed came along a few years later as CEO. We had an alliance in which Jim Robinson of American Express, John Reed, and Hank Greenberg of AIG were working together. I was the go-between. Having those three men with a lot of staff was the key. We went from zero probability of success to having a chance...One of the things that distinguish the American private sector from the rest of the world again is its relationship to the media, which is very good. All kinds of events are held with the U.S. media and sometimes the foreign media in attendance. This is very, very important. We do not see this any- where else in the world."

    Finally, in 1998 Geithner and Summers delivered. What did they deliver? What are the realities of the "Understanding on Commitments in Financial Services" in the GATT agreement that were thrust on the global sovereign world? Well, as two small examples from the document:

    "Notwithstanding Article XIII of the Agreement, each Member shall ensure that financial service suppliers of any other Member established in its territory are accorded most-favoured-nation treatment and national treatment as regards the purchase or acquisition of financial services by public entities of the Member in its territory. "

    And:

    "A Member shall permit financial service suppliers of any other Member established in its territory to offer in its territory any new financial service".

    If being a public servant is funneling unreasonable amounts of taxpayer capital, without market discipline, to the largest and most poorly managed banks, then Geithner's selection as Secretary of Treasury makes sense. The same logic that allows senior officers of Lehman, Pepsi, Pfizer, GE, and Loews to be selected as 'Class B Directors' of the New York Fed, chosen as "representatives of the public" makes Geithner the perfect "public servant" to oversee those instutions these largest banks have successfully robbed. To be fair, it is also the same twisted logic that seated the last Treasury Secretary, a man who is being publically whitewashed in the media today -- even though, as Chairman of Goldman, he single handedly convinced the SEC to allow Goldman and other investment banks to lever-up so wrecklessley that they would need to be bailed out as AIG counterparties.

    Joshua Rosner is managing director of an independent financial services research firm.

    Read more

    Share This

  • Congress and TBTF – Bring in the Bomb Squad

    Oct 28, 2009Joshua Rosner

    bomb-150Joshua Rosner examines the House regulatory reform bill, which does not, in its current form, acknowledge that "Too Big to Fail" is too big to exist.

    bomb-150Joshua Rosner examines the House regulatory reform bill, which does not, in its current form, acknowledge that "Too Big to Fail" is too big to exist.

    The House draft bill written by Rep. Barney Frank (D - MA) - along with several former Fed attorneys and Treasury staff and consultants -- ignores fundamental reality: You don't employ a bomb squad to sit around and wait for a bomb to explode, you engage them to dismantle it as soon as they find one.

    Unfortunately, this bill is one more act of sleight of hand by a congress that, to the detriment of the public, fails to see that banks are there to serve the public good and can be regulated with such a goal. An honest bill would recognize that any institution that is "Too Big to Fail" should be given economic ‘incentives' (through prohibitively high capital levels and insurance assessments) to shrink or sell off business units. The notion that we do not have the right to break up anti-competitive and oligo-polistic businesses flies in the face of antitrust laws and ignores the valuable lessons in growth demonstrated by Teddy Roosevelt's trust-busting. Those legislators who are truly seeking to protect the public interest and to be worthy of re-election, should demand that legislation spell out, in plain English, that the entire capital structure of a TBTF institution be wiped out, and its holding company held responsible as a source of strength, before taxpayers are exposed to a single dollar of loss. If leadership won't add such language, call your elected official and ask how much they actually receive when they agree to put on the kneepads.

    Rather than require the break-up or shrinkage of those institutions, this bill suggests we leave the institution intact until it becomes ‘troubled' and instead subject it to greater oversight by the same Fed that mismanaged prudential oversight of precisely the large financial holding companies at the center of the crisis. Keep in mind that even on the 1-5 (best to worst) secret rating scale regulators use to define ‘troubled institutions', BofA was only a 3 and it has been speculated that Citi was only a 2 even as they were begging the government for support. Should we wait to act until an institution is even worse off than they were in the height of the crisis?

    This Trojan horse of a bill will recognize and codify the view that we must accept and agree to live in a world where there are institutions that are TBTF. We have chosen to head in the opposite direction from the responsible approach suggested by both Bank of England Governor Mervyn King, who wants to break up TBTF institutions, and other European regulators who are likely to oversee the breakup of TBTF institutions, ING and Lloyds.

    Each of the elements of this historic and flawed approach was carefully negotiated in close coordination with the most interested parties – that is, the bankers and their friends. Mock hearings will be this week and the complete bill will be marked up mid-week next week. When the hearings begin, the public should demand to know how many of these “experts” have ever taken money as consultants or employees of the “Too Big To Fail” (TBTF) banks or the Federal Reserve System. You can play along with the game show at home by watching the testifying “experts” closely. Try to keep score of how many of them identified the collapse of our credit markets in 2006 or 2007. You can go on to the bonus round and score which of these “experts” expressed a view or highlighted the risk that the Fed’s “emergency powers” would create a moral hazard and be used to bail out our banks. Importantly, Senator Chris Dodd put these powers into legislation in the dark of night in 1991 at the request of Goldman Sachs and other large beneficiaries of government support in this crisis.

    Perhaps I expect too much of these policy experts, after all, in May 2007 even Tim Geithner and the intelligent and thoughtful Fed Vice Chairman Don Kohn didn’t, in the face of over 100 mortgage lender failures and specific direct warnings, fully consider the risks that a crisis was already upon us.

    As part of this Japanese-style kick-the-losses-down-the-road kabuki drama, Secretary Geithner desires that TBTF institutions write a "living will" so that when (not “if”) they end up in trouble, there will be a road map for investors and regulators to follow. This is honorable, but far from requiring banks or their managements to submit to the still more honorable tradition of Hara-kiri.

    The story of an “unlevel playing field”

    Those who argue against a more proactive reduction in risk and size of TBTF institutions will, as always, revert to an argument that strikes a natural chord in every American’s heart: ‘Doing so would create an unleveled international playing field for our institutions relative to their international competitors’. Level playing fields are a worthy goal, but this is not a relevant argument. Instead, this tired bromide must be resoundingly dismissed on several counts:

    • Those countries with the largest banks as a percentage of GDP (Iceland, Ireland, Switzerland) demonstrated that a concentration of banking power can cause significant sovereign risk and tilt global economic playing fields away from that country.
    • The likely breakups of ING, Lloyds and KBC suggest that it is we who seek to support an unlevel playing field where we subsidize our TBTF banks while other nations recognize the policy failures of moral hazard. If we continue down this path we will likely be at risk of violating international fair trade regimes.
    • When the “unlevel playing field” argument is cited, keep in mind this reasoning supports the disadvantaging of 8000+ community banks relative to our largest banks, all in the name of protecting big banks from governmentally- subsidized international competition.
    • There is no longer any evidence that, beyond a cost of capital advantage that comes with implied government support, there are sustainable and tangible economies of scale arising from being the largest. The financial supermarket concept has been proven a failure. The only ones who benefit are the high-level executives.
    • We must demand that our legislators no longer allow unelected officials at the independent Federal Reserve to sign international accords created by the TBTF banks through supra-national bodies like the Basel Committee.
    • Are we to believe that if we did not have such large and globally dominant firms, US borrowers might be paying more that the 29% interest that several of the TBTF firms are now charging on their card accounts? Perhaps we should think about what advantage our population has gained as a result of our financial institutions being such a large part of our economy or being globally dominant.
    • Since when did we accept a national strategy of following rather than leading? When we do what is right, others follow. As example, consider the bank secrecy havens – they made money for a bit. Now, even the Swiss and the Cayman authorities are coming around to our view.
    • We are already at a disadvantage given that the largest foreign banks operate in the US without any tier one capital requirement and yet mostlarge foreign banks have not built a bricks and mortar presence here. Nobody screams about their undercapitalization nor has that undercapitalization caused deposits to migrate to foreign banks.

    Having provided preemptive arguments against their notion I would point out that by getting out of the TBTF game, we will have a more robust and economically competitive economy where no players have a governmentally-conferred advantage or subsidy. Such a leveled playing field will begin the process of regaining credible markets and attracting stable foreign capital. Let other nations pursue misguided policies of protecting uneconomic and anti-competitive businesses. Such an approach will allow our taxpayers to avoid having to be part of the next banking bailout crisis.

    New GSEs for you and me

    The Administration’s preferred approach, which is politically cynical, re-creates a class of special public companies that, because of their ties to the government, receive the benefit of a GSE-like “implied government guarantee”. For background, for the better part of the past 10-years market participants were increasingly convinced the GSEs (Fannie and Freddie) could become unstable. Even so bondholders viewed the companies as low credit risks. It was assumed that if they into trouble they would be bailed out with taxpayer dollars and without significant losses being forced upon bondholders. As a result of this belief, the GSEs had a significantly lower cost of capital than their non-“special” and fully private competitors. No matter how much Treasury, the Fed, the White House or Congress said that the government did not stand behind the obligations of the GSEs the markets did not accept that view and, when push came to shove and the GSEs were taken over by the government last September it was the taxpayer that was place on the hook for up to $400 billion of GSE losses. GSE creditors walked away from the accident and even equity holders, who had always been paid to take the first loss, were not wiped out. So, are we expected to believe that these TBTF institutions will not be provided a lower cost of capital by the markets based on the understanding that the government will always stand ready to fund their losses? Moreover, from where in history can we draw comfort that when a macro crisis hits, regulators and policymakers will assess the cost of the losses on other TBTF institutions rather than arguing that that might lead to a contagion risk? As witnessed in this crisis, a withdrawal of liquidity from one systemically risky institution can lead to both a withdrawal of liquidity to its peers and also a contagious decline in asset values leaving all undercapitalized at the same time. If there is a positive to the GSE model and the “implied government guarantee” it is for the Washington political class. These companies will provide all legislators, regardless of their political affiliation, with a constant stream of lobbying dollars in return for help in stymieing regulators. The lobbying and campaign dollars the TBTF banks are spending to convince officials that their derivatives books were never at risk and their credit trends are stronger are welcome in Washington. In a testament to Washington’s love affair with large financial firms Jamie Dimon has been repeatedly dubbed Obama’s “favorite banker”. Even so, there is still a massive lobbying dollar hole left by the withdrawal of the largess that disappeared with the predictable collapse of Fannie and Freddie.

    Contingent capital is neither contingent nor capital

    While it is not yet clear if the absurd notion of "contingent capital" will be referenced in final legislation or left to the regulatory hacks to codify in rulemaking, it is gaining support in the Fed as witnessed by recent comments from Governor Tarullo and NY Fed President Dudley. Rather than requiring banks to raise and hold significantly more (good, old’ fashioned) equity capital, they want banks to use "contingent capital" or debt that converts to equity in cases of precipitously falling equity values.

    Contingent capital is a deeply flawed notion proposed by academic economists who should either be locked away in institutions or sent off to a vast wilderness where they can no longer threaten the broader population. Equity is equity, there is no substitute. As long as the Federal Reserve retains the "13.3" emergency powers one must expect that when a TBTF institution is imperiled or required to convert their contingent debt to contingent equity the TBTF institution will lobby hold legislators and regulators hostage to the notion that such a conversion would cause a market panic and lead to counterparties pulling secured lines and withdrawing liquidity…hmmm, sound familiar?

    Moreover, unless there are clear and specific prohibitions against banks investing in each other’s “contingent capital notes”, we will increase systemic risk by engendering precisely the entanglement and interconnectedness that defines systemic risk. We have witnessed the problem of interconnectedness in this crisis in at least two situations; banks and insurers investing in each other’s trust preferred securities (TRUPS) and becoming exposed to not only declines in the equity value of their TRUPS but also to losses on their investments in other banks’ TRUPS. We have also seen the damage caused by regional banks outsized exposure to GSE preferreds. Lastly, unless market participants saw through the contingent capital notion and considered it to carry an “implied government guarantee”, the cost of issuance of the notes would be at a prohibitively high rates.

    Salvaging regulatory reform for the good of our public

    There remains some hope for those who would like to see real regulatory reform. The first chance for the public to force a more real reform on Washington will come as taxpayers awaken to the realization that, absent the government largess, bank credit trends demonstrate the economy is hardly stable and that unsustainable improvements in banks’ results arise from their capital markets business, not traditional lending.

    A second chance for meaningful reform might come if an unlikely bout of mass sanity takes over our legislators causing the government to abandon its reckless “a golden egg in every pot” approach to trying to pull forward future demand is stopped. A more destructive catalyst could ultimately come in the form of a U.S. variant of the “Soros v the Bank of England” incident if foreign investors abandon dollar assets until the government rejects the financial obligations of the private sector.

    To be clear, passage of the House Financial Services Committee regulatory reform bills does not ensure that Senator Dodd (D - CT), who intends to introduce his bill in November, will have any luck moving it. In fact, sources suggest that Mitch McConnell (R - Kentucky) sees Senator Dodd as vulnerable in his re-election campaign and is encouraging Republicans not to support his bill. Senate Banking Committee Minority Leader Richard Shelby (R - ALA) continues to suggest he will not negotiate any regulatory reform legislation unless it meaningfully addresses GSE reform.

    While it is unclear if this is a hard line or an opening position, he has also made it clear he will not entertain the Fed in the role of either “il capo di tutti capo” of prudential financial regulators nor will he accept Ben Bernanke wearing a pinky ring and playing systemic risk regulator. On the latter Dodd is seemingly in agreement. Democrat leadership appears to believe Shelby is merely posturing and that, even though the reform language on OTC derivatives, consumer protection, TBTF, and systemic risk are laughably weak, it will be impossible for Republicans to convince the public that they are holding up reform legislation for honest and political reasons, rather than merely political ones. Democrats expect that they will be able to shift the debate from a debate on what would constitute good public policy to one of "the Republicans are a party of ‘No’". I will predict that passage of this legislation on a partisan vote would have more negative implications for Democrat re-elections than the passage of a healthcare reform bill on a party-line vote. Americans hate their healthcare insurers but like their pharmacists and doctors. Americans hate their banks and have grown to hate bankers and their bailouts far more.

    Even so, populist acrimony should not be directed at "the" bankers, rather it should be focused on the “Too Big to Fail” bankers. Perhaps we will ultimately force them to wear scarlet letters. Maybe we will tie them to rocks and throw them in water to determine if they are witches. It is urgent for taxpayers to see that their greatest allies in pursuit of good public policy on most of these issues are institutional investors, who bet that market forces ultimately prevail and rebalance to equilibrium, and also those small community bankers who largely stuck to their knitting, made plain vanilla loans, didn't arbitrage regulatory capital rules, remained sufficiently well capitalized relative to their exposures. It is those two groups that suffer because the implied government backstop of the TBTF crowd is resulting in small banks being forced to compete for business at an economic disadvantage. It is institutional investors that now have to chase assets bid up by to those TBTF institutions that speculate and take on more risk as a result of their “implied government guarantee”.

    Make no mistake, the TBTF crowd is still controlling both Congress and most regulators as witnessed by all the focus on secondary reform items rather than resolution authority and an end to TBTF. If you are TBTF you are too big and must shrink or be broken up. If we achieve this these bankers will be better and more focused on risk management and we wouldn't have to even care as much about other secondary issues.

    Over the next few days I will offer a section analysis and critique of the discussion draft.

    Joshua Rosner is managing director of an independent financial services research firm.

    Read more

    Share This