Interesting article on financial reform

[ziggy29]

Memo from USAA's CEO to its customers on financial reform:

https://www.usaa.com/inet/ent_blogs...wsroom&postkey=usaa_ceo_robles_please_contact

Excerpt:

The U.S. Senate currently is considering legislation (S.3217) that would impose new rules on the nation's financial services industry, including USAA.

As the leading provider of financial services to America's military community, USAA supports financial services reform.

However, the current Senate bill would disproportionally impact USAA because we are a unique and fully integrated association. USAA is not like the banks and other companies that helped bring down our economy, and we never took a penny of TARP funds. We do not engage in the harmful practices this legislation seeks to resolve.

If unchanged, the bill would:

• Prevent USAA from managing the association's portfolio as we have for the past 87 years.
• Jeopardize our ability to continue offering many of our competitive products.
• Limit our ability to return money to our members. Last year, USAA returned $1.2 billion to our members in the form of distributions, dividends, and bank rebates and rewards.1

So, we are asking all USAA members and employees to urge their U.S. senators to amend a portion of the bill, known as the "Volcker Rule," to eliminate its effect on a company like USAA. Please know that this legislation does not impact individual member's investments.

Anyone understand the specific impact here?

 

[ERD50]

donheff - the summary looks pretty good. One thing that disappointments me though, is no mention of financial education for the public (maybe it is in the article?).

It isn't that tough to make sure that someone getting a loan understands the difference between adjustable and fixed. And gets an understanding of what it means if they buy a house with 10% down, their real estate market drops 15%, and they have to move to find a job. And understand that they better save money, because SS alone probably won't keep them 'in the style in which they've become accustomed'. The basics.

off topic a bit, but you shouldn't have to hesitate to link to something just because it was produced by a 'liberal' or a 'conservative'. As long as there is content worth reading. Even if we need to sift through some bias (if it is 'too much' bias, the content is probably lacking anyhow) - every article has bias in some form. Thanks for posting it.

-ERD50

 

[Gone4Good]

Good, then take out the "naughty bits" about bailing out creditors and pass the rest of it. It should be easy.

Sure, as long as you reconcile the above comment with this discussion here. Simply repeating "bailout" may be an effective political strategy (see Frank Luntz January 2010) but it isn't an effective policy in dealing with future runs on the financial system. Maybe you could walk us through your preferred alternative to government resolution authority.

"Frankly, the single best way to kill any legislation is to link it to the Big Bank Bailout" - Frank Luntz, Political Consultant, January 2010

 

[Gone4Good]

Anyone understand the specific impact here?

They'd have to be a lot more specific as to why they are prevented from doing the things they say. As I understand it, the rule specifically permits companies for executing trades on behalf of their customers. So its hard to see how they'd be prevented from offering customer related products and services under the "Volker" rule unless there is some weirdness in the actual language.

 

[REWahoo]

Ziggy, here's more info from USAA regarding their issue with the Volker Rule:

he Volcker Rule

The "Volcker Rule," as drafted in Section 619 of the Restoring American Financial Stability Act of 2010 ("the Senate bill"), gives regulators the discretion to limit and prohibit certain investment activities of financial services companies, like USAA. In particular, this bill directs regulators to prohibit government insured depository institutions from engaging in "proprietary trading," whereby a company trades for its own account. However, the reach of the bill extends beyond the bounds of a depository institution to its affiliates and subsidiaries. For insurers that own banks or thrifts, like USAA, this could mean that all of the investment activity essential to the running of the insurance operations would be significantly limited to investment in only government securities, despite these operations already being heavily regulated by state insurance regulators. The result would be that products that require more robust investments to support them would be limited to government securities, which do not earn enough to keep the cost of such products affordable.

To illustrate this effect, insurers collect premiums from customers in return for a promise to pay a possible future claim. During the time between the collection of premiums and the claims payout, the insurer takes those premium dollars and invests them in order to ensure that funds exist to pay later arising claims. By limiting an insurer's investments to government securities, that insurer may not be able to generate the income necessary to continue offering its products at affordable rates. This could then result in the need to charge higher premiums on policies and pay less favorable rates on annuities.

 

[Gone4Good]

Ziggy, here's more info from USAA regarding their issue with the Volker Rule:

Yeah, the simple answer here is to separate the insurance company from FDIC insured institutions . . . like they did under Glass-Stegall. I think this is kind of what Volker has in mind and isn't exactly an unintended consequence. Nonetheless, I very much doubt anything so restrictive will pass.

 

[samclem]

(Provided by REWahoo)
For insurers that own banks or thrifts, like USAA, this could mean that all of the investment activity essential to the running of the insurance operations would be significantly limited to investment in only government securities . . .

Gee, I wonder if there's any reason the government might want to force more money into government bonds? It would sure help prop up the massive spending for a few years longer, and artificially drive down the interest rates the government has to pay. I wonder if there is an escape clause allowing these companies to invest in corporate bonds instead when/if their ratings become better than US govt bonds?

 

[Gotadimple]

Yeah, the simple answer here is to separate the insurance company from FDIC insured institutions . . . like they did under Glass-Stegall. I think this is kind of what Volker has in mind and isn't exactly an unintended consequence. Nonetheless, I very much doubt anything so restrictive will pass.

+1.

Those who fail to learn from history are bound to repeat it -- Winston Churchill

Niall Ferguson has done an outstanding compilation of the history of money in society (see The Ascent of Money). Bottom-line, in every age where restrictions on business transactions were loosened, excesses occurred, followed by panics, recessions, depressions, etc. Once governing rules were re-established, the markets and business cycles experienced fewer wild swings between boom and bust.

So, I don't think our legislators are unaware of history. But I do think that short-term thinking and political pressure get us what we deserve.

-- Rita

 

[samclem]

Maybe you could walk us through your preferred alternative to government resolution authority.

As we seem to disagree on the causes of the previous crisis and the proper role of government in general, I doubt we'll agree on appropriate future steps. I would say this:
1) Goldman Sachs and other large financial firms are not like commercial banks. The FDIC regulates deposits, required reserves and restricts allowed investments by commercial banks (and S&Ls), and this is relatively simple. This allows the government to provide insurance, since they closely regulate how these businesses are run. GS creates and invests in CDOs, swaps, and other leveraged investments that are so complex that very few people understand them--there's no hope of the government staying ahead of the invention of new products so that they can effectively regulate all of them, which is a requirement if the government (really you and I) are going to provide insurance for them, their depositors, and/or their creditors.
2) I would like Goldman Sachs and other firms to take responsibility for their own security. Investors should have objective data (supplied by the government) that allows them to assess the safety of various firms, and the investments they offer. When these firms compete for customers, one of the selling points should be the safety and stability of the firm. Consider these two options:
a) All the firms contribute to a government fund, or have certain guarantees of government action if they are at risk of default or if the product "blows up". No firm enjoys a particular advantage, and none go the extra mile to provide extra reserve capital, etc, since the safety net is the same. In fact, the riskier firms might be "safer" if they are forced to fold their tent early in a crisis before the "safety fund" (and the patience of taxpayers) is exhausted. "Go ugly early if you want to get your money back." Is this the best way to encourage responsible behavior?
b) Firms are responsible for their own stability. GS gets to say that "our clients are protected by a 32% capital reserve fund invested in US government bonds, the highest reserve ratio in the industry." So, other firms seek to match or exceed this in order to gain more clients (and sell at higher margins due to reduced risks).

Another example: When shopping for a bank, I look for a lot of things: good interest rates, good customer service, etc. I don't care at all about safety and security--as long as I stay under the FDIC limits, I don't care. And the banks don't make their safety a selling point--they just show the FDIC logo and consider the issue settled. This works okay for banks, but it is a terrible construct for firms engaged in complex and risky financial trading. I want their customers to care very deeply about the safety of the firms and their products, and I want the firms to compete based on their ability to inspire confidence in their customers. With claims certified as accurate by the Feds.

I'm tired of other folks making money while I assume their risk. When Chris Dodd is out of office, he can invest his own money to back up these financial firms, but I wish he'd leave me out of his good ideas. As I said, I don't expect we'll agree on this.

An interesting article: Washington Post: Let the Bankers Fail
In part:

Like one of those notorious exploding collateralized debt obligations, the American financial system is built as if to break down. The combination of socialized risk and privatized profit all but guarantees it. And when the inevitable happens? Congress and the regulators dream up yet more ways to try to outsmart the people who have made it their business in life not to be outsmarted. And so it is again in today's debate over financial reform. From the administration and from both sides of the congressional aisle come proposals to micromanage the business of lending, borrowing and market-making: new accounting rules (foolproof this time, they say), higher capital standards, more onerous taxes. If piling on new federal rules was the answer, we'd long ago have been in the promised land.
Until 1999, Goldman Sachs was a partnership, with the general partners bearing general and unlimited liability for the firm's debts. Today, Goldman -- like the vast majority of American financial institutions -- is a corporation. Its stockholders are liable only for what they invested, no more. And while there are plenty of sleepless nights, the constructive fear of financial oblivion is, for the senior executives, an all-too-distant nightmare.
The job before Congress is to bring the fear of God back to Wall Street. Not to stifle enterprise but quite the opposite: to restore real capitalism. By all means, let the bankers savor the sweets of their success. But let them, and their stockholders, pay dearly for their failures. Fair's fair.

 

[ziggy29]

Question: If the government was not commonly exempt from the laws it passes, would it be a violation under the proposed regulations for Social Security to put its money in Treasuries? I guess I'd be less cynical if government didn't exempt its own agencies from so many of the regulations it places on businesses and individuals.

 

[Independent]

Sam, you seem to be saying that:

1) It's impossible for gov't employess to understand what investment banks do well enough to set capital limits, or to wind them down in an orderly fashion when they fail; and

2) Gov't employees understand what investment banks do well enough to determine all the relevant information that investors need, and investors understand well enough to read the information and make well informed decisions.

I can imagine that one of those statements could be true, but I can't imagine how they could both be true.

 

[samclem]

Sam, you seem to be saying that:

1) It's impossible for gov't employess to understand what investment banks do well enough to set capital limits, or to wind them down in an orderly fashion when they fail; and

2) Gov't employees understand what investment banks do well enough to determine all the relevant information that investors need, and investors understand well enough to read the information and make well informed decisions.

I can imagine that one of those statements could be true, but I can't imagine how they could both be true.

If investors can define the information they need to evaluate the safety of a particular investment, then I'm confident the government can serve as the validator of that information (supplied by the banks/investment houses). Alternatively, the government could function only to administer punishment when the supplied information is fraudulent. (Meaningful punishment).

If investors can't identify the information they'd need to evaluate the safety of a particular investment, then they have no business making that investment.

Regarding the sophistication of the customers (investors). We already have the commercial banks that provide services for "regular" savers. We have the SIPC that monitors and regulates the promises security dealers can make to mom amd pop investors. Folks who actively seek out exotic, highly leveraged, or entirely opaque ways to invest their money either need to be qualified in some way (as is presently done for some investments) or at least advised that they've left the kiddie pool and are now in the ocean--with the sharks. "Warning: The government will make every effort to punish the 'bad' sharks, but that may be little consolation to you as you will likely not be reimbursed for your losses. There's really not much for you here, we recommend you go back to the kiddie pool. Sign this waiver if you want to stay in the ocean."

 

[Nords]

Folks who actively seek out exotic, highly leveraged, or entirely opaque ways to invest their money either need to be qualified in some way (as is presently done for some investments) or at least advised that they've left the kiddie pool and are now in the ocean--with the sharks.

"Accredited investors" get plenty of paperwork protection already. Just the voucher form is a couple pages of legalese intended to scare away anyone with any concerns whether the company they're investing in has aligned its interests with its investors. The other paperwork accompanying a "sophisticated investment" will either show that you know what you're doing (and know it's not worth filing lawsuits about it) or show that you're willing to sign away all your rights (and won't be able to file lawsuits about it).

One rumor is that [-]raising[/-] adjusting the $1M net worth limit for inflation would raise it to $2.3M and lock out about two-thirds of the entrepreneurs who become angel investors. (I'm not sure what's proposed about the other two parts of the accredited investors rule regarding annual income.) In other words the people most likely to support successive startups, and to understand the industry, would have to form their own groups (with additional layers of legalese and expenses) to be able to do what can now be done by signing a document and writing a check.

The compromise may be that the $1M limit stays but home equity can no longer be included in that total. Ironically one reason some Hawaii residents pursue angel investments is because they have too much of their net worth locked up in home equity and they're trying to tap into it...

I don't think angel investing needs any "reform" on either side. The process is already too viciously Darwinian to allow any miscreants to get away with anything for very long.

 

[Gone4Good]

I would say this:

What I didn't see in your answer is how you propose to prevent a future run on the financial system. Or maybe you don't think we should, which would be interesting to know too.

(BTW, the idea that "market discipline" can prevent financial runs and resulting depressions is empirically disproved by about 110 years of US financial history. As in . . .

The Panic of 1819
The Panic of 1837
The Panic of 1857
The Panic of 1873
The Panic of 1893
The Panic of 1907
The Great Depression

Incidentally, many of those prior panics were at the time called "The Great Depression" only to be renamed "Panics" when a more recent "Great Depression" took its place. Interestingly those panics and depressions stopped when we started "bailing out" short-term creditors (a.k.a. depositors) and heavily regulating financial institutions.)

 

[Gone4Good]

Question: If the government was not commonly exempt from the laws it passes, would it be a violation under the proposed regulations for Social Security to put its money in Treasuries? I guess I'd be less cynical if government didn't exempt its own agencies from so many of the regulations it places on businesses and individuals.

Are you referring to the "Volker rule"? I don't see how it would apply to SS. The rule prohibits companies with FDIC insured deposits from engaging in speculative trading for its own account. To my knowledge SS neither takes FDIC insured deposits nor does it trade securities for its own gain.

 

[Gone4Good]

Further BTW, regardless of their complexity Goldman Sachs and other shadow banking institutions are very much like deposit taking firms in that one of their primary businesses is the conversion of short-term savings into long-term investment (but instead of deposits the shadow banking system uses the Repo Market and other short-term funding sources). Effectively borrowing short and lending/investing/speculating long can be tremendously profitable, but is also tremendously risky. And is vulnerable to runs and panics . . . which is why it must be contained just like a deposit taking institutions (because it serves the same function in largely the same way). And to the extent the the "real" economy is dependent on the liquidity and financing that the shadow banking system provides, we can no more let the entire shadow banking system collapse than we can the entire normal banking system.

A rose by any other name . . . (should be handled the same).

 

[ChrisC]

I would say this:

I would also say there's a lot of misinformation in your post as well. Goldman Sachs is now a bank holding company and has insured depository institutions within its affiliated network. As a bank holding company, GS is now subject to regulatory oversight of the FED. GS is really no different from JP Chase Morgan Holding Comapny) -- only the size of its deposit base is quite different from JP. Also, the FDIC does not regulate deposits, require reserves, or restrict investments -- this is generally the primary function of the primary bank regulator (Federal or State), though the FDIC does have certain "back-up powers." There's more misinformation, but I give up.

 

[Independent]

If investors can define the information they need to evaluate the safety of a particular investment, then I'm confident the government can serve as the validator of that information (supplied by the banks/investment houses). Alternatively, the government could function only to administer punishment when the supplied information is fraudulent. (Meaningful punishment).

If investors can't identify the information they'd need to evaluate the safety of a particular investment, then they have no business making that investment.

Regarding the sophistication of the customers (investors). We already have the commercial banks that provide services for "regular" savers. We have the SIPC that monitors and regulates the promises security dealers can make to mom amd pop investors. Folks who actively seek out exotic, highly leveraged, or entirely opaque ways to invest their money either need to be qualified in some way (as is presently done for some investments) or at least advised that they've left the kiddie pool and are now in the ocean--with the sharks. "Warning: The government will make every effort to punish the 'bad' sharks, but that may be little consolation to you as you will likely not be reimbursed for your losses. There's really not much for you here, we recommend you go back to the kiddie pool. Sign this waiver if you want to stay in the ocean."

Okay, I can see that I implicitly bought into the assumption that the only people hurt when a financial institution goes down are the people who loaned money to that institution. If that were true, your solution probably works.

The problem seems to be that when the institutions fail, lots of people besides the lenders get hurt. So the rest of us have a reason to want more safety than the investors.

 

[IndependentlyPoor]

Here is another Krugman article to chew on.
Our Giant Banking Crisis—What to Expect | The New York Review of Books

 

[samclem]

Given that we've already created this safety net for commercial banks (which puts the taxpayers on the hook for making depositors whole), it's obvious that we should make the line between these institutions and investment banking very clear. This includes a division of operations/interests to assure that government gaurantees in the commercial banking side are not, in fact, backing up investors in the investment banking side.

Preventing market panics: Well, we can start by not creating the situations that cause bubbles and ensuing panics. Government policies created the last one (the Fed's easy money policy starting in 2002, the recognized role of Fannie Mae and Freddie Mac in causing/accelerating the housing bubble, the CRA which encouraged loans to ill-suited borrowers, etc). And, yes, private money was to blame--especially to the extent it responded to these government actions. Many have written, with some evidence, that a stock market correction was turned into the Great Depression by government actions (especially higher tax rates and prevention of wage adjustments that would have reduced unemployment and led to higher production). Aside from avoiding making the matter worse, governments can take positive steps to turn "market panics" into more orderly events that still allow market forces to work. "Circuit breakers" to slow trading, prohibitions against naked short selling, margin limits, etc are all, admittedly, government restrictions on free trade, but less intrusive and harmful than government bailouts and promises to pass buckets of money to people who made poor decisions.

When firms fail, let them fail. And people who invested poorly should not be made whole with money taken from Americans. When government swoops in to "help" with our money, they prevent others from solving the problems with their own money--and maybe making a profit. Hey, that vulture getting the bargains might be working to benefit you! Warren Buffet makes a lot of money this way.

 

[chinaco]

Bottom line - The fox [-]Financial Services Industry[/-] is guarding the hen house.

There is not a great solution.

IMO - Some independent regulation is needed. If it is not there... those larger entities will take advantage of the rest of us and cause bubbles and economic calamity. Since the bulk of the money is now our IRAs and 401ks (widely distributed and fragmented... i.e., little power), we are susceptible to their malfeasance (and often the target of the money grab either directly or indirectly).

Lesser of two evils.

Unfortunately, some politician can paint what appears to be a compelling lopsided story (partial picture). But one thing cannot go unnoticed... look at what has happened over the last 10 years... several massive bubbles and meltdown. Status Quo will only leave us vulnerable to more of it.

Unfortunately, wall street thinks they are above the rest of us and entitled to game the market. If it is not absolutely illegal... darn near anything goes (for some of them).

Yes--- they are brazen enough to take advantage of weak regulations, regardless of the consequences. Individuals in those companies seem to always walk away filthy rich after the dust settles!

 

[Westernskies]

Are you referring to the "Volker rule"? I don't see how it would apply to SS. The rule prohibits companies with FDIC insured deposits from engaging in speculative trading for its own account. To my knowledge SS neither takes FDIC insured deposits nor does it trade securities for its own gain.

Now, if we could just impose this same criteria on investment of public pension funds...

 

[Gone4Good]

Preventing market panics: Well, we can start by not creating the situations that cause bubbles and ensuing panics. Government policies created the last one (the Fed's easy money policy starting in 2002, the recognized role of Fannie Mae and Freddie Mac in causing/accelerating the housing bubble, the CRA which encouraged loans to ill-suited borrowers, etc)

Neither Fannie nor Freddie nor the CRA existed in the 1930s. None of them or the Fed existed in the 1800's. None of these things existed in other areas of the globe that also experienced recent financial collapse. Financial panics can not be so easily explained away by the things you site. Neither can 80 years of relative financial stability. Yours is an ideological answer grafted on to a fact pattern which simply doesn't fit.

The answer seems pretty simple to anyone willing to look at our economic history. We have a system that worked well for 80 years. It simply needs to be extended to incorporate the recent evolution of modern finance.

 

[Gone4Good]

Now, if we could just impose this same criteria on investment of public pension funds...

Also not deposit taking institutions. And to my knowledge not exempted from any planned regulation. So maybe you could elaborate.

 

[chinaco]

If the average American can get past their political biases... I do not believe too many can honestly say "no change is needed".

Human nature is what it is... give enough people the chance to take, and some will do it, not matter how it impacts others! Unfortunately some of the approaches are legal.