Wednesday, April 21, 2010

Agriculture committee measure for the Financial Reform Bill is MISGUIDED

As reported by Bloomberg News, "today the Senate Agriculture Committee approved a measure that would require U.S. lenders such as JPMorgan Chase and Bank of America to spin off their swaps trading desks." This would impact Citicorp, Wells Fargo, and other large institutions as well.

Anyone who has read commentary on this blog over the last year and a half knows the strong opinion here that naked credit default swaps should be banned and the entire CDS market regulated. They would know the opinion here that CDO's serve no economic purpose and endanger the financial system. What the Agriculture Committee measure would do has no resemblance to anything supported here. This comment focuses on what may be one small, in print space, part of the new derivatives regulation rules, and much of what they passed may be constructive. This one aspect is not, and here's why.

The great majority of the swaps market --- interest rate derivatives, foreign exchange derivatives, and commodity derivatives --- serve a valuable and legitimate purpose in providing economic hedges to support lending, trade, and financial planning in many industries. They represent the great majority, and great as a modifier is too weak, of swaps transactions and have played no significant role in our financial crisis. To remove this function from the leading lending institutions in this country will likely:
---significantly reduce corporate lending by these major banks as corporate lending as stand-alone business is not a business that meets hurdle rates for return on equity because of the capital required to back up the balance sheet positions.
---disadvantage the major U.S. banks against all major foreign banks such that major U.S. firms will be beholden to Swiss, German, Japanese, and other major foreign banks for their capital funding.
---immensely benefit the pure investment banks that were fundamental to the crisis like Goldman and Morgan Stanley. If they had survived, Bear Stearns and Lehman would be happy as clowns, and Merrill, if not owned by Bank of America, would be salivating as well. Recent small new entrants like MF Holdings, run and primarily owned by two Goldman alumni, could have astounding growth.
---impact a basic tenet of business growth for this country as capital formation is choked off due to the leading major banks losing their tools for doing business safely and managing their profitability by doing fundamental hedging for both their own businesses and those of their clients. Community banks and small regional banks are fine and deserve the room to grow, but they cannot remotely match up with the needs of U.S. multinational companies that account for the majority of export growth and are important to the food chain of small business suppliers that create domestic jobs.
---spinning off swaps desks of these major banks will almost immediately impact the new spin offs business drastically. On a stand alone basis, these "swap desks" will not benefit from the capital base of the commercial, regional, and retail businesses of their former parent. Their access to counterparty lines necessary for liquid trading will plummet, their best personnel will head for hills, and as independent entities they will become boutiques if they survive at all. Goldman, Morgan Stanley, Deutsche, Paribas, and others will benefit in a huge way. Is this the intention or, as the tea party activist in my hometown said when he almost had the area congressman's family killed, just "collateral damage".

MISGUIDED is not the right word. This aspect of the measure is just plain stupid. It shows no understanding of today's banking business. It shows a view of banking as it existed in the early 1980's when the old Wall Street reaped all of the benefits of finance and the then clueless commerical banks took all of the risk. It shows a vindictiveness spawned by the Congressional Democrats that prefers ignorance and a political win to constructive legislation.

Is this just a way to get back at Jamie Dimon who has been arrogantly untouchable because of his success in running JPM throughout the crisis, at the same time giving the departed Ken Lewis one last stab in back because he dared challenge the Fed and Treasury over their role in the BofA acquisition of Merrill Lynch, and satisfy the FDIC and Sheila Barr's transparent hatred of Vikram Pandit. Politics is personal and power can be abusive. This paragraph is a bit hysterical but how else can this apparent part of the financial reform bill be explained other than with an extreme explanation.

This an incredibly bad proposal and I hope that "proposal" is an operative word and this measure can be significantly moderated. As it stands what was approved today is so bad that it's almost impossible to believe.

If my position on this is somehow not clear, please add a comment.


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