Archive for the ‘Financial Reform’ Category

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The Roman army responded to desertion by randomly executing a tenth of those soldiers remaining. They called it decimation, derived from the Latin word for “tenth.” This discipline, of course, prompted all soldiers to police against desertion so as to save their own skins.

New York Federal Reserve Bank President William Dudley seems to have borrowed a piece of this incentive structure for a current financial situation. In a speech on October 20, this key regulator of the nation’s largest banks proposed that a major chunk of pay for all senior executives at a particular bank be forfeited when the bank violates the law.

Specifically, Dudley proposes that part of senior bankers’ pay be sequestered in a “performance bond.” If the bank must pay a large fine, this bond is forfeited and paid as part of the fine. “This would increase the financial incentive of those individuals who are best placed to identify bad activities at an early stage, or prevent them from occurring in the first place.”

Making bankers pay for fraud may stifle a replay of one of the glaring judicial miscarriages following the response to the financial crisis of 2008. Despite the massive frauds subsequently documented by the Department of Justice, no senior executives faced penalties. The billion-dollar fines meted out by the DOJ were, in fact, borne by shareholders innocent of any conspiracy.

Prosecutors have offered varying reasons for this indefensible result, including the recent excuse offered by James Cole, who just retired as deputy attorney general at the DOJ: the fraudsters were “rocket scientists” who simply outsmarted the prosecutors. Under the Dudley scheme, even if the DOJ failed to track down some of the guilty individuals, all the senior bankers at a firm would nevertheless suffer at least some financial pain.

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The bank gambling trade association and its regulators are giving each other high-fives over an agreement that supposedly makes it easier to bail out a failed mega-bank. Progress? If viewed from the vantage of an average taxpayer who finances bank bailouts, the progress is miniscule. And the circumstances that put this agreement barely into the “progress” column beg for far more ambitious reform.

Specifically, 18 of the largest global banks just agreed to wait about a day when one of them fails before pocketing the winnings from bets made with each other. Exactly how long the waiting period will be isn’t clear. These bets are called swaps. The agreement about how bets are settled is governed by a master contract of the International Swaps and Derivatives Association (ISDA), which is the industry trade association.

Originally conceived as hedges (the way farmers lock in a price for commodities such as corn that hasn’t yet been grown, harvested and sold) swaps have now been perverted into a $700 trillion racket largely patronized by banks. This high-stakes game primarily plays out in what’s called the over-the-counter (OTC) market. Ninety percent of the OTC bets are between banks themselves. In fact, four banks account for most of the bets in the US banking industry. Real economy companies such as airlines or car manufacturers account for only about 10 percent of the OTC casino. Even mega-bank Wells Fargo, currently the most valuable bank on the US stock market, doesn’t gamble nearly at the scale of its peers JPMorgan Chase, Citigroup and Bank of America.

In other words, if swaps are so useful to the economy, why doesn’t Main Street account for most of them? And how can Wells Fargo be so successful a bank without a swaps portfolio that matches Citi’s?

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If punishment is meant to deter crime, then perhaps the reason Wall Street seems undeterred from committing crimes is the fact that it doesn’t face punishment.

Earlier this year, Credit Suisse pleaded guilty to a decades-long scheme to help Americans escape income taxes; but it has been a pain-free guilty plea. In fact, the government fine was borne by shareholders innocent of the conspiracy. When Attorney General Eric Holder announced the guilty plea, he stated that the business of the bank itself wouldn’t be interrupted and it could “move forward.” And the Department of Labor (DOL) recently proposed to exempt Credit Suisse from an otherwise mandatory penalty involving the firm’s pension fund management business.

The DOL oversees pension fund managers through a law approved in 1974 as a result of notorious swindles. Generally, the law requires fund managers to avoid complex, risky investments, and it provides that such investments only be offered if the manager is sophisticated and squeaky clean. A criminal record anywhere at the fund manager’s firm means those risky investment strategies must be examined with greater care. That requires more effort by Credit Suisse — a little pain. And that’s appropriate. Crimes are supposed to be punished. Yet the DOL proposes to let Credit Suisse retain its status as trustworthy for complex, high risk investments.

Before the DOL excuses Credit Suisse from this mandatory penalty, it asks for public comment. Public Citizen has written the DOL outlining our objections, and we call for a hearing. “Pension fund beneficiaries are especially vulnerable to Wall Street abuse because their savings may be managed by firms they do not even choose, let alone control.” Three members of Congress also call for a hearing: California’s Rep. Maxine Waters, the ranking Democrat on the House financial services committee, California’s George Miller, ranking Democrat on the House education and workforce committee, and Rep. Stephen Lynch (D-Mass). “The American public has grown increasingly frustrated about the lack of accountability in our financial system.” They pointed out that “regulators are not using the full arsenal of tools available to them to protect the public.” In fact, every commenter urged the DOL to enforce the law, and not grant Credit Suisse an exemption, with one exception: Credit Suisse. The Credit Suisse letter actually asks for even greater latitude in pension management. In the face of this comment record, bolstered by letters from senior members of Congress from committees responsible for banking and pension fund oversight, it will be a miscarriage of the regulatory process if the DOL grants Credit Suisse a pass from this penalty without a hearing. Unfortunately, the DOL habitually grants such exemptions – 23 straight times in previous cases. We hope the comment record changes this streak.

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Nobody openly supports unequal justice.

When Attorney General Eric Holder confided to Congress that some banks were too “large” to prosecute because it might cause systemic tremors, he was appropriately pilloried for declaring a “too big to jail” policy.

A recent disquieting episode sheds light on some of the interactions between government regulators and the banks they oversee. This episode refines our understanding of regulatory capture (at least at one bank). The “Carmen Segarra” incident shows us more about how the regulators think, how they approach errant bankers, and how far the regulators may be from adopting the obvious solution of breaking up these too-big-to-jail banks.

Spoiler alert: they are far.

Carmen Segarra spent seven months beginning in October 2011 as a senior bank examiner at the New York Federal Reserve Bank. The New York Fed is one of the front-line supervisors of the big Wall Street banks. It counts among of the regulators that the Justice Department might consult before prosecutors decide whether to seek full penalties, or to pull a punch if advised that a criminal conviction of a bank could endanger the economy,

Segarra took this job after positions at Citigroup, Societe General and MBNA, and after schooling herself at Harvard, Columbia and Cornell. The NY Fed assigned her to help oversee Goldman Sachs. While there, she uncovered serious problems. In a chain of events, when she brought these problems to her supervisors, they fired her.

In 2013, Segarra sued the New York Fed and several of her supervisors. She outlined episodes where her bosses blocked her efforts to ask tough questions or promote better policies at Goldman Sachs. For example, Goldman worked for El Paso Corp as an advisor as it bid for Kinder Morgan, Inc. Advisors help buyers secure the lowest price and best conditions. But Goldman also owned some $3 billion worth of Kinder, and a Goldman banker held a sizeable personal stake in Kinder. Sellers want the highest price when they sell. Segarra questioned Goldman’s conflict-of-interest policy. But her bosses demanded that she tone down her memorandum on the issue.

Her allegations from 2013 received some public attention at the time. Regulatory capture — where crooks control the cops — is a festering problem in bank supervision.

This September, Segarra went a step further when she released audio tapesThe very Goldman and New York Fed staff described in her lawsuit can be heard saying what she alleges. The “tone it down” conversation with her boss allows the listener to verify her charge. You are there. As Michael Lewis observed, these tapes could become the “Ray Rice moment” for bank regulators. (Rice is a Baltimore Raven football player guilty of domestic violence. That episode had been known for months, but when the tape was released, the NFL increased its sanctions on the player.)

The Segarra audio tapes emphasize the servility of regulators. In one exchange, Segarra’s boss’ boss — Michael Silva — raises a glaring problem with a Goldman executive with the indirection and timidity of a mail room clerk searching for a delicate way to tell the CEO he’d spilled coffee on his shirt. (Silva now works for GE Capital, another example of the revolving door problem behind regulatory capture.) Pulitzer winner Jake Bernstein of ProPublica shepherded Segarra’s tapes, of which there are 46 hours, into the public domain. As he summarizes, the tapes demonstrate the extraordinary deference of the regulators to the banks. (Of note, it is legal under New York and federal law to make tapes.)

It may be unrealistic to expect Hollywood histrionics from our bank regulators, but the Segarra tapes reveal that some senior bank regulators can’t even utter a clear criticism to a banker.

If Segarra was told to tone down her criticisms, if her bosses won’t confront bankers, if these same regulators leave government to work for mega-banks, we might realistically expect them to tell prosecutors in a timid way that a serious criminal charge is unwise for the financial system.

How can regulatory capture be addressed? Legislating spine may difficult.

One step would be greater transparency. Presumably, officials at the New York Fed are thinking more seriously about their capture problem following Segarra’s lawsuit and the release of the audio tapes. If these regulators knew in advance that discussions would be made public, particularly in the case where they consult with the Justice Department about a pending prosecution, they might be less beholden to the mega-banks. Transparency might serve as a prophylactic against capture. Public Citizen believes that criminal cases with too-big-to-jail banks deserve this kind of transparency.

Congress should hold hearings on the Segarra case. Helpfully, several leading members have called for hearings, including Sens. Elizabeth Warren (D-Mass), Sherrod Brown (D-Ohio), and Reps. Maxine Waters (D-Calif.), Keith Ellison (D-Minn), Al Green (D-Texas). If and when they do, Public Citizen believes that solutions including transparency should be accorded a full discussion.

Bartlett Naylor is the financial policy advocate for Public Citizen’s Congress Watch division.

Join Sen. Elizabeth Warren (D-Mass.) and other lawmakers in calling for hearings to hold the New York Fed accountable for its disgraceful deference to Goldman Sachs and its firing of Carmen Segarra.

Co-authored with Craig Holman

In addition to blowing up the world economy occasionally, Wall Street sometimes sets local fires as well. Consider Jefferson County, Alabama. Here, JP Morgan arranged finance deals to fix its sewer system that proved so expensive to the county that it declared bankruptcy. Bribery of public officials played a role, resulting in the conviction of 21 individuals. Another example is Detroit, where onorous deals with Wall Street are part of its bankruptcy story. The Detroit mayor was convicted of a major scheme of bribery and kickbacks leading up to these dire straits. The common factor in these tales is corruption and subsequent financial hardship. Private firms hoping to profit from municipal deals pay public officials — through bribes or campaign contributions — to choose their firm even when the firm’s profits come at unnecessary and even crippling taxpayer expense.

In good news, the Municipal Securities Rulemaking Board (MSRB) is writing a rule that strengthens its anti-corruption policies. Already, under Rule G-37, Wall Street firms that sell municipal securities generally can’t make contributions to elected officials who have the power to select specific municipal securities dealers. These are the bonds that fund sewers, schools and streets, and must be repaid by taxpayers. The new rule will apply these same contribution restrictions to muncipal securities advisors. These are the consultants who advise a municipal government on which dealers to use, or how to structure finance.

The new rule isn’t perfect. One loophole is that if a firm has two divisions, one providing municipal securities sales, and one providing municipal funding advice, each can make political contributions to the portion of the government that doesn’t oversee its work. The advisors could contribute to a public official who only has control over the selection of the municipal securities dealing. And the advisor department could only make contributions to an official with power over selecting the municipal dealer. This is a problem.

Another issue is that the small municipal securities business might be part of a larger company. And that larger company can make political contributions to any of the officials. This is also a problem. Case in point, a filing by JP Morgan Securities on the MSRB website shows that the firm peformed underwriting services for the Delaware River Authority in 2013. In answer to the question about whether it made political contributions to any municipal finance official related to this service, JP Morgan Services reports “none.” At the same time, the JP Morgan PAC filing at the Federal Election Commission (FEC) shows a contribution to State Treasurer Chipman Flowers in 2013. Further research shows that JP Morgan officials helped Flowers with his campaign.

Why do the rules permit this? Because the MSRB provides that if contributions aren’t “controlled” by the municipal securities division of JP Morgan, that doesn’t pose a quid pro quo danger. Presumably, the JP Morgan PAC feels justified in making the contributions because the firm determines that the PAC contributions are not “controlled” by its securities affiliate, JP Morgan Securities. But that’s a problem for two reasons. First, its not obvious who makes the decisions at the JP Morgan PAC. The Federal Elections Commission, which regulates PACs, doesn’t require any information about who makes decisions. Second, even if the folks at JP Morgan Securities don’t communicate with the parent company PAC, they wouldn’t need to. The PAC folks know their firm provides prodigeous municipal finance services, and making contributions could help win business.

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