Repealing Dodd-Frank

Donald Trump wants the big banks to take the kind of risk that caused the housing crisis. I started working in the hedge fund industry as an accountant in 2008. I saw their books, including some held at Lehman Brothers. It was mostly a bunch of write-offs and unwinds and legal payments.

I am fully aware of the personality of these people. They intend to work on Wall Street for only 2 years and then move to a private equity firm, which means that they most likely won’t be around when their actions start to cause major damage years later. Most of them are gamblers, unscrupulous, rude to their clients, and generally seem like they don’t care about anyone but themselves. I’ve seen it, lived it, and got the hell out of it.

The housing crisis was the best evidence that this way of thinking is dangerous when this type of person is managing your money. The excess risk, the short time horizon, the carelessness about client goals, and the lack of a backup plan in case they fail is what caused the financial crisis that many people are still feeling. Many people who had planned to retire at 65 are still working, and many people have just as much or less than they had before 2008.

Dodd-Frank was passed to prevent all the pain caused by these people. Moreover, they endeavored to rein in their behavior. They wanted to stop all the risk-taking. They wanted to make sure that commercial banks couldn’t speculate with depositor money such that the money wouldn’t be available if you went to the ATM. They created a bunch of oversight and even a new agency, the CFPB. They also gave the SEC and the CFTC the “authority to regulate “over-the-counter” derivatives trading.” They even increased capital requirements so that banks couldn’t gamble away the last dollar in the vault.

I can’t say whether another crisis would happen again, and very few people could predict that, but these protections make sure that we minimize the damage to the general public.

In case you’re wondering whether it might happen again, check Bloomberg, and you’ll see that the default rate on bonds backed by car loans is getting close to critical levels. Currently, Dodd-Frank is there is protect against the damage, but Trump wants to remove that protection.

If you saw The Big Short, you know how this would play out, but in case you didn’t, here’s how it goes: a commercial bank gives a loan to someone at a really low rate because, to the bank, it’s an asset they can sell to a much larger investment bank who will purchase the loan for pennies on the dollar. The commercial banks will give these loans to anyone because they know they’ll get paid right away. However, when the default rate gets so high that even the large investment banks can’t cover their risk, they end up losing the money. So, they can’t invest in new businesses, companies backed by investment banks have to lay off workers, and this ripple effect keeps going. It doesn’t matter if it’s homes, cars, healthcare receivables, or anything else.

What does matter is that Donald Trump wants to minimize the protections you’d have if the banks screwed up one of their formulas and took too much risk and didn’t have any money left to cover their margins. Trump is in favor of letting banks do it again!

So let’s take this new bill called the Financial CHOICE Act one provision at a time as it rolls back Dodd-Frank and see the effects. It’s passed the House and is now waiting for a Senate vote, and then Trump would sign it.

Rolling Back Regulations on Community Banks

For a long time now, Republicans have been saying that community banks are overburdened by compliance regulations that require them to hire compliance officers and that the extra payroll cost is making them unprofitable. They also say that these banks are merging with each other so they can afford these extra costs. They go on to say that these larger banks then aren’t able to get to know their local communities and understand the unique concerns of their clients. They say 75% of agricultural loans comes from these small banks and that small-business loans often come from them, as well, and that large banks wouldn’t want to lend to a small business or a family farm because they don’t want to take the risk with such a small client. They say expensive regulations cause these mergers that lead to large banks that don’t pay attention to community needs.

Consumer Financial Protection Bureau

The Choice Act is also intent on changing the definition, operation, and oversight of the Consumer Financial Protection Bureau. They want to make the Director of the CFPB an at-will employee. They want Trump to be able to fire Director Cordray whenever he wants, without giving a reason.

Republicans also want this agency to be subject to the Congressional appropriations process, which means Congress decides whether to fund or defund the agency, giving it whatever amount of money they want to give it.

Additionally, they want to turn this agency into a “consumer law enforcement agency” but “limit the agency’s authority to action against entities for abusive practices.” Those quotes are taken straight from Congress.gov.

Federal Housing Finance Agency

The FHFA is the agency that took Fannie Mae and Freddie Mac into conservatorship when they weren’t solvent. They couldn’t provide stability to the mortgage market after the collapse. Therefore, the FHFA took control of their operations and assets until they could function on their own.

Fannie Mae and Freddie Mac offer to purchase mortgages from banks to make those banks less hesitant to lend to people that might otherwise be considered too risky for them. It’s similar to a being a guarantor on a bank loan. Instead of offering to make the loan payments if a customer defaults, Fannie Mae and Freddie Mac regularly purchase mortgages before a customer defaults in order to make banks more comfortable lending to people and keep the economy going. With Fannie Mae and Freddie Mac taking the hit instead of the bank, the banks felt more comfortable, and Fannie Mae and Freddie Mac were more comfortable taking the hit because they were backed by the U.S. Treasury Department.

When they could no longer do that even with the support of the Treasury, the FHFA took control of their operations and tried to work it all out so that the mortgage market didn’t totally shut down.

Republicans want to give Trump the ability to fire the Director of the FHFA without cause. Additionally, they want to subject the FHFA to the Senate and House Appropriations Committees, which are run by Republicans, which means FHFA might be defunded just CFPB might be.

FDIC

Republicans want to get rid of the Orderly Liquidation Authority, which requires that banks create a living will that explains how they would “safely be unwound in the event of a collapse.” This reduces the requirement to bail them out because they would essentially be explaining in advance how they could handle their affairs themselves without assistance from the government. According to former Fed Chairman Ben Bernanke, this contains the damage to within the private sector and doesn’t let it spread to the taxpayers.

Additionally, the FDIC is allowed to take these banks into receivership to help them work through any complications that may occur when they are executing their living will during a crisis.

Republicans want to remove all of the above.

Volcker Rule

The Volcker Rule was created by Dodd-Frank to prevent investment banks from taking more than certain about speculation with their own funds. Investment banks had previously been allowed to gamble away all their money, even though they’re already required to provide liquidity to secondary financial markets by taking the other side of any position. In other words, if someone wants to buy, they have to sell, and vice-versa. They can’t do this if they run out of money.

More importantly, these banks provide credit to businesses and individuals. If they don’t have the money to do that or if they have less money than before, then they won’t issue as many loans, which means businesses can’t grow and the economy starts to decline rather rapidly like it did in the financial crisis. Banks aren’t allowed to use their own money to invest in securitized assets or derivatives. That means they can’t invest in something that depends on something else. In other words, you can’t invest in securitized assets that depend on someone paying their car loan or mortgage, and you can’t use your own funds to purchase derivatives simply for short-term gain because they could be wrong.

Limits on Credit/Debit Fees

This bill also wants to remove the limits on how much credit card companies can charge merchants for accepting debit card transactions on credit card machines. Since a debit card is basically cash, it’s best to have limits on how much the merchant can charge. Otherwise, merchants would have to charge more for products purchased with a debit card so that they can make their profit. Alternatively, some merchants would stop accepting debit cards, as some already don’t accept credit cards.

Statistically, most merchants were already charging the same price for goods and services paid with a debit card and very few were complaining about debit card fees. After the Durbin Amendment was passed to limit interchange fees on debit card transactions, banks fought back and started charging people that have checking accounts and charging really high prices for new checks.

“Too Big To Fail”

This bill also removes the Financial Stability Oversight Council’s authority call certain institutions “too big to fail.” However, this only includes “non-bank financial institutions and financial market utilities.”

Republicans are saying they want to allow banks to fail, claiming that would prevent reckless behavior because they know they can’t be bailed out, and opponents say that the banks would never be able to work through bankruptcy proceedings quickly enough to not dry up the credit markets, leading to another economic downturn.

So what are the effects of all of this?

Basically, we’re putting the nation at risk again. Quite literally, we’re allowing more risk, which then puts the nation at more risk. Since those that provide liquidity to the financial markets would start to invest that liquidity in riskier and riskier investments as if they don’t have a role to play in the broader community, the risk to that community, indeed the country and many other countries, as well, grows and grows until the pinpoint accuracy of their hedges misses a step and we fall like a Jenga tower once again.

Here’s a little more detail about each point I made above.

Community banks will benefit from deregulation. The cost of compliance is overwhelming, and larger banks do not care as much about small depositors as do smaller banks, especially when it comes to small-business loans and loans to family farms. However, the banks that will benefit the most are the large banks. Their actions matter than that of community banks because they make up the bulk of the financial activity that runs the economy. Their risky behavior can’t be offset by community banks behaving more appropriately. Plus, the personality of the typical investor gets more and more aggressive and insatiable as their funds grow, making a community bank manager endlessly focused on growth, no matter the risk. Therefore, the community bank manager doesn’t lack the risk-taking behavior. He or she just lacks the funds to make the trades the large banks make. Therefore, they’ll likely try to work their way up and take risky behavior with their depositors’ money, as well.

As far as mergers being necessary to stay afloat, well, yes, they are right on the money (pardon the pun) on that one. However, getting larger and caring less about small depositors now that you’re larger is a character flaw of the bank manager. You can’t get rid of that by making the banks smaller.

It would’ve been better if someone focused on building technology that brings small banks into compliance without having to hire compliance officers. By now, the efficiencies of that technology would be high. The distribution would be high to the point of possibly high barriers to entry. There would be a set group of companies produces the compliance technology, and given barriers to entry and the law of supply and demand, prices for versions for this technology would have stabilized by now. However, money was spent on employees and lobbying so we’re stuck now with tons of money spent on allowing risky behavior that will likely hurt the economy again. Check out the spike in auto loan defaults. There have been record student loan defaults, too, and there are plenty of bonds backed by the assumption that those will be paid. Yet Trump wants to allow them to syndicate more securitized loans and remove oversight, which makes me conclude that we won’t know what happened until it happens and that we won’t be able to untangle the mess to figure out who’s fault it was.

I want to focus on the FHFA for just one paragraph. I applied to work there and did a lot of research on it, and in addition, having worked in the hedge fund industry for nearly four years from 2008 to 2012, precisely when all this went down, I have seen a real lot of what happened during the mortgage crisis. However, what’s the effect of being able to defund or even fire the Director of the FHFA and take away their role as conservator? Nothing. This issues with risky, syndicated, securitized, unchecked and unreserved, apathetically motivated credit derivatives is not about housing anymore. It’s about student loans and car loans and, coming soon in my prediction, service receivables. Therefore, the role of Treasury in funding FHFA to manage the operations of Fannie Mae and Freddie Mac and provide liquidity to the mortgage market is quite minimal and probably totally unnecessary. Republicans are violating the spirit of FHFA’s role, but the effect on you and me will be quite minimal. If there were a more generalized agency role of providing liquidity to any credit market that now includes securitization, then defunding that would be a monstrosity.

Getting rid of the OLA and FDIC oversight and FDIC assistance in reorganizing banks that have gambled away their liquidity will have the effect of letting them figure it out for themselves. They try to claim that they can do that in a weekend while the markets are closed and no one will get hurt. However, they couldn’t do that before Dodd-Frank created regulations that require them to show how they would do that, and I doubt that their living will has done more than follow the letter of the law and will not be following in implementation when a crisis occurs. With no FDIC oversight, a simple personality observation will tell you that they are going to throw that living will in the garbage. They’ll end up being “too big to fail” once again. If we can get a majority of Democrats in the House and Senate, then we may be able to get regulators to come into these banks and guide their reorganization so that the damage is limited to the private sector and not the taxpayers, but that’s where you come in, getting as many Democrats in office as possible.

Removing the Volcker Rule is also a major problem. The effect is obvious. Allowing proprietary trading will remove the liquidity set aside to make markets and provide stability to the financial markets and credit markets when something goes wrong, a miscalculation or an unforeseen economic event like a spike in defaults. Removing the Volcker Rule allows banks to ignore their responsibility to provide liquidity, which was enumerated as a requirement embedded in the powers given to them by the Federal Reserve decades ago. Therefore, they are claiming that they are not required to care about anyone else in this country and many other countries. True, they are not required, and I’m not sure apathy or a lack of humility should be punished, but I’ve tasted the toxicity of these places, and I know what will happen. They simply do not care about anyone but themselves. That’s the long and short of it all.

Allowing banks to raise the interchange fees on debit card transactions will likely not do much. It could provide relief for checking account holders. This may be a good one. The fee economy, as I call it, has allowed anyone to avoid laws by calling a charge a fee or a penalty. In China, there are monetary penalties for being late to work that push net pay way below a living wage. I should know. My contract there stated a maximum of 20% of my monthly salary for being 20 minutes late to work one day that month, including no pay for that entire day. We don’t do that here, but there’s a trend to charge fees when the company wants more money because you can always call something a fee and not break any laws. With banks, however, interest rates are so low that they actually need to charge you fees otherwise they will immediately take a loss just by having your money. So, while that is unfortunately, the most vulnerable people are hurt by checking account fees and overdraft fees and other fees on the most basic of banking operations. Charging people who can actually afford to buy something is better than charging someone who is still trying to save enough to be able to buy something someday.

So, what can we do about this?

You need to start saving money. Ironically, I don’t think you need to worry about getting loans you can afford because, even if we all doing this, we’re limiting our potential now and not doing anything to stop the coming financial crisis that will hurt us much more. If have some money, you might want to establish some short positions. That will prove very lucrative, and the downsize is a few pennies compared to the upside. The way to do that is buy out-of-the-money index puts for roughly $0.10 per underlying index, preferably an index that tracks the whole credit market, and when the credit market fails, the $0.10 value would probably spike to at least $2.00. If you invest $100, you’ll get 1,000 put shares, which will become $20,000. Don’t expect to get paid right away though because the markets will be disorganized and payment processing may be halted until market regulators know what’s going on and, unfortunately, until big players get paid first.

My prediction is not that there is an unstoppable or imminent threat to our financial system, just that certain signs that are popping up again are in their infancy and that politicians are doing nothing to stop their growth into a potentially full-grown disaster that, while far less dangerous than the housing crisis, will hurt just as bad, especially because most of us are already worse off and with less foreseeable upside in our lives than we were before the last crisis. So, whether it happens and it’s small or whether it happens but not for another 10 years, it seems likely that Republicans and Wall Street are encouraging the likelihood of it happening to approach certainty in our lifetimes. If Wall Street doesn’t change their ways, the interval between the Great Recession and the Great Depression will be far longer than the Great Recession and whatever they decide to call the next one.

On the political front, we need to get as many Democrats in office. We’re not going to have a housing crisis and any possible crisis going forward will be less than that, and an additional benefit is that it will likely not occur for a couple years, though perhaps within two. Therefore, it won’t happen during the current session of Congress. There’s plenty of time to Democrats in office, and as I’ve said before, we have the power to do that.

The last thing to remember, and this is crucial, is that in addition to safeguarding your financial future, take care of each other. One of the most common things I saw during the last crisis was non-profit organizations merging in order to cover costs like rent and office supplies. They also had employees who were willing to stay on and work longer hours. While they’re all trying to make a name for themselves and care about their causes, they found ways to work together, even though NGO is the last type of organization that you can think of that would be focused on cost.

Since I believe the issue will stem from car loan defaults, give your neighbors a ride to work if they can’t get a car loan if the credit markets dry up. If you know someone who’s never taken the bus to work, teach them the route, how often the bus is on time (or not), whether you need exact change and whether it’s just quarters or dimes are accepted, and so on. In short, take care of each other.

If you read my previous post about the Opioid Epidemic, then you know my advice on what can happen when people get hurt or upset. While I don’t believe economic hardship by itself leads to drug use, it is statistically more likely. Whether it’s drug use, crime against another person, harming yourself in any manner, or exhibiting any other negative behavior that isn’t good for you or someone else, I strongly encourage you to focus on what you do have so that you don’t succumb to temptations that could harm you, land you in jail, or hurt someone else.

The world is a scary place when the people in power don’t care about you, but your neighbors are right nextdoor, which means they have far more power to help or hurt you than someone on Wall Street or here in D.C. There are neighborhood watch organizations in some communities, and you should consider forming neighborhood assistance organizations, as well, so you’re not just looking out for bad behavior but also looking out for people in need.

Always remember that your happiness is not defined by how much you have but how you feel about what you do have and that what you have that makes the most difference in your lives is usually not a material item but the intangible, the love and the sense of self-worth, and if you’re strong enough, no one can EVER take that away from us.

 

Next Post: Crumbling Infrastructure

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