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The trust that wasn’t

By: Paul Cella (Diary)  |  June 10th, 2011 at 07:51 AM  | 

RESIZE: AAA

I anticipate that we will see more and more court decisions like the one described here by Yves Smith. The mortgage industry, in connivance with bankers and financiers of all shapes and sizes, introduced into the political economy, by means of innumerable frauds and sophistries, a whole field of unhedged risk: namely, the risk that the documents do not demonstrate what the securities confected out of them need them to demonstrate in order to be functioning legal securities.

Bond markets, among other menaces, remain perplexed by this uncertain risk. The financiers, again, have only themselves to blame for their woes. Let some hack attempt to prove that government, dread government, forced these enterprisers to commence their business of setting up trusts to pay out revenue to investors, by failing to properly set up legal trusts for said purpose, and I will presently prove that I am a donut.

The problem is that when the securities are shown to be overvalued, because the trust which holds their underlying asset — the mortgages — wants for legitimate evidence of its right to hold such assets, the financial system as a whole (that is, the collection of big banks which allocate capital in our capitalist system) is struck another grievous blow. The banks are undercapitalized; many are flat-out insolvent. Their parasitism is choking small business everywhere. Large businesses have direct access to capital markets (and indeed investment-grade corporate debt may be just the sort of reliable asset that could conceivably replace government debt as the pricing mechanism for bond markets, in an imagined brave new world of discredited sovereigns); but small businesses must purchase credits from banks. And banks, exposed so gruesomely by their failing mortgage assets, ain’t selling.

So while at the highest, most concentrated and bureaucratic level the weakness of the banks further entrenches the plutocratic principle of TBTF, down in the trenches of small business, the weakness of banks further encourages the failure of even promising firms.

It’s one hell of a mess.

(Cross-posted.)

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  • Death_of_the_Donkey

    banking/finance is the one area of the economy that has proven itself incapable of self-regulating and since finance is a backbone of our capitalist system, we need to make sure that is is well regulated, solvent, and thus able to act in its role of financier instead of speculator. Had we simply regulated the banks and not passed such absurd laws as CFMA this mess would likely have not happened.

    • skorrent1

      Of the economy that has had more regulations than any other. (Though the rest of the economy is fast catching up.) The assumption that a disinterested government regulator, subject to the political whims of Congress and Obama, would do a better job for the overall economy than the diverse directly-interested parties is way too leftist for me. Regulators tend to become risk-averse (the FDA) or politically directed (the NLRB). A market where everyone recognizes that there is no “TBTF” might provide better recognition of financial risk.

      • Death_of_the_Donkey

        rather than more, but as I was thinking about CFMA, we do in fact need more in that area since the CFMA eliminated regulation for a huge sector of finance. Also, unless you are going to remove the ability of financial institutions to incorporate and make them back into partnerships, even eliminating TBTF doesn’t necessarily end our problem, as the risk takers still go unpunished. And last I checked, we had period of little regulation on finance and those “diverse directly-interested parties” nearly destroyed the global economy.

        • judges176

          …sounds a lot like the Easter Bunny, both are mythical. I maintain, while I don’t know the exact details, that the situation we got in the mortgage markets arose BECAUSE of government interference, which is the impolite way to say regulation. The lenders were more or less ordered to find a way to loan money to non-credit worthy borrowers so that Everybody Can Own Their Own Home (except when they have nothing at risk, Big Brother will bail them out if they ever miss a payment, they don’t really own it, do they?), so they found a way to do it. We can never imagine all the ways to game the system, all we can do is close the barn door after the horse is long gone, and we don’t do a very good job of that! I’m not so sure we need to return to the days of anybody-with-a-barrel-of-money-is-a-bank (think pre-Civil War) but in some ways, that was better than what we have now. Maybe we should just wipe the slate clean and start over?

          CPS

    • acat

      The problem isn’t “more laws, more laws!” .. the problem is enforcement of the existing laws.

      Mew

      • Death_of_the_Donkey

        ie CFMA (and possibly FSMA) both of 1999. When you write laws that basically remove areas (ie credit default swaps) from regulation or laws that create monopolies (ie the ratings agencies) then you need you do need more regulation so the system doesn’t collapse again (like 2008). Finance isn’t a means to its own end (or at least shouldn’t be), it should be a facilitator of real economic activity.

        • acat

          Who’s going to enforce these revised laws? Laws don’t go around on wheels enforcing themselves, you know…. Are you thinking “health inspectors” where they show up on a schedule, find one or two things, take the occasional payoff, and go away, never noticing what happens the rest of the year? Are you thinking NASA, where only the government does the work?

          In any case, in highly regulated industries government picks the winners and losers – and the only guaranteed loser is the general public.

          Mew

  • Death_of_the_Donkey

    did pretty well before we deregulated with CFMA and FSMA in 1999 (CFMA at the behest of Enron and FSMA at the behest of Citigroup). Sometimes regulation isn’t so much a matter on inspecting books as it is the allowance of certain activities at all. And why should we think, as I stated above, that the two laws most responsible for the 2008 panic were good laws in the first place since they were really just corporate lobbying efforts. While I agree that regulation isn’t always the answer (and isn’t in most cases), I would also argue that deregulation isn’t always appropriate either (like in this case).

    • Death_of_the_Donkey

      nt

      • acat

        Not that the Resolution Trust Corp solution was a great idea, or would work here, my point is more that someone is *always* going to game the system.

        Enron, for example, gamed the power market.

        There is no way to build a perfect market .. so perhaps the best answer is a “youth football league” one .. limit the size of players who are allowed on the field.

        Mew

        • Death_of_the_Donkey

          the S&L crisis began in the 80′s and was the result of a combination of several laws (including the elimination of a tax shelter for real estate investments in 1986), financial innovations (ie money market accounts, etc), and a downturn in the real estate market (circa 1991) all of which predated Clinton.

          However, to your last point, the FSMA essentially eliminated the long held limit on size and scope of financial institutions (by eliminating Glass-Steagal) and allowing Citi to combine with Travelers (ie no more separate I-banks vs commercial banks).

          And that Enron law (CFMA) allowed for all these CDS (and CDO’s) to be traded in a non-regulated market and with minimal (if any) collateral held against them.

          And there is a big difference between a bad actor “gaming the system” and an environment that allows everyone to do the same, at which point it becomes the system instead of gaming it.

          • acat

            The point was that there have and always will be bad actors seeking to game the system. I did not mention Madoff because I thought it was obvious .. perhaps I shouldn’t make such assumptions.

            There is no difference between an actual free market and “an environment that allows everyone to [game the system], at which point it becomes the system…” .. in fact, the uglier definitions of a free market say just that.

            The point I’m making here, Donkey, is that the only suitable regulations I can see are ones that require honest and open dealings (i.e. sunshine laws) and ones that limit the size of actors.

            While it’s true that Glass-Steagal had the effect of size-limiting, it did so via creating artificial industry segments.

            I would suggest that it’d be more sensible to restrict access to various “retail banking” industries to outfits with a large enough market capitalization.

            If Citi or BoA want to be ginormous, that’s fine, but they can’t do retail banking or insurance – the risk to the taxpayers is too great.

            If First American Bankcorp of Illinois (a relatively small bank) wants to do insurance and retail banking, that’s fine .. because the risk to the taxpayers is too small.

            The point is, eliminate the idea of “too big to fail” by eliminating the very big. This is counterintuitive, but does not “choose winners and losers”, nor does it restrict what a bank can do – it just forces banks to choose between being large vertically or being large laterally.

            How on earth we get politicians to implement it is anybody’s guess – with every pol having a hand out it’s a matter of time before someone else games the system somehow. (and that’s leaving the Madoffs of the world out of it)

            Mew

          • Death_of_the_Donkey

            collateral requirements, leverage ratios, tangible common equity, reserves, etc?

            I agree that size limitations make some sense (on the retail banking side), but on the investment banking side, if we limit size too much we may lose competitiveness globally, which is why I believe the functions should still be separate (we dominated global banking prior to the repeal of Glass-Steagal in 1999 for instance).

          • acat

            If – and this is the salient point – the financial outfit is required to be up front with the customers about the level of risk involved, then .. I do not have a problem with financials being allowed to take on more risk (running with lower reserves, forex) .. but *again to my point above* the risk taken on by the *taxpayer* is the key point.

            Consider it this way – I am younger than your grandma, so will be willing to tolerate a higher risk/reward ratio than she will. I’ve got more time to rebuild my portfolio if my risk doesn’t pay off.

            Again, legislate and *enforce* with more than just health-inspector spot-checks honesty about the level of risk, legislate that if an outfit gets too big they have to drop some activities (the ones that put the taxpayer at risk…) and let the markets decide.

            Mew

          • Paul Cella

            Eliminating Glass-Steagall was a huge mistake. Permitting FDIC-back deposits to become the capital base for exotic securities trading — right there you have the origin of TBTF.

          • acat

            and while they were effective in reducing risk to the taxpayers, there were more market-efficient ways of achieving the same goals.

            In short, repealing Glass-Steagall was not *in itself* a problem, had it been replaced with some other mechanism to prevent TBTF…

            My point in mentioning the thrift crisis is that .. even before Glass-Steagall was repealed, we had people trying to game the system. That’s why limiting the size is important – reduces the risk to the *taxpayer*, who should *not* be “on the hook” for the misbehaviour of thrift owners, bankers, mortgage scam artists, etc. etc. … and yet, somehow always end up holding the bag.

            Mew

            p.s. heard that insurance companies are trying to foist some of the claims from the recent southern tornadoes onto the taxpayers? they’re saying that damage caused by rain blown into buildings by the tornadoes is “flood damage”, not “wind damage”, because water is involved. the point is – the taxpayers are on the hook for floods…