Trumped! A Nation on the Brink of Ruin... And How to Bring It Back

by David Stockman

  For at least a generation, as it happened, Wall Street kept its distance and its lobbyists at home. After all, for the next several decades it was still run by the chastened survivors of the 1920s’ gambling orgies and the Crash of 1929

  By contrast, today we have almost the opposite history. Wall Street is run by a generation that has been bailed-out too many times to count and that has been blatantly and egregiously coddled by perverse central bank theories and practices that have turned the nation’s capital and money markets into veritable gambling casinos.

  As I have previously explained, this includes such practices as the stock market puts, the wealth-effects doctrine and years and years of ZIRP.

  The latter is nothing more than free gambling money that can be used to fund the carry trades. That is, it’s free overnight money to buy anything with a yield or prospect of short-term gain—and that can be rolled over day after day with the assurance from the Eccles Building that the cost of carry is fixed and subject to change only upon ample notice.

  MICHAEL CORBAT—CRONY-CAPITALIST POSTER BOY

  In fact, the spoiled rotten generation now running Wall Street is personified by the current Citigroup CEO. The unconscionable raid on the taxpayers described above did not occur because the banks hirelings were sitting around K Street looking for an issue for which to bill their client.

  No, the command to mount this deplorable attempt to take the entire budget of the United States hostage in the middle of the night came straight from the C-suite at Citigroup. So just consider the monumental hutzpah of Michael Corbat and his Wall Street confederates.

  In point of fact, these unvarnished crony capitalists had been trying to gut Dodd-Frank and especially the Volcker rule and the “push out” standard for years.

  But their case was so threadbare and self-serving that they could not even buy the necessary votes through the normal legislative process. And that’s notwithstanding millions of PAC contributions and every accouterment of the lobbying trade at their disposal. Their attempt to gut the push-out provision was, in fact, a dead letter on Capitol Hill.

  So during the lame duck session in December 2014, they resorted to the low road. Owing to its usual dysfunction, Congress had once again failed to pass the appropriations bills for the current fiscal year which had been underway for 80 days.

  Therefore it had again resorted to an 11thhour punt via a giant omnibus appropriations bill. The latter authorized $1.1 trillion of spending in 1600 pages of fine print bedecked with prodigious helpings of pork. No one could have possibly read or comprehended it in the several days between the vote and when it had been fashioned in the backrooms during the wee hours of the night.

  In short, the so-called Cromnibus caper was appalling enough in its own right. But the fact that the CEO of Citigroup had ordered his henchmen to pile on is stark testimony to the insuperable arrogance of the generation that now runs Wall Street and to their sheer sense of “entitlement.”

  That is to say, Wall Street’s movers and shakers have come to believe that Washington is there to do “whatever it takes” to ensure that Wall Street profits are fattened one more quarter. After all, the share prices of the gambling halls which operate there, and the executive options and bonuses of the executives who run them, must never fail to advance.

  Yes, Michael Corbat is a Citigroup “lifer” and is just doing his corporate duty in behalf of shareholders. But that’s precisely the problem.

  There should be no Citigroup “lifers” whatsoever—because there should have been no Citigroup left standing. In fact, “C” is testimony to the financial folly of the last three decades.

  Indeed, Michael Corbat is a “lifer” from this whole misbegotten chapter, going back to his days at Salomon Brothers and his rise through the Sandy Weill machine and all the departments and far-flung operations of Citigroup after it finally came together.

  We have no clue about what he learned about banking along the way. But there is absolutely no doubt that what he did learn over that journey is that Washington exists to do Wall Street’s bidding.

  The truth is, the generation represented by Michael Corbat knows nothing about the idea of the “public interest” as opposed to private advantage. It is steeped in the practice of crony capitalism, but it knows nothing of free markets.

  After all these years of Washington’s rank servility, in fact, Wall Street leaders like Corbat now think taking the people of America hostage in the middle of the night is all in a corporate day’s work.

  That’s also why Dodd-Frank is a crony capitalist regulatory puzzle palace that will not do one bit of good. Instead, its incomprehensible 1,700 pages of legislative pettifoggery has become a Beltway lawyers, accountants and lobbyists full employment act.

  Rather than market based financial discipline and efficiency, what it has given rise to is 10,000 pages of obscurantist rule-makings that are suffocating mid-sized and community banks with compliance trivia while anesthetizing Washington’s sleepwalking politicians—until the next crisis.

  THE KEY TO BANKING REFORM: HOG TIE THE FED

  By contrast, a Super-Glass/Steagall would entail a legislated breakup of the multi-trillion behemoths like Bank of America, Citigroup, Wells Fargo and JPMorgan. It would also encompass a sharp rollback of FDIC insurance to only “narrow” banks which take deposits and make loans, and it would eliminate the Fed’s discount window privileges for any financial institution involved in trading, underwriting and proprietary risk-taking.

  Most importantly, Super Glass-Steagall would also hog-tie the Fed by ending discretionary interest rate pegging and the entire gamut of FOMC market interventions and securities price falsification.

  The latter point, in fact, is the sine qua non of true banking reform. As we demonstrated in Chapter 4, our debt saturated economy—with $64 trillion of credit market debt outstanding representing an unsustainable leverage ratio of 3.5X national income—does not require artificially priced credit to rejuvenate growth and prosperity.

  Nor is there any point whatsoever in perpetuating ZIRP and the Fed’s long-standing and destructive regime of financial repression. The major consequence of 93 months on the zero bound has been a massive transfer of income—upward of $250 billion per year—to the banking system from the hides of savers and depositors.

  The relevance here is that BAC and most of the other giant financial conglomerates would be insolvent without these arbitrary transfers.

  Given BAC’s $1.2 trillion deposit base, in fact, the Fed’s financial repression probably reduced its funding costs by at least $30 billion last year compared to a free market pricing environment.

  Needless to say, that wholly unwarranted and economically wasteful subsidy amounts to more than double the $14.6 billion of net income BAC posted in the most recent 12 months, and is more than 8X the size of its dividend distributions.

  And, no, in the face of free-market interest rates, BAC and other banks would not have automatically made up the difference via higher yields on its loans and assets.

  The fact is, BAC’s loan book today is smaller than it was on the eve of the crisis because as we demonstrated in Chapter 6, U.S. households and businesses have reached a condition of Peak Debt.”

  Accordingly, in a free market the current central bank–driven deformation of pricing would be unwound. Interest rates on savings would rise more than yields on borrowings because demand for market rate debt—as opposed to Fed subsidized rates—would fall sharply.

  Stated differently, BAC and most other giant banks are solvent only because the lion’s share of their earnings have been indirectly manufactured by the monetary central planners in the Eccles Building.

  Yet no matter how interest rates and profit spreads might ultimately shake out on the free market, one thing is certain. To wit, there is not a snowball’s chance in the hot place that BAC could have earned the $75 billion in dividends and share repurchases it made over the last decade. Not even close.

  So what real bankin
g reform would do is strip the giant banks like BAC, Citi, JPM, Wells Fargo—and the next tier as well—of the deposit cost subsidies which accrue from Fed financial repression, as well as their access to the discount window and FDIC insurance.

  By the same token, once the mega banks were stripped of these state-conferred privileges and subventions, they would be free to operate any financial business they wished. And they would be free to employ whatever balance sheet arrangements their at-risk depositors, bond investors and equity holders would permit.

  The banking behemoths keep demanding less government interference and regulation. Well, Super Glass-Steagall would provide the free market they claim to desire.

  Getting from here to there requires one more Super Glass-Steagall feature. The nation’s handful of mega- banks have operated so long in the corrupt world of bailouts and state conferred moral hazard that they are inherently unstable and prone to the errors and abuses for which BAC and C are the poster boys.

  Moreover, none of them would have gotten to their current size without the serial M&A campaigns and roll-ups that were enabled by the current rotten banking regime. Giant, multi-trillion banking conglomerates would not arise in a free market because there are simply no demonstrated economies of scale in banking beyond a few hundred billion in balance sheet footings, at most.

  So cap their size at 1% of GDP, or about $200 billion, during the transition period when they are being weaned from their state crutches, subsidies and privileges and finding their sea-legs on the free market.

  At the end of the day, cesspools like BAC and Citi need to be completely drained. And the only way to get them out on the free market where this could actually be accomplished is through the enactment of the kind of Super Glass-Steagall described below.

  SUPER GLASS-STEAGALL—A MODEL FOR SWEEPING CHANGE

  As indicated, Super Glass-Steagall would consign today’s handful of giant financial services conglomerates to the arena of pure free enterprise, where they would live or die at the hands of competition and their value to customers. There would be no bailouts of alleged too-big-to-fail institutions because this proposed enactment would strip the statute books of every vestige of authority to rescue banks with assets greater than $200 billion (<1% of GDP).

  To remove any doubt, it would also impose multi-million fines and jail time for top officers of the Federal Reserve and U.S. Treasury if they tried to circumvent any of the new Super Glass-Steagall restrictions. So doing, it would reassure the American public that the larcenous crony capitalism of the last two decades has been abolished and that the ability of the racketeers of K-Street to corrupt the halls of government has been drastically curtailed.

  In order to further purge the hoary myth of “systemic importance” and “financial contagion” from the Washington excuse bag, banks with more than $200 billion in assets would be denied access to the Fed’s discount window. Likewise, they would be ineligible to have their deposits backed by FDIC insurance.

  Accordingly, the failure of a behemoth like Citigroup would not threaten to bankrupt FDIC as it did during the 2008 crisis. Even more crucially, the giant banking conglomerates would not become a pretext for the power-hungry bureaucrats at the Fed to yell “contagion!” during a time of financial dislocation, thereby giving themselves an excuse to bailout their Wall Street wards.

  That’s because under a new Super Glass-Steagall type regime most banks below the $200 billion threshold would drastically limit their counter-party risk exposure to the dozen or so too-big-to-insure banks in the United States.

  Today, giants like JPMorgan, Bank of America, Citi, Well Fargo and the other usual suspects including the charted banks of Goldman and Morgan Stanley are viewed as privileged wards of the state. But without the implicit backing of Uncle Sam, smaller banks would be forced to put a market based risk discount on their exposures to such free market behemoths.

  This would leave approximately 6,000 commercial banks and thrifts below the size threshold to offer FDIC insurance to all currently covered depositors. There could be no demagogic claim that ordinary citizens were being consigned to potential financial ruin.

  So the argument that blue-haired widows and financially uninformed wage workers need the protection of universal deposit insurance just doesn’t cut it. They could still obtain FDIC coverage on their deposits and savings, but only at what would be thousands of narrow banks engaged solely in the business of deposit taking and lending.

  At the same time, the public could be assured that taxpayers were not unwittingly underwriting Citigroup’s $53 trillion of derivative exposures or the $51 trillion at Goldman and JPM. Likewise, the risky multi-trillion trading books of the big banks would be sequestered in a pure free-market arena.

  Finally, to ensure that the Fed’s discount window and deposit insurance was not abused even by smaller banks, the 6,000 remaining federally privileged institutions would also be prohibited from engaging in trading, underwriting, investment banking, private equity, hedge funds, derivatives and other activities outside of deposit taking and lending.

  The overwhelming share of midsize and community banks do not participate in these activities today, anyway. But if their customers demanded such services in the future, and they wished to remain in competition with the big free market banks under Super Glass-Steagall, they would have to spin-off such activities to separate, independent companies—just as did the big Wall street banks after the original Glass-Steagall was passed in 1934.

  In short, these latter inherently risky economic functions would be performed on the free market by at-risk banks and financial-services companies. The latter could never get too big to fail or oo big to manage because the market would stop them first; or, after the fact, they would be disciplined by the fail-safe institution of bankruptcy.

  No taxpayer would ever be put in harm’s way by trades like those of the London Whale.

  TODAY’S BANKS ARE WARDS OF THE STATE, NOT FREE-MARKET ENTERPRISES

  Besides, severing the big banks’ pipeline to the federal bailout trough and putting the big Wall Street banks back on a free-market-based level playing field is the right thing to do. Today’s multi-trillion banks are simply not free enterprise institutions entitled to be left alone.

  Instead, as we have shown, they are wards of the state dependent upon its subsidies, safety nets, regulatory protections and legal privileges. Consequently, they have gotten far larger, more risky and dangerous to society than could ever happen in an honest, disciplined market.

  Foremost among these artificial props is the Fed’s discount window. The latter provides cheap, unlimited funding at a moment’s notice with no questions asked. The purpose is to ensure banking-system liquidity and stability and to thwart contagion, but it also nullifies the essential bank management discipline and prudence that comes from fear of depositor flight.

  Likewise, FDIC insurance essentially shields banks’ balance sheets and asset-management practices from depositor scrutiny. Whatever its merits in behalf of the little guy, there is no doubt that deposit insurance is a font of moral hazard and excess risk-taking in the bonus-driven executive suits.

  Indeed, the function of maturity transformation (borrowing short and lending long)—which is the essence of fractional-reserve banking—is inherently risky and unstable. Once upon a time the state attempted to limit banks’ propensity for excesses by permitting injured depositors to bring suit against stockholders for double their original investment. That tended to concentrate the minds of bank boards and stock-owning executives.

  The opposite incentives prevail in today’s bailout regime. Under current legal and regulatory arrangements shareholders and boards face no liability at all—let alone double liability—for mismanagement and imprudent risk taking.

  Instead, insolvent or failing institutions are apt to be bailed out; and even if share prices are permitted to plunge, boards and executives are likely to be given new stock options struck at the post-collapse price. That happened in e
very big bank in America after the 2008 meltdown.

  Likewise, prior to the establishment of the Fed and its bailout windows, the big New York money center banks were required to remain super liquid by holding cash reserves equal to 20% or more of deposits. In that regard, the post-Keynesian history books have been stripped of the fact that even at the peak of the infamous banking crisis on the eve of FDRs inauguration in March 1933, none of the big New York City banks had lines at their teller windows or were in any way illiquid or insolvent.

  By contrast, one of Greenspan’s most deleterious actions was to essentially reduce cash reserve requirements to zero. Owing to the release of such immobilized assets and the costs of carrying them, of course, banks became more profitable.

  Yet the ultimate cost of keeping the banking system liquid was not eliminated; it was just transferred to public institutions including the Fed, FDIC and eventually the U.S. Treasury via TARP.

  TWO DECADES OF BANK-MERGER MANIA MADE IT WORSE

  All of these violations of free market discipline have had a cumulative historical effect that’s no longer tolerable. And these distortions, disincentives and moral hazards were immensely compounded by two decades of monstrous bank merger roll-ups that resulted in incomprehensible and unmanageable financial services conglomerates like Citigroup and BAC.

  Indeed, the worst excrescence of that trend—the merger of Travelers and Citibank—happened only after the old Glass-Steagall was repealed in 1999.

  Once these unnatural and inherently unstable multi-trillion-dollar financial services conglomerates came into existence after the turn of the century, the subsequent regulatory acquiescence in the 30-to-1 leverage ratios achieved by the Wall Street brokers, including the vast investment-banking operations inside Citigroup, Bank of America and JPMorgan, only added insult to injury. So did the regulatory lapse that enabled Citigroup and others to establish trillion-dollar off-balance-sheet SIVs during the run-up to the financial crisis.