The Wrongologist

What’s
Wrong Today:

Before
we get into the latest from America’s corrupt banking system, Lou Reed died
yesterday. He (or someone close to him) posted the photo below, called “The
Door” on his Facebook
page on the day he died:

The picture tells us that Lou Reed remained
who he was to the end, you don’t know if he went through that door or not. Lou
didn’t sell out in the 80’s, he didn’t go disco, he didn’t try to modernize
his sound. 

The
Wrongologist came late to the Velvet Underground.
He didn’t even listen to their first LP. Then came “Walk on the Wild Side”, “Sweet
Jane”, and others. Lou proved that you didn’t need a great voice in rock ‘n roll,
just something to say. His death is a big deal. Happy trails to the Rock ‘n Roll Animal, he made the
1970’s interesting.

Now,
on to last week’s news that JP Morgan settled with the Department of Justice (DoJ)
for $13 billion for their misdeeds during the mortgage bubble.  

This was a fine folks, not a penalty, so JP Morgan can deduct
these costs from their taxable income. Therefore, taxpayers will pay 30+% of the
fine. Since JP Morgan is a bank, it could raise all of the money necessary to
pay the fine from whom? Your Federal Reserve. It could do this by accessing
what is called the Fed’s discount
window. It could use the government’s money to pay the government’s fine.

Fines do not punish the banks. The only true form of punishment is
to prosecute and jail those who run afoul of the Exchange Act of 1934. The big takeaway
from this is that nobody who benefited
from the bad behavior got hurt in the settlement. The big bonuses remain
paid to the perpetrators of the fraud. There is a concept in financial firm employment
contracts called claw back policies that allow companies to recover
erroneously awarded compensation from executive officers. They have
increased in popularity over the past few years. C-Suite
Insight reports that the prevalence of claw back provisions among Fortune
100 companies increased from 3% prior to 2005 to 82% in 2010.The Sarbanes-Oxley Act requires the Securities and
Exchange commission (SEC) to pursue the repayment of incentive compensation
from senior executives that are involved in a fraud.

In
practice, the SEC has enforced its claw back powers in only a few cases.

The Dodd-Frank
Act mandated that the SEC require US public companies to include a claw back
provision in their executive compensation contracts that is triggered by any financial
reporting restatement, regardless of fault by the executive. (Sarbanes only
required claw back in the case of intentional fraud).

But this
portion of the Dodd-Frank Act has not been implemented, since the SEC has not
yet issued guidance on the specifics of the claw back provision that firms must
employ. Isn’t that convenient? No claw backs of any portion of the immense
bonus compensation paid to Wall Streeters, despite the fact that just 5 banks
involved in the meltdown that began in 2008 have
amassed nearly $100 Billion dollars in fines in 81 separate settlements.
Look at the chart below from the Economist:

What
the hell is the point of imposing fines on these big banks when no banker pays
a personal price in jail time or in bonus claw backs?

Are these
fines greater than the banking industry’s ill-gotten profits? Not close. So,
the “fines” were not a penalty for wrongdoing at all, they were merely a cost
of doing business for the banks and a profit-sharing deal for the government that
collects the fines.

The
banking industry sold $2 Trillion in mortgages to the US government through Fannie
Mae and Freddie Mac in the years leading to the financial crash. A little known
condition of those sales allows Fannie and Freddie to return those mortgages to the banks where proper procedures of
mortgage origination were not followed.

But,
that hasn’t happened.

Do
Fannie and Freddie have the political backing to “sell” much of the bad mortgages back to the banks? Could the banks
be stuck with hundreds of billions of underwater mortgages that probably did not
meet the original conditions of sale?

Why
isn’t this the correct “fine” for the Banksters?

Since
the banks see these fines as a cost of doing business, they will simply
continue to look for ways of increasing the volume of their derivatives and trading
activities. The long term net effect will be to undermine demand in our economy
for goods and services and to help build us towards the next bubble.

The Glass-Steagall
Act regulated banking from 1933 until 1999. It was about 40 pages long and
everyone knew what it was for, and its implementation was immediate. During
that period we corrected what was wrong as it happened. Since its repeal, we
have bailed out the Too Big To Fail (TBTF) banks and let their executive managements
skate. And 5+ years after the meltdown, we still haven’t implemented final rules for Dodd-Frank.

Following
the financial crisis of 2007-08, legislators unsuccessfully tried to reinstate elements
of Glass–Steagall as part of the Dodd–Frank,
without success. In Sunday’s NYT, Gretchen
Morgenstern quoted Luigi Zingales
a professor of
entrepreneurship and finance at the University of Chicago Booth School of
Business. Dr. Zingales doesn’t argue that a new Glass-Steagall act would have prevented
the financial meltdown, but he said that an
unintended consequence of its repeal is that the merger of banking and
underwriting has allowed the TBTF banks to become a huge lobbying force that
was impossible before 1999 when they all competed:

There is not even a theoretical possibility of reform today. In
the past, banking has reformed itself mostly by being led kicking and screaming
by vigorous government involvement. Now, it is nearly invulnerable to reform. What does Dr. Zingales suggest we do
to reduce the implied guarantees bestowed on the banks? He recommends a
two-pronged approach:

Here is a little history: By 1911, JP
Morgan controlled about 40% percent of the capital raised in America. Judge Louis
Brandeis wrote that the main objection
to a financial oligarchy was not primarily economic, it was moral. It
was a threat to political liberty and democracy:

We need an army of modern day Louis Brandeis’. House to House fighting
is the only way we will break the hegemony of the TBTF banks.