Category Archives: Alarm Bells and Whistles

Financial Reform Destined To Fail, Top Federal Reserve Official Says

Reforms instituted after the financial crisis to prevent future taxpayer-funded bailouts are bound to fail and will likely be weakened within the next few years, the Federal Reserve’s longest-serving policy maker predicted Monday.

The stark warning, offered by Federal Reserve Bank of Kansas City President Thomas Hoenig, who’s been warning about the rise of too-big-to-fail banks for more than a decade, comes as international regulators finalize plans to increase supervision of and toughen requirements on the world’s largest banking organizations as a reaction to the global financial crisis. Rather than break up big banks, politicians decided to simply subject them to more oversight.

Yet debate rages as to whether the requirements are too tough, or not tough at all, and whether regulators will have the backbone to follow through on their commitments. Republicans in the U.S. House of Representatives are trying to dismantle the domestic financial reform law passed last year; banks are screaming that lending will dry up, inhibiting the anemic U.S. recovery; and on the global level, regulators from some countries where large banks dominate the national economy (and thus enjoy overt taxpayer backing) are trying to weaken international accords.

For Hoenig though, the choice is clear when it comes to what to do with the financial institutions that caused the most punishing downturn since the Great Depression: break them up into pieces that regulators can understand and provide a backstop to entities engaged in the so-called real economy — but allow those dabbling in more risk-laden activities to fail.

The Obama administration and Congress chose the alternate route in passing the Dodd-Frank financial regulation law. To Hoenig, they made a mistake.

via Financial Reform Destined To Fail, Top Federal Reserve Official Says.

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Financial System Riskier, Next Bailout Will Be Costlier, S&P Says

The financial system poses an even greater risk to taxpayers than before the crisis, according to analysts at Standard  Poors. The next rescue could be about a trillion dollars costlier, the credit rating agency warned.SP put policymakers on notice, saying theres “at least a one-in-three” chance that the U.S. government may lose its coveted AAA credit rating. Various risks could lead the agency to downgrade the Treasurys credit worthiness, including policymakers penchant for rescuing bankers and traders from their failures.”The potential for further extraordinary official assistance to large players in the U.S. financial sector poses a negative risk to the governments credit rating,” SP said in its Monday report.But, the agencys analysts warned, “we believe the risks from the U.S. financial sector are higher than we considered them to be before 2008.”Because of the increased risk, SP forecasts the potential initial cost to taxpayers of the next crisis cleanup to approach 34 percent of the nations annual economic output, or gross domestic product. In 2007, the agencys analysts estimated it could cost 26 percent of GDP.Last year, U.S. output neared $14.7 trillion, according to the Commerce Department. By SP’s estimate, that means taxpayers could be hit with $5 trillion in costs in the event of another financial collapse.Experts said that while the cost estimate seems unusually high, theres little dispute that when the next crisis hits, it will not be anticipated — and it will likely hurt the economy more than the last financial crisis.

via Financial System Riskier, Next Bailout Will Be Costlier, SP Says.

Greenspan Testifies To Financial Crisis Commission, Blames Fannie, Freddie For Subprime Crisis (LIVEBLOG, VIDEO)

The U.S. banking system has been “undercapitalized” for the past “40 to 50 years,” former Federal Reserve Chairman Alan Greenspan told a panel today in Washington convened to investigate the roots of the financial crisis.

In response to a question about the Fed’s failure to guard against megabanks becoming so large and interconnected that they posed a systemic risk — risks that pose threats to the entire financial system — Greenspan said the Fed wasn’t alone in that regard.

Rather, he said, everyone — the financial industry and their regulators at the Fed — failed to appropriately appreciate how badly banks were guarding themselves against risk.

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Once the Fed realized how poorly the banks’ risk management systems were, Greenspan realized how poorly they were capitalized — money, in short, that banks keep on hand to protect themselves from going under in the case of huge losses.

In fact, the banking system has been “undercapitalized” for the past “40 to 50 years,” he said.

Put another way: for the past few generations, the U.S. banking system has not been holding enough money to guard itself from insolvency, putting taxpayers at great risk in case a panic were to materialize — a lesson painfully learned in 2008.

When regulators judge banks to be undercapitalized, the banks are told to shore up their capital or shed potential sources of future losses, like sour loans or underperforming businesses. If they can’t, they’re shut down. Most of the time, it’s an open-and-shut case.

“The risk management paradigm nonetheless harbored a fatal flaw. In the growing state of euphoria, managers at financial institutions, along with regulators including but

not limited to the Federal Reserve, failed to fully comprehend the underlying size, length, and potential impact of the so-called negative tail of the distribution of risk outcomes that was about to be revealed as the post-Lehman Brothers crisis played out,” Greenspan said in his prepared remarks.

via Greenspan Testifies To Financial Crisis Commission, Blames Fannie, Freddie For Subprime Crisis (LIVEBLOG, VIDEO).

via Greenspan Testifies To Financial Crisis Commission, Blames Fannie, Freddie For Subprime Crisis (LIVEBLOG, VIDEO).

News Analysis – A Decade of Enormous Deficits May Alter American Politics and Power – NYTimes.com

Mr. Obama has published the 10-year numbers in part, it seems, to make the point that the political gridlock of the past few years, in which most Republicans refuse to talk about tax increases and Democrats refuse to talk about cutting entitlement programs, is unsustainable. His prescription is that the problem has to be made worse, with intense deficit spending to lower the unemployment rate, before the deficits can come down.

Mr. Summers, in an interview on Monday afternoon, said, “The budget recognizes the imperatives of job creation and growth in the short run, and takes significant measures to increase confidence in the medium term.”

He was referring to the freeze on domestic, non-national-security-related spending, the troubled effort to cut health-care costs, and the decision to let expire Bush-era tax cuts for corporations and families earning more than $250,000.

But Mr. Summers said that the long-term projections of deficits were “not sustainable,” and that “through the budget and fiscal commission, the president has sought to provide maximum room for making further adjustments as necessary before any kind of crisis arrives.”

Turning that thought into political action, however, has proven harder and harder for the Washington establishment. Republicans stayed largely silent about the debt during the Bush years. Democrats have described it as a necessary evil during the economic crisis that defined Mr. Obama’s first year. Interest in a long-term solution seems limited. Or, as Isabel V. Sawhill of the Brookings Institution put it Monday on MSNBC, “The problem here is not honesty, but political will.”

via News Analysis – A Decade of Enormous Deficits May Alter American Politics and Power – NYTimes.com.

via News Analysis – A Decade of Enormous Deficits May Alter American Politics and Power – NYTimes.com.

Watchdog: Bailouts created more risk in system – Yahoo! Finance

WASHINGTON AP — The governments response to the financial meltdown has made it more likely the United States will face a deeper crisis in the future, an independent watchdog at the Treasury Department warned.The problems that led to the last crisis have not yet been addressed, and in some cases have grown worse, says Neil Barofsky, the special inspector general for the trouble asset relief program, or TARP. The quarterly report to Congress was released Sunday.”Even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car,” Barofsky wrote.Since Congress passed $700 billion financial bailout, the remaining institutions considered “too big to fail” have grown larger and failed to restrain the lavish pay for their executives, Barofsky wrote. He said the banks still have an incentive to take on risk because they know the government will save them rather than bring down the financial system.

via Watchdog: Bailouts created more risk in system – Yahoo! Finance.

via Watchdog: Bailouts created more risk in system – Yahoo! Finance.

Bond Investors Beware – Don’t Underestimate Current (Escalating) Risks — Seeking Alpha

The 2007-2009 global financial panic and collapse provided investors with a once in a lifetime rollercoaster ride as all asset classes except for treasury bonds dropped to extreme lows. A vast spectrum of emotions accompanied investors on this thrill-ride and not surprisingly many of these emotions are shaping investors’ current investment decisions.

In a search for safety and income, investors are stampeding into the apparent safety of government bonds and bond mutual funds. Over the last year, bonds have been purchased in record amounts despite historic low interest rate levels. It is likely that many of these investors do not understand the risks in bonds. These investors, with a false sense of security, are unknowingly setting themselves up for another rough rollercoaster ride ahead.

Warning Sign: High Level of Flows to Bond Funds

Despite the remarkable rally in stocks over the last nine months, the distrust in equity markets is still widespread. The cash flow figures into bond mutual funds this year illustrate this point (click on chart below) as almost $313 billion has been invested in bond funds compared to the $2 billion added to stock funds through October. In addition, insignificant yields on money market funds are testing investors’ patience and are yet another reason for the remarkable cash flow into bonds.

History shows that cash flows to mutual funds tend to follow strong outperformance by a particular asset class and can provide a contrarian warning sign when a particular class is becoming too popular.

via Bond Investors Beware – Don’t Underestimate Current (Escalating) Risks — Seeking Alpha.

via Bond Investors Beware – Don’t Underestimate Current (Escalating) Risks — Seeking Alpha.

Robert Reichs Blog: The Great Disconnect Between Stocks and Jobs

The result, overall, is an asset-based recovery, not a Main Street recovery. Yes, the economy is growing again, but the surge in productivity is a mirage. Worker output per hour is skyrocketing because companies are generating almost as much output with fewer workers and fewer hours. The Fed, meanwhile, has become an enabler to all this, making it as cheap as possible for companies to axe their employees. Money costs so little these days it’s easy to substitute capital for labor. It’s also easy to buy up foreign assets with cheap American money. And it’s now blissfully easy for Wall Street to borrow money almost free and buy all sorts of interests in foreign assets, especially commodities. Thats why were seeing the prices of foreign commodities and other assets go through the roof. At the same time, the Treasury continues to be fixated on keeping banks afloat. The Administrations mortgage mitigation efforts are lagging. Small businesses are starved of credit. The White House has announced a “jobs summit,” which is better than nothing but not nearly as good as pushiing immediately for a larger stimulus, a new jobs tax credit, and a WPA-style jobs program. The Fed and the Teasury have, in effect, placed a huge bet on a recovery driven by asset prices. That’s a bad bet. The great disconnect between the stock market and jobs is pushing stock prices way out of line with the real economy. This isnt sustainable.

via Robert Reichs Blog: The Great Disconnect Between Stocks and Jobs.

via Robert Reichs Blog: The Great Disconnect Between Stocks and Jobs.