According to Merrill Matthews; Senior Fellow at the Institute for Policy Innovation, “We do not think a U.S. recession is imminent, but the threat is very real; the caution flags are waving. Nor do we think recessions are inevitable. Rather, they are almost always the result of misguided policies — sometimes exacerbated by the Federal Reserve Bank, but usually caused by politicians.”
To prove him right, it appears that instead of following prudent strategies to prevent a recession, the administration is heading in the other direction. With the administration’s push to foster more deregulation, the Federal Reserve is also slowly, but steadily, making a series of regulatory changes that could chip away at new requirements put in place to prevent a repeat of the 2008 meltdown.
These include changes to the Volcker Rule, which was aimed at preventing banks from trading for their own profit with depositors’ money and other funds. The revised rule, recently approved by the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, eases restrictions on how banks invest for their own gain.
The original Volcker rule was intended to lend more oversight to how banks invested, and banned larger banks from proprietary trading, (the making of short -term investments, those less than 60 days) with their own money. Banks were required to apply for exemptions in order to conduct these trades.
Proponents of the original legislation have warned that the loosening of the Volcker Rule opens the door to a rebound in risky behavior on Wall Street.
One investor said the rule has been “quite powerful in lowering proprietary trading in banks and quite frankly the gambling mentality – it definitely made capital markets trading focus more on clients.” He noted that the revisions “opened the way for the return of conflicted interests, as banks traded simultaneously for themselves and their clients.”
However, the Volcker Rule (part of the Dodd- Frank law, which was put in place after the 2008 financial crisis) has been viewed by regulators and bankers as too complicated to enforce and has slowly been diluted.
The Federal Reserve is also considering other changes which would effectively loosen capital requirements. But some former and current Fed officials, including Robert Kaplan, President of the Federal Reserve Bank in Dallas, and Neel Kashkari, President of the Federal Reserve Bank of Minneapolis have warned against making changes that reduce capital requirements.
Other officials are concerned that these revisions will again give large banks, already making record profits, “an unnecessary gift that could leave the economy exposed in the next downturn.”
There is a reason bank executives oppose tougher capital requirements
In case we forget, there is a reason bank executives oppose tougher capital requirements. They force banks to limit stock buybacks and dividend payments, curbing moves that manipulate and help lift share prices. A big chunk of senior bank executives’ compensation is made up of stock.
Are we forgetting that last year the eight largest American banks spent $104 billion on stock buybacks and dividend payments, up nearly a fourth from $84 billion in 2017? The existing capital requirements already allow banks to return large amounts of excess capital to their shareholders and thus increase their stock prices.
Dennis M. Kelleher, President and Chief Executive Officer of Better Markets, in commenting on the proposed changes to the Volcker Rule, reminds us that “Prop trading is how Morgan Stanley lost more than $9 billion on a single bet in December 2007, at the same time it was hemorrhaging losses due to subprime lending and derivatives. It was also how J.P. Morgan Chase lost more than $6 billion in 2012 from its so-called ‘London Whale’ trades.”
Weakening of the Volcker Rule comes at the worst possible time
He states, “The FDIC’s weakening of the Volcker Rule comes at the worst possible time. The U.S. is in the middle of the longest continuous economic expansion in recent history, but the business cycle has not been repealed and the question is when not if a downturn comes… this is no time to be unleashing Wall Street’s biggest banks to engage in high-risk prop trading.”
A working paper I’ve cited before, brilliantly prepared by Jihad Dagher, Regulatory Cycles, Revisiting the Political Economy of Financial Crisis, is a thorough, well documented study of boom and bust cycles worldwide over the last 300 years, with an emphasis on regulations affecting banks and credit-issuing entities.
The paper clearly points out, “that episodes of financial boom went hand in hand with a period of significant deregulation. These episodes were generally accompanied, and sometimes triggered, by procyclical policies by governments that actively amplified credit booms, weakened existing financial regulations and supervision, and engaged in regulatory forbearance… When spectacular booms came to an end, the ensuing crises led to major reforms and reversal of earlier policies.”
We often point fingers for financial meltdowns at irresponsible traders and greedy bankers. However, as Mr. Dagher suggests, perhaps we need to more closely look at the “politicians whose policies sometimes fan the flames.”
Misguided policies almost always source of recessions
As Dr. Matthews of IPI says, recessions “are almost always the result of misguided policies—sometimes exacerbated by the Federal Reserve Bank, but usually caused by politicians.”
From the staggering amount of study that has been done, not just on Mr. Dagher’s part, but others he references throughout the paper, it is definitively shown that “rolling back regulations comes before a financial meltdown.”
Let’s hope we listen this time around and slow down this deregulatory train before we are back into another financial meltdown.
Richard Bowen is widely known as the Citigroup whistleblower. As Business Chief Underwriter for Citigroup during the housing bubble financial crisis meltdown, he repeatedly warned Citi executive management and the board about fraudulent behavior within the organization. The company certified poor mortgages as quality mortgages and sold them to Fannie Mae, Freddie Mac and other investors.
