Senate approves sweeping Wall Street reform bill

Reuters) - The Senate approved a sweeping Wall Street reform bill on Thursday night, capping months of wrangling over the biggest overhaul of financial regulation since the 1930s.

By a vote of 59-39, the Senate awarded a victory to President Barack Obama, a champion of tighter rules for banks and capital markets after a 2007-2009 financial crisis that slammed the economy and led to massive taxpayer bailouts.

The Senate bill must now be merged with a measure approved in December by the House of Representatives. Only then could a final package go to Obama to be signed into law, something that analysts said may happen next month.

Changes proposed in both bills -- driven by lawmakers eager to look tough on Wall Street before congressional elections in November -- threaten to constrain the banking industry and reduce its profits for years to come.

Barney Frank, head of a key House panel, told CNBC it was important to complete reform soon to ease uncertainty.

Frank, the Democratic author of Wall Street reform in the House, on Thursday drew an early negotiating line ahead of impending talks with the Senate on a final package.

In letters to senior Senate Democrats that were obtained by Reuters, Frank said certain House proposals on financial firm regulation and bank trading limits must be preserved.

He said the House proposals were important to his home state of Massachusetts and that "none of them threaten or weaken the broad objectives of comprehensive reform ... I will insist that they be maintained in the final bill."

The letters were addressed to Senate Democratic leader Harry Reid and Banking Committee Chairman Christopher Dodd, the Democratic author of the Senate bill. Both will likely be key players, along with Frank, in the House-Senate talks.

The regulation issue is of special interest to me, because I served as Lane County, Oregon’s first and only Investment Officer from 1976-1982. In 1979 and 1980 Marian County and the State of Oregon had their cash investment portfolios devastated by investments in GNMA Standby Agreements (similar to derivatives) and U.S. Treasury Forward Agreements. Treasuries and GNMA’s were on the ORS approved list of securities, but these people violated the “prudent person” rule and other basic directions by betting they could turn a long term commitment for a profit in time to meet the short term cash needs of taxing districts.

The Treasurer for Marion County reported a $12 million loss in the year I believe I made $10 million for Lane County. Or rather my investments recovered $10 million in lost purchasing power between the time we received the money, and the taxing districts and the county called for its use. Scary, isn’t it?

In the aftermath the Attorney General David Frohnmayer wrote a legal opinion from the existing statutes, which explained direct accountability, and extended culpability to the host of elected and appointed officials who had oversight of the two treasurer’s work. The legislature would have none of that, and passed a bunch of rules getting the others off the hook. Now we have laws at a national level adopting this same tragic approach.

Before graciously accepting Congress’ and the Administration’s plan to prevent a repeat of the financial crisis, people should consider parallels to the Great Depression. The late 20’s brought an obvious speculative rampage in stock prices. However, the SEC failed to exercise existing regulatory authority to sharply increase cash people put up to borrow money for stock. Next came the Smoot-Hawley tariff, and predictable international retaliatory actions. The bill disastrously exacerbated the damage done by the Fordney- McCumber tariff of 1922. (Remember the United States had the only sizeable economy not devastated by WW I, which could restart international trade.) As recession tumbled into depression, the Federal Reserve decreased the money supply by one third.

FDR’s New Deal policies obscured these true causes, installed unprecedented Federal power, and prolonged the economic malaise. Finally a new world war rescued the country from a slide into renewed economic hopelessness.

This time a new world war could easily result in a nuclear winter and not economic prosperity. However, the Administration and Congress remained undeterred from steps to hide their primary responsibility for the financial crisis. Current hearings and speeches distracted from questions about how a government lead mortgage debacle allowed explosive growth of a market, so entangled amongst participants, as to imperil the financial system. They began by selling illusions about predatory lenders and Wall Street greed, as if greed and predation were not part of the common human condition. Next came “show trials” for Goldman Sachs and others, with final consummation in 1,400 pages of government oppression disguised as financial services reform.

The premier predatory lenders in this story were Bill Clinton, Janet Reno, Barney Frank, Maxine Waters, and Christopher Dodd. They used threats to banks of Justice Department action concerning the Community Reinvestment Act to provide themselves and colleagues with trillions of dollars of “walking around” money for electioneering. The relentlessly severe actions of Congress, and the Clinton and Obama Administrations stilled voices within and without government counseling traditional prudence. On YouTube you can see the 2004 video of Barney Frank and Maxine Waters abusing the regulator informing them of the speculative character of Fannie Mae and Freddie Mac.

Government actions spawned a host of private sector predators among mortgage brokers, real estate salesmen, security dealers, and appraisers, who immediately profited from the decisions of borrowers and lenders bearing the ultimate risk of the transactions. Ordinary Americans were duped into borrowing for homes, when there was no possibility of making payments leading to eventual ownership. Private lenders became increasingly anxious and used Fannie Mae and Freddie Mac as a dumping ground for sub-prime, high risk real estate loans politicians coerced them into making. When mortgage portfolios continued to increase in risk, politicians turned a blind eye to explosive growth in the derivatives market, which was used in attempts to mitigate perilous lending positions.

Derivatives are not that exotic. Regulatory oversight routinely controls hosts of investments best understood as potentially lucrative wagers in commodity, stock, bond, and insurance markets, where one receives a tiny current income compared to huge potential future loses. The derivatives market produces a pseudo-financial instrument once removed from the grouping of mortgages used to create a bond. Derivatives attempt to transfer to others for a price the risk associated with these mortgage pools. Elegant and esoteric descriptions cloud an economic reality similar to accepting $5,000 for co-signing fifteen auto loans, and being at risk for $210,000 if they later go bad.

Effective regulations and effective oversight would have focused on economic risk attributes, and not on marketing schemes and legal jargon hiding the character of investments. Proper government intervention would have meant Federal Reserve, Treasury, and Justice applying brutal persuasion to private firms, including those so pretentious as to claim they were “too big to fail.” (Can we say Freddie and Fannie?) Persuasion, approaching condemnation by the Geneva Conventions as torture, would have ensured suspending any cascade of financial losses, further enabled mergers and bankruptcies, dismissed flagging management, and produced market clearing asset prices. As the dust settled, there would be no bailouts, and ownership would remain wholly private. Bankruptcy proceedings would have been modified such that board authorized compensation for the current and several prior years, including performance bonuses and “golden parachutes”, would have been recovered for bankruptcy assets.

There is little hope now in controlling financial markets when regulations do not drill down through these political, legal and marketing facades. Regulation reform as passed remains nothing more than an exercise where the current political/private cohort in power protects themselves, destroys competitors, and establishes parameters to game the system in the future.

I can sympathize. One of the most challenging tasks I had was closing down my father’s estate. He had a living will and the value was small enough I didn’t need a lawyer. Even though this was my professional skill area, the environment was different when you showed up with a $20,000 issue involving him, rather than a $5,000,000 issue involving my college.

I found this among sources I studied for an understanding of derivatives. At the end was a summary giving lessons to be learned. These lessons would always apply regardless of the investment involved. I always said you could consider an investment in the next business cycle and not it’s first where the product, process, and investors had not undergone the shock of a recession.

A Primer on Credit Derivatives
http://www.ermsymposium.org/2009/pdf/2009-darcy-primer-credit.pdf

12. Lessons for Enterprise Risk Management (Applies to anyone in oversight role.)
The rapid growth in credit derivatives and the recent financial crisis caused, at least in part, by these instruments provide several valuable lessons for those involved in Enterprise Risk Management. These include:
1. Manage for risk, not for regulation. Risk does not disappear just because regulations do not recognize it.
2. Understand all the significant risks the organization is assuming. This admonition applies to the chief risk officer, other executives and to board members (yes, city council). If a risk is too complex for its board and officers to understand, the organization should not be accepting that risk.
3. If an organization does not understand an investment it is offered, it should decline. Comprehension cannot be delegated down the hierarchy or to investment advisers.

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