Banks Win Big as Regulators Refuse to Rein in $700 Trillion Derivatives Market

Bill Black: Weakness of financial regulators shows you can not “tame the scorpion”.

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Baltimore. And welcome to this week’s edition of The Black Financial and Fraud Report with Bill Black, who now joins us from Kansas City.

Bill’s an associate professor of economics and law at the University of Missouri-Kansas City, a white-collar criminologist—he was and is. He was a former financial regulator. And he’s the author of the book The Best Way to Rob a Bank Is to Own One.

Thanks for joining us again, Bill.

BILL BLACK, ASSOC. PROF. ECONOMICS AND LAW, UMKC: Thank you.

Jay: So what’s on your mind?

Black: So the big question has been: can you keep these systemically dangerous institution, these roughly in the U.S. context 20 biggest banks and somehow turn them into a tame scorpion that’ll be good for economic life. That’s one school of thought. And the other school of thought, people like me says there’s no way to tame a scorpion. You have to get rid of the scorpion.

So two pieces of information on—relevant to this debate. First is there’s been a vote at the Commodity Futures Trading Commission, and after a whole series of negotiations trying to reach a deal. And once more, I know it will shock you, but the big banks won, and they won big. So the context was a rule to restrict the biggest banks and how they do financial derivatives. This is to the tune of about $700 trillion in transactions.

Jay: Now just remind us again, because this is, like, bigger than the global GDP, right?

Black: This is massively bigger than the global GDP. This is so much bigger than the real economy that it now dwarfs it, but can ruin it.

Jay: Okay. Let me quickly try to explain what this is for people that don’t follow this kind of story at all, and tell me if I’m right. Essentially, these derivatives, this $7 trillion—

Black: No, no, seven—.

Jay: —are rich people bidding—betting against rich people about things they don’t actually own. It’s like going to a racetrack, sitting in the stands, and betting on somebody else’s horses.

Black: That’s one part of derivatives. There are many different kinds of derivatives. But this is not $7 trillion; this is $700 trillion.

Jay: Yes. I’m sorry. I mispoke. Yeah, $700 trillion.

Black: Yeah. So, yes, a lot of it is essentially betting—a bunch of it is weird offsets and such. But it’s huge. It’s different. It was deliberately made through bank power, completely unregulateable, just an absolute black hole. And it blew up AIG and was part of blowing up the global economy. So now, in Dodd-Frank, they said, well, we have to have some rules. And, of course, it left it largely to the agencies to adopt those rules. So we’re now seeing bank power played out in the agencies. And you might think, if you were still naive at this point, that the fact that the Democrats have a majority might mean that you’d get tougher regulations. But it turns out even at the CFTC, which has had a pretty good chairman, Gary Gensler, who at least has tried to adopt reforms in a number of areas—surprise—one of the Democrats on the Commission is a Wall Street supporter. And, of course, the Republicans are unwilling to adopt a meaningful reform. So that gives them a majority vote to gut the effectiveness of the rules designed to deal with the derivatives. And so—.

Jay: What specifically was the rule that got voted down here?

Black: Well, the particular rule is a, quote-unquote, compromise as opposed to being voted down. And it’s pretty arcane. It’s about how many banks that you need to get bids from before you go forward with one of these deals, because one of the features of all of this is, again, this is vastly bigger than the real markets, and it doesn’t operate like markets. So people who are supposedly defending markets, this has nothing to do with markets. This is a group where five U.S. banks do virtually all of that business. Right? So even very, very, very large banks in America, if they’re not the absolute largest, are completely blocked from doing these deals. There’s no real competition. It’s a disaster on every score you can imagine. This was a very limited effort to reform, to get more competition, and they won’t even insist on rules to get more competition. So the free-market people are opposing markets in the derivative context. It’s quite hilarious, except that of course it’s so dangerous to the world. The second—.

Jay: So—yeah, go ahead.

Black: Yeah, the second variant of this is Brown-Vitter, which, again, hey, it’s being sold as a reform, because it would impose higher capital requirements, not so much on systemically dangerous institutions, but just on about the five largest, what they call the mega banks. And that might be okay, except that it’s being completely oversold as something that would supposedly ensure that there would never be a bailout, ensure that there are no implicit federal subsidy that would go to the mega banks. And it doesn’t do any of those things.

First, again, it leaves the great bulk of the systemically dangerous institutions essentially alone, only trivial changes in their capital levels. Even as to the mega banks, it doesn’t remove the thing that creates the implicit federal subsidy, which is the bailout of creditors. So it can’t accomplish its function. It’s incredibly naive. It acts like capital is something real, you know, that there’s a vault with capital there that protects us from losses. It’s just an accounting residual. And the way the banks get in trouble is by scamming the accounting. Indeed, the example that Brown-Vitter give as to why you need this rule, they say Lehman Brothers ended up with assets that were worth only $0.09 on the dollar. Well, then, what will a higher capital requirement do? Nothing to that. Right?

What you need is absolute vigorous bank examiners and supervisors, which gets us back into the first story, that Obama has deliberately appointed in many cases people who are exceptionally weak on regulation and supervision, and, of course, a Justice Department that has turned into a national scandal in terms of its complete refusal to prosecute the elite banksters that drove this crisis.

But it isn’t simply that Brown-Vitter does nothing to fix the severe problems in examination and supervision. It makes it worse, because it’s got a smear-your-examiner provision, in which they create this ombudsman, who is supposed to get anonymous attacks on the examiners—and, doubtless, the supervisors—which by statute under Brown-Vitter the ombudsman can’t alert the examiner to what he’s being charged with. The ombudsman simply runs a star chamber investigation in which the other side can’t defend itself, and then presumably in a number of cases pronounces the examiners guilty of whatever the latest smear is. So you’re taking what has been a terrible weakness in the crisis, that they destroyed effective examination, destroyed effective supervision. And then they want Brown-Vitter, a policy that’s dependent upon examination, which is absolutely dependent on restoring vigorous, effective examination, and instead the statute is going to further weaken examination and supervision by having this smear-your-examiner provision. And it’s all on this silly premise that you can make a tame scorpion out of the five biggest banks, which have proven to be even conservative finance scholars in a recent study said that at our largest banks, fraud was—and this is the word they used—pervasive.

Jay: Why don’t we see from other sectors of the economy, people that produce goods, that are not involved directly in owning or directly profiting from what the five big banks do in terms of what this virtually unregulated speculative activity, why aren’t we hearing any screams from these big companies in the tech centers of the economy or in the, you know, retail and all that? You would think they’d be screaming, ’cause they’re the ones—I mean, they’ll suffer again if there’s another crash triggered by these people. Or are they all just afraid of the big banks, and no one can afford to piss them off?

Black: No, I don’t even think it’s that. I think that ideological solidarity at the level of the wealthiest Americans, the plutocrats, is incredibly large. So there have been recent studies on this as well. And they show that the really, really rich, they have distinctly different views than the American people. And the first thing, the thing that drives them absolutely berserk, they think is the great crisis in the world, is not unemployment. They think it’s the federal deficit. Indeed, 25 percent of them said that the top priority should be inflation. Inflation is nonexistent in the United States. So the people that—you know, the Cato Foundations and things like this of the world have done, actually, a stellar job in creating a class consciousness among the plutocrats that says the banks are our friends and such.

But you’re quite right. The substance is: the banks have become the parasite. Or to go back to my earlier metaphor, they are the scorpion still. And they sting not just workers; they sting an enormous part of the real economy, what’s sometimes called Main Street.

Jay: And I would think they’d have a lot of, you know, leverage against these bigger companies that don’t directly profit from this speculative activity, although all of them probably participate to some extent or another, in the sense that, you know, they have to—they want to keep their stock price up, they don’t want anyone going after them. Someday they may need these banks for capital infusion. So you don’t want to cross swords with these guys, I would think, too easily.

Black: Well, you’re certainly right that they’re by far the biggest and the baddest parts of corporate America and they’re nasty. And, indeed, they pride themselves at their CEO levels on their nastiness and vindictiveness. But I think this is actually a time of overall minimal leverage. After all, Main Street is choking on cash, which it’s not investing because the economy is so low. So people don’t need to go to Wall Street.

Now, Wall Street has also done an excellent job conning—.

Jay: You mean corporate America’s choking on cash.

Black: Yeah, corporate America. The rest of us, obviously, are in huge troubles. But corporate America, Main Street, is choking on cash. And the other thing is that the banks have done a bang-up job in scamming their customers, and I mean their corporate customers, so that if you go to the GEs of the world and such, they are the huge defenders of derivatives, say, oh my god, we need to protect ourselves against this risk and that risk. Well—and there are some ways theoretically derivatives can protect against some risk. But what we’ve seen is that derivatives are the great risk. So that’s been a fabulous selling job. And, of course, the people that make the most money and the best sellers, they go to Wall Street, not to Main Street.

Jay: Okay. So you can’t get even measly regulation through. You can’t tame the scorpion. And the scorpion ain’t changing its nature. I guess most people know this little story by now. So you’re talking about let’s get rid of the scorpions. What does that mean?

Black: Yeah. So my thing is we’ve got to do three things. And the good news is economically it would make a better economy. The first of the three things is stop the entities that are systemically dangerous from growing. And many of them are growing very substantially.

The second thing is to order them to shrink over the next five years below $50 billion in assets, a point where they’ll no longer pose a systemic risk. And let them figure out how they’re going to do that.

And the third thing that we need to do—admittedly it assumes to some extent the answer—is to have hyperintensive regulation during that time period. Now, I do recognize that I just told you a story about how the Commodity Futures Trading Commission couldn’t even get fairly weak regulation, but that’s why I’m saying where our effort should be as progressives during that period is to be hypervigilant about the regulation.

Jay: So to get to what you’re talking about means a political transformation of the country, ’cause right now the scorpions control the politics.

Black: And that’s really my point is that the systemically dangerous institutions, first, they are so large that they are horribly inefficient and risky.

Second, they have this massive implicit federal subsidy that means that any of these, you know, odes you hear to free markets are completely fictional. And conservative scholars agree that there’s absolutely nothing free about the financial markets.

Then you have the fact that they do create these periodic crises that are getting worse. We simply cannot afford to have the next crisis.

And the final thing is the point you were raising. It is impossible to have a real democracy with these kind of systemically dangerous institutions. What you have instead is crony capitalism, and crony capitalism is the death of democracy.

Jay: Alright. Thanks for joining us, Bill.

Black: Thank you.

Jay: Thank you for joining us on The Real News Network.

And don’t forget there’s a Donate button somewhere around here. If you’d like to see these interviews with Bill Black and some of the other economic coverage we do at The Real News, we can only do economic coverage if your economics are in good shape, which means we need you to hit the Donate button.

Thanks for joining us on The Real News Network.