Finreg Please Don’t Be Serious Edition: House Dems Dismantling the Volcker Rule?

(Update at end.)

I explained before how Bear Sterns had a $40 million dollar upfront bet sponsoring a hedge fund that ended up putting them on the hook for billions of dollars in losses. That’s how it goes sometimes with hedge funds, especially with complicated strategies and tail risk. Implosions can go big, quickly. That’s the risk that the investors take: but is it risk that needs to be attached to someone with a commercial banking charter?

And what are Democrats doing fighting for State Street’s ability to put a hedge fund and shadow bank right in the middle of their crucial, boring custodial business? Did they like the business model of AIG and State Street, and the subsequent bailouts, so much they want to do it all over again?

Brian Beutler makes a great catch: Behind Closed Doors Four Key Democrats Maneuver To Weaken Financial Reform. Brian (my bold):

Two sources identified four House members on the conference committee–Reps. Dennis Moore (D-KS), Gregory Meeks (D-NY), Mel Watt (D-NC), and Luis Gutierrez (D-IL)–who have privately pushed to write a loophole into the Volcker rule which would allow banks to invest in hedge and private equity funds. That loophole has the strong backing of Bank of New York Mellon, and State Street Bank and Trust among other firms, but is fiercely opposed by Volcker himself, who has had tremendous influence over the shape of the reform bill. Volcker was supposed to meet with the Democrats yesterday to warn them away from supporting this loophole, but the meeting was canceled at the last minute.

Hey look, it’s noted TARP-recipient State Street Bank lobbying and teaming up with Democrats! Remember the Cambridge Winter analysis, released this week, of the complete 2008-2009 failure of State Street and the subsequent taxpayer bailout? If you are interested in reform and the lobbying process read it again (here’s my discussion of it).

State Street runs the custodian business of 19 trillion dollars in assets. This is the business of physical and electronic safekeeping and record-keeping of equity, fixed-income, and money market securities for institutional investors. It’s really low margin, high volume, and boring. Essential, but boring. If one of these firms had a major guns-blazing-into-failure collapse like Lehman did, it would destroy a large part of the world economy. Hence the reason we bailed it out when its shadow banking division collapsed in 2008-2009. How bad would it have been if it had collapsed? Here’s a commenter from my coverage post:

Let’s not forget that SSgA manages some of the most widely traded securities in the world: the SPDR ETFs and the GLD ETF (State Street stores more physical gold than all central banks combined). Plus the fact that they manage investments for thousands of the nation’s biggest pension funds, especially their passive investments.

The panic effect caused by a State Street bankruptcy would probably be bigger than any bank failure, anywhere in the world, since the 1930s. I’d say it’s the financial equivalent of shutting off a sizeable portion of the US electric grid for weeks at a time. But I suppose this is very unlikely.

And here’s Raj Date following up with me:

Hedge funds fail all the time; P.E. funds do too. That’s sad, I’m sure, for the principals, and the investors, but that’s just life in the big city. But that doesn’t mean you should deliberately create a structure in which their failure brings the system down with them, or a structure that allows them to siphon value from a bank charter that exists for a decidedly different reason. Frankly, it is the separation of these vehicles — all of which serve legitimate purposes — from the banking system that enables us to ‘just let them them fail.’

And it’s hard to imagine what failure (aside from the failure of a major sovereign, or of quasi-sovereigns like the GSEs) would be more disruptive than that of a major custody bank. These firms — State Street, Bank of New York, JP Morgan — are a big part of the central nervous system of the markets. If you thought Lehman was bad — well, my advice in that case would be: buckle up, you’re in for the scariest ride of your life.

And there State Street goes, lobbying away to make sure it can continue to do the very things that required taxpayers to bail it out the first time around.

Raj’s quote is important here: Hedge funds fail everyday. And I encourage people to start hedge funds, and to start commercial banks. But just don’t do them in the same place, a place where the main benefit is getting to siphon value off the bank charter. Here’s State Street getting bored and placing a shadow banking casino inside their firm:

And of course it collapsed, and of course the taxpayer has to step in to pick up the tab. Instead of expanding access to state colleges (or prisons if you are a conservative, it’s a big tent in financial reform), us taxpayers get to spend our tax dollars doing the following:

That’s the bailout we just did of State Street bank. Click through to see it in all it’s gory details. And here they are, not even 2 years later, demanding that the one reform which would have stopped that be gutted. And we will get to do this crisis all over again hoping that everyone learned their lesson. And that’s the problem. It’s that the lesson State Street may learn is that it will get bailed out and still get to write sections of the financial reform bill.

And it is possible that Reps. Dennis Moore (D-KS), Gregory Meeks (D-NY), Mel Watt (D-NC), and Luis Gutierrez (D-IL) are running point for this bailed out firm in dismantling the Volcker Rule. I hope they clarify.

UPDATE: Brian reports “Gutierrez’s spokesman Doug Rivlin calls to say that his boss hasn’t taken a position on the Volcker rule. “Volcker rule isn’t something that he’s been working on,” Rivlin says, noting that Gutierrez’s main concern is with the portion of the reform bill dealing with resolution authority. Gutierrez wants a liquidation fund to be created in advance of the failure of any systemically significant financial firm–the Senate bill calls for those funds to be raised in the aftermath of a failure.”

That’s very good to hear. Gutierrez, in addition to being my old congressman, is leading the fight on the prefunding resolution, which I am rooting for him as it is a major thing to make resolution authority credible.

I still hope for clarifications from the other three.

This entry was posted in Uncategorized. Bookmark the permalink.

2 Responses to Finreg Please Don’t Be Serious Edition: House Dems Dismantling the Volcker Rule?

  1. Guillaume says:

    Sorry, my numbers were inflated. Actually State Street is the world’s seventh largest holder of physical gold, ahead of China:

  2. Jim says:

    A commenter wrote: “Let’s not forget that SSgA manages some of the most widely traded securities in the world: the SPDR ETFs and the GLD ETF (State Street stores more physical gold than all central banks combined). Plus the fact that they manage investments for thousands of the nation’s biggest pension funds, especially their passive investments.”

    Mutual funds and ETFs are generally separate entities from the firms that manage them. Their assets don’t show up on the manager’s balance sheet. In the event of a fund manager’s bankruptcy, the individual ETFs would probably continue normal operations. Fund management is basically just a fee for service activity for the bank. In any bankruptcy, the solvent parts of the business are kept running while the courts work out the restructuring.

    The ETFs are probably exposed to counter-party risk from transaction clearing and securities lending, but that’s another matter. I would have guessed that the funds would have insurance to mitigate this, but I don’t know how this works exactly. (Funds love to engage in securities lending because the revenue it generates can shave a bunch of basis points off expense ratios).

    In any case, there’s no risk that a bankruptcy court could force the gold held by GLD to be liquidated as part of a State Street bankruptcy.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s