Economy

http://itsoureconomy.us/2013/03/the-london-whale-and-the-real-link-between-the-us-economy-and-cyprus/

Many highly-respected Washington types have been running around for the last three years yelling that because of its large budget deficits, the United States is Greece. Then we learned last week that the immediate danger is the United States being Cyprus. As we now know, Cyprus is a small island country with a financial sector that has run amok, following in the footsteps of Ireland and Iceland. The assets of its banks were eight times the size of the country’s economy. This meant that when the banks’ big bets went bad, there was no way Cyprus’ government could afford the price of the bailout. As a result, Cyprus was forced to go hat in hand to the European Central Bank and accept whatever offer was put on the table. However the Cyprus crisis is finally resolved, it is not likely to be a pretty picture for the citizens of Cyprus.

As the Cyprus crisis was unfolding last week, we also got to see the report of the Senate Permanent Subcommittee on Investigations (pdf) on JP Morgan‘s losses at its “London Whale” trading division. The report chronicles a series of bad bets on derivatives that were compounded by traders doubling down their stakes. They concealed the size of their losses both to bank officers and regulators. The end result was a $6bn loss. JP Morgan is a huge bank and can swallow $6bn in losses, but the incident showed as clearly as possible that the Dodd-Frank reforms are not working. The London Whale’s losing trades were all done in the Dodd-Frank era. The bill’s provisions did not prevent JP Morgan from making massive bets and misleading regulators about their nature and the risks involved. If the regulators were not able to catch the London Whale’s huge gambles before they went bad, why would we think that they will catch the next crapshoot from the Wall Street gang? It’s time that we looked at this seriously: the regulators lack either the will or the competence to rein in the big banks. The big banks are going to get away with everything they want, regardless of the provisions of Dodd-Frank.

If the big banks are too big to regulate and, according to Attorney General Holder, too big to prosecute, then the only sensible course is to break them up. There have been some promising developments in this area. At the top of the list is Elizabeth Warren’s election to the senate. Senator Warren has already made it clear that she will use her seat on the Senate banking committee to try to hold the banks and bank regulators accountable. The other important development is that Warren seems to have an ally in Louisiana Senator David Vitter. At first glance, this might seem an unlikely alliance. Warren is clearly on the left side of the Democratic party and Vitter is to the right of center of a very conservative Republican party. But Vitter, apparently, takes his belief in the market seriously enough to realize that there is no place for “too big to fail” banks in a free market. The point is straightforward: if a bank’s creditors know that the government will cover its losses, the bank is gambling with the taxpayers’ money, not its own.

If there is ever going to be enough political force to break up the big banks, it will have to come from this sort of left-right coalition that moves in toward the center. As it stands, the leadership of both parties is too closely tied to the financial sector to take any steps that fundamentally threaten their interests. This has nothing to do with political philosophy: the leadership of both parties is owned by the financial industry. However, if the outsiders in both parties can build up enough popular outrage over Wall Street’s shenanigans, the party leadership will follow. There is precedent for this sort of left-right coalition. In 2009, Representative Alan Grayson, one of the most progressive members of the House, joined with Ron Paul, one of the most conservative Republicans, to co-sponsor a bill calling for an audit of the Federal Reserve Board by the Government Accountability Office. Over the next year, the bill gradually got more co-sponsors until eventually an overwhelming majority of members had signed on. It was difficult to see why the operations of such an important government agency should be exempted from normal oversight. As a result of this pressure, an amendment was slipped onto the Dodd-Frank bill that required the Fed to release the details of the $16tn in loans that were made through its special lending facilities. It will take the same sort of dynamic to create the political space where the big banks can be broken up. Of course, this effort will be much harder. It means pulling the big banks away from the public trough, not just releasing some embarrassing information. We can also expect the elite media to provide the same sort of condescension and misinformation in the battle to break up the banks as they did in the battle over the Fed audit. Proponents of downsizing the banks will be ridiculed, regardless of their expertise in finance. The big banks will be given every opportunity to push their line, in spite of its absurdity and the lack of supporting evidence.

It will be a tough fight. On its face, it seems that the Wall Street crew is invincible. But the London Whale episode and the silly efforts at cover-up should provide some grounds for confidence. These people can be pretty brazen in their contempt for the law and the general public. This arrogance on the part of the Wall Street gang is exactly what we need to give democracy a chance.