To save U.S. banks from losing their license to dangle the nation's economy over a cliff, the U.S. Federal Reserve and the country's elected elite threw them a bailout party and gifted them with the accounting- world's version of "Transformers. "
Unfortunately, new banking regulations aimed at solving these problems are little more than the same old song and dance that forced the bailout - and stuck U.S. taxpayers with a multi-trillion-dollar tab.
A Year After the Market Bottom - Happy Anniversary?
This month marks the first anniversary of Congress putting undue pressure on the Financial Accounting Standards Board (FASB) to gift banks with the ability to transform losses into profits by replacing mark-to-market accounting with mark-it-so-I-get-a-bonus accounting.ÂIt's no coincidence that it's also the one-year anniversary of the bear-market low - from which emerged the near-record-setting stock-market rally that sent U.S. share prices on a 70% rocket ride.
The future of the stock-market rally and of America's position as the world leader in financial services and capital-markets innovation is wholly dependent on having a healthy banking sector. We have a window of opportunity to undo some of the desperate - but sometimes necessary - measures that were put in place to save the U.S. financial system from a complete collapse.
So if this market rally signals that the worst of the crisis is over, thanks to a liquidity-filled punch bowl being fed by a government spigot, and if banks are making so much money, literally in the tens of billions of dollars, why don't we use this "window" to really clean up the U.S. banking system? Why don't we close banks that aren't solvent, break up all the too-big-to-fail banks, and set the stage for a long-term economic rally and a revitalization of the world's faith in the American brand of global capitalism?
We should take these steps. Indeed, some brave souls already are trying to move us in this direction. But other forces are undermining necessary bank-reform efforts and obscuring the transparency needed to determine the true value of the types of securities that drove us into the credit crisis and the Great Recession.
Here's what's not making the daily headlines. And here's what you need to know to participate in the backroom discussions now taking place.
It's Apparent ... it's Not TransparentFrighteningly, there is still no transparency in the pricing of asset-backed securities (ABS), including mortgage-backed securities (MBS) and collateralized-debt obligations (CDO) that are all widely held by banks. The banks like it that way precisely because they can still hide behind the accounting gimmickry that masks unrealized losses.
On March 1, a new Financial Industry Regulatory Authority (FINRA) rule - which was approved last September by the U.S. Securities and Exchange Commission (SEC) - went into effect.
According to the new rule, any broker-dealer that's subject to FINRA and SEC oversight has to submit trade, price and size data on transactions in debt (bonds) issued by federal government agencies, government corporations, Government Sponsored Enterprises (Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) are two examples) and primary corporate bond issues into FINRA's Trade Reporting and Compliance Engine (TRACE).
TRACE was established in 2002. It is the bond market's equivalent of the stock market "ticker tape." The tape is the scrolling data feed of all exchange-traded securities that lists the stock's symbol, the price of the transaction, and the number of shares traded - all in real time. Until March 1, TRACE only displayed trades on secondary corporate bonds. Trades in new issues of corporate bonds did not have to be posted.
In its conception, TRACE was designed to enhance the "ability to detect fraud, manipulation, unfair pricing and other misconduct" in the bond market. But while the new rules seem to add transparency, don't be fooled. Even if you read the FINRA release on the new rules, you may have missed an important subtlety: The rules apply to the bonds of government agencies and corporate bonds of issuers who package asset-backed securities; but they don't require any ABS, MBS, or CDO transactions to be posted.
There's another problem with this rule: It doesn't apply to banks.
Banks Pull End-Around on New RulesIn a letter to the Federal Reserve Bank and FINRA, the Regional Bond Dealers Association (RBDA) asked FINRA to suspend the new TRACE reporting rules because they correctly claim that it creates an unlevel playing field between bond dealers. According to the RBDA, bank-affiliated dealers constitute the Top 15 of all debt-and-equity underwriters in the country. The RBDA says that big banks are getting around the new reporting requirements by shifting transactions from their broker-dealer subsidiaries back to the banks themselves, since the banks aren't subject to the new rules.
So much for transparency.
On Oct. 1, two days after FINRA announced that the SEC had approved its TRACE reporting requirement and said the new provisions would take effect on March 1, 2010, FINRA issued another news release. The Oct. 1 release was a follow-up to the announcement that had been made the day before - or at least was supposed to appear that way.
Like its Sept. 29 predecessor, the Oct. 1 news release proposed the collection of transaction data on ABS trades. But there was one difference. This data would be entered into TRACE, but would not be publicly disseminated.
If you study the March 1 FINRA news release announcing the start of the new TRACE reporting rules, there's no mention of any trading data being collected on asset-backed securities. If you hadn't seen the earlier FINRA release, the only way to find that important tidbit of data would be to dig it out of the Federal Register, Vol. 75, No. 39 (Monday, March 1, 2010) - which is what I did.
Granted, this is a highly technical point.
But it's also highly relevant to the discussion at hand.
Neither FINRA nor the SEC has any authority over bank regulation. The SEC has authority over publicly traded corporations, but when it comes to banks the agency usually yields to each individual bank's primary regulatory authority. The new TRACE rules don't apply to banks: They apply to broker-dealers owned by banks and to smaller broker-dealers not affiliated with any banks. Big banks get a pass on two counts: first, they can route transactions from their broker-dealer subsidiaries through the banks themselves (thus not posting transactions and prices) and, second, they can route trades back through their broker-dealers when they want to post transactions at favorable prices against which they can mark the assets on their balance sheets. A similar "marking" technique, called "painting the tape," is used in equity trading when someone tries to post the last trade of the day at a price that benefits their position for margin or other purposes.
Since FINRA isn't going to disseminate ABS transaction- and- pricing information, these new rules will fail to create the transparency that has been missing from the U.S. banking sector and the U.S. capital markets. Remember, it was the lack of transparency into the pricing, types and amounts of liabilities banks were carrying on their balance sheets that served as a key financial-crisis catalyst in the first place.
FINRA has indicated that it may eventually post ABS- transaction data, but unless new regulations call for it, escalating pressure from institutions carrying heavy loads of these securities may ensure that the data is buried.The purpose of the "tape" is to show all exchange-listed transactions so that no back-room manipulation can distort equity markets (don't get me started on that one). TRACE was supposed to be a fraud-and-misconduct detection system for the U.S. bond market. Instead, it's a joke. Even worse, the new rules could actually now operate as a high-tech Trojan horse, giving still more inside knowledge to the Masters of the Universe who already possess major advantages by virtue of the massive capital pools and political influence that they control.
We clearly haven't learned a thing. As we observe the first anniversary of one of the biggest stock-market rebounds in U.S. history, it appears the driving force behind this bounce off the bear-market bottom was the healing and strengthening of America's banking system.
The truth, however, is that the new rules enacted to ensure this healing are nothing but a thin veil to further enrich banking-sector executives by pumping up their compensation pools. Given such a realization, we better make sure we have our stop-loss orders down and our hedges in place.
U.S. taxpayers and retail-level investors have been taken into the heart of the forest - and intentionally abandoned. The only way to escape is via a pathway paved by true transparency and real accountability.
At a time when banks are fat with profits - even as deep problems remain - these institutions should be prohibited from making bonus payments, and should instead be forced to write down all their non-performing assets in accordance with proper accounting standards. The projected bank bonus pools would cover most of those write-downs over the next few years.
We have a chance to celebrate a second anniversary of stock- market gains and another year of economic growth, but to ensure that prospect we need to start to break up all the too-big-to-fail banks. Once the giants are cut down to size, maybe we can have real transparency and not be afraid of being driven over a cliff by a bunch of greedy, drunken party boys.
[Editor's Note: Money Morning Contributing Editor R. Shah Gilani has seen it all - which is why his columns and analyses have been read by millions.
A retired hedge-fund manager and gifted analyst, Gilani is able to take readers behind Wall Street's "velvet rope," exposing pitfalls that can inoculate investors against ruinous losses even as he highlights profit opportunities that most other experts never even recognize.
Gilani's newest advisory service - The Capital Wave Forecast - is slated to debut next week. In that service, Gilani will show investors the monster "capital waves" now forming, will demonstrate how to profit from every one, and will make sure to highlight the market pitfalls that all too often sweep investors away.
Watch Money Morning next week for more information on The Capital Wave Forecast - as well as for the profit opportunities Gilani so regularly uncovers.]
News and Related Story Links:
Money Morning Special Investment Report:
A Year After the Bear-Market Bottom, Investors Must Still Pursue Profits - Without Ignoring Risk
Financial Accounting Standards Board:
Official Web Site.
Money Morning Special Report:
By Relaxing "Mark-to-Market" Rules, Has the U.S. Switched Off its Financial Crisis Early Warning System?
Money Morning News Analysis:
Rising Tide of Level 3 Assets a "Disaster Waiting to Happen."
Money Morning Commentary:
It's Time For "Banks" to Stop High-Risk Trading
The Washington Post:
Banks 'Too Big to Fail' Have Grown Even Bigger.
Too Big To Fail.
Collateralized Debt Obligations.
Financial Industry Regulatory Authority:
Official Web Site.
Financial Industry Regulatory Authority Press Release:
TRACE Bond Reporting to Now Cover Government Agency Debt; SEC Approval of FINRA Rule Also Expands TRACE to Primary Bond Market.
Tale-of-the-Tape - the Stock Market Ticker Tape.
Regional Bond Dealers Association:
Official Web Site.