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    03-17-08 CP-The Fed's Wall Street Dilemma by PAM MARTENS

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    Mark Welkie
    The document discusses the Federal Reserve's bailout of Bear Stearns and criticism of how it enabled the problems on Wall Street. It argues that the Fed stopped being independent and took its orders from Wall Street. Repealing Glass-Steagall allowed banks to become "too big to fail" and led to the current crisis. The incentive structures on Wall Street prioritized greed over investors, creating artificial demand for risky financial products and concentrating counterparty risk among interconnected firms. Congress is blamed for repealing Glass-Steagall in response to Wall Street donations.

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    03-17-08 CP-The Fed's Wall Street Dilemma by PAM MARTENS

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    Mark Welkie
    57 views4 pages
    The document discusses the Federal Reserve's bailout of Bear Stearns and criticism of how it enabled the problems on Wall Street. It argues that the Fed stopped being independent and took its orders from Wall Street. Repealing Glass-Steagall allowed banks to become "too big to fail" and led to the current crisis. The incentive structures on Wall Street prioritized greed over investors, creating artificial demand for risky financial products and concentrating counterparty risk among interconnected firms. Congress is blamed for repealing Glass-Steagall in response to Wall Street donations.

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    The document discusses the Federal Reserve's bailout of Bear Stearns and criticism of how it enabled the problems on Wall Street. It argues that the Fed stopped being independent and took its orders from Wall Street. Repealing Glass-Steagall allowed banks to become "too big to fail" and led to the current crisis. The incentive structures on Wall Street prioritized greed over investors, creating artificial demand for risky financial products and concentrating counterparty risk among interconnected firms. Congress is blamed for repealing Glass-Steagall in response to Wall Street donations.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    57 views4 pages

    03-17-08 CP-The Fed's Wall Street Dilemma by PAM MARTENS

    Uploaded by

    Mark Welkie
    The document discusses the Federal Reserve's bailout of Bear Stearns and criticism of how it enabled the problems on Wall Street. It argues that the Fed stopped being independent and took its orders from Wall Street. Repealing Glass-Steagall allowed banks to become "too big to fail" and led to the current crisis. The incentive structures on Wall Street prioritized greed over investors, creating artificial demand for risky financial products and concentrating counterparty risk among interconnected firms. Congress is blamed for repealing Glass-Steagall in response to Wall Street donations.

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    of 4

    53407732.

    doc Page 1 of 4

    March 17, 2008

    Too Big to Bail

    The Fed's Wall Street Dilemma


    By PAM MARTENS

    Americans learned two new truths last week from the Bush Administration's version
    of Life's Little Instruction Book: if you're a Wall Street miscreant you're thrown a
    lifeline; if you're a Wall Street crime fighter you're thrown a land mine.
    In the first effort, the Feds effectively handed a Federal Reserve ATM card to
    JPMorgan to funnel your tax dollars to the teetering Bear Stearns brokerage firm to
    address counterparty risks that have been building for at least 4 years as the Feds
    snoozed. Counterparty risk is the trillions of dollars of insurance contracts (credit
    default swaps and other derivatives) taken out by Wall Street firms on each others
    (counterparty) bonds, bundled mortgage and commercial debt (collateralized debt
    obligations). The firms have used unregulated over-the-counter contracts to perform
    this risk transfer alchemy and funded their own company, Markit Group Ltd., to take
    the place of a regulated exchange for price discovery.
    In the second effort, the Feds tapped the Department of Justice, Internal Revenue
    Service, U.S. Attorney's office in New York, FBI, five federal judges and a busy federal
    court to root out that Code Red threat to our national security: consensual sex. The
    sex involved a prostitution ring and Democratic New York State Governor, Eliot
    Spitzer, who was savaged and forced to step down by an avenging media mob
    abundantly fed with well placed leaks from a suspiciously homogenous group called
    "anonymous law enforcement officials." Governor Spitzer, in his former role as New
    York State Attorney General, had taken the lead in rooting out Wall Street crimes
    against small investors because the Federal Reserve was preoccupied with lobbying
    to remove regulations on Wall Street's crime factory.
    As usual, the Feds handed the bill to the governed with no thought to the will of the
    governed.
    While mainstream media called the Bear Stearns bailout the first brokerage bailout
    since the Great Depression, in truth it was the second in seven months.
    The first brokerage bailout came without all the media fanfare because it arrived not
    on the wings of a public announcement but in five pages of indecipherable Fed jargon
    addressed to the General Counsel of Citigroup.
    Here is the effective message sent by the Federal Reserve to Citigroup in its letter of
    August 20, 2007: now that we have allowed you to become both too big to fail and
    too big to bail by repealing the depression era investor-protection law known as the
    Glass-Steagall Act at your mere beckoning, we have to bend more rules to keep you
    53407732.doc Page 2 of 4

    afloat. So, for example, the rule that says the Federal Reserve is not allowed to lend
    to brokerages, just banks, from its discount window can be tweaked for you by
    lending up to $25 billion to you and then we'll let you lend it to your brokerage arm.
    The Federal Reserve Act rule that says a bank can't loan more than 10% of its capital
    stock and surplus to its brokerage affiliate, we'll let you go as high as about 30% and
    say it's in the public interest.
    By giving Citigroup an exemption from Rule 23A of the Federal Reserve Act, by
    allowing it to funnel up to $25 Billion from the Fed's discount window to its brokerage
    clients who were getting hit with margin calls, the Federal Reserve and Chairman Ben
    Bernanke telegraphed an incredibly dangerous message to global markets: we're just
    as unaccountable as Wall Street. The Federal Reserve as enabler under Alan
    Greenspan created today's problem and today's Crony Fed under Ben Bernanke is
    killing off what's left of U.S. financial credibility. (I had barely finished typing these
    words on Monday, March 17, 2008, when a news alert came across my screen
    advising that the Federal Reserve was taking the breathtaking step of making direct
    loans to all brokerage firms which are primary dealers for Treasury securities.)
    The Federal Reserve is stumbling around in the dark and regularly bumping into the
    next bailout because it stopped being an independent monetary force and started
    taking its marching orders from Wall Street quite some time ago.
    Here's what Nancy Millar, President at the time of the National Organization for
    Women in New York City, presciently testified in writing to the Securities and
    Exchange Commission in August 2001. (Ms. Millar edited and signed this testimony
    while I and other Wall Street activists provided input. This testimony is available in
    full on the SEC's web site.)
    We thank the Securities and Exchange Commission for extending the
    comment period to September 4, 2001 in the critical area of bank
    oversight now that the lines between banks and brokerage firms have
    been blurred with the repeal of the Glass-Steagall Act.
    We believe that the comments made in the letter dated June 29, 2001
    from the Federal Reserve, the Federal Deposit Insurance Corporation
    (FDIC) and the Office of the Comptroller of the Currency should be
    disregarded in their totality. The banks of America have enough
    lobbyists and trade associations to argue their case before the SEC. It
    is not the charter or mandate of these three regulatory bodies to lobby
    on behalf of banks.
    The body of evidence that should dictate how the SEC must now
    proceed since Congress saw fit to eliminate the critical protections
    afforded the investing public in the Glass-Steagall Act, resides in the
    tens of thousands of pages of transcripts of the Pujo Committee
    hearings held in 1913 and the Pecora Committee hearings of 1933 and
    1934. Fancy promises from regulators that banks functioning in the
    dual role as brokerage firms can and will be self-policing is not what
    the SEC or Congress should rely on. The well-developed history of
    egregious abuses bestowed on the investing public prior to the
    enactment of Glass-Steagall, and since its recent repeal, is what the
    SEC and Congress must look to. To believe that the dynamics of power
    and greed have been materially altered in nine decades is to engage in
    naiveté at the public's peril.
    Our Nation's prosperity, democracy and the productivity of its citizens
    demand a level playing field to acquire and safeguard financial assets.
    Society crumbles when assets achieved through years of honest hard
    work can be fleeced by brokerage firms masquerading as insured-
    53407732.doc Page 3 of 4

    deposit banks. It is the role of federal regulators to maintain a level


    playing field through stringent regulation.
    We ask that the SEC immediately impose the same regulations that
    govern outside broker-dealers to securities' operations within banks.
    And, we herewith ask Congress to reconsider the repeal of the Glass-
    Steagall Act or be held accountable for the peril that unfolds from this
    unwise and inadequately deliberated decision.
    If ever there was evidence that America is now facing that peril, it was the most
    recent news that the Bush administration's much touted "free and efficient market"
    had priced Bear Stearns at $30 a share at the close of trading on Friday, March 14,
    2008 but on further examination of its books over the weekend, it was valued at $2 a
    share and absorbed by JPMorgan at that price.
    Equally troubling is the growing awareness among Wall Street veterans that neither
    the Federal Reserve nor the U.S. Treasury comprehend was has happened here,
    much less how to contain it. Here's what we heard from Hank Paulson, the Treasury
    Secretary, last week:
    "regulation needs to catch up with innovation and help restore investor confidence
    but not go so far as to create new problems, make our markets less efficient or cut
    off credit to those who need it."
    Innovation? Less efficient? Is there anything at all that looks innovative or efficient
    about Wall Street today? It is a seized up house of cards built on a toxic formula of
    hubris, corruption and free market madness.
    Before there is a complete breakdown, Congress must quickly address the five key
    reasons we have today's mess on our hands:
    (1) Incentive: from mortgage brokers paid higher fees to sell subprime loans rather
    than prime loans, to stockbrokers paid dramatically higher fees to sell mortgage-
    backed securities rather than U.S. Treasury securities, to investment bankers paid
    dramatically higher fees to package Collateralized Debt Obligations rather than issue
    plain vanilla corporate bonds, Wall Street has been incentivized to greed rather than
    honest service to investors.
    (2) Artificial Demand: The above outsized incentive produced a glut of unwanted
    and unneeded product that had to be eventually hidden off Wall Street's balance
    sheet in Structured Investment Vehicles (SIVs) or dressed up to look like Commercial
    Paper and buried in mom and pop money market funds. It is this glut and the lack of
    transparency as to where else this toxic paper is hiding that is creating the fear and
    panic on Wall Street.
    (3) Counterparty Risk: The regulators allowed Wall Street firms/banks to balloon
    their asset base and pretend they were meeting capital adequacy tests by buying
    "insurance" in the form of derivative contracts. There was only one problem with
    these "hedging" techniques; the counterparty in many cases was just another Wall
    Street firm or an inadequately capitalized municipal bond insurer. Instead of
    spreading risk, the risk was concentrated among the same players.
    (4) Glass-Steagall Act: Congress was incentivized through Wall Street campaign
    financing to throw reason and judgment out the window and repeal the only law that
    stood between the country and another 1929. Glass-Steagall must be restored; and
    public financing of federal campaigns is the only means of restoring the will of the
    governed to Washington.
    53407732.doc Page 4 of 4

    Pam Martens worked on Wall Street for 21 years; she has no securities position,
    long or short, in any company mentioned in this article. She writes on public interest
    issues from New Hampshire. She can be reached at [email protected]

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