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Presenta8on to Federal Reserve Bank of Chicago
TBTF – A Viable Business?
Earnings growth is not from core banking ac8vi8es:
• Investment Banking
• Cost cuMng driving income. Last quarter:
• Wells revenue growth was ﬂat, income up 20%;
• Bank of America revenue growth 3%, income up 70%;
• Ci8 revenue growth 8%, income up 26%;
• JPMorgan revenue growth 14%, income up 32%.
Gramm-Leach-Bliley Act’s allowance of ‘nonﬁnancial ac8vi8es’
Legal requirements that the Federal Reserve must address when considering Gramm-Leach-Bliley Act’s allowance
of ‘nonﬁnancial ac8vi8es’ is: “the aaributed aggregate consolidated assets of the company held by the holding
company pursuant to this subsec8on, and not otherwise permiaed to be held by a ﬁnancial holding company, are
equal to not more than 5 percent of the total consolidated assets of the bank holding company, except that the
Board may increase that percentage by such amounts and under such circumstances as the Board considers
appropriate, consistent with the purposes of this Act”.
Perhaps we should consider whether ﬁve percent is s8ll an appropriate threshold. When one company can have its
hands on 50% of all metals on LME and s8ll be less than 5% of total assets, the ques8on becomes one of
compe88on rather than arbitrary thresholds.
Conﬂict between the private mo8ves of managements, with their primary obliga8on to shareholders, and the
public interest are not rare. They exist and are the fundamental reason for regula8on within industries. Where
these conﬂicts lead to abuses that circumvent regula8on they oeen can lead to failure, as was the case with Enron.
– Where Enron could be shut down easily, the reality is that our systemically important ﬁnancial ins8tu8ons
are more complex.
– Unlike a bank, Enron did not have ability to drive capital away from compe8tors and this reduces the
development of natural compe8tors and possible successor ﬁrms.
– Enron did not have the explicit guarantee that backs the deposits of our banks or the implied guarantees s8ll
conferred by the market, even in the wake of the Dodd-Frank Act.
Given the various forms of “control”, one should ask how much can that threshold can be gamed and what the
banks are coun8ng as being in their control? As we have now seen, the banks may abide by the leaer of the
regula8on but not its spirit, ﬁnding various loopholes to exploit as they conduct their business.
– JPMorgan’s "tolling agreements" with electricity generators are a means for them to buy and sell power
without having to own it. Five-percent appears to be an arbitrary number and easily manipulated as a liar
Our government and central bank have allowed an unprecedented mixing of banking and commerce.
– The result of these changes directly supported fomenta8on of the ﬁnancial crisis.
– The complexity of the interconnec8ons made it harder to resolve trouble ﬁrms without further
nega8ve consequence to wholesale funding markets and ﬁnancial intermedia8on in the real
– As interconnectedness and unrecognized risks became apparent yet incalculable, counterpar8es
backed away from each other, even in markets with liale dura8on risk.
S8ll, even in the aeermath of the crisis the Federal Reserve has acted to further allow expansion of bank
ac8vi8es into non-tradi8onal businesses. Businesses that pose the real poten8al for new and systemic
risks and would require the Federal Reserve to once again become the central party ac8ng between ﬁrms
that otherwise would not transact with each other.
Is Anybody Listening?
Should we ignore the warnings?
– “Lee unchecked, the trend toward the combining of banking and business could lead to the
forma8on of a rela8vely small number of power centers domina8ng the American economy. This
must not be permiaed to happen; it would be bad for banking, bad for business, and bad for
borrowers and consumers.” – Richard Nixon (1971, aeer the 1970 amendments to the Bank Holding
– “Widespread aﬃlia8ons of commercial ﬁrms and banks [carry] the ul8mate risk of concentra8ng
banking resources into a very few hands, with decisions aﬀec8ng these resources inﬂuenced by the
commercial ownership links, resul8ng in inevitable conﬂicts of interest and impairment of impar8al
lending judgment.” – Paul Volcker (1987, as the White House contemplated “Superbanks”)
– “I have not heard any concern over the years that American banks are not ac8ve compe8tors
interna8onally. They have been at the cuMng edge of interna8onal banking compe88on and we
have very ac8ve interna8onal compe8tors among the American banks.” - Paul Volcker (1987
responding to comments on the Japanese & German banking systems)
No!, The Federal Reserve Board should not allow banks to be in businesses that don't directly support the
resilience of the payments system or the stability of FDIC insured deposits.
JPMorgan – An Example to Consider. Are Regulators equipped to
Enforce Exis8ng Orders?
In 2005, the Federal Reserve, in an Order to the BHC decided that: “Based on JPM Chase’s policies and
procedures for monitoring and controlling the risks of Commodity Trading Ac8vi8es, the Board concludes
that consumma8on of the proposal does not pose a substan8al risk to the safety or soundness of
depository ins8tu8ons or the ﬁnancial system generally and can reasonably be expected to produce
beneﬁts to the public that outweigh any poten8al adverse eﬀects. ”
“To minimize the exposure of JPM Chase to addi8onal risks, including storage risk, transporta8on risk,
and legal and environmental risks, JPM Chase would not be authorized (i) to own, operate, or invest in
facili8es for the extrac8on, transporta8on, storage, or distribu8on of commodi8es; or (ii) to process,
reﬁne, or otherwise alter commodi8es.”
Without waivers, approvals or any pushback from the Fed’s Reg/Sup or General Counsel’s oﬃces, JPM
repeatedly violated this order.
– Between 2008 and 2010, through its purchase of Bear Stearns and parts of RBS Sempra, JPMorgan
acquired a number of power plants, electricity tolling agreements, and the metals concentrates and
warehouses of Henry Bath.
– This can not be considered “grandfathered”, approved under merchant banking nor jus8ﬁably
subject to extensions to dispose. Aeer all, the 2005 Order covered the holding company.
A New Focus for Our Largest Banks – Commodi8es &
Our largest bank holding companies now seek further control over other nonﬁnancial infrastructure assets
through the long-term leasing and control over America's patrimony, in return for short-term inﬂuxes of
cash. We're on the threshold of a new Gilded Age, where the fruits of all are enjoyed by a few.
In 2003, with the stroke of a pen, the Federal Reserve razed the walls between deposits and commerce
with its approval of Ci8’s ownership of Phibro, a nonﬁnancial business.
It did so again, in 2005, when it approved JPM's entry into the physical commodi8es business.
Risks grow exponen8ally and complexity of new oversight is liale considered.
– Although the Federal Reserve remains the primary regulator of our Federally chartered bank holding
companies, today these banks operate businesses overseen by:
• The Federal Energy Regulatory Commission;
• state u8lity regulators;
• The Commodity Futures Trading Commission;
• The Securi8es and Exchange Commission;
• commodity exchanges;
• interna8onal regulators
Control Rather than Ownership
Today, there are few ﬁnancial assets classes lee to support growth of the size necessary to generate
returns propor8onal to our largest banks’ needs.
Our largest bank holding companies now seek to “control” other nonﬁnancial infrastructure assets.
The control of assets in which the public has funded and invested, oeen for genera8ons, by our largest
ﬁnancial ﬁrms should give elected oﬃcials and regulators pause.
Why Control Assets Rather than Owning them
Avoid 5% Threshold.
Avoid consolida8on of assets.
Retain opera8onal control as General Partner and asset manager.
“Monopolis8c” and “quasi-monopolis8c” nature of the assets.
Can “support more debt / leverage without incurring more risk than real estate”.
Have “aarac8ve inﬂa8on protec8on characteris8cs”.
So, What’s the Problem?
Example: By 2011, warnings were being sounded before the United Kingdom’s House of Commons.
– “I believe there is a lot we can do just by enforcing correct commercial law. For example, on the
London Metal Exchange there are four very large companies that own the very warehouses that
people deliver metal into. J.P. Morgan is one of them. They own a company called Henry Bath. They
are, therefore, a ring-dealing member of the exchange and they also own the warehouse. That is
restric8ve. They were also reported, at one point, to have had 50% of the stock of the metal on the
London Metal Exchange. That is manipula8ve. These are things that we can do something about
here. That would mean the copper price probably would not be $10,000 a tonne, which is higher
than for some forms of 8tanium. That price is not down to the fact that the metal is not being mined,
it is because of such ac8ons. ”
Energy Market Manipula8ons:
– In 2013
• Sealed with FERC for “engaging in 12 bidding strategies in wholesale energy markets from
September 2010 to November 2012, resul8ng in tens of millions of dollars in overpayments
from the grid operators”;
• FERC ac8on over aaempts at preven8ng the implementa8on of state-requested changes to
two California power plants. Seemingly aaempted to prevent new capacity from reducing
So Far, No Pushback
Our largest banks now control numerous:
– Electric utilities;
– Gas utilities;
– Water utilities;
– Sewer utilities;
– Wind power farms;
– Solar power generation;
– Parking garages;
– Rail leasing;
– Parking meters;
– Charter schools.
More regulators in more jurisdictions? How will that oversight and coordination fare?
Labor disputes due to replacement of municipal union contracts.
Conflicts of interest dues to:
• Municipal advisory business;
• Municipal debt management;
• Investment banking clients as ‘preferred partner network’ ;
Often retain the operational risk in these non-financial transactions
Always retain the reputational risk:
– Chicago Parking Meters;
– Failed toll roads;
– Price fixing in metals;
– Manipulation in regulated energy markets.
– Manipulation of forex markets.
– Manipulation of LIBOR
Where potential liability costs exceed asset value, risk is systemic and reverts to taxpayer regardless of DFA.
If bank controlled Valdez, Bhopal facility, Fukushima:
• Counterparties would demand more collateral against positions;
• Bank liquidity would be strained;
• Counterparty concerns would become contagious;
• Fed would have to step in to stabilize system.
– Could this ever happen? Hasn’t it?
How are They Sourcing these Deals?
Municipal advisory work (not a great track record of integrity… bid rigging, illegal payments to
Press and editorial validators
Strategic partnerships and think tanks
Na8onal Partners in Homeownership
Na8onal Homeownership Strategy
– Pioneered for poli8cal purpose
• Aﬀordability at 20 year low in early 1990’s;
• Access to credit constrained;
• Asset value stagnant;
– Goals on homeownership
• Move housing assets oﬀ government balance sheet onto private sector;
• Reach all-8me record levels of ownership by end of the decade;
– Methods to achieve them
• “innova8ve ﬁnancing”;
• New mortgage products;
• Reduced down-payment;
• Changes in appraisal process.
Sounds a lot like same old story
Similari8es to Warehouse Lending in Mortgage Finance
Single, third party origina8on assignment leads to
• Warehouse lending for 2-4%
• Provides assets to securi8ze;
• Provides principal and agency trading opportuni8es;
• Provides informa8onal advantages;
• Provides opportuni8es to oﬀer second lien loans and reﬁnancings
• Provides mortgage servicing opportuni8es;
• Provides new investment banking engagements (manage deal ﬂow to client = debt/equity issuance
Unfortunately it can also lead to :
• Adverse selec8on of warehouse borrowers;
• Poor due diligence;
• Fraud claims;
• Firrea Claims;
• Unmanageable leveraged liabili8es…
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