On Thursday, two panels of experts will convene at the American Enterprise Institute For Public Policy Research in Washington, D.C., to consider policy issues raised by the current state of the financial bubbles in the United States and the European Union that led to the prolonged recession that still grips these economies. The series started after I introduced the principals, and the sessions usually begin with musings about the fact that ‘here we are again.’
One of the questions considered at these meetings is where the U.S. housing market stands. This time there will be some evidence that the market has bottomed and that some markets are showing significant appreciation. There also seems to be a boomlet in mortgage refinances, and in a segment on CNBC Monday, several banks — Wells Fargo, PNC, US Bancorp and Fifth Third — were touted as benefiting from this business. This raises the question of whether the policymakers are doubling down on their commitments to this industry and setting the stage for another round of failures of banks, mortgages companies and related participants in this notoriously cyclical business.
Another question on the agenda is the role of the Federal Reserve and the European Central Bank as investors of last resort in any securities that seem to need support in order to keep the banking system afloat. One principle that has long been established is that each country is responsible for the capital position of its banks. For the United States, this runs counter to the claim of the regulators that the policy of ‘too big to fail’ is over and that the largest banks must prepare for a possible breakup. Former Treasury official Roger Altman committed truth recently when he stated bluntly that ‘too big to fail’ is still alive, and this is a good thing for the international economy.
The manifold implications of central bank management were illustrated Monday when an analyst pulled the plug on the junk bond segment on the ground that defaults are about to rise and that the Fed’s quantitative easing policy has made it impossible to achieve price discovery. An overlooked effect of intervention is that it creates crowded trades that can themselves become sources of systemic risk. When Chuck Prince was still running Citibank, he famously said that he tries to determine whether the dance is still going on, and he jauntily boasted that as far as Citi was concerned, “We’re still dancing!”
As the years go by and the nature of the crisis evolves, the dance become reminiscent of the dance marathons of the Depression era, as the dancers spent their last bit of energy trying to outlast the other dancers. It looks like the Treasury and Fed have succeeded in ensuring that the economy will limp along, at least through the election. Fed Chairman Ben Bernanke has hinted that the Fed might have some tricks to help manage the fiscal cliff if Congress fails to take timely action.
Perhaps the most likely source of the next crisis event is the extent to which banks are funding long-term assets with short-term liabilities. This is a variation of the duration mismatches that brought down the savings and loan industry and the housing government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Now the ‘too big to fail’ banks have become GSEs in their own right and count on the Fed to buy any assets that become illiquid, as investor preferences rotate in the normal course of financial markets. The existence of this “Bernanke Put” in turn encourages bankers to test the system in order to derive the greatest possible benefit from the federal safety net.
Note one possible trading glitch: CNBC had a segment on a finding that 4 percent of trading last week was traced to a single algorithm, but that no trades were actually executed. This led to a discussion of measures the regulators are taking to improve their surveillance of the markets. One that was cited was the purchase of proprietary software that should enable newly hired staff to get a better view of what algorithms might be doing. Another was that the Securities and Exchange Commission is putting in place a Consolidated Audit Trail (CAT), which will enable real-time surveillance. However, the latter is manifestly not true. The regulation the SEC adopted merely calls for the industry to come up with a plan for a CAT, and amazingly, the plan specifically provides that data should not be received before 8 a.m. on the next day after trading. A former regulator from the SEC discounted the notion that real-time data are needed and worth the cost. So, the SEC is bound to remain far behind the curve when it comes to monitoring the high-frequency trading and other anomalies have become the “new normal” in securities markets.
Robert Feinberg served on the staff of the House Banking Committee for 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms, and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog, and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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