The Geithner Letter

I do agree with the Amnesia analogy. We see it even in Europe today. Suddenly it’s “crisis over” yet printing money and providing extremely cheap debt to banks hardly seems like a solution. There has already been push back on anything that increases regulatory capital requirements. Now, in this period of calm is the time to push banks to raise regulatory capital – not through the “carry” trade but by raising real equity capital. Would it be dilutive? Yes, but a few hundred billion of new equity capital at the banks would be a real firewall – and the cost would come largely from those who benefit from all the policies. After Bear there was little real pressure on banks to raise capital and it came back to haunt us. Even this fall, BAC and MS were under extreme pressure largely because they haven’t raised the capital. Yes it’s dilutive, but necessary and a cost of being too big to fail.

But what I find most interesting is how much of the letter is devoted to Bear and the derivatives market. That makes perfect sense. What doesn’t make sense is how little has changed in those markets. The bulk of Dodd-Frank seems to include all sorts of provisions for consumer protections and other odds and ends that had basically nothing to do with the mess at Bear.  Is the derivatives market much less opaque now than then?  All evidence points to a conclusion that not much has changed. CDS isn’t on an exchange yet and even the more simplistic approach of SEF’s continues to face delay after delay. The Volcker rule is likely to be watered down over fears of liquidity.  Yet the bond market, particularly the more credit intensive part, still clings to the technology and methods of the 90’s. Bloomberg was the last real innovation in the high yield bond trading universe – it replaced Monroe calculators, which had replaced yield books. Other products trade just fine with limited prop trading and actual markets – rather than the MSG, 3 go 1 go monkey system, and phone calls pleading for an actual bid or offer. What other market has better prices for size trades than small trades?  The ETF’s are changing things, odd lot bond platforms are changing things, otherwise the street wouldn’t spend so much time bashing them. The arguments against the volcker rule have as much to do with protecting the archaic status quo as they do with providing liquidity. Though, frankly I think banks should be allowed to have prop bets, it just has to be adequately capitalized. With truly adequate capital rules – prop bets are fine and make sense, but less credit has to be given to “hedges” and more focus needs to be spent on extreme events and size of position.

I really think Mr. Geithner should re-read his letter, see how much space is devoted to Bear and derivatives, and get focused on the parts of Dodd-Frank that are meant to address them. It’s 4 years now since Bear and so little has changed.