Several banks in the United States passed a stress test by the Federal Reserve this week that probed whether they met minimum standards for capital adequacy, debt management and liquidity in the event of another financial crisis.
Part of a package of reforms under the Dodd-Frank Act following the 2008 financial downturn, these tests were also designed to ensure banks could withstand smaller shocks to the sector when they occur.
The Feds administered the test to 34 U.S. banks on June 28 and banking stocks and indices that carry a significant weighting of financial stocks shot up on news that most of them had passed.
In fact, ace investor Warren Buffett made himself a profit of US$12 billion this week, driven as much by market reaction to the stress test as the leap in the price of two of his investments in Bank of America and Wells Fargo which, you would recall, was fined last year for fraudulently issuing credit cards to more than half a million customers without their authorisation.
Wells Fargo moved quickly to oust CEO John Stumpf and revamp its governance framework to prevent a repeat of the phantom banking that cost it more than US$180 million. As it turns out, investors seem inclined to give them an opportunity to redeem themselves on Wall Street.
Predictably, the big banks sought to use their performance on the stress test—and the Fed’s own conclusions about the results—to renew calls for more relaxed regulations across the banking sector and amendments to the Dodd- Frank Act.
"This year's results show that, even during a severe recession, our large banks would remain well capitalised," Governor of the Federal Reserve Jerome H. Powell said in a statement. "This would allow them to lend throughout the economic cycle, and support households and businesses when times are tough."
The new regulations, you will recall, came into effect under the Obama administration for all the right reasons after a series of bailouts and acquisitions of key players like Lehman Brothers and Bear Stearns.
Yet one of the first campaign promises of President Nimble Thumbs was to undo the Dodd-Frank Act and allow banks to take more risks. Theoretically, such a move could boost their stock performance.
But it could also result in another major financial meltdown if these firms go rogue again.
Without getting too political, I expect a significant part of the new leadership’s policy—if the word “leadership” could even be used here—is to undo much of what the Obama administration put in place with little regard to the harm that could accrue to the U.S. and the rest of the world.
Ostensibly, some U.S. bankers are using technical arguments to mask a more personal political agenda. One aspect of the Dodd-Frank Act they obsess over is the Volcker Rule. In short, this rule was put in place to prevent banks from using depositors’ funds for speculative investments rather than traditional lending.
Before the Volcker Rule many of the investments originated by U.S. investment banks and sold globally with “investment grade” credit ratings were funded with banks’ core capital rather than capital apportioned for non-traditional investments.
In reality, the products they marketed and sold were far from investment grade. Instruments such as subprime mortgages found themselves on balance sheets far and wide. Defaults on weak underlying assets were all but guaranteed.
The aftermath of the subprime crisis which we are still feeling today ought to serve as reminder that not so long ago, without the protection of strict regulations, the financial world fell apart.
Following this relatively unpunished debacle, it was the wide-ranging financial sector reform known as the Dodd-Frank Act that led to significant recovery in the global financial markets. Trinidad and Tobago would do well to learn from Dodd-Frank in the wake of the CL Financial crisis which took place just months after U.S. markets collapsed in 2008. President Nimble Thumbs would do well to leave these regulations untouched.
Eight years ago, Clico executives tried to hide behind the U.S. meltdown in some misguided attempt to convince Trinidad and Tobago citizens that Clico’s crash had nothing to do with greed, the exploitation of public trust and the absence of serious financial regulations.
But it did. Clico’s crash had everything to do with greed, the exploitation of public trust and the absence of serious financial regulations.
Yet financial crises are crises of confidence. As the local regulator, the Central Bank had no choice but to step in to reestablish confidence in the sector. Both the government and the Central Bank had a duty to preserve the integrity of a local financial sector facing systemic risk.
It happened with a TT$20 billion bailout of the embattled conglomerate which helped CL investors—who, for years, had been raking in supernormal returns—recover a decent portion of their investments.
There was some regulatory reform coming out of the CL Financial debacle with amendments to the Financial Institutions Act (FIA). A key amendment came in the form of Section 46 of the FIA which now mandates financial institutions to limit investments between related companies within a group.
Defined in the Act as “Connected Party Exposures,” it’s an attempt to prevent related parties investing in each other above certain prudential limits to avoid a complete collapse if one entity went under. Like Dodd-Frank, the changes to the FIA were driven by the need to preserve public trust in the system. But was it enough?
In the United States, authorities brought the likes of Bernie Madoff and Allen Stanford to justice. That meant the liquidation of personal assets and jail time. To this day, that kind of justice is not part of the laws and regulations that govern Trinidad and Tobago’s financial system.
The mess created by a few mercenary CL executives paved the way for the collapse of the Clico Investment Bank, Clico Mortgage and Trust, Caribbean Money Market Brokers (CMMB), British American Insurance and hurt a lot of people.
Your guess is as good as mine as to who will have the political will to drain the swamp here.