Saturday, 14 August 2010

What are the US banks up to?


Fighting greed is not going to be easy even with new laws

IF anyone had apprehensions over the Finance Reform Bill that US President Barack Obama has pushed through to become law, they should look at what US banks continue to do.

It should be obvious from that, why the bill was so necessary in the first place. In fact, there is an increasing body of opinion that feels that the bill has not gone far enough to ensure that key financial institutions stayed on the straight and narrow and did not endanger all its stakeholders.

The reforms were signed into law last month and were heavily criticised by some sectors who felt that it permits too much interference by the state into the running of financial institutions, some of the largest of which had to be rescued through hundreds of billions of dollars of US government funding.

The eventual cost to the system and the fall-out caused by the collapse of major financial players on to all sectors of the US economy and the collateral damage to the world may easily raise the total cost of the collapse into tens of trillions of US dollars.

The underlying cause of this sorry episode was greed. The bankers were permitted to come up with increasingly complex and dubious financial instruments, which they packaged in all manner of wrapping, marketing it to all and sundry.

All that mattered under such a scenario was profit to the banks and enormous bonuses to staff.
Some traders earned more than US$100mil in a year.

The most profitable investment bank Goldman Sachs, even after its bailout by the US, paid out nearly 50% of its revenue – yes revenue – as bonuses in the second quarter of last year.

Goldman Sachs, which, as an investment bank, was not entitled to a bailout, had to change its charter to become eligible for US government assistance. Post bailout it also came to pass that it had profited enormously from a deal with the AIG group which posted massive losses as a result of underwriting sub-prime bonds.

The Finance Reform Bill was aimed at stopping some of these abuses and make it unnecessary for the US government to bail out the so-called “too big to fail” financial institutions by selling off their assets and having disincentives to let them grow too big in the first place.

It also aims to stop banks from using customer deposits to fund extremely speculative, hedge-fund-like activities although it is not clear how it proposes to do this.

Already this year, some of the major investment banks reported losses on some days from trading operations. Here are the reports from Bloomberg:

“Goldman Sachs, the bank that makes the most revenue trading stocks and bonds, lost money in that business on 10 days in the second quarter of this year, ending a three-month streak of loss-free days at the start of the year.

“Losses on Goldman Sachs’ trading desks exceeded US$100mil on three days during the period that ended June 30, according to a filing by the New York-based company with the Securities and Exchange Commission. The firm also disclosed that trading losses surpassed its value-at-risk estimate, a measure of potential losses, on two days.

“Morgan Stanley lost money on 11 days during the second quarter. The losses never exceeded US$75mil daily, and never surpassed the firm’s value-at-risk estimate. Morgan Stanley’s traders made more than US$175mil on one day, the firm said in an SEC filing.

“JP Morgan Chase & Co traders also broke their three-month winning streak, losing money on eight days in the second quarter, according to an Aug 6 securities filing. JP Morgan’s average daily trading revenue fell to about US$72.4mil during the second quarter from US$118mil during the prior three months.

“The firm made more than US$200mil on ten days in the first six months of the year.”

What do all these mean? How can a bank make US$200mil on one day and then lose US$100mil on another day? The answer has to be sheer speculation. High returns come with high risks – that should have been the lesson of the international financial crisis. But obviously that lesson has not been learnt. If banks, which have so recently been bailed out, speculate like that, we can expect that there will be every chance that there will be another crisis.

Obama is trying to prevent that through legislation but already he is being heavily castigated and criticised, especially by Wall Street, for his efforts.

One can only hope he has the guts to go through with it and that most people in the US do not fall for that emotional appeal by Wall Street profiteers to preserve free market and enterprise.

Wall Street needs to be regulated – now. If it is not, there is danger not just to the US but to the world at large.

> Managing editor P Gunasegaram says there is no such thing as a free market although there may be such a thing as a free lunch – sometimes.

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