It may sound overly basic, but the times being what they are there is a very well deserved need to be elementary about certain things again. That starts with banks and really defining what is and is not one. When money was money, banking was a very simple procedure, though not quite so stylized and rudimentary as it is often recollected. There was just as much sophistication, but under those terms where delineation was bright because money was just so concrete, wrong-doing had to be almost in plain sight and at the very least easily understood.
I have written before, many times, how rehypothecation and especially repo fails are anti-capitalist, well those are just the visible parts that offend the desire to create an efficient, helpful monetary system that aids the real economy rather than the other way around. In furtherance of that effort, Bloomberg today offers a very compelling story delving a layer or two further inside the offense. You really should read the whole thing, but this part is especially poignant:
Further illustrating the incestuousness of the deal, Paschi would need to buy the bonds and hand them over to Deutsche as collateral. Deutsche, for the sake of its own accounting, would need to sell the bonds to come up with cash that it then would give right back to Paschi to pay off the Santorini loss. And Paschi would buy the bonds in the first place from a third bank that had bought them from Deutsche.
The “deal” at issue was essentially fraud, a non-economic trade whose sole purpose was to hide a large loss that would have to be booked and disclosed at an inopportune moment (late 2008) for Italy’s most troubled bank (whose troubles never seem to end). Rather than being an isolated case, the article suggests much more widespread use. The problem, in my view, isn’t limited to just that possibility, as the entire purpose of credit default swaps, for example, during the great RHINO phase of Alan Greenspan’s “tightening” regime in the middle 2000’s was to undo that “tightening” and then some.
“Capital relief” is in essence quite similar, though the total retreat of CDS from the banking platform post-crisis has opened an opportunity for more creative (meaning hidden) means of accomplishing the same goal, if not to the same extent (maybe?). Using a derivative instrument (or four) to reduce capital weightings and paying another party a premium to use it without any intention of either party of having to pay out at any point is not at all in a separate category from what Deutsche Bank is alleged to have done here.
We know that parts of the crisis story were written in exactly that way, as AIG’s downfall, for example, wasn’t about losses but about how it never really reserved liquidity for the possibility of them. They took in premiums, the (primarily) European banks booked their “capital relief”, and everyone was happy until reality challenged major assumptions. All those assumptions revolved around “dollars”, and who had them. But in the eurodollar system, nobody does.
What is an acceptable basis of payment across the myriad eurodollar platforms are whatever banks will accept; that is why I consider it more a computer network, a system of protocols and standards for financial communication, than currency. Because of these blurred distinctions, that often aren’t distinctions anymore, it is exceedingly difficult to separate the mundane necessity from the brilliantly devious overkill from the outright fraud; it all appears as if totally alike. The modern bank just does things, and who is to say otherwise?
Not regulators, of course, as they are undermanned and more often a generation or two (or five) behind. Basel 3, for example, is still primarily worried about subprime mortgages and things like them. I actually have no reservation about letting modern banks do what they feel they can (outside of fraud, of course) but that would only be consistent if we first define banking such that it isn’t what we find now. Pace Gramm-Leach-Bliley, there are now only banks even if the vast majority of banking isn’t actually banking. In other words, shadow banks that are really nothing more than officially sanctioned hedge funds are given every curtesy and privilege once reserved for actual banks.
And so it would make sense for a round of self-segregation, rather than an imposed regulatory government view (Basel being one of the worst regulatory regimes ever conceived, and that is truly saying something). One of the most abusive and insulting aspects of the crisis, among an extensive list of bad acts and results, was Goldman Sachs and Morgan Stanley becoming “depository institutions” for the sole purpose of being statutorily prepared for more direct Federal Reserve intervention should it have ever gotten that far. That is exactly the wrong direction that should have been taken: if you want to operate your institution like a hedge fund, be our guest but you cannot be involved in the domestic or global dollar payment system. If you want to be in the business of money as separate from finance, then there is no possible way to get into repos, derivatives, or “regulatory relief.”
I suspect if we did that, most of what we now call banks would become fully open hedge funds, at the same time monetary functions would gravitate and be served primarily by firms like VISA or ApplePay. In the modern world, it does make sense to redefine what it means to be a bank, because clarification of money vs. finance will solve a great deal of dysfunction and righteous indignation (TBTF). A robust and clearly defined payment system, the first role of money itself, removes TBTF entirely; the system cannot fail even if one or several of individual firms inside it might.
How to replicate such a system in global capacity, to carry out reform to the dying eurodollar system, is another debate, only partially involved in this one.
Deutsche also benefited from the way it accounted internally for its side of the deal. That complex shuttling of Italian bonds? The bank decided that all of the back-and-forth maneuvers canceled themselves out and did not need to appear on its balance sheet. Deutsche began to apply the practice to transactions around the world, totaling more than $10 billion that never showed up on its books and making the bank look smaller and less risky than it really was.
The financial functions provided by what are now called banks are still necessary, though in the more recent sense they can be reasonably classified as somewhat repugnant. Proprietary trading is not in and of itself a bad thing, for instance, as we very much need firms like Goldman Sachs and Deutsche Bank to provide the services of securities firms. What we don’t need is for them to abuse the privilege of being a “bank” so as to never have to reckon with mistakes, or worse.
Defining banking very clearly should lead to those firms paying for those mistakes in their own way, rather than what started almost a decade ago where they have been “paying” for them but with the global monetary system.