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Fed Cover-Up

The Fed is Helping Banks Profit

Written by Briton Ryle
Posted August 13, 2014

I guess I shouldn't be surprised.

After all, not one banker in the U.S. was even charged with a crime after the financial crisis. Our government made it painfully clear that saving the banks was priority #1.

Instead, the banks were rewarded with cash injections, loan guarantees, and a blind eye.

So it was no surprise that yesterday's Wall Street Journal headline read, "Bank Profits Near Record Levels."

That's what happens when the Fed floods the banks with cash through quantitative easing.

According to the WSJ article, U.S. banks made $40.24 billion in net profits during the second quarter of 2014, April to June. Apparently, that's the second biggest profit in 23 years.

Of course, we're supposed to think that the fact that banks are making more money than they have in 23 years means the economy is improving. We're supposed to believe the banks have done a good job of getting back on their feet after the financial crisis.

But the fact is America's biggest banks — affectionately known as “too big to fail” — haven't done anything new or different to make so much money. In fact, they're making this money by doing the exact same things they did that lead to the financial crisis.

The worst part is that the “too big to fail” banks have the Fed's blessing. And the Fed may even be actively covering up the banks' non-compliance.

The Dodd-Frank financial regulation law was supposed to rein in the banks and keep them from taking huge leveraged risks with derivatives and risky lending practices. But if the banks' watchdog — the Fed — won't enforce the new rules (and actually bends the rules to benefit banks), how can we legitimately expect anything to change?

The Fed is allowing a “business as usual” approach, and it's downright scary.

Fed Cover-Up

I'm going to show you a couple passages from Section 165 of the Dodd-Frank Act, with my own emphasis.

This is the section that requires banks to submit annual reports to the Fed that have come to be known as the banks' “living wills”:

The Board of Governors [the Fed] shall require each ... bank holding companies... to report periodically to the Board of Governors ...the plan of such company for rapid and orderly resolution in the event of material financial distress or failure, which shall include—

(A) information regarding the manner and extent to which any insured depository institution affiliated with the company is adequately protected from risks arising from the activities of any nonbank subsidiaries of the company;

(B) full descriptions of the ownership structure, assets, liabilities, and contractual obligations of the company;

(C) identification of the cross-guarantees tied to different securities, identification of major counterparties, and a process for determining to whom the collateral of the company is pledged; and

The Board of Governors [the Fed] and the Corporation [FDIC]… may jointly direct a nonbank financial company ... to divest certain assets or operations identified by the Board of Governors and the Corporation [FDIC], to facilitate an orderly resolution of such company under title 11, United States Code...

Yeah, I know... government-speak can be a little thick.

But what this means is that banks have to disclose their structure, their assets and liabilities, and their leverage to the Fed.

In addition, they are supposed to report to the Fed how all of their obligations can be accounted for and resolved in the case of another financial crisis. (Hence the term “living will.”)

Finally, the Fed is given the power to tell the banks to get rid of certain assets and change their business structures — basically whatever it takes to make sure the banks can't threaten the entire global economy.

As you might guess, this hasn't happened. Far from it. The fact is, banks today are bigger and have more complicated structures than at any time before the financial crisis.

Disaster Waiting to Happen

You may recall that it was the bankruptcy of Lehman Brothers on September 15, 2008 that really kicked the financial crisis into high gear. (The Dow Industrials dropped 500 points that day.)

At the time, Lehman Brothers reportedly had $639 billion in assets spread amongst 209 subsidiaries. But it couldn't raise any cash because no other banks trusted the value of its assets. And so it went belly-up.

It took three years to clear the whole mess up. Not exactly the “rapid and orderly resolution in the event of material financial distress or failure” standard that Dodd-Frank now requires the Fed to enforce.

Well, would you be surprised to learn that today, JP Morgan counts $2.4 trillion in assets spread out among an incredible 3,391 subsidiaries?

JP Morgan is far bigger than Lehman was at the time of its demise. And with 3,391 subsidiaries, JP Morgan has a far more complicated structure.

Would you be surprised to learn that not once has the Fed made any changes to JP Morgan's living will or otherwise made any requirements of JP Morgan? Not once!

In her most recent testimony before Congress, Fed Chief Janet Yellen was called out for letting the banks do whatever they want by Senator Elizabeth Warren:

"Can you honestly say that JP Morgan could be resolved in a rapid and orderly fashion as described in its plans with no threats to the economy and no need for a taxpayer bailout?"

Yellen, of course, didn't really answer. Instead, she said this:

"We have given feedback on the first round of plans that were submitted, and are working, actually, to at this point, give feedback on the second round of plans. In fact, the firms have now submitted a third round of plans."

To which Warren asked:

"I guess the question I'm asking is have they ever gotten to a plan that you can say with a straight face is credible?"

And once again, Yellen danced around the issue:

"I've understood this to be a process, these are extremely complex documents to produce. In our second round of submission, we're looking at plans that run into tens of thousands of pages.”

Senator Warren finished with this pointed remark (emphasis mine):

"I think the language in the [Dodd-Frank] statute is pretty clear. That you are required, that the Fed is required to call it every year on whether these institutions have a credible plan. And I remind you, there are vey effective tools that you can use if those plans are not credible. Including, forcing these financial institutions to simplify their structure, or forcing them to liquidate some of their assets. In other words, break them up."

I don't usually agree with Elizabeth Warren's politics. But this time, she got it exactly right: The Fed is not doing its job in regulating the banks. It seems like it's the banks that are ordering the Fed around.

And when they screw it up again, it's you and me that will be on the hook for another round of bailouts.

I don't like it any more than you do, but the fact is our political system is now bought and paid for by Corporate America. Their profits get bigger and bigger, while the average American gets poorer.

I guess I shouldn't be surprised...

Until next time,

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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