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The Symbiotic Alliance of Washington and Wall Street


″Too big to fail,″ over-leverage in the banking system won't be resolved in financial reform legislation because Washington, Wall Street need each other to survive.

Editor's Note: This article was written by Robert Barone, head of Ancora West. Mr. Barone currently serves on AAA's Finance and Investment Committee which oversees $5 billion of investible assets.

Despite all of the political rhetoric surrounding financial-reform legislation, "too big to fail," over-leverage in the banking system, and high-risk bets at proprietary Wall Street trading desks won't be resolved in the pending legislation because Washington and Wall Street have a symbiotic relationship held together by the realization on both sides that they need each other for survival.

Recently, the Wall Street Journal ("Banks Trim Debt, Obscure Risks," Rapoport & McGinty, May 25, 2010) revealed that the large Wall Street banks manipulate ("window dress") their end-of-quarter numbers to make it appear that they have significantly less leverage (and therefore more capital) than, in reality, they have. In looking at 10 quarters of average data that the largest eight banks are required to disclose, the Journal found that, on average, borrowings were 41% higher than reported on their required quarterly "Call Report." Those reports only require a snapshot of the balance sheet on the call report date, i.e., the last business day of the quarter. So, by significantly reducing "borrowings" on the last day of the quarter, they're able to hide their true leverage and technically produce higher capital ratios for their regulatory reports.

Such leverage, of course, was and continues to be the major cause of financial instability. Leverage, along with the risks taken by the proprietary trading desks of the "too big to fail" were supposed to be fixed by the financial regulation bill now in a House-Senate conference committee. But, a closer look at the pending legislation reveals that neither excessive leverage nor the risks taken on the proprietary trading desks have really been addressed. A Wall Street Journal opinion piece entitled "The New Lords of Finance" (May 24, 2010), indicates that the Volcker Rule (restrictions on proprietary trading) "is really a Volcker Suggestion," as the bill gives the appointed regulator the "authority to immediately rewrite the law." Imagine the lobbying and campaign contributions that are now about to take place!

Let's not forget that the new financial regulations were also supposed to resolve the "too big to fail" issue itself. But, according to the Journal, the pending legislation fails here, too:

"... the discretion handed to the FDIC as the resolution overseer allows a replay of the AIG debacle in which the company was used as a conduit to pay counterparties 100 cents on the dollar."

Remember that the beneficiaries of the AIG (AIG) payouts of 100 cents on the dollar for AIG highly impaired credit default swaps were Goldman Sachs (GS), JPMorgan Chase (JPM), Citigroup (C), etc.

"The FDIC will now be empowered to do the exact same thing, except that it will be allowed to discriminate even further -- with the discretion to give some creditors a total bailout while imposing losses on others. Think United Auto Workers versus Chrysler bond holders."
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