2015 Budget Deal: How You Will Pay for the Big Bank’s Gambles

(This article is written by Terry A. AmRhein author of “Democracy on the Edge, A Discussion of Political Issues in America” to be published in early 2015.)

 

Last week something unusual happened in Congress.  The Democrats and Republicans actually negotiated to pass the 2015 budget and avoided another government shutdown.  However, something very important was hidden within the budget deal that many people don’t know about or may not understand.  Let me explain.

 

The 2008 Financial Crisis occurred partly because certain big banks like Citibank, JP Morgan, Wells Fargo and Goldman-Sachs had been trading in risky forms of securities.  These securities are called derivatives because they derive their value from trading something else like credit cards or mortgages.  Before 2008 and the financial crisis, big banks bought thousands of mortgages, bundled them up into a huge packages and traded them to willing investors.  Mortgages were considered to be a good investment, people almost never default on there mortgages (right!) and the interest payments on the derivatives is much higher than interest on saving accounts.

 

After the Financial Crisis, congress passed the Dodd-Frank Act in 2010.  Basically the Act’s purpose was to institute regulations to prevent another financial disaster.  One provision, for example, was to prevent banks from using people’s saving accounts to invest in the derivatives markets for the bank’s own profit.  The problem with this is that savings accounts are insurance by the Federal Deposit Insurance Corporation, FDIC.  So if the bank’s investment in derivatives went “bust”, as it indeed did, the banks lose absolutely nothing because the saving deposit is insured.  The bank takes absolutely no risk.  Taxpayers who fund FDIC take all the risk and endure all the losses.  So this type of behavior was prevented by Dodd-Frank.  This portion of the Act became known as the Volcker Rule.

 

Another section of Dodd-Frank prevents banks from trading the riskiest derivatives, such as credit default swaps, as FDIC insured investments.  (Credit default swaps are basically insurance policies that banks can buy to insure the bank against loss of an investment. CDSs can also be treated as derivatives.)   What the banks were required to do was to pull out theses riskiest of investments and trade them through a non-insured affiliated bank.  Therefore if the bank lost these riskiest investments, they would not be FDIC insured and the public would not foot the bill.

 

Of course, banks hated this provision of the Act.  They complained that trading through an affiliate bank was too cumbersome and complex (poor banks!).  The provision of Dodd-Frank to trade the riskiest derivatives through affiliated banks, was exactly the provision that was eliminated by in the 2015 Budget.  Now, you may ask, what the heck has regulating how banks conduct business have to do with the national budget.  The answer is nothing at all.  Congress stuck this into the budget at the last minute because it could and because it would reduce discussion over the issue.

 

Abolishing the trade of the riskiest derivatives through affiliated banks represents a degradation in the authority of Dodd-Frank.  But is this a good thing?  Those who think that regulations on business is bad, may applaud the regulation reduction.  But I’d wager that most people belief that the tax-payer should not be responsible for the risky behavior of big banks, that the regulation was a good thing. After all, who wants to pay for banks to make more money?  Think about it, almost all business regulations, from fair pay, to work safety and work equality, to protecting our environment, result from big business’s unfair practices in the first place.  But of those who extol the success of big business, regulations are bad.  Now that the Republicans have taken over the House and Senate look for congress to slowly dissent Dodd-Frank.  Look for the Volcker Rule to be stripped out of the act: and for the teeth to be pulled out of the Consumer Financial Protection Bureau, an agency developed to protect consumers from unfair bank lending practices, and for regulations covering derivative trading to be reduced.  We will be plunging back into the era before the Financial Crisis and will be setting the stage for the whole episode to occur again.  Only when the American citizens realize that certain regulations are good and necessary and stop believing the myth that businesses should run without regulations, will we have a society where business can be trusted.