Wall Street facing tighter scrutiny as regulators move on Volcker rule

Rule, going to vote Tuesday, aims to separate everyday banking from the kinds of high-risk trading that caused the financial crisis

Wall Street is facing tighter scrutiny of its trading activities after US regulators moved on Tuesday to impose stricter rules on the types of trades banks can make following the financial crisis.

The long-delayed “Volcker rule” is aimed at curbing high-risk trading on Wall Street of the kind blamed for triggering the worst financial crisis in living memory. But the rule hit yet another hurdle Tuesday – snow storms closed much of Washington and some staff at the top five US financial regulators looked set to vote on the rule from home.

Five years after the financial crisis, the Volcker rule has become the most controversial element of the Dodd-Frank Act, the largest overhaul of the financial system since the Great Depression.

Many details of the 71-page rule, preceded by about 900 pages of explanatory text, are still to be finalised. But according to those who have seen the final draft, it appears the new legislation will impose tougher requirements in some areas than the banks had first expected.

The rule, named after former Federal Reserve chairman Paul Volcker, aims to crack down on so-called proprietary trading – betting on financial markets for banks' own gain. The rule aims to separate everyday banking from the kinds of high-risk trading that caused the financial crisis.

The rule would curb the number of risks banks can take so that they do not exceed "the reasonably expected near-term demands of customers", the regulators said.

The rule will also tackle so-called portfolio hedging, a practice that was supposed to allow banks to offset risks with investments in other portfolios but which critics charge has been used by Wall Street to hide risky speculative bets. Under the new rule banks will be required to identify the exact risk that is being hedged.

According to the executive summary issued by the US Federal Reserve, Volcker would also prohibit “any banking entity from acquiring or retaining an ownership interest in, or having certain relationships with, a hedge fund or private equity fund,” with some exceptions. It would also require banks to establish an internal compliance programme “designed to help ensure and monitor compliance with the prohibitions and restrictions of the statute and the final rule.”

While the Volcker rule was drawn up in the wake of the financial crisis, it was given fresh impetus last year after JP Morgan Chase’s $6bn losses on the so-called “London whale” trades. The bank contended at the time that the huge risky bets being made in London were meant to hedge risks being taken elsewhere.

Wall Street’s lobbyists have won some key concessions. Some securities linked to foreign sovereign debt – money owned by foreign governments – will be exempt. There will also be exceptions for banks’ market-making desks, as long as traders are not paid in a way that rewards proprietary trading. Wall Street’s bonus culture has been seen by some as a prime cause of excessive risk taking.

“This provision of the Dodd-Frank Act has the important objective of limiting excessive risk-taking by depository institutions and their affiliates,” Federal Reserve chairman Ben Bernanke said in a statement. “The ultimate effectiveness of the rule will depend importantly on supervisors, who will need to find the appropriate balance while providing feedback to the board on how the rule works in practice.”

The rule will not come into force until July 2015 and Wall Street lawyers are now expected to comb through the document looking for loopholes and considering whether to mount a legal challenge.

Oliver Ireland, co-head of financial services practice at Morrison and Foerster, said with such an enormous rule “the devil is very much in the detail.”

“Fundamentally it’s the same rule in that it tries to put an end to prop trading,” he said. But he said he doubted it would be enough to halt the next financial crisis. The rule addresses banking entities – not hedge funds. And even in this case, where risky trades are being limited, Ireland said there was a good case that the wrong issues were being tackled.

“It’s not going to stop ‘too big to fail’. It’s not going to stop banks taking risks. Banks lend money with the expectation of getting it back and that’s fundamentally a risky business,” he said. “This is aimed at trading and if you look back at the last financial crisis that goes back to bad lending practices on mortgages. That happened before anyone had traded anything,” he said.

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Why central bankers' composure is pure theatre

Federal Reserve, European Central Bank and Bank of England know extricating from stimulus policies is fraught with danger

Central bankers like to project a sense of serenity. The markets may be traumatised and the politicians may be panicking, but nothing fazes the technocrats in charge of our money. They are headmasterly figures: slightly detached but with their fingers on the pulse.

That's the image. In reality, the central bankers are in a funk about the health of their nations' economies and the challenge of extricating their institutions from the stimulus policies that have been responsible for what has, so far, been a tepid global recovery.

Why else would the Federal Reserve have bottled a decision on gradually winding down its bond-buying programme? Why else would the European Central Bank have surprised the markets with a cut in borrowing costs last week? Why else would the Bank of England feel the need to reassure the public that the 0.5% bank rate that has been in force since early 2009 would remain in place until unemployment came down to 7%, barring some unforeseen inflationary shock?

Mark Carney will face the press this week for the first time since he outlined Threadneedle Street's forward guidance in August and the governor will have the job of explaining why unemployment is now expected to come down faster than the Bank predicted three months ago.

On the face of it, this is an easy gig. Carney could stand up and say it is a jolly good thing the economy is doing better than expected and, therefore, interest rates can start to return to more normal levels a little earlier than planned. This, though, is the UK, and here there are really only three economic moods: periods when there is concern that the economy is not growing, periods when the worry is that it is growing too fast, and periods when a combination of steady growth and low inflation is considered too good to last.

For now, the UK appears to have moved from fretting about a triple-dip recession to fears about overheating without any intervening Goldilocks period. Accordingly, the financial markets will be focused in coming months on barometers of excess demand: the housing market, the trade figures, earnings and consumer spending.

Carney will have a period of grace before the markets start to demand action. In part that's because those indicators speaking of problems to come – the housing market and the trade balance – are flashing amber rather than red. In part, though, it is because problems are more acute elsewhere.

For the Fed, it is a question of when to taper, not whether. It wants to continue supporting what is a historically modest recovery with low interest rates and quantitative easing, but thinks the amount of new money creation each month should be reduced.

But it wants to do this without causing chaos either domestically or in the broader global economy. When the Fed chairman, Ben Bernanke, floated the idea of a gradual taper to bond-buying back in May, financial markets threw a fit. The laws of supply and demand have meant that bond prices have risen as central banks have bought more and more of them. The interest rate on a bond goes down as the price goes up, and these interest rates (bond yields) affect how much it costs firms and households to borrow over long periods.

Speculation about a Fed taper pushed up bond yields, which in turn made mortgages more expensive in the US. That put the dampers on the recovery in the housing market.

The same laws of demand and supply meant that electronically printing trillions of dollars has driven down the value of the US currency. It has also created a massive pool of funds looking for places around the world where returns were high. This was not in the west, where both growth and interest rates were low, but the emerging world, where growth was strong and borrowing costs much higher.

Even the threat of a Fed taper was enough to put this process into reverse. Money came flooding back out of emerging markets, putting pressure on their currencies as growth rates were slowing.

Europe has a different problem. Relief during the summer that the eurozone was at last coming out of an 18-month double-dip recession pushed up the value of the single currency. But a stronger currency means lower inflation because the cost of imported goods falls.

Inflation in the 17-nation bloc as a whole stands at 0.7%, well below the ECB's target of close to but just less than 2%. In those countries worst affected by the sovereign debt crisis it is already negative.

Deflation is not always a bad thing. In fact, if you are a saver it is a good thing because your money goes further. For debtors, though, a period of falling prices means that your debt burden increases. If interest rates are rising, then you can quickly find yourself in a situation where your debt is increasingly unpayable even if your income is going up at the same time.

What applies to individuals applies to countries also. Greece is already in a situation where it will require another bailout to make its debts sustainable and it wouldn't take much to push some other countries on the eurozone's periphery – Italy and Spain most notably – over the edge.

Economists at Fathom financial consultants have modelled what would happen to eurozone debt sustainability given plausible (if relatively generous) assumptions for budget deficits, growth rates and inflation. They found that if primary government budget balances (excluding debt interest payments) and growth rates were set at their long-term average, debt sustainability hinges on what happens to inflation.

At an inflation rate of 2%, the level of debt to national output (the debt to GDP ratio) declines for every country in the eurozone, including Greece. At 1%, and assuming a Fed taper leads to an increase in long-term interest rates of 1.5 percentage points in the next two years, debt becomes unsustainable for the peripheral eurozone countries. At zero inflation, even without a taper, debt sustainability is a problem for the core of the currency zone as well.

This threat explains many things. It explains why ECB head Mario Draghi moved so quickly to cut ECB interest rates last week. It explains why there is a lot of nervousness about the upcoming asset quality review of Europe's banks, since they are awash with eurozone bonds. It explains why the Americans, who know a taper is coming, are openly frustrated with Germany's failure both to reflate and to press ahead with banking union. And it explains why the sang-froid of central bankers is strictly for show.

Article Source : http://www.guardian.co.uk
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Federal Reserve begins two-day meeting as stimulus taper looms

Speculation mounting that chairman Ben Bernanke is preparing to announce cuts on economic stimulus programme

The Federal Reserve began a two-day meeting Tuesday as speculation mounted that chairman Ben Bernanke is preparing to announce cut-backs on the US's $85bn-a-month economic stimulus programme.

Bernanke will hold a press conference Wednesday to discuss the Fed's plans. The event comes amid speculation that he will announce his resignation: Bernanke has made clear he will not seek a third term as chairman and Barack Obama is now assessing replacements.

The Fed's third round of bond buying, known as quantitative easing, was announced last September and has so far pumped about $800bn into the bond markets in an attempt to kick-start investment and keep interest rates down. In June, Bernanke announced some "tapering" of policy could begin later this year if the economy continued to improve.

The Federal Reserve's open markets committee (FOMC), however, is split on QE with some concerned about the unintended consequences of the massive programme. In previous FOMC meetings some members have made clear they want an early end to the programme.

On Monday, stock markets reacted positively to news that former Treasury secretary Larry Summers had withdrawn from the race to succeed Bernanke. Janet Yellen, the Fed's vice-chairman, is now seen as the most likely successor. Summers was seen as being more critical of QE while Yellen has backed Bernanke in his support of the programme on the FOMC.

Paul Dales, senior US economist at Capital Economics, said the Fed was likely to announce some tapering of QE. "It will be a close call but I think it's more likely than not," he said. "It will depend on whether the Fed believes the labour market has improved enough in the last months, and for the right reasons."

Last month the US unemployment rate dropped to 7.3%, down from 8.1% a year ago. But the pace of job recovery remains slow and part of the drop was due to people leaving the workforce. The labour force participation rate slumped to 63.2%, its worst reading in 35 years.

Dales said it was clear that some members of the committee were becoming increasingly alarmed by the scale of the QE programme. "They are not too sure what the costs are," he said. "Perhaps further asset bubbles or destabilizing the financial markets. They have never done before."

Bernanke has ducked questions about his future at previous press conferences. He will not hold another scheduled FOMC press conference until December. His term is due to expire at the end of January. Despite the tight timetable economists expect him once more to focus on economic policy rather than his future and the appointment of a successor.

Article Source : http://www.guardian.co.uk

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Larry Summers withdraws name for Federal chairmanship

Barack Obama says he will 'always be grateful' to his former economic aide for his 'tireless work and service'

Barack Obama's hopes of a smooth transition of power at the US Federal Reserve were dealt a significant blow on Sunday night when Larry Summers unexpectedly pulled out of the running to replace Ben Bernanke when he stands down in January.

Summers, a former Treasury secretary under President Clinton, had been frontrunner to take charge of US monetary policy during a crucial phase in the economic recovery but is understood to have been deterred by the prospect of bumpy Senate confirmation hearings.

Despite an impeccable track record as an economist and policymaker, Summers remains widely associated with the period of laissez-faire economic policy-making that led up to the banking crash and his decision to step aside on the eve of the fifth anniversary of the crisis shows how raw the politics remain in Washington.

The White House will issue a report on Monday detailing the steps it has taken to reform Wall Street and repair the economy, but has been criticised by Democrats for failing to tackle the entrenched power of the banks.

Obama paid tribute to the role of Larry Summers in dealing with the aftermath of the financial crisis as director of the White House economic council from January 2009 until November 2010.

"Earlier today, I spoke with Larry Summers and accepted his decision to withdraw his name from consideration for Chairman of the Federal Reserve," Obama said in a statement. "Larry was a critical member of my team as we faced down the worst economic crisis since the Great Depression, and it was in no small part because of his expertise, wisdom, and leadership that we wrestled the economy back to growth and made the kind of progress we are seeing today."

The decision leaves the way open again for Janet Yellen, current vice chairwoman at the Fed, who has been lobbying hard for the job and would be the first woman at the helm of US economic policy.

Summers withdrew from the race in a phone call to Obama on Sunday morning, according to initial reports in the Wall Street Journal.

"I have reluctantly concluded that any possible confirmation process for me would be acrimonious and would not serve the interest of the Federal Reserve, the Administration or, ultimately, the interests of the nation's ongoing economic recovery," Summers wrote in a separate letter.

Obama said in a White House statement issued on Sunday: "I will always be grateful to Larry for his tireless work and service on behalf of his country, and I look forward to continuing to seek his guidance and counsel in the future."

Summers's career was dogged by controversies, notably over his support for deregulation in the 1990s and for comments he made while president of Harvard about women's aptitude in maths and science.

Rumours that Obama was leaning toward nominating Summers over Yellen elicited an unprecedented amount of controversy for a potential nominee to run the US central bank. Four Democratic senators on the Senate Banking Committee were expected to vote against him if nominated by the president.

Summers is the second high-profile potential nominee to withdraw under pressure in Obama's second term. Susan Rice, now Obama's national security adviser, stepped back from consideration to be secretary of state over controversy surrounding her role in explaining the 2012 attack in Benghazi, Libya, which claimed the lives of four US government employees, including the ambassador.

Article Source : http://www.guardian.co.uk

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