Warren Investigation Finds Taxpayers Could Be on the Hook for $10 Trillion in Risky Derivatives

  November 16, 2015

Warren Investigation Finds Taxpayers Could Be on the Hook for $10 Trillion in Risky Derivatives

After Congress rammed through a 'cromnibus' spending bill last year that repealed parts of Dodd-Frank financial regulation, UMKC's Bill Black explains how with or without this repeal another Wall Street bailout is still a real possibility
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William K. Black, author of The Best Way to Rob a Bank is to Own One, teaches economics and law at the University of Missouri Kansas City (UMKC). He was the Executive Director of the Institute for Fraud Prevention from 2005-2007. He has taught previously at the LBJ School of Public Affairs at the University of Texas at Austin and at Santa Clara University, where he was also the distinguished scholar in residence for insurance law and a visiting scholar at the Markkula Center for Applied Ethics.

Black was litigation director of the Federal Home Loan Bank Board, deputy director of the FSLIC, SVP and general counsel of the Federal Home Loan Bank of San Francisco, and senior deputy chief counsel, Office of Thrift Supervision. He was deputy director of the National Commission on Financial Institution Reform, Recovery and Enforcement.

Black developed the concept of "control fraud" frauds in which the CEO or head of state uses the entity as a "weapon." Control frauds cause greater financial losses than all other forms of property crime combined. He recently helped the World Bank develop anti-corruption initiatives and served as an expert for OFHEO in its enforcement action against Fannie Mae's former senior management.


Warren Investigation Finds Taxpayers Could Be on the Hook for $10 Trillion in Risky 
DerivativesJESSICA DESVARIEUX, PRODUCER, TRNN: Welcome to the Real News Network. I'm Jessica Desvarieux in Baltimore.

So you may remember back at the end of last year, Congress passed a cromnibus spending bill which included a partial repeal of the Dodd-Frank Act. That's the financial regulation bill that came to be after the financial crash of 2008. what this reveal did was essentially reverse a so-called swaps pushout rule for certain derivatives. I know. That sounds very confusing, and we'll explain more of that later.

But at the time, Massachusetts Democratic Senator Elizabeth Warren came out strongly against this repeal and spoke on the Senate floor about her frustration. Let's take a listen.

ELIZABETH WARREN (D-MA): Enough is enough. With Citigroup passing eleventh hour deregulatory provisions that nobody takes ownership over but everybody will come to regret.

DESVARIEUX: Well, have we come to regret it? It's been almost a year since that happened, and let's see if her prediction was right. An investigation launched by Senator Warren and Maryland Democratic Representative Elijah Cummings found that the rule reversal allows banks to keep $10 trillion in swaps trades on their books, which taxpayers could be on the hook for if the banks need another bailout. Here to dig into the findings of the investigation and put this all into context is our guest, Bill Black. Bill is an associate professor of economics and law at the University of Missouri Kansas City. He is a white-collar criminologist, former financial regulator, and a regular contributor to the Real News. Thanks for joining us, Bill.

BILL BLACK: Thank you.

DESVARIEUX: So Bill, this is like another language for most people. Can you just explain to folks exactly how this partial repeal of Dodd-Frank works, and would it affect everyday people?

BLACK: So to put it in context, this is one of the byproducts of the repeal of Glass-Steagall. So Glass-Steagall was the law passed in the great depression after another investigation about what helped cause the Great Depression. And it said we shouldn't be providing deposit insurance, a federal subsidy, to banks when they're out owning things and competing with other businesses. That doesn't make any sense. It would distort competition, give them an advantage, and it would put us at enormous risk, and it would create lots of conflicts of interest. And Glass-Steagall worked brilliantly for decades, but then in, near the end of President Clinton's term in office, he eagerly worked with the Republicans to get rid of Glass-Steagall.

Then came, of course, the current financial crisis. And you would have thought that we would have reinstated Glass-Steagall. But President Obama and the Republicans agreed that they would not bring Glass-Steagall back. So Paul Volcker, former chairman of the Federal Reserve and someone President Obama had touted in his first campaign, that Paul Volcker, by then the most prestigious finance expert in the world, was serving as an economic advisor to the president. So Paul Volcker said, well, if you aren't willing to bring back Glass-Steagall, you should at least prevent what's called proprietary trading in derivatives. And that means trading for the bank's own purposes. And so we got the Volcker rule and restrictions on swaps. A swap is a form of a financial derivative, and as the name implies you swap two things between two parties.

So the most common of these is interest rate swap, where one party, usually a bank, swaps with another party, usually a bank. One gets a fixed rate of interest and the other gets a variable rate of interest that is usually based off of LIBOR, that other fraud that we've talked about in the past. So when they [gimmicked] the LIBOR rates, these were, these $10 trillion figure that you talked about, is a subset of the $350 trillion in derivatives that they were manipulating when they manipulated the LIBOR rate.

DESVARIEUX: And Bill, just really quickly, what's a derivative again?

BLACK: A derivative is a financial instrument that gathers its value from something else in the real economy. So the derivatives that people are most familiar with probably are the collateralized debt obligations and the credit default swaps that played such a role in the crisis. So a collateralized debt obligation is supposedly backed by mortgages, or mortgage-backed securities. Those things that back it and provide the cash flow are called the underline. So that's what this kind of derivative, or all kinds of derivatives, are examples of it.

Now, it's a really bad, you know, it's the best Volcker could do, but it's not very good. Because once you don't have Glass-Steagall, and the rule is whether it's, the bank is trading for its own account or whether it's hedging, well, you can call almost anything a hedge, and obeyed the Volcker rule, and frankly obeyed much of the swap rule as well. So there's a bit of a question whether even without the repeal that you talked about, whether the law would have been effective. But of course they made--they being Wall Street, wanted to make absolutely sure it was ineffective. So they got this repeal, which tells you that since they used their political capital to get it that it was a very high priority, and they literally drafted the great bulk of the legislation that did this. And so the actual language was taken from the banks by the legislators.

And this was done, you know, somewhat over the resistance of the Obama administration. Because the Republicans were holding hostage the budget. But in truth, major parts of the Obama administration, which is to say Treasury and the chiefs of staff and [inaud.] have typically opposed the Volcker rule. Hate Glass-Steagall. And so they weren't so terribly unhappy to reach this deal with the Republicans. They could tell progressives, oh, we didn't really want to do it. We were forced to do it by the Republicans. But with the bankers, you know, they took credit for it to see how we worked together in a spirit of bipartisanship and remedy these things.

Okay. So all of this means that there's roughly $10 trillion of this stuff out there. To the extent it's interest rate swaps, it's not the scariest of derivatives. Collateralized debt obligations and credit default swaps were much scarier derivatives than things like interest rate swaps. But you can see situations in which they could cause bank failures, or amplify bank failures, make them more expensive, and we would be on the hook. But more broadly, again, it distorts commerce. It gives an unfair federal subsidy to a particular subset of banks.

So here's what you need to know about derivatives. Depending on the exact time period, the big five banks in the United States that do derivatives do roughly 95 percent of all the derivative trades in the United States. So this hasn't ever been done for banks as--and that clip you read from Senator Warren, this was done for Citibank. For Citigroup, at this point. And a handful of other institutions, like JP Morgan, as well.

DESVARIEUX: Okay. And Bill, I want to bring up another part of the report. It found that regulators had not conducted an analysis of the financial and taxpayer risk posed by this repeal. So what do you make of this? I mean, Washington's always talking about accountability, but we haven't been able to even do a proper analysis of the repeal one year later.

BLACK: Well, more precisely, both the Obama administration, the Wall Street wing of the Democratic party, and virtually all Republicans, certainly all the candidates, Republican candidates, say we've got to really stop the government from acting. It should never act without a cost-benefit analysis. Asterisk, except of course if you're doing something that the banks want. In which case, no problem. No cost-benefit analysis ever done to support any of the deregulation, and none of them could have passed an honest cost-benefit analysis. But of course it wouldn't have been a cost--an honest cost-benefit analysis even if they had done so.

But yes, you're absolutely right. There wasn't even the pretense that this was good for the United States of America and shown through any kind of study. This was raw political power, and Congress, with a fair degree of acquiescence and maybe even outright support from the Obama administration, and for cutting back this aspect of Dodd-Frank that they never wanted. And remember, there's still this huge wing, Bill Clinton, Hillary Clinton have said they don't want to bring back Glass-Steagall even though it was immensely successful, and even though we can see when you don't have that general rule and you have to rely on specific, partial provisions, it's easy to evade and it's even easier to chip away at. And this was a big chip, a $10 trillion chip, that they've already taken out of Dodd-Frank.

DESVARIEUX: All right. Bill Black, joining us from Kansas City. It's always a pleasure having you on the program. Thanks so much for being with us.

BLACK: Thank you.

DESVARIEUX: And thank you for joining us on the Real News Network.


DISCLAIMER: Please note that transcripts for The Real News Network are typed from a recording of the program. TRNN cannot guarantee their complete accuracy.


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