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Fed Lets Goldman Sachs and Morgan Stanley Off Hook, Investors Profit Billions

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Even though Goldman Sachs and Morgan Stanley failed the so-called ‘stress test,’ to determine whether these banks can weather a financial crisis, the Fed allowed them to pay billions in dividends and stock buybacks to investors. Former financial regulator Bill Black explains the consequences

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GREG WILPERT: It’s The Real News Network, and I’m Greg Wilpert.

Last month, the Federal Reserve allowed the giant investment banks Morgan Stanley and Goldman Sachs to pass the so-called “stress test” even though they had failed it. That is, in the review of their financial conditions, it was determined that the banks did not have enough assets to allow them to weather a financial crisis. Despite this, though, the Fed agreed to allow the banks to pay up billions of dollars in profits to investors which, under normal application of the rules, the banks should have kept. This is just the latest example of leniency that the Fed, governed now by Trump appointees, is showing the financial industry. Other examples include the dismantling of the Consumer Financial Protection Bureau, the rolling back of the Dodd-Frank post-2008 financial regulations for medium-sized banks, and the reduction of compliance penalties under the Community Reinvestment Act.

Joining me now to discuss this latest deregulatory move is Bill Black. Bill is a white-collar criminologist and former financial regulator, and Associate Professor of Economics and Law at the University of Missouri Kansas City. He’s also the author of the book “The Best Way to Rob a Bank Is to Own One.” Thanks for joining us again, Bill.

BILL BLACK: Thank you.

GREG WILPERT: So, first, what are the implications of the Fed allowing Morgan Stanley and Goldman Sachs to pass their stress test? That is, to pay investors even though they technically failed those tests, and should have kept most of these billions as assets to back them up.

BILL BLACK: OK. They didn’t technically fail the test. They actually failed the test. And what the new Fed, as you say, Trump appointees, have said, well, a failure isn’t going to be treated as a failure if you’re a really massive financial institution like Morgan Stanley and Goldman Sachs.

So, what are the stress tests designed to do? Stress tests are designed to say, hey, when the next big problem comes, will the bank be able to not only survive the problem, but stay healthy? Right? And a short background. First, the Fed has never been a vigorous regulator, or supervisor, or enforcer, in its entire roughly 100-year existence. What the Fed cares about is the open market committee, the Federal Open Market Committee, which is setting interest rates and the money supply. The second thing the Fed cares about is institutionally it’s run by economists, so they have their own research agenda.

So a really tertiary concern is supervision. They finally created a position where they choose one of the Fed governors and make him or her the person that is supposed to pay attention to regulation. You might think that was a perfectly sensible thing, but they typically pick people who are particularly weak on supervision and regulation, and that’s exactly what they’ve done in this instance.

GREG WILPERT: So what is happening here? I mean, back when Trump was running for office, he often blasted Hillary Clinton for being too close to Wall Street. What does Trump’s relationship to Wall Street look like now, a year and a half into his presidency, given all of these things that he’s been doing, including this latest move?

BILL BLACK: OK. So what’s happening in all of this is, of course, the huge banks should be passing stress tests with ease. After all, we are in the eighth straight year at this point, seventh straight year, of economic expansion. We are certainly relatively close to what economists usually call full employment. Businesses aren’t failing left, right, and center. They shouldn’t be defaulting on their loans. You have to try pretty hard to be making bad loans as a bank in this situation. So the banks should easily pass these stress tests. That’s first.

Second, right now there actually are storm clouds on the horizon. So the Fed Reserve Bank of San Francisco just very recently published results that showed in the last 60 years what we call an inverted yield curve has predicted every single one of the recessions. And in every single case but one an inverted yield curve was followed by a recession, and the one exception, it was followed by a very substantial reduction in growth. And guess what? The yield curve looks like it’s about to invert again. What that means is that longer-term interest rates are actually lower than shorter-term interest rates. That doesn’t make a whole lot of sense, normally, because it’s riskier to loan for longer time periods. More bad things can happen to credit quality, more bad things can happen in terms of inflation and such. And so the usual thing that economists think is going on is that people are anticipating a future recession.

So this is the worst possible time to be reducing capital requirements and your ability to meet the stress test, because we finally have a serious risk that we’re about to kick into one of those periods when there might be actual stress. And it’s not like there’s any particular reason why these banks couldn’t be building up their capital and meeting the stress test. By that I mean they’re super profitable. Right? All they have to do is retain a slightly bigger chunk of their profits, and they would easily beat the stress test.

So it is nuts not to enforce the stress test in these precise circumstances. But there’s more. A, by changing the rules, how they grade the stress test, and calling a failure a pass, they allow these two huge financial institutions to pay out in dividends and stock buybacks straight- not for investment, not for anything productive- but to go to already extraordinarily wealthy shareholders who have absolutely no need for the cash. And the second thing, what a surprise. It turns out that the way this change in grading the stress test works will increase the bonuses of both the CEO of Goldman Sachs and Morgan Stanley. These are guys making over $10 million a year. And they decided hey, for failing the stress test, we should give you a bigger bonus. And third, it’s arcane and probably not worth the people’s time to go through, but they didn’t just fudge the and change the scoring. They did it in two different ways, alternatively, that you could pick as the bank that failed the test. And no surprise, one of those alternatives is really good for Goldman Sachs’ particular circumstances, and the other alternative is really good for Morgan Stanley.

So we’re super flexible. Anything we can do to help you reduce your capital as we go into a potential recession. That’s what the new Fed wants to do. And here’s another surprise. The new guy who is the anti-regulator in charge of all of this, well, his background was Wall Street lawyer, and then private equity. You know, like the Romney Bain Capital types of the world. So these are folks who every bit of their identification, like Trump, is to be in the swamp with Wall Street, doing its bidding in ways that the Obama administration, which is very close to banks, would have never done.

GREG WILPERT: Finally, you know, there’s another bank that actually completely failed the stress test. I mean, that is, that didn’t get a pass for failing it, which is the Deutsche Bank. But what does it mean that it failed it? And what are the consequences, first of all, for the bank? And what does it mean for the larger economy, especially in the context, also, of the fact that- or not the fact, but rather the allegation, I guess, that Trump is allegedly heavily indebted to the Deutsche Bank?

BILL BLACK: So, remember I said the economy has been pretty darn good, and if you wanted to go to Europe to where an economy has been pretty darn good for a long time, it’d be Germany. And Deutsche Bank, of course, is the leading bank in Germany. And you know, one of the remarkable things is that Deutsche Bank keeps failing stress tests. It just doesn’t have enough capital. And it’s because it had one series of scandal after another. Frauds, predation, violations of funding terrorists, and it just continues year after year. The largest cartels in world history, LIBOR and federal exchange. One violation after another at Deutsche Bank.

Indeed, Deutsche Bank’s problems with capital are so deep and so perennial that they have driven Germany- and that’s to say largely the EU’s response to what’s called Basel III, which is the latest effort on an international basis to raise capital requirements. And Germany has been stalling and slow-walking this increase in capital requirements for a literal decade now out of concern that Deutsche Bank couldn’t meet the standards.

So Trump has, of course, bragged about stiffing creditors time after time, and those creditors were often banks, where he had the money to pay them back, but it would be better for him economically instead to put a subsidiary into bankruptcy. Well, eventually U.S. banks got sick of that. And so the only major bank in the world that will lend to Donald Trump has been Deutsche Bank, which, again, has this reputation worldwide for sleaze, and clearly wanted this kind of relationship with someone they saw as politically powerful. So if Deutsche Bank were ever actually cracked down upon for its failures, not just on failing the stress test, but for violating essentially every law related to banking, then Donald Trump would be in a world of hurt. Because if his debts were ever called by Deutsche Bank, he would be in an immediate liquidity crisis and his empire would crumble.

GREG WILPERT: Well, we’re going to have to leave it there for now. I was speaking to Bill Black, Associate Professor of Economics and Law at the University of Missouri Kansas City. Thanks, Bill, for having joined us again today.

BILL BLACK: Thank you.

GREG WILPERT: And thank you for joining The Real News Network. Also, keep in mind we recently started our summer fundraiser and need your help to reach our goal of raising $200000. Every dollar that you donate will be matched. And unlike practically all other news outlets, we do not accept support from governments or corporations. Please do what you can today.