You’d think the former chief bank regulator would know the banks they regulate and supervise aren’t allowed to do this, and that it’s up to the FDIC to see they don’t:

Sheila Bair:

“For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.”

39 Responses

  1. She doesn’t know how it all works. She just works there!

    [It might be worse if she DID know, and was still speaking this way? When things are this bad, we’re left arguing which side of a split hair is worse.]

      1. @Winslow R., The feeling that when Legarde was tarnished by Ghadaffy connections, she got kicked out of France to a place where she can do even more harm?

    1. @roger erickson,

      “She doesn’t know how it all works. She just works there!”

      Good one. Can be applied to many others, too, like Geithner and Bernanke. And, of course, Greenspan was the classic case.

  2. She knows. It’s likely she believes the FDIC continues its failure to enforce the law. Perhaps you should test her hypothesis?

  3. Or perhaps they believe the law doesn’t take effect until July?

    ‘London whale’ drives market, say investors
    Updated: 2012-04-09 08:06

    (China Daily)
    Traders at work on the floor of the New York Stock Exchange. Bruno Iksil, a London-based JPMorgan Chase & Co trader who specializes in credit-derivative indexes, has been nicknamed “the London whale” by some traders. Investors have complained that Iksil’s trades may be distorting prices and are affecting bondholders who use the instruments to hedge hundreds of billions of dollars in fixed-income holdings. Jin Lee / Bloomberg
    Iksil prompting price moves in derivatives trading of $10 trillion
    A JPMorgan Chase & Co trader of derivatives linked to the financial health of corporations has amassed positions so large that he’s driving price moves in the $10 trillion market, traders outside the company said.
    The trader is London-based Bruno Iksil, according to five counterparts at hedge funds and rival banks who requested anonymity because they’re not authorized to discuss the transactions. Iksil specializes in credit-derivative indexes, a market that has overtaken corporate bonds during the past decade to become the biggest forum for investors betting on the likelihood of company defaults.
    Investors complain that Iksil’s trades may be distorting prices, affecting bondholders who use the instruments to hedge hundreds of billions of dollars of fixed-income holdings. Analysts and economists also use the indexes to help gauge perceptions of risk in credit markets.
    Though Iksil reveals little to other traders about his own positions, they say they’ve taken the opposite side of transactions and that his orders are the biggest they’ve encountered. Two hedge fund traders said they have seen unusually large price swings when told by dealers that Iksil was in the market. Some traders refer to Iksil as “the London whale,” according to one person in the business.
    Joe Evangelisti, a spokesman for New York-based JPMorgan, declined to comment on Iksil’s specific transactions. Iksil didn’t respond to phone messages and e-mails seeking comment.
    The credit indexes are linked to the default risk on a group of at least 100 companies. A credit-default swap is a financial instrument used by investors to hedge against losses on corporate debt or to speculate on a company’s creditworthiness.
    Iksil may have “broken” some credit indexes – Wall Street lingo for creating a disparity between the price of the index and the average price of credit-default swaps on the individual companies, the people said. The persistence of the price differential has frustrated some hedge funds that had bet the gap would close, the people said.

    Some traders have added positions in a bet that Iksil will eventually liquidate some holdings, moving prices in their favor, the people said.
    Unlike JPMorgan traders who buy and sell securities on behalf of customers, Iksil works in the chief investment office. The unit is affiliated with the bank’s treasury, helping to control market risks and investing excess funds, according to the lender’s annual report.
    “The chief investment office is responsible for managing and hedging the firm’s foreign-exchange, interest-rate and other structural risks,” said Evangelisti. It is “focused on managing the long-term structural assets and liabilities of the firm and is not focused on short-term profits”.
    Iksil probably traded under close supervision at JPMorgan, said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia.
    “The issue is how much capital they’re putting at risk,” said Miller, a former examiner for the Federal Reserve Bank of Philadelphia.
    A US curb on proprietary trading at banks, meant to reduce the odds they’ll make risky investments with their own capital, is supposed to take effect in July. Regulators are still determining how the so-called Volcker rule will make exceptions for instances where companies are hedging to curtail risk in their lending and trading businesses.
    Wall Street banks including JPMorgan, Goldman Sachs Group Inc and Morgan Stanley have submitted comment letters and met with regulators to discuss their complaints about the rule.
    “Several agencies claiming jurisdiction over the Volcker rule have proposed regulations of mind-numbing complexity,” said JPMorgan Chief Executive Officer Jamie Dimon in his annual letter to shareholders last week. “Even senior regulators now recognize that the current proposed rules are unworkable and will be impossible to implement.”
    JPMorgan had $4.14 billion of combined revenue last year from the chief investment office, treasury and private-equity investments, according to the annual report. The treasury and chief investment office held a combined $355.6 billion of investment securities as of December 2011, up 14 percent from a year earlier, according to a year-end earnings statement.
    Chief Investment Officer Ina Drew, who runs the unit, was among JPMorgan’s highest-paid executives in 2011, earning $14 million, a 6.8 percent pay cut from 2010, the bank said in a regulatory filing last week. Drew referred a request for comment to Evangelisti.
    Iksil has earned about $100 million a year for the chief investment office in recent years, the Wall Street Journal said in an article, citing people familiar with the matter.
    Iksil joined JPMorgan in 2005, according to his career- history record with the UK Financial Services Authority. He worked at the French investment bank Natixis SA between 1999 and 2003, according to data compiled by Bloomberg.
    Bloomberg News in New York
    (China Daily 04/09/2012 page14)

  4. Bair’s misunderstanding of finance reaches Obama-levels at this point in the column: “We will all cross our hearts and promise to pay the money back in full after 10 years so the Fed won’t lose any dough.”

    Actually, the whole column reaches Obama-levels, but this part made me cringe because it is where she approached an idea that would work: marking up the 90 percent’s bank accounts.

    1. @Tyler, The article targets a redistribution of access which would work, just will never happen. Redistribution of new assets would also work but will also be unlikely to happen.

  5. Okay, I just read the Blair article. I’d say she is ‘tongue in cheek’ but I’ve been proposing the same thing for the last 5 years.

    Warren don’t worry, it will never happen. 🙂

    1. @Winslow R., Of course it’s tongue-in-cheek. She’s basically defending the classic neutrality of money thesis and mocking the idea that any problems can be solved by printing and injecting money into the household sector. But along the way she’s getting in a huge dig at the carry trade, and arguing that the financial sector is getting a lot free tax-free money for doing no valuable work.

      She is apparently a deficit hawk, since she mocks Congressional tax cuts and spending increases, and apparently thinks one of the reasons to be offended by the carry trade is that the rentiers aren’t contributing enough to deficit reduction.

  6. Can someone explain to me why this is wrong? It seems to be a commonly held belief that banks borrow from the Fed at 0 and lend at 2. Why is this wrong?

    Thanks in advance!

    1. @Stanley_St, There are all kinds of wrong.

      Mosler says it is wrong because it is against the law to have the type of ‘maturity mismatch’ Blair suggests/recognizes is happening.

      Blair’s takeaway is in terms of opening access to something that shouldn’t be happening but does.

      The incredulous response is due to the ‘fact’ that the guys that run hedge funds, given access to 0% money, know how to make socially responsible investments way better than the average citizen.

      ………Like building really fast cars instead of/in addition to buying beer……

      1. @Chris Wroth, Since this is Warren’s site, he has done amazing things, and he has helped me tremendously, I should be more respectful.

        Not sure why I wrote that 🙂

    2. banks are examined based on CAMELS
      capital, asset quality, management, earnings, liquidity, and sensitivity to interest rate changes.

      It’s about the S- there isn’t supposed to be any

  7. so they get state-backed currency(chartalism, correct?) at 0%interest to do whatever the hell they want with? damn i am in the wrong business. they do this in broad day lite as well? this makes me sick. huge balls or is this the norm?

      1. @WARREN MOSLER, matthew 6:26

        8000 banks, the financial sector is too big, needs to shrink:

        They sow not, neither do they reap – There is a saying among the rabbins almost similar to this – “Hast thou ever seen a beast or a fowl that had a workshop? yet they are fed without labor and without anxiety. They were created for the service of man, and man was created that he might serve his Creator. Man also would have been supported without labor and anxiety, had he not corrupted his ways. Hast thou ever seen a lion carrying burthens, a stag gathering summer fruits, a fox selling merchandise, or a wolf selling oil, that they might thus gain their support? And yet they are fed without care or labor. Arguing therefore from the less to the greater, if they which were created that they might serve me, are nourished without labor and anxiety, how much more I, who have been created that I might serve my Maker! What therefore is the cause, why I should be obliged to labor in order to get my daily bread?

        I think 7900 banks need to sit down and get the surplus food Warren says is bountiful and not worry about complicating the sector so they may eat, it is biblical after all…

      2. @Save America,

        What part of diversity & adaptive selection don’t you get? Too few TBTF institutions is exactly what all cults, clans & religions vie for. Our job is to maintain dynamic stability as an equilibrium between enough conflicting forces that none ever fail by winning.

        Reducing the number of recombinant banks can be as dangerous as reducing the number of cells in your liver. You better understand the system WELL before tinkering with the design & number of components. Most knee-jerk reactions quickly lead to beef jerky (i.e., death).

      3. @Save America, Roger this is true, but using your liver cell example, a cancer cell that grows and reproduces in that same liver, kills the larger organism eventually. Warren has preached for 10 years now that the financial sector is far too large and unnecessarily complicated, (700 trillion in global derivatives that I am sure you do not understand nor do most other humans – if any) Warren has said it needs shrinking by 90% or more. The main reason being I think that all the smart big brains are going into trading credit derivatives and quant math with abstractions four or 10 levels out and wasting human ingenuity that could be put to use to more practical issues facing humanity. Keynes warned of the same thing as Warren with his “liquidity fetish” Certainly you agree with Warren that the current allocation of real human resources to the financial abstractions is FAR too high and need adjustment.

        The US Editor of the economist has just come out and said some ugly things against fiat money:

        Matthew Bishop, the US Editor of The Economist, has been interviewed by the Wall Street Journal TV about gold and why “people have lost faith in the 20th century religion of government backed fiat money.”

        He says that he has become an agnostic or an atheist with regard to his belief in government-backed money as he fears that governments are in a position whereby they are going to debase currencies such as the “paper dollar and “paper euro” “in a big way.” Gold becomes one of the “alternative religions” in that environment.

        History shows that a deleveraging downturn takes a long time and can take 7 or 8 years. Inflationary pressures are building and will be seen in the second half of the cycle, according to Bishop.

        Bishop says he would put some of his money into gold but is prohibited from this due to the investment policies of The Economist.

        (LOL do as I say, not as I do)

  8. I like the pedestrian terminology of basketball or football scoreboards, but to dumb things down for the younger generation, how’s this sound?

    Our monetary system today resembles virtual credits in a game like World of Warcraft or Mario Bros or Second Life.

    (I’m not actually a gamer, so I’m not sure.)

    The game can issue credits or penalize (tax or fine) players, and in some games players win points taking them from competitors. Game cheats are usually strictly forbidden.

    1. @Gary Goodman, I think the World of Warcraft economy is a really good analogy for a fiat currency. New currency is added to the game’s economy when players kill monsters. The gold the monsters drop can be freely traded among the players, so you can buy weapons and armor from other players for gold.

      Players are taxed in several ways: (1) your items slowly wear down and require repairs, money spent on repairs is erased from the system, (2) players may pay for quick transportation from one town to another, and (3) gold spent at game-run vendors is erased from the system.

      I think it’s very easy for World of Warcraft players to understand that gold is created when monsters are killed (when the government spends), and gold is erased when you spend money at vendors (when the government taxes). I also think it’s easy for most players to understand that the amount of gold created and destroyed has an effect on the player-run economy. But getting people to understand that this is also happening in the U.S. economy may take a bit more convincing than I’m capable of.

  9. For those who slept through English Lit class, yes, this article is satire. I think the criticism is the Fed’s loose lending policy to its member banks. Which, btw– the FDIC is not their primary regulator.

    1. @Justin M,

      “Congress is really good at spending money, so long as lawmakers don’t have to come up with a way to pay for it.”

      If that’s satire, she needs new writers.

      1. @roger erickson,

        Your homework: go read Swift’s “Modest Proposal”

        Understand that the purpose of satire is not to just poke fun at your opponent, but to convince them to see things from your perspective.

      2. @Justin M, Agreed. She just makes it too easy for the misinformed to endorse some passages literally instead of actually thinking. To me, the article is a confusing mix of lightly effective satire and familiar propaganda. I’ll bet $ it fails the satire test with the avg WalMart shopper.

  10. Sorry to sound like I work for the FDIC, but what exactly is unlawful? I thought the carry trade was ubiquitous.

  11. Could someone please tell me the rule number or where I can find the FDIC statement on this. I would like to document that cannot be done. I have sent the question to the FDIC but I haven’t heard back yet. It is not that I don’t believe it but I would like to see where it is written in regulation, please.

    1. @John Wilkins,

      I don’t know if Warren is referencing this code which obviously leaves a lot to nterpretation to the BOD and either wasn’t enforced or was inadequate in specificity to avoid a meltdown.


      Interest rate risk is the exposure of a bank’s financial condition to adverse movements in interest rates. It results from differences in the maturity or timing of coupon adjustments of bank assets, liabilities and off-balance-sheet instruments (repricing or maturity-mismatch risk); from changes in the slope of the yield curve (yield curve risk); from imperfect correlations in the adjustment of rates earned and paid on different instruments with otherwise similar repricing characteristics (basis risk–e.g. 3 month Treasury bill versus 3 month LIBOR); and from interest rate-related options embedded in bank products (option risk).

      Changes in interest rates affect a bank’s earnings by changing its net interest income and the level of other interest-sensitive income and operating expenses. Changes in interest rates also affect the underlying economic value2 of the bank’s assets, liabilities and off-balance sheet instruments because the present value of future cash flows and in some cases, the cash flows themselves, change when interest rates change. The combined effects of the changes in these present values reflect the change in the bank’s underlying economic value.

      As financial intermediaries banks accept and manage interest rate risk as an inherent part of their business. Although banks have always had to manage interest rate risk, changes in the competitive environment in which banks operate and in the products and services they offer have increased the importance of prudently managing this risk. This guidance is intended to highlight the key elements of prudent interest rate risk management. The agencies expect that in implementing this guidance, bank boards of directors and senior managements will provide effective oversight and ensure that risks are adequately identified, measured, monitored, and controlled.”

    2. @John Wilkins,

      Section 28(d)(1) of the FDI Act, 12 U.S.C. 1831e(d)(1). Regulations governing permissible investment activities for federal savings associations are found in 12 CFR part 160, and regulations governing permissible investment activities for state savings associations are found in 12 CFR 390.260–262.

      Under Section 28(d)(2), the investment-grade requirement does not apply to a corporate debt security acquired or retained by a ‘‘qualified affiliate’’ of a savings association, defined as, (i) In the case of a stock savings association, an affiliate other than a subsidiary or an insured depository institution;and (ii) in the case of a mutual savings association, a subsidiary other than an insured depository institution, so long as all of the savings association’s investments in and extensions of credit to the subsidiary are deducted from the capital of the savings association.

      –Not an exhaustive list, but a good place to start if you want to understand a savings bank’s restrictions in debt securities.

  12. Thank you. To the extent that “bank boards of directors and senior managements provide effective oversight and ensure that risks are adequately identified, measured, monitored, and controlled” does that mean they are allowed to buy notes, bills, and/or bonds? Is it a question of the ‘quantity’ of these instruments they buy relative to their capital?

    1. @John Wilkins, Looks like it is left to the BOD’s discretion. I don’t own a bank, Warren does. My guess is, from interpreting Warren’s comments, he runs a very safe small bank and it also my guess that most large banks are not run that way as they can depend on large bailouts. Currently I believe small banks were thrown some TARP scraps with little evidence except there hasn’t yet been a massive shakeout in the commercial real estate sector. Perhaps it will take an increase in short term rates before small banks really start coming apart which probably won’t happen until the big banks are ready to feed.

  13. only indirectly MMT, but so bizarre that it’s depressingly embarrassing

    Selva wrote:

    “Traditional Shield Beating Dance of the Missouri Police”
    performed ex tempore at Whiteman Air Force Base

    This is what we CAN spend public currency on? When we’re supposedly “running out of fiat” ?

    From this, you’d think that fiat was an Italian car that was really difficult to produce. Maybe Sheila Bair thinks this is effective satire too.

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