This
is related to Ch.2 by T. Hirai (Hirai, T.
ed . [2015], Capitalism and the World
Economy, Routledge).
Lecture 4
Financial Globalization
1. Introduction
We could divide
globalization into two types: “financial globalization” (FG), on the one hand,
and “market system (or capitalist) globalization” (MG) on the other. FG is the
global unification or liberalization of the financial market, while MG is the
multiplication of nations, on the global level, which favor adopting the market
system as the fundamental economic mechanism.
In this chapter we will focus mainly on how
FG has been making the world economy increasingly unstable and volatile as time
goes by. In Section 2 we
will explain how financial liberalization has proceeded in the US, while in
Section 3 we will see how the world financial system has become unstable and
vulnerable, leading up to instability in the world economy, as a result of FG.
In Section 4 we will
reflect upon what financial liberalization has implied in relation to the world
economy, and in Section 5 go on to explain how the US administration grappled
with the meltdown caused by the Lehman Shock and barely managed to enact the
Financial Regulatory Reform Act in July 2010, still being hard-pressed to implement it. Finally,
in Section 6, we will consider the need for financial regulation reform.
2. U.S. Financial Liberalization －Attenuation
of the Glass-Steagall Act and Enactment of the Gramm-Leach-Bliley Act
2.1 The Outline
The
Glass-Steagall Act (the GS Act hereafter) enacted in 1933 had long been a
dominant measure for regulating and overseeing the US financial system. The USA
of the 1920s saw financial fraudulence rampant, to the extent that President
Roosevelt ascribed the Great Depression to it1. Thus the GS Act was enacted,
aiming at imposing strict regulations on the financial institutions. It is
composed of three pillars: (i)
regulation of interest rates (“Regulation Q”); (ii) separation of commercial
banking from investment banking; (iii) regulation of interstate banking.
As early as the 1960s a movement calling for softer
regulation was launched through the lobbying activities of banks, eager to
enter the municipal bond market. But the GS Act had worked well enough up until
the 1970s, when the situation took a new turnchange .
In the 1970s the investment banks tried
to edge into the sphere of commercial banking, providing customers with money
accounts (with interest paid), and check and credit services. The role which
the DTCC (Depository Trust and Clearing Corporation) played
here was significant. Throughout the 1970s and 1980s computerization went ahead
only in mega investment banks, where individuals came to make transactions by
means of the so-called “street names”, which worked as a sort of reserve ratio
in the case of commercial banks. Investment banks were able to obtain new funds
by exploiting these “street names”, which aggravated the commercial banks’ growing
impatience.
In the 1980s bills aiming at relaxing the GS
Act had often been submitted to the Congress. Abolition of Regulation Q came first in 1986, followed by
the bill for regulation of interstate banking in 1995 (the Rigle-Neil Act).
Lastly, the separation of commercial banking from investment banking was
unlocked by the Gramm-Leach-Bliley Act (the GLB Act hereafter) in 1999.
2.2 Relaxation
of the Separation of Commercial Banking from Investment
Banking
Here we will see
how the GS Act came to be alleviated and finally abolished, focusing on the
separation of commercial banking from investment banking.
The progress toward relaxation might be said to have proceeded through
a sequence of extended interpretations of Section 20 of the GS Act by the FRB.
In December of 1986 the FRB interpreted a clause in the Section, which
prohibits “in principle”
a commercial bank from dealing in investment banking, in such a way that it is
allowed to do so for up to 5 percent of the total revenue, followed by the FRB’s
decision (spring of 1987) that a commercial bank may underwrite some
securities.
Since A. Greenspan, a former executive of the J.P. Morgan, was
appointed Chairman of the FRB in 1987, relaxation of the GS Act was expedited
through the following stages:
(i) In 1989 the FRB permitted commercial
banks to engage in underwriting
(ii)
In December 1996 the FRB authorized bank holding companies to have
(iii)
February 1998 saw a merger deal between the Travelers Insurance Company (the
CEO was S. Weil) and the Citicorp (the president was John Lead). This should
have been impossible under the GS Act, but vigorous lobbying activities
developed, targeting top figures
such as Clinton, Greenspan and Rubin, resulting in the FRB’s approval of the
merger in September;
(iv) The final blow came with pressure from
hardliners calling for abolition of the GS Act, resulting in enactment of the
GLB Act in November 1999.
2.3 Promulgators
for the GLB Act
It was financiers such as Wile and Read, and politicians
and/or academics such as R. Rubin, L. Summers (whose protégé was Rubin), A.
Greenspan and P. Gramm (Republican Senator) who worked on the GLB Act.
Summers and Greenspan were responsible
for drawing up the GLB Act, alias “the Citi-Group Approval Act”. R. Rubin, who
resigned as Secretary of the Treasury in July 2000, was welcomed as CEO of the
Citi Group. While he was there, he induced the Citi Group to embark on risky
investments such as the CDO (Collateralized Debt Obligation)2.
Phil Gramm was also involved with
enactment of the Commodity
Futures Modernization Act of 2000 (the CFM Act hereafter), which gave
momentum to moves to legalize the future trade of energy and credit default
swaps (the CDS hereafter).
Prior to this, B. Born, chairperson of the Commodity
Futures Trading Committee (the CFTC), who was worried about OTC
(Over-The-Counter) Derivatives (esp. the CDS) being transacted on an ever
larger scale, evading control by the financial authorities, insisted on the
need for supervision. Her move, however, came up against harsh opposition from
Greenspan, Rubin (the then Secretary of the Treasury), and Summers, who had
promoted relaxation of the GS Act. It was they who reversed the direction and succeeded
in putting through the CFM Act. Wendy, Gramm’s wife and chairperson of the CFTC
under the Reagan and the G.H. Bush Administrations, also worked hard for the CMF
Act, thanks to which she was to be welcomed by Enron.
The salient feature of the CFM Act,
known as the so-called “Enron Loophole” (exemption from supervision for futures
trading), lies in “the single stock future” being allowed; this was to enable higher
leverage and more speculative activities (the Act is held responsible
for the California Electricity Crisis in 2000-2001).
Enron had
been very much involved in derivative dealings in the 1990s. In 1999 it set up “Enron
Online” and greatly extended derivative dealings. It was subsequently to be exposed
for continued fraudulent accounting and was forced into bankruptcy. Thus began
the burst of the so-called “Dotcom Bubble”.
P. Gramm3 was
thereafter welcomed as executive for the UBS4, where he is reputed
to have played a central role in its extensive involvement with the CDS.
3. The
Instability of the World Financial System
How are we to evaluate
the influences on the world economy which financial liberalization or
globalization has brought about? They can be approached from both affirmative
and problematic positions.
Because the FG has enabled capital to
move to regions where it can obtain higher rates of profit, it has contributed
to bringing about high economic growth where otherwise it might have been
impossible.
Leaving consideration from this
affirmative viewpoint to Section 3.2 of Chapter 1, we will here focus on the problematic aspect – the
instability of the world financial system as the cause of collapse of the world
economy. Firstly we will take the rise of the Shadow Banking System, followed
by the two turbulent examples.
3.1 The Rise of the Shadow Banking
System
FG, which gained momentum in the 1980s,
generated the “Shadow Banking System” (SBS hereafter). The US financial system,
which had so far been supervised by the FRB under the GS Act of 1933 with the
purpose of keeping the speculative activities of banking business under
control, came to be relaxed through the above-mentioned financial
liberalization, bringing forth manifold new types of financial firms such as hedge funds and
private equities that lend themselves freely to speculative dealings
without supervision by the financial authorities. Devising various kinds of securitized papers such
as the MBS, the CDO and the CDS and using leverage, these firms came to be
involved in risky speculative dealings in the global financial markets. Observing
their surprisingly high rates of return, the commercial banks, which had been
kept under control by the FRB, found their way into the SBS by means of an off-balance
technique, the product being “Special Investment Vehicles” (or SIVs).
Thus
as the years went by the SBS grew bigger and bigger, squeezing the share of
conventional banking to ever smaller dimensions, and making the world financial
system increasingly unstable and volatile.
Excessive FG had often precipitated the
world economy into critical conditions, and yet the world had managed to evade serious
catastrophe. But it eventually led to the Lehman-shock in September 2008, which
set the world financial system as well as the world economy plunging
precipitously.
This
series of events prompts the following questions: could the rise of the SBS have
been desirable, and indeed indispensable to the development of the world
economy? How are we to justify the layered securitized papers and the financial
institutions’ speculative activities free from any supervision? To what degree
can the finance engineering be justified in terms of improvement and/or growth
of the capitalist system?
Leaving these questions to Section 4.2
below, here we will consider two examples of economic instability as caused by
the excessive FG: the Asian
financial crisis in 1997-1998 and the subprime loan crisis of 2008, from
which the US, the EU and Japan have yet to find the way out5.
3.2 Two Examples
The Asian
Financial Crisis ― The crisis of 1997, which started in Thailand, was caused by
speculative activities in hedge funds. Thailand, which adopted the
dollar-pegged system, began to suffer from a sharp drop in exports due to
appreciation of the dollar (and thus of the baht ). Hedge funds, seeing the
opportunity for speculation, continued to sell off the baht , which finally
forced the Thai Government to depreciate it. The Thai economy, which had so far
continued to enjoy a high rate of economic growth thanks to dollars borrowed in
the short term, plunged into serious depression with abruptly increased debt in
terms of the dollar. The depression rapidly propagated to Malaysia, Indonesia
and so forth.
Hedge fund speculative activities then
turned to target Russia in 1998.
In 1991 the Soviet Union disintegrated
into several nations, the largest being Russia. President Yeltsin went ahead
with headlong transformation of the Russian economy into a capitalist system –
the so-called “shock-therapy method”, accepting the IMF’s advice. The result
turned out to be devastating, causing high inflation and severe unemployment as
well as the 1997 fiscal crisis. The Russian government was forced to collect the
necessary revenues through issue of national bonds. Thus it was Russia, sunk in
a very precarious and chaotic situation, that hedge funds targeted.
Now
came the turn of a hedge fund named “Long Term Capital Management” (LTCM
hereafter), which continued to buy the Russian bonds. It gloried in two Nobel
Laureates for Economics (for the “Black-Scholes Equation” determining option
prices) as co-founders. Although it had only 200 employees, it gained such a
high reputation with its startling initial success that major banks from all
over the world were willing to hand out blank checks. Around 1998 the LTCM, a
neutral-type hedge fund, came to manipulate 100 billion dollars and take a position
of 1,000 billion dollars.
The LTCM took a long of Russian national bonds. However, Russia failed to
maintain the ruble, and was forced to declare default for the national bonds .
Then the LTCM suffered heavy loss. Suddenly there emerged
a serious possibility6 that , if the LTCM were left as it was, the
world would plunge into a formidable financial crisis, and in September 1998 the Federal
Reserve Bank of New York (the then president was T. Geithner), asked the Wall
Street megabanks to bail out the LTCM. Thanks to this prompt action the
world economy managed to evade an impending crisis.
The Subprime Loan
Crisis － The
crisis erupted in September 2008. Since 2005 high interest rate mortgage loans
had been made targeting low income earners (the so-called “subprime loans”). The
financial institutions bought them up, and issued MBSs (Mortgage-Backed
Securities) with them as collateral. A spate of new types of securities was then
unleashed, mingling other loans such as car loans, credit card loans and so
forth as collateral. Thus the US economy came to be filled with multi-layered securities (“securitized
papers”), which came to be certified by rating agencies such as Moody’s
as definitely safe securities (80 percent of the securitized papers based on the subprime
mortgage loans were ranked AAA), and were sold all over the world. The financial
institutions eventually started to issue subprime mortgage loans without any
assessment (the so-called “Ninja
Loans”), and, based on them, set about structuring layered securitized papers. …
Thus the negative catenation went on. It was on the occasion of the Lehman
Shock that this fragile monetary and credit structure collapsed, plunging the
world economy into the deep depression we have been experiencing.
4. “Financial
Liberalization” Considered
As explained
above, financial liberalization proceeded with the impulsion of financial
capital as catalyst . It was a movement led by the US commercial banks, eager to
break out of conditions imposed by the GS Act in competition with the US
investment banks which , free from regulation, saw rapid development, and by the
US government, which again wanted to hold the world financial market as well as
the world economy in the palm of its hands.
In sympathy with this impulsion, the big
figures such as Rubin, Greenspan, Summers and politicians like Gramm made great
efforts to attenuate the GS through extended interpretations of Section 20,
finally succeeding in enacting the GLB Act as well as the CMF Act.
4.1 The
Geopolitical Significance
Financial liberalization accorded well with the US
government’s desire to regain world hegemony in the economic scene. The US
Administrations which had suffered miserable economic performance throughout
the 1980s came to think that finance could be a key to regain and extend US influence
over the world economy. The “Washington
Consensus” line taken by the IMF and the World Bank as well as the “Shock Therapy”
method adopted by the former members of the Soviet Bloc with US economists as
advisers7 also accorded with the financial liberalization movement.
These movements, moreover, derived
strong support and credibility from the intellectual authority associated with
Neo-Liberalism, finance theory, and the New Classical School, as well as
ideologies like Neo-Conservatism and deep South Christian Fundamentalism. To
say nothing of these ideologies, Neo-Liberalism also took on a very
authoritarian stance, quite different from its ostensible attitude. As champions
of “freedom”, the Neo-Liberalists did not hesitate to interfere with foreign
countries where freedom as they conceived it was judged to be lacking, either
through the “structural adjustment programs” or with military operations. In this sense, Neo-Liberalism
contains a sort of “Power-ism”.
In
terms of political dynamics, furthermore, these movements can be said to have
proceeded hand in hand with Cleptocracy
- the “quid pro quo” ties between
4.2 The Economic
Significance
What kind of
economic significance will financial liberalization be seen to have?
It is an extension of the markets in which
the financial institutions can raise funds at their own disposal (where
securitized papers are structured, accompanying leverage), ever pursuing
speculative profits by means of the funds thus obtained. The pursuit of profit has been
engaged in to such a degree, at times, as to incur moral hazard.
Hedge
funds have targeted weak and fragile countries, mounting speculative attacks to
make huge gains with no concern for the considerable damage to the countries
concerned, ascribing the defects and failures to their economic system. In
recent years these attitudes have become blatantly evident. The “finance for the sake of
finance”, or speculative activities without any regard for the real economy,
can be characterized as “autotelism ” on the part of financial capital,
far from the original role which finance should play ― the
role of providing the finance required to make the real economy grow, and
making the market economy run smoothly. Thus we see the phenomenon of the real economy caught up in
speculative waves.
The enlargement of the SBS was also a
product of the activities of governments under the leadership of the US
administration, entailing some divergence from the original role which each
government should be playing －
the pursuit of its own economic growth. All governments should be independent
of the financial community, implementing their own policies and placing top
priority on the well-being of their people. On the road to financial liberalization, in fact, various
governments including the US government have gone hand in hand with the
financial community at the cost of a stampede of hedge funds, the emergence of
multi-layered securitized papers and a catastrophic meltdown.
4.3 Significance
for Japan and the BRICs (Brazil, Russia, India and China)
Financial globalization and the
multiplication of financial products achieved with financial engineering under
the leadership of the US and the UK in the 1990s has revived the hegemony of the world market by US and
UK financial capital. In the same period, moreover, it was young US
entrepreneurs who led the world market through IT innovation, placing the US as
world leader even in the real economy, where Japan and West Germany had been
leading8.
On the other hand, financial globalization
was to contribute, in consequence, to boosting the emerging nations such as the BRICS to
high economic growth. The rise of the BRICS is not only a matter of the developing
countries attaining economic growth, but a phenomenon of historical
significance on a world-wide scale in that they have become important economic and political
players in the world of the 21st century.
As for China, it has attained high
economic growth over a long period such as no other country has shown in human
history, making use of foreign capital.
In the case of Russia, the situation is
quite different, for (as the Soviet Union) it had been the leader of the
Communist Bloc and a major power in terms of its economy. It suffered a serious
meltdown (devastating capitalism) through Shock Therapy in the 1990s. However,
since the early 21st century it has made a miraculous recovery due to the
momentum given by the surge in prices of natural resources. The following two circumstances
also proved lucky for Russia: (i) commodities themselves became a target of “index
speculation”; (ii) the economic growth of China raised the demand for
commodities.
In the case of
India, which had suffered from an inferiority in infrastructure detrimental to
economic development, the IT revolution, which began in the US, has since the early 1990s created
the right conditions for the economic exploitation of brainpower , which
was a great factor in qualifying India as a member of the BRICS.
In the case of
Brazil, contributing in no small measure to the country’s economic development is
the miraculous economic growth of China, generating a high demand for all sorts
of commodities.
5. The Financial Regulatory Reform Act
The instability of the world economy
recently experienced appears to be attributable to the growth of the SBS so, in
order to stabilize the world economy, we need to bring it under the control of
the financial authorities. This is a point recognized by the Obama
administration.
5.1 How Things Went in the US
Obama’s Financial Regulatory Reform
Proposals ― In June 2009
President Obama made public the outline of his financial regulatory reform
proposals, aiming at repeal of the GLB and modern-day resurrection of the GS
Act.
The
central pillars are: (i) enlargement of the FRB, which is to work not only as a
central bank but also as an institution to oversee systemic risk, and (ii)
creation of the Consumer Financial Protection Agency (CFPA), to safeguard
consumers against financial abuse and fraudulence.
Through
these institutions, securitized papers, financial derivatives, futures and so
forth should be dealt in on open and clear markets, while the activities of
hedge funds, investment banks, rating agencies and so forth could be overseen. Thus
the proposal aims at scaling down, if not abolishing, the SBS.
The
Bailout and Early Recovery of the Megabanks
― The Wall Street megabanks were rescued first and foremost through
bailout with huge sums of public money10. But the story does not end
here. They were soon able to make immense profits by investing gigantic volumes
of money, obtainable thanks to both the FRB’s zero interest rate and its quantitative
easing (QE) policy, in the emerging nations (such as China, Brazil and India) –
the so-called “zero carry
trade”. Having repaid the public
money to the government, the megabanks were then to engage in a fierce battle
aiming at blocking Obama’s financial regulatory reform11.
The Growing Perception of Unfairness－ Contrastingly,
in spite of the FRB’s easy-money policy
the US real economy cannot be said to have made much progress towards recovery.
What has concerned the US people are, among other things, the continued high
unemployment rate, the rapid increase in arrears and foreclosure due to the
housing market bust, which has also driven many local banks into bankruptcy (the
number reaching a record high subsequent to the S&L crisis in 1992). The
credit crunch brought in by the local banks has, in turn, aggravated conditions
in the real economy.
The perception of unfairness has grown among the public,
for Wall Street was instantaneously bailed out (by the Bush Administration)
while Main Street remained stagnant (in spite of the Obama Administration’s
strenuous efforts).
5.2
The Dodd-Frank Act
The
Process － After public announcement of Obama’s
financial regulatory reform proposals in June 2009, deliberations in the two
houses proceeded very slowly.
On December 11, 2009 the financial regulatory
reform act (the Wall Street
Reform and Consumer Protection Act) got through in the House of
Representatives. However, the Senate version which was first elaborated as a
discussion draft in November 2009 was to proceed along a very difficult road thereafter. Leaving the details to my other
paper12, let us here summarize the process in the Senate:
(i) In May 2010 the Dodd Act (the Restoring
American Financial Stability Act) was deliberated.
(ii) The deliberations continued
for three weeks. On May 21 at long last the Dodd Act was passed with some
slight modification.
(iii) The Conference Committee
was then set up to unify the House and Senate versions. After a few weeks’
deliberations, the committee report was adopted.
(iv) On June 30 the Dodd-Frank
Act was passed in the House, while on July 15 it finally got through the
Senate.
(v) On July 21 the Act was enacted with President Obama’s signature.
The Gist of the
Act － The Dodd-Frank Act covers the following
items.
(1) The Consumer Financial Protection Agency (CFPA)
This is to be set up within the FRB, but
should remain independent. The head is
to be nominated by the President (this reflects some compromise with the House
version and the President’s view.）
During the subprimeboom many financial institutions made mortgage loans to people on low
incomes without any serious screening. In consequence, when the bubble burst great
numbers of people were rapidly driven into default and foreclosure. In order to
prevent this state of affairs from recurring (that is, to prevent consumers
from being cheated and forced to conclude unfair contracts), the CFPA is to be
set up.
During the subprime
(2) The Volcker Rule
This was first advocated by P. Volcker
in January 2010 and supported by Obama,
and subsequently incorporated into the Act. The rule aims at prohibiting commercial banks from
dealing in so-called “proprietary trading for their own account” and at
imposing limits on the commercial banks’ investments in hedge funds and private
equity funds, for
it would expose the depositors’ money to risk through speculative activities engaged
in by the banks13.
(3) The Lincoln Provision
This provision was first adopted by the Senate AgricultureCommittee chaired by
B. Lincoln in April 2010 and was incorporated into the Act. It aims at making derivative
transactions fair and transparent by abolishing Over the Counter (OTC)
derivatives and creating an open market14.
This provision was first adopted by the Senate Agriculture
(4) Creation of a committee for
prevention of possible systemic risk
The committee is to be composed of nine members headed by the Secretary
of the Treasury.
(5)
The president of the FRB of New York is to be appointed by the US President.
This condition aims at blocking Wall
Street influence.
(6) In the case
of megabank bankruptcy, clearing and dissolution should be
In
short, the “TBTF” (Too Big
To Fail) idea should be swept away. The megabanks have got used to assuming
that because they are huge the government will never fail to rescue them in the
event of their failure. Otherwise the economy as a whole, they think, would be
exposed to serious crisis . Thus they are likely to run into impossible
speculative activities – with serious moral hazard.
Challenging
the TBTF, the provision aims at clearing financial institutions on the brink of
failure through the self-responsibility of the financial sector rather than taxes.
It is estimated that it will take a year
and a half for the Dodd-Frank Act to be implemented. Each section needs
interpretation, so there will be confrontation on it. The lobbying activities
are very influential and might change the nature and/or course of direction.
Moreover, should other countries –
including the EU (with the UK) – fail to follow suit, the aim of the Dodd-Frank
Act will be thwarted, for
finance has been developed on the global scale, so loopholes will remain
gaping. If the US intensified regulation but other countries did not follow
suit, the financial institutions would continue risky speculative activities,
shifting their headquarters elsewhere.
And
yet the Dodd-Frank Act should be welcomed, for this will be the only feasible
and effective road which could lead to financial regulation on the global
level.
5.3 Tough Path
for Implementation
President Obama
finally succeeded in enacting the Dodd-Frank Act, of epoch-making importance in
US history, getting through many difficulties. Three years have passed since then, and yet it is still
far from becoming effective. The concrete process for implementation has
been very tough, as illustrated below.
Up Until August
2011 ―
In January 2011, a Republican of the Tea Party persuasion brought in a motion to repeal the
Dodd-Frank Act (July 2010) in the House to the effect that the act
entails excessive authority of the administration over the banking sector,
while it does not deal with GSEs such as Fannie Mae and Freddie Mac. It will also
bring about unemployment. The Dodd-Frank Act is against the Constitution.
It got through in the House, but not in
the Senate.
Dispute arose over the organizational
form of the CFPB.
First came the
problem of appointing its director. Obama strongly endorsed E. Warren, the
founder of the CFPB, whom the Republicans fiercely opposed (Thereafter Obama
gave her up, and went on to nominate R. Cordray in July 2011).
The Republicans, instead, proposed to
change the organization of the CFPB.
They first
demanded adoption of a collegiate system composed of five members appointed by
the leadership of the two parties rather than one director; secondly they demanded
that its budget be drawn up not from within the FRB but as a matter requiring the
approval of Congress15
(these tactics aimed at weakening the activities of the CFPB by excluding an
influential director and curtailing the budget); thirdly, they demanded that
the activities of the CFPB be subject to the Banking Overseeing Committee
majority rule.
Thereafter the Republican Party tried to obstruct the Dodd-Frank Act.
To take
Together with
the CFPB, the Republicans
made the CFTC (Commodity Futures
Trading Commission) and the SEC
(Securities and Exchange Commission) major
Then
came the victory of
the Republican Party in the mid-term election in November, which naturally intensified
their opposition activities.
As of July 2013
and February 2014 ―
As
mentioned above, in July 2011 Obama
Republicans
continued to oppose him, Obama made Cordray director in January
2012 by means of
“Recess Appointment”. Thus it was one year and a half after
The story of the director does not end here,
however. For another year and a
Republicans. In
July 2013, in order to break out of this state of affairs, the leader
Let us now see the present situation of
implementation of the Dodd-Frank Act, based on the testimony of Daniel Tarullo16,
director of the FRB, to the committee in the Senate in July 11, 2013 and February 6, 2014 (in
the following, (i) indicates a testimony on July, (ii) on February.
(1) Request for greater “prudence” towards megabanks
(i) The rule for the dissolution plan and stress
test has already been established.
(ii) The FRB issued proposed rules which
would establish enhanced prudential standards for megabanks . The FRB is making
efforts for regulatory proposals which aim at reducing the probability of
failure of a GSIB (Global Systematically Important Bank).
(2) Requirement of stress test and
capital planning for major banks
(i) Full-scale stress test is scheduled to be extended to more than
ten megabanks with 50 billion dollars in assets this fall.
(i) In July the
FRB, OCC and FDIC reached an agreement on the final plan to be carried out in
the US for implementing capital rule along Basel III.
(ii) The FRB issued proposed supervisory guidance for stress
testing by big banks and issued interim final rules clarifying how banks should
incorporate the revised Basel III capital framework into their capital
projections.
(ii) The FRB and
other US banking agencies have proposed imposing leverage surcharges on GSIBs.
(ii) The FRB is considering
imposing risk-based capital surcharges on GSIB surcharges.
(3) Improvement of the method for liquidation of megabanks
(i) The Orderly Liquidation Authority (OLA) was set up, under which it
was decided that the FDIC has the authority to ask shareholders and creditors to
cover loss, change the management personnel, and liquidate a financial
institution except for its robust sections.
(ii) The FRB is
making efforts to improve GSIBs’ resolvability , proposing relevant rules in consulting
with FDIC and OLA.
(4)
The FRB, CFPB, FDIC, FHFA (Federal Housing Financial Agency), NCUA (National
Credit Union Agency), and OCC (Office of the Comptroller of the Currency)
issued the final rule for implementing assessment of high-risk mortgage loans.
(5) Article for Excluding Derivatives (Derivatives push-out)
(i)
This became effective in July 2013. It was applied to the American branches of
foreign banks lacking deposit guarantee, while the banks with deposit guarantee
can apply for two years’ suspension.
(ii) In
December 2013 the FRB approved a final rule which clarifies the treatment of
uninsured U.S. branches and agencies of foreign banks.
(6) The Measure for the Shadow Banking System
(i) This is a measure to prevent financial institutions which use
extreme levels of leverage from reaping huge amounts of short-term capital. In
July two non-banks (including AIG) were selected as its targets.
(ii) Since the
crisis, regulators have collectively made progress in
addressing some of the close linkages between shadow banking and traditional
banking organizations, and have addressed risks resulting from derivatives
transactions. In August 2013, the FSB issued a consultative document that
outlined a framework of minimum margin requirements for securities financing
transactions.
Still, regulators have
yet to address head-on the financial stability risks from securities financing
transactions and other forms of short-term wholesale funding that lie at the
heart of shadow banking.
(7) The Volcker Rule
(i) In the fall
of 2011 the FRB and the SEC proposed a rule implementing the Volcker Rule,
followed by a similar rule by the CFTC a few months later. The Volcker Rule is
yet to be finalized, due mainly to the difficulty of distinguishing between the
proprietary trading and the hedging and market making activities.
(ii) In December 2013 the US banking
agencies, the SEC and the CFTC finalized the Volker Rule.
(8) Problem of regulating the amount of credit to
single OTCs
(i) It is under review.
(9) Liquidity rules for megabanks
(ii) In October 2013 the FRB and other US
banking agencies proposed a rule for quantitative liquidity requirement for
megabanks .
(10) FRB emergency lending
authority
(ii) In December the FRB proposed amendments
to Emergency Lending Authority to protect taxpayers from
loss and provide liquidity to the financial system.
(11)
Supervisory Assessment Fees
(ii) In August 2013 the FRB issued a final rule for
Supervisory
Assessment Fees. This rule became effective in October. Payments for the 2012
assessment period were made by 72 companies worth $433 million.
(12)
Risk retention responsibility provision
(ii) In August
2013 the US banking agencies, the Federal Housing Finance Agency, the
Department of Housing and Urban Development, and the SEC revised a rule
proposed in 2011 to implement the risk retention responsibility provision.
＊＊＊
What is clear from the above is that, although more
than four years have passed since the Dodd-Frank Act was enacted, while some of
the items are, at last, set to start, the most important have yet to be finalized.
Long delay seems to be the
prospect on all sides.
What will
this delay implicate? The financial institutions, with the help of the
Republican Party, having successfully bounced back from the brink of failure due
to huge bailout from the government, have been trying to obstruct the creation
of organizations designed to oversee their speculative activities. They have also been making great
efforts to have the Act softened and weakened with big loopholes, lavishing
huge sums of money on the political arena and engaging in lobbying activities
with some success. Thus the SBS has remained intact, which suggests the serious
risk of a huge financial crisis hitting the world again in the near
future.
It needs to be borne in mind that so far
it is only the US that has put through a
5.4 Appendix : the UK and the EU
The following is the present state of UK and EU action
in tackling financial instability. As compared with the US, implementation of
the measures is much slower.
The UK ― The
Vickers Report, which was published by the Independent
Commission on Banking (ICB) in September 201117, is
an important document proposing the appropriate approach to financial
regulatory reform.
The most salient feature of the Report is the creation of a ring-fence
between commercial banks and investment banks so that money
deposited at the former be protected from being used speculatively by the
latter. In spirit, it is similar to the Glass-Steagall Act, but different in
that a fence is built rather than two types of banks being separated. Another
feature is a device for raising the British banks’ “loss absorbing power”.
In December 2013, the Financial Services
(Banking Reform) Act was enacted,
EU － The Euro group is considering whether it should adopt the Volcker rule and/or ring-fence method. In Germany the Ring-Fencing and Recovery and Resolution Planning of Credit Institutions Act, based on the Liikanen Report, was enacted in May 2013. In France the Banking Reform Act, adopting a ring-fencing method, was enacted in March 2013.
Per contra, the ECB is
skeptical about the ring-fence method while the European Commission (EC) is
planning a law to prohibit Prop Trading.
Moreover, there is the Banking
Union plan (which the EU prefers most, but it is difficult to implement) and the financial transaction tax
(FTT. It is a kind of Tobin tax). Let us take a look at the FTT, which
is making the most progress.
The FTT was first discussed in June 2010.
However, it did not go down so well in the EU as a whole. Then, in October
2012, the European Commission
(EC) changed the plan in such a way that would-be member countries should be
authorized to enjoy “enhanced co-operation ”. In December 2012 the plan, which
eleven member countries had endorsed, was approved in the Europarliament . In
February 2013 the EC again submitted the plan, in a revised form, to the
Europarliament, and it was approved in July. The plan, according to which 0.1%
is imposed on transaction of equities and debts, and 0.01% on transaction of
derivatives, is to be finalized among the eleven member countries by mid-2014
(This is different from the bank levy, which is to be imposed on banks ready
for possible bailouts in the future).
It should be
noted that financial regulation reform is not a priority for the EU. The Euro
System crisis continues, rooted in its inherent characteristics.
6. The Need
for Financial Regulation Reform
We now turn to the fundamental question: Why is
financial regulation reform needed? Two points are worth noting in particular. One is “distorted capitalism”,
the other reconsideration of “freedom and market” as concepts.
6.1 The Distorted Capitalist System
Finance is an essential element for the modern
capitalist system. Without it, the smooth working and development of the
economy would be inconceivable. The problem is, however, the relation between financial liberalization
and the “sound” development of capitalism.
If the financial sector is left unchecked, those involved seek to gain as large a share of GDP as they can for their own advantage. In consequence, they are tempted to distort income distribution to a considerable degree; hence the emergence of distorted capitalism.
If the financial sector is left unchecked, those involved seek to gain as large a share of GDP as they can for their own advantage. In consequence, they are tempted to distort income distribution to a considerable degree; hence the emergence of distorted capitalism.
It should be
noted that regulation or overseeing is not inconsistent with liberalization.
What the financial institutions have done in recent decades in the name of “liberalization”
is to bring about the
phenomena of market “non-existence” and “opaqueness”. Non-existence
emerged as a result of multi-layered securitized products, while opaqueness
characterizes the financial market in which many hedge funds can deal in huge
amounts of money without
any obligation to report their dealings to the authority.
It is
very important to make a rule for the financial market. It is wrong to identify
lack of rules with financial liberalization. To take one example, Wall Street
has, with lobbying activities, shown fierce resistance to the transaction rule
for derivatives, on the ground that it is an unjust intervention in the market.
This is not the case, however. The measure aims at observance of the rule of
the market, and as a framework to guarantee this, puts forward a proposal to
construct a system which is fair and transparent as equity market . Here we need to work out “what
the market is, and how the market should be”.
6.2 Freedom and Market as Concepts that Must Be Rethought
Neo-Liberalism
has vociferously maintained that the capitalist economy is a system of
self-responsibility, so the need is to challenge the future under one’s own
responsibility, not depending on the government, while the government should
not interfere with the market.
The
transfer of short-term capital has been liberalized to an extreme degree, and
the multi-layered securitized products have gone to extremes in the name of the
triumph of financial engineering.
Many
international financial banks which had been leading in the race then found
themselves in serious jeopardy. They then asked the governments for financial help, abandoning the “Self-Responsibility”
gospel.
This phenomenon
should, to a considerable degree, be attributed to an extreme belief in the “pure
market economy”. Liberalization without due prudence has set extremely
short-run speculative activities completely free, and business ethics and social ethics have been
dropped.
On the other
hand, the people who went bankrupt due to subprime loans have lost their homes
in foreclosure, with the loans left. It is on them that the principle of self-responsibility
is enforced. Neoliberalism collapses of itself in the face of the nitty-gritty.
7. Conclusion
This chapter has
addressed the problems of financial liberalization which have
However,
the administration has been extremely slow in implementing financial
This chapter
also warns against the dogma that regulation is incompatible with
1) The Pecora Commission made a great
contribution to revealing this fact.
2)
Incidentally, Geithner, the Secretary of the Treasury (Summers was a protégé),
was president of the FRB of New York. In September 2008 he forced the Lehman
Brothers into bankruptcy, and yet bailed out the Citi Group with the TARP fund.
3)
Gramm ran for Republican nomination in the 1966 presidential election. In the
2008 campaign for the Presidency he was among McCain’s principal supporters.
According to some sources, he would have been Secretary of the Treasury if
McCain had been elected President.
4) In October
2008 the UBS, which suffered a huge loss, not
only received public money (amounting to 6 billion Swiss francs) from the Swiss
government, but also handed the bad assets (worth 72 billion Swiss francs) over
to it.
5)
As examples of serious financial crises which occurred in the US (though it had
no influence on the international scene), we may mention the S&L crisis (around
1990） and
the burst of the Dotcom Bubble (around 2001; Enron is emblematic here).
6)
For this dramatic story, see an interview with Brooksley Born - Chair, Commodity
Futures Trading Commission (1996-1999).
http://www.pbs.org/wgbh/pages/frontline/warning/themes/ltcm.html
7)
The most famous, and indeed, notorious was A . Schleifer, Professor at Harvard
University (his protégé is L. Summers), in the case of Russia.
8) As a
prelude to this, we need to mention the Plaza Accord of 1985. This was to mean
a great ordeal for Japan, and, due to the failure in appropriately dealing with
subsequent events, led to the “Lost Decade” of the 1990s.
9) China
goes on playing a sort of imperialistic role in vast parts of the globe,
including the African Continent, much as the Western Powers had formerly done.
10) Funded by the TARP (the Troubled Asset
Relief Program), which was hastily proposed, and was to be used in a very
ambiguous way by the Bush Administration.
11） As representative of the lobbyists criticizing
financial regulation, we may mention the American
Bankers Association, and in support of it the U.S. Public Interest Research
Group.
12)
See Hirai (2012, Chapter 7).
13) This
September JP Morgan and Goldman Sachs decided to close the proprietary trading
section, considering the Volcker Rule.
14)
Recently the yields gained by hedge funds have shown some decline. Wary of
risks, investors are now tending to concentrate their resources in large funds
rather than small ones.
15) The
Fed, the FDIC and the OCC are allowed to carry out operations with independent
funds while the SEC and the CFTC are incorporated in the budget system, which
requires the approval of Congress.
16) See
Tarullo [2013; 2014].
17) See the Independent Commission on Banking [2011].
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