The Professor Who Wrote the Seminal Book on Wall Street Megabanks Calls Today?s Financial System ?Dangerously Unstable?

[Gunnar Larson]

https://wallstreetonparade.com/2024/04/the-professor-who-wrote-the-seminal-book-on-wall-street-megabanks-calls-todays-financial-system-dangerously-unstable/


By Pam Martens and Russ Martens: April 18, 2024 ~

Taming the Megabanks, Book JacketGeorge Washington University Law
Professor, Arthur Wilmarth, has done it again. After authoring the seminal
book on the insidious evolution and enormous dangers still posed by the
Wall Street megabanks (Taming the Megabanks: Why We Need a New
Glass-Steagall Act) Wilmarth is now out with a new, gripping paper. In the
paper’s abstract, Wilmarth explains how the risks posed by the Wall Street
megabanks in 2008 have become exponentially more dangerous today. He writes:

“The dangers created by universal banks (including their ‘internal’ shadow
banking affiliates) and ‘external’ shadow banks have intensified since
2009. A toxic symbiosis has developed between the syndication and
underwriting of risky loans and debt securities by universal banks and the
origination of speculative private credit by ‘external’ shadow banks. That
noxious partnership has helped to generate unprecedented levels of risky
consumer and corporate debts.

“Universal banks and shadow banks have created dangerously unstable
financial markets that depend on frequent bailouts from central banks and
other government agencies. Four serious financial disruptions since the GFC
[Global Financial Crisis] have triggered significant government
interventions and bailouts—the repo crisis of 2019, the pandemic financial
crisis of 2020–21, the failures of three U.S. regional banks in 2023, and
the collapse of Credit Suisse. Those episodes demonstrate that universal
banks and shadow banks pose massive and unacceptable threats to our
financial system, economy, and society.”


Patrick Corrigan, Associate Professor of Law, Notre Dame University School
of Law

Wilmarth’s paper expands on the groundbreaking work of Patrick Corrigan,
Associate Professor of Law at the University of Notre Dame Law School, who
last August did a deep dive into the shadow banks that exist off-balance
sheet in the form of Variable Interest Entities (VIEs) at the largest Wall
Street megabanks (a/k/a universal banks). Corrigan documents the key role
these shadow banks/VIEs played in the financial crisis of 2007-2010.

Wilmarth explains the breakthroughs in Corrigan’s research as follows:

“…Professor Corrigan shows that universal banks used off-balance-sheet VIEs
[Variable Interest Entities] to evade rules governing bank capital, bank
affiliates, and investment companies. The Basel Capital Accords and
implementing rules adopted by U.S. regulators ‘allowed banks to reduce
their capital requirements either by moving their loans (through
securitization) to off-balance sheet conduits or by obtaining financial
guarantees from AAA- or AA-rated companies’— such as AIG, Ambac, and MBIA.
The most extreme example of such arbitrage occurred when federal regulators
allowed universal banks to reduce their risk-based capital requirements by
90% if they transferred RMBS [Residential Mortgage-Backed Securities] or
CDOs [Collateralized Debt Obligations] to off-balance-sheet conduits that
were backed by short-term guarantees (liquidity puts) from banks.

“Professor Corrigan makes a new and important contribution to the
securitization literature by showing that the Federal Reserve Board (Fed)
and the Securities and Exchange Commission (SEC) exempted off-balance-sheet
securitization conduits from regulation either as affiliates of the
sponsoring banks or as investment companies. An informal exemption granted
by the Fed and a 1992 rule issued by the SEC allowed bank sponsored VIEs to
escape a host of regulations governing bank affiliates and investment
companies—including capital rules, restrictions on affiliate transactions
and investments, prudential supervisory standards, and special receivership
proceedings. By allowing securitization VIEs ‘to avoid virtually all of the
rules that apply to bank affiliates and investment companies,’ the Fed and
the SEC ‘exacerbated distress as the 2007–2009 financial crisis unfolded.’ ”

The poster child for off-balance sheet hubris before, during and after the
2008 financial crisis was the megabank, Citigroup. The official report from
the Financial Crisis Inquiry Commission provides these shocking details:

“…More than other banks, Citigroup held assets off of its balance sheet, in
part to hold down capital requirements. In 2007, even after bringing $80
billion worth of assets on balance sheet, substantial assets remained off.
If those had been included, leverage in 2007 would have been 48:1, or about
53% higher….”

For our as-it-happened reporting on the collapse of Citigroup in 2008, see
The Rise and Fall of Citigroup. By March of 2009, Citigroup was a 99-cent
stock.

What is lurking in the form of off-balance sheet VIEs today at some of the
megabanks on Wall Street is just as opaque and dangerous (if not more so)
than it was in 2008.

JPMorgan Chase’s 10-K (Annual Report) filed with the Securities and
Exchange Commission (page 202) shows it has $1.498 trillion in off-balance
sheet exposures as of year-end 2023. This is the same bank whose Chairman
and CEO, Jamie Dimon, is bullying his regulators to drop their demand that
his bank hold 25 percent more capital.

Where Corrigan and Wilmarth part paths in their latest papers is how to
reform these off-balance sheet risks to the U.S. financial system. Corrigan
proposes rule changes while Wilmarth sticks to his book’s well-documented
case that the only lasting and meaningful way to reform the Wall Street
megabanks is to restore the Glass-Steagall Act via Congressional
legislation and permanently separate federally-insured banks from the
trading casinos on Wall Street.

Given the corrupt revolving door between Wall Street and its regulators,
and Wall Street’s long-held attitude that “it’s legal if you can get away
with it,” clearly Wilmarth has the only workable reform idea.
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