After limited debate the US Senate overwhelmingly approved a further reduction in “Dodd-Frank” banking regulations introduced in 2010 to avoid another 2008 style bank generated economic collapse.

Dodd-Frank‘s primary mechanism for doing this was to require financial institutions that were “too big to fail” to withstand stress tests.  The idea being that if your bank was going to need a government bail out in the event of failure, effectively making you and me the banks insurance company, that such banks need to prove that they can withstand large economic downturns by keeping enough cash (and near cash) on hand to cover their immediate debts.

If banks pass the stress test, and ALL did in June 2017, they can issue dividends and buy back their own stock (financial engineering to raise their own stock price).  If they fail, they can’t.  The results and some key details are published so both the markets and individual investors know which banks are stable and which ones are not.

The principle Dodd-Frank change passed in March 2018, was to increase the threshold needed to be included in the stress test, from $50B to $250B.

Banks and other large financial institutions are not evil corporations but they are run by greedy people just like you and me.  When those people are given massive incentives to bring in large amounts of income to the banks, they are likely to take risks that are absurd in retrospect, just likely they did in the 2000’s.

When the money that is risked belongs only to shareholder, employees, and board members, there is not public issue with those risks; even ‘crazy’ ones.  The problem occurs when the company (bank) in question is so large that if it fails it will bring down the countries (globe’s?) economy.  This is also called “systemic risk“.  Such a failure cannot be allowed to occur, so governments step and transfer your tax money to those companies.

Put simply, if you are ‘too big to fail’, the public has a right to validate your stability.

While laws must be periodically updated to keep up with the products offered for sale and global political / financial environment, the problem with the March 2018 changes is that they are all reductions:

It is important to remember that the most notable cause of the 2008 collapse, was the bundling (obfuscating) of very low quality (sub-prime) mortgages into opaque packages called “mortgage backed securities“.  MBS’ are part of a larger group of bundled financial ‘products’ called derivatives.  Those derivatives were then insured (bet on) by the same large banks that sole the ‘credit default swaps“.  This meant that if a mortgage bundled (derivative) did not return the expected (guaranteed) profit, the bank that sold it to you (usually) would pay you to make up the loss.  That meant that the banks were all tied together so when one big one falls (AIG, Lehman Brothers, Merrill Lynch…) that many fall, credit for new purchases dries up and economy collapses.

If you have two hours and want to know the details of the 2008 crisis watch this excellent, non-partisan, FrontLine documentary, Inside The Meltdown.

In January 2017, Donald Trump ordered a review of Dodd-Frank and the so called ‘repealers’ went into high gear.

Most analysts, economists and financial insiders agree that Dodd-Frank stress test limits should have been increased (but not to $250B) but the there has been no serious thought of adding regulation to impose monitoring or even reporting of derivatives and credit default swaps.

Today there is no meaningful regulation on credit default swaps (CDS’).  How many there are, who owns them, who is liable in a failure, … are all unknowns.  There is no public market for CDS, no reporting or oversight.  This means financial institutions, and therefore everyone else, will almost certainly end up in the same situation we were in 2008.

The 1929 stock market crash, the late 1980’s Savings & Loan crisis, the 2008 economic crash all had overly exuberant smart people make insane decisions.  Has history taught us nothing?



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