When Interests Collide

The title here is a deliberate knock-off
of the title of a work of science fiction
that was somewhat well known in the 1950s:

But seriously,
interests are indeed colliding and causing the "gridlock" and bad decisions
that we have seen in America over the last half century.
Here is an example:

Local, state and foreign officials attack Volcker Rule
By Zachary A. Goldfarb and Howard Schneider
Washington Post, 2012-02-29

A new federal rule aimed at limiting risky behavior by banks is prompting protests from local and foreign governments alike, which warn it could make it harder for them to borrow money for public projects and operations.

State and local officials say the new regulation, known as the Volcker Rule, could make it more expensive for them to raise money from investors to pay, for instance, for environmental cleanup and housing assistance. In the Washington area, the rule could affect borrowing costs for agencies, such as the authorities that operate the Walter E. Washington Convention Center and Dulles International and Reagan National airports, according to the District’s chief financial officer.

European governments warn that the regulation could further aggravate their debt crisis, which is already roiling global financial markets.

The Volcker Rule, which was included in the Dodd-Frank overhaul of financial regulation passed by Congress in response to the financial crisis, bans banks from speculating with their own money. The idea was that banks can pose too much risk to the financial system if allowed to pursue such trading.

Regulators are now working to finalize rules that distinguish between when a bank is buying and selling for a customer, which would still be allowed, and when it’s betting for its own gain.

The draft rule released by regulators late last year created a few exemptions, allowing banks to continue speculating on U.S. government bonds and most municipal bonds. But the proposal extended the ban to hundreds of billions of dollars worth of other municipal securities, as well as bonds issued by foreign governments.

Municipalities and foreign governments alike are complaining that the rule would significantly curtail the purchase of their bonds by banks, increasing the interest rates that bond issuers may have to pay to attract investors.

From Texas to Europe to Malaysia, officials have been lobbying U.S. regulators to change the proposed Volcker Rule to avoid these consequences. The European Union and Japan sent officials to lobby U.S. regulators last week in Washington.

Regulators generally believe they have struck the right balance in terms of limiting risk-taking as Congress directed in the Dodd-Frank legislation while also preserving enough flexibility for banks to trade in municipal securities and foreign bonds.

But they have left the door open to possible changes — which could range from exempting additional categories of bonds because regulating them so tightly could pose risks to the financial system or other changes in the language of the Volcker Rule. They have not committed to any changes, however.

Federal regulators will release a final version of the Volcker Rule in coming months before it takes effect July 21. They have declined to comment publicly on the rule while it is still under discussion. A spokeswoman for the Federal Reserve said “all comment received will be evaluated before the board acts on the rule.”

On Friday, Treasury Secretary Timothy F. Geithner, who is helping to coordinate the writing of the new rule, said on CNBC that as regulators work to implement the rule and limit the risks that banks can take, they will be working to preserve “well-designed, carefully constructed exceptions for market-making hedging.”

Threat to projects

A water treatment project on the banks of the Potomac illustrates the issues raised by the Volcker Rule. Montgomery, Fairfax and Prince George’s counties and the District are paying up to $2 billion to clean water of nitrogen at the Blue Plains facility.

The localities will raise money through bonds to pay for the project. Current federal law doesn’t distinguish between the bonds issued by the differing localities.

Officials say that could change under the Volcker Rule, however. Bonds issued by the Washington Suburban Sanitary Commission, an agency that is part of both Montgomery and Prince George’s counties, would be unaffected.

But bonds issued by the D.C. Water and Sewer Authority could be affected because it is not technically an agency of the D.C. government. Rather, it is an independent entity overseen by a board appointed by the mayor. Since banks would face restrictions in trading the authority’s bonds, the authority might have to pay more to borrow.

The Volcker Rule “creates these bifurcations now in the municipal markets where you’re going to have authorities, enterprise funds, and water utilities paying more to issue their bonds simply because of how they’re structured,” said Timothy L. Firestine, chief administrative officer of Montgomery County and vice chairman of the D.C. water authority.

Beyond the region, a variety of municipal and local agencies — from an electric utility in Texas to a housing authority in Connecticut — have written to federal regulators expressing concerns about whether their ability to raise money through bonds would be constricted.

Complaints from Europe

Foreign governments have unleashed a torrent of criticism, urging U.S. officials to soften the rule on the grounds it could make Europe’s debt problems even worse.

Banks in Europe are among the chief investors in bonds of their home and neighboring countries. These financial firms also play an important role in reselling those government securities to other investors and helping bond markets function.

The Volcker Rule could pose problems for banks with U.S. subsidiaries, branches or other operations in the United States in carrying out transactions that are vital to European bond markets, according to the Association of German Banks in comments submitted to regulators.

“As soon as there is the slightest relation to the U.S. in terms of trade counterparty, personnel or trade execution . . . [banks] worldwide would have to cease their proprietary trading in E.U. member states government bonds,” the group said.

Michel Barnier, head of internal markets and services for the European Commission, the executive arm of the E.U., pressed Geithner on the issue in meetings last week. At a news conference during his visit, Barnier called the Volcker Rule’s provisions on government debt “unilateral and protectionist.” He noted that enacting the rule could complicate efforts by Europe and the United States to synchronize the adoption of other new financial regulations.

The breadth of the proposed rule has angered officials and bankers who argue that its reach extends far beyond U.S. borders and would require compliance from overseas firms, regardless of whether their U.S. presence is large or small.

Foreign banks would face the choice of closing U.S. branches or subsidiaries, or restructuring their home-based businesses to comply with the Volcker restrictions.

George Friedlander, an analyst at Citigroup Global Markets, said the issue could be fixed in two ways. Either all municipal bonds and sovereign debt could be exempted. Or the guidelines for what banks may do with bonds that are covered by the Volcker Rule could be relaxed.

“If it is, then a substantial amount of the problems . . . dwindle substantially,” he said.

Back to the comments of the author of this blog:

We have all seen the great loss to the taxpayer caused
when banks are allowed to
privatize their gains while they socialize their losses.
Do we really want to repeat that experience?
Is the (relatively) small gain to governments today worth
the almost certain great loss to the federal government in the future,
the next time the banks are allowed to engage in risky behavior
knowing the risks will be absorbed by (future) taxpayers,
not by the excessively well-paid bank decision makers?

That conflict has been made explicit in the article, to its credit.
But there are two other conflicts that are implicit in this situation.

The first is at the level of the borrowing governments.
Why are they so hard-pressed for capital that
first, they need to borrow to implement these socially worth-while projects,
and second, are so desperate to keep their borrowing costs down
that they are demanding that banks be allowed to engage in the risky behavior described above?
(That is clearly a case of being penny-wise and pound-foolish.)
The reason that they are so hard-pressed
for capital to spend on these worthy projects
is that, by historical standards,
they are spending so $%^&* much money on health care!
Even the most pointy-headed health-care advocate needs to observe that
national spending on health care has risen from
well under 5 percent in the 1940s to 17-18 percent in 2012.
At the governmental level, this is reflected in
the titanic sums that are being spent on Medicare (federal spending) and Medicaid (local spending).
The reality, which people need to keep in mind, is that
governments, under political pressure
from the advocates of greater health care spending,
have made the decision to spend vast sums on health care
while investments in infrastructure and the other goals mentioned in the article
are put at the bottom of the priority list.
If you argue that
some infrastructure investments have always been funded through bond issues,
well, that is true,
but governments always managed to pay
whatever interest rate was demanded by investors
without letting the banks engage in
the disaster-causing risky behavior
that allows them to lower up-front interest rates,
at the expense of the government covering
the inevitable losses that will eventually ensue on some of their bets.
In other words, letting the banks get away with what they are demanding
makes all governments participants in a high-level financial casino.
Anyhow, the first conflict I am pointing out is that between
the demand of health care for vast pots of government money and
the need to pay banks and investors an interest rate that will attract their investments
without engaging in high-risk financial speculation.

The second conflict is one within the banks themselves.
That is between
the desire to pay their employees and managers salaries and remuneration on a scale that is far above the American norm, and
the possibility of simply taking less for the banks and employees themselves
(i.e., keeping their internal costs low)
and thereby charge lower fees and interest rates to the governments seeking loans.

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