I Say, Let 'Em Crash

By: Michael Ashton | Mon, May 27, 2013
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John Mauldin wrote a piece last week about Brown-Vitter, a piece of legislation making its way through Congress that has a "simple" approach to getting the government out of the bank-rescue business: for big banks (basically defined in the legislation as banks who use derivatives to structure customer deals), a massive capital buffer is demanded, which would effectively take big US banks out of the derivative business and greatly increase costs and decrease variety of derivative and other solutions (many bonds issued by corporate entities are coupled with a swap to the dealer, which would now be subject to a massive capital charge).

The appeal of the legislation is its simplicity. It simply destroys the business model of the largest banks.

Moreover, it doesn't solve the "too big to fail" problem. It merely changes the hurdle of how much bad stuff needs to happen, in order to cause a bank to fail in the first place and to require saving. It wouldn't cause the government to exit the position of writing puts on banks: it would merely move the strike prices of those puts.

I will say that in my interactions with Wall Street banks, I have not run across anyone who is concerned, at least not yet, that Brown-Vitter will actually become law. It is simply too blunt of an approach - akin to burning a town down in order to keep it from being flooded.

The cynic in me says that all of this legislation is designed mainly to produce big contributions from banks to the reelection campaigns of public officials. There is a much simpler way to get the government out of the too-big-to-fail business, which furthermore does not involve causing massive side effects in the derivatives and other markets. Congress could simply pass a rule that prohibits the government (including the Fed) from bailing out a private enterprise. Problem solved, subsidy ended.

The Fed already has the power to close down and wind down insolvent banks. Of all of the Fed's powers, this is the one that has been used most successfully over the years. It isn't the failure of a bank that is the problem, but the chaotic failure of a bank that is the problem. Task the Fed with reducing the chaos inherent in large bank failures, and let the chips otherwise fall where they may.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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