Author: Annie Lowrey

Last week, J.P. Morgan announced that it made a first-quarter profit of $3.3 billion on revenue of $28.2 billion, meaning for every dollar of business the bank did, it kept 12 cents as profit. This morning, Goldman Sachs — the Wall Street giant charged by the Securities and Exchange Commission with defrauding customers with mortgage-backed financial products last week — released its first-quarter earnings statement as well. It made $3.46 billion in profit from $12.78 billion of revenue — meaning for every dollar of business it did, it kept 27 cents.

This is not quite a picture of a healthy industry. In a competitive marketplace, prices and fees at Wall Street firms should fall and margins should become thinner. On the one hand, Wall Street firms like J.P. Morgan and Goldman Sachs have seen a number of their competitors die in the past two years, and have absorbed business from the failed Lehmans and Bear Sterns of the world. But on the other hand, Wall Street profit margins have remained sky high except for a short blip during the worst of the credit crunch. And, an economist would tell you, such sustained levels of high profitability point to anti-competitive behavior.

Consider another high-profit company in a competitive industry — say, Exxon Mobil. Last year, it made about $19 billion in profit on $300 billion in turnover, giving it a margin of six percent. WalMart? It is in the low-margin grocery and retail business, and managed a profit margin of around 3.5 percent. In the first quarter, Goldman’s margin was just two percentage points below Google’s — and consider how dominant Google is in its industry.

In short, the profits point to a lack of competition. That is one thing the Dodd bill — via derivatives regulation — attempts to fix. Right now, Wall Street firms do not bid for big derivatives contracts — they simply quote a price and work over-the-counter. For that reason, derivatives are wildly profitable for the companies. The Dodd bill will force derivatives pricing to become public to the market, driving down margins as companies compete.

Recently, J.P. Morgan’s chairman, Jamie Dimon, put a number on how much that might cost his firm — $700 million to a “couple” billion dollars — less than a quarter or a tenth of his company’s annual profits.

Bloomingdale — a pretty neighborhood in central Washington, D.C., with brightly painted Victorian townhouses and wide tree-lined streets — is gentrifying. Ten years ago, it had problems with gangs, robberies and drug-related violence. Today those issues are greatly reduced, thanks in large part to the efforts of the neighborhood’s tight-knit community of black families and young professionals. In the past five years, it has cleaned up its streets, developed two new parks and a small urban farm and watched its home values rise.

Now, residents of Bloomingdale — east of the U Street corridor, near Howard University — could use some businesses. There is Windows Market, which sells sandwiches and groceries; Big Bear, a popular coffee shop; and Timor Bodega, an organic grocer. But the closest place to grab brunch or a drink after work is a fifteen-minute walk away. “There’s just tremendous pent-up demand,” John Salatti, the neighborhood commissioner, says. “I couldn’t imagine how well a business would do if it could just open up.”

But the problem for Bloomingdale is that it just cannot get businesses to open up. It is not for a lack of trying. In the past year, at least half a dozen restaurants have attempted to set up shop in one of the neighborhood’s empty storefronts. There is the sandwich and pizza place attempting to move in next to the Howard dorm and the fancy new condo building. There is the neighborhood tavern trying to open near the yoga studio. There is the restaurant that wants to take over the old fire house. Not one has succeeded.

Consider, for instance, the case of Aleks Duni. He owns Veranda, a Greek restaurant in the Shaw neighborhood, as well as Heller’s Bakery and Marx Cafe in Mount Pleasant. The three small businesses together employ nearly 40 people and did well even during the worst of the recession. Duni set out to open a pizza restaurant on the main drag in Bloomingdale. He scouted out a location and secured the necessary permits, even getting a liquor license and thus a guarantee of good revenue. Now, no bank will lend him the $50,000 he needs to finish the job. “It is only a matter of getting the money,” Duni says. “If I did, I could be open in a month.”

Duni approached four banks about securing the loan to finish construction and open the doors. Each one said no. “There are a million reasons they give,” Duni says. “The first of them is that credit has been reduced.” Now, he says, he is concerned about continuing to apply for loans just to be denied. “If you apply and you don’t get the loan, your credit score goes down,” he notes. Frustrated, he has even sought the help of the Small Business Administration, the government agency. “They had nothing for me,” he says. “I don’t need to know what the loan requirements are. And the SBA cannot give me a loan.”

Duni is one of millions of frustrated small-business owners, who represent a lost opportunity for economic recovery and a major concern for the Obama administration. Over the past 15 years, two-thirds of the new jobs created in the United States were created by a small business. Small businesses, like big businesses, require loans to grow and hire new employees. But unlike their medium and large counterparts, small businesses are still hobbled by frozen credit markets. Lending remains on the wane despite the Obama administration throwing tens of millions of dollars at the problem. An  SBA initiative to back loans has worked, but only on a limited scale. Most Main Street banks continue to decrease funding to small businesses, allergic to the higher risks they pose.

Small businesses generally use commercial banks and finance companies for loans, and those lenders have continued to cut back their books even as the recession has started to lift. Commercial and industrial lending — the economic category that includes small-business loans — fell 20 percent in 2009 and declined a further four percent in the first three months of 2010. In January, the latest month for which data is available, nine big banks provided 28 percent less credit to small businesses than the month before, the Treasury Department reports.

A recent report by the National Federation of Independent Businesses, a small-business lobbying organization, underscores the point. The NFIB found that in 2009, 20 percent fewer businesses held a loan or credit line than in 2008. Just 40 percent of small-business owners that applied for a loan had “all of their credit needs met,” down from nearly 90 percent five years ago. The continued seizure of the credit markets is reducing small-business hiring and confidence, NFIB argues. Its index of small business optimism actually fell in March, with most businesses saying they had a gloomy outlook and did not feel it would be a good time to expand.

The underlying economic problem is twofold. First, banks claim that they do not have enough funds to lend to small businesses. Second, banks with funds are unwilling to take the risk of lending to small businesses, since they tend to default at higher rates. The Obama administration has tackled both problems with a spate of bills and initiatives. The two main ones include: a $730 million infusion of funding to the SBA, letting it increase government loan-backing to 90 percent and reduce fees, enacted last spring; and $17.5 billion in tax cuts, credits, and subsidies aimed in part at small businesses in the jobs bill passed last month.

These efforts have successfully boosted SBA lending back to pre-crisis levels. “Once the recovery act passed in February 2009, provisions went to the SBA to let us increase our guarantee immediately,” Hayley Matz of the SBA explains. “Since then, lending has increased 90 percent. We’re where we were. We’re at 2007 levels.” But the SBA is not a direct lender — and credit markets outside of the SBA’s control have remained frozen solid. “There is bipartisan support for SBA has done and acknowledgment that our recovery programs have been good,” Matz says. “The next step is not just to continue with what works.”

The administration is thus now pushing a stronger set of provisions to entice lenders to extend credit to small businesses in a bill currently being assembled under the watch of Sen. Debbie Stabenow (D-Mich.) and Sen. Mary Landrieu (D-La.), who heads the Senate Small Business Committee. The bill includes various tax breaks, including an exemption for earnings from small-business stock. But its centerpiece is a Treasury program to redirect $30 billion from the Troubled Asset Relief Program to community banks.

Still, small business advocates say it is too little, and too late. “We sure would have liked to have seen quicker action,” says Terry Gardner, policy director at the advocacy group Small Business Majority. “Like so many issues, these proposals are just bogged down. With the SBA loans, I had to ask — who is actually against this? Why is this still not moving? It has bipartisan and presidential support, plus support from banks and small business groups. It is frustrating.”

Moreover, he says that it is not clear if the administration plans will effectively convince banks to lend to small businesses. “The Treasury proposal providing more capital to community banks is only a good idea if it actually induces them to make loans,” Gardner says. “There has to be some incentive structure that guarantees that taxpayer money being loaned to these banks is accomplishing its purpose — to get more capital to small businesses to create jobs — because efforts to do that have stalled.”

Tomorrow, the House Financial Services Committee, headed by Rep. Barney Frank (D-Mass.), will hear testimony regarding the Valukas Report — a lawyer’s examination of the collapse of the investment bank Lehman Brothers, which uncovered fraudulent actions, including the now-infamous “Repo 105” accounting trick.

The lineup is full of heavy hitters, including Treasury Secretary Timothy Geithner, Fed Chairman Ben Bernanke, former Lehman Chief Executive Officer Dick Fuld and Securities and Exchange Commissioner Mary Schapiro. And several of the prepared testimonies are online in advance of the hearing. Most notably, Fuld’s. The former Lehman head makes some rather extraordinary claims.

First, he argues that Lehman was appropriately capitalized before its collapse: “The world still is being told that Lehman had a huge capital hole. It did not. … Using the Examiner’s analysis, as of August 31, 2008 Lehman therefore had a remaining equity base of at least $26 billion. That conclusion is totally inconsistent with the capital hole arguments that were used by many to undermine Lehman’s bid for support on that fateful weekend of September 12, 2008.” But then again, the examiner’s report does state: “The Examiner concludes that there is sufficient evidence to support a finding of undercapitalization of [Lehman Brothers] as of August 29, 2008.” I am not sure how Fuld squares that circle.

Fuld also argues that he had no knowledge of Repo 105: “Let me start by saying that I have absolutely no recollection whatsoever of hearing anything about Repo 105 transactions while I was CEO of Lehman. Nor do I have any recollection of seeing documents that related to Repo 105 transactions. The first time I recall ever hearing the term ‘Repo 105′ was a year after the bankruptcy filing, in connection with questions raised by the Examiner.” There is probably no way to know whether Fuld knew about Repo 105 or not — but regardless, it is now abundantly clear that he should have known.

He also argues that, in contravention of the Valukas finding, Repo 105 was acceptable accounting: “As I now understand it, because Lehman’s Repo 105 transactions met the FAS 140 requirements, that accounting rule mandated that those transactions be accounted for as a sale. That was exactly what I believe Lehman did. Lehman should not be criticized for complying with the applicable accounting standards.”

Valukas’ testimony is interesting as well. For one, he goes after Lehman’s regulators, including the SEC and the New York Fed: “We found that the SEC was aware of these excesses and simply acquiesced. With no regulator in place that required Lehman to adhere to its risk limits, … Lehman’s risk limits became meaningless.” He later says, “So the agencies were concerned. They gathered information. They monitored. But no agency regulated.”

On Friday, the Securities and Exchange Commission made a bombshell announcement: It is charging Wall Street giant Goldman Sachs with civil fraud for failing to reveal to clients that a hedge fund shorting the housing market had engineered the product they were purchasing to fail.

It seems that might not be the only allegation the bank will have to deal with. Michael Hirsch at Newsweek reports that Sen. Carl Levin (D-Mich.), who heads the Permanent Subcommittee on Investigations, believes there is “another big shoe to drop on Goldman,” without specifying any more details. The panel has been investigating investment banks’ role in the boom and bust in detail, and is due to hold hearings with Goldman executives next week. The unnamed source in Hirsch’s article says Levin plans to reveal the nature of the allegations as soon as tomorrow.

Sen. Chris Dodd (D-Conn.) is calling the Republicans out: The Senate plans to give them the opportunity to vote for or filibuster the financial regulatory reform bill as soon as Wednesday, Brian Beutler at Talking Points Memo reports.

Democrats need one Republican crossover to break a filibuster and move forward to an up-or-down vote on financial regulation. Right now, it is unclear who that crossover will be, with all 41 Republicans signed on to a letter of opposition written by Minority Leader Mitch McConnell (Ky.). Sen. Susan Collins (R-Maine) was the last signer of the letter, and Treasury Secretary Timothy Geithner, a strong proponent of the bill, is due to meet with her this afternoon.

Dodd, the chair of the Senate Banking Committee, predicted that Republicans would not stick together to filibuster the bill. “I don’t really believe Republican members want to be with their leaders when they’re talking about filibustering a bill that would allow us to address [regulatory reform],” he said. Still, Republican leadership has repeatedly indicated that it plans to filibuster to force substantive changes to the legislation.

(As an aside — I doubt that the Senate would move the bill to the floor by Wednesday, given that Obama plans to make his banner speech on the subject at Cooper Union on Thursday.)

This morning, White House Press Secretary Robert Gibbs announced that President Obama will give a speech on financial regulatory reform from New York City on Thursday:

Almost two years after the crisis hit and almost one year after the Administration first laid out a detailed plan for holding Wall Street accountable and protecting consumers, he will call for swift Senate action. The crisis has already wiped out trillions of dollars in family wealth and cost over 8 million jobs. The President will also remind Americans what is at stake if we do not move forward with changing the rules of the road as a part of a strong Wall Street reform package.

Two years ago, during the presidential campaign, Obama spoke about the need for financial reform from Cooper Union — where he will deliver his remarks on Thursday. And he will need to deliver them well. The administration’s efforts to reform Wall Street have been hampered not just by Republican intransigence, but by messaging problems. Despite the popularity of reforming the banks, the administration has faltered in explaining just what it plans to do and why that is the best way to do it — in part because rather than using blunt regulatory instruments, such as a tax on financial transactions, the bill is a patchwork quilt of tripwires, oversight changes and complex rules. For more on the complexity of Wall Street reform, see Ryan Avent’s smart comments here.

It’s earnings week on Wall Street, and analysts had estimated that megabank Citigroup would break even in the first quarter. This morning, it announced a $4.4 billion profit — meaning the bank made around $49 million a day in the first three months of the year. Sure, markets improved and revenue grew, but, in a release along with the financial statement, Chief Executive Office Vikram Pandit noted the real reason for the company’s profitability:

All of us at Citi recognize that we would not be where we are without the assistance of American taxpayers. We are gratified that Citi has been able to repay their TARP investment in our company, with a substantial return, as well as create a significant increase in the value of their equity in Citi.

Still, that is not enough. We owe taxpayers a huge debt of gratitude for assisting us at a critical time. We are determined to repay this debt by continuing to build a strong company and contribute to America’s economic recovery.

Citigroup received a total of $45 billion in bailout funds during the worst of the crisis. It has repaid billions to the Treasury Department, which announced that it will sell off its Citigroup stock before the end of the year. The government owns nearly 30 percent of Citigroup shares, and stands to make a $7.5 billion profit if the stock stays up.

At the end of last week, the Obama administration reportedly told Senate Democrats to drop the $50 billion liquidation fund — often referred to as a “bailout fund” — from the financial regulation bill as a concession to Republicans. Senate Democrats broached the deal with Republican leadership. They refused.

Still, yesterday, Senate Minority Leader Mitch McConnell (Ky.) made the “bailout fund” the centerpiece of his argument against financial regulation reform on CNN’s State of the Union with Candy Crowley.

Of course, the “bailout fund” is no “bailout fund.” The idea is that banks would fund a $50 billion pool; were any to get into trouble, regulators would fire every member of management, wipe out shareholders, split the company up and sell the pieces, and tap the $50 billion fund to pay for the process and ensure the orderly dissolution of the firm. Companies like Citigroup were given bailouts during the crisis. This would be an execution (or, as Sen. Mark Warner (D-Va.) likes to say, a “death panel“).

Still, McConnell has made the fund a central talking point. The political calculation is clear: At least for now, Republicans believe that they are better off arguing the bill is not good enough rather than voting for reform, no matter how cynical and hypocritical it might seem.

Speaking with ABC’s Jake Tapper on This Week, former President Bill Clinton — during whose tenure the government decided against regulating derivatives, allowed the repeal of some of the Depression-era Glass-Steagall Act, allowing the creation of megabanks — said he was wrong.

I think [Treasury Secretaries Robert Rubin and Larry Summers] were wrong and I think I was wrong to take [to take their advice], because the argument on derivatives was that these things are expensive and sophisticated and only a handful of investors will buy them and they don’t need any extra protection, and any extra transparency. The money they’re putting up guarantees them transparency. And the flaw in that argument was that first of all sometimes people with a lot of money make stupid decisions and make it without transparency.

Clinton’s admission underscores the basic importance of financial regulation; during the boom and bust, derivatives, worth at least $4.5 trillion notionally, went entirely unregulated.

Sen. Blanche Lincoln (D-Ark.) has released her language for the derivatives portion of the bill overhauling financial regulation. I’ve gone through the section-by-section report, and am now digging into the language more deeply. Bills are complicated things, and I’ll be looking more closely this afternoon. But here are some provisional impressions of major aspects of the regulatory reform.

Swap desks spin-out?

Among the more controversial provisions reportedly in the act was a proposal to make investment banks spin out their swap desks (a swap desk being the department of the bank that sets up the kind of derivatives contract, a swap — like a credit default swap — that is currently mostly unregulated and not traded on exchanges). Why? To make sure that banks would not speculate on the other side of their clients’ bets. The problem is, investors agree to make trade derivatives with banks because they believe the bank is stable and profitable enough to pay out, if need be — a tiny swap entity might not be, and it might discourage investors from making the deals at all. But I can’t find any language clearly stating that swap desks need to be spun out from financial institutions, lest they lose access to the Federal Reserve’s discount window or F.D.I.C. deposit insurance. I’ll keep looking.

The end user exemption

The bill does keep an “end user exemption,” meaning that non-financial companies — say, Caterpillar — looking to use derivatives to hedge against changes to prices or interest rates do not need to put derivatives deals through a clearinghouse. They can continue to make the deals over the counter with their investment banks, as before, if they choose.

Commercial end users are exempted from mandatory swap clearing. Such end users are defined by nature of their primary business activity. Financial entities may not claim this exemption. These end users can opt out of the clearing requirement for the swaps only if they are hedging commercial risk…

High capital and margin requirements for OTC deals — for financial firms, but not end users

The bill calls for “capital and margin” — that is, the money an investor needs to post in a kind of escrow fund, just in case the derivative contract starts making losses — to be “significantly higher” for over-the-counter derivatives deals than for ones moving through clearinghouses. It seems to exempt non-financial firms from posing those higher rates of collateral.

Capital and margin must be set to ensure the safety and soundness of the Swap Dealer or Major Swap Participant and be set significantly higher for uncleared swaps as opposed to cleared swaps. Transactions are exempt from initial and variation margin requirements if one of the counterparties is not a Swap Dealer or Major Swap Participant.

No loophole for banks

The bill attempts to preclude banks from creating non-financial subsidiaries to act as end users, to avoid higher collateral and other requirements.

Affiliates of commercial end users may opt out of the clearing requirement for swaps if the affiliate is using the swap to hedge risk of the parent or affiliates of the parent. Affiliates cannot use the parent’s exemption if they are themselves swap dealers, security-based swap dealers, major swap participants, major security-based swap participants, issues that would be investment companies but for certain exemptions in the Investment Company Act, a commodity pool, a bank holding company with over $50 billion in consolidated assets, or affiliates of certain of these entities.

If the CFTC sees abuses taking place, it can write rules to end it

The CFTC has the authority to write rules to prevent abuses of the clearing exemption.

Collateral does not have to be cash

Banks do not necessarily need to pose cash or stable, liquid investments like Treasuries as collateral. But the bill does not specify what counts as collateral.

The Prudential Regulator sets capital and margin for bank Swap Dealers and Major Swap Participants, and the CFTC sets capital and margin for non-bank Swap Dealers and Major Swap Participants. Capital and margin should be comparable under all regulators and set within 180 days of the date of enactment. Non-cash collateral is permitted but may be restricted by appropriate regulators.

Brian Beutler at Talking Points Memo reports that Sen. Susan Collins (R-Maine) has signed Minority Leader Mitch McConnell’s letter in opposition to the Democrats’ financial reform bill. Republicans claim — inaccurately, experts say — that the bill will lead to more Wall Street bailouts. Here is the text:

Dear Leader Reid:

We encourage you to take a bipartisan and inclusive approach, rather than the partisan path you chose on health care.

A bipartisan bill should address the damaging financial practices of big Wall Street firms and government-sponsored entities that led to unprecedented taxpayer bailouts and caused our government to take on enormous amounts of debt. We simply cannot ask the American taxpayer to continue to subsidize this “too big to fail” policy. We must ensure that Wall Street no longer believes or relies on Main Street to bail them out. Inaction is not an option. However, it is imperative that what we do does not worsen the current economic climate or codify the circumstances that led to the last financial crisis.

We are united in our opposition to the partisan legislation reported by the Senate Banking Committee. As currently constructed, this bill allows for endless taxpayer bailouts of Wall Street and establishes new and unlimited regulatory powers that will stifle small businesses and community banks.

This is a complex issue that could have unintended consequences on job growth, the ability of Americans and business owners to access credit, and the United States’ role as a worldwide leader in innovation and capital formation. The consequences of this bill will reverberate across our economy for years to come.

We urge you to support the bipartisan negotiations by the Banking and Agriculture Committees. We are confident that the Senate can overcome political tensions and provide a bipartisan approach to financial reform this year.

But today’s events have only made financial regulation reform more popular and more urgent. If Republican leadership plans to filibuster, I would be surprised to see it hold onto all 41 Senators for any period of time. More likely, Republicans and Democrats will agree to various popular amendments to make them both look good after a few weeks of back and forth.

Find it here. And here is a section-by-section summary.

I’ve been reading the Securities and Exchange Commission’s civil charges of Goldman Sachs and one of its vice presidents carefully. It’s a complicated case dealing with complicated financial instruments, but I think there is a handy analogy to explain it in layman’s terms.

Let’s say that you are buying a house in a foreign country where you do not know much about the real estate markets and therefore prices are fairly opaque to you. You decide to hire a real estate broker to help you find and buy a house and to act as a guide to the market. You know that real estate brokers sometimes represent the person selling a home as well as a person buying a home, but also know that your broker has a legal responsibility to act in your best interests and disclose as much about the house as possible. Ultimately, the broker makes money on the deal, but does not have a direct financial interest in the house.

So you meet with the broker, who shows you a plain apartment in a plain apartment building. You decide to go for it. He says he will hire an independent home inspector to appraise the home, to make sure it is sound and to help you determine your bid. The process moves forward, you buy the house and pay the broker his fee.

But just months later, you find out that the neighborhood is drug-addled and the apartment filled with leaks. You try to sell the apartment, but can only do so at a 90 percent loss. It turns out that the third-party independent home inspector had been hired by the seller; that the seller had made a bet with a bookie that the price of the house would go down; and that the broker knew it — he let them overvalue your house.

In this analogy, Goldman is the broker. Paulson is on the short side of the trade, and behind the home appraiser. The analogy is by no means perfect — collateralized debt obligations are more complicated than houses. But it goes to show that the issue here was that Goldman had a responsibility to disclose pertinent information to the buyer, and it did not.

Today, the Securities and Exchange Commission charged Goldman Sachs and one of its vice presidents with selling clients a financial instrument that another client had purposefully designed to fail and had shorted, betting on its collapse:

The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO.

To simplify how the gambit worked: The hedge fund Paulson & Co. (no relation to former Treasury Secretary Henry Paulson) handpicked mortgage-backed securities that were doomed to stop performing, being backed with subprime mortgages, and Goldman packaged them into a kind of bond. Paulson bet against the bond, with Goldman acting as the broker; at the same time, Goldman sold the bond to other clients without disclosing that Paulson had engineered the bond to fail.

The SEC filing notes that those other clients lost $1 billion. Goldman had no direct stake in the success or failure of the CDO. It made money either way. Felix Salmon explains:

The scandal here is not that Goldman was short the subprime market at the same time as marketing the Abacus deal. The scandal is that Goldman sold the contents of Abacus as being handpicked by managers at ACA when in fact it was handpicked by Paulson; and that it told Abacus that Paulson had a long position in the deal when in fact he was entirely short.

Goldman Sachs has lost more than $10 billion in market capitalization today, in the wake of these revelations. Good. It can go long markets and it can go short markets. But it can’t lie to its clients. That’s well beyond the pale.

One of the reasons the markets must be so spooked about Goldman? This sort of deal seems to have been ubiquitous during the run-up to the housing crash. This is just one SEC filing. My guess is that more will be forthcoming.

The Hill is eagerly awaiting the full text of the proposal by Sen. Blanche Lincoln (D-Ark.) to regulate derivatives. The legislation reportedly requires most derivatives to be processed through clearinghouses and for investment banks to house “swap desks” outside the bank, or otherwise to lose access to the Federal Reserve’s discount lending window and F.D.I.C. deposit insurance, among other provisions.

To discuss the proposal, I spoke with Robert Litan, a senior fellow at the Brookings Institution and the vice president for research and policy at the Kauffman Foundation. He recently published a paper offering optimal policy solutions to regulate derivatives without over-dampening the market.

I’d be interested in your reaction to the derivatives proposal put forward by Lincoln. It hasn’t actually been released yet, but we have some details about it the general ideas. What do you think thus far?

I have a couple reactions. If I had my druthers, I wouldn’t force derivatives onto clearinghouses and exchanges. I’d use capital charges as an incentive to get companies to use them instead.

I have a section in my recent paper that argues that regulators aren’t the best judge as to what should be cleared and not. But Lincoln’s proposal, as well as the Dodd and House bills, have mechanisms to force things onto clearinghouses and exchanges. There has been some criticism of the proposals from the other side, but I’m not sure that Republicans support the incentive-approach either. Maybe they’ve made the the political calculation that this is what’s necessary. But, if I were writing the bill, I’d be using capital charges rather than requirements.

The second point is that she wants to cut off the derivatives desk and put it outside the bank. I worry about that, because it is possible, not necessarily certain, but possible that you could seriously crimp the market before it gets going. That is because one of the reasons end users deal with banks for derivatives trades is that they treat them as too big to fail. The reason, if you’re a company making a swaps deal, that you go to Goldman Sachs is that you think that they are going to honor that contract, no matter what happens. But if rather than going to Goldman Sachs, you’re going to an affiliate, you might think again. And that means that on aggregate we might end up with less derivatives traffic.

The counterargument to that is that when, say, Bank of America sets up a derivatives affiliate, the counter-party might assume that the affiliate is part of the too big to fail organization and nothing changes. That’s likely. But if that is the case, there’s a presumption that we’ll end up bailing out the affiliates. That means, there would have been no point to moving the derivatives portions out of the banks to begin with. Maybe what that’s what Congress wants to do. But I’m nervous. It really could disrupt legitimate derivatives activity.

Finally — again, if I had my druthers — I’d put in more emphasis on incentives for clearing and trading. I don’t think the bills touch it at all. I haven’t looked closely enough and the fine print, and I’m not sure we even know yet. But it seems the bills don’t touch it at all. Right now, prices for derivatives in question, those are end-of-the-day prices. They aren’t actual prices. They’re just averages from the day before. So, we have little pricing transparency in this market. And I’d want the regulators to have more authority to push for much more frequent reporting of transaction prices. It is conceivable that the authorities could push dealers to do that — but I don’t know if it will assure us that we’ll get real-time pricing. That’s absolutely critical.

Right — and presumably on the buy-side, purchasers of derivatives, would want more pricing information via exchanges or clearinghouses, rather than over-the-counter deals, too. Say you’re Cargill, or some other company that purchases a lot of derivatives. Wouldn’t you presume that the pricing information will drive your costs down, even if the regulations require you to put some capital up?

I think the buy side would love that transparency. Right now, if you’re Caterpillar, you rely entirely on the price quoted from the bank or from the day before. You can’t go look up the price on a Bloomberg terminal. You can see what the average price was yesterday — but that really isn’t a price.

The next day is a new day. Things change. So, when you call your broker, they say, “Well, I’ll get back to you.” Or, “Here’s the price, but it’s not a firm price. Give us your business and we’ll confirm the price to you, and we’re promising we’re getting you the best possible deal.”

That leads to the next question, which is the end user-exemption. It seems that’s going to be a big fight. I know the Caterpillars of the world don’t want to go onto central clearing now — they don’t want to pay for it. My view is that if you had significant capital charges on non-cleared derivatives, that would induce the dealers to try to get these transactions into clearinghouses, and it would induce the buy side. Because if dealers have to have substantial capital behind buy-side trades, they want the transactions to become standardized and go through clearinghouses, and it will be cheaper for the buy side. I’m not that sympathetic with the broad end-user exemption. I think they ought to go through central clearing. But that is not something that the Lincoln or Dodd bill seems to do now.

Still, we just don’t know enough details. The details are really important. But right now, the buy side seems to want out. They don’t want to have to post collateral. But we’ll know more on that.

As it is now, I agree, and I’m confused as to why there is so much end user opposition to this bill. You would think that firms would want to pay less for these deals even if it meant putting up capital.

Absolutely. If we get central clearing, that is a predicate to exchange trading, which will necessarily reduce the spread and bring prices down. That is the logic. You have to ask: Why is it that some of the big guys don’t recognize that?

I only have a couple theories — I don’t know for sure. One theory is that they just don’t trust or don’t believe the regulatory process will bring us to that brand new world of exchange trading. They do not trust it will happen, and therefore are more comfortable with the world as it is. Then, if exchange trading does happen, they do not believe there will be a compression in the spreads, contrary to all of financial history. The stock market shows us that spreads massively narrow when exchange-trading is put in place. So, they just don’t trust or believe this is going to happen, for some reason.

Another theory is that in effect they’re doing the dealers’ bidding, and the dealers have enormous incentives to keep the current system under place as well as leverage over their clients. My understanding if that you’re a big buy-side user, you don’t spend time a lot of time shopping between Goldman Sachs, J.P. Morgan, Morgan Stanley. You just have your favorite dealer. In a world of non-transparency, the world the derivatives market is in right now, the way I understand it, if you try to call four or five dealers, to shop around, none give you a real price. They might quote you an indicative price. If you commit, then they give you pricing information.

So, since now, you have a favored dealer, you’re worried that if you come out in public and say you want clearinghouses or exchange trading, until that is in place, you are concerned that you will offend your dealer, and you aren’t going to get good terms. Because, as it is, buy a derivatives contract, it isn’t like walking into WalMart and looking at the sticker price. Maybe, if you take a public policy position contrary to your dealer, you might not get that favored treatment.

I have no basis for making those claims, I’ll note. Those are just plausible, rational explanations.

Then, there’s a third reason which makes the most sense. And that is — well, it makes sense in the short run. There is a classic collective action problem here. Nobody wants to pay to make the system safer for everybody. It’s like taxes. I don’t want to pay for defense, I want you to pay for defense. If I can get you to pay, then, I get a free ride.

So, as it is, since these companies might be getting good deals now. Their costs will go up at the beginning when they have to start posting collateral. If the system evolves over time, we’ll get to that nirvana with clearinghouses and lower spreads. But if these companies are just thinking about the short term, they might oppose the change. That’s a short sighted but semi-rational thought process. And it’s just people acting in their own interests.

The Census Bureau and the Department of Housing and Urban Development report that housing starts climbed more than expected in March. Builders applied for 685,000 permits (60,000 more than expected, up from 637,000 in February) and filed 626,000 housing starts (16,000 more than expected, up from 616,000 in February).

On one hand, this is good news. It signals that homebuilders believe that supply and demand have stabilized, that housing prices might turn up and that the economic outlook is sunny. On the other hand, at least two of those presumptions are questionable. Foreclosures are increasing, not decreasing; and some economists estimate that home values have another 10 to 20 percent to fall.

That said, we’re missing a crucial piece of information in the release — as always in real estate, “location, location, location.” The Census release breaks starts and permit applications out by region, but not by state. And the housing bust continues to be heavily concentrated in a few states — California, Florida, Arizona and Nevada being the worst-hit. I think we’ll continue to see state stratification in the housing market, with the real estate market returning to normalcy in most regions, but those states continuing to struggle with oversupply, poor general economic growth, and falling prices.

This afternoon, the Senate filed cloture on the nomination of Lael Brainard to become undersecretary for international affairs, one of the highest ranking positions in the Treasury Department. Both Larry Summers and Treasury Secretary Timothy Geithner are former undersecretaries for international affairs — the top governmental adviser on international economic issues, such as the dollar-yuan currency exchange rate. Brainard’s nomination had been held up for 13 months due to problems with some of her income tax filings.

There was speculation that President Obama might appoint Brainard — a longtime academic economist and Clinton appointee who has been working as a counselor in Treasury for months — over the Easter recess. But the recess appointment would have only lasted until the end of the congressional term. Now, once Brainard’s nomination passes an up-or-down vote, she will be in her position permanently.

A happy tax day to all readers. Yesterday, I took a look at the conservative talking point that only 47 percent of Americans pay income taxes. Today, Keith Hennessey, an economic adviser to President George W. Bush, explains that Republicans expanded the tax credits that ensure that a relatively small proportion of Americans pay those income taxes:

But most of the increase since the mid-1990s in the number of people who owe no income taxes is the result of the child tax credit. This policy was created by Congressional Republicans and expanded with Republicans in the lead.

To boot, he goes through a timeline of the changes.

The Hill reports that Sen. Susan Collins (R-Maine) has declined to sign a letter circulated by Sen. Mitch McConnell (R-Ky.), the minority leader, asking Republicans to vow to block the financial reform bill from coming to a vote. Democrats only need one crossover to prevent a Republican filibuster and to move forward with reform. Sen. Harry Reid (D-Nev.) has indicated that he might bring the bill onto the floor as soon as next week.

The Huffington Post has two stories on various politicians and policymakers warming to the idea of breaking up big banks and possibly bringing back parts of Glass-Steagall, an act that prohibited companies from mixing insurance, commercial and investment banking functions that Congress repealed in 1999, making way for today’s megabanks.

Shahien Nasiripour reports that three Fed governors — heads of three of the Federal Reserve’s regional banks — support ending too big to fail by breaking banks up. “If there was a good way to do so, if you had a clear road map about how you were going to go about it, and why you were going to break them up in this particular way,” James Bullard, the head of the St. Louis bank, said he would support it.

And Ryan Grim reports that Republican legislators mentioned they might support the “Volcker Rule,” an proposal by former Fed President Paul Volcker to restrict proprietary trading, where banks make speculative bets for themselves rather than on behalf of customers:

“Sixty percent of all the banking assets are concentrated in ten banks in the country,” said [Sen. John Cornyn (R-Texas)]. HuffPost asked if he’d support what’s known as the Volcker Rule, an administration plan to split off risky trading done by banks for their own gain from standard commercial banking activities.

“Yes,” he said, “I think that’s one approach.”

Without prompting, he added: “Glass-Steagall, we need to look at that.”

“We all — I say we all, but almost all of us — made the mistake of repealing Glass-Steagall in 1999,” Sen. Johnny Isakson (R-Ga.) told HuffPost. “Some of the problems of the big banks were brought about by the blurring of the restrictions on where they could go. And they went into brokerage and they went into derivatives they went into lots of other things. Maybe we need to look back to that, but it’s hard to put the genie back in the bottle.”

But the bill proposed by Sen. Chris Dodd (D-Conn.) solves the too big to fail problem differently — by creating a $50 billion fund, paid for by banks, to cover the cost of resolving a failing bank and wiping out its shareholders and management — meaning such statements of support are likely too little, too late, even if they might be a more effective solution.