Regulation of OTC Markets & Fed Cover Up

In a statment before the Senate Committee on Banking, Housing and Urban Affairs Subcommittee on Securities, Insurance, and Investment, Christopher Whalen, an analyst from New York, delivered the following testimony (excerpts, full version here, emphasis added):

Perhaps the most important issue for the Committee to understand is that the structure of the OTC dervivatives market today is a function of the flaws in the business models of the largest dealer banks, including JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Goldman Sachs (NYSE:GS). These flaws are structural, have been many decades in the making, and have been concealed from the Congress by the Fed and other financial regulators.

Simply stated, the supra-normal returns paid to the dealers in the closed OTC derivaties market are effectively a tax on other participants, especially investors who trade on open, public exchanges and markets. The deliberate inefficiency of the OTC derivatives market results in a dedicated tax or subsidy meant to benefit one class of financial institutions, namely the largest OTC dealer banks, at the expense of other market participants. Every investor in the global markets pay the OTC tax via wider bid-offer spreads for OTC derivatives contracts thatn would apply on an organized exchange.

The taxpayer in the industrial nations also pay a tax trough periodic losses to the system caused by the failure of the victims of OTC derivatives and complex structured assets such as AIGs and Citigroup (NYSE:C). And most important, the regulators who are supposed to protect the taxpayer from the osts of cleaning up these periodic loss events are so captive by the very industry they are charged by law to regulate as to be entirely ieffective. As the Committee proceeds in its deliberations about reforming OTC derivatives, the views of the existing financial regulatory agencies and particularly the Federal Reserve Board and Treasury, should get no consideration from the Committee since the views of these agencies are largely duplicative of the views of JPM and the large OTC dealers.

See market-ticker for more on that story.

In addition, it was claimed today by House Republicans that the Fed deliberately withheld information from other regulators to push the Bank of America-Merril Lynch merger through. See here.

I have been writing just recently that the securitization process was, in my view, inherently geared towards the benefit of a few, and was in effect constituting a money laundering device to rip unsuspecting people off in and funnel the money off to other people’s bank accounts.
I am, obviously, not alone in thinking this way.

It comes as no surprise than, that the banks are doing all they can to block effective regulation of these OTC markets – they have been doing that for decades.

Where (Some) Banks Make their Money

The brilliant investment bankers make their money by properly selecting their investments, right? So lets see what kind of talent needs to be retained so desperately by the banks.

It turns out, that trading is not the major source of income for most banks. Here is where the money is made:

Income Sources for Banks 2006¹

The income of the six banks² I looked at came on an average of 41% from commissions and fees, and 22% in interest. Which happen to be the traditional – and rather boring – activities of banks.
On average only 29% were made in trading. I chose 2006 because it is the last year all of the banks were in the positive. Bank of America is the outlier here, it was not an investment bank and made its money almost exclusively from traditional banking.

In case you are wondering how much of this net-revenue goes into financing compensation (salaries, bonuses) of that talent, this is what the compensation-to-net-revenue ratio for 2006 looks like: