Regulators at Senate Bitcoin Hearing Missed Opportunity to Protect Public

We noted, with interest, testimony before the Senate Banking Committee on Tuesday, February 6th concerning cryptocurrencies. The heads of the Commodity Futures Trading Commission and the Securities and Exchange Commission, J. Christopher Giancarlo and Jay Clayton, respectively, testified about cryptocurrencies.

Their comments focused on fraud in the initial coin offering marketplace. An initial coin offering uses crowdfunding to issue cryptocurrency, which is then used as capital for a startup. Blockchain is a new technology used to structure cryptocurrencies like bitcoin. It is believed to have a structure in which falsification is extremely difficult relative to conventional centralized-management systems and is expected to be applied to a wide variety of fields.

Of course, this hearing was not about protecting the public: It was about turf. The SEC does not have direct authority over cryptocurrencies or ICOs. Congress will probably explicitly give the agency direct authority to regulate cryptocurrency exchanges, however.

Given the SEC’s track record of failing to actually protect the public, this does not bode well for blockchain technology. The agency is likely to apply a heavy-handed approach that favors large financial institutions and discourages small innovators from any use of blockchain technology.  

However, both agency heads, with their focus on using bitcoin, missed the real opportunity to protect the public – blockchain.

Creative Investment Research launched a survey to collect opinions on the most appropriate applications for blockchain technology. The survey was posted to blockchain software mailing lists, like the one for Hyperledger, which describes itself as “an open-source collaborative effort created to advance cross-industry blockchain technologies.” We also posted the survey to various blockchain-related MeetUp, LinkedIn and Facebook groups on Jan. 19.

The response was very good, resulting in an appropriate, statistically significant sample and results. By statistically significant, we mean that survey answers probably cannot, at the 95 percent level, be attributed to chance. The survey recently closed.

We will be releasing additional insight from the survey over the next few days, but the results are clear. Most blockchain developers and aficionados, according to our survey, do not believe cryptocurrency is the “killer app” for blockchain.

In answering the question “what are the most appropriate applications for blockchain technology?”, survey respondents selected “establishing and safeguarding digital identity” and “establishing ownership rights” as the two top uses. Using blockchain for digital currency fell in the bottom half of appropriate uses.

Markets will, as they always do, figure out a way around any restrictions you throw at them. We continue to believe that the nature of blockchain is such that this technology, not regulators, will win in the long term. 

We have long believed that capital market regulators in other regions of the world will, at some point, enhance their ability to access capital using internet-based tools. Thus, the competitive advantage with respect to capital access is available to any country with significant economic potential and a modest communications infrastructure.

(Published on Morning Consult. See: https://morningconsult.com/opinions/regulators-at-senate-bitcoin-hearing-missed-real-opportunity-to-protect-public/)

Senate Banking Committee Hearing on Fostering Economic Growth by Kari Nelson, Impact Investing Intern, University of Virginia

Soon, it may be easier to be a Wall Street Bank. We knew that one of President Trump’s central campaign promises was to dismantle the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (LA Times)— passed after the 2007-2009 financial crisis to prevent similar crises from occurring—but that didn’t necessarily mean anything major was going to happen. Campaign promises go unfulfilled all the time (*cough* the Wall *cough*). Now, the Trump administration seems to be moving to follow through on dismantling Dodd-Frank. With that in mind, we take a look at developments in this area over the past few weeks to see what changes are likely in the near future.

On June 8, there was a surge of excitement (either out of fear or joy, depending on your perspective) when the House passed the Financial Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs Act, which would repeal many of Dodd-Frank’s banking reforms (CNBC). Then, everyone calmed down a bit and realized that Senate Democrats could block the bill from passing so the House vote was a largely symbolic victory for the Republicans and the banking industry (CNBC).

But, on June 12, Treasury Secretary Steven Mnuchin released a report—the first of four examining Dodd-Frank ordered by Trump—proposing many of the same changes as the Financial CHOICE Act (LA Times). These proposals have been on Wall Street’s wish list since Dodd-Frank was passed, reflecting the fact that the Treasury Department consulted with 17 times more banking industry groups than consumer groups when developing the report (Fortune). Note though that the suggestions in the Treasury report present a real danger to consumers because “about 80% of the substance in the report can be accomplished by regulatory changes,” according to Mnuchin (Fortune). Therefore, a Senate Democratic filibuster would not block the majority of the changes proposed in the report.

On June 22, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled, “Fostering Economic Growth: Regulator Perspective,” the third in a series of hearings held by the Banking Committee as it prepares to draft a regulatory relief bill (Washington Post). I attended this hearing in order to get a sense of the vibe in the room and one thing quickly became clear: regulators are siding with Trump and the big banks on this one. 

Among the main targets brought up by the panel – full list here – were requirements for living wills, the asset thresholds for stress tests, strict leverage ratios, and the Volcker Rule. But the real question is: will any of these changes (which require legislation) make their way into the upcoming bill? In his opening statement, Chairman Mike Crapo (R-Idaho) expressed his commitment to bipartisan regulatory reforms in this area, so presumably Crapo and the other Republicans on the Senate Banking Committee will be looking to please the moderate Democrats first.

Currently on the Committee are three moderate Democrats from red states who have tough reelection races coming up in 2018 – Sen. Joe Donnelly (Indiana), Heidi Heitkamp (North Dakota), and Jon Tester (Montana). This may be an opportunity for Republicans because these three Dems need to demonstrate to constituents that they can work across the aisle to pass legislation (Washington Post). Tester even said that he has an “open mind” regarding Volcker Rule rollbacks (Washington Post). The buy-in from these moderates may be enough to bring a regulatory relief bill to the floor, but I find that unlikely. I tend to agree with Tory Newmyer of the Washington Post who judged that a regulatory relief bill will not make it to the floor of the Senate if the liberals on the Committee – led by Sen. Elizabeth Warren (D-Massachusetts) – maintain their current commitment to stopping the bill; Republicans likely won’t try to bring a bill to the floor unless left-wing Dems in the Senate agree to limit amendments (this would prevent poison pill amendments, or amendments intended to weaken a bill’s effect or prevent it from passing).

As long as Warren and the rest of the left remain committed to stopping this bill, they will not be agreeing to any such deal. It doesn’t seem that Warren will be backing down any time soon, pointing out during the hearing that she saw no benefits to the recommendations in Mnuchin’s Treasury Report and telling the Wall Street Journal that she views any significant changes to Dodd-Frank as dangerous to the American economy (Washington Post).

So, I’m sorry Wall Street, but unless Warren and her fellow progressives have a massive change-of-heart it seems that regulatory relief, at least relief based on legislation, may not come any time soon.

Five Key Takeaways from Yellen's Monetary Policy Testimony

Federal Reserve Chair Janet Yellen testified on Capitol Hill on Wednesday and Thursday.
She appeared before the House Financial Services Committee and the Senate Banking Committee. We attended both hearings. Here are the key points:

1. An undercurrent of protest from both the left and the right (Google #whoserecovery) is beginning to have an impact on monetary policy. See the photo above of protesters at both hearings. We have issues with both the left and right wing versions. The right is simply crazy. The left is financed by labor unions. I can guarantee that none of the black folks in the photo of protestors at the hearings below are well paid. Their labor union managers, most of whom are white, are. (Can you say rock and a hard place?)

2. At the start of the Senate Banking Committee hearing, Senate Banking Committee Chairman Richard Shelby unveiled a letter from 30 economists who support implementation of the Taylor Rule, a mechanical approach to monetary policy that sets limits on the ability of a central bank to respond to economic conditions. We note two things:

• Not one of these economists accurately predicted the financial crisis. (We did, BTW.)
• Ms. Yellen pointed out that no central bank anywhere in the world uses the "Taylor Rule" or anything like it. None. This should be enough to end the conversation. It won't.

3. The Fed's current balance sheets equals 20% of the U.S. economy. In essence, the Fed stepped in to rescue the economy. From our perspective,  this confirms, as the Chair noted, that Fed independence and Fed accountability are NOT mutually exclusive.

4. When Senate Banking Committee Ranking Member Sherrod Brown asked for information on which groups (by race, gender and sector) have fared better during the recovery, Ms. Yellen indicated she had no data on which to base a response. She then went on to claim that most of the benefits of the economic recovery have flowed to the better educated portion of the workforce. Again she has no data to support this contention. Thus, her statement is both unscientific and prejudicial.

5. Her key statements on current economic conditions and monetary policy are as follows:

• Financial conditions are less supportive of growth. Both the dollar and interest rates are up, and lower oil prices do not seem to be meaningfully impacting growth prospects. 
• The recovery in the housing sector is ongoing. Prices, and activity are both up. 
• Consolidation in the banking industry is also ongoing. This results in fewer and fewer banks, less competition, and less beneficial terms for bank customers. (We suggest people start looking at Credit Unions..)
• The Fed looked at implementing negative interest rates (that's where you pay the bank to hold your money..) but rejected this approach. The Fed is taking a fresh look at implementing monetary policy that implements negative interest rates, however.
• She noted that economic "expansions do not die of old age." They die because of policy mistakes. We agree.

The Bear Rescue and the Senate Banking Committee

I have been following the Bear rescue and the Financial Market reform plan. I attended today's SBC hearing. A few things to note:

a. Treasury sounded a little defensive when asked by Senator Jack Reed about the lack of foresight, claiming that no one could have foreseen this crisis.

Actually, we did, in August, 2007:

"Major market institutions are now, as the troubled Bear Stearns reveals, feeling the negative effect of allowing these practices to flourish. Bear Stearns may be in real danger - it's stock decreased in value by 27% over the last month. We do not expect, but would not be surprised if the firm failed, another casualty of arrogance and greed."

See: http://twisri.blogspot.com/2007/08/morgage-gses-predatory-lending-and.html and http://www.sec.gov/comments/s7-16-07/s71607-495.pdf

b. In addition, even the claim that perfect foresight was needed is wrong. With the development of toxic (derivative and subprime lending) financial products, the relationship between investment banks and the economy has turned parasitic. A financially parasitic relationship is defined as (modifications from the standard definition noted):

"a type of symbiotic (financial or economic) relationship..in which one, the parasite, benefits from a prolonged, close association with the other, the host (economy or financial institution), which is harmed. In general, parasites are much smaller than their hosts (investment banks, while large, are smaller than the economy as a whole), show a high degree of specialization for their mode of life (investment banks are highly specialized) and reproduce more quickly and in greater numbers than their hosts (check.)

The harm and benefit in (financial or economic) parasitic interactions concern the fitness of the (economy) involved. Parasites reduce host (financial or economic) fitness in many ways, ranging from general or specialized pathology (such as regulatory nullification), impairment of (economic) characteristics, to the modification of host (economy) behaviour. Parasites increase their fitness by exploiting hosts for money (from hedge funds, pension funds, deposits at banks), habitat (HQ location) and (toxic product) dispersal."

c. Despite protestations to the contrary, the rescue was, in fact, a bailout since, as Senator Jim Bunning mentioned, "Bear shareholders did better with the Fed's help than they would have without it." Note: Bailout is defined as: " a situation where a bankrupt or nearly bankrupt entity, such as a corporation or a bank, is given a fresh injection of liquidity, in order to meet its short term obligations. Often bail outs are by governments, or by consortia of investors who demand control over the entity as the price for injecting funds."

d. The $30 billion dollar figure was calculated based on a mark-to-market provided by Bear Stearns.

e. Given (d.) the Fed does not really know the total dollar amount of the liability it accepted.

f. Blackrock was hired as an Investment Advisor to the Fed for purposes of managing and providing advice about the value of the Bear collateral. No competing bids were sought. The contract for Blackrock's services has not been written yet and no cost for these advisory services has been determined. Following hedge fund pricing (2% upfront and 20% of gains) we (the public) could be looking at a minimum fee of $600 million (2% of $30 billion).