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David Paul Headshot

With Wall Street Shorting the Dollar, It is Time for Congress to Pursue Fundamental Change

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Just imagine how angry the American public would be if they knew the whole story.

For months, we have listened to the whining from Wall Street. U.S. banks are having a record year, and they want to be paid a lot of money. Billions and billions of dollars.

Public indignation is deep. After all, over the past year, we have watched as hundreds of billions of dollars of public money has been poured into bank balance sheets. We have--we are assured--taken steps that were necessary to bring our financial system back from the brink. We may not have liked it, but we had no choice.

But now that we have stemmed the tide, now that the Great Panic of 2008 has abated, we have been forced to watch these same institutions moan about how bad they have it. Citigroup--the one that received $45 billion in taxpayer funds, plus a couple hundred billion extra in public underwriting of bad assets--wants to wipe the slate clean by paying the money back and calling it even. So they can pay themselves billions of dollars in bonuses.

Wells Fargo, the arriviste among the financial elite, is complaining about the competitive disadvantages that they face as a consequence of federal compensation constraints. Constraints that prevent them from paying themselves billions of dollars in bonuses.

Goldman Sachs--caught in a lie by a federal Inspector General who refuted Goldman's sanctimonious claim that even if the world had collapsed, they would have been fine--is trying to fend off accusations of unwarranted hubris and greed--which reached a pinnacle when they announced plans to pay themselves $21 billion in bonuses--by announcing that their senior partners will take their share of the billions in stock.

But what if the public understood the whole story? How is it that the banks are now having one of their most profitable years ever? Given that there is not much lending going on, and that the newly increased credit card fees have only just begun to flow into bank coffers, where is all that money coming from?

It is coming from proprietary trading. "Prop trading" is the kind of betting with the bank balance sheet that was made illegal for commercial banks back during the Great Depression, when the FDIC and deposit insurance was created. The price of having the federal government guarantee bank deposits was separating the lending and depositary functions of commercial banking from trading and risk activities of investment banking. Thus, in 1935, the commercial bank J.P. Morgan & Company was separated from the investment firm Morgan Stanley.

But this separation was undone in 1999 to facilitate the creation of the megabanks that we have today. However, while the Financial Services Modernization Act of 1999 ended the separation of activities, FDIC deposit insurance remained in place. And this year, the elite of the financial world--JP, Citi, Wells, BofA, Goldman and Morgan Stanley--have finally emerged for what they are: Gigantic hedge funds backed up by the full faith and credit of the United States of America. Wall Street bankers making big bets with our money, content in the knowledge that if they win their bets, they will pocket the cash. And if they lose, we will all pick up the mess.

But it really does get better. So exactly how did they make all that money this year?

Well, the trade of the moment has been the U.S. dollar carry trade. A foreign currency carry trade is simple in concept. Borrow money where interest rates are low, and invest where interest rates are high. Or simply stated: Short the U.S. dollar. Buy the currency of a country where interest rates are higher. The beauty part is that by continually assuring the world that U.S. interest rates will remain near zero for the foreseeable future, the Federal Reserve has assured traders that they can keep the trade in place for some time.


But it is nothing personal. It is strictly business.

And the carry trade will work out fine. Until it doesn't. Then the trade will unwind quickly, and those who do not get out in time will get hurt badly.

But the banks are not worried. If the unwinding of what NYU economist Nouriel Roubini has labeled "the mother of all carry trades" takes a bank or two down with it, everything will be all right. Because the bank deposits are still insured, and we now know to an absolute certainty that if one of the elite institutions fails, we will bail it out. Again.

It is time that we come to grips with the depravity of the current situation, and potential damage that continuing down this path may yet do to the financial system and to our economy.


The U.S. dollar carry trade is destructive to our currency, and is creating asset bubbles across the world, as leverage is transferred from our markets into others. For their part, credit default swaps serve no useful purpose in proportion to the systemic risks they create.

It is time to go back to basics. Commercial banks provide essential services in our economy. They enable the Fed to control the distribution and pricing of capital to the productive sectors of the economy. They provide secure depositary and asset management services.

Unfortunately, pending Congressional legislation has done nothing to address the central risks that the new financial landscape presents to our economy. Rather than reinstitute restrictions on bank activities or restrain institution size, Congress is looking to regulatory solutions that hold little promise of success when the next crisis emerges. And rather than recognizing the problem of moral hazard, this week Congress took the first step of embracing it in statute.

This year, Wall Street has shown its true colors, but the public has yet to understand the depth of the betrayal. It is not the continuing absence of lending, or jacking up credit card fees, or hiking consumer interest rates, or even the constant refrain of complaints about limitations on executive compensation. No, the greatest betrayal is that with the American economy as weak as it has been in years, with the dollar weakness threatening to unravel the international commitment to the role of the dollar as the reserve currency, Wall Street has shown no shame about attacking the currency of the nation that came to its aid.

If this is the path that the elite commercial banks have chosen, if they have been fully seduced by the lucre of trading, Congress needs to revisit the fundamental rules of the game, and revisit the central rationale for deposit insurance and the structure of the commercial banking system.