The NYT points out that while financial regulation laws were passed last year, the agencies it established have yet to be staffed. This has the obvious consequence:
Without strong leaders at the top of the nation’s financial regulatory agencies, the Dodd-Frank financial reform doesn’t have a chance. Whether it is protecting consumers against abusive lending, reforming the mortgage market or reining in too-big-to-fail banks, all require tough and experienced regulators.
Too many of these jobs are vacant, or soon will be, or are filled by caretakers. So it was a relief last week when President Obama said he had decided on a well-qualified nominee to be the new chairman for the Federal Deposit Insurance Corporation and would make other nominations soon. The White House needs to move quickly and be prepared to fight.
Much of the blame for the delays lies with Republican lawmakers who have consistently opposed qualified candidates. In the case of the new Consumer Financial Protection Bureau, they have vowed to obstruct any nominee unless Democrats first agree to gut the agency’s powers. Until now, the administration hasn’t pushed back.
This points out a secondary way that legislation can be curtailed. If the opposition lacks the strength to stop a law from being passed, they may be able to use obstruction as a way to ensure that the law is not implemented as originally intended.
Showing posts with label finance reform. Show all posts
Showing posts with label finance reform. Show all posts
Tuesday, June 14, 2011
Friday, January 21, 2011
Does Growing Income and Wealth Inequality Threaten the Republic?
Yes and no according to this author:
Here's the argument that it does not:
In terms of immediate political stability, there is less to the income inequality issue than meets the eye. Most analyses of income inequality neglect two major points. First, the inequality of personal well-being is sharply down over the past hundred years and perhaps over the past twenty years as well. Bill Gates is much, much richer than I am, yet it is not obvious that he is much happier if, indeed, he is happier at all. I have access to penicillin, air travel, good cheap food, the Internet and virtually all of the technical innovations that Gates does. Like the vast majority of Americans, I have access to some important new pharmaceuticals, such as statins to protect against heart disease. To be sure, Gates receives the very best care from the world’s top doctors, but our health outcomes are in the same ballpark. I don’t have a private jet or take luxury vacations, and—I think it is fair to say—my house is much smaller than his. I can’t meet with the world’s elite on demand. Still, by broad historical standards, what I share with Bill Gates is far more significant than what I don’t share with him.
Compare these circumstances to those of 1911, a century ago. Even in the wealthier countries, the average person had little formal education, worked six days a week or more, often at hard physical labor, never took vacations, and could not access most of the world’s culture. The living standards of Carnegie and Rockefeller towered above those of typical Americans, not just in terms of money but also in terms of comfort.
Here's the argument that it does:
If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets. And to be sure, the high incomes in finance should give us all pause.
The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.
In short, the financial sector has increased its political power over the past decades and is using this to pursue policies that advantage them at the expense of financial stability. Their interests lie in taking advantage of instability.
It's worth a close read.
Here's the argument that it does not:
In terms of immediate political stability, there is less to the income inequality issue than meets the eye. Most analyses of income inequality neglect two major points. First, the inequality of personal well-being is sharply down over the past hundred years and perhaps over the past twenty years as well. Bill Gates is much, much richer than I am, yet it is not obvious that he is much happier if, indeed, he is happier at all. I have access to penicillin, air travel, good cheap food, the Internet and virtually all of the technical innovations that Gates does. Like the vast majority of Americans, I have access to some important new pharmaceuticals, such as statins to protect against heart disease. To be sure, Gates receives the very best care from the world’s top doctors, but our health outcomes are in the same ballpark. I don’t have a private jet or take luxury vacations, and—I think it is fair to say—my house is much smaller than his. I can’t meet with the world’s elite on demand. Still, by broad historical standards, what I share with Bill Gates is far more significant than what I don’t share with him.
Compare these circumstances to those of 1911, a century ago. Even in the wealthier countries, the average person had little formal education, worked six days a week or more, often at hard physical labor, never took vacations, and could not access most of the world’s culture. The living standards of Carnegie and Rockefeller towered above those of typical Americans, not just in terms of money but also in terms of comfort.
Here's the argument that it does:
If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets. And to be sure, the high incomes in finance should give us all pause.
The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.
In short, the financial sector has increased its political power over the past decades and is using this to pursue policies that advantage them at the expense of financial stability. Their interests lie in taking advantage of instability.
It's worth a close read.
Sunday, December 19, 2010
The Revolving Door -- Peter Orszag and Citibank
From Deal Book:
Wall Street has long stacked its ranks with Washington types.
It is the elephant in the room of White House grand bargains: after building a reputation and Rolodex in politics, the wise man moves on — or in many cases, back — to the financial industry to make a killing.
A decade ago, a former Treasury secretary, Robert E. Rubin, left the Clinton administration to become a senior adviser and board member at Citigroup — collecting a $10 million a year paycheck with no management responsibility.
On Thursday, Peter R. Orszag, President Obama’s first budget director and a protégé of Mr. Rubin, followed in his mentor’s footsteps and joined Citi’s investment banking group as a vice chairman. Mr. Orszag, 41, is the second cabinet official to join Citi this month, and his appointment comes days after the Treasury Department’s $10.5 billion stock offering helped further extricate the bailed out bank from Washington.
- Commentary from James Fallows.
- A response.
Wall Street has long stacked its ranks with Washington types.
It is the elephant in the room of White House grand bargains: after building a reputation and Rolodex in politics, the wise man moves on — or in many cases, back — to the financial industry to make a killing.
A decade ago, a former Treasury secretary, Robert E. Rubin, left the Clinton administration to become a senior adviser and board member at Citigroup — collecting a $10 million a year paycheck with no management responsibility.
On Thursday, Peter R. Orszag, President Obama’s first budget director and a protégé of Mr. Rubin, followed in his mentor’s footsteps and joined Citi’s investment banking group as a vice chairman. Mr. Orszag, 41, is the second cabinet official to join Citi this month, and his appointment comes days after the Treasury Department’s $10.5 billion stock offering helped further extricate the bailed out bank from Washington.
- Commentary from James Fallows.
- A response.
Thursday, November 11, 2010
Wall Street Lobbyists Eye Financial Regulations
Over 700 firms hired almost 3000 lobbyists to address financial regulations passed last year.
Thursday, October 7, 2010
Foreclosures Proceedings Stopped By Judges
Some checks and balances from Ezra Klein:
Judges across the country are ruling foreclosures illegal because of faulty paperwork, report Brady Dennis and Ariana Eunjung Cha: "If millions of foreclosures past and present were invalidated because of the way the hurried securitization process muddied the chain of ownership, banks could face lawsuits from homeowners and from investors who bought stakes in the mortgage securities - an expensive and potentially crippling proposition. For the fragile housing market, already clogged with foreclosure cases, it could mean gridlock and confusion for years. And there is concern in Washington that if the real estate market and financial institutions suffer harm, it could force the government to step in again."
Judges across the country are ruling foreclosures illegal because of faulty paperwork, report Brady Dennis and Ariana Eunjung Cha: "If millions of foreclosures past and present were invalidated because of the way the hurried securitization process muddied the chain of ownership, banks could face lawsuits from homeowners and from investors who bought stakes in the mortgage securities - an expensive and potentially crippling proposition. For the fragile housing market, already clogged with foreclosure cases, it could mean gridlock and confusion for years. And there is concern in Washington that if the real estate market and financial institutions suffer harm, it could force the government to step in again."
Thursday, July 22, 2010
Travelling the Ozarks
I've been driving through the Ozarks the past few day (I'm sitting in a motel in Hot Springs Ark at the moment) so I've no had time to keep up on posts. I'll fill in blanks when I come back home.
- Here's a start: Finance Reform Legislation is signed into law.
- Here's a start: Finance Reform Legislation is signed into law.
Thursday, July 15, 2010
Monday, June 28, 2010
Thursday, June 17, 2010
About the Financial Reform Conference Committee
The House and Senate finance reform bills (H.R.4173 Title: Restoring American Financial Stability Act of 2010) have gone a conference committee where they will, or are intended to be, reconciled with each other. If they are able to pass a single report, and if that report is then accepted by each chamber, the report will be sent to the president for a signature.
The Center for Media and Democracy tells us that this is the schedule so far:
- Thursday, June 17: Systemic risk regulation, resolution authority and payments/clearing/settlement issues.
- Tuesday, June 22: The Consumer Financial Protection Bureau, predatory lending, remittances, interchange fee and access issues.
- Wednesday, June 23: Prudential regulation.
- Thursday, June 24: Derivatives regulation.
I've also read that this could drag on for two weeks, so who knows how accurate this timetable is.
For information about the members of the conference, click here: A look at House, Senate conferees .
Some comments on the process:
- Do You Like to Whip It?
- House-Senate panel lets SEC create credit rating board
- Reviving Investor Protection
- Cheques and imbalances
- Will The Next Three Weeks Change Wall Street Forever?
- Financial Reform: Credit Rating Agencies Most Worried About Liability
Plus:
- Everything you ever wanted to know about Conference Committees.
- The impact of the Filibuster on Conference Committees.
The Center for Media and Democracy tells us that this is the schedule so far:
- Thursday, June 17: Systemic risk regulation, resolution authority and payments/clearing/settlement issues.
- Tuesday, June 22: The Consumer Financial Protection Bureau, predatory lending, remittances, interchange fee and access issues.
- Wednesday, June 23: Prudential regulation.
- Thursday, June 24: Derivatives regulation.
I've also read that this could drag on for two weeks, so who knows how accurate this timetable is.
For information about the members of the conference, click here: A look at House, Senate conferees .
Some comments on the process:
- Do You Like to Whip It?
- House-Senate panel lets SEC create credit rating board
- Reviving Investor Protection
- Cheques and imbalances
- Will The Next Three Weeks Change Wall Street Forever?
- Financial Reform: Credit Rating Agencies Most Worried About Liability
Plus:
- Everything you ever wanted to know about Conference Committees.
- The impact of the Filibuster on Conference Committees.
The Revolving Door: From Congressional Staffer to Financial Industry Lobbyist
From the Center for Responsive Politics:
Lobbyists for the financial services industry enjoy longstanding ties to the members of Congress who were named this week to the conference committee on financial reform legislation, according to a joint analysis of available data released today by Public Citizen and the Center for Responsive Politics.
At least 56 current industry lobbyists previously served on the personal staffs of the 43 members of Congress named Wednesday to the conference committee, according to the study, available here: ConferenceKlatchReport.pdf. Notably, these figures do not include 59 lobbyists who served on either the Senate or House of Representatives banking committee but never worked directly for a member. Those lobbyists were enumerated in a report published in early June by Public Citizen and the Center for Responsive Politics.
Lobbyists for the financial services industry enjoy longstanding ties to the members of Congress who were named this week to the conference committee on financial reform legislation, according to a joint analysis of available data released today by Public Citizen and the Center for Responsive Politics.
At least 56 current industry lobbyists previously served on the personal staffs of the 43 members of Congress named Wednesday to the conference committee, according to the study, available here: ConferenceKlatchReport.pdf. Notably, these figures do not include 59 lobbyists who served on either the Senate or House of Representatives banking committee but never worked directly for a member. Those lobbyists were enumerated in a report published in early June by Public Citizen and the Center for Responsive Politics.
Wednesday, May 26, 2010
On the Role and Capacity of Government: Is Stability a Realistic Goal?
With apologies to the National Journal, here's another highly relevant article. It gets to the core of the ideological disputes that we've noted are at the heart of questions about the role of government. The national government is expected to provide stability to the financial system, but given its complexity, is this a realistic goal? What, is anything, can the national government do to minimize the risks of the marketplace?
FINANCIAL INSTITUTIONS
Is Stability A Realistic Goal?
Can the U.S. government really guarantee the nation's vast and complex financial system? There are few precedents.
Saturday, May 22, 2010by John Maggs
In many ways, the financial reform bill moving through Congress resembles other landmark pieces of legislation. Like health care reform, it tackles a pernicious side effect of America's free-market economy and treats it with a typically light touch by offering a package of incentives and disincentives for businesses and consumers. Instead of forcing banks to become smaller, the bill encourages them to do so. Instead of banning the kinds of home loans that contributed to the housing crisis, the legislation sets up a consumer protection agency that will rely mainly on disclosure to prompt Americans to make smarter financial decisions.
Like other regulatory reforms, the financial overhaul eschews a massive reorganization in favor of shifting oversight functions and responsibilities among several government agencies. The Federal Reserve System will continue to audit big national banks and some state-chartered banks; the two other bank regulators will split the rest, more or less as they do now.
Responsibility for one of the reform package's most far-reaching steps -- imposing the first rules for derivatives trading -- would mostly fall to private companies and big banks themselves, rather than to a government agency. The overhaul package leaves many details to regulators to work out. "It is really just a series of general guidelines," said Vincent Reinhart, a former top Fed official. He supports this conservative approach, saying that it will allow government officials to deliberately work through what rules to change and how to change them.
In at least one way, though, the financial reform plan represents a new approach. Grafted onto the largely familiar array of agencies that regulate banks is a council of top economic officials tasked with counteracting instability in the financial system before it becomes a critical threat. The council will look beyond individual institutions and practices to anticipate bubbles and spot potentially destabilizing financial innovations -- such as the bonanzas that subprime lending and collateralized debt obligations seemed to be a few years ago.
The proposed Financial Stability Oversight Council, as the Senate legislation calls it, is an interagency group of nine people chaired by the Treasury secretary; it would include the chairman of the Federal Reserve Board, the heads of other financial agencies, and one or two other appointees (the House and Senate bills have slight differences). Some of its functions approximate the emergency powers that the Federal Reserve and Treasury have traditionally kept for themselves. But giving the council the job of foreseeing problems and acting to preserve stability in the nation's vast and complex financial system is an audacious undertaking, even for the U.S. government.
"It hasn't been tried before," said Morris Goldstein, a senior fellow at the Peterson Institute for International Economics. "We don't really know what [the council] will do -- a lot, or perhaps not a lot."
If the council doesn't do a lot, then the separate bank regulators might decide to be much more active and attentive than before. Perhaps the Fed, chastened by the near-failure of the financial system, would take a more active approach to its informal role of overseeing Wall Street and the rest of the "shadow banking system." New disclosure rules, although limited, might discourage banks from using derivatives for highly lucrative speculation. Unlike the subprime-fueled housing crisis, the next financial bubble could be safely deflated by the various bank regulators, even if that intervention deprives the banks they oversee of huge profits. "The [bank oversight] system isn't changing that much," Doug Elliott, a former investment banker and a finance expert at the Brookings Institution, said. "There is a hope, I think, that everyone is going to do better."
But if fragmented oversight again yields regulatory failure and threatens another economic meltdown, the "systemic risk council" could play a significant coordinating role. How would the council define instability? Would it intervene only in a crisis that threatens the imminent collapse of the financial system, or would it move earlier to quell turmoil before it could lead to such a crisis? Would the council act to rein in excessive executive pay that could fuel risky behavior? Would it move to deflate a financial bubble, even if that bubble is making people richer? If consumers are borrowing too much, would the council curtail credit? Would it deal with the domestic effects of an international financial crisis? Most important, if the council took any of these aggressive steps, would it be effective?
"We don't know," Goldstein said. "It is an experiment. We'll have to see what it does and how that works."
Like Elliott, Norman Ornstein believes that the risk council won't do much more than sign off on the emergency actions that the government would take in any case to deal with a financial crisis. Ornstein, a resident scholar at the American Enterprise Institute, doubts that the government is about to embark on an uncharted, proactive approach to financial oversight.
Goldstein disagrees. The legislation signals a substantially different and more hands-on regulatory regime, he argues. The repeated promises from President Obama and virtually every member of Congress that expensive bailouts won't be needed (or forthcoming) again have raised the bar, he says. "When lawmakers say 'Never again,' I think there is an expectation that things are going to be done differently, and [the council] is part of that," Goldstein said. "I expect it to try things that haven't been tried before."
We're Not Good At It
The government has long set rules for businesses operating in the market-based economy. Washington has little practice, however, in guaranteeing the outcomes of market activity. The 1,000-point drop in the Dow Jones industrial average on May 6 demonstrated that even in the highly regulated stock market, the government has few tools to prevent a degree of instability that many people would regard as disastrous. Under current rules, only a 30 percent plunge in the market can shut down trading for the day.
In times past, Americans would have blanched at the prospect of the government's guaranteeing the health of an entire industry, even one considered essential to the well-being of the overall economy. In 2009, the Treasury Department loaned more than $100 billion to rescue General Motors and Chrysler, but it put the automakers on a short leash, forcing them to promptly repay most of the money. If they were to falter again, Washington would likely allow them to fail.
The financial system that seized up in 2008 is exponentially larger and more complex than the stock market or the auto industry, and a government promise to maintain its stability is unprecedented.
"When lawmakers say 'Never again,' I think there is an expectation that things are going to be done differently, and [the council] is part of that." -- Morris Goldstein, Peterson Institute for International Economics
To put this commitment into perspective, consider the scope of the health care reform package enacted this year. Imagine for a moment that Washington had empowered a council to guarantee the stability of the U.S. health care system. If medical care, like credit, was scarce or too expensive, the council could intervene to make sure it was affordable and readily available, by acting wherever it chose to head off, say, shocking rate increases, or by guaranteeing medical care to everyone, with or without insurance. This sounds far-fetched because the epic health debate revealed that Americans are hardly eager to embrace government intervention to guarantee such ambitious outcomes.
Compared with many other countries, the U.S. government has tended to take a laissez-faire approach to regulating such essential services as transportation, electricity, and telecommunications. Washington does attempt to preserve the stability of agricultural supply and prices, with only mixed results. Most economists say that the current system of farm subsidies and price controls exists more to boost the farmers' income than to protect consumers.
But even these examples involve industries much smaller and simpler than the financial system, which extends beyond banks to include insurance, mortgage lending, and consumer credit -- sectors that will remain relatively free of federal regulation, even after the regulatory reform package becomes law. The most comparable example of the government ambitiously trying to maintain the stability of markets was World War II and the extensive system of rationing and price controls that the Roosevelt administration used to prevent inflation, hoarding, and profiteering. That intervention was arguably successful, but a more recent iteration wasn't.
President Nixon imposed wage and price controls from 1971 to 1973 to combat inflation and escalating wage demands by labor unions. The move triggered runaway inflation, slow growth, food and commodity shortages, and an era of declining living standards. Economists consider the controls one of the most disastrous economic policy decisions ever by a U.S. president.
Looking for more?
Before The Emergency
Oddly, the debate over financial reform hasn't focused much on the question of whether government can or should try to assume responsibility for stabilizing the financial system. Neither party in Congress has drawn attention to the goals of the systemic risk council or to the very notion that a government body would try to head off instability throughout the financial system before it causes a crisis.
Most of the discussion in Congress has centered on the council's role in managing the shutdown of giant financial companies that fail. The council is supposed to handle this emergency action in an orderly and predictable way, in contrast to the ad hoc, chaotic bailouts and shotgun mergers that took place in 2008 and 2009. This process has been the focus of ideological skirmishes in the Senate between Republicans, who charged that the bill that arrived on the floor would permit bailouts to save faltering banks, and Democrats, who insisted that the opposite was true.
To settle that argument, the first amendment, offered by Sen. Barbara Boxer, D-Calif., simply reiterated that the systemic risk council would have no choice but to break up faltering banks and financial companies rather than bail them out. The amendment passed by a wide, bipartisan margin.
In one form or another, the federal government has always taken emergency action to stem financial panics and other crises that threaten the economy, according to Liaquat Ahamed, author of The Lords of Finance: The Bankers Who Broke the World, a 2009 book on the early years of central banking. Congress established the Federal Reserve Board in 1913 to coordinate emergency action, using the power to make emergency loans to counter bank runs and otherwise manipulate interest-rate policy to maintain liquidity in the banking system. Although the Fed and Treasury took actions during the recent crisis that were messy and in some ways unprecedented in size and scope, the interventions essentially followed past patterns, Ahamed said in an interview.
In Ahamed's view, the earliest days of the crisis made it clear that the United States had to do three things to minimize the risk of a plunge that could wreck the financial system. First, the government needed to bolster the capital reserves of banks, which had used holes in the accounting rules to evade reserve requirements; second, Washington needed to take on increased oversight to prevent excessive risk-taking and leveraging; and third, if the first two requirements weren't met, government would need a more streamlined and effective process to handle emergencies.
Steps to meet the first requirement, he said, are well under way. The Fed and other bank regulators, in coordination with their counterparts in Europe, are expected to issue interim capital requirements in late 2010 or early 2011 and to finalize regulations over the next two years. In the past, banks traditionally had capital reserves of 8 to 10 percent of their total deposits, but through "off balance sheet" transactions and other creative accounting, some big banks had shrunk their reserves to perhaps half this level. "Recapitalization of the banks is happening," Ahamed said. "The banks have been preparing for it."
The emerging legislation intends to provide a smoother and swifter process for the government to seize insolvent banks and sell their assets. This process will also allow regulators to capture and execute nonbank financial companies, such as American International Group, that are large enough to threaten the financial system if they fail.
These two functions were already important government responsibilities, according to Ahamed, but the middle role -- seeking to guarantee the stability of the financial system -- is different. The Fed has been responsible for auditing many of the largest banks, and it has important duties to keep interests rates and inflation low and employment and the economy growing.
The Fed's responsibility for maintaining the overall stability of the financial system has been more ambiguous, especially in recent decades. Although regulators have stepped up its efforts to stabilize the financial system, "it is also true that the financial system is more complex" than a decade or two ago, Ahamed said.
The Federal Reserve has long had close relations with large bank holding companies such as Citigroup and Bank of America (where Fed examiners actually showed up for work every day at their headquarters). Until recently, though, Fed accountants were not as involved in the day-to-day operations of Wall Street banks -- such as Bear Stearns, Goldman Sachs, and Lehman Brothers -- that were some of the biggest customers for the Fed's Treasury bills. The chaos of the financial crisis revealed just how little attention the Fed paid to ensuring their stability and how limited were its powers to help them.
This Time Is Different
Ahamed and others contend that the Fed has traditionally served as a kind of systemic risk council for the financial system. They point to the 1998 rescue of the hedge fund Long Term Capital Management. Worth about $4.7 billion at the start of that year, the fund made a number of risky bets in derivatives that went bad, and it faced the prospect of failure as investors tried to withdraw their money.
Long Term Capital Management was involved with every big bank on Wall Street, and its failure arguably threatened similar runs at other institutions. Moreover, a separate and less quantifiable risk was a crash in the value of privately traded financial derivatives of the kind the fund held. The big banks' direct business with the hedge fund represented a few billion dollars in potential losses, but their exposure to the derivative market as a whole was much larger, and that was a major factor in motivating the Fed to act.
The rescue that Federal Reserve Board Chairman Alan Greenspan organized in September 1998 demonstrates how different the new risk council will be. The government used no taxpayer funds to bail out Long Term Capital Management, and the Fed did not even use its emergency lending powers, as it did during the recent financial crisis. Instead, Greenspan and officials at the Federal Reserve Bank of New York were able to cajole the fund's creditors to invest from $100 million to $300 million each, approximately what each stood to lose if it failed. Of course, in 1998, in the midst of the dot-com boom, the rest of Wall Street was otherwise flush with cash, in contrast to 2008.
A hallmark of the Greenspan era, from 1987 to 2006, was the Fed's unwillingness to serve as the kind of guarantor of financial stability envisioned in the plan for the Financial Stability Oversight Council. At the same moment that Long Term Capital Management's derivatives trades were souring, Greenspan was otherwise engaged in killing off an effort by Brooksley Born, then the chairwoman of the Commodities Futures Trading Commission, to regulate derivatives. At multiple congressional hearings, Greenspan argued successfully that no oversight was needed -- because the self-interest of big banks and investors would be more effective than any government agency in controlling risk and maintaining stability.
Since then, Greenspan has expressed wonderment at the failures of such market discipline during the financial crisis, but he has not admitted that he might have been mistaken about unregulated trading in derivatives. Ten years after his tidy and privately financed rescue of Long Term Capital Management, one type of unregulated derivative was at the center of the subprime mortgage meltdown, and a related derivative underlay the $182 billion bailout of AIG, which at last count is expected to cost taxpayers $50 billion.
Reinhart has low expectations for the systemic risk council and the rest of the regulatory overhaul because he thinks that Congress is aiming at the wrong target -- preventing banks from becoming "too big to fail." Reinhart, a former director of the Fed's Division of Monetary Affairs, believes that in the 24 years since the government made major changes to the tax code, banks have exploited weaknesses in accounting rules. Banks' "splintering" of their balance sheets, he says, made it impossible for regulators to understand what was going on, for the market to exercise the discipline that Greenspan was depending on, and even for managers of the banks to understand the risks that had accumulated.
Washington's crucial decision to allow Lehman Brothers to fail in September 2008 came after the Treasury Department tried for a week to sell off pieces of the company. The stumbling block, Reinhart says, was that neither the prospective buyers nor Lehman's management really understood the company's liabilities, which at that point were buried in the more than 2,000 affiliates and "special-purpose vehicles" that Lehman had created to conceal its debts. At Citigroup and banks much larger than Lehman, the complications were even bigger, and they got government bailouts because no one wanted to find out what would happen to the counterparties to those trades if all of the banks' activities dissolved. "The problem wasn't that [the banks] were too big to fail -- they were too complicated to understand," Reinhart said.
"We are giving the [risk] council a nearly impossible job," he says, because the complications of stabilizing an entire financial system are almost unimaginable. Reinhart asks rhetorically whether regulatory reform will make the balance sheets of big banks any easier to understand. "If not, then I think the council has a mission it can't accomplish."
The Peterson Institute's Goldstein is more optimistic. He believes that the council will try to use "countercyclical" policy to respond to changes in banks' level of risk-taking, even in the absence of cash-flow problems. As a hypothetical, if banks invent a home mortgage or debt instrument that is producing big profits but arguably creating new risks for the financial system, the Financial Stability Oversight Council could pre-emptively raise capital reserve requirements based on the level of this newfangled lending, he argues. Another countercyclical option, anticipated in the Senate version of the legislation, is a requirement that banks issue a certain level of "contingent capital," bonds that automatically convert into equity if a bank falls into financial difficulty. This would spread the pain of the bank failure to debt holders as well as stockholders.
Would the risk council use such countercyclical means to try to head off the next financial bubble? Goldstein thinks it is possible, but Reinhart is doubtful. When Greenspan issued his famous warning in late 1996 about "irrational exuberance" in the stock market, Reinhart said, no one wanted to listen. The market doubled in the next four years, until the dot-com crash, and Greenspan, according to his memoirs, concluded that even Fed chairmen are powerless to puncture a financial bubble.
No elected or appointed official would risk the political fallout from taking action against a possible bubble, Reinhart argues. At best, a lot of people will be poorer. At worst, he said, government officials risk destabilizing rather than stabilizing the situation.
If we are lucky, former investment banker Elliot says, the risk council's existence will be enough to deter excessive risk-taking. Depending on whether the House or Senate version is enacted, either a two-thirds vote or a simple majority of the council could force a company to sell off some divisions, even if it wasn't yet in financial difficulty. More likely though, Reinhart warns, it will take another crisis to move government to directly address the complexity of large banks that is at the root of systemic risk. "I fully expect it," he said.
FINANCIAL INSTITUTIONS
Is Stability A Realistic Goal?
Can the U.S. government really guarantee the nation's vast and complex financial system? There are few precedents.
Saturday, May 22, 2010by John Maggs
In many ways, the financial reform bill moving through Congress resembles other landmark pieces of legislation. Like health care reform, it tackles a pernicious side effect of America's free-market economy and treats it with a typically light touch by offering a package of incentives and disincentives for businesses and consumers. Instead of forcing banks to become smaller, the bill encourages them to do so. Instead of banning the kinds of home loans that contributed to the housing crisis, the legislation sets up a consumer protection agency that will rely mainly on disclosure to prompt Americans to make smarter financial decisions.
Like other regulatory reforms, the financial overhaul eschews a massive reorganization in favor of shifting oversight functions and responsibilities among several government agencies. The Federal Reserve System will continue to audit big national banks and some state-chartered banks; the two other bank regulators will split the rest, more or less as they do now.
Responsibility for one of the reform package's most far-reaching steps -- imposing the first rules for derivatives trading -- would mostly fall to private companies and big banks themselves, rather than to a government agency. The overhaul package leaves many details to regulators to work out. "It is really just a series of general guidelines," said Vincent Reinhart, a former top Fed official. He supports this conservative approach, saying that it will allow government officials to deliberately work through what rules to change and how to change them.
In at least one way, though, the financial reform plan represents a new approach. Grafted onto the largely familiar array of agencies that regulate banks is a council of top economic officials tasked with counteracting instability in the financial system before it becomes a critical threat. The council will look beyond individual institutions and practices to anticipate bubbles and spot potentially destabilizing financial innovations -- such as the bonanzas that subprime lending and collateralized debt obligations seemed to be a few years ago.
The proposed Financial Stability Oversight Council, as the Senate legislation calls it, is an interagency group of nine people chaired by the Treasury secretary; it would include the chairman of the Federal Reserve Board, the heads of other financial agencies, and one or two other appointees (the House and Senate bills have slight differences). Some of its functions approximate the emergency powers that the Federal Reserve and Treasury have traditionally kept for themselves. But giving the council the job of foreseeing problems and acting to preserve stability in the nation's vast and complex financial system is an audacious undertaking, even for the U.S. government.
"It hasn't been tried before," said Morris Goldstein, a senior fellow at the Peterson Institute for International Economics. "We don't really know what [the council] will do -- a lot, or perhaps not a lot."
If the council doesn't do a lot, then the separate bank regulators might decide to be much more active and attentive than before. Perhaps the Fed, chastened by the near-failure of the financial system, would take a more active approach to its informal role of overseeing Wall Street and the rest of the "shadow banking system." New disclosure rules, although limited, might discourage banks from using derivatives for highly lucrative speculation. Unlike the subprime-fueled housing crisis, the next financial bubble could be safely deflated by the various bank regulators, even if that intervention deprives the banks they oversee of huge profits. "The [bank oversight] system isn't changing that much," Doug Elliott, a former investment banker and a finance expert at the Brookings Institution, said. "There is a hope, I think, that everyone is going to do better."
But if fragmented oversight again yields regulatory failure and threatens another economic meltdown, the "systemic risk council" could play a significant coordinating role. How would the council define instability? Would it intervene only in a crisis that threatens the imminent collapse of the financial system, or would it move earlier to quell turmoil before it could lead to such a crisis? Would the council act to rein in excessive executive pay that could fuel risky behavior? Would it move to deflate a financial bubble, even if that bubble is making people richer? If consumers are borrowing too much, would the council curtail credit? Would it deal with the domestic effects of an international financial crisis? Most important, if the council took any of these aggressive steps, would it be effective?
"We don't know," Goldstein said. "It is an experiment. We'll have to see what it does and how that works."
Like Elliott, Norman Ornstein believes that the risk council won't do much more than sign off on the emergency actions that the government would take in any case to deal with a financial crisis. Ornstein, a resident scholar at the American Enterprise Institute, doubts that the government is about to embark on an uncharted, proactive approach to financial oversight.
Goldstein disagrees. The legislation signals a substantially different and more hands-on regulatory regime, he argues. The repeated promises from President Obama and virtually every member of Congress that expensive bailouts won't be needed (or forthcoming) again have raised the bar, he says. "When lawmakers say 'Never again,' I think there is an expectation that things are going to be done differently, and [the council] is part of that," Goldstein said. "I expect it to try things that haven't been tried before."
We're Not Good At It
The government has long set rules for businesses operating in the market-based economy. Washington has little practice, however, in guaranteeing the outcomes of market activity. The 1,000-point drop in the Dow Jones industrial average on May 6 demonstrated that even in the highly regulated stock market, the government has few tools to prevent a degree of instability that many people would regard as disastrous. Under current rules, only a 30 percent plunge in the market can shut down trading for the day.
In times past, Americans would have blanched at the prospect of the government's guaranteeing the health of an entire industry, even one considered essential to the well-being of the overall economy. In 2009, the Treasury Department loaned more than $100 billion to rescue General Motors and Chrysler, but it put the automakers on a short leash, forcing them to promptly repay most of the money. If they were to falter again, Washington would likely allow them to fail.
The financial system that seized up in 2008 is exponentially larger and more complex than the stock market or the auto industry, and a government promise to maintain its stability is unprecedented.
"When lawmakers say 'Never again,' I think there is an expectation that things are going to be done differently, and [the council] is part of that." -- Morris Goldstein, Peterson Institute for International Economics
To put this commitment into perspective, consider the scope of the health care reform package enacted this year. Imagine for a moment that Washington had empowered a council to guarantee the stability of the U.S. health care system. If medical care, like credit, was scarce or too expensive, the council could intervene to make sure it was affordable and readily available, by acting wherever it chose to head off, say, shocking rate increases, or by guaranteeing medical care to everyone, with or without insurance. This sounds far-fetched because the epic health debate revealed that Americans are hardly eager to embrace government intervention to guarantee such ambitious outcomes.
Compared with many other countries, the U.S. government has tended to take a laissez-faire approach to regulating such essential services as transportation, electricity, and telecommunications. Washington does attempt to preserve the stability of agricultural supply and prices, with only mixed results. Most economists say that the current system of farm subsidies and price controls exists more to boost the farmers' income than to protect consumers.
But even these examples involve industries much smaller and simpler than the financial system, which extends beyond banks to include insurance, mortgage lending, and consumer credit -- sectors that will remain relatively free of federal regulation, even after the regulatory reform package becomes law. The most comparable example of the government ambitiously trying to maintain the stability of markets was World War II and the extensive system of rationing and price controls that the Roosevelt administration used to prevent inflation, hoarding, and profiteering. That intervention was arguably successful, but a more recent iteration wasn't.
President Nixon imposed wage and price controls from 1971 to 1973 to combat inflation and escalating wage demands by labor unions. The move triggered runaway inflation, slow growth, food and commodity shortages, and an era of declining living standards. Economists consider the controls one of the most disastrous economic policy decisions ever by a U.S. president.
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Before The Emergency
Oddly, the debate over financial reform hasn't focused much on the question of whether government can or should try to assume responsibility for stabilizing the financial system. Neither party in Congress has drawn attention to the goals of the systemic risk council or to the very notion that a government body would try to head off instability throughout the financial system before it causes a crisis.
Most of the discussion in Congress has centered on the council's role in managing the shutdown of giant financial companies that fail. The council is supposed to handle this emergency action in an orderly and predictable way, in contrast to the ad hoc, chaotic bailouts and shotgun mergers that took place in 2008 and 2009. This process has been the focus of ideological skirmishes in the Senate between Republicans, who charged that the bill that arrived on the floor would permit bailouts to save faltering banks, and Democrats, who insisted that the opposite was true.
To settle that argument, the first amendment, offered by Sen. Barbara Boxer, D-Calif., simply reiterated that the systemic risk council would have no choice but to break up faltering banks and financial companies rather than bail them out. The amendment passed by a wide, bipartisan margin.
In one form or another, the federal government has always taken emergency action to stem financial panics and other crises that threaten the economy, according to Liaquat Ahamed, author of The Lords of Finance: The Bankers Who Broke the World, a 2009 book on the early years of central banking. Congress established the Federal Reserve Board in 1913 to coordinate emergency action, using the power to make emergency loans to counter bank runs and otherwise manipulate interest-rate policy to maintain liquidity in the banking system. Although the Fed and Treasury took actions during the recent crisis that were messy and in some ways unprecedented in size and scope, the interventions essentially followed past patterns, Ahamed said in an interview.
In Ahamed's view, the earliest days of the crisis made it clear that the United States had to do three things to minimize the risk of a plunge that could wreck the financial system. First, the government needed to bolster the capital reserves of banks, which had used holes in the accounting rules to evade reserve requirements; second, Washington needed to take on increased oversight to prevent excessive risk-taking and leveraging; and third, if the first two requirements weren't met, government would need a more streamlined and effective process to handle emergencies.
Steps to meet the first requirement, he said, are well under way. The Fed and other bank regulators, in coordination with their counterparts in Europe, are expected to issue interim capital requirements in late 2010 or early 2011 and to finalize regulations over the next two years. In the past, banks traditionally had capital reserves of 8 to 10 percent of their total deposits, but through "off balance sheet" transactions and other creative accounting, some big banks had shrunk their reserves to perhaps half this level. "Recapitalization of the banks is happening," Ahamed said. "The banks have been preparing for it."
The emerging legislation intends to provide a smoother and swifter process for the government to seize insolvent banks and sell their assets. This process will also allow regulators to capture and execute nonbank financial companies, such as American International Group, that are large enough to threaten the financial system if they fail.
These two functions were already important government responsibilities, according to Ahamed, but the middle role -- seeking to guarantee the stability of the financial system -- is different. The Fed has been responsible for auditing many of the largest banks, and it has important duties to keep interests rates and inflation low and employment and the economy growing.
The Fed's responsibility for maintaining the overall stability of the financial system has been more ambiguous, especially in recent decades. Although regulators have stepped up its efforts to stabilize the financial system, "it is also true that the financial system is more complex" than a decade or two ago, Ahamed said.
The Federal Reserve has long had close relations with large bank holding companies such as Citigroup and Bank of America (where Fed examiners actually showed up for work every day at their headquarters). Until recently, though, Fed accountants were not as involved in the day-to-day operations of Wall Street banks -- such as Bear Stearns, Goldman Sachs, and Lehman Brothers -- that were some of the biggest customers for the Fed's Treasury bills. The chaos of the financial crisis revealed just how little attention the Fed paid to ensuring their stability and how limited were its powers to help them.
This Time Is Different
Ahamed and others contend that the Fed has traditionally served as a kind of systemic risk council for the financial system. They point to the 1998 rescue of the hedge fund Long Term Capital Management. Worth about $4.7 billion at the start of that year, the fund made a number of risky bets in derivatives that went bad, and it faced the prospect of failure as investors tried to withdraw their money.
Long Term Capital Management was involved with every big bank on Wall Street, and its failure arguably threatened similar runs at other institutions. Moreover, a separate and less quantifiable risk was a crash in the value of privately traded financial derivatives of the kind the fund held. The big banks' direct business with the hedge fund represented a few billion dollars in potential losses, but their exposure to the derivative market as a whole was much larger, and that was a major factor in motivating the Fed to act.
The rescue that Federal Reserve Board Chairman Alan Greenspan organized in September 1998 demonstrates how different the new risk council will be. The government used no taxpayer funds to bail out Long Term Capital Management, and the Fed did not even use its emergency lending powers, as it did during the recent financial crisis. Instead, Greenspan and officials at the Federal Reserve Bank of New York were able to cajole the fund's creditors to invest from $100 million to $300 million each, approximately what each stood to lose if it failed. Of course, in 1998, in the midst of the dot-com boom, the rest of Wall Street was otherwise flush with cash, in contrast to 2008.
A hallmark of the Greenspan era, from 1987 to 2006, was the Fed's unwillingness to serve as the kind of guarantor of financial stability envisioned in the plan for the Financial Stability Oversight Council. At the same moment that Long Term Capital Management's derivatives trades were souring, Greenspan was otherwise engaged in killing off an effort by Brooksley Born, then the chairwoman of the Commodities Futures Trading Commission, to regulate derivatives. At multiple congressional hearings, Greenspan argued successfully that no oversight was needed -- because the self-interest of big banks and investors would be more effective than any government agency in controlling risk and maintaining stability.
Since then, Greenspan has expressed wonderment at the failures of such market discipline during the financial crisis, but he has not admitted that he might have been mistaken about unregulated trading in derivatives. Ten years after his tidy and privately financed rescue of Long Term Capital Management, one type of unregulated derivative was at the center of the subprime mortgage meltdown, and a related derivative underlay the $182 billion bailout of AIG, which at last count is expected to cost taxpayers $50 billion.
Reinhart has low expectations for the systemic risk council and the rest of the regulatory overhaul because he thinks that Congress is aiming at the wrong target -- preventing banks from becoming "too big to fail." Reinhart, a former director of the Fed's Division of Monetary Affairs, believes that in the 24 years since the government made major changes to the tax code, banks have exploited weaknesses in accounting rules. Banks' "splintering" of their balance sheets, he says, made it impossible for regulators to understand what was going on, for the market to exercise the discipline that Greenspan was depending on, and even for managers of the banks to understand the risks that had accumulated.
Washington's crucial decision to allow Lehman Brothers to fail in September 2008 came after the Treasury Department tried for a week to sell off pieces of the company. The stumbling block, Reinhart says, was that neither the prospective buyers nor Lehman's management really understood the company's liabilities, which at that point were buried in the more than 2,000 affiliates and "special-purpose vehicles" that Lehman had created to conceal its debts. At Citigroup and banks much larger than Lehman, the complications were even bigger, and they got government bailouts because no one wanted to find out what would happen to the counterparties to those trades if all of the banks' activities dissolved. "The problem wasn't that [the banks] were too big to fail -- they were too complicated to understand," Reinhart said.
"We are giving the [risk] council a nearly impossible job," he says, because the complications of stabilizing an entire financial system are almost unimaginable. Reinhart asks rhetorically whether regulatory reform will make the balance sheets of big banks any easier to understand. "If not, then I think the council has a mission it can't accomplish."
The Peterson Institute's Goldstein is more optimistic. He believes that the council will try to use "countercyclical" policy to respond to changes in banks' level of risk-taking, even in the absence of cash-flow problems. As a hypothetical, if banks invent a home mortgage or debt instrument that is producing big profits but arguably creating new risks for the financial system, the Financial Stability Oversight Council could pre-emptively raise capital reserve requirements based on the level of this newfangled lending, he argues. Another countercyclical option, anticipated in the Senate version of the legislation, is a requirement that banks issue a certain level of "contingent capital," bonds that automatically convert into equity if a bank falls into financial difficulty. This would spread the pain of the bank failure to debt holders as well as stockholders.
Would the risk council use such countercyclical means to try to head off the next financial bubble? Goldstein thinks it is possible, but Reinhart is doubtful. When Greenspan issued his famous warning in late 1996 about "irrational exuberance" in the stock market, Reinhart said, no one wanted to listen. The market doubled in the next four years, until the dot-com crash, and Greenspan, according to his memoirs, concluded that even Fed chairmen are powerless to puncture a financial bubble.
No elected or appointed official would risk the political fallout from taking action against a possible bubble, Reinhart argues. At best, a lot of people will be poorer. At worst, he said, government officials risk destabilizing rather than stabilizing the situation.
If we are lucky, former investment banker Elliot says, the risk council's existence will be enough to deter excessive risk-taking. Depending on whether the House or Senate version is enacted, either a two-thirds vote or a simple majority of the council could force a company to sell off some divisions, even if it wasn't yet in financial difficulty. More likely though, Reinhart warns, it will take another crisis to move government to directly address the complexity of large banks that is at the root of systemic risk. "I fully expect it," he said.
Sunday, May 23, 2010
Finance Reform Bill: Fiduciary Responsibility
More detail on a provision of the finance bill: Financial advisers have to take their clients interests into consideration when doing deals for them.
Saturday, May 22, 2010
Understanding the Senate's Finance Bill
We should discuss the major components of the finance bill passed in the Senate soon.
Here they are:
- It provides for the oversight of sale of derivatives
- It creates a Consumer Protection Agency
- It creates a council of regulators to look for systemic risk
- It applies restrictions on large failed banks
- It establishes that executive compensation be set by independent directors
- It prohibits banks from making investments that do not benefit clients
- It establishes that companies selling complex financial products must retain part of the risk of these products.
For amendments that failed, click here.
If you have time to kill, here's the bill itself.
The bill now goes to a conference committee where it will be reconciled with the House bill already passed. Nothing is set in stone, but typical lobbying rules do not seem to apply, almost certainly due to voter anger.
Here they are:
- It provides for the oversight of sale of derivatives
- It creates a Consumer Protection Agency
- It creates a council of regulators to look for systemic risk
- It applies restrictions on large failed banks
- It establishes that executive compensation be set by independent directors
- It prohibits banks from making investments that do not benefit clients
- It establishes that companies selling complex financial products must retain part of the risk of these products.
For amendments that failed, click here.
If you have time to kill, here's the bill itself.
The bill now goes to a conference committee where it will be reconciled with the House bill already passed. Nothing is set in stone, but typical lobbying rules do not seem to apply, almost certainly due to voter anger.
Friday, May 21, 2010
Wednesday, May 5, 2010
No Backroom Deals for Finance Reform?
If these stories are to be believed, Senate Committees aren't what they used to be. It is said that sunlight is the best disinfectant, and it is alleged that media exposure breaks apart issue networks and iron triangles. Let's see.
Thursday, April 22, 2010
Framing Financial Reform
From Politico, a story about a debate regarding where the idea emerged that opposition to financial aid reform is best done by framing it as being a "permanent bailout."
Friday, April 16, 2010
Senate Republicans United in Opposition to Financial Reforms
But apparently not all 41 support a filibuster. There are concerns whether opposition to the bill will be seen as protecting Wall Street from the wrath of Main Street.
Here are the key parts of the bill (copied from calculatedriskblog):
- The consumer financial protection agency would be part of the Federal Reserve.
- Creates a systemic risk council that would be headed by the Treasury Secretary and would include "representatives of the Fed, the new consumer agency, the F.D.I.C., the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Federal Housing Finance Agency — along with an official appointed to monitor the insurance industry, which is largely regulated by the states."
- Regulate over-the-counter derivatives: "Standardized swaps and derivatives would have to be traded on exchanges or clearinghouses."
- The Federal Reserve would regulate bank holding companies with $50 billion or more in assets, and "systemically important nonbank financial institutions".
- Many smaller banks that the Federal Reserve currently regulates would be overseen by the Office of the Comptroller of the Currency or the Federal Deposit Insurance Corporation, depending on the bank charter.
- Some shareholder provisions that allow shareholders to vote on executive pay and nominate directors.
click here for the committee report.
Here are the key parts of the bill (copied from calculatedriskblog):
- The consumer financial protection agency would be part of the Federal Reserve.
- Creates a systemic risk council that would be headed by the Treasury Secretary and would include "representatives of the Fed, the new consumer agency, the F.D.I.C., the Securities and Exchange Commission, the Commodity Futures Trading Commission and the Federal Housing Finance Agency — along with an official appointed to monitor the insurance industry, which is largely regulated by the states."
- Regulate over-the-counter derivatives: "Standardized swaps and derivatives would have to be traded on exchanges or clearinghouses."
- The Federal Reserve would regulate bank holding companies with $50 billion or more in assets, and "systemically important nonbank financial institutions".
- Many smaller banks that the Federal Reserve currently regulates would be overseen by the Office of the Comptroller of the Currency or the Federal Deposit Insurance Corporation, depending on the bank charter.
- Some shareholder provisions that allow shareholders to vote on executive pay and nominate directors.
click here for the committee report.
Monday, March 22, 2010
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