October 28, 2021

Today’s Economists: Marc Jarsulic and Simon Johnson: A Big-Bank Failure Scenario

Marc Jarsulic, chief economist at Better Markets and author of Anatomy of a Financial Crisis.

Marc Jarsulic, chief economist at Better Markets, is the author of “Anatomy of a Financial Crisis.” Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

Defenders of big banks are adamant that we have fixed the problem of too big to fail. Organizations such as the Bipartisan Policy Center and the law firm Davis Polk Wardwell assert that the critical breakthrough was the introduction of new orderly liquidation powers under the 2010 Dodd-Frank financial reform legislation, enabling the Federal Deposit Insurance Corporation to handle the resolution or managed failure of very large financial companies.

Today’s Economist

Perspectives from expert contributors.

This is the core of their argument that no financial reforms or higher capital requirements are needed. This discussion can get a little abstract, so to understand the details – and why the bank advocates’ position is wrong – consider what could happen if there were a hypothetical problem at a major international financial conglomerate such as Deutsche Bank or Citigroup.

Deutsche Bank is not currently in obvious trouble, but during the financial stress and instability at the end of 2008, the Taunus Corporation, the American subsidiary of Deutsche Bank, looked very vulnerable to the financial storm building around it. Although the bank had more than $396 billion in assets, making it one the top 10 bank-holding companies in the United States, it had equity of negative $1.4 billion on an accounting basis (i.e., its assets were worth less than its liabilities).

A large fraction of Taunus’s liabilities, perhaps $294 billion, consisted of short-term dollar borrowing, in the form of uninsured deposits at its essentially unregulated branch and agency network, along with what is known as repo and commercial paper borrowing.

It was not clear how much help Taunus’s thinly capitalized global parent could or would provide. But the United States government did not choose to find out, because bankruptcy accompanied by distressed sales of hundreds of billions in dollar-denominated assets could have produced another Lehman-like shock.

Instead, the Federal Reserve stepped in to replace short-term creditors that chose to run on Taunus. Taunus borrowing — through the discount window, the Term Auction Facility, the Primary Dealer Credit Facility, the Term Securities Lending Facility and Single-Tranche Open Market Operations — peaked at $66 billion in October 2008.

The Federal Reserve also began huge currency swaps with the European Central Bank, making it possible for Deutsche Bank to swap euros for dollars and meet the dollar funding needs of Taunus (see this speech by the Federal Reserve governor Jeremy Stein, from December 2012).

Deutsche Bank (and indirectly Taunus) was also greatly assisted by the Fed and Treasury decision to rescue A.I.G. Deutsche Bank received $11.8 billion as a result of that rescue (in payments covering A.I.G. credit default swap and securities lending obligations that otherwise would not have paid out).

Taunus received this help from the United States government because its failure would have intensified an already chaotic financial situation. It was not provided because the Federal Reserve knew that, once the storm passed, Taunus’s assets would be sufficient to repay its creditors. Accounting data said otherwise, and it was not possible for the Fed or anyone else to estimate the fundamental values of the assets located in the 180-odd Taunus subsidiaries. Taunus got United States government support because it was simply too big and too interwoven with the American financial system to fail.

We are now told by responsible government officials and leading bank lobbyists that the era of too big to fail has come to an end, because of Dodd-Frank legislative prohibitions on the rescue of individual companies, together with the legal authority of the F.D.I.C. to prevent the disorderly bankruptcy of big American financial companies by putting them into receivership using the new Orderly Liquidation Authority.

But the case of Taunus-Deutsche Bank illustrates that it is far from clear that these new provisions really signal the end of too big to fail. Officials are making promises not to provide what may be considered “bailouts” — but are these promises really credible?

It is true that Fed lending can no longer be funneled directly to a failing A.I.G.-type company, and we fully understand that the recently proposed requirements for foreign banking organizations doing business in the United States are designed to make banks like Taunus less likely to fail.

But the rewritten provisions of Fed emergency lending authority explicitly allow it to establish widely available lending facilities of exactly the type that helped keep Taunus afloat – with the difference being that the A.I.G. funding was company-specific, while Taunus was saved by lending programs available to a broader class of institutions or covering a class of assets.

The Fed will now need the agreement of the Treasury secretary before setting up the facilities, lending is restricted to solvent firms and chief executives may be required to certify solvency in writing. But solvency is an ambiguous concept in a crisis. It is hard to imagine that this will slow down bailouts by more than 15 minutes.

The F.D.I.C. will, in the future, be able to guarantee the debt of solvent distressed banks through programs like its Temporary Liquidity Guarantee Program, which guaranteed hundreds of billions in unsecured bank borrowing during the crisis. The F.D.I.C. will now need the agreement of the Fed, the administration and Congress to establish the program. That might take a day or two.

Given circumstances similar to 2008, is it likely that Congress and the administration will choose to stand in the way of efforts to prevent a systemic meltdown? Would there be any serious resistance to deploying trillions dollars in loans and guarantees to keep big banks from failing?

If the Treasury secretary, the chairman of the Federal Reserve Board and the president of the New York Fed all attest, as they did in fall 2008, that the alternative would be the end of the world’s financial system, Congress will acquiesce.

Nor is it obvious the Orderly Liquidation Authority would be able to wind down one of our large banks during a crisis. If past events are a guide, Citigroup will be one of the failing. It has its $1.9 trillion in assets dispersed across 2,372 subsidiaries that span the world. Just like any other company operating across borders, it is subject to the bankruptcy code and other laws of foreign jurisdictions where it does business. In the case of Citigroup this includes Britain, Germany, Hong Kong, Japan and other places.

So to smoothly “resolve” the Citigroup holding company, all the foreign jurisdictions, including creditors and courts, would need to stand back and allow the F.D.I.C. to determine the priority of claims under its Orderly Liquidation Authority.

Other jurisdictions might agree to some or all of this in a period of calm, but will they follow through if there is a general crisis?

When the F.D.I.C. says that a complex institution like Citigroup is insolvent, the amount of total losses will be unclear, and the harm to individual bank counterparties will be hard to forecast. If foreign regulators can preserve the interests of domestic creditors and counterparties of Citigroup by winding up Citigroup subsidiaries under domestic law, won’t they have very strong incentive to do so?

The legal changes of which large bank supporters are most enamored, and which they contend are sufficient to end too big to fail, both suffer from potential time inconsistency. That is, they rest on promises that are unlikely to be fulfilled at the crucial moment.

Federal authorities have promised not to come to the rescue of large failing financial companies, but they still have more than enough permissible lending authority to do just that. And if that authority proves insufficient to the task, they will have every reason to expand it.

Foreign authorities may promise to allow the United States to resolve global banks under the Orderly Liquidation Authority, but when the time comes to use it, they are likely to have good reason to find a way around their agreements.

The Dodd-Frank Act does give regulators other authority that can effectively reduce the risk posed by large banks and nonbank financial institutions. Those institutions can be required to finance their operations using substantially more equity, thereby changing their incentives and buffering themselves and the public against their miscalculations. Their use of short-term debt can be constrained so that they can survive runs by uninsured short-term creditors. And if they cannot develop a credible plan for orderly resolution in the event of failure, they can be required to divest assets and activities to make such a resolution possible.

To date regulators have made only limited use of this authority. They need to do far more.

Article source: http://economix.blogs.nytimes.com/2013/05/23/how-a-big-bank-failure-could-unfold/?partner=rss&emc=rss

Common Sense: Following a Herd of Bulls on Apple’s Stock

By November, with Apple stock in the midst of a precipitous decline, they were still bullish. Fifty of 57 analysts rated it a buy or strong buy; only two rated it a sell. Apple shares continued their plunge, and this week were trading at just over $450, down 36 percent from their peak.

How could professional analysts have gotten it so wrong?

It wasn’t supposed to be this way. A decade ago, Congressional hearings and an investigation by Eliot Spitzer, then the New York attorney general, exposed a maze of conflicts of interest afflicting Wall Street research. There were some notorious examples of analysts who curried favor with investment banking clients and potential clients by producing favorable research, and then were paid huge bonuses out of investment banking fees. Many investors and regulators blamed analysts’ overly bullish forecasts for helping to inflate the dot-com bubble that burst in 2000.

After a global settlement of Mr. Spitzer’s investigation by major investment banks and the Sarbanes-Oxley reform legislation in 2002, investment banking and research operations were segregated. Conflicts had to be disclosed, and research and analyst pay was detached from investment banking revenues, among other measures.

These reforms seem to have worked — but only up to a point. Other conflicts have come to the fore, especially at large brokerage firms and investment banks. And studies have shown that analysts are prone to other influences — like following the herd — that can undermine their judgments. “The reforms didn’t necessarily make analysts better at their jobs,” said Stuart C. Gilson, a professor of finance at Harvard Business School.

It may be no coincidence that the only analyst who even came close to calling the peak in Apple’s stock runs his own firm and is compensated based on the accuracy of his calls. Carlo R. Besenius, founder and chief executive of Creative Global Investments, downgraded Apple to sell last Oct. 3, with shares trading at $685. In December, he lowered his price target to $420, and this week he told me he may drop it even further, to $320.

Mr. Besenius founded his firm a decade ago after spending many years in research at Merrill Lynch and Lehman Brothers. “I saw so many conflicts of interest in trading, investment banking and research, so I started a conflict-free company,” he said this week from Luxembourg, where he was born and now lives. “Wall Street is full of conflicts. It still is and always will be. It’s incompetent at picking stocks.”

Since the passage of Sarbanes-Oxley, several studies have documented a decline in the percentage of analysts’ buy recommendations, albeit a modest one, while sell recommendations have increased. “Before 2002, analyst recommendations were tilted toward optimistic at an extreme rate,” Ohad Kadan, a professor of finance at Washington University in St. Louis, and co-author of one of the studies, told me this week. “That’s still true today, but it’s not as extreme. It’s a little more balanced.”

While investment banking conflicts have been addressed, “the most obvious conflict now is that research is funded through the trading desks,” Professor Gilson said. “If you’re an analyst and one way your report brings in revenue is through increased trading, a buy recommendation will do this more than a sell. For a sell, you have to already own the stock to generate a trade. But anybody can potentially buy a stock. That’s one hypothesis about why you still see a disproportionate number of buy recommendations.” That may be especially true for heavily traded stocks like Apple, which generate huge commissions for Wall Street.

Article source: http://www.nytimes.com/2013/02/09/business/following-a-herd-of-bulls-on-apples-stock.html?partner=rss&emc=rss

Today’s Economist: Simon Johnson: Volcker Spots a Problem

DESCRIPTION

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

On Monday, at the end of a long day of wrangling over technical details at the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory Committee, Paul A. Volcker cut to the chase. The resolution authority created by the Dodd-Frank financial reform legislation was a distinct improvement on the previous situation, making it easier to handle the failure of a single large financial institution.

Today’s Economist

Perspectives from expert contributors.

It does not, however, end the myriad problems associated with that most daunting and modern of phenomena: too big to fail.

At age 85, Mr. Volcker, the former chairman of the Federal Reserve, speaks softly and displays a razor-sharp mind. The room where the committee met was hushed as everyone leaned forward to catch his words. Mr. Volcker incisively observed that the general legal framework of Dodd-Frank, as currently being put into effect, definitely puts more effective powers in the hands of the Federal Deposit Insurance Corporation to handle the failure of what is known as a systemically important financial institution.

But the bigger issue is a point made by Mr. Volcker and others at the table. When big banks boom, they find new ways to finance themselves and, too often, regulators go along. The assets they buy look like a sure thing until the moment they collapse in value. This is the classic and future recipe for systemwide panic and potential collapse. The only solution to prevent this is to limit the size of the largest institutions and the activities they can undertake.

The F.D.I.C. has long had the powers necessary to handle the failure of a bank whose deposits it insures. It can take over such an institution, sell off the viable parts of its business and place the remainder in a form of liquidation, so that as much asset value as possible is recovered. Management and boards of directors are immediately let go (with no golden parachutes). Shareholders are typically wiped out – meaning that the value of their shares falls to zero, as it would in the case of bankruptcy. Creditors to the original company also suffer losses – with the full extent determined by how much value the F.D.I.C. can recover; again, a close parallel with bankruptcy, but the F.D.I.C. is in charge, not a bankruptcy court judge.

Sometimes this kind of F.D.I.C.-managed process is referred to as nationalization – in fact, that is the term the White House used to describe this option in early 2009, when it was proposed that Citigroup, Bank of America and other large bank-holding companies should go through a form of F.D.I.C. resolution. But nationalization is a complete misnomer and President Obama was poorly advised when he used the term.

The F.D.I.C. operates state-of-the-art bank resolution processes. Depositors typically do not lose access to their funds for even five seconds – and that includes all forms of electronic access. And the reason we want the F.D.I.C. to do this is simple: it prevents the kind of disruptive bank runs that previously plagued the United States and that helped make the economy of the 1930s so depressed.

The question for the modern financial world, however, is not so much how to handle the failure of small and medium-size banks with retail deposits. The specter that haunts us – in the form of Lehman’s bankruptcy and the bailouts provided subsequently to other large firms – is how to handle the imminent collapse of large nonbank financial companies.

The F.D.I.C. is now central to a process that can take any kind of financial company through resolution. The Federal Reserve and the Treasury are also involved, and safeguards are in place to prevent capricious action. These may sometimes delay action.

But the F.D.I.C. unquestionably now has the legal authority and practical ability to impose losses on shareholders and creditors of the holding company. It has also embarked on an ambitious outreach program to explain that the goal is to allow operating subsidiaries to keep functioning, in the hope of minimizing the disruption to the world’s financial system. (Big banks are now organized with a single holding company owning and controlling a large number of operating subsidiaries.)

No taxpayer money is supposed to be put at risk in this situation. Shareholders in the holding company will be wiped out. Creditors will find their debt converted to equity, typically involving a reduction in value. This new equity forms the capital base of the continuing company – meaning its obligations are restructured so that it is again solvent (meaning the value of its assets exceeds the value of its liabilities).

Creditors to operating subsidiaries would suffer losses only if there were not enough debt at the holding-company level – in other words, after reducing all that debt to zero (converting it entirely into equity), the company’s liabilities still exceed its assets.

Together with Sheila Bair, the former chairwoman of the F.D.I.C., and other colleagues, I wrote to the Federal Reserve Board earlier this year, impressing upon them the importance of ensuring there is enough debt at the holding company – relative to potential losses at the operating subsidiary level. I was disappointed to learn on Monday that the Fed is still a considerable distance from issuing even a proposal for comments on this important issue.

In addition to Mr. Volcker, among the other heavyweights at the table were Anat R. Admati of Stanford, Richard J. Herring of Wharton, David Wright of the International Organization of Securities Commissions and several experienced practitioners.

Big banks do not typically fail individually. More often, there are herds that stampede toward a particular issue or fad: emerging-market debt (1970s and 1990s); commercial real estate (United States, 1980s); residential real estate (United States, Spain, Ireland, Britain, 2000s); sovereign debt (Europe, 2000s).

These banks finance themselves with short-term wholesale money – creating the impression that this is safe, when in fact it is incredibly precarious (think Iceland in 1998 or the exposure of American money-market funds to European banks as recently as 2011.) In any truly dangerous boom, markets and regulators become equally infatuated with this new way of doing business – until it collapses.

Can the new resolution authority handle the next big wave of potential failures, whatever it might be? Probably not, even with the greater level of cooperation announced on Monday of the F.D.I.C. and the Bank of England, with an eye to handling cross-border resolution of difficulties between the two nations, which could be immense considering how our big banks operate.

If it is built well and works properly, a good resolution framework allows a company to fail, without socializing losses and without destabilizing the financial system. As a result, it will provide a level of market discipline that should lessen the herd mentality of taking on the kind of risks that create a systemic problem – and the next big wave of failures. But the primary lesson from F.D.I.C. planning and our discussions is this: no resolution framework can correct a systemic problem once it has occurred.

The United States needs multiple fail-safes. As Professor Admati has been arguing, we should rely on equity – not debt – to absorb losses in our financial system (see this comment letter). In addition, I stand with the original intent of the Volcker Rule and with the current position of Thomas Hoenig (the current vice chairman of the F.D.I.C.): in addition to stronger resolution powers and much more equity capital, the size of the largest financial institutions should be capped and the activities they can undertake limited.

Article source: http://economix.blogs.nytimes.com/2012/12/13/volcker-spots-a-problem/?partner=rss&emc=rss

Economix Blog: Simon Johnson: Volcker Spots a Problem

DESCRIPTION

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

On Monday, at the end of a long day of wrangling over technical details at the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory Committee, Paul A. Volcker cut to the chase. The resolution authority created by the Dodd-Frank financial reform legislation was a distinct improvement on the previous situation, making it easier to handle the failure of a single large financial institution.

Today’s Economist

Perspectives from expert contributors.

It does not, however, end the myriad problems associated with that most daunting and modern of phenomena: too big to fail.

At age 85, Mr. Volcker, the former chairman of the Federal Reserve, speaks softly and displays a razor-sharp mind. The room where the committee met was hushed as everyone leaned forward to catch his words. Mr. Volcker incisively observed that the general legal framework of Dodd-Frank, as currently being put into effect, definitely puts more effective powers in the hands of the Federal Deposit Insurance Corporation to handle the failure of what is known as a systemically important financial institution.

But the bigger issue is a point made by Mr. Volcker and others at the table. When big banks boom, they find new ways to finance themselves and, too often, regulators go along. The assets they buy look like a sure thing until the moment they collapse in value. This is the classic and future recipe for systemwide panic and potential collapse. The only solution to prevent this is to limit the size of the largest institutions and the activities they can undertake.

The F.D.I.C. has long had the powers necessary to handle the failure of a bank whose deposits it insures. It can take over such an institution, sell off the viable parts of its business and place the remainder in a form of liquidation, so that as much asset value as possible is recovered. Management and boards of directors are immediately let go (with no golden parachutes). Shareholders are typically wiped out – meaning that the value of their shares falls to zero, as it would in the case of bankruptcy. Creditors to the original company also suffer losses – with the full extent determined by how much value the F.D.I.C. can recover; again, a close parallel with bankruptcy, but the F.D.I.C. is in charge, not a bankruptcy court judge.

Sometimes this kind of F.D.I.C.-managed process is referred to as nationalization – in fact, that is the term the White House used to describe this option in early 2009, when it was proposed that Citigroup, Bank of America and other large bank-holding companies should go through a form of F.D.I.C. resolution. But nationalization is a complete misnomer and President Obama was poorly advised when he used the term.

The F.D.I.C. operates state-of-the-art bank resolution processes. Depositors typically do not lose access to their funds for even five seconds – and that includes all forms of electronic access. And the reason we want the F.D.I.C. to do this is simple: it prevents the kind of disruptive bank runs that previously plagued the United States and that helped make the economy of the 1930s so depressed.

The question for the modern financial world, however, is not so much how to handle the failure of small and medium-size banks with retail deposits. The specter that haunts us – in the form of Lehman’s bankruptcy and the bailouts provided subsequently to other large firms – is how to handle the imminent collapse of large nonbank financial companies.

The F.D.I.C. is now central to a process that can take any kind of financial company through resolution. The Federal Reserve and the Treasury are also involved, and safeguards are in place to prevent capricious action. These may sometimes delay action.

But the F.D.I.C. unquestionably now has the legal authority and practical ability to impose losses on shareholders and creditors of the holding company. It has also embarked on an ambitious outreach program to explain that the goal is to allow operating subsidiaries to keep functioning, in the hope of minimizing the disruption to the world’s financial system. (Big banks are now organized with a single holding company owning and controlling a large number of operating subsidiaries.)

No taxpayer money is supposed to be put at risk in this situation. Shareholders in the holding company will be wiped out. Creditors will find their debt converted to equity, typically involving a reduction in value. This new equity forms the capital base of the continuing company – meaning its obligations are restructured so that it is again solvent (meaning the value of its assets exceeds the value of its liabilities).

Creditors to operating subsidiaries would suffer losses only if there were not enough debt at the holding-company level – in other words, after reducing all that debt to zero (converting it entirely into equity), the company’s liabilities still exceed its assets.

Together with Sheila Bair, the former chairwoman of the F.D.I.C., and other colleagues, I wrote to the Federal Reserve Board earlier this year, impressing upon them the importance of ensuring there is enough debt at the holding company – relative to potential losses at the operating subsidiary level. I was disappointed to learn on Monday that the Fed is still a considerable distance from issuing even a proposal for comments on this important issue.

In addition to Mr. Volcker, among the other heavyweights at the table were Anat R. Admati of Stanford, Richard J. Herring of Wharton, David Wright of the International Organization of Securities Commissions and several experienced practitioners.

Big banks do not typically fail individually. More often, there are herds that stampede toward a particular issue or fad: emerging-market debt (1970s and 1990s); commercial real estate (United States, 1980s); residential real estate (United States, Spain, Ireland, Britain, 2000s); sovereign debt (Europe, 2000s).

These banks finance themselves with short-term wholesale money – creating the impression that this is safe, when in fact it is incredibly precarious (think Iceland in 1998 or the exposure of American money-market funds to European banks as recently as 2011.) In any truly dangerous boom, markets and regulators become equally infatuated with this new way of doing business – until it collapses.

Can the new resolution authority handle the next big wave of potential failures, whatever it might be? Probably not, even with the greater level of cooperation announced on Monday of the F.D.I.C. and the Bank of England, with an eye to handling cross-border resolution of difficulties between the two nations, which could be immense considering how our big banks operate.

If it is built well and works properly, a good resolution framework allows a company to fail, without socializing losses and without destabilizing the financial system. As a result, it will provide a level of market discipline that should lessen the herd mentality of taking on the kind of risks that create a systemic problem – and the next big wave of failures. But the primary lesson from F.D.I.C. planning and our discussions is this: no resolution framework can correct a systemic problem once it has occurred.

The United States needs multiple fail-safes. As Professor Admati has been arguing, we should rely on equity – not debt – to absorb losses in our financial system (see this comment letter). In addition, I stand with the original intent of the Volcker Rule and with the current position of Thomas Hoenig (the current vice chairman of the F.D.I.C.): in addition to stronger resolution powers and much more equity capital, the size of the largest financial institutions should be capped and the activities they can undertake limited.

Article source: http://economix.blogs.nytimes.com/2012/12/13/volcker-spots-a-problem/?partner=rss&emc=rss

Today’s Economist: Simon Johnson: Read This Book, Win the Election

DESCRIPTION

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

With the presidential election looming and both sides looking for a knockout blow in the vice-presidential debate on Thursday evening, now is a good time for both Democrats and Republicans to look for one more defining issue. The new book by Sheila Bair, “Bull by the Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself,” offers exactly that – to whichever party is smart enough and fast enough to take up the opportunity.

Today’s Economist

Perspectives from expert contributors.

Ms. Bair lays out a compelling vision for financial-sector reform and for dealing with the continuing mess around mortgages. Neither presidential campaign is likely to endorse her ideas in all their specifics. But if a candidate signaled that he had read and understood the main messages in this book, this would have great appeal with undecided centrist votes and – importantly – with their respective bases.

Ms. Bair was chairwoman of the Federal Deposit Insurance Corporation from June 2006 to July 2011. She had a seat at the table for all the big decisions during the financial crisis of 2007-9, and she was also an important player during the financial reform negotiations of 2009-10, leading up to the Dodd-Frank financial reform legislation of 2010.

(Disclosure: I’m a member of the nongovernmental Systemic Risk Council that Ms. Bair created and leads; I was also appointed to the F.D.I.C.’s Systemic Resolution Advisory Committee while Ms. Bair was still chairwoman.)

Ms. Bair, a Republican from Kansas, worked with Bob Dole and was appointed to the F.D.I.C. by President George W. Bush. Her defining positions were against the interests of the very largest financial institutions.

And her biggest confrontations were with Treasury Secretary Timothy Geithner, the former president of the Federal Reserve Bank of New York, and, according to Ms. Bair, someone who continually favored the largest banks and their profitability in the mistaken view that this would serve the broader social interest in financial stability and sustained economic prosperity.

During the height of the financial crisis, Mr. Geithner wanted at various times to commit more taxpayer resources with fewer conditions to support very large banks, including allowing them to pay very large bonuses to executives. Ms. Bair was consistently on the side of wanting more strings attached – the point being that these financial institutions had managed themselves into great trouble. As she notes on Page 363:

An institution that is profitable is not necessarily one that is safe and sound or one that is serving the public interest. All of the large financial institutions were profitable in the years leading up to the crisis, but they were making big profits by taking big risks that ultimately exploded in their – and our – faces.

Ms. Bair’s point was not about any kind of retribution but rather that the long experience of the F.D.I.C. indicated that the best time to clean up any financial sector mess was at the moment and point of intervention. Because it has insured small depositors – the public – since the 1930s, the F.D.I.C. has developed a well-informed approach to failing banks. It works hard to ensure that depositor protection works – and it does – without imposing costs on the taxpayer.

When I worked at the International Monetary Fund during 2004-6 and 2007-8, we regarded the F.D.I.C. as carrying out best practice in the world with regard to how to handle failing banks.

In Ms. Bair’s persuasive account, the George W. Bush and Barack Obama administrations were primarily focused on protecting the large banks. Both administrations consistently ignored the relationship between the need to fix our bloated, free-wheeling financial sector and sustaining our broader economic prosperity. And both administrations paid insufficient attention to the persistent problem of mortgages.

In most financial crises, there is some form of “debt overhang” problem, meaning that the economy cannot fully get back on its feet until loans are written down, typically through some form of bankruptcy or negotiated restructuring process. Some of the most fascinating details in “Bull by the Horns” concern instances when Ms. Bair and her F.D.I.C. colleagues proposed various ways to deal with mortgages, only to be shot down or undermined by Mr. Geithner and his colleagues at Treasury (see, for example, Chapter 21).

Judging from the most recent presidential debate, the candidates are still not drawing the link from stable finance to economic prosperity, and they are offering no ideas on how to restructure mortgages.

As new cases are brought against big banks for their mortgage-lending practices, including JPMorgan Chase (for activities of Bear Stearns, which it acquired in 2008) and, this week, Wells Fargo, policy thinking increasingly must grapple with how to structure a potential “global settlement” on mortgages.

It would be good for Ms. Bair to have a seat at that table; most of the workable ideas are already articulated in her book. More broadly, her policy suggestions are simple and obvious, like putting tougher limits on the ability of large financial institutions to take risks with borrowed money, requiring those who securitize mortgages to retain risk if the mortgages later default and breaking up institutions so large and interconnected that they cannot be resolved in bankruptcy without causing wider damage to our economy.

Ms. Bair’s messages and common sense have appeal across the American political spectrum. The right wants an end to implicit government subsidies for large financial institutions. The left wants to curtail the power of global megabanks. Independents want Wall Street to have less political sway in Washington. These are all reasonable and responsible requests.

Either Mr. Romney or Mr. Obama could seize upon the themes in Ms. Bair’s book, craft these into political language and hammer home the substance in the concluding weeks of the campaign.

Or they could just quote the final paragraph of the book:

Life goes on, as Robert Frost observed. But financial abuse and misconduct don’t have to. Tell the powers in Washington that you want these problems fixed, you want them fixed now and that you will hold all incumbents accountable until the job is done.

Article source: http://economix.blogs.nytimes.com/2012/10/11/read-this-book-win-the-election/?partner=rss&emc=rss

Still Writing, Regulators Delay Rules

The Securities and Exchange Commission said on Wednesday that market participants would not have to comply with many aspects of derivatives reform scheduled to take effect in mid-July. It declined to specify how long the delay would be in the equity derivatives it oversees.

The announcement follows a similar statement on Tuesday from the Commodity Futures Trading Commission, although that agency imposed a year-end deadline for many of the changes in the derivatives it oversees.

The idea of changing the deadline had been divisive at the commodities commission. The two Republicans on the five-commissioner board had wanted to create an extension without a deadline. The Democrats, however, wanted a specific date to keep some pressure on the group to complete the rule writing, according to three participants in the meeting.

The commissioners ultimately agreed unanimously on the extension, but the dispute illustrates the political divide that has been brewing in Washington for months as regulators work to roll out hundreds of rules required by the Dodd-Frank financial reform legislation of last summer.

Though the Dodd-Frank measure was passed with bipartisan support, it has come under fierce criticism from many Republicans as well as some Democrats with financial constituents, who have urged regulators to slow the rule writing. Republicans are also trying to shave financing from agencies like the Securities and Exchange Commission and the Commodity Futures Trading Commission, which now have a larger workload in writing and enforcing scores of new rules.

Gary Gensler, the Democratic chairman of the trading commission, testified in Congress on Wednesday about the agency’s limited resources. In an interview, he pointed out that the derivatives market is seven times the size of the futures market, which his agency has long overseen.

“This agency has been asked to take on a very expanded mission,” he said. The decision this week to push back the derivatives deadline, he added, “was not about delay. It was just giving the market the certainty while we’re completing the rules.”

Regulators have missed more than two dozen deadlines for new Dodd-Frank rules, which cover a swath of topics, be it consumer protections in mortgage lending, bank responsibilities for dealing with city governments, or future resolution powers for troubled financial institutions. The legislation was the government’s main response to the financial crisis, and it is supposed to rein in Wall Street and reduce the kind of risk that led to the market implosion three years ago.

Observers say that the two delays this week make sense: with regulators so behind schedule, putting some of the rules into effect could be problematic. Still, regulatory experts warned that delays could be dangerous.

“Sounds like common sense to me,” said James J. Angel, a professor at the McDonough School of Business at Georgetown. “The regulators have this tsunami of work dumped on them, and it’s important to get it right.”

Still, he said, it is unclear whether the banks calling for a slowdown have legitimate concerns.

“You don’t know whether they’re just whining because they’re trying to get a few more pennies or if this is really Armageddon to them,” he said.

At hearings, bank officials have urged regulators to move slowly, saying that the rules will be better if created with greater care and consideration. The industry also has warned against what its officials call the “big bang” approach, under which many rules would take effect at once.

One difficulty is that many rules are related, and some rules drive others. Nowhere is this more true than in the derivatives market, where financial insurance contracts are written to protect against many different risks.

For instance, the rules to impose position limits in some commodities derivatives, like oil contracts, may depend in part on how much money financial players hold in different investments. But the commodities commission has been unable to demand all the data on these holdings — and the banks have not been volunteering — until it has written certain other rules and passed the one-year mark on the law.

The law specified that some derivatives rules would go into effect next month, no matter the status of rule writing, and those are what both financial commissions voted to delay this week.

At the commodities commission, Democrats and Republicans agreed that the July deadline for many rules was untenable because its staffers had not even finished defining terms like “swaps dealer” — an entity that buys and sells a type of derivative.

Jill Sommers, one of the Republican commissioners at the commodities regulator, said in an interview that she absolutely wants the rules to go into effect. But the commission needs to take its time, she said. “We didn’t want a date,” Ms. Sommers said. “We’re trying to makes sure we don’t miss anything. I think we need to be very deliberate.”

One of her opponents in the meeting was Bart Chilton, a Democrat. He said in an e-mail on Wednesday that he worried that having no deadline would take away much needed urgency. “We should be putting the hammer down and making up for lost time,” he wrote. “That means doing what the agency has done: given us a time certain — the end of the year — in which to complete our work.”

The commission has three Democrats, but one, Michael Dunn, has his term expiring this summer. He can stay on beyond that date, but if he chooses to leave, a successor is sure to face fierce confirmation questions in the Senate, where lawmakers are heavily divided on the new rules.

Edward Wyatt contributed reporting.

Article source: http://feeds.nytimes.com/click.phdo?i=f0fff3f46b4ebc577589462f47c21007

Economix: When Regulators Side With the Industries They Regulate

Today's Economist

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The Office of the Comptroller of the Currency is one the most important bank regulators in the United States — an independent agency within the Treasury Department that is responsible for “national banks” (for more on who regulates what in the United States, see this primer).

Over the last decade, the Office of the Comptroller of the Currency repeatedly demonstrated that it was very much on the side of banks, for example with regard to fending off attempts to impose more consumer protection. (James Kwak and I covered this in “13 Bankers,” and those details have not been disputed by the agency or anyone taking its side.)

After suffering some serious and well-deserved loss of prestige during the financial crisis of 2007-9, the comptroller’s office survived the Dodd-Frank reform legislation and is now back to pushing the same agenda as before. In its view and that of its senior staff — including key people who remain from before the crisis — the “safety and soundness” of banks requires, above all, not a lot of protection for consumers.

This is a mistaken, anachronistic and dangerous belief.

Probably the most egregious mistake made by the Office of the Comptroller of the Currency during the subprime boom was to push back against state officials who wanted to curtail malpractice in housing loans, including predatory lending.

The comptroller’s office ultimately lost that case before the Supreme Court, but its delaying action meant that an important potential brake on abuse and excess was not available — which contributed to the worst business practices that took hold in 2006 and 2007 (see this nice summary or Eliot Spitzer’s account).

Naturally, post-debacle the Office of the Comptroller of the Currency talks an ostensibly better game but, as Joe Nocera put it, “it sure looks as though the country’s top bank regulator is back to its old tricks.” In discussions regarding a potential settlement on mortgage foreclosures — and how they have been handled — the comptroller’s office has supported an outcome that is more favorable to the banks (see the Nocera column for more details).

Now it is again insisting that federal regulation pre-empts the ability of states to regulate in a way that would protect consumers.

In a letter on May 12 to Senator Thomas Carper, Democrat of Delaware, the agency asserted that its pre-emption regulations are consistent with the Dodd-Frank Act (see this interpretation by Sidley Austin, a law firm, which I draw on). There is a lot of legalese in the letter but the basic issue is simple — are states allowed to protect their consumers vis-à-vis national banks, or do they have to rely on the Office of the Comptroller of the Currency, despite its weak track record?

The comptroller’s office is clear — the states are pre-empted, meaning that national comptroller regulations will always overrule them on the issues that matter. (As a technical matter, the issue comes down to what is known as visitation: whether state-level authorities can gain access to bank documents if the bank or the comptroller’s office has not already determined that there is a problem.)

The American Bankers Association was, not surprisingly, delighted: “The O.C.C.’s action helps clarify the rules of the road for national banks and how they serve their customers.”

Richard K. Davis
, chief executive of U.S. Bancorp and then chairman of the Financial Services Roundtable, a powerful lobbying group, emphasized the importance of the pre-emption issue to national banks in March 2010, during the Dodd-Frank financial reform debate in the Senate: “If we had one thing to fight for, it would be to protect pre-emption.”

It is hard to know which would seem more incredible to a second grader: that we left in place the same agency that was responsible for a significant part of past misbehavior, or that this agency seems determined to continue with the same philosophy and policies.

The problem is not that the Office of the Comptroller of the Currency sees its primary duty as the “safety and soundness” of the financial system. Rather, the danger to the public arises because it has consistently taken the view that the best way to protect banks — and keep them out of financial trouble — is to allow them to be harsh with consumers.

This is worse than short-sighted — it completely ignores all externalities, such as how business practices and ethics evolve, and it pays no attention to even the most basic macroeconomic dynamics, such as the fact that we have a credit cycle during which we should expect lenders to “race to the bottom” in terms of standards.

The Office of the Comptroller of the Currency should have been abolished by Dodd-Frank. Unfortunately, it is too late for Congress to revisit this issue. President Obama should at the very least nominate a new head of the Office of the Comptroller of the Currency — the job has been open since August of last year — and a serious reformer could make a great deal of difference.

Under its current leadership and with its current approach, the Office of the Comptroller of the Currency is putting our financial system into harm’s way. The lessons of 2007-9 have been completely lost on it. As Talleyrand said of the Bourbons, “They have learned nothing and forgotten nothing.”

Article source: http://feeds.nytimes.com/click.phdo?i=63ce5295d71fcdae7b30ca2e7d8b8e40