March 21, 2008
The Fed sets its sights on regulating investment banks
Things happen very rapidly in a crisis. A week or two ago, the Federal Reserve was still hesitant about providing back-up finance for investment banks on the same terms as the banks it regulates.
Now, the Fed has not only extended back-up financing to Wall Street primary dealers following the Bear Stearns collapse, but has its sights set on taking over their regulation from the Securities and Exchange Commission.
It makes sense for the regulatory division that mirrored the Glass-Steagall Act separation of banks and brokers to break down now that banks and investment banks compete directly with each other.
But you could have made that argument endlessly on Capitol Hill without anything shifting until very recently, given the entrenched interests of the various financial regulators, from the Fed to the SEC and the Comptroller of the Currency. Regulators protect their turf zealously until force majeure intervenes.
The credit crisis is that force majeure. The Fed clearly does not see any way to return investment banks to their former status outside the discount window when this crisis winds down. But it will want to gain regulatory oversight of the Wall Street firms’ holding companies in return for access to Fed financing.
The Wall Street broker-dealers are likely to accept Fed regulation in return for not going the way of Bear Stearns in any future crisis. And senior politicians such as Barney Frank will probably treat a shift to Fed regulation as a tightening of regulation, which is what they want. This FT article lays out the mood in Washington.
How fiercely will the SEC try to resist, I wonder? If primary oversight of the big investment banks really does pass to the Fed, it will diminish the status and powers of the SEC markedly. I imagine the SEC still has some fight left in it. We shall see how much in the next few months.
This is a bit off-topic, Mr Gapper, but as you write about finance and media for the FT I am sure you will enjoy Peer Steinbrück, the German Finanzminister, rapping “I love cash”. In his intro he gives himself a pat on the back, with details of how he reduced the German budget deficit to zero and that from now on there will be surpluses!
Posted by: fh | March 21st, 2008 at 3:04 pm | Report this commenthttp://i-love-cash.de
It is most important to realize that America’s Federal Reserve is not part of Government, but a private cartel. For our Govt to abdicate responsbility, by transfering oversight control from the Securities and Exchange Commission (part of Govt and expressly formed to combat Wall Street irresponsibility) would be terrible.
Posted by: H Canu | March 21st, 2008 at 5:00 pm | Report this commentI agree with H Canu. The Federal Reserve has far too much control over the U.S. economy. Prosperity or depression the FED has its hand in it.
Posted by: J Kloster | March 21st, 2008 at 5:29 pm | Report this commentThe SEC is not the place for this sort of regulation. This agency has a difficult enough time monitoring stock transactions. Neither is the Comptroller of the Currency, an incredibly stodgy place staffed with old-fashioned, risk-adverse green-eyeshade auditors. There’s no reason Congress couldn’t set up an agency inside Treasury to oversee this industry, probably with a light hand.
Posted by: edward allen | March 22nd, 2008 at 1:58 am | Report this commentInterestingly, Citgroup’s Robert Rubin, the former Treasury Secretary in the Clinton administration, is a major player in writing the new laws because he has the respect both of the investment community and is trusted by Democrats on Capitol Hill. (See his PBS News Hour interview Friday). Treasury Secty. Paulson has handled this crisis very astutely and is just as knowledgeable as Rubin, but unfortunately he is part of a Bush administration that has no political currency left to spend with Democrats. (That’s why I think Rubin has reappeared in Washington.).
In the end, I expect a lot of brave talk, but nothing draconian in regulation. What the last few weeks have shown, imo, is that this government hasn’t got the foggiest idea what these investment banks are doing with derivatives and other exotics, and at a minimum is going to require a lot more disclosure so the Fed won’t be playing catch-up the next time. I also expect Congress will move very quickly setting up this new regime in record time, perhaps by May, largely to say it is trying to restore confidence and show unsettled voters they can do something. All House members are standing in November, and as they say there’s nothing that concentrates the mind than the prospect of execution.
Banking regulation has lagged behind the evolution of banking. The transition from ‘originate to own’ to ‘originate to distribute’ changed the relationship between debtor, creditor, asset valuation and investor.Credit is no longer the sole domain of the bank. The shadow banking system, made infamous by Gross and Maculley of PIMCO, skirted regulations by raising capital in the Aset Backed CP market, funneling money off balance sheet to SIVs who put the funds to use in the derivatives market. Levered Asset Liability mismatches will always be slave to the money markets. When funding dries up we get either a bankruptcy, buyout or bailout.This is no way to run the worlds largest economy. We need regulation that puts integrity and transparancy back in the credit creation and securitization process. We either need fully independent ratings companies or we need to toss them aside as conflicted parties to any transaction. I agree the regulator should be an agency other than the Fed.But it must be populated with seasoned wall street types and quants who can disect a derivative and spot a sows ear even when disguised as a silk purse.Rest assured the street will come up with another variation of the current derivatives. A product that masks the risks of A/L and credit quality mismatches run by expert managers backed by bell curve models that would make John Merriwether proud.Taxpayers and working Joes deserve regulators who will say” Sounds good BUT I’ve seen this somewhere before and it didn’t turn out well.”
Posted by: gym-bob | March 22nd, 2008 at 3:32 am | Report this commentCommercial risk one expects in business, but moral risk (doing business with people who do not stop at misrepresentation or even fraud) is the big danger from now on. Hustlers or sherrifs? Fraud or negligence? Don’t the terms “structured products”, MBO, CDO, ABS, SIV etc. sound a bit too arcane and arouse suspicion?
The Chief Economist at BNP Paribas (Philippe d’Arvisenet, who is also a Prof. of Economics) gave an example in an interview with the Swiss French-Language weekly “L’Hebo” www.hebdo.ch
Posted by: fh | March 22nd, 2008 at 10:44 am | Report this commentSecuritization enables risk to be spread, he says, but this has been done with too little transparence, and he explains that CDOs (Collateralized Debt Obligations) are much more complicated than “Obligations” which is the word meaning “bonds” in both French AND German.
D’Arvisenet continued “When CDOs are rated with a triple AAA, that means that such tranches of CDOs are the ones that are FIRST in line to take the hit from any losses”. In other words, a CDO with an AAA rating is the most risky!!! D’Arvisenet thinks that “some buyers of these products did not understand this and believed the risk present in a CD OBLIGATION rated AAA by a US-rating agency (?) to be in the same category as the risk present in an “Obligation” rated AAA (which in Europe is regarded as super-safe).
1) Presumably this is an example of what “transparence” and lack of the same is all about?
2) And how can one legislate against descriptions which may or may not be misinterpreted because the buyer has or has not
asked sufficient questions and/or the seller has only given incomplete answers?
Wasn’t the Glass-Steagel Act drafted as a direct result of the Great Depression? Isn’t there a direct line between the current crisis and the repeal of this Act? Wasn’t the intention of this act a direct attempt to establish accountability in the Banking industry and to eliminate fundamental conflicts of interest between retail, investment and broking activities?
I have never understood why this Act was repealed, but I am now lead to believe that it stood in the way of the narrow interests of Citigroup/Travellers mega-merger.
Some background and analysis of this topic in relation to the calls for greater regulation of the markets would make interesting reading.
Posted by: Jim | March 23rd, 2008 at 11:47 am | Report this commentAs we enter, unfortunately, an era of ever greater welfare-statism, we must resist both federal bail-outs AND increased regulation. Banks must be held accountable for their bad investments–and they must be free to fail. By the same token, they should be able to reap the rewards of their good investments–and for this they must be free to succeed. Federal Reserve and fiscal policies are what have created the mess we’re in. More cancer does not cure cancer; likewise, more government will not solve a government-created crisis.
Posted by: Ryan | March 23rd, 2008 at 4:06 pm | Report this commentCapitalism is a Darwinistic competition of “Smart Evolution” The ideas of Schumpeter and Kondrateiff ring true. Entrepreneurs have always done the heavy lifting as agents of change.Change comes in powerful waves that can render obsolete that which was cutting edge a decade earlier.But even the rawest and most brutal competition requires rules or it soon degenerates into anarchy. Rules govern Keynes “animal spirits” so that human traits like greed and lost integrety don’t damage the greater good. No system in nature functions without rules.Capitalism is an evolving ecosystem.Humans can certainly damage the homeostatic condition of the economy as we have seen with poorly regulated lending and securitization. We need to play by the rules and punish the rule breakers.The most fit will adapt and live on.The failures will wither and die.Competition does not require the chaos of anarchy to be pure.Bear Srearns, Countrywide and MBIA to name a few,are symptoms of an ecosystem in trouble.Cheap money and the “fed put” introduce poison to the economic environment.Worse yet these practices risk altering evolutionary paths from those that ensure survival of the fittest to those that reward the politically connected and financially gifted.Lord knows they are rarely one in the same.We live in a nation where false wealth has been created through obsene leverage and voyeur markets where derivatives dwarf the real economy.The ecosystem is sick and needs to be cleaned up.Its time for the regulations to catch up with the contamination while the ecosystem can still sustain itself.
Posted by: gym-bob | March 23rd, 2008 at 5:32 pm | Report this comment