TheCenterLane.com

© 2008 – 2024 John T. Burke, Jr.

The Window Of Opportunity Is Closing

Comments Off on The Window Of Opportunity Is Closing

September 17, 2009

In my last posting, I predicted that President Obama’s speech on financial reform would be “fine-sounding, yet empty”.  As it turned out, many commentators have described the speech as just that.  There weren’t many particulars discussed at all.  As Caroline Baum reported for Bloomberg News:

At times he sounded more like a parent scolding a disobedient child than a president proposing a new regulatory framework.

“We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis,” Obama said in a speech at Federal Hall in New York City.  (“You will not stay out until 2 a.m. again.”)

*   *   *

Obama warned “those on Wall Street” against taking “risks without regard for consequences,” expecting the American taxpayer to foot the bill.  But his words rang hollow.

*   *   *

But you can’t, with words alone, alter the perception — now more entrenched than ever — that the government won’t allow large institutions to fail.

How do you convince bankers they will pay for their risk-taking when they’ve watched the government prop up banks, investment banks, insurance companies, auto companies and housing finance agencies?

They learn by example.  The system of privatized profits and socialized losses has suited them fine until now.

Although the President had originally voiced support for expanding the authority of the Federal Reserve to include the role of “systemic risk regulator”, Ms. Baum noted that Allan Meltzer, professor of political economy at Carnegie Mellon University, believes that Mr. Obama has backed away from that ill-conceived notion:

“The Senate Banking Committee doesn’t want to give the Fed more power,” Meltzer said.   “I’ve never seen such unanimity, and I’ve been testifying before the committee since 1962.”

Ms. Baum took that criticism a step further with her observation that the mission undertaken by any systemic risk regulator would not likely fare well:

Bankers Outfox Regulators

It is fantasy to believe a new, bigger, better regulator will ferret out problems before they grow to system-sinking size.  Those being regulated are always one-step ahead of the regulator, finding new cracks or loopholes in the regulatory fabric to exploit.  When the Basel II accord imposed higher risk- based capital requirements on international banks, banks moved assets off the balance sheet.

What’s more, regulators tend to identify with those they regulate, a phenomenon known as “regulatory capture,” making it highly unlikely that a new regulator would succeed where previous ones have failed.

At this point in the economic crisis, with Federal Reserve chairman Ben Bernanke’s recent declaration that the recession is “very likely over”, there is concern that President Obama’s incipient attempt at enacting financial reform may already be too late.  A number of commentators have elaborated on this theme.  At Credit Writedowns, Edward Harrison made this observation:

If you are looking for reform in the financial sector, the moment has passed.  And only to the degree that the underlying weaknesses in the global financial system are made manifest and threaten the economy will we see any appetite for reform amongst politicians.  So, as I see it, the Obama administration has missed the opportunity for reform.

More important, the following point by Mr. Harrison has been expressed in several recent essays:

Irrespective, I believe the need for reform is clear.  Those gloom & doom economists were right because the economic model which brought us to the brink of disaster in 2008 is the same one we have at present and that necessarily means another crisis will come.

At MSN’s MoneyCentral, Michael Brush shared that same fear in a piece entitled, “Why a meltdown could happen again”:

Some observers say it’s OK that a year has gone by without reform; we don’t want to get it wrong.  But the political reality is that as the urgency passes, it’s harder to pass reforms.

“We have lulled ourselves into the mind-set that we are out of the woods, when we aren’t,” says Cornelius Hurley, the director of the Morin Center for Banking and Financial Law at Boston University School of Law.  “I don’t think time is our friend here. We risk losing the sense of urgency so that nothing happens.”

*   *   *

Douglas Elliott, a former JPMorgan investment banker now with the Brookings Institution, thinks the unofficial deadline for financial-sector reform is now October 2010 — right before the next congressional elections.

That leaves lawmakers a full year to get the job done.

But given all the details they have to work out — and the declining sense of urgency as stocks keep ticking higher — you have to wonder how much progress they’ll make.

On the other hand, back at Credit Writedowns, Edward Harrison voiced skepticism that such a deadline would be met:

You are kidding yourself if you think real reform is coming to the financial sector before the mid-term elections, especially with healthcare, two wars and the need to ensure recovery still on politicians’ plates. Obama could go for real reform in 2011 — or in a second term in 2013.  But, unless economic crisis is at our door, there isn’t a convincing argument which says reform is necessary.

At The Washington Post, Brady Dennis discussed the Pecora Commission of the early 1930s, which investigated the causes of the Great Depression, and ultimately provided a basis for reforms of Wall Street and the banking industry.  Mr. Dennis pointed out how the success of the Pecora Commission was rooted in the fact that populist outrage provided the fuel to help mobilize reform efforts, and he contrasted that situation with where we are now:

“Pecora’s success was his ability to crystallize the anger that a lot of Americans were feeling toward Wall Street,” said Michael Perino, a law professor at St. John’s University and author of an upcoming book about the hearings. “He was able to create a clamor for reform.”

But Pecora also realized that such clamor was fleeting

*   *   *

“We’ve passed the moment when there’s this palpable anger directed at the financial community,” Perino said of the current crisis.  “When you leave the immediate vicinity of the crisis, as you get farther and farther away in time, the urgency fades.”

Unfortunately, we appear to be at a point where it is too late to develop regulations against many of the excesses that led to last year’s financial crisis.  Beyond that, many people who allowed the breakdown to occur (Bernanke, Geithner, et al.) are still in charge and the players who gamed the system with complex financial instruments are back at it again, with new derivatives — even some based on life insurance policies.  Perhaps another harbinger of doom can be seen in this recent Bloomberg article:  “Credit Swaps Lose Crisis Stigma as Confidence Returns”.  Nevertheless, from our current perspective, some of us don’t have that much confidence in our financial system or our leadership.



wordpress visitor


The Longest Year

Comments Off on The Longest Year

September 14, 2009

As I write this, President Obama is preparing another fine-sounding, yet empty speech.  His subject this time is financial reform.  You may recall last week’s lofty address to the joint session of Congress, promoting his latest, somewhat-less-nebulous approach to healthcare reform.  He assured the audience that the so-called “public option” (wherein a government-created entity competes with private sector healthcare insurers) would be an integral part of the plan.  Within a week, two pieces of political toast from the Democratic Party (Nancy Pelosi and Harry Reid) set about undermining that aspect of the healthcare reform agenda.  This is just one reason why, on November 2, 2010, the people who elected Democrats in 2006 and 2008 will be taking a “voters’ holiday”, paving the way for Republican majorities in the Senate and House.  The moral lapse involving the public option was documented by David Sirota for Danny Schechter’s NewsDissector blog:

House Speaker Nancy Pelosi for the first time yesterday suggested she may be backing off her support of the public option – the government-run health plan that the private insurance industry is desperately trying to kill.  According to CNN, Pelosi and Senate Majority Leader Harry Reid “said they would support any provision that increases competition and accessibility for health insurance – whether or not it is the public option favored by most Democrats.”

This announcement came just hours before Steve Elmendorf, a registered UnitedHealth lobbyist and the head of UnitedHealth’s lobbying firm Elmendorf Strategies, blasted this email invitation throughout Washington, D.C. I just happened to get my hands on a copy of the invitation from a source – check it out:

From: Steve Elmendorf [mailto:steve@elmendorfstrategies.com]
Sent: Friday, September 11, 2009 8:31 AM
Subject: event with Speaker Pelosi at my home
You are cordially invited to a reception with

Speaker of the House
Nancy Pelosi

Thursday, September 24, 2009
6:30pm ~ 8:00pm

At the home of
Steve Elmendorf
2301 Connecticut Avenue, NW
Apt. 7B
Washington, D.C.

$5,000 PAC
$2,400 Individual

Again, Elmendorf is a registered lobbyist for UnitedHealth, and his firm’s website brags about its work for UnitedHealth on its website.

The sequencing here is important: Pelosi makes her announcement and then just hours later, the fundraising invitation goes out. Coincidental?  I’m guessing no – these things rarely ever are.

I wrote a book a few years ago called Hostile Takeover whose premise was that corruption and legalized bribery has become so widespread that nobody in Washington even tries to hide it. This is about as good an example of that truism as I’ve ever seen.

Whatever President Obama proposes to accomplish in terms of financial reform will surely be met with a similar fate.  Worse yet, his appointment of “Turbo” Tim Geithner as Treasury Secretary and his nomination of Ben Bernanke to a second term as Federal Reserve chairman are the best signals of the President’s true intention:  Preservation of the status quo, regardless of the cost to the taxpayers.

On this first anniversary of the demise of Lehman Brothers and the acknowledgment of the financial crisis, many commentators have noted the keen observations by Simon Johnson, a former chief economist at the International Monetary Fund, published in the May, 2009 issue of The Atlantic.  The theme of Johnson’s article, “The Quiet Coup” was that the current economic and financial crisis in the United States is “shockingly reminiscent” of those experienced in emerging markets (i.e. banana republics and proto-capitalist regimes).  The devil behind all the details in setting these systems upright after a financial crisis is the age-old concept of moral hazard or more simply:  sleaze.  In making the comparison of the United States to the emerging market countries he encountered at the IMF, Mr. Johnson began this way:

But there’s a deeper and more disturbing similarity:  elite business interests — financiers, in the case of the U.S. — played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.  More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive.  The government seems helpless, or unwilling, to act against them.

Here are a few more passages from “The Quiet Coup” that our political leaders would be well-advised to consider:

Even leaving aside fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason:  it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change.  As an unnamed senior bank official said to The New York Times last fall, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.”  But there’s the rub:  the economy can’t recover until the banks are healthy and willing to lend.

*   *   *

The second problem the U.S. faces—the power of the oligarchy— is just as important as the immediate crisis of lending.  And the advice from the IMF on this front would again be simple:  break the oligarchy.

Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business.  Where this proves impractical—since we’ll want to sell the banks quickly— they could be sold whole, but with the requirement of being broken up within a short time.  Banks that remain in private hands should also be subject to size limitations.

Mr. Johnson pointed out the need to overhaul our current antitrust laws – not because any single institution controls so much market share as to influence prices – but because the failure of any one “to big to fail” bank could collapse the entire financial system.

One of my favorite reporters at The New York Times, Gretchen Morgenson, observed the anniversary of the Lehman Brothers failure with an essay that focused, in large part, on a recent paper by Edward Kane, a finance professor at Boston College, who created the expression: “zombie bank” in 1987.   This month, the Networks Financial Institute at Indiana State University published a policy brief by Dr. Kane on the subject of financial regulation.  In her article:  “But Who Is Watching Regulators?”, Ms. Morgenson summed up Professor Kane’s paper in the following way:

This ugly financial episode we’ve all had to live through makes clear, Mr. Kane says, that taxpayers must protect themselves against two things:  the corrupting influence of bureaucratic self-interest among regulators and the political clout wielded by the large institutions they are supposed to police. Finally, he argues, taxpayers must demand that the government publicize the costs of efforts taken to save the financial system from itself.

Although you may have seen widely-publicized news reports about an “overwhelming number” of academicians opposing the current efforts to require transparency from the Federal Reserve, Professor Kane provides a strong argument in favor of Fed transparency as well as scrutiny of the Treasury and the other government entities enmeshed the complex system of bailouts created within the past year.

At thirty-eight pages, his paper is quite a deep read.  Nevertheless, it’s packed with great criticism of the Federal Reserve and the Treasury.  We need more of this and when someone of Professor Kane’s stature provides it, there had better be people in high places taking it very seriously.  The following are just a few of the many astute observations made by Dr. Kane:

Agency elitism would be evidenced by the extent to which its leaders use crises to establish interpretations and precedents that cover up its mistakes, inflate its powers, expand its discretion, and extend its jurisdiction. According to this standard, Fed efforts to use the crisis as a platform for self-congratulation and for securing enlarged systemic-risk authority sidetracks rather than promotes effective reform.

*   *   *

A financial institution’s incentive to disobey, circumvent or lobby against a particular rule increases with the opportunity cost of compliance. This means that, to sort out the welfare consequences of any regulatory program, we must assess not only the costs and benefits of compliance, but include the costs and benefits of circumvention as well.

*   *   *

Realistically, every government-managed program of disaster relief is a strongly lobbied and nontransparent tax-transfer scheme for redistributing wealth and shifting risk away from the disaster’s immediate victims.  A financial crisis externalizes – in margin and other collateral calls, in depositor runs, and in bank and borrower pleas for government assistance – a political and economic struggle over when and how losses accumulated in corporate balance sheets and in the portfolios of insolvent financial institutions are to be unwound and reallocated across society.  At the same time, insolvent firms and government rescuers share a common interest in mischaracterizing the size and nature of the redistribution so as to minimize taxpayer unrest.

In principle, lenders and investors that voluntarily assume real and financial risks should reap the gains and bear the losses their risk exposures generate.  However, in crises, losers pressure government officials to rescue them and to induce other parties to share their pain.

The advocates of crony capitalism and their tools (our politicians and regulatory bureaucrats) need to know that we are on to them.  If the current administration is willing to facilitate more of the same, then it’s time for some new candidates to step forward.




The Forgotten Urgency Of Financial Reform

Comments Off on The Forgotten Urgency Of Financial Reform

September 10, 2009

With all the fighting over healthcare reform and the many exciting controversies envisioned by its opponents, such as:  death panels, state-sponsored abortions and illegal aliens’ coming to America for free breast implants, the formerly-urgent need for financial reform his slipped away from public concern.  Alan Blinder recently wrote a piece for The New York Times, lamenting how the subject of financial reform has disappeared from the Congressional radar:

After all we’ve been through, and with so much anger still directed at financial miscreants, the political indifference toward financial reform is somewhere between maddening and tragic.  Why is the pulse of reform so faint?

Blinder then discussed five reasons why.  My favorite concerned lobbying:

Almost everything becomes lobbied to death in Washington.  In the case of financial reform, the money at stake is mind-boggling, and one financial industry after another will go to the mat to fight any provision that might hurt it.

Mr. Blinder expressed concern that these three important changes would be left out of any financial reform legislation:  a) resolving the problem of having financial institutions that are “too big to fail”, b) cleaning up the derivatives mess and c) creating a “systemic risk regulator”.   (All right — I rearranged the order.)

In case you’re wondering just what the hell a “systemic risk regulator” is, Blinder provided the readers with a link to one of his earlier articles, which said this:

The main task of a systemic-risk regulator is to serve as an early-warning-and-prevention system, on the prowl for looming risks that extend across traditional boundaries and are becoming large enough to have systemic consequences.

*   *   *

Suppose such a regulator had been in place in 2005.  Because the market for residential mortgages and the mountain of securities built on them constituted the largest financial market in the world, that regulator probably would have kept a watchful eye on it.  If so, it would have seen what the banking agencies apparently missed:  lots of dodgy mortgages being granted by nonbank lenders with no federal supervision.

If the regulator saw those mortgages, it might then have looked into the securities being built on them.  That investigation might have turned up the questionable triple-A ratings being showered on these securities, and it certainly should have uncovered the huge risk concentrations both on and off of banks’ balance sheets.  And, unless it was totally incompetent, the regulator would have been alarmed to learn that a single company, American International Group, stood behind an inordinate share of all the credit-default swaps — essentially insurance policies against default — that had been issued.

Blinder shares the view, expressed by Treasury Secretary “Turbo” Tim Geithner, that the Federal Reserve should serve as systemic risk regulator, because “there is no other alternative”.  Unfortunately, President Obama is also in favor of such an approach.  The drawback to empowering the Fed with such additional responsibility was acknowledged by Mr. Blinder:

On the other hand, some members of Congress are grumbling that the Fed has already overreached, usurping Congressional authority.  Others contend that it has performed so poorly as a regulator that it hardly deserves more power.

Federal Reserve Chairman Ben Bernanke discussed this issue himself back on March 5, in a speech entitled:  “Financial Reform to Address Systemic Risk”.  Near the end of this speech, Bernanke discussed the subject objectively, although he concluded with a pitch to get this authority for his own realm:

Some commentators have proposed that the Federal Reserve take on the role of systemic risk authority; others have expressed concern that adding this responsibility would overburden the central bank.  The extent to which this new responsibility might be a good match for the Federal Reserve depends a great deal on precisely how the Congress defines the role and responsibilities of the authority, as well as on how the necessary resources and expertise complement those employed by the Federal Reserve in the pursuit of its long-established core missions.

It seems to me that we should keep our minds open on these questions.  We have been discussing them a good deal within the Federal Reserve System, and their importance warrants careful consideration by legislators and other policymakers. As a practical matter, however, effectively identifying and addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role.     .  .   .   The Federal Reserve plays such a key role in part because it serves as liquidity provider of last resort, a power that has proved critical in financial crises throughout history.  In addition, the Federal Reserve has broad expertise derived from its wide range of activities, including its role as umbrella supervisor for bank and financial holding companies and its active monitoring of capital markets in support of its monetary policy and financial stability objectives.

This rationale leads me to suspect that Mr. Bernanke might be planning to use his super powers as: “liquidity provider of last resort” to money-print away any systemic risks that might arise on his watch in such a capacity.  This is reminiscent of how comedian Steve Smith always suggests the use of duct tape to solve just about any problem that might arise in life.

In the September 8 edition of The Wall Street Journal, Peter Wallison wrote an article entitled:  “The Fed Can’t Monitor ‘Systemic Risk’”.   More important was the subtitle:  That’s like asking a thief to police himself.  Wallison begins with the point that President Obama’s inclusion of granting such powers to the Fed as the centerpiece of his financial regulatory reform agenda “is a serious error.”  Wallison seemed to share my concern about Bernanke’s “duct tape” panacea:

The problem is the Fed itself can create systemic risk.  Many scholars, for example, have argued that by keeping interest rates too low for too long the Fed created the housing bubble that gave us the current mortgage meltdown, financial crisis and recession.

Vesting such authority in the Fed creates an inherent conflict of interest.  Mr. Wallison explained this quite well:

Tasking the Fed with that responsibility would bury it among many other inconsistent roles and give the agency incentives to ignore warning signals that an independent body would be likely to spot.

Unlike balancing its current competing assignments — price stability and promoting full employment — detecting systemic risk would require the Fed to see the subtle flaws in its own policies.  Errors that are small at first could grow into major problems.  It is simply too much to expect any human institution to step outside of itself and see the error of its ways when it can plausibly ignore those errors in the short run.  If we are going to have a systemic-risk monitor, it should be an independent council of regulators.

When the dust finally settles on the healthcare reform debate, perhaps Congress can approach the subject of financial reform  . .  .  if it’s not too late by that point.



wordpress visitor