The latest FinReg incarnation gets a couple of things right, notably pushing some derivatives trading to clearinghouses and exchanges, requiring collateral to support derivatives trading, and creating a mechanism to facilitate wind-down of systemically important yet failing institutions. Sadly, however, the bill otherwise seems to deliver the worst of both worlds. It doesn’t address the fundamental causes of the 2008 subprime mortgage crisis, and it complicates an already complex regulatory structure. To wit:
- The restriction on proprietary trading is sufficiently loose that it will likely have no impact on the major banks, either because their prop trading – as defined in the new law – is less than the 3% threshold or because the banks will probably be able to set up offshore subsidiaries to do the trading within their bank holding company structure. It also seems that prop trading is defined in a way that it doesn’t include the massive off-balance-sheet derivatives trading being done by the banks. Chalk up a victory for the lobbyists.
- The limitations on the reach of the derivatives trading ban is so wide that most of the total derivatives exposure is exempted, especially interest rate and foreign currency swaps which comprise 92% of the $216.5 trillion in off-balance-sheet derivatives exposure held by U.S. banks. The legislation implies that these derivative exposures are not risky, which is absurd. Chalk up another victory for the lobbyists.
- Banks will still be allowed to choose ratings agencies, whose ratings – thanks to the reality of incentives – will inevitably continue be a factor in the banks’ selection of ratings agencies. Chalk up another victory for the lobbyists.
- The law does nothing to address the flawed nature of the government’s sponsorship of Fannie Mae and Freddie Mac, the largest players in the home mortgage market. The government’s sponsorship allows risk to be transferred from Fannie and Freddie shareholders to the U.S. taxpayer, thus implicitly encouraging those entities to take risks.
- The bill will create an $850 million Consumer Protection Agency. I know billion $ legislation seems so yesterday when our government now routinely passes trillion $ legislation. However, $850 million per year is a lot of dough. And for what purpose? I continue to struggle with how consumers were victims of the subprime mortgage crisis. In fact, it seems that most of the lower-credit borrowers made smart personal decisions when they saw a good deal: no money down to live in a house that they might not have otherwise afforded.
- The bill won’t dilute the Fed’s unconstitutional reach in any way and in fact gives it more authority. The easy money policies of the Fed are important drivers of our big bubbles over the last twenty years. The Fed has already failed miserably in its regulatory authority over banks. So why give it more authority?
- The bill won’t simplify the already complex regulatory structure in place for the financial services industry. Why not consolidate them into a single regulatory authority with a clear mission? Chalk up another victory for the lobbyists, this time the lobbyists of the regulatory agencies!
- The bill will create a new risk monitoring council comprising multiple agencies such as the Fed, the SEC, etc. Please! Why would a new layer of bureaucracy make an already jumbled regulatory structure better? And since the bill still leaves many of the regulations to be determined by these agencies in the future, the lobbyists will have plenty more influence still to come.
To protect against another crisis, Uncle Sam needs to make it clear that he will not bail out the banks in future crises (thus discouraging excessive risk taking) or Uncle Sam needs to restrict the banks from the excessive risk taking. This new legislation doesn’t do either very well.
The banks are clear near-term winners of the latest rounds of negotiations for FinReg. And unfortunately the rest of us lose. We can expect continued excessive risk-taking by the financial sector due to moral hazards of crony capitalism, regulators bought and paid for by the banks themselves. This legislation has done little to prevent the next banking crisis and in fact probably makes it more inevitable. While the bill does protect taxpayers from being called upon to bail out a large failed bank, the Fed still has extraordinary money printing powers to mop up such crises. In the end, we are only assured of more of the same: money printing, crony capitalism, and regulatory incompetence, the same issues that created the mess in the first place.
Posted June 28, 2010 by Dan H. under Financial Sector Bust, Uncategorized
June 28th, 2010 at 12:41 pm
Nicely written, useful and thought provoking.
June 28th, 2010 at 10:55 pm
The regulation’s weaknesses, nicely articulated in your review, are significant. The absence of meaningful reform of derivative trading is disheartening and makes the prospect of an interconnected, global financial system freeze-up or worse, collapse, all the more likely. Asset deflation and economic contraction accompanied by currency debasement continues to be most likely path.