Cutting turf: Part 1, the driver
Turning slabs of excreta into regulatory fuel
In any new or emerging sector, business innovation always outpaces regulation – experimenting with giddy speed and venturing into that free libertarian space which sounds idyllic until the snakes of corruption slither in. Decadence and wild excess ensue, which is fun when it lasts, and then the world gets the mother of all risk hangovers. This financial catastrophe is the precondition to fundamental financial and regulatory reform, at which point enters the architect of new regulation – in this case, Treasury Secretary Tim Geithner, who’s been the Administration’s chief designer of a macro-level regulatory structure.
It is a job both thankless and pressure-packed, leading to the frustration recently chronicled in the Wall Street Journal:
WASHINGTON — Treasury Secretary Timothy Geithner blasted top U.S. financial regulators in an expletive-laced critique last Friday as frustration grows over the Obama administration’s faltering plan to overhaul U.S. financial regulation, according to people familiar with the meeting.
‘Expletive-laced’ is a phrase few would associate with our mild-mannered Treasury Secretary. What could so fray his nerves?
Read my Anglo-Saxon, polysyllabic lips
While it may seem trivial gossip, I suspect that underlying it is a much deeper structural concern – namely, that creation of a newer holistic and coherent financial regulatory architecture is in jeopardy, not from its enemies, but from the inevitability effect on its friends.
Mantra for a reformer: beware the inevitability effect
As Dwight Eisenhower said, If a problem cannot be solved, enlarge it. Every time business expands its reach, regulation must follow. Now capital is at least national if not global, money is stored in computers not vaults, and what constitutes a financial institution has morphed beyond the capacity of post-Glass-Steagall regulators even to envision.
“Do I really have to sign this?”
President Roosevelt flanked by Glass and Steagall
In a post-physical banking world, it makes no sense whatsoever for financial entity regulation to be narrow-limited either in geography or in ecosystemic niche. Instead we must create the Bank of Glass, which I prophesied last summer:
Transparent scalable granularity
What is it and why do I want it?
Market investors want three things:
1. Transparency. If opacity leads to fragile balance sheets, then transparency creates strength. Tomorrow, the price of doing business will be an open-book acceptance that investors have the right to look anywhere they want, any time they want, and ask any question they want about the holdings.
People who bank in glass houses, know what their positions are
2. Granularity. What got Wall Street and its customers into the self-reinforcing-writedown cycle was aggregation, slicing, and the resulting loss of information.
Information is granular, in Wall Street parlance, when there is a clear and complete chain of numbers from the smallest bit of data to the largest aggregation – when, that is, aggregating entails no loss of information. This implies a ‘custody chain’ whereby all information gathered at one end of a financial structuring chain (the capital consumer) is fully accessible at the other end of the chain, the capital provider or long-term asset holder.
3. Scalability. Capital providers and capital markets demand scale, which demands standardization and consolidation.
If you want a metaphor for post-Bear reporting, imagine Google Earth.
Everything from here is just detail
Life in a glass bank
However this market chaos shakes out, when it stabilizes, there will not only be new and stricter rules from regulators, reporting requirements will render the data-opaque brick bank a thing of the past. Only via full transparency will those who want to grow their portfolios or businesses be able to regain the trust – and the money – of the capital markets.
To tap capital, we will all have to live in financial glass houses, where everything we own, everything we do, is on display all the time.
Over-arching regulation unifying all financial institutions and all financial products whether direct or derivative will require a grand unified theory of banking, observed by all banking regulators overseeing all financial institutions.
Wouldn’t it be nice if banking regulators were treed together?
This problem would be hard enough if starting from a clean slate; it is made harder for regulation because every initial regulatory framework is at best a patchwork quilt. At worst it’s a realm of feuding fiefdoms, where each established regulator enjoys its local sovereignty and zealously guards its prerogatives. Each regulator’s turf-protectiveness works against the larger goal.
You really think I’m interested in dissolving my autonomy?
Just as the Articles of Confederation proved unworkable when the newly independent nation was faced with an interstate challenge (Shay’s Rebellion), the absurdly Balkanized US financial regulatory structure was completely exploited by a dizzying pace of derivatives piled upon securities and pureed through tranches.
And in the end, who knows what it was?
The United States has a patchwork quilt of regulatory bodies, dating back to the Jeffersonian phobia of capital, and means, as I wrote nearly a year ago, that the emerging new regulatory framework must be larger and more expansive:
This story – that Congress drove us into excessive lending – is gaining wide circulation among the financial sector’s libertarian and conservative fraternities. I think it completely reverses causality – the banks betook themselves into the space in pursuit of quick profits – but its dismantling would take us away from the theme of this post.
While it will be painful, the present crisis will at least provide another opportunity to give this country, finally, a unified banking system of large, diversified, well-capitalized banking institutions that are under the control of a unified and coherent regulatory system free of undue political influence.
The inadequate and multiply-provincial regulatory system we now have must be superseded by an integrated new framework, which requires a principal designer, for which position Secretary Geithner has already been chosen:
The proposed regulatory revamp is one of President Barack Obama’s top domestic priorities. But since it was unveiled in June, the plan has been criticized by the financial-services industry, as well as by financial regulators wary of encroachment on their turf.
It would take too much time (for me to figure out and for you to read) to dissect the particulars of each proposal, many of which will change anyhow before they are implemented.
No point in dissecting it if it’s dead on arrival?
Instead, keep your eye on the macro principles, which are these:
1. Everyone is a bank. By any other name – even a Wal-Mart ATM in a grocery store – if it takes deposit-like inflows and provides credit-like outflows, then it is a bank.
2. Everything is a financial instrument. If you buy or sell it in the money store, it’s a financial instrument.
3. Everyone is a Bank of Glass. You get up to hijinks between closed doors, you lose your privacy privileges. All financial institutions depend, directly or implicitly on the state’s balance sheet to backstop their actions. The state having discovered that even unregulated entities can make gargantuan horribly overleveraged bets, the state will now insist that everybody sleep with the lights on.
4. All banks and all financial instruments are capital-charged with the originator having hard equity at risk. I’ve pointed out before the concentrating effect of having hard equity at risk. The way to compel this is via capital charge. (The parallel here is with regulation of psychotropic drugs. When they were naturally grown, they were free and legal; as they became more refined, poppies into opium into heroin, they became first regulated and then criminalized. The same goes for psychedelic financial instruments, man; far out.)
Wow, man, derivative
Nothing sobers up a risk-taker like having his own money permanently in the transaction. Expect heavy capital charges – probably excessively weighted for a while, but that will be better than the unbearable lightness of B-piecing.
5. All professionals are licensed. So we license the mortgage brokers; we intermediate the home appraisers. We’ll clamp down on originators, standardize disclosure documents, improve consumer protection (via disclosure, not a new super-agency, please), and generally put everyone through a series of road tests.
Secretary Geithner has to know all this; he’s known it at least for a year, probably for several years. Now, having migrated form the relative obscurity of the New York Fed to the spotlights of Treasury, he must have expected that his control over the levers of power would enable him to force through logical change.
No such luck.
Can’t find your way out of committee?
Larry Summers, who preceded Mr. Geithner as Treasury Secretary and who now glowers in friends-close proximity to the President, was massively unable to pull Harvard together out of its entrenched fiefdoms. He failed because each graduate school faculty has its own budget and endowment and donor base. That money power enabled them cordially to invite the Harvard President to go pound sand. Unable to compel, and likewise unable to require, Mr. Summers was emotionally incapable of persuading.
Mr. Geithner, who is smoother, has evidently been trying the route of persuasive pressure, only to find that appointed officials have a similar power of veto:
Mr. Geithner told the regulators Friday that “enough is enough,” said one person familiar with the meeting. Mr. Geithner said regulators had been given a chance to air their concerns, but that it was time to stop, this person said.
Oooh, I love it when you talk ultimatum.
Whom was he lecturing?
Among those gathered in the Treasury conference room were:
Federal Reserve Chairman Ben Bernanke
Securities and Exchange Commission Chairman Mary Schapiro
Federal Deposit Insurance Corp. Chairman Sheila Bair.
Grasping? Turf conscious? Me?
In addition to Mr. Bernanke, Ms. Bair and Ms. Schapiro, other attendees at Friday’s meeting were:
Fed Governor Daniel Tarullo
Comptroller of the Currency John Dugan
Commodity Futures Trading Commission Chairman Gary Gensler
Office of Thrift Supervision Acting Director John Bowman.
Regulate him, not me
Spokespeople for all regulatory agencies represented at the meeting declined to comment.
There being no upside whatsoever in doing so …
Friday’s roughly hour-long meeting was described as unusual, not only because of Mr. Geithner’s repeated use of obscenities, but because of the aggressive posture he took with officials from federal agencies generally considered independent of the White House.
See, that’s the problem – they are independent of the White House, and have always been. Independence of central bankers is a cornerstone of modern economic policy, so much so that promptly upon Gordon Brown’s becoming Chancellor of the Exchequer, he immediately granted independence to the Bank of England.
Mr. Geithner reminded attendees that the administration and Congress set policy, not the regulatory agencies.
“Remember, I’ve been appointed already, your appointment’s still coming up”
Dangerous ground there, and an inflammatory statement. Independent agencies have their freedom for a policy reason – not to kowtow to the current prevailing winds is intrinsic to their value. Contradicting that premise could easily offend listeners and harden their skepticism into opposition.
Mr. Geithner, without singling out officials, raised concerns about regulators who questioned the wisdom of giving the Federal Reserve more power to oversee the financial system. Ms. Schapiro and Ms. Bair, among others, have argued that more authority should be shared among a council of regulators.
I think it was Abraham Lincoln who remarked that he never posed strategic questions to a council of generals, because their consensus bias led them always to counsel caution. Shared authority is divided authority – good, maybe, for deliberative bodies (like a Congress); bad for executive and administrative ones.
“If you need my consent, baby, you’ll wait until I’m ready”
[Continued tomorrow in Part 2]
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