The Problem With Promontory

Includes: GS, IAI, JPM
by: Felix Salmon

The NYT and American Banker have both published detailed articles on Gene Ludwig and Promontory, with the former getting the most eyebrow-raising datapoint: never mind his $11.5 million Washington estate, Ludwig is paying himself “more than $30 million annually, making him better paid than top executives at many big banks”.

In fact, $30 million a year makes Gene Ludwig better paid than any executive at any bank: to put that number in context, JP Morgan’s (NYSE:JPM) Jamie Dimon was paid $11.5 million last year, down from $23 million in 2011, while Goldman Sachs’s (NYSE:GS) Lloyd Blankfein made $21 million in 2012. Those men run huge international banks with tens of thousands of employees and balance sheets which are properly calculated in the trillions; Ludwig, by contrast, basically just runs an advisory shop with no balance sheet to speak of at all.

Promontory is proof positive, then, of just how lucrative the revolving-door business can be. The company is full of lavishly-paid former regulators, hiring themselves out at $1,500 an hour to banks desperate for advice on how to navigate Washington’s regulatory thicket.

But what really strikes me about Promontory is how unique it is. It’s carved out its bank-regulation niche and it dominates it to the exclusion of any other shop: you really don’t find McKinsey, say, doing this kind of work. Essentially, Promontory has a monopoly on what it does, and can charge anything it likes, in the knowledge that no big bank can risk missing out on the institutional knowledge of current regulatory policy that’s embedded there.

It’s not just Promontory’s regulatory-advice arm which has an effective monopoly. There’s also Promontory Interfinancial Network, which I wrote about in 2010; since then, the CDARS product has been augmented with something similar, called Insured Cash Sweep. Both of these are pure regulatory arbitrage, designed to circumvent the legal $250,000 limit on deposit insurance. And again, Promontory is the only company which offers such things.*

There’s no doubt that Promontory’s monopoly on such services is related to its unrivaled connections to the US regulatory apparatus. Banks hire Promontory for two main reasons. The first is that its staff of former regulators can tell banks, in a friendly rather than adversarial way, exactly what existing regulators are likely to do in certain situations. (And because Promontory sees regulatory responses much more frequently than any individual bank does, it is much more sensitive to which way the wind is blowing.) The second is that, as the NYT puts it, “the firm acts as an advocate for banks, helping draft letters that challenge crucial rules and discussing reforms with regulators”. Regulators are more likely to trust their former colleagues than they are the banks they’re trying to regulate, and by hiring Promontory, banks can co-opt those former regulators and use them to to effectively work the refs.

During the financial crisis, America’s former bank regulator in chief, Alan Greenspan, was shocked to discover that for-profit banks were actually very bad at regulating themselves. And one key lesson from the crisis, which was learned the world over, is that banks can’t be left to their own devices, as Greenspan and Rubin and Summers — the famous Committee to Save the World — thought in the 90s that they could be.

That’s why Promontory worries me: it represents the privatization of regulation, and the almost literal capture of regulators by the banks. Sure, those regulators are former regulators rather than current ones. But Promontory isn’t just relied upon by banks; it’s increasingly relied upon by regulators, too — it has become a trusted interlocutor for regulators in the way that the banks themselves never could be. Indeed, it’s probably fair to say that regulators have started to effectively outsource some part of their role to the private sector, here, in much the same way as the Department of Defense is outsourcing chunks of its own role to Blackwater. But at least Blackwater is paid by the DOD, rather than by the DOD’s adversaries.

The result is that the discourse around and between regulators and bankers is becoming less adversarial, at exactly the point at which it should be getting more adversarial. There is such a thing as too much regulation, and there is such a thing as an overly aggressive regulator. But our current system is nowhere near that point: instead, it continues to err on the side of leniency and toothlessness, egged on all the while by Promontory.

All of which is to say that Promontory itself, I think, is in need of regulation at this point. It has not registered as a lobbyist since 2009, but it is surely more influential than any lobbyist. When the man in charge of Promontory is making substantially more money than any banker, that’s a strong hint that Promontory is helping its clients to extract billions of dollars of value from somewhere. We should be asking ourselves exactly where that value is coming from. And who might be paying the cost.

*Update: Promontory is by far the biggest company in this space, but it’s not the only one. From a 2010 American Banker article:

Promontory is not the first company to come up with a private-sector solution for continuing the blanket coverage. At least four firms offer similar products: Anova Financial Corp. of North Carolina; Total Bank Solutions of Hackensack, N.J., which has partnered with Deutsche Bank on a service; Institutional Deposits Corp. of Miami; and Intrasweep of New York.

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