History Repeats Itself, Financial-Regulation Edition

by: Felix Salmon

Here’s a quick and dirty way of judging the quality of your country’s financial regulation: to what extent do you create and impose tougher-than-international standards?

By their nature, international standards are the lowest-common-denominator. Individual countries can and should extend them and create their own rules; when those rules turn out to work well, sometimes the international community will start adopting them more broadly.

Historically, the US has a mixed record on this front. It did a good job of beefing up the fatally flawed Basel II regulations, largely because of pressure from small community banks, which weren’t sophisticated enough to lose billions of dollars on derivatives, and which didn’t want the big banks having an unfair advantage over them. As a result, the FDIC essentially kept the simpler and stronger Basel I rules in place — which turned out, in hindsight, to be a very good idea.

On the other hand, when CFTC head Brooksley Born tried to impose some sensible derivatives regulation back in the late ’90s, Treasury and the Fed lost no time in slapping her down — and kicking her out. Her ideas, they said, raised “important public policy issues that should be dealt with by the entire regulatory community” — which, of course, turned out to be code for “we’re going to do absolutely nothing about any of this”. The SEC was equally opposed, saying that it didn’t want to do anything which would risk the status of America’s banks as “the global leaders in derivatives technology and development”.

Right now, history is repeating itself. On the positive side of things, the FDIC is insisting on beefing up Basel III, specifically its non-binding 3% leverage ratio. The US is looking to double that number, in a move which might force the eight biggest banks to raise another $89 billion in capital. It’s a very good idea, since America’s banks in particular seem to be extremely good at holding roughly zero capital against their mind-bogglingly enormous derivatives books.

On the negative side of things, however, we once again have Treasury and the SEC vs the CFTC: this time, as Shahien Nasiripour predicted, Treasury secretary Jack Lew and SEC chair Mary Jo White are forcing CFTC chairman Gary Gensler to delay crucial new derivatives regulations. The stated reason? “Complaints from policy makers and others about a lack of coordination between U.S. and foreign governments”. On top of that, the White House is rewarding Gensler’s zeal by refusing to nominate him for another term.

Overall, I’d say the US is not doing a great job on the regulatory front. Dodd-Frank created a lot of noise, but ultimately was much less important than Basel III; what’s more, the banks are now driving the rule-making process so as to effectively neuter most of it. Meanwhile, in lots of other corners of the regulatory universe, you can see the forces of capture at work: one prime example is the way in which the FHFA — the regulator for Fannie Mae and Freddie Mac — has hired a prominent insurance-industry lobbyist to help it regulate the very insurers he not only used to represent, but still represents.

The fact is that regulation is one of those things that doesn’t have a natural political constituency: rich banks are good at lobbying against it, while there are no effective or well-resourced lobbyists on the other side. So while it’s worth celebrating the occasional piece of capital-related good news, the long-term outlook remains exactly the same as it did in 1998: at the margin, the administration — no matter whether it’s Republican or Democrat — is going to help the financial industry be “internationally competitive”. Which is another way of saying domestically dangerous.