Does the New Regulatory Reform Bill Concede Past Errors?

The banking system bailout programs have been quite expensive and while they did salvage the money center banks from the credit crisis, a fair question is for what purpose. Banks are doing too little lending, although I have to concede borrowers are not breaking down their doors.

Those banks are quite busy; however, trading on their own accounts, making money by loaning their excess reserves to the Fed and gearing up to fight regulatory reform. Meanwhile, they remain insolvent, but are not being put into FDIC insolvency proceedings, like their smaller brethren are. The help has gone to the profligate top end in banking and medium and smaller banks have been left to fend for themselves, many unsuccessfully.

Now regulatory reform is at hand and in truth it is a bit of a misnomer given what authority is being sought from Congress. It is less regulatory reform than it is a license to restructure not only the banking industry, but other targeted companies or industries as well.

My argument is from what authority is being sought for “regulatory reform” it is pretty clear that the Administration is conceding substantial failure in regard to the bailout programs. It is not now a question of “tough love;” it is just license to be tough and largely do what the market has long wanted to in those quarters. Consider the authority the Administration is asking for.

The five key points of the Administration’s Regulatory Reform Bill are the following:

1. The government has to have the ability to resolve failing firms, with losses absorbed not by the taxpayers, but by the unsecured creditors and equity holders.
2. Firms which cannot survive without government support must face the consequences of that failure. The government would facilitate the "orderly demise" of the failing firms, not ensure their survival.
3. Taxpayers must not be on the hook - the government will recoup losses by assessing fees on industry peers.
4. The FDIC and FED must have limited authority with respect to these abilities to take over failing firms.
5. The government must have stronger supervisory authority.

The obvious question is why didn’t we do this earlier, especially after the credit crisis was resolved? I think the answer is the Administration still believed the bailout programs would work.

But now, like good pragmatists, the Administration is basically saying those programs have not done the job, many of the big banks are still insolvent and they have become an uncooperative burden on the recovery.

The surviving big banks are also too well positioned to reap the rewards of later taking over the turfs of the many smaller banks that simply failed. Fairness is an implicit issue here as well, I think.

Three core concepts emerge from the regulatory authority requested. One is the Administration wants broad FDIC-like proceedings and supervision authority over not just the big banks, but also the target recipients of earlier aid efforts. Second, the taxpayer is off the hook on the proposed reforms. Finally, shareholders, bondholders and management are to take the fall, as many have long felt they should.

These proposals are a far cry from the bailout programs. They amount to a concession those programs have too largely failed, but they also reflect a desire to get done what now has become obvious to many needs to be done.

We should hope these proposed reorganizational reforms are not a ploy to leverage the banking industry to accept what would really be true regulatory reform. In that connection, we should also hope Congress cooperates and does not succumb to banking industry lobbyists on either score.

Disclosures: none

Comments

[john s. gordon:]

'congress not succumb to bankster lobbyists' -
that'll be the day.
> jack

Nov 08 09:36 AM

[bob adamson:]

Thank you for this article Kimball.

If only a modern version of the Glass-Steagall Act were also enacted as well, it together with the Regulatory Reform Act and the capacity to bring FDIC proceedings would give the US Government the necessary capacity to adequately restructure and reform the US bank and the investment banking industry. Hopefully the US, UK and other primary global investment centres will coordinate their reform efforts in this regard.

You stress the vital points that the remaining US banks that were central to the creation of the US and global investment banking crisis have received massive public funding, remain essentially insolvent and are resisting necessary reform. While it was probably necessary to delay confronting the banks in a fundamental way while the US Government and central bank were struggling day to day during the October of 2008 to March of 2009 period to save the financial system and economy from collapse and needed the cooperation of these banks and their senior executives in those efforts, the time for decisive action is fast approaching now that the economy and banking system has stabilized.

Arguably the key points that must be appreciated in envisaging the framework of reformed banks are that:
1. The focus of investment banking is properly on accepting and managing risk of a nature and extent that is very different than what is acceptable for the other, properly “boring”, banking functions.
2. Globalization and information technology have both increased the possibility that unforeseen risk in investment banking will arise and the means for its better management.
3. In the modern world the pre-eminent global investment banking centres are comprised of investment banks, hedged funds and other ‘near banks’ and insurance bodies to back-stop investment banking and it is often difficult and unnecessary to distinguish banks, hedged funds and other ‘near banks’ dedicated to investment banking from each other by role or function and therefore the new investment banking framework needs to cover them all.
4. It follows that the reformed investment banking system needs to be segregated from the system for boring banking and the global dimension of investment banking must be accommodated in the reformed investment banking system.

The following needs to be done therefore:
1. There is a need is to segregate ‘boring banking’ from investment banking by creating and implementing a modern version of Glass-Steagall.
2. A regulatory and governance framework broadly analogous to those in Canada and Australia should be created for boring banks.
3. A regulatory and governance framework for the banks, hedged funds and other ‘near banks’ dedicated to investment banking and for insurance bodies that back-stop investment banking needs to be devised and implemented through cooperative and coordinated efforts, where possible in a timely manner, among the nations that are the primary global investment centres.
4. Because the actual demarcation line between investment and boring banking is somewhat arbitrary this line should be defined by the new modern version of the Glass-Steagall Act.
5. Given the nature and extent of risk involved, the terms of the new the regulatory and governance framework for investment banking must reflect the fact that if a bank, hedged fund or other near bank dedicated to investment banking or one of their insurers becomes insolvent this can not be allowed to endanger the solvency or ongoing functioning of the system generally. The allowed size, governance, capitalization, regulation, allowable risk exposure etc. for participants in investment banking must therefore be limited to reflect this need.
6. While it would be preferable if the banks and near banks etc, themselves split and reorganized voluntarily to transition into the new Glass-Steagall Act regime, in light of the current insolvency of many of them absent the current support from the US authorities it would be appropriate and advisable to employ the Regulatory Reform Act and the capacity to bring FDIC proceedings to achieve restructuring expeditiously if needed.

Obviously there are further issues of internal governance and external oversight etc. not discussed above but my intent is simply to outline the framework work for banking reform broadly for discussion purposes.

Nov 12 12:26 PM