Tag: Dodd-Frank

FSOC’s Arbitrary, Ever-Changing Double Standard

In the Dodd-Frank Act, Congress, without irony, decided the best way to end “too big to fail” was to have a committee of regulators label certain companies “too big to fail.”  That committee, established under Title I of Dodd-Frank, is called the Financial Stability Oversight Council (FSOC) and is chaired by the Treasury Secretary. Like so much of Dodd-Frank, FSOC gets to write its own rules. Unfortunately FSOC won’t even write those rules, but instead it has decided that it knows systemic risk when it sees it. This has led to an ad hoc process that almost makes the bailouts of 2008 look systematic.

Compare the process for asset management firms and that for insurance companies. In late 2013, the Treasury released a report on the asset management industry. It was widely viewed as an attempt to make the case for labeling some asset management firms “systemic.”  The report was widely criticized. Such criticism did not stop FSOC from conducting a public conference on the asset management industry in May 2014.  Whether it was the public reaction to the conference or the paper, FSOC has largely abandoned labeling asset managers as “too big to fail.”  That was an appropriate outcome as firms in that industry are not systemic and shouldn’t be lead to expect a federal rescue.

Now don’t get me wrong: A shoddy report and a conference do not constitute a thorough process. As someone who has overseen a rulemaking process, I can say they do not even meet the basics of the Administrative Procedures Act. But just when that process seemed wholly inadequate, along comes the “process” for insurance companies.

Not unexpectedly, AIG went along without a peep. Given its role in the crisis that’s not a surprise. But there’s been no report or even a conference on whether insurance companies pose systemic risk. Completing either one would, of course, require FSOC to define systemic risk and to offer some minimal metrics. Instead, what we have is unelected bureaucrats simply making it up as they go along.

And here I was thinking Dodd-Frank was meant to end the haphazard behavior of regulators in 2008 and lead us towards a predictable rules-based approach to ending systemic risk!

Some Preliminary Thoughts on the New “Final” Volcker Rule

There was only one way that the five regulatory agencies tasked with drafting the Volcker Rule–the provision of Dodd-Frank limiting proprietary trading by banks–were ever going to meet the year-end deadline and give meat to a poorly drafted statutory provision. That was if they retained maximum ex post facto discretion to decide whether bank activity is permissible or not under the rule. Unsurprisingly, this appears to be exactly what they have done.

I have some particular concerns:

The rule will require a “maze of regulators” (via the Wall Street Journal)

You thought the debate over the extraterritorial application of cross border derivatives (i.e., the fight between the Securities and Exchange Commission and the Commodities Futures Trading Commission)was contentious? Volcker is going to be five times worse. The rule still requires ongoing monitoring and enforcement by FIVE separate agencies and, as Wayne Abernathy of the American Bankers Association noted, there is still no mechanism for coordination built into the rule.

The rule lacks “bright line distinctions” (per Janet Yellen)

Basically banks won’t know if they’re in compliance or not until their regulator determines it. Ominously, SEC chairman Mary Jo White said that the regulators would be available to add “clarification.” Needless to say, a final rule should not need clarification.

The devil is in the enforcement

Several of the regulators noted that the key to “successful” implementation of the rule is ongoing monitoring and enforcement. But how do you monitor and enforce a rule that doesn’t have a bright line? So much for the rule of law.

The rule contains an exception for sovereign debt

In other words, banks can trade in as much sovereign debt as they want for their own account, but if they were to engage in similar activity with respect to investment grade corporate debt–Exxon Mobil for example–this will be illegal proprietary trading. (I feel safer already!)

Much of the “new final” rule does not have the benefit of public input

The two SEC commissioners who voted against the rule both complained they did not have sufficient time to review the contents–one labeled the year-end deadline “wholly political”–and were concerned that many of the new provisions did not have the benefit of public comment. They are correct that, at the very least, the rule should have been re-proposed as a draft.

For a full transcript of the final rule and Volcker related materials, see here.

Faith in Government, Unshakable

Belatedly, I’ve come across the review by Jonathan Martin of Politico of the book Act of Congress: How America’s Essential Institution Works, and How It Doesn’t by Robert Kaiser, a 50-year reporter and editor at the Washington Post. What struck me was that both of these very knowledgeable Washington journalists seem very clear-eyed about the deficiencies of the legislative process, and yet their understanding doesn’t cause them to question the idea of having government manage every facet of our lives. Here are some excerpts from the review:

Congress is dominated by intellectual lightweights who are chiefly consumed by electioneering and largely irrelevant in a body where a handful of members and many more staff do the actual work of legislating. And the business of the institution barely gets done because of a pernicious convergence of big money and consuming partisanship.

That is Robert Kaiser’s unsparing assessment in “Act of Congress,” the latest volume in a growing body of work lamenting our broken capital….

In the passing of Dodd-Frank, the public interest—however that might be defined—often took a back seat to money, special interests and political expediency.

It did not help, notes Mr. Kaiser, that many members of Congress are politics-obsessed mediocrities who know little about the policy they’re purportedly crafting and voting on. Indeed, it is Mr. Kaiser’s frank and often scathing criticism of Congress that enlivens a book that might otherwise strain the attention of anyone not intensely interested in the regulation of derivatives….

That phone call, writes Mr. Kaiser, underlined a fact of modern congressional life: “Most members both know and care more about politics than about substance.”…

“Of the 535 members of the House and Senate, those who have a sophisticated understanding of the financial markets and their regulation could probably fit on the twenty-five man roster of a Major League Baseball team,” Mr. Kaiser writes. “Members’ ignorance empowers lobbyists and staff.”

What makes “Act of Congress” especially valuable is its detailed portrait of Washington’s influence peddlers and, in particular, the powerful aides who script their boss’s statements, write the bills and often become lobbyists themselves after leaving the government payroll. 

Martin concludes:

Big money, small politicians, and the lobbyists and staff running the place: It’s hardly a new story about Washington. But Mr. Kaiser names names and spares no one.

So the question is, If you understand just how poorly most legislation is crafted, if you understand the corruption and ignorance that go into making rules for 300 million Americans, why are you still wedded to the idea that inevitably ignorant and corrupt people should make rules for everything from health care to banking to retirement to drug policy? 

Both Jeffrey Friedman and Ilya Somin have written for the Cato Institute, and in Somin’s forthcoming book, about the problem of public ignorance and value of a much smaller and less centralized government that could depoliticize decision-making and limit the scope of errors.

Faith in government, like a second marriage, is a triumph of hope over experience.

Yay Authoritarianism!

Cato-at-Liberty readers who are enjoying—or, at least, chronicling—our nation’s slide down The Road to Serfdom will have to add Neil Irwin’s Washington Post Outlook piece, “Why the financial crisis was bad for democracy,” to their travelogue:

In a democratic society, there will always be tension over which decisions should be made by expert appointees, and which by those with the legitimacy and accountability that come with competing for citizens’ votes. The technocrats can make complex decisions quickly, quietly and efficiently. The words “quick, “quiet” and “efficient” are rarely applied to the U.S. Senate or the Italian Parliament — but these institutions are imbued with an authority that comes directly from the people, the explicit consent of the governed.

So, in a crisis, which do you want: unaccountable decisiveness or inefficient accountability?

Consciously or not, we’ve made our choice: The financial crisis and its long, ugly aftermath have marked the triumph of the technocrats…

None of this is a great way to run a society. Like most journalists, I believe in transparency and accountability. I wish the Federal Reserve’s policy meetings were broadcast on C-SPAN. Instead, we get written transcripts five years later. (That still beats Europe, where such information is under lock and key for 30 years.)

Yet, when the world is on the brink, decisive problem-solving trumps the niceties of democratic process. I won’t like it much — but I’ll take it.

Authoritarianism cannot take hold without intellectual support, and Friedrich Hayek couldn’t have described the rationale better himself. Just equally well. Almost verbatim, actually.

For more, see my paper (with Diane Cohen) on IPAB and this Cato policy forum on IPAB and Dodd-Frank. And of course, read Hayek’s The Road to Serfdom while it’s still legal.

Fed Toys with Ratcheting Up the Credit Crunch

When the Basel I accords, mandating higher capital-asset ratios for banks, were introduced in 1988, they were embraced by the administration of President George H.W. Bush. With higher capital-asset ratios came a sharp slowdown in the money supply growth rate and—unfortunately for President George H. W. Bush and his re-election campaign—a mild recession from July 1990 through March 1991.

Now, we have Basel III and its higher capital-asset ratio requirements being imposed on banks in the middle of a weak, drawn-out economic recovery. This is one of the major reasons why the recovery is so anemic.

How could this be? Well, banks produce bank money, which accounts for roughly 85% of the total U.S. money supply (M4). Mandated increases in bank capital requirements result in contractions in bank money, and thus in the total money supply.

Here’s how it works:

While the higher capital-asset ratios that are required by Basel III are intended to strengthen banks (and economies), these higher capital requirements destroy money. Under the Basel III regime, banks will have to increase their capital-asset ratios. They can do this by either boosting capital or shrinking assets. If banks shrink their assets, their deposit liabilities will decline. In consequence, money balances will be destroyed.

So, paradoxically, the drive to deleverage banks and shrink their balance sheets, in the name of making banks safer, destroys money balances. This, in turn, dents company liquidity and asset prices. It also reduces spending relative to where it would have been without higher capital-asset ratios.

The other way to increase a bank’s capital-asset ratio is by raising new capital. This, too, destroys money. When an investor purchases newly-issued bank equity, the investor exchanges funds from a bank account for new shares. This reduces deposit liabilities in the banking system and wipes out money.

We now learn that the Fed, using the cover of the Dodd-Frank legislation, is toying with the idea of forcing foreign banks that operate in the United States to hold billions of dollars of additional capital  (read: increase their capital-asset ratios).

This will make the credit crunch “crunchier” and throw the U.S. economy into an even more vulnerable position.  The last thing the Fed should be doing is squeezing the banks and tightening the screws on the production of bank money.

Occupy Pennsylvania Avenue: How the Government’s Unconstitutional Actions Hurt the 99%

That’s the title of a new paper that Carl DeNigris and I just published in the Drake Law Review.  Here’s the abstract:

Economic freedom is the best tool man has ever had in the perpetual struggle against poverty. It allows every individual to employ their faculties to a multitude of opportunities, and it has fueled the economic growth that has lifted millions out of poverty in the last century alone. Moreover, it provides a path for individuals and communities to free themselves from coercive government policies that serve political elites and discrete political classes at the expense of the politically weak. Because of their relative political weakness, the poor and lower middle class tend to suffer the most from these inescapable power disparities.

Yet economic freedom — and ultimately, economic growth — is not self-sustaining. This tool of prosperity requires sound principles that provide a framework for cooperation and voluntary exchanges in a free society. Principles equally applied to all and beyond the arbitrary discretion of government actors; principles that provide a degree of certainty and predictability in an otherwise uncertain world. That is, economic freedom requires the rule of law, not men.

In this article, we discuss the corrosive effects that unconstitutional actions have on the rule of law, economic growth and, in turn, on the ability of the poor to improve their economic misfortune. We focus on the institutional dangers and adverse incentives that unconstitutional policies tend to create. These dangers are not just abstract or theoretical; this article shows how specific unconstitutional actions adversely affect the lives of poor Americans. And while Part IV shows that even constitutional violations by local governments can have disastrous effects, our central theme is that the federal government’s disregard for the U.S. Constitution has led to policies that kill jobs, stymie economic growth, and ultimately exacerbate the problems of those living in poverty.

The case studies we use to illustrate our argument are Obamacare, bailouts/crony capitalism, the Sarbanes-Oxley/Dodd-Frank financial regulations, and housing policy.  It’s truly stunning to see how the policies that the government pursues – unconstitutional ones at that – hurt the very people they’re designed to help.  Read the whole thing.

If the ‘Volcker Rule’ Is So Great, Why Exempt Treasuries and Agencies?

One of the more controversial provisions of the Dodd-Frank Act is its restrictions on proprietary trading, contained in Section 619. Setting aside the fact that even Paul Volcker has said the provision would have done little to avoid to the recent crisis, the Act’s various exemptions illustrate the confusion and hypocrisy underlying the rule.

Foremost among these exemptions is the allowance of proprietary trading when the financial instrument in question is either a U.S. Treasury bill/bond or a security issued by Fannie Mae and Freddie Mac. These instruments are actually the bulk of proprietary trading. Remember the failed hedge fund Long Term Capital Management? Their signature trade was arbitraging on-the-run and off-the-run Treasuries. Ever hear of Bear Stearns? The largest single asset in Maiden Lane I, those Bear Stearn assets guaranteed by the New York Federal Reserve, were Fannie and Freddie securities.

Countries around the World, such as Japan and Canada, have already raised concerns that if their government debt is subject to the Volcker rule, the result will be less liquidity and higher funding costs. But then one has to suspect that former senator Chris Dodd (D-CT) and Rep. Barney Frank (D-MA) understood this, as they allowed an exemption for Treasuries and Agencies (Fannie/Freddie). While I’m no expert on trade policy, this may very well raise World Trade Organization questions since the Volcker rule, as proposed, favors U.S. debt over foreign debt. Of greater concern should be that the Volcker rule favors non-productive investment, that of the U.S. government and Fannie/Freddie, over productive investment, such as corporate paper.

As in so many other areas, Dodd-Frank does leave the actual decision-making to the bank regulators. (Is it too much to ask Congress to actually legislate?) Section 619 is very clear that regulators may exempt Treasuries and Agencies, which implies they also may not. The first best solution would be to just scrap the Volcker rule, but if we are going to have it, then apply it to everyone and all asset classes. Otherwise, one is just introducing additional distortions into our financial markets, some of the same distortions that actually lead to the financial crisis.