Tag: jp morgan

Dimon on NY Fed Board a Distraction, Solution Is to Remove the Fed from Bank Regulation

It is not surprising that the recent losses at JP Morgan have resulted in calls by current and would-be politicians to remove bankers from the boards of the regional Federal Reserve banks, as JP Morgan CEO Jamie Dimon currently sits on the board of the New York Federal Reserve. There’s even a petition for the “public” to demand Dimon’s resignation. Setting aside the irony of having senators call for keeping bankers off the regional Fed boards just days after they voted to place a former investment banker on the Federal Reserve board, the real question we should be debating is: Should the the Federal Reserve even be involved in banking regulation?

As I’ve noted elsewhere, a recent paper by economists Barry Eichengreen and Nergiz Dincer suggests that separating monetary policy from banking supervision would yield superior outcomes, both for banking stability and the economy more generally. While there is a very real conflict-of-interest when bankers sit on the boards of their regulators, there is an even bigger conflict-of-interest when those setting monetary policy are also responsible for bank safety. Rather than let institutions they supervise fail, and face public criticism, there exists a strong incentive for the monetary authority to mask bank insolvency by labeling such a liquidity crisis and then injecting easy and cheap credit. The result is that the rest of us are left paying for the mistakes of both the bank and regulator. A far better alignment of incentives would be to separate the conduct of monetary policy from bank supervision.

Like anything, such a separation would not be without its costs. I am the last to go around claiming a “free lunch” when it comes to banking and monetary policy. The current Boston Fed President made a strong case over a decade ago for keeping the two combined. The Richmond Fed has also offered a useful discussion of the pros and cons of such consolidation, as well as consolidating regulators more generally. These costs aside, I believe having the Fed focus solely on monetary policy would improve both.

Exit Interview with Sheila Bair

Sunday’s New York Times Magazine has an interesting exit interview with Sheila Bair, who until this past Friday served as Chair of Federal Deposit Insurance Commission (FDIC). While I haven’t always been her biggest fan, I did find it refreshing to hear a bank regulator state the obvious:  we should have let Bear Stearns fail. As she puts it:

Bear Stearns was a second-tier investment bank, with — what? — around $400 billion in assets? I’m a traditionalist. Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail.

I’d be hard-pressed to say it better. Assisting the sale of Bear to JP Morgan created the expectation that anyone larger, like Lehman, would be assisted as well. Perhaps the most interesting part of the interview is that Bair gets right to the heart of the matter: the treatment of bondholders. ”Why did we do the bailouts?” Bair states “It was all about the bondholders.” Again she couldn’t be more correct. If there was anything Dodd-Frank should have fixed it was this, ending the rescue of bondholders and injecting market discipline back into bank.  It is also refreshing to hear her admit: ”I don’t think regulators can adequately regulate these big banks, we need market discipline. And if we don’t have that, they’re going to get us in trouble again.”

Where I disagree, besides her misguided take on mortgage re-sets, is whether Dodd-Frank will actually impose losses on bondholders. Bair expresses some optimism that such is the case, but there are just too many holes in Dodd-Frank to make that believable. Plus you pretty much have the same set of rules in place for Fannie Mae and Freddie Mac, yet the last time I checked the bondholders are still being protected at the expense of the taxpayer. If we don’t impose losses on Fannie creditors, even now after the panic, what makes anyone think we will do so to Citibank. Section 204 of Dodd-Frank is quite clear that the FDIC indeed retains the power to rescue creditors. Something that Bair was willing to do during the crisis, even if pushed to do so by Tim Geithner. Despite some errors, the interview is really a worthwhile read and has some real lessons for avoiding the next financial crisis.