Opinion

Felix Salmon

The new regulatory structure begins to emerge

By Felix Salmon
May 20, 2009

The WaPo all-star team of Zachary Goldfarb, Binyamin Appelbaum and David Cho broke the news this evening that Elizabeth Warren’s dream of a Financial Product Safety Commission is likely to become reality, thanks to the Obama administration. The WSJ’s Damian Paletta then did a fantastic job with his follow-up (although weirdly Warren’s name is nowhere to be seen):

Under the patchwork of regulation that presently exists, oversight of financial products is now split between a myriad of state and federal agencies, including the Fed, the Securities and Exchange Commission, the Federal Trade Commission, and others.

One possible scenario is that government officials consolidate some government agencies, such as the Office of Thrift Supervision, and strip some powers from the Federal Reserve and others to centralize the policing of financial products within a new body.

Anything which spells the end of the OTS (which, you’ll recall, was in charge of “regulating” AIG) is surely a good thing. And if the consumer-protection arms of the Fed and the SEC are bundled together into a new entity, that would surely reduce the chances of regulatory capture. As would this:

The creation of a financial product regulator would match a theme that Mr. Geithner has suggested is central to his vision of financial supervision. Instead of having regulators that look at specific companies, he has suggested having regulators that look horizontally at products and practices.

For example, he has called for the creation of a systemic risk regulator that would look at the concentration of risks in specific sectors, such as subprime lending. A financial product regulator could detect abusive practices in specific products, regardless whether a bank or small finance company originated the loan.

My feeling is that regulation by product — one entity regulating derivatives, another consumer-facing products (including insurance), and maybe a revamped SEC regulating securities — makes a great deal of sense. Then the Fed would sit atop those “horizontal” regulators, get data from them, and try to keep an eye out for systemic risks, with a particular emphasis on institutions which are too big to fail.

I’m reminded of the silliness that is the fact that Lending Club is regulated by the SEC — something extremely onerous for Lending Club, on the one hand, and something which is clearly outside the scope of what the SEC was designed to do, on the other. Instead, it, along with other peer-to-peer lenders, should be regulated by the new entity.

Is such a radical revamp politically possible? I think so, yes. Pointless regulators like the OCC and the NCUA might go by the wayside, but I doubt anybody will much mourn their passing, and most of their functions will be incorporated into the new horizontal regulators. The tougher fight will be with powerful state regulators, who probably have quite a lot of clout with the federal legislature. But it just doesn’t make sense to regulate financial products on a state-by-state basis, and it’s long past time that anachronistic practice came to a welcome end.

Comments
7 comments so far | RSS Comments RSS

i totally agree- i think this is the best time to do some regulatory clean-up. i’d add to that information transparency. This may not go very well with the politicians, but the public would certainly be able to make better decisions knowing the state of the financial system, and where the risk pockets may be concentrated.

This would help with public confidence not only in the financial institutions but also in government agencies, showing ‘they are doing their job well’ … today, i don’t think that’s the public attitude towards institutions like the FED and the SEC.

- Ludwig

 

What about crossover products like reinsurance? It can have elements of all three.

Posted by Dave | Report as abusive
 

The real trick will be erecting a political firewall to prevent the parties attempting to play to this new agency, which will be the only one most Americans will watch closely.

Is it a good idea? Yes. Can it become a weapon of destruction in the wrong hands? Yes. Let’s watch the details.

 

It is a bad idea. The extent of the meltdown has been limited because of the proliferation of regulators. Wouldn’t it be better to have only one car maker? The meltdown in the old USSR proves that a number of makers is preferable to one. If NCUA is so bad, what are the big failures caused by it?

Posted by Blue Phillips | Report as abusive
 

Bad idea – one man to think for everyone – NAZI Germany – old USSR. Would make meltdowns more extensive and worse. It gets rid of the smoke proof doors out of the building. Look what the feds did with forcing the lending to bad credit risks. Would it be better if this had happened in the States as well?

Posted by Blue Phillips | Report as abusive
 

OTS losing IndyMac and Washington Mutual in the past 12 months certainly helped spell their doom. In fact I think they are operating under a temporary director. NCUA has been napping as well.

I disagree on the OCC. While there are holes, OCC stands to benefit from any consolidation and you still need their organizational capabilities. Terms like “too big to fail” need to be sidelined forever…10 years from now maybe a “de-consolidation” would have occurred: BAC spins out MER, JPM spins out something, C spins out everything but retail / consumer.

Posted by Griff | Report as abusive
 

OTS is not the problem, FDIC is. Sheila Bair is the one out there trying to grab more power despite all the messes she created, while OTS and SEC stayed silent from their scandals involving Indymac and Madoff…

FDIC And Its Newest Victims: Small Business Owners, Farmers, And Community Banks
http://seekingalpha.com/instablog/387205 -ppy/4125-fdic-and-its-newest-victims-sm all-business-owners-farmers-and-communit y-banks

Our Congress has once again voted favorably to hand billions of our tax dollars to another unelected official. It recently increased FDIC’s borrowing power to at least $100 billion, if not more, without the stipulation that such fund must be used only to protect deposit and process bank failures. This time, Sheila Bair will assume Hank Paulson’s previous role and emerge as bankers’ new best friend and turn FDIC into the next AIG. This is a continuation of the greatest financial travesty against all American taxpayers, unrestrained even after Elizabeth Warren of COP blasted these regulators for spending “beyond what Congress appropriated… exceeding $4 trillion and smacking of high level of corruption.” FDIC’s own OIG also reported that the agency was at fault in at least 6 bank failures. It is a blatant insult to our justice system when these regulators are not held accountable for their mistakes, mistakes that should not have been repeated and worse, so costly and the damage so comprehensive that they ended up creating systemic risk instead of preventing it. Throughout this economic crisis, as the director of Federal Deposit Insurance Corporation, Bair’s decisions and actions have often posed major stumbling blocks to the goals of our administration and further deteriorated public confidence and trust in the financial industry.
http://uk.reuters.com/…
http://www.econblog.org/2009/...
mwcnews.net/content/vi…/

Currently FDIC has about $19 billion to guarantee over $4 trillion in deposits. Its DIF reserve ratio is around 0.4%, significantly lower than “the statutorily mandated minimum of 1.15 percent.” Yet, even before Bair proposed to raise bank fees and Congress passed the bills to increase her agency’s borrowing limit, FDIC had already gotten itself involved in TLGP and PPIP. “According to President Barack Obama’s fiscal 2010 budget proposal,” FDIC was “expected to guarantee about $600 billion in bank loans over the life of the temporary debt program.” This was in addition to the $500 billion Bair expects to finance for the legacy asset program.
http://globaleconomica…
http://www.reuters.com…
http://www.fdic.gov/ne…

“Nearly all of the Deposit Fund’s assets are held in U.S. Treasuries… any drain on FDIC reserves starting from dollar number one is met by sales of Treasuries, which are a direct obligation upon the U.S. taxpayer.” In other words, with FDIC’s reserve at a meager $19 billion, Bair singlehandedly threw over $5 trillion worth of burden on the shoulders of all taxpayers, including the guarantee of approximately $1 trillion for TLGP and PPIP. We now not only protect our own deposit with our tax dollars, we also back bank bonds and buy toxic assets to help these financial institutions clean up their balance sheets.
http://www.deltaga.com…

What kind of an insurance corporation is this? How many bank failures can it really cover and who gave Bair the authority to guarantee billions for TLGP and PPIP? With this pathetic reserve insurance premiums FDIC collected was no longer sufficient to keep it solvent. Bair committed one of the greatest moral hazards ever when she prioritized her agency over private properties belonging to the citizens of the United States. She had chosen to insure FDIC’s survival at the expense of both the depositors it was mandated to protect, and taxpayers.

Even more disconcerting was the fact that these two programs benefitted mainly the very same institutions which dragged us into this financial chaos. TLGP was our government’s solution to a devastating misstep by FDIC using our tax dollars. Bair’s impetuous decision to wipe out Wamu bondholders dealt a fatal blow to the bond market; it became nearly impossible for banks to raise capital by selling bonds without our tax dollar guarantee. This program created a double jeopardy for the general public because it also enabled banks to raise capital while allowing them to avoid TARP restrictions such as those on executive pay and bonuses. Bair vigorously endorsed PPIP, boasting this government program would “likely… generate a ‘healthy’ proft” to taxpayers. However, FIDC itself had only been able to “clear performing commercial loans at 50 cents on the dollar on average in its own regulated, orderly auctions.” Fed’s latest financial release on the Maiden Lanes further weakened her assessment, showing a $10 billion loss, instead of a profit, for the toxic/legacy assets that belonged to Bear Stearns and AIG.
http://www.bloomberg.com/apps...
http://www.reuters.com…
http://zerohedge.blogs…
http://www.bloomberg.c…

What was even more outrageous was the irresponsible and random manner in which FDIC had been dealing with bank supervision, seizure, and receivership. Did these banks really fail? How many of these failures occurred as a result of poor supervision? Furthermore, did FDIC manage the receivership fairly and effectively? The fact was, in 2008, “FDIC faulted in four bank failures… [and] fell short in correcting deficiencies at four U.S. banks before they were seized last year at a cost of almost $1 billion to the deposit insurance fund, the agency’s inspector general said.” Those banks included Silver State Bank, Integrity Bank, First Priority Bank, and Columbian Bank and Trust.
http://news.cincinnati…

More recent reports by OIG also showed that “FDIC supervision fell short for Freedom Bank” in Florida. The agency was “criticized for failing to take supervisory action quicker.” “Freedom Bank (FBBEE) failed primarily due to an aggressive growth strategy that relied on high-risk commercial real estate loans and poor underwriting. But mistakes by FDIC and Florida regulators helped exacerbate the problems that led to the bank’s demise.” In another case, FDIC was found liable for not “tak[ing] ‘timely and effective’ action to prevent Georgia’s Alpha Bank and Trust from failing less than three years after opening.”
http://www.bizjournals.com/ta...
online.wsj.com/article…
http://www.washingtonpost.com...

While it is understandable that no government agency is perfect, with over 30 banks already failed thus far in 2009, supervisory effort by our current financial regulatory agencies had clearly been a horrendous failure. Instead of shamelessly demanding jurisdiction expansion and diverting FDIC’s manpower and resources, Sheila Bair should be re-examining its actions, or lack of. When her own agency was found to be at fault for not one, two, but SIX bank failures why she had the audacity to ask for more power was beyond logic.

FDIC now “wants the power to curtail certain payments owed to counterparties of a tottering firm if the U.S. is expected to sustain losses from winding down.. counterparties could receive no less than 80% of the net due depending upon the government’s losses.” 80%? Why any at all? In the Wamu sale to JP Morgan, FDIC “made the claims of the counter-parties of all the swap contracts, futures contracts senior to those of the bondholders in the capital structure… This is a HUGE deal.” Who gave Bair the right to completely screw up system to give “counter-parties… precedence over the debt holders of the firm?” Why should AIG make Goldman Sachs whole a priority? No wonder taxpayers got stuck backing TLGP because all these actions by FDIC killed any incentive to buy company bonds.
online.wsj.com/article…
http://www.dailymarkets.com/s...

Next, “FDIC is… seeking authority to seize bank and thrift holding companies that are not deemed systemically important but have one or more failing subsidiaries.” Take a look at the Wamu case. FDIC did not even know the parent company had over $4 billion in deposit (so much for that liquidity issue Bair cited for the seizure). In other words, this request clearly showed it shouldn’t even be in court right now fighting for that money because it currently has NO authority to seize holding companies.

“[T]he agency is [also] pushing to scrap a requirement… that gives Treasury veto power over FDIC’s decisions.” What happened to “checks and balances?” If it weren’t for the Treasury and Fed interference, Wachovia would have been sold to Citigroup and Sheila Bair would have created the biggest bank failure in the history of mankind, wasting billions more of our tax dollars with all the guarantee she offered in that deal.
http://www.nypost.com/seven/1...

This was the same regulator who tried to increase bank fees by declaring potential insolvency, even though she knew “Competitive Equality Banking Act of 1987.. serves as a reaffirmation by Congress that the United States pledges its full faith and credit behind the federal deposit insurance funds.” Bair also double-crossed Citigroup in a poorly arranged rescue that cost Wachovia investors millions. On Friday Bloomberg reported ” U.S. stocks fell, extending the worst weekly loss for the Standard &Poor’s 500 Index since March, as… Sheila Bair predicted the heads of some banks may be replace.” No sensible and prudent government official would make misleading statements that might result in a nationwide bank run, betray the trust of the institutions he or she was regulating, and destroy preciously recovered investor confidence by dictating possible change of control in the management of private corporations. Congress should realize by now it is our regulators that require the most oversight. Incompetent officials such as Bair must be reprimanded and investigated, and not be granted addiitional power until they take proper and serious measures to prevent a repeat of similar mistakes.
http://www.fdic.gov/regulatio...
http://www.bloomberg.com/apps...

As President Obama attempted to create more jobs and increase lending and credit flow, especially to small businesses, FDIC’s actions frequently dampened his effort.

FDIC seized Wamu last September and sold the bank to JP Morgan for $1.9 billion, citing severe liquidity pressure. Many investors were shocked because “Washington Mutual had a Tier 1 capital ratio of 8.4 percent on Sept. 30, well above the 6 percent threshold that regulators use to classify a bank as well capitalized.” It also had a TCE ratio of 7.8%, well above the 4% many analysts believe banks must maintain to pass the stress test. In other words, this $300 billion institution was considered a failure by OTS and immediately seized by FDIC because of a one week bank run that temporarily affected its liquidity, despite the fact that it probably could have passed the latest stringent examination conducted by our Treasury.
http://www.kciinvesting.com/a...
http://www.cfo.com/art…
http://www.thediscipli…

Worse, this FDIC seizure and sale did not just hurt Wamu shareholders, employees, and customers. As mentioned previously, Bair also wiped out Wamu bondholders. This unprecedented action led to credit freeze worldwide, crippling the effort by our Treasury to re-establish liquidity and depleting what President Obama called “economy’s ‘lifeblood.’” In Europe, for instance, daily deposits to European Central Bank increased from $0.09 billion to an astonishing $169 billion the week after Wamu seizure; banks were hoarding money and not even lending to each other, much less the general public.
politicalticker.blogs….
http://www.newyorkfed….

As President Obama persevered to decrease unemployment, Bair’s hasty and thoughtless decisions often led to job and benefit loss inadvertently. Her rescues of Washington Mutual and Wachovia “deposits” was really a rescue of FDIC itself, period. JP Morgan laid off over 12,000 Wamu employees and delayed 401k contribution to its own employees making between $50,000 and $250,000 (yes, that is you again, the responsible middle class Americans getting sacrificed) to cut “COST,” while contemplating the purchase of more private jets and the building of a “premier hangar.”
http://www.bloomberg.com/apps...
http://www.bloomberg.com/apps...
abcnews.go.com/Blotter…

Many institutions Bair, Paulson, and other officials deemed “too big to fail” never appeared to be concerned with public welfare. No taxpayer I know wanted to give JP Morgan $25 billion in TARP and $38 billion in TLGP-backed bonds so it could spend millions converting the already new, modern Wamu Occasio branches instead of retaining more workers during this economic downturn. We did not want to give Citigroup billions so it could keep its Mets Stadium sponsorship. And we certainly did not want to give AIG billions for its extravagant spa retreats and making Goldman Sachs whole.
financial-market-watch…

President Obama wanted to increase credit flow for small business owners, because “a line of credit [could] be a lifesaver, giving them a buffer against cash-flow problems and enabling them to handel regular expenses such as payroll. But beginning in March, according to documents obtained by BusinessWeek, JP Morgan suspended credit lines for a large number of business owners [many of them NEVER EVEN MISSED A PAYMENT BEFORE]. According to someone familiar with the matter the move affected thousands of businesses. They had been clients of Washington Mutual before Chase bought the ailing bank in September 2008.”
http://finance.yahoo.c…

According to the Center for Public Integrity, “U.S. and European Investment banks invested enormous sums in subprime… [and] made huge profits… Investment banks Lehman Brothers, Merrill Lynch, JPMorgan & Co., and Citigroup Inc. both owned and financed subprime lenders.” Given most banks were corrupt, why let Wamu, a “Mainstreet” bank, with its free checking and excellent customer service, fail and small business owners suffer? In 2007, as “one of the nation’s leading banks for consumers and small businesses,” it “was ranked the highest retail bank in customer satisfaction in two regions of the U.S. by J.D. Power and Associates… BusinessWeek named Wamu a Top 25 Service Champ- the only bank to make the list… Fortune designated WaMu a Blue Ribbon Company for 2006 as a result of its listing on Fortune’s 100 Best Companies to Work For, America’s Most Admired Companies, Fortune 500 and Global 500.”
newsroom.wamu.com/phoe…
http://www.publicintegrity.or...

Community banks have also been victims of FDIC’s unfair and improper seizure. In Colorado, New Frontier Bank’s failure led to despair among many farmers. “One Fort Morgan farmer broke down in tears Monday morning as he spoke to Colorado’s congressional delegation at the Morgan County Fairgrounds in Brush. He said he’s under a 30-day deadline to find new financing for his cattle and farm operation or face liquidation.” “The Teagues spent about $50 million a year in the Morgan County community through its farming operations and employs about 155 people, who also contribute to the local economy.” “A month is not enough time to find a new lender, especially when many banks are undercapitalized and ill… many are now facing liquidation threats from the FDIC.” “FDIC … of the Division of Resolution and Receivership Ron Bieker said the agency had no policy which requires that borrowers pay off or refinance loans within that time period, implying that this was a misunderstanding… [but] Windsor Mayor John Vazquez said he could show Bieker a letter which did say loan customers had only 30 days to do something about their loans.” &… was business as usual at FDIC: just another “misunderstanding… another mess for Congress and taxpayers to help clean up.
http://www.greeleytrib…
http://www.coloradoan.com/art...
http://www.fortmorgantimes.co...

New Frontier did not have to fail, at least according to the bank president. Though he followed FDIC’s instruction and tried to raise more capital, he claimed that ” deal was doomed because [at the same time] the FDIC offered a sweeter deal… the icing on the cake being that the FDIC would take the bank’s troubled loans out of the deal… when the FDIC has you out on the bid process, why would anyone buy you… he also expressed frustration with [TARP], $53 million of which New Frontier Bank would have qualified for based on its size… [but] was denied… he called the process politically corrupt… it will cost the FDIC… $500- $750 million… if they give us $53 million we could save it.”
http://www.greeleytrib…

The situation became so urgent that Congressional leaders had to step in and help buy these farmers more time from FDIC. In addition, USDA will “pump” $253 million to help these farmers. What? USDA? Isn’t USDA funded by the government and that means TAXPAYERS? What FDIC did was NOT the least cost solution. The agency expected to lose $670 million for New Frontier. With the money from USDA , total cost for this seizure soared to about $900 million. Why not just give New Frontier the $53 million it needed to avert disaster in the first place? That $253 million should not have been used to help rectify another FDIC mistake; it should have been saved for OTHER farmers in need.
http://www.coloradoan.com/art...
http://www.coloradoan….
http://www.fdic.gov/news/news...

In the case of First Bank of Idaho, ” lawmakers questioned whether federal regulators acted too hastily and knowingly took steps to exacerbate the bank’s failing financial health in its final days… OTS gave the bank until june 30 to raise $10 million and bring its capital level up to 12 percent… But regulators moved to shut down the bank before that June deadline, shocking bank executives who contend they had investors lined up to give the bank a cash infusion and clear millions in bad loans.”
http://www.theolympian…

“Local newspapers learned of the Cease and Desisit order and announced it to the community (the bank did not release this information, which means that government agencies probably “leaked” the news of their own actions. The only possible result of leaking this information would be to prevent the bank from saving itself.”
http://www.sunvalleyon…

“The FDIC says they will lose $191 million because of what happened, but if they’d waited a few weeks it never had to happen,” said Schauer. “That’s 191 million reasons why this takeover should be undone. Now the losses are incalculable,” she said. “A $35 million loss to our shareholders, the loss of more than 60 local jobs, which is a huge number of jobs for this area, the payroll that won’t be spent here, the taxes that won’t be collected here, the home foreclosures. People here know how much this bank has done for the communit, and it’s a calamity for many small businesses.”
http://www.newwest.net…

Other scandals involving FDIC also made national headlines recently. In one example, “Citizens for Responsibility and Ethics in Washington (CREW), a public watch dog group, urged the inspector General’s Office at the Federal Deposit Insurance Corp. on Monday to investigate a contract that the agency awarded to a real estate firm headed by the husband of Sen. Dianne Feinstein.” Apparently the terms were a bit too lucrative, the firm a bit too inexperienced “dealing with foreclosed residential properties,” and the timing a bit too coincidental.
http://washingtontimes…

In another example, FDIC drew criticism for trying to relocate its office in New York. Its “decision to pay any price to abandon Lower Manhattan is wrong on so many levels it is hard to know where to start… [it] is prepared to pay about $2.5 million more each year… [to shorten] the commute for some of its suburban workers.” Thousands of people lost their jobs after their banks got seized and FDIC was worrying about the convenience of its workers’ commute? Sheila Bair must have forgotten that “wasteful spending” problem President Obama had been trying to end.
http://www.downtownexpress.co...

Irresponsible decisions and inconsistent actions are NOT the answers to solving economic crisis as systemic as the current one. We all know Congress will not let FDIC fail. This does not mean, however, Sheila Bair should get an increase to $100 billion, and up to potentially $500 billion, in borrowing power without any legitimate reason. She recently estimated that bank failures through 2013 would cost her agency $65 billion. Especially now that these stress test results are boosting investor and public confidence in our financial industry, and big banks are raising capital on their own, what is that extra $35 billion, or $435 billion for? As far as I am concerned, neither TLGP nor PIPP protects deposits or facilitates processing bank failures. It is time to “REGULATE” our financial regulators and replace corrupt officials with those who will truly serve in the best interest of ALL hard-working, responsible taxpayers.
http://www.usatoday.co…

*imho*

Posted by PPY | Report as abusive
 

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