Felix Salmon

Where will effective bank regulation come from?

Felix Salmon
Jun 17, 2009 14:15 UTC

What kind of creature will the new National Bank Supervisor be? No one seems to be entirely sure. The NYT and WaPo say that Obama wants “merge” the OTS with the OCC. Reuters and the WSJ say the OTS will be closed, but make no mention of the OCC or the NBS at all. Bloomberg says the OTS will be “eliminated”, while the NBS will “assume the responsibilities of” the OTS and the OCC.

The white paper itself says that the NBS will “take over the prudential responsibilities” of the OCC and the OTS, and will “inherit” both agencies’ powers.

I suspect the vagueness is deliberate, but that by the time everything has shaken out, the OCC’s John Dugan will emerge as the head of the NBS, regulating federally-chartered banks, and will continue to spar with the FDIC’s Sheila Bair, who will regulate state-chartered banks. Banks, meanwhile, will continue to pick and choose whichever regulator they think will have the softer touch: Goldman Sachs, for instance, has decided to go for a state charter. Is there any particular reason why Goldman should be regulated by the FDIC rather than the NBS? Of course not — it’s all politics.

Meanwhile, “macroprudential” regulation of the banks — whatever that means — will be performed by the new Financial Services Oversight Council. But it’s hard to see either Dugan or Bair giving much if any of their current regulatory powers to the FSOC, which increases the already-high probability that the FSOC will be a Terribly Important Body which achieves essentially nothing.

There’s simply no way that this kind of structure is conducive to encouraging powerful and committed and intelligent regulators to do their job with a minimum of bureaucratic interference. Given how much such interference already exists within agencies like the SEC, I can’t imagine that it isn’t going to get even worse when you start getting turf wars between agencies. And remember that Congress hasn’t had the opportunity yet to take the white paper and make it even more complicated and less effective.

By the time this is all over, I’m sure a lot of time and effort will have been expended on creating the new regulatory architecture. But whether the outcome will constitute a significant improvement is far from clear.


This is hilarious. I worked for the OCC for a decade and as the fox watching the hen houses, there were plenty of incentives to turn a blind eye to blantant violations of the federal rules and regulations! The OCC pampers their banks but for a higher price than the old FRB or FDIC regulators. Handholding is what we did and cover-up happened more than anyone will ever EVER know. Do you know why? Because they are PROTECTED by The National Banking Act. They are not subject to FOIA because they are protected by a LAW that the othe regulators don’t have. Let’s face it, we didn’t want those mega banks getting upset with us when they didn’t get the rating they wanted because they might just jump ship and take all those fees they paid for our salaries with them! The OCC is “quasi” govt in that salaries are paid by the banks they regulate and the bigger the bank, the greater the size of their assets and guess what? THE MORE THEY PAID US IN FEES! Check it out and verify what I’m saying. It’s 100% true. And Obama wants to give them COMPLETE control? Being that I’m retired these days, I get to just sit back and watch the fireworks and you can ALL rest assured, there will be plenty of that. Power corrupts but absolute power corrupts absolutely and when someone does something wrong in the OCC, they get promoted and they pay off complainants to merely go away. This is such a joke I can’t help but get a perverse thrill out of watching all these govt clowns pretend to have a clue as to what is REALLY going on behind closed doors!

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Tuesday links get the picture

Felix Salmon
Jun 17, 2009 03:27 UTC

The New York Stock Exchange’s Sarah Palin Shrine

The Twitterwar in Iran: What you can do – and what you shouldn’t do.

World’s first microinsurance fund launches with $44m

BA pays its cabin crew more than double what Virgin pays

Inflation: not a worry. US industry is operating at just 68.3% of capacity

This time unemployment might be a leading indicator

If you live or work in an Ando, you need to clean and re-seal the outside cement every year

Hopelessly flawed, widely abused, a pathetic substitute for meaningful information, and a danger to human life

Financial regulation: The alphabet soup gets much worse

Felix Salmon
Jun 17, 2009 03:20 UTC

Do you know a FHC from a BCBS? If not, you’re going to have a hard time wading through the government’s white paper on financial reform, which is full of such things. (An FHC is a financial holding company; the BCBS is the Basel Committee on Banking Supervision. The link is to the WaPo leak of the paper, there might be minor changes in the final document.) This, for instance, is a real sentence from the paper:

The United States will work to implement the updated ICRG peer review process and work with partners in the FATF to address jurisdictions not complying with international AML/CFT standards.

But never fear! Your tireless blogger has waded through all 85 pages, and I’m pretty sure I’ve got the gist of it at this point.

In a nutshell: If you thought this was going to make the current horribly-complicated system of financial regulation less complicated, think again.

And so to the specifics. Were you hoping that the present alphabet soup of regulators would get rationalized and downsized? I know that I was. But there’s only one place that’s going to happen: the OCC and the OTS are going to be folded into a new regulatory entity called the National Bank Supervisor (NBS), which (along with the Fed, natch) will oversee federally-chartered banks.

The National Bank Supervisor will not oversee state-chartered banks: those will remain under the umbrella of the FDIC, which is not being folded into the NBS. And the NBS will similarly not oversee credit unions: the NCUA will retain its independence and continue to regulate those itself.

Why perpetuate these distinctions between federally-chartered banks, state-chartered banks, and credit unions? I have no idea. But in order to get some measure of cohesion over all this, a second brand-new regulatory entity, the Financial Services Oversight Council, or FOSC, which will consist of the leadership of the NBS; the FDIC; the NCUA; the SEC and the CFTC (yes, they are remaining separate too); the FHFA (that, too, gets to remain independent for no obvious reason); the Treasury; the FOMC; and the brand-new Consumer Financial Protection Agency.

Or, to put it another way, FOSC = NBS + FDIC + NCUA + SEC + CFTC + FHFA + FOMC + CFPA + Treasury.

I know what you’re thinking — it can’t possibly be as simple as that. And you’d be right! There’s also a Financial Consumer Coordinating Council, which comprises the Consumer Financial Protection Agency, the Federal Trade Commission, and the SEC’s Investor Advisory Committee.

Oh, and I almost forgot, they’re also creating an Office of National Insurance.

In other words, if you thought the bureaucracy was bad until now, just wait until you see what’s coming down the pike.

Which is not to say that there aren’t any good ideas in this white paper. I like the fact that the CFPA will have the power to conduct Community Reinvestment Act examinations, for instance, and I love the fact that stockbrokers will — finally — have a fiduciary responsibility to their clients. The Obamacrats have also managed to sneak in legislation forcing opt-out, rather than opt-in, retirement plans for corporate employees.

But there are weaknesses here, too, and not just at the org-chart level. Treasury has decided that no financial institution can be allowed to engage in any nonbanking activities at all — basically there’s no way that Walmart, for instance, or Safeway, will ever get a banking license. That’s bad for consumers.

The white paper also punts on trying to clear up the mess of conflicts between the SEC and the CFTC: it basically just tells the two agencies to go away and work it all out on their own.

And the new extra-stringent regulations on what the white paper calls “Tier 1 FHCs” — the systemically-important financial institutions — don’t seem particularly stringent to me. For instance, there’s this:

Tier 1 FHCs should be required to have enough high-quality capital during good economic times to keep them above prudential minimum capital requirements during stressed economic times.

This sounds good, until you realize that exactly the same language is used with respect to all banks, and bank holding companies, a couple of pages later.

But the main message of this white paper (and I’m sure Congress will do all manner of mischief to it before anything gets passed into law) is that there aren’t any problems of financial regulation which can’t be solved by setting up a high-level committee. In other words, it’s a bust.


“Why perpetuate these distinctions between federally-chartered banks, state-chartered banks, and credit unions? I have no idea.”There was this thing called the S&L crisis about 20 years ago. Go read up on it. Since then, there has been a distinction between these organizations.”Treasury has decided that no financial institution can be allowed to engage in any nonbanking activities at all — basically there’s no way that Walmart, for instance, or Safeway, will ever get a banking license. That’s bad for consumers.”GM persisted as long as it did and did not correct its underlying difficulties because its banking arm supported its crumbling industrial arm. If this was not the case, the problems with the latter would have been worked out before they became systemic. Having powerful retailers and employers also have power of banker over citizens opens the way to corporate dictatorship. It has happened before, and that was why reforms were undertaken in the first half of the 20th century.”In other words, if you thought the bureaucracy was bad until now, just wait until you see what’s coming down the pike.”Regulation did not lead us down this path to ruin – absence of regulation did. It is because these organizations cannot regulate themselves bureaucracy has been put in place to do it for them. This has been the case after each and every systemic failure for centuries and nations are without exception the better for it, from John Law to the world of Sinclair to FDR to today.

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The risk of global economic meltdown

Felix Salmon
Jun 17, 2009 01:53 UTC

Mohamed El-Erian has some imperatives for governments in general, and the US government in particular:

Policymakers face three distinct challenges… First, their market interventions must be accompanied by a clear notion of when and how they will get out. Second, they must manage their involvement with an eye on minimizing disruptions to the normal functioning of markets and incentives. Third, they must be able to identify and address the adverse unintended consequences of their actions…

Policymakers must find a way to upgrade their liability management approaches consistent with the paradigm shift in the public finance area. They must also credibly signal their intention to return to longer-term fiscal sustainability through the generation of meaningful primary budgetary surpluses.

That’s five “must”s there, zero of which are going to happen. Which is one reason why, if the current phase of the economic crisis is a function of financial-market failure, the next phase of the economic crisis is going to be a function of government failure, at every level from the municipal, up through federal fiscal and monetary policy, to the level of international economic coordination and cooperation.

There’s no doubt that some countries will bear more of the brunt than others — I wouldn’t want to be Italy right now, for instance, with its dysfunctional government, its massive exposure to toxic eastern European assets, and its status as the most likely country to be forced to leave the euro, default and devalue. But the global economy is so interconnected that no one will be protected from the effects of these failures around the world.

Nouriel Roubini came in to Reuters this morning and talked about the way in which the stock-market and credit-market rally since the lows of March was partly (but not entirely) a function of the fact that tail risk has genuinely diminished: the probability of a second Depression is lower now than it was in March. There’s truth to that, but (and I never thought I’d say this) Nouriel might be being too sanguine here.

In March, markets were worried that the fierce left jab of global financial failure would deliver a resounding KO to the world economy. It’s now clear that didn’t happen, although all global economies have suffered some extremely nasty bruises, and some, like Iceland, really were knocked out entirely. The problem is that none of the markets are remotely pricing in the risk of the right hook of government failure — something which we’re beginning to see with things like Angela Merkel’s remarks on monetary policy or the Obama administration’s inability to push climate-change legislation, or root-and-branch regulatory reform legislation, or even a financial-institutions rescue package, through Congress. (Hence the need for horrible creatures like PPIP instead, which don’t need Congressional approval.)

One of Nouriel’s other points was that it’s going to be extremely difficult for Ben Bernanke and the FOMC to walk the tightrope between raising rates too slowly and raising rates too quickly: the former causes inflation and mistrust in government institutions, while the latter could send GDP growth straight back into negative territory. My gut feeling is that there is no tightrope to be walked, and that even with some Platonically perfect monetary policy we’re probably going to end up with some combination of the two outcomes. I believe the term of art is stagflation. And that’s just the beginning of what could go wrong as a result of government actions around the world.

My view, then, is that tail risk is as big as ever, and that world markets are in something of a state of denial about it. Maybe economic armageddon isn’t quite as terrifyingly incipient as it was in March. But it’s still a real possibility. And it isn’t priced in.

Update: Euromoney suggests that the solution is to take fiscal policy out of the hands of lawmakers entirely.


Euromoney’s idea is not quite new. In fact, there has been some academic work on this concept for quite some time. For example, see Wyplosz:

Visit W3Schools!

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Blog traffic datapoint of the day

Felix Salmon
Jun 16, 2009 20:19 UTC

Ben Smith gets some traffic numbers out of The Atlantic:

“It turns out Andrew’s surge in Iran-related traffic put a strain on our servers,” the website’s editorial director, Bob Cohn, e-mailed, saying Sullivan’s Iran blogging had driven more than half of the 1.2 million visits to the site that day and accurately calling the blogger “a force of nature.”

Smith is not entirely correct when he calls Sullivan a “solo political blogger”: putting out up to 10 blog entries per hour, Andrew does have help from various Atlantic staffers and interns. But yes, he’s undeniably a force of nature, and his Iran blogging has been truly spectacular — and necessary, in the face of a story which is so fluid that the MSM has great difficulty nailing down to its own satisfaction. It’s great that he’s getting the traffic he deserves on this.

The reverse-convert scam

Felix Salmon
Jun 16, 2009 19:49 UTC

How would you like to lend money unsecured to a highly-leveraged financial institution while at the same time writing an out-of-the-money put option on an extremely volatile individual stock? Sounds unappetizing, right? Except somehow a bunch of banks, including Citigroup, which really ought to know better, are approaching retail investors and proposing they do just that — by buying something called a “reverse convertible note”.

Larry Light’s article on these beasts is not particularly clear — it took me a bunch of homework before I realized that it was the banks who were borrowing money, not the companies referenced in the notes — but the main takeaway of what he writes — that they’re a “nest-egg slasher” — is exactly right. This is the kind of thing that a Financial Product Safety Commission should exist to regulate — and, frankly, to outlaw entirely. The number of people buying these notes who are qualified to price them is exactly zero. Reverse converts are a scam, and it’s high time US regulators put an end to them.


Take a look at NASD’s Notice to Members 05-59 (Sept. 2005). The regulators have known that this is a problem for some time now. My read is that they view the risk of reverse converts as greater than options, and yet know that reverse converts are marketed to unsophisticated investors as a good alternative to traditional equity and fixed income investments since they pay interest or are usually tied in some way to an underlying blue chip.

More silly hedge fund coverage

Felix Salmon
Jun 16, 2009 19:21 UTC

What is it with Bloomberg’s Singapore bureau? Not content with a ridiculous article suggesting that US inflation might approach Zimbabwe levels, they’re now running a silly story about a shop by the name of “36 South Investment Managers Ltd” (me neither, but the only AUM datapoint I can find is that one of their funds has an extremely underwhelming $11 million under management.)

36 South is setting up a fund which will buy out-of-the-money call options on stocks and commodities, in the hope/expectation that if we enter a world of global hyperinflation, it will make lots of money:

The Excelsior Fund targets returns that will be five times the average annual rate of inflation of the Group of Five economies — France, Germany, Japan, the U.K. and the U.S. — should the rate exceed 5 percent.

This is just daft. France, Germany, and Japan between them account for 60% of the basket: is anybody anticipating hyperinflation in Japan? Besides, given the leverage they’re employing, how much time needs to elapse before they run out of money? As Vincent Fernando says, anybody thinking of investing in this fund would be much better off buying options on Treasury ETFs. And as Ryan Avent says, 5% isn’t hyperinflation anyway.

But more to the point, why is Bloomberg writing about these guys, given that they have zero demonstrated ability to get taken seriously by anybody with real money to invest? The reporter, Netty Ismail, quotes the co-founder of the firm as saying with a straight face that $100 million would be a “good” amount to raise, despite the fact that there’s no indication whatsoever that he’s raised anything like that sum in the past. If a well-known fund manager with a proven track record came out with a fund like this, that might be interesting. But this looks like little more than a marketing gimmick, designed — successfully, it would seem — to get press.

Incidentally, it would be nice if anybody writing about small and startup hedge funds did a bit of due diligence on them first. Before writing about firms like this as though they’re legitimate, any reporter should first confirm that they are legitimate — perhaps by asking to speak to their prime broker or asking to see some audited accounts for prior years. Otherwise, what’s to stop any old fraudster from calling himself a hedge fund, getting a couple of credulous Bloomberg stories, raising a few million, and retiring to the beach?


Well done, Felix.

It’s not the first time this Bloomberg reporter has published gloryfying articles on start up funds without track record or verifiable claims.

Check out this other ‘gem’ where Alan Howard is compared to a random Singaporean trader.

http://www.bloomberg.com/apps/news?pid=2 0601087&sid=aiKUyLXPdY4c

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Ideas for fixing the economy

Felix Salmon
Jun 16, 2009 18:18 UTC

The July/August “ideas” issue of the Atlantic is now online, and I’ve contributed two ideas to it. The first is essentially the Baker-Samwick proposal from August 2007, which makes so much sense to me I can’t believe it never even came close to taking off. The second is my old argument in favor of arts subsidies: you get much more bang for your buck there, especially when it comes to employment, than you do with any other kind of government spending.

Elsewhere, Megan McArdle gets rather more space than I got (she does work there, after all) to argue for abolishing corporate income taxes while raising all capital gains and dividend taxes to the general rate of income tax. The problem is that if corporate entities don’t need to pay money on non-dividended income, then rich individuals will turn themselves into companies and pay tax only on what they spend, rather than what they earn. Which might be a good thing from Megan’s perspective, but I don’t think it would do any favors for the government fisc.


The opportunity for clever tax dodges is minimized when all tax rates are the same: corporate, individual, dividends, capital gains, interest, etc.

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Are ETFs too easy to sell?

Felix Salmon
Jun 16, 2009 17:59 UTC

Jim Wiandt reports on internecine warfare among index investors:

Mr. Bogle has done some intensive research that shows that ETF investors have an even stronger tendency to trade their way into losing to the market, and to an even greater degree than active mutual fund investors.

Mr. Bogle is in effect saying that guns do kill people and that ETFs should perhaps be locked away safely in a cabinet and not employed in retail investor portfolios.

This is a fascinating concept — and, as Wiandt emphasizes, an entirely separate discussion from the question of whether investors are being ripped off when they trade in and out of structured ETFs like the USO oil fund or vehicles which give leveraged exposure to the stock market.

The question is this: assume, for the sake of argument, that you’re a buy-and-hold investor in broad stock market indices: you’ve decided, not unreasonably, that’s the best way to go. The problem is that you’re human, and humans (Neal Templin being one example) have a tendency to do exactly the wrong thing and sell when stocks go down, even when they have no immediate need for the money and indeed are just moving money around within their 401(k).

Now, are you more likely to panic and sell your index funds if they’re ETFs than you are if they’re mutual funds like the ones peddled by Mr Bogle? If so, then maybe it’s better to stick to mutual funds in general — and possibly even switch to a company like Dimensional in particular, not because it has higher returns (it’s selling index funds, after all) but because it has salesmen who can talk you gently back from the precipice and thereby prevent you from doing exactly the wrong thing at exactly the wrong time.

On the other hand, I’d want to take a very close look at Bogle’s “intensive research” before accepting its conclusions — precisely because it’s not easy to separate the buy-and-hold crowd from the day-trading crowd. Both of them invest in ETFs, but for very different purposes. How could Bogle have separated out only those ETF buyers who would otherwise have invested in mutual funds? I’ll be very interested to find out.


While buy/hold is a good strategy, it is not perfect and to prestend otherwise is folly.

Like many people, I lost money in my 401k/IRA during the market meltdown. Nevertheless, I am only down about 6% due to a decision to “go to cash” before things really got out of hand.

Bogle seems to think buy/hold is buy/forget. It is not.

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