Counterparties: How’s financial reform coming along?

May 3, 2012

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Remember financial reform? It’s been two years since the passage of the Dodd-Frank Act and nearly as long since Basel III arrived. Thankfully, two speeches yesterday by central bankers give us an indication of where we are.

In a speech in New York City, Fed Governor Daniel Tarullo argues that the financial crisis revealed two main problems. First, financial firms, including those not directly regulated by the Fed, became too big to fail and required bailouts. Second, the shadow banking system, including those infamous derivatives, grew to become enormous and unstable, threatening the safety of the economy.

Tarullo says that we’ve done a lot about the first problem. Regulators now have power to oversee all systemically important firms, Tarullo says, capital requirements have been raised, and the FDIC now has “liquidation authority” and power to impose losses on creditors. This won’t “solve” the too-big-to-fail problem, Tarullo says, but it’ll help.

But fixing the shadow banking system hasn’t been going as well:

Although some elements of pre-crisis shadow banking are probably gone forever, others persist. Moreover, as time passes, memories fade, and the financial system normalizes, it seems likely that new forms of shadow banking will emerge. Indeed, the increased regulation of the major securities firms may well encourage the migration of some parts of the shadow banking system further into the darkness – that is, into largely unregulated markets.

In a much less wonky speech delivered on the same day, Mervyn King, the governor of the Bank of England, has an interesting notion: In the UK, at least, newly empowered central bankers may get a lot more vocal. Here’s how King describes his financial crisis do-over:

With the benefit of hindsight, we should have shouted from the rooftops that a system had been built in which banks were too important to fail, that banks had grown too quickly and borrowed too much, and that so-called ‘light-touch’ regulation hadn’t prevented any of this … We should have preached that the lessons of history were being forgotten – because banking crises have happened before.

King’s view is the British take on regulation. Good regulation, he says, is about  “understanding and guarding against the big risks, not compliance with ever more detailed rules.” It’s fascinating to think of central bankers shouting “from the rooftops” and operating on principles rather than rules, even if the UK’s experiment with principles didn’t save them from the crisis.

In America at least, we’re stuck with a rules-based system in which the substance of those rules is – slowly – being decided. Look, for example, at the protracted debate over the Volcker Rule or the fight over bank counterparty exposure that Tarullo is overseeing.

And on to today’s links:

Regulations
After hearing bank CEOs’ complaints, the Fed sticks to the silent treatment – WSJ
The SEC “courageously assails tiny firms at the pace of a three-toed sloth” – ProPublica

Facebook
Your complete guide to valuing the biggest tech IPO of all time – Lex
Facebook IPO could be priced in the $27-to-$35 range – TechCrunch
Facebook’s IPO could make Zuckerberg a cool $18.7 billion – WSJ

New Normal
How income inequality and household debt are connected – IMF
American’s expected retirement age has jumped seven years in the last decade and a half – Economix

EU Mess
It’s time to start calling Europe’s trouble a depression – The Economist

Inefficient Markets
Five years after Blackstone’s IPO, investors still don’t know how to value PE firms – Term Sheet
Carlyle prices IPO at $22 – Dealbook

Alpha
Warren Buffet’s Berkshire Hathaway: lagging the S&P for the third year in a row – Bloomberg
Introducing the Warren Buffett running shoe – DealBook
28% of Americans think gold is the safest investment – The Big Picture
Mutual funds confront not-quite-as-dumb money – Bloomberg Businessweek

Diplomacy
Blind Chinese dissident: Let me leave the country on Hillary Clinton’s plane – Daily Beast

Quotable
Einhorn: Ben Bernanke is force-feeding us “the 36th jelly donut of easy money” – HuffPost

Wonks
Krugman explains why he attacked Bush’s tax cuts, but supports them now – Reddit
Is higher inflation really the answer? – MacroMania
We have no idea how the Fed could get us to 4% inflation – Econobrowser

Oxpeckers
The reporter who saw the financial crisis coming – CJR

Billionaire Whimsy
Virgin Atlantic unveils “Little Richard,” the Richard Branson-shaped ice cube – USA Today

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