What are the consequences of allowing multi-billion-dollar systemically important multinational corporations to report their assets using proprietary mark-to-model tools involving discredited Monte Carlo simulations? I think we all know the answer to that one. But unbelievably, after such shenanigans contributed enormously to the greatest financial meltdown in living memory, the SEC is now set to allow more or less exactly the same thing in the oil industry.

Otto points to a stunning report by oil consultant Alan von Altendorf which spells it all out. Up until now, oil companies needed to actually prove they had reserves before they reported proven oil reserves. Now, however, the SEC is allowing them to use internal, proprietary computer models to essentially pull their “proven reserve” numbers out of thin air (or the nearest friendly Monte Carlo simulation).

Von Altendorf goes into great detail about how such numbers are useless and meaningless, and how the “proven reserve” rules should probably be tightened, rather than loosened, given the number of enormous write-downs in proven reserves which have taken place across the oil industry in recent years.

So what’s the SEC thinking here? Frankly, it’s not thinking at all: this is just another case of regulatory capture. And a sign that, so far at least, nothing has changed at the unsalvageable and dysfunctional institution.

Many thanks to Paul Solman for putting my question to Sheila Bair. Her answer is quite astonishing in its chutzpah:

Solman: Felix Salmon, who blogs for Reuters and does a lot of very interesting reporting, wanted us to ask this: was the Washington Mutual intervention a mistake, given the knock-on effects it seems to have had on the broader community. And more generally, is there anything you would do differently, in hindsight, about Washington Mutual or any other of things that you did?

Bair: I think actually that’s a bit of a myth. WaMu was a liquidity failure. It could not meet its obligations, it didn’t have enough cash on hand to meet the funding obligations it had contractually committed to. That is a basis for closing an institution. And the other option would have been to pump government money in there too, and we’ve tried to resist a lot of these bailouts. So I don’t think that was the right solution. So we really didn’t have any other option.

It was a below-the-fold story. It didn’t even really get that much press play. It was completely smooth. Shareholders and creditors, yes, took significant losses, but everybody else was pretty much protected: the general creditors, even the uninsured depositors were protected. The employees: almost all were kept. So actually I don’t think the WaMu failure had a disruptive impact at all.

Now at about the same time, Congress voted down TARP, and there was a very severe market reaction to that. Those all happened about the same time, and I think that maybe sometimes people get that confused. But the WaMu failure itself was barely a ripple in what was going on with the financial system at that time.

Solman: Felix Salmon’s question is in general, in hindsight, is there anything you would now have done differently?

Bair: Yes, certainly there is. I think we would have tried to tried to dissuade Treasury from making the TARP capital investments…

Just, wow. I don’t necessarily expect Bair to get into the nitty-gritty of the difference between senior unsecured debt and tier-2 capital in a national TV interview. But the fact is that she did have the option of paying off WaMu’s senior unsecured bondholders, and she dismisses that option a little bit too blithely in saying that she doesn’t like “bailouts”. WaMu would still have been a major failure, complete with creditor losses, if she had done that.

And I think she’s simply wrong when she says that hitting WaMu’s bondholders as she did had no disruptive impact. Maybe this is a matter of opinion, since it’s hard to prove a direct causal relationship, but Bair, here, wiped out the senior debt of an enormous commercial bank — the kind of debt which is exactly what Libor measures. It seems to me pretty improbable that she could do that without a pretty significant knock-on effect on interbank markets and on the level of trust between banks. And as we saw at the end of 2008, when that trust disappears, all manner of extremely gruesome consequences result.

Certainly the failure of the TARP legislation to pass the first time round didn’t help things, partly because the markets were hoping that it would rapidly shore up that fast-eroding trust. But the need to shore up trust wouldn’t have been as urgent as it was were it not for WaMu. (And Lehman, of course, but that was out of Bair’s bailiwick.)

Finally, Bair, when asked if there was anything she would do differently in hindsight, essentially says no, there isn’t: the only thing she points to is a decision that Treasury made, not that she made. Rather than taking the opportunity to revisit her own decisions, she quickly turns on Treasury. That’s something she’s done many times in the past. When it comes to admitting to human fallibility, she’s still batting zero.

Ten years ago today:

SEC. SUMMERS: Let me welcome you all here today for the signing of this historic legislation. With this bill, the American financial system takes a major step forward towards the 21st century, one that will benefit American consumers, business, and the national economy for many years to come…

It goes on in that vein for over 4,000 words. But the limit of how much I could stomach was much lower than that. Tim Dickinson has some of the most damning quotes; unfortunately I haven’t been able to find a photograph of Alan Greenspan, Larry Summers, and others drinking champagne and eating a large cake upon which was written “Glass-Steagall, R.I.P., 1933-1999″. Maybe that’s just as well.

Go Fed! In a very CFPA-ish move, the Fed has now announced that effective July 1, no bank can impose overdraft fees on its customers for ATM or debit card transactions, unless and until they explicitly ask for that “protection”. And they even come with a quote from Ben Bernanke talking about “an important step forward in consumer protection”, which is not the kind of language we’re used to hearing from Fed chairmen.

One weird thing, though: in the letter the Fed has published as a model for banks to follow, consumers are given two choices at the bottom: the first choice is opting out of overdraft protection on ATM and debit-card transactions, while the second choice is opting in. That’s confusing, because opting out is the default option: if you simply ignore the letter and do nothing, you’re opted out automatically.

Why ask customers to sign and date a piece of paper to opt out of something they’re already opted out of by default? I’d much rather see language saying “if you don’t want us to authorize or pay overdrafts on ATM and everyday debit card transactions, you need do nothing”. But that’s just a niggle: this is an important step forwards.

Update: The Center for Responsible Lending emails to point out all the things which the Fed didn’t do, including capping the number of overdraft fees that a bank can charge per day, and preventing banks for charging far more in fees than the total size of the transaction. So there’s still work for the CFPA to do!

Paul Solman is taking questions for Sheila Bair. If I could ask her just one question, it would be about her actions taking over WaMu and wiping out all its senior unsecured debt. That’s the wholesale interbank market right there, and in the wake of the WaMu collapse, banks pretty much stopped lending to each other, fearful that at any point Bair could step in and wipe out billions of dollars in assets. The ensuing credit crunch was responsible for trillions of dollars in stock and bond-market losses, and Tim Geithner, for one, was furious at Bair for her precipitous decision.

So the question is this: was the WaMu intervention a mistake, given the knock-on effects it had on the broader economy? Or, more generally, is there anything Bair would do differently, in hindsight?

Bair’s a political beast, and I suspect she’ll brazen it out, saying that her WaMu decision was the right one. But that would put her in the dubious company of all the other executives who feel they have nothing to apologize for. Is it too much to hope that she might show a glimpse of humanity or fallibility?

I’m not at all convinced that any CEO is ever worth a $10 million pay package, but if it wasn’t clear when that deal was signed, it became obvious very quickly that Robert Benmosche was something of a prima donna. That’s far from unusual in people earning 8-figure salaries: indeed, being the recipient of such a massive emolument tends to exacerbate such tendencies in anybody.

The real culprit in this story, however, isn’t Benmosche, who has been something of a known quantity from day one at AIG. Rather, it’s the people at Treasury, who are now zero for two in picking AIG CEOs. Maybe it’s not as easy as they thought.

The problem is that the CEO of AIG isn’t like the CEO of a public company: he’s fundamentally a civil servant, and is much more constrained in his actions, including his ability to hire people at high salaries, than 99% of other CEOs. The leader of AIG is always going to be second-guessed and micromanaged, which will make any CEO type unhappy.

It’s become clear that the Obama administration is incapable of hiring a largely-independent CEO for AIG and then leaving him to his own devices. So if and when Benmosche leaves, they should probably reconsider the whole job, and how much it’s really worth to them. My guess is that the answer is going to be much less than $10 million.

I like a very great deal of Chris Dodd’s proposed regulatory reforms, and overall the Dodd bill is I think a significant improvement on Treasury’s proposals. A good place to start is the discussion draft, but there’s a great deal going on here (the full bill is 1,136 pages), so expect lots more details to emerge in the coming days and weeks. In general I’m a fan of it, although I have reservations about the new Agency for Financial Stability, and the reduced powers at the Fed.

The heart of the Dodd bill involves setting up three new agencies: the Financial Institutions Regulatory Administration, the Agency for Financial Stability, and the Consumer Financial Protection Agency. The last — the CFPA — is if anything a beefed-up version of the agency envisaged in Treasury’s proposal, and it’s a very good idea. But the first two are new.

The Agency for Financial Stability is the agency charged with monitoring systemic risk — a job which under Treasury’s proposal would be given to the Federal Reserve. On this I think I have sympathy with Treasury: the Fed in general, and the New York Fed in particular, is better placed to monitor these risks than a brand-new agency with no direct ability to supervise banks or to break them up. A giveaway appears on page 3 of the discussion draft:

The Agency for Financial Stability will identify systemically important clearing, payments, and settlements systems to be regulated by the Federal Reserve.

Clearly, the Fed is going to play a necessary role here, and it’s not exactly rocket science to identify key clearing and settlement systems. So why take that job from the Fed and give it to powerless technocrats in Washington? Similarly, on page 5, the discussion draft says that

The Federal Reserve will continue to play a key role in assessing financial stability and have guaranteed access to financial institutions and any needed information.

That does seem to me to be somewhat duplicative in terms of what the Agency for Financial Stability is meant to be doing.

The Dodd bill is also big on trendy concepts like contingent capital and living wills, none of which have ever been shown to work in practice. It’s so sure, in fact, that it can mandate a way in which the FDIC can “unwind failing systemically significant financial companies through receivership” that at the same time it places an outright ban on the Fed stepping in to bail out a failing institution.

I fear this is dangerous. Yes, it would be great if all of this worked as planned. But that never happens, in the heat of a crisis, and I’m not a huge fan of cutting off the optionality we currently have at the Fed. By all means put in place the contingent capital and the living wills and the FDIC as the first best option for resolving a bank in crisis. But there’s no harm in keeping the Fed as a backstop if none of that works.

The Financial Institutions Regulatory Administration, on the other hand — the new single bank regulator — is a great idea. As the discussion draft says, it

combines the functions of the Office of the Comptroller of the Currency and the Office of Thrift Savings, the state bank supervisory functions of the Federal Deposit Insurance Corporation and the Federal Reserve, and the bank holding company supervision authority from the Federal Reserve.

About time too. For political reasons, the state banking system, governing community banks, will remain in place; I also note that the discussion draft says nothing about the NCUA, and I wonder whether that too is somehow politically impossible to fold into the new agency.

The Dodd bill is great on derivatives regulation, giving the SEC and CFTC broad powers to force markets onto exchanges where they can pose less systemic risk. Any trades not taking place on an exchange will be penalized with margin and capital requirements: a very good idea.

I also like the way that the Dodd bill forces hedge funds with more than $100 million in assets — the potentially dangerous ones — to register with the SEC. Investment advisers looking after less than that will be left to state supervision, which is also a good idea, in terms of not stretching the SEC too far.

There will also, finally, be an Office of National Insurance, within Treasury. About time too!

The Dodd bill is good on regulating credit rating agencies, and also on executive compensation, although I worry a bit about the way that companies will be asked to compare executive pay to stock performance. Executives have control over how their companies perform internally, not over how much outside investors are willing to pay for their stock. But that’s a niggle: over a five-year time period, you’d expect a company which had shown significant improvements internally to also have done well in the stock market.

I’m a big fan, too, of eliminating different standards for broker‐dealers and investment advisers, and holding any broker who gives investment advice to the same fiduciary standard as investment advisers. Makes perfect sense to me.

Banks who securitize loans are going to be forced “to retain at least 10% of the credit risk”; I haven’t looked at the full bill to see what exactly that means, but it’s good in principle. And there will also be lots more regulation of the municipal-bond market, which is long overdue.

The worry, of course, is that if the Senate ends up passing anything like this, it’s going to be very hard to reconcile with something more along Treasury’s lines coming out of the House. But even the vague possibility that Treasury’s plans will end up being strengthened rather than weakened has to be heartening.

Bill Black makes mincemeat of the idea that the government can and should keep a top-secret list of systemically-dangerous institutions which are subject to “heightened prudential standards”:

I’ll put aside for a later time discussing the obscenity of proposing that the American people be kept from learning which banks are SDIs and can secretly tap the U.S. Treasury and the Fed for unlimited funds. I’ll also mention only in passing the hilarity of Congress proposing that we can successfully create a super secret society of those, including some members of Congress, who will know which banks are on the list – and will never leak.

Here, I want to emphasize the investor. The drafters have forgotten that the SEC mandates the disclosure of material information to investors. The fact that a bank is on the secret list is extraordinarily important to investors. So, the bill as drafted would create a system in which the banking regulators and Congress must keep the DOUBLE SECRET PROBATION list secret – but the banks must publicly disclose that they are on the list. Of course, it’s possible that the Treasury and the Fed – you remember, the folks that tell us constantly about their commitment to “transparency” – are actually so insane that they will propose amending the securities disclosure laws and destroy the entire concept of mandating that publicly traded companies disclose material information to investors.

Obviously, there would be a stigma involved were a bank to go onto this list. But equally obviously, the whole point of having this list in the first place is that such banks are too big to fail. Which means that the banks’ investors can have some little faith that they managed to make a moral-hazard play instead of simply investing in a bank going down the tubes.

In any case, as Black says, it’s hardly the job of regulators to keep from investors the fact that their bank is looking shaky. Either banks are small enough to fail, in which case there are no systemic problems if lots of investors try to exit at once. Or else they’re too big to fail, in which case it’s the job of regulators to reassure the markets that a backstop exists — rather than to try to keep those markets in the dark. The plan as it stands is just idiotic.

I don’t understand much of the mathematics in Nassim Taleb’s new paper, co-written with Charles Tapiero. But still I fear that the paper’s main point is hidden in a blizzard of equations:

…

The point here is that the risk to the taxpayer associated with any given bank grows exponentially with that bank’s size. Ceteris paribus, a bank with $500 billion in assets is a lot riskier than a bank with $400 billion in assets, not only 25% riskier.

Treasury seems to consider too-big-to-fail to be a binary thing: either you are, or you’re not, and if you are, then you’ll have to get by with higher capital requirements. But if that kind of a scheme is implemented, then it automatically creates a strong incentive for any too-big-to-fail bank to grow, and grow fast. The bigger that a TBTF bank gets, the more moral hazard can be palmed off onto the taxpayer, while the bank’s own capital ratios don’t have to rise at all.

Treasury I think should consider a scheme where capital ratios rise steadily with the size, risk, and interconnectedness of financial institutions, rather than simply falling into one of two buckets. And there should be no cap on how high those capital ratios can get. If such a cap is put in place, then every big bank will simply be given an incentive to blow straight past it.

I’m back, relaxed, after the longest amount of time I’ve spent off-blog in three years. Trying to get back up to speed this morning, I noticed an interesting twist in the annals of bailed-out too-big-to-fail companies: RBS is being forced to sell some core assets, like its auto-insurance operations, which give stability to its earnings. At the same time, GM has managed to unsell Opel, an equally-core asset which had been going to Canada’s Magma Magna.

I like both of these developments. There’s a big difference between a too-big-to-fail bank and a too-big-to-fail automaker: leverage. GM’s failure would have devastating repercussions in terms of midwestern unemployment, which is why the US government bailed it out. But it wouldn’t threaten the international financial architecture in the way that the failure of RBS would. So the world’s taxpayers have more interest in shrinking RBS than they do in shrinking GM.

Opel is GM’s best hope for the future, in that it’s very good at making small, fuel-efficient cars. Selling it makes much less sense than trying to import that technology into the US. If GM’s management can work out a way in which keeping Opel costs less than selling it, that’s a great result for the company.

At RBS, by contrast, it’s long past time that the financial-supermarket model is broken up. If RBS can really manage its retail banking network as well as it says it can, that should be just as much of a source of stable and predictable earnings as the auto-insurance business is. And no one’s telling RBS to sell of the disastrously-acquired ABN Amro branches, which means that the bank can evolve into becoming another strong Anglo-Dutch giant like Unilever or Shell.

If all goes according to plan, both GM and RBS will end up as large, successful, boring companies — the kind of companies that Warren Buffett has made his fortune by buying-and-holding. Both have a macroeconomic tailwind behind them right now: GM in the form of a natural rebound in car sales from their depressed 2008-9 levels, and RBS in the form of an extremely low cost of funds. If these were private companies, they might use that tailwind to make big and risky bets. But because they’re state-owned, instead they’re using it to simply get into a position where they can become established and profitable enough to let their respective governments sell down their stakes sooner rather than later. Although even after that happens, regulators will continue to keep a close eye on RBS, and the amount of risk it’s taking on.

Update: As John notes in the comments, RBS didn’t get ABN Amro’s branches. Those went to Fortis, which then also ended up nationalized.