COMMENTARY: Populist politics and bank reform: poor aim at an easy target – McCleskey

January 25, 2016

By Scott McCleskey for Thomson Reuters,

NEW YORK – Elections, like other forms of reality TV, provide moments of great entertainment but are often short of actual reality. It seems both parties this year need to have (at least) one candidate who captures airtime and ink with populist ideas unmoored from the practical world of getting things done. Democrats, not to be out-Trumped by Republicans, feature Bernie Sanders and his platform for Wall Street reform.

Like the Occupy Wall Street movement, Sanders takes a legitimate policy issue – financial industry reform — and turns it into a populist battle flag. His recent regulatory proposals are his latest whack at the piñata. And like Occupy Wall Street, he comes close to having a point, but the good points are overshadowed by the bad ones.

Sanders’ main proposal, to break up “too big to fail” banks, is neither good nor new. The notion that financial institutions are risky because they are big took hold during the crisis, but it was based on shallow thinking. The institutions at the center of the crisis were problematic not because of their size, but because of their complexity, their weak risk management, and above all their interconnectedness to the rest of the financial system.

The failure of a single institution, no matter how enormous, will not bring down the system unless it is enmeshed with other institutions throughout the system. The financial crisis wasn’t caused by the failure of any single bank, but by the financial system’s vulnerability to contagion. A narrow obsession on size may play well to the crowds but runs the danger of overlooking less-obvious dangers.

If the point is to prevent another financial crisis, the focus should shift from what happens within banks to what happens among them. The use of asset-backed securities allowed firms to create risky instruments and then get them off their books, but they created a lethal systemic risk. Their eventual failure undermined the normal mechanisms through which banks financed themselves and others – chiefly repos and money market funds – threatening the system as a whole. Today’s high-frequency, automated, complex markets make the system even more vulnerable than it was before the crisis, and this is the far greater danger than the size of the institutions themselves.

Sanders gets closer to the mark when he identifies the culture within banks as central to many of the problems that persist in the financial system. The regulators agree and have put it high on their list of priorities for 2016. As for the absence of criminal prosecutions which he criticizes, the problem is more complex. He’s right that punishing organizations rather than individuals makes little sense, especially when the fines involved are a tiny fraction of the company’s revenues. Deterrence is better served by focusing on the individual: the best deterrent is to make sanctions against culpable individuals personal, painful and predictable.

But Sanders is wrong to think the prisons should be filled with those responsible for what happened in 2008. The crisis was largely a story of arrogance, herd mentality and a cavalier attitude towards risk and compliance. None of these are against the law. In more recent years, actual fraudulent activity has surfaced such as the rigging of interest rates, currencies and commodities prices and in those cases criminal charges have been pursued.

Sanders’ other proposals are generally well-meaning but would require buckets of fairy dust to make them workable. Reinstating the Glass-Steagall Act to separate investment and retail banking would first require the construction of a time machine to take the market back to its structure before the Act was repealed. Barring Wall Street executives from posts at the Federal Reserve Banks would be like barring doctors from a hospital board. Taxing “speculation” on Wall Street and using the proceeds to make college education free is another real head-scratcher – the more the tax reduces speculation, the less revenue it raises for education.

Give Bernie Sanders credit for keeping the spotlight on problems facing the financial system. But the goal of financial reform should not be mixed up with social justice aims. Rather, it should be the safety and soundness of the financial system as the system itself evolves.

(Scott McCleskey is a financial services compliance and regulation advisor with 25 years of U.S. and international experience at senior professional and executive levels. He is the author of “When Free Markets Fail: Saving the Market When It Can’t Save Itself.” The views he expresses are his own.)

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Jan. 13. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @RiskMgment)

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