Regulation reform hints of “Old Europe”

June 18, 2009

bob-bench— Robert R. Bench, a former Deputy Comptroller of the Currency in the Reagan administration, is a senior fellow at the Boston University School of Law’s Morin Center for Banking and Financial Law. The views expressed are his own. —

“Le laissey faire, c’est fini” – French President Nicolas Sarkozy

There indeed is a French flavor to the administration’s proposals for reforming the structure of regulation and supervision of financial institutions operating across the United States. In many ways the proposals resemble the “Commission Bancaire,” the French regime for financial oversight.

Perhaps the proposals reflect commitments the U.S. has been making at the meetings of the G20 countries, consisting of countries which finance much of U.S. government operations and American consumer credit.

If we want those countries to continue to be our banking lifeline, we need to engage in reforms to satisfy their expectations for financial discipline and integrity. We cannot restore confidence and trust in our financial institutions and markets until investors feel again that U.S. financial transactions are on the “up and up.”

The same goes for domestic investors and savers. Financial institutions made promises to U.S. pension funds, municipalities, and trusts. Those promises were broken, as losses of 20, 30, and 40 percent have been incurred. U.S. financial institutions sold “dreams” to American financial consumers: first house, vacation house, student loans, secure retirements, etc. For some, those dreams are totally broken. For many, the dreams have turned into nightmares.

U.S. customers of U.S. financial institutions rage at those institutions’ lack of performance and executives’ performance bonuses. U.S. financial leaders sit on the beach while American taxpayers are stuck on a treacherous fiscal sandbar.

In essence, this financial crisis has reminded us all that the financial system is a public utility and the U.S. financial institutions are chartered by the government because of their social utility to the commonwealth.

In recent years, unfortunately, financial institutions became less involved in financial service and consumed by financiering for the sake of volume — because volume drove individual compensation up and down the executive ladder. Splendid financiering is the work of rascals and humbugs, wrote Hugh McCullough, the first Comptroller of Currency in 1863. President Obama’s new proposals are dealing with 21st century rascals and humbugs.

The proposals are for getting back under the umbrella of government charters the financial transactions that escaped the regulatory umbrella in recent years. They are intended to show global investors and U.S. taxpayers that Washington intends to return U.S. finance to a safe-and-sound enterprise first and foremost, but should something go wrong in the future the losers will be private capital and not taxpayer capital.

The proposals call for a return to a “trust but verify” regime in which significantly more federal examinations will be carried out across all elements of U.S. finance. This will include a stronger advocacy for consumers of financial products.

More specifically, the president’s reforms call for a dramatic extension of federal regulation and supervision of financial markets and financial institutions, while also calling for a status quo and/or expansion of financial supervision in state governments. All significant financial holding companies will fall under regulation and supervision of the Federal Reserve. So will all significant clearing and settlement systems for financial products.

Financial institutions will have to have more capital reserves and liquidity, cushioning the taxpayer from risks. Those cushions will be managed in a counter cyclical way, i.e., the institutions put away more earnings in good times so it is available when things go wrong. And they’ll have to put it away in protection before they can pay it out in compensation. This process will involve the accountants coming up with revised policies for marking-to-market and for loss reserves, further dampening any chance for irrational exuberance in the future.

Significantly, the president’s proposals provide for special bankruptcy proceedings to deal with sick, large financial institutions. The FDIC has those proceedings for sick banks and this year is deploying those proceedings just about weekly. But big problems arise when the bank is owned by a holding company and that holding company is large, complex, and likely multinational. For an enormous amount of reasons, normal bankruptcy rules cannot be used because that involves freezing activity at the holding company, which in turn would freeze the entire financial system because of interconnectedness. So, new, customized wind-up processes need to be devised for large, systemically important financial institutions, not just banks.

The president requests new processes because without them the government remains stuck in the rut of using taxpayer monies to keep the sick company afloat. And trust and confidence in finance will not be restored until sick financial companies are resolved.

If this reads as if we have entered “old Europe” somewhat, perhaps we have. The financial system and institutions in it have failed the “test of the marketplace.” The “invisible hand” of the marketplace has needed the guiding wallet of the American taxpayer. Financial managers have privatized their profits but socialized their losses. Reforms are necessary to restore the balance between the government and its government-chartered institutions.

Personally, I would have liked the president’s proposals to have spoken more about restoring integrity in private-sector governance. That also must come in order to regain confidence. Maybe we need a simple proposal to change “CEO” to that European “Governor” to remind executives on whose behalf they really work for every day.


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You will remember that there was a massive failure by the banking regulators, including the Fed, leading up to this crisis. More spineless regulation is not a solution!!

I am a former senior bank regulator. Please let me offer the following comments:

1. The bank regulators had the authority to examine any aspect of a bank’s activities. They had the authority to figure out what was going on at the banks and to limit it. The regulators did nothing. So creating yet another regulatory bureaucracy will mean nothing if the regulators cannot or will not do their jobs.

2. There are dim bulbs and deadwood at the top of the agencies and all of it needs to be cleaned out. A Herculean task if there ever was one.

3. We recently saw the regulators “stress-test” the major banks and compute the additional capital that the banks required to weather the economic turmoil. Then some of the largest banks complained vociferously about the additional capital requirements and the regulators backed off.

Posted by Steve | Report as abusive

Only one regulaion needed to solve any future investment crises, regardless of the flavour ie bonds, property or equities. Any financial advicer, banker etc that offers investments over 5% pa must take all the downside of that investment. Problem solved no more specuative bubbles because the sprukers will loss their pants on the downside. Sounds like commonsense, therefore it will never happen!

Posted by gd | Report as abusive

Steve, your observations are absolutely correct. I would submit that the deadwood and dim bulbs exist in much of corporate America’s leadership. I fear even Heracles would avoid the task of cleaning up this mess.

Posted by Anubis | Report as abusive