The Great Debate

The battle over money funds

Both Securities and Exchange Commission Chairman Mary Schapiro and Federal Reserve Chairman Ben Bernanke have warned in recent days that money market funds remain vulnerable to runs. That is unquestionably true, and if a run occurs, U.S. taxpayers will bear the costs of bailing them out. Should taxpayers continue to subsidize the money market mutual fund (MMMF) industry?

The run on U.S. MMMFs in September 2008 was a critical moment in the financial crisis. It underscored the extent to which these funds, an important part of the shadow banking system, created systemic risk that indirectly threatened the financing of even the healthiest U.S. firms. To end the run, the U.S. Government guaranteed MMMF liabilities, sustaining the funds’ promise to pay $1 for every share.

That guarantee stopped the run, but it also created enormous moral hazard. Were a similar threat to arise today, we can safely assume that taxpayers would remain on the hook to rescue the MMMFs. This uncompensated, rainy-day backstop constitutes a subsidy to the MMMF industry — and to its investors and borrowers.

No wonder, then, that representatives of these groups loudly oppose regulatory efforts to counter the systemic threat that still emanates from the MMMF business model. The SEC (which is the industry’s regulator) reportedly is considering the introduction of capital requirements, constraints on fund convertibility and — most important — replacement of the $1-per-share valuation commitment with a floating net asset value (NAV).

From the point of view of taxpayers, policy action to address the systemic threat is long overdue. Aside from the government-sponsored enterprises, the most glaring omission in the Dodd-Frank financial reform was the failure to address critical short-term markets such as those for money funds and repurchase agreements.

There is no shortage of evidence for an enduring systemic threat. As recently as May 2011, according to Fitch, more than half the assets of the largest prime MMMFs were invested in European banks as the funds searched for yield to attract investors. When these funds (and their regulator) finally woke to the crisis in the euro area, it triggered a run. The scramble by the funds to exit put pressure on European banks to sell their dollar assets rapidly. A fire sale of dollar assets could have quickly undermined U.S. credit conditions. To avoid this outcome, the Federal Reserve reactivated its dollar-swap agreements with foreign central banks, allowing the European Central Bank to meet the dollar funding needs of euro-area banks from which MMMFs were running.

So why do we regulate MMMFs so differently from banks? To be sure, their assets are short term and of relatively high quality, making them less risky. Yet MMMFs are the prototypical “shadow” banks — providing liquidity services that are virtually identical to those of banks, with the advantages of much less regulation and an uncompensated insurance policy from taxpayers. It is an extraordinary and enduring regulatory arbitrage for an industry that still holds $2.5 trillion in assets.

The next hot ticket in financial reform

John Morrall

Oct 8, 2010 14:47 EDT

By John Morrall, Richard Williams and Todd Zywicki The opinions expressed are their own.

With Larry Summers leaving his post at the White House and Elizabeth Warren recently appointed as the special adviser to the new Consumer Financial Protection Bureau, the hot ticket is still to be the head of the bureau. All eyes should not just be on the appointment of the bureau’s first head, though, but on the bureau itself, for it is the centerpiece of financial regulatory reform.

More important than the innocent wagering among K streeters and Hill staffers, the horse-race to head this powerful new regulatory entity is emblematic of the incredible uncertainty surrounding new financial regulation. This makes it even more important to be clear about the effects, and not just the intentions, of this new regime.

Issuing regulations without trying to predict the consequences of those decisions is like shooting in the dark. It’s bad policy and it’s dangerous. You are not likely to hit what you are aiming for and more likely to hit something else — and the CFPB is the perfect example of this. It is a bureau that has virtually no oversight with the power to regulate every credit card, mortgage, and payday loan in America.

There is also no requirement for them to try and predict the likely results of their actions. Their result may be both higher prices and less access to credit for consumers.

Of great concern as well is that this board, like the Fed and other agencies that are affected by the new financial law, is independent, meaning they are not accountable to the President. While independence can protect agency decision-makers from improper special influence, that same independence can also insulate decision makers from proper oversight and public responsiveness.

Unaccountable bureaucracies develop tunnel vision and become incapable of balancing their priorities with social values that fall outside of their jurisdiction such as economic growth and job creation. In particular, if they do not analyze the likely results of their decisions, they may make it much harder to get loans while trying to “protect” people from taking excessive risks.

Senate vote exposes Wall Street impotence

John Kemp

May 21, 2010 08:42 EDT

Wall Street’s diminished influence in Washington was made plain yesterday when the Senate voted to approve financial reform legislation by 59 votes to 39.

Industry lobbyists will point out the bill only just managed to scrape the required votes needed to end debate and forestall a filibuster. It fell far short of a lopsided bipartisan majority.

But the formal tally on HR 4173 (Wall Street Reform and Consumer Protection Act 2009) as amended by S 3217 (Restoring American Financial Stability Act 2010) conceals a much wider bigger majority of 63-37 for enacting far-reaching reforms.

In the final vote on passage, the bill was backed by 53 Democrats, 2 Independents and 4 Republicans (Maine’s Susan Collins and Olympia Snowe, Iowa’s Charles Grassley and Massachusetts’ Scott Brown).

It was opposed by 37 Republicans and 2 Democrats (Maria Cantwell of Washington and Russ Feingold of Wisconsin). Two senators were not present (Democrats Robert Byrd of West Virginia and Arlen Specter of Pennsylvania).

But the two Democrats who voted “No” did so because they thought it did not go far enough and were registering a protest in a bid to get it toughened further. The two absent members were Democrats who had voted in favor of the legislation before.

All four votes should really be added to the “Yes” column to give an effective underlying majority of 63. By any measure that is a very high tally or a major piece of legislation.

Communities of color need financial protections

- Jose Garcia is associate director for research and policy at Demos. He is responsible for providing statistical and policy analysis for Demos’ Economic Opportunity Program on issues such as household debt and assets. -

As the days heat up, so too has the debate in Congress over what type of consumer protection to include in financial reform legislation. Detractors have moved to take the bite out efforts to crack down on abusive lending practices while advocates try to hold the line. Should there be an independent Consumer Financial Protection Agency? Or should it be housed in the Federal Reserve? And what authority should it have?

The debate has taken place at a time when debt continues to undermine the economic mobility of many American families and how Congress resolves the issue in the next couple of weeks will be critical to the future of those families, particularly consumers of color. It’s no exaggeration to say the creation of an independent agency may be the only means for addressing generations of abusive lending that has saddled communities of color with unmanageable debt.

A new report by the Institute on Assets and Social Policy at Brandeis University shows that over the past two decades, African-American families with low asset levels — unfortunately, a disproportionate number of African-American families — have increasingly relied on credit to make ends meet. Examining longitudinal economic data collected from the same set of families over 23 years, the study found that when you subtract total debt from total assets, one in 10 African-American families owed at least $3,600 in 2007 — nearly double their debt burden, in real terms, in 1984.

The growth in debt among previously credit-starved minority communities surged as markets were deregulated and paved the way for high-cost lending, including securitized subprime and predatory loans, payday loans and check-cashing stores, the study said.  With greater numbers of families struggling with growing debt that far outstrips their income and savings, many low-income and minority households have had no choice but to turn to costly lending products for immediate but expensive solutions to pressing needs.

Minorities and low-income consumers resort more frequently to credit card debt and other forms of high-cost debt in the absence of assets. An analysis of Survey of Consumer Finance data in 2004 by Demos, the public policy research and advocacy organization, found that 84 percent of African-American cardholders carried balances, compared to 79 percent of Latino cardholders and 54 percent of white cardholders. On average, minority and low-income borrowers are more likely to carry high interest and fee-laden credit cards. Another study commissioned by Demos found that four groups — low-income individuals, African Americans, Latinos and single women — are much more likely to pay interest rates above 20 percent on their credit cards.

This segmentation of the lending markets has exacerbated disparities in wealth and asset accumulation. Studies show that property values in predominantly African-American neighborhoods are lower than those in similarly situated white communities. Today, less than half of African-American and Hispanic households own their own home compared to three quarters of white households. In times of economic distress, where the use of home equity can help a family weather the gap between income and expenses, housing wealth remains elusive for a majority of African-American and Hispanic households. This diminished asset-building potential has a range of implications: families have no “nest egg” for emergencies, higher education or retirement. A vicious cycle of declining opportunity takes hold.

After clash, Senate filibuster ends in whimper

John Kemp

Apr 29, 2010 10:14 EDT

Just a few minutes after the Senate failed for a third time in as many days to reach the 60-votes needed to approve a cloture motion on the financial reform bill (failing 56-42), Senate Majority Leader Harry Reid rose to his feet and asked the chamber’s presiding officer:

“Mr President, I now ask unanimous consent the motion to proceed to S 3217 be agreed to.”

After the president officer asked for objections, and heard none, he replied “Without objection, it is so ordered,” according to the Congressional Record.

And with that the Senate decided to commence debate on the Restoring American Financial Stability Act of 2010. No roll call, no vote on the record, no 60th vote to cut off debate, just an absence of naysayers.

In effect, the bill moves forward by a lopsided margin of 98-0 as dissent melted away, for the moment.

Reid’s unanimous consent agreement provides both parties with a neat way out of an embarrassing impasse while preserving maximum flexibility for further negotiations.

For Senate Democrats it gets the bill onto the floor in exchange for a token concession (dropping the pre-funded $50 billion bank rescue levy most had not wanted in the first place).

Wall Street needs to return to the basic principles of regulation

– Damon Silvers is director of policy and special counsel for AFL-CIO. The views expressed are his own. —

The Wall Street Accountability Act is a conservative piece of legislation.  It is a return to the basic principles of financial regulation that helped our country and the world avoid major financial crises from the 1930’s to the 1980’s, principles that our country turned away from in the name of free market fundamentalism and under pressure from the political power of the financial sector itself.

While the legislation is long and detailed, the principles of financial regulation it embodies are simple and straightforward.

1)    Insurance should only be sold to parties that have something to insure, and a company that sells insurance should have to put capital aside to back up their promise (derivatives regulation). 2)    If you are buying and selling stocks and bonds and other investments on behalf of other people, you have to be loyal to your customers and provide them with enough information for them to oversee what you are doing (hedge fund regulation). 3)    A stable banking system requires deposit insurance, and insured institutions must be regulated to limit their leverage and keep them away from highly risky activity (systemic risk regulation and the Volcker rule). 4)    If an insured institution fails, it must be shut down in a way that protects both its depositors and the financial system, but that wipes out the management, stockholders and long term creditors to the extent the insured institution’s liabilities exceed its assets (resolution authority). 5)    You can’t ask a regulator to at the same time ensure banks are financially healthy and to ensure that consumers are treated fairly (independent Consumer Financial Protection Agency).

Derivatives, hedge funds, private equity firms, off balance sheet vehicles, the repeal of Glass-Steagall—all these so-called financial innovations were and are really nothing more than successful efforts by smart lawyers to undermine these principles, and the Wall Street Accountability Act is nothing more than an effort to restore them.

Of course the Wall Street Accountability Act is an imperfect effort to end the Swiss cheese system of financial regulation.  It is, after all, the product of a political process that continues to be far too much under the influence of the financial firms.

The Act needs to be strengthened by covering private equity funds as well as hedge funds, and giving the SEC the power to force disclosures by these funds to their investors.  Congress should close loopholes in the derivatives section.  Most of all, the Senate should adopt limits on bank size such as those in Senator Sherrod Brown and Ted Kauffman’s amendment.  We should understand by now that as banks get bigger, it becomes harder for our political system to obey these common sense principles.

SEC’s case against Goldman highlights need for Wall Street reform

Ed Mierzwinski

Apr 22, 2010 13:55 EDT

– Ed Mierzwinski is the longtime consumer program director of U.S. PIRG, the federation of state Public Interest Research Groups. U.S. PIRG is a founding member of Americans for Financial Reform, an unprecedented coalition of over 250 labor, senior, civil rights, community and consumer organizations. –

Over 18 months ago, U.S. taxpayers bailed out the reckless Wall Street banks. Yet, despite widespread and overwhelmingly public support for Wall Street reform and dramatic House action in December, efforts to move a Wall Street bill through the Senate have been stalled for months by a phalanx of powerful Wall Street lobbyists. While we cannot count them out, because they’ve increased their lobby and campaign spending as we move toward the endgame, Banking Committee Chairman Chris Dodd’s (D-CT) coup in moving a strong bill closer to floor action gave us some wind in our sails.

Then, several events last week put an even bigger whirlwind behind our reform efforts.

The biggest was that on Friday the SEC filed fraud charges against Wall Street’s high-flying Goldman Sachs and its bond salesman Fabrice Tourre. The SEC alleged that they had made “material misstatements and omissions in connection with a synthetic collateralized debt obligation marketed to investors” and that these CDOs (a type of derivative) had contributed to the enormity of the financial crisis. The SEC’s claim, if proven, essentially will translate to this: Goldman stacked the decks against investors. Fabrice Tourre (who is known as Fab) even sent one email (SEC complaint paragraph 18) that said:

“The whole building is about to collapse anytime now… Only potential survivor, the fabulous Fab… standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstruosities!!!””

In Washington, you don’t have to make this stuff up, it writes itself.

That same day, over at the Permanent Subcommittee on Investigations, Senator Carl Levin (D-MI) excoriated former Office of Thrift Supervision (OTS) boss John Reich for his mishandling of the Washington Mutual collapse (WashPost). Earlier in the week, he had done the same with the executives of the failed bank. In his statement announcing the hearings, Levin was succinct: “The recent financial crisis was not a natural disaster; it was a man-made economic assault.” Consumers were sold predatory, unsustainable loans, by WaMu, Countrywide and many, many others.

China’s yuan, not the dollar, is too cheap

– Peter Morici is a Professor at the Smith School of Business, University of Maryland, and former chief economist at the United States International Trade Commission. The views expressed are his own. —

From Berlin to Bangkok, governments are screaming about the falling dollar, because they can no longer rely on reckless American consumers to power their economies.

From the late 1980s to 2007, the global economy enjoyed The Great Moderation-low inflation and sustained growth interrupted by brief recessions. Driving global growth was an eight fold increase in the U.S. trade deficit, facilitated by a doubling of the value of the dollar against other currencies from 1989 to 2002.

Deregulation and new technologies powered U.S. growth, and Americans flush with success bought whatever the world had to sell. However, when imports substantially exceed exports, Americans must consume more than they earn producing good and services, or demand for what they make is inadequate, inventories pile up, and layoffs and recession follow.

From 2003 to 2007, the U.S. trade deficit averaged $665 billion, and Americans massively borrowed from abroad to keep the U.S. economy going. They posted as collateral overvalued homes financed on shaky mortgages. When mortgages failed, banks failed, home prices dropped, and retail sales tanked. The U.S. economy was thrust into the worst recession in 70 years and pulled the rest of the world into crisis.

Imports of oil and consumer goods from China account for the lion share of the U.S. trade deficit. Americans drive big cars powered by thirsty engines. They sit on vast untapped deposits of natural gas but burn too much heating oil in the winter. Simply, conservatives in Congress are unwilling to submit to genuine energy conservation, and liberals teach developing domestic fossil fuels resources is evil.

For nearly two decades, China has maintained an undervalued currency. The Chinese government tightly regulates private trading in the yuan, and each year, purchases more than 400 billion U.S. dollars with newly printed currency to keep the yuan artificially cheap against the dollar. That is 10 percent of China’s GDP and 20 percent of exports to make Chinese goods artificially inexpensive on U.S. store shelves and juice Chinese exports.

Don’t give the Fed a new job

– Mark T. Williams, a former Federal Reserve Bank examiner, teaches finance at Boston University’s School of Management and is writing a book on the rise and fall of Lehman Brothers. The views expressed are his own. —

In the real world, outside the Washington Beltway, when someone does a bad job they do not get more work.  The Council of Institutional Investors and the CFA Institute Center for Financial Market Integrity task force report agrees with this fundamental point:  Don’t give the Fed the new job.  As an ex-Fed examiner, I applaud this conclusion.

Creating an independent Systematic Risk Oversight Board (SROB) to monitor firms that pose significant risk to the market would inject new honesty to regulatory supervision.  This sound proposal comes at a time when Treasury Secretary Geithner would like to give his former employer, the Fed, additional regulatory duties even if they have failed to earn this right.  The report also is critical of previous light-touch regulation.  The SROB would provide a firmer approach, not repeating the mistake made by the Fed of coming with a knife to a gunfight.

A new oversight board would provide a fresh approach to preventing banks and other financial firms like insurance companies from engaging in risky and financially harmful practices.  Importantly, the task force report recommends restricting risk-taking activities, forcing banks to refocus on their core competencies – taking in deposits and making loans.  Although banks can get into trouble making loans, such activities are more transparent and easier to monitor than the trading of derivatives that, in a flick of a finger, can blow up a firm.  The report also advocates strengthening capital adequacy standards, important for a cushion against losses and insolvency.

Traditionally, banks have made money only three ways — loan interest, fees for services, and trading.  It would be extreme to say that all banks should be restricted from trading.  But there are many that lack the expertise, capital, trained staff, or sophisticated monitoring systems needed to adequately measure, monitor and control risk.

In a capitalistic system it is important to allow market forces to work so that risk taking is adequately rewarded and excessive risk taking is penalized.  However it is equally important to make sure that risky practices of banks do not come at the expense of broader market disruption, economic decline, lost jobs, and financial hardship.

The banking industry is at a fundamental inflection point.  To say, “It’s business as usual, let the Fed do the heavy lifting,” does not address the underlying problem.  How much risk taking should be allowed and how much concentrated financial power should be permitted in the hands of a few banks and non-bank financial firms is a paramount policy issue.

Regulation reform hints of “Old Europe”

– 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.