The financial regulatory reform debate is starting to kick into high gear, and I hope to bang out a post on financial reform this weekend. But in the meantime, here are a few general (and somewhat random) thoughts relating to financial reform:
- My nomination for the Ten Worst Decisions in the Financial Crisis List (you know, if that list existed, which I think it should): Citi's decision to bail out its SIVs and bring over $100bn in toxic assets back onto its balance sheet. Really this was Vikram Pandit's decision — the day after he was appointed CEO, he decided to bail out the biggest Citi-managed SIVs and bring ~$50bn in toxic assets back onto Citi's balance sheet (reversing the bank's previous position, which had been that it wouldn't bail out investors in SIVs without liquidity puts). If you're wondering how Citi ended up with so many toxic assets, and how regulators missed such a massive build-up of risk on Citi's balance sheet, this is your answer. This is also why I'm somewhat sympathetic to the regulators (in this case, the NY Fed). For supervisory purposes, all these toxic assets were gone from Citi's balance sheet, because these were true-sale securitizations to bankruptcy-remote SIVs. Then, all of the sudden, the toxic assets were back on Citi's balance sheet. And it's understandable that regulators didn't foresee that Citi would voluntarily agree to buy back $100bn in assets that it had previously sold in true-sale securitizations.
- It's true that the idea that "what's good for Wall Street is good for America" has been disproved, but that does NOT prove the opposite—that is, it doesn't prove that "what's bad for Wall Street is good for America." It's frightening how many commentators fail to grasp this distinction. Which brings me to...
- Cutting into Wall Street's profit margins shouldn't be an explicit goal of financial reform. In other words, we shouldn't look for where the Street has the highest profit margins, and then say, "OK, now how can we cut into those profits?" In most instances, enacting sensible regulation based on an objective weighing of the evidence will lower Wall Street's profit margins anyway. But the fact that the Street is going to profit from a particular regulatory change doesn't necessarily make the regulatory change ineffective, or insufficiently "tough on Wall Street." One argument I hear a lot on OTC derivatives is that we need to push them onto exchanges rather than clearinghouses because Wall Street would still make fat profits if they just went through clearinghouses. That's not a coherent argument for why public policy should require exchange-trading for standardized OTC derivatives.
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15 comments:
1. Solid. I enjoy not only your arguments/content but your writing style. Long-time reader, 1st (maybe 2nd) time commenter btw.
2. As a fellow full-time Finance practicioner/part-time commentator, I can't believe you're still on Blogger and not Typepad/Wordpress/whatever. Not a big deal besides the fact that my evil overlords, er, employer, a big tarp black hole of a firm, blocks blogger. /whining.
3. Blogger (the blog set-up) doesn't even allow basic html text formatting tags, booo!
/seriously I'm done whining now
Two points in terms of financial regulation (and a question):
1) I do not know of any other sector that can simultaneously sell a product as it buys insurance to protect itself from the product's failure. Transfer that business model to any other sector and it would be appalling.
Imagine an airline company that sells tickets for flights and then buys insurance so that it can profit in the event their planes crash. Not insurance to pay out claims to bereaved family members, but insurance so that the company will profit and pay its executives bonuses when their planes go down.
Simply an unimaginable transaction, when placed within the context of the economy outside of Wall Street. (If you think this approach is good for the economy, please elaborate! Would love to know the value of this kind of innovation, other than ensuring profits for companies that sell instruments that blow up in the hands of customers.)
And for any company that claims to focus on customers, buying insurance to protect you from the failures of products you sell to your customers cannot be good for customers. (Still troubled by companies who maximize profits by selling short the US housing market. That's some vision!)
2) When will the ratings agencies have their day before Congress? Rating crap as AAA investments should be considered criminally negligent, and yet there appears to be no move to change the behaviors of those companies.
Question: Can you explain why investment banks remain as "bank holding companies?" Who gains by this change? How has it made our economy safer?
By the time that Citi bought back those assets they were under close regulatory supervision. The Fed could have stopped them from those purchases if it had wanted to.
Anne: investment banks are remaining bhc's for two reasons. 1 -- the regulators won't let them switch back because then they will be even more independent. 2 -- they get access to insured deposits through their bank subsidiaries and ensured access to the discount window (all primary dealers do right now but who knows if that will remain in effect). Of course we are really only talking about two investment banks these days, GS and MS...
anne, I think virtually every single industry has insurance in the case there is some failure in their products. Furthermore, in the UK at least, it is the norm to have Director liability insurance.
I am at a loss to see exactly what you are outraged about. You upset because GS didn't lose a ton of money and end up bankrupt like LEH? Sold for a song like BEAR? Owned by the government like CITI? Did it somehow become morally reprehensible to make a bet and win in the US? You outraged because GS customers were demanding exposure to these products? You outraged that unlike CITI GS didn't make whole the investors who lost money on their bets and unlike CITI, GS didn't end up needing government mouth to mouth?
As for who gained? Well off the top of my head, there is the majority of sub-prime borrowers who have not defaulted but otherwise would have been denied credit. There is everyone including the government who benefited from 7 extra years of sterling growth. In the UK, there was the bloated public sector that got fat off IB and banking profits.
As for rating agencies, they are measuring a very specific risk - ie default risk. It would be an interesting study to see how many of these CDOs actually defaulted... Weird that given all this stuff - according to you - was so obviously crap that more people didn't make as much money as GS. Almost like you are using hindsight to judge forecasters.
Danny
To Danny:
"Did it somehow become morally reprehensible to make a bet and win in the US?"
It is morally reprehensible to make a bet then have the US government bail you out when the bet tanks.
Then to claim that your brilliance is the sole reason for your massive profits in the year following the massive bailout.
If the "bets" placed by the financial sector hadn't threatened the entire US economy, we would not be having this conversation.
So it's moral to allow millions of Americans to have their retirement income destroyed by the bankruptcy of AIG, or to allow tens of millions of additional people to lose their jobs because it's immoral to save AIG because AIG made bad bets?
anne,
except the bet DIDN'T tank. GS made alot of money shorting RMBSes. The outrage - apparently - is about the fact they MADE money off the sub-prime collapse. The banks that made good profits this year are precisely the ones that DIDN'T need a bailout.
Danny
When one has people like anonymous defending the bailouts without simultaneously calling for the heads of those responsible, it's clear to me that taking the "what's bad for Wall St is good for America" position is closest to the truth.
The other side isn't judicious consideration; it's 'bail out the malefactors of great wealth, and then do nothing about it'.
Your Buy GW2 Goldregulating reform discussion is beginning to help kick into large products, and that i aspire to boom out an article in financial reform a few days ago. On the other hand, here are a couple standard (along Buy RS Goldwith relatively random) thoughts pertaining to financial change:
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