How should we regulate the derivatives markets? Dodd-Frank gave the CFTC (and SEC, for securities derivatives) the power to act. But how should they act? Again, Dodd-Frank offered guidance, but the terms of regulation, in particular of the clearinghouses that are supposed to centralize derivatives trading has been set not by statute, or by CFTC rule, but by a just-concluded agreement with European regulators on how to oversee the market. That's increasingly how capital markets regulation works, given the mobility of capital and need for standardization. But it is certainly idiosyncratic, both as a method of domestic regulation and international governance, because it constitutes rule by agreement, not by law, which is something I've written about in the past.
Today the Fed issued a $131 million penalty against HSBC for playing fast and loose with some of the evidence designed to support its mortgage foreclosure documentation, which it amped up in the wake of the financial crisis. It got the bank to agree to a consent order to stop doing that in 2011, and took its sweet time in assessing a fine. But don't worry, it wasn't just HSBC:
The terms of the monetary assessment against HSBC are similar to those that were part of the penalties issued by the Board in February 2012 and July 2014 against six other mortgage servicing organizations that reached similar agreements with the U.S. Department of Justice and the state attorneys general.
Matt Levine observed only yesterday that "The supply of pre-crisis mortgage misconduct seems limitless, the statutes of limitations are flexible, and the mortgage-lawsuit industry may be too large and lucrative ever to really end." It turns out that we are still in business on post-crisis foreclosure dodginess, too.
I wrote an article that was meant to serve as a pretty comprehensive overview of the way that the crisis has played out in the courts. And I still like the article. But it turns out that I wrote it in media res.
There's talk in the Senate of imposing new rulemaking restrictions on the SEC, and over at DealBook, I take a look:
The legislation would require more math and permit less flexibility by those regulators. But it would also limit Congress’s own ability to require the government to embrace good governance values like “transparency” and “honesty,” if the S.E.C.’s most recent rule-making is any guide.
The senators have suggested that they would impose cost-benefit analysis requirements on America’s financial regulators. No important rule could be passed without establishing that the dollar impositions on the financial industry would not be outweighed by the dollar benefits created by the rule.
The S.E.C. has, because of a series of adverse court decisions, grudgingly embraced a version of this sort of cost-benefit analysis in its rule-making proposals.
Now you can take a look too!
I'm no expert on labor law, we leave that to Matt, but one pays attention when the decision of an Administrative Law Judge makes the paper. You can't fire workers for trying to unionize, and I really don't understand WalMart's defense of its decision to fire workers who tried to unionize.
Most of the allegations related to a coordinated set of strikes collectively referred to the "Ride for Respect" because they involved traveling by bus to the company's headquarters in Arkansas for protests at its shareholders' meeting in June 2013.
WalMart called this an unexcused absence and disciplined or terminated the workers who went on the Ride. To me it looks like an effort to unionize, and I didn't think that was a legal firing offense. But it sounds like the firm prefers to fire workers who try to unionize and face the consequences.
For those who believe that bank regulators are totally captured, I give you MetLife's very grudging decision to maybe break itself up in an effort to get undesignated as a systemically important financial institution, subject to extra capital requirements and Fed supervision. GE hated being a SIFI so much that it got out of of the business of finance. MetLife was so outraged by its designation that it sued. And the enormous asset managers, such as BlackRock, watching this must be terrified that they will be designated next.
The exception? Very large banks, who were already subject to Fed supervision, aren't trying to get smaller, or at least haven't so far. It could be that one of the things that they consider to be part of their skill set is dealing with regulators. For those who grew into prominence with other skills, regulatory management is clearly not worth the candle. But that's what big banks do.
The giant insurer MetLife said on Tuesday that it was exploring spinning off its retail life and annuity business in the United States because of financial pressures it is facing under regulations put in place in the wake of the financial crisis.
The decision was made two years after the Financial Stability Oversight Council, a group created by the 2010 Dodd-Frank regulatory legislation, named MetLife a systemically important nonbank financial institution, or SiFi. That designation carries requirements to set aside more capital as a cushion against a substantial decline in the nation’s financial markets as occurred in 2008, potentially limiting its earnings.
MetLife is considering several options, including an initial public offering to create a company that would, presumably, be better able to compete with smaller life insurance and annuity providers who are not subject to the same regulatory restrictions.
Daniel Gallagher has announced that he will be joining Patomak Partners, a company that is going to do the same thing that Promontory and PWC does - accumulate regulators who can get banks and broker-dealers out of regulatory trouble, partly by relying on the expertise and contacts of their principals, who tend to have run the agencies regulating the banks. It's a huge growth industry in banking regulation, sometimes dubbed shadow regulation, and a controversial one, because revolving door etc. I, however, am all in favor of the revolving door, and see nothing particularly wrong with this one.
However! Patomak is new and young and small, but what it represents is the politicization of these sorts of firms. Promontory invented the genre, and it was started by Democrats, but it reads as relatively non partisan. A review of the masthead of Patomak reveals a litany of Republican former political appointees at the SEC and CFTC, starting with the president and CEO, Gallagher, and Paul Atkins, probably the most aggressively conservative SEC commissioners ever, surely at a cost to their standing with the agency staff.
It makes you wonder what the play is. Trent Lott successfully created a Republican K Street, annoyed at the liberal dominance of lobbying firms, and thinking that the existence of a parallel more conservative DC ecosystem would benefit his party. Those firms do fine, I think, but being able to seriously negotiate with enforcement officials usually requires a vaguely non-partisan hue; that's one reason why law firm white collar practices generally don't sort into liberal and conservative. I'm not sure that a right wing financial regulation consultancy makes a ton of sense from a business perspective. So maybe you think this is like a think tank - a place where politicians hang out and make a little money before accepting their next appointment. Except that the next appointment for SEC and CFTC commissioners, other than chair, never usually happens. Instead, they go to law firms or academia, and become wise old people of capital markets regulation.
I suspect that the assumption is that even independent agency work is getting increasingly politicized, and so the next time there's a Republican presidency, the SEC and CFTC appointees are going to listen to Patomak, and aren't going to listen to anyone else. That will make for some feast and famine years for the business, and isn't an entirely appetizing prospect for regulation in general. It's also a big bet by Atkins and Gallagher, et al, on President Trump, or whoever. But maybe they were having a hard time getting hired by less partisan firms.
The chief executives of some of the largest banks in America are allowed to serve on its boards. During the Wall Street crisis of 2007, Jamie Dimon, the chief executive and chairman of JPMorgan Chase, served on the New York Fed’s board of directors while his bank received more than $390 billion in financial assistance from the Fed. Next year, four of the 12 presidents at the regional Federal Reserve Banks will be former executives from one firm: Goldman Sachs.
These are clear conflicts of interest, the kind that would not be allowed at other agencies. We would not tolerate the head of Exxon Mobil running the Environmental Protection Agency. We don’t allow the Federal Communications Commission to be dominated by Verizon executives. And we should not allow big bank executives to serve on the boards of the main agency in charge of regulating financial institutions.
If I were elected president, the foxes would no longer guard the henhouse. To ensure the safety and soundness of our banking system, we need to fundamentally restructure the Fed’s governance system to eliminate conflicts of interest. Board members should be nominated by the president and chosen by the Senate. Banking industry executives must no longer be allowed to serve on the Fed’s boards and to handpick its members and staff. Board positions should instead include representatives from all walks of life — including labor, consumers, homeowners, urban residents, farmers and small businesses.
That change makes a ton of sense. But there's also a call by Sanders, duplicated by Rand Paul and others, to "audit the Fed."
In 2010, I inserted an amendment in Dodd-Frank to audit the emergency lending by the Fed during the financial crisis. We need to go further and require the Government Accountability Office to conduct a full and independent audit of the Fed each and every year.
I don't even know what this means. Audit how? To what end? Does someone think that the Fed fails to accurately report its assets and liabilities? A GAO report on the Fed would differ from what we already know about the Fed's finances not one whit. When confronted with avidly pursued meaningless policy claims, my assumption is that it's a means to some other end. In Paul's case, that end would be to eliminate the Fed. Sanders can't possibly want the same thing, can he?
If you missed it, Lucian Bebchuk and Robert Jackson are in the Times today decrying the budget bill's one year prohibition on the SEC's issuance of political spending disclosure requirements rules. That's pretty micro-managey, and you can't imagine the legislature getting so involved in the details of banking regulation. Bebchuk and Jackson are, as proponents of regulation here, displeased:
The rider also undermines the standing of the S.E.C. It reflects a judgment that the commission and its staff, which have served the investing public well for generations, cannot be trusted to reach an appropriate decision about whether and how to develop rules in this area. Legislators should not tie the hands of independent and expert regulators and prevent them from doing their job.
And the rider undermines the critical premises on which the Supreme Court has relied in its Citizens United decision. In this consequential decision, the court reasoned that “the procedures of corporate democracy” would ensure that political spending by public companies does not depart from shareholder interests. Without disclosure to investors, however, such procedures cannot be expected to limit or prevent such departures.
Under a Carolene Products theory, this would be the sort of case that could call for judicial involvement; it involves legislators legislating for opacity about who gives to their own campaigns - a self interested effort that undermines the democratic process.
Earlier this week, while on the road, I had a column in DealBook on the use of the Fed's balance sheet to fund the bipartisan highway bill. I'm skeptical:
The bill exemplifies a new trend of legislative hostility toward the agency, which has expressed itself in Republican-sponsored bills calling for audits of the central bank, efforts to limit the Fed’s discretion in setting monetary policy and even calls for its dissolution.
Those bills had never gone far. But now, the tax-averse legislature has chosen to pay for new highway funding through two raids on the Fed’s budget. If this bill becomes law, it will represent a new and troubling interference by Congress in the affairs of the central bank.
The first raid drains the central bank’s “rainy day fund,” money set aside from revenue earned from its trading operations – it trades government debt to set monetary policy — to deal with the possibility of market losses.
The second raid reduces the dividend that the Fed has paid to its member banks. Since 1913, that dividend has been set at 6 percent. Under the highway bill, the new, lower dividend would track the rate of return on the 10-year Treasury note, currently around 2.2 percent, with the difference being used for highway funding.
Reactions and corrections welcome!
For the first time in almost a decade, the Federal Open Markets Committee is likely to raise rates today. Whole careers have been launched without going through one of these things, so there's plenty of attention being paid, though I don't know, maybe instability in the bond market will make them less likely to do it.
That the speculation above is the sort of thing that a lot of people are doing illustrates what an odd creature of administrative law the FOMC is. It essentially is exempt from most rule of law requirements, although its empowering statutes featured a ton of guidance from Congress about what it should think about when it thinks about the monetary supply. But its decision about whether to raise or lower the federal funds rate is a matter left entirely to its discretion, and neither the courts, nor Congress, nor the President will have anything to say about it.
There's lots of good reasons for that - politicized money tends to be very susceptible to inflation. But one of the reasons to have administrative law is to render decisionmaking predictable, and really, nothing's more important than predictability when it comes to the monetary supply, where there's not a good reason, absent terrible economic conditions, to surprise anyone ever. In my view, that's why the FOMC has adopted rather stable customs in lieu of legal constraints, and I wrote about it here. Boring meetings, standardized voting, releases of the data on which the decisionmakers relied ... not of it is required by law, and yet all of it has been adopted by the agency.
Gretchen Morgenson says no, in a long front-page story in the Times, which should raise the hackles of any free-marketer. I though Matt Levine's comments were smart. The political economy of what to do about Fannie and Freddie is partly driven by the hedge funds who have taken big positions on the failed government agencies' stock, which wasn't wiped out when the government took the agencies over (and perhaps you can see how that structure is a weird one). If they don't win their takings claims based on that takeover, they want a "recap and release," that is, they want Fannie and Freddie to go back to being the super profitable guarantors of mortgages that they used to be. It's basically a big bet on Congress agreeing with them, because the current executive branch is dead set against it, and that seems like a very risky bet to me. It is also buccaneering capitalists pushing for government support for residential mortgages, which you don't expect to see every day; it appears that Morgenson thinks the hedge funds are onto something.
Anyway, the takings claim isn't a bad one - Steven Davidoff Solomon and I wrote about it here.
Via Corp Counsel, I enjoyed this talk by outgoing SEC Commissioner Luis Aguilar on "(Hopefully) Helpful Tips for New Commissioners." Indeed, some of the people associated with this site might find it particularly interesting. Aguilar makes being a commissioner sound a little like being a judge. There's a staff of five, four counsels, and one confidential assistant, and you spend all your time talking to them, so they have to be good. I also found these quotes - quotes from which Aguilar took inspiration - to be somewhat dark and foreboding:
“You have enemies? Good. That means you’ve stood up for something, sometime in your life.” — Sir Winston Churchill
“The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather a lack of will.” — Vince Lombardi
If you set out to be liked, you would be prepared to compromise on anything at any time, and you would achieve nothing.” — Margaret Thatcher
I would have thought that being a commissioner would be much more like being the deputy secretary of an agency than a judge, but perhaps for nonstop meetings with a dizzying array of underlings, it's the chair or nothing.
The conflict between the SEC and Congress over its investigation of a tip from a committee staffer on Medicaid reimbursement regulations has resulted in an opinion requiring the House and the staffer to respond to an agency subpoena. Matt Levine has the opinion and a review of it (meh, he says), here. Here's a wrap.
I'm not sure I agree with the opinion. On the one hand, Congress could not have more clearly waived sovereign immunity for insider trading in the STOCK Act, which applied that doctrine explicitly to itself. On the other hand, the Speech and Debate Clause is meant to prevent the executive branch (for which read the SEC, although it less in the sway of the executive than is, say, the Department of Justice) from intimidating the legislative one when it is legislating, and there's lots of good precedent applying the protections enjoyed by members of Congress to their staffers, and applying them to investigations as well as prosecutions. The tip in question in this case went from a staffer to a lobbyist, and I can't think of a more legislative thing to do than to have those conversations - indeed, the court acknowledges that Congress was legislating at the time.
It could be that there is no good reason to protect insider tipping by staffers, but that's not clear to me, at least under the facts of this case. Staffers are going to want to talk to lobbyists about how to get things done, and that could easily involve discussions about what Congress is likely to do next, and that could easily be seen as market moving information. It would make it hard to legislate if staffers had to worry about these conversations.
So maybe Congress is standing up for its staffers as a true matter of principle. I don't quite follow the political economy here, though. If Congress is upset about this, I'm surprised the agency is willing to take it to litigation, but maybe they take the STOCK Act especially seriously over there.
My esteemed colleague Kent Barnett has an op-ed in today's WSJ regarding the problematic use of in-house administrative judges. Kent has shared some of his insights before, when a district court judge enjoined an SEC enforcement action because the presiding administrative law judge (ALJ)' s appointment violated the Constitution. Administrative judges (AJs) outnumber ALJs and are far less independent of the federal agencies that employ them. Here's Kent in the WSJ:
The Securities and Exchange Commission has recently come under fire for pressuring its in-house administrative-law judges to rule in its favor during agency enforcement proceedings. These are serious charges because ALJs are guaranteed independence by statute. More troubling, but largely overlooked, are the judges in federal regulatory proceedings who lack statutory independence.
They have many titles, including hearing officer, appeals officer or immigration judge. But they are often collectively referred to as administrative judges. More than 3,000 AJs—approximately double the number of administrative-law judges—work in numerous federal agencies, including the IRS and the Equal Employment Opportunity Commission.
Administrative judges preside over trial-like hearings that award or deny benefits or licenses, assess penalties for regulatory or statutory violations, or resolve private disputes. Agencies often appear in proceedings opposite the parties they regulate.
Significant statutory safeguards exist for administrative-law judges. Federal regulatory agencies appointing one must choose from three candidates whom another independent agency, after administering an exam, has deemed the most qualified. ALJs cannot receive bonuses or performance reviews from agencies. They cannot report to enforcement officials and generally cannot speak to agency officials about a case without the other party present. Agencies can discipline or remove them only if another independent agency determines that “good cause” exists for doing so.
Administrative judges are an entirely different matter. Federal agencies can appoint their own AJs directly and reward them with bonuses after agency-led performance reviews. Agency officials can discuss matters in dispute privately with them. Nearly all AJs lack statutory protection against arbitrary discipline or removal.
Go read the rest to find out what Kent recommends. Or read this for even more of the story.
With this terse order by the D.C. Circuit, it is official, the SEC's conflict minerals rule is unconstitutional ... but only to the extent that it requires public issuers who did make use of conflict minerals to state on their disclosures that their products have “not been found to be ‘DRC conflict free.’”
The idea is that this was forcing firms to declare that they had blood on their hands, and I find it all pretty unconvincing. The SEC can require firms to make disclosures in particular ways, it can require firms to make climate change disclosures, and it can tell them to identify, say, risk factors of participating in a securities offering that make the issuer look bad. This is all forced speech, and a disclosure based agency couldn't function if it couldn't require disclosures, including uncomfortable disclosures, permitting an inference that the issuer is incompetent, naive, whatever, and that the speaker would rather not say.
There may be a line that can be drawn - the SEC can require firms to say uncomfortable things, but it can't require them to say an exact set of words that make them look bad. I guess that would be a rule, but it wouldn't be much of a rule.
For example, consider the conflict minerals rule itself, which is both unconstitutional and very much in effect. Although companies do not have to attest that the products they make are not DRC-conflict free, they do have to do everything else: investigate their supply chains, describe their investigation, and report on the results of that investigation, including whether it revealed that they make products involving conflict minerals.
Anyway, Congress hasn't lost its taste for conflict minerals, and bills have been introduced in the House and Senate to add to the SEC's policing in this area. That's something that will not overjoy those in the agency who never thought of it as the tip of the spear in the spreading of human rights values.