I'm at a banking conference in Hong Kong, but noticed that the Treasury Department has urged a greater federal role in the regulation of insurance in a long-awaited report issued by its Federal Isurance Office. It's a role that the large insurance firms, always unethusiastic about 50 state regulation, would no doubt welcome. Some observations:
- The report does not seek to end state insurance supervision, but would like some direct federal regulation of the sector (for example, for mortgage insurers), and the capacity to threaten states with supplanting regulation if the states do not shape up in various ways.
- The report justifies the need for a federal role in part on the internationalization of isurance, and, to some degree, through IAIS, the internationalization of insurance regulation.
- The rationale for state supervision is that insurance doesn't really need to be regulated for capital adequacy (but see AIG), but rather for consumer protection (your policy doesn't pay out, you get sold insurance you don't need).
- This, like the Volcker Rule, is a product of Dodd-Frank, which created the FIO.
- A report is, as a matter of law, meaningless. Indeed, Congress would have to act to give the FIO some of what it wants.
A wrap on the report is here. It will be interesting to see whether this lands with anything more than a thud.
I've got a piece over in DealBook on the advantages of a multi-regulator regime, which can be seen if you squint in just the right way. A taste:
No other country has created such a patchwork of agencies to deal with financial oversight. Henry Paulson, a former Treasury secretary, called for a rationalization of financial regulation before the financial crisis in 2008. You wouldn’t dream up a world where a rule on proprietary trading by banks has to be administered by five agencies, if it is going to work at all.
Nonetheless, even historical accidents have their merits. Cass Sunstein, the former White House regulatory czar, has long argued that group dynamics — whether they involve multiple judges looking at the same issue, or multiple agencies thinking about the same regulation — can moderate the extremes, and, perhaps, reflect the more careful deliberation that a give-and-take among decision makers should produce.
Moreover, if those regulators, in the end, decide to do things differently, we might expect the benefits of experiment, followed by market discipline, as investors flock to those financial institutions subject to the regulations most likely to keep them profitable and solvent.
Go give it a look, and let me know what you think.
One of the things the FSOC is supposed to be is a task force keeping an eye on financial stability. But it is also, to that end, supposed to be a noodge. It keeps threatening to do something about money market funds in an effort to force the SEC to do more, for example. And it has designated two insurance companies and GE Capital as systemically significant because their primary regulators had not done so.
That is why it is kind of interesting that the Chamber of Commerce has urged that the noodge factor be tamped down. Currently the FSOC can just vote to designate a financial institution as systemtically signficant over the objection of their primary regulator. As Reuters reports on the Chamber's proposal:
"If the primary regulator or independent council member does not vote in favor of designating a non-bank financial company for which the council member has industry expertise... then a second vote shall be scheduled within 45 days," the Chamber wrote. "The primary regulator shall issue a report to the FSOC within 30 days of the initial vote explaining its rationale as to why a firm should not be designated."
It's not a dramatic change - it would slow, rather than end, the council's designation role - but it does suggest that regualted industry is worried about what the FSOC is doing. And that is worth noting, because it wasn't clear that the committee would be able to accomplish much at all, considering that it is a jammed together new federal entity, without totally obvious powers to forces its members to do anything (not always - Jake Gersen has a nice article on the entity that characterizes some of its powers to require as a "Mother-May-I" approach - the cite to that is here, and after the jump).
Longtime readers will know that I have little problem with the revolving door between government and the private sector. Given that regulators of every stripe have, almost in all cases, gone through that door at some point, it seems a little naive to just indict the thing because it is a thing. And there are plenty of reasons to believe it has an upside - but you'll have to read this if you want to find them out.
And now that Tim Geithner, the former Treasury Secretary, has joined a pretty obscure, if legendarily named, private equity firm, I'm declaring victory for the pro-door view. At least in the popular press. Here's a lintany of influencers: Sorkin, Yglesias, Bloomberg. All find Geithner's move unproblematic. And so should you - though you might wonder why you'd take this job instead of becoming chair of the Fed. If being the second most powerful person in Washington is less appetizing than working for not much money in an obscure corner of private equity, perhaps we are going to have to incentivize public service more than the revolving door already does.
Banking regulation is increasingly being done through private contractors - these days, the OCC will require a bank in trouble to hire a consultant, usually composed of former OCC employees, to set things straight, or expect a bank to come to it with that sort of proposal. There are plenty of worries about conflicts of interest in this practice, while at the same time, bank consulting is a business really growing in value, making, for example, former OCC head Eugene Ludwig, who has founded the consultancy Promontory, dynastically wealthy.
Yesterday, the OCC issued guidance - not a rule, nothing binding, so no lawsuit over this is in the offing - to banks on how they should handle requests from the agency to hire consultants. Here's a nice take on the context, from DealBook. The document is short; and it doesn't really constrain the agency. But it does suggest the values that the agency thinks is important when taking on a consultant.
One is competence - that is, the competence of both the bank and the consultant. From the guidance:
When determining whether to require an independent consultant, the OCC considers, among other factors,
- the severity of the violations or issues, including the impact of the violations on consumers, the bank, or others.
- the criticality of the function requiring remediation.
- confidence in management’s ability to perform or ensure that the necessary actions are taken to identify violations and take corrective action in a timely manner.
- the expertise, staffing, and resources of the bank to perform the necessary actions.
- actions already taken by the bank to address the violations or issues.
- services to be provided by an independent consultant (for example, a full look-back or a validation of the bank’s look-back).
- alternatives to the engagement of an independent consultant.
Another is independence:
When evaluating the independence of a consultant, including whether an actual or potential conflict of interest exists, the bank’s assessments should address, and the OCC considers, among other things, the following factors:
- Scope and volume of other contracts or services provided by the independent consultant to the bank. As part of its submission to the OCC, a bank should disclose all prior work performed by the consultant for the bank for at least the previous three years. This information allows the bank and the OCC to assess the nature of the contracts and whether the consultant has been involved in any work closely related to the engagement under consideration. The information also allows the bank and the OCC to assess whether the number of contracts or services the consultant has had or has with the bank may pose an inherent conflict of interest.
- Specialized expertise of the consultant and availability of other consultants, i.e., whether the bank evaluated other consultants with the requisite expertise and independence.
- Proposed mitigants to address any potential conflict or appearance of conflict. For example, when the proposed consultant already has a contractual relationship with the bank, a mitigant could include the creation or maintenance of effective barriers to the exchange of information by different teams of the proposed consultant with differing responsibilities to the bank. Any proposed mitigant must be well established and documented in the engagement contract as well as in ongoing documentation and practice.
- Any financial relationship, including the amount of fees to be paid, or previously paid to the person or company as a percentage of total revenue of that person or company, and any other financial interest between the bank and the proposed consultant.
- Any business or personal relationship of the consultant, or employees of the consultant, with a member of the board or executive officer of the bank.
- Prior employment of consultant staff by the bank.
- Other relevant facts and circumstances.
It isn't clear whether this marks the onset of new oversight of a new set of gatekeepers in financial regulation, or is meant to head off alterantive forms of regulation coming from elsewhere, notably the state of New York. But it's an important development in compliance, I think.
I don't mind the occasional bailout. For financial institutions, unless you're headed into a depression, they often don't lose the government money; instead you hang onto volatile assets until they mature, and when they mature, volatile instruments become more predictable. And often there isn't an alternative to bailing out an important financial intermediary, either. That doesn't mean you celebrate bank bailouts; the loss of discipline on the banks - that is a terrible thing. But it often ends up being the bitter you have to take with the not so sweet, but not so sour either. They do not have to be massive money losers - just time-to-repayment shifters.
Still, we knew that industrial company bailouts might present their own problems. And Treasury hasn't held onto GM long enough for it to bounce back (nor is it obvious that that would eventually happen):
Treasury would need to get $147.95 on its remaining shares to break even. That’s not going to happen: GM’s stock closed Wednesday at $35.80, up $0.21, or 1 percent. At current trading prices, the government’s remaining stake is worth about $3.6 billion. At current stock prices, taxpayers would lose about $10 billion on the bailout when all the stock is unloaded.
Earlier this month, Treasury reported it sold $570.1 million in General Motors Co. stock in September, as it looks to complete its exit from the Detroit automaker in the coming six months. The Treasury says it has recouped $36 billion of its $49.5 billion bailout in the Detroit automaker. The government began selling off its remaining 101.3 million shares in GM on Sept. 26, as part of its third written trading plan.
It will lose $9 billionish on the deal. It isn't obvious to me that Treasury has interfered overly with the corporate governance of the auto companies once it took them over. But it did insist on the divestment of a ton of auto franchises, may have pressed GM to sell Volts, and, in the end, lost money. That's not exactly a record to celebrate, even if you do conclude that some sort of intervention was necessary.
I've been watching the various bailout takings suits against the US government with interest. There are two in particular that are proceeding apace. One is a suit by Chrysler and GM auto dealers who lost their franchises, in their view at the behest of the government, in exchange for the bailout of those companies. Those plaintiffs have done well before the Court of Federal Claims, but will have to defend their efforts in an appeal certified to the Federal Circuit next month.
The other is a suit by Starr, Inc., controlled by Hank Greenberg, the former CEO of, and major stockholder in, AIG, againt the government for imposing disproporionate pain on AIG owners vis a vis other financial institutions that received a bailout. That case has also done well before the CFC, and is now in discovery. And David Boies, Greenberg's lawyer, hasn't kidding around about the discovery, either. He has already deposed Hank Paulson and Tim Geithner on what they knew (presumably a lot), about the decision to structure the AIG bailout the way they did, and he noticed a deposition of Ben Bernanke that required the government to use a mandamus appeal to quash it, which it semi-successfully did last week.
It wasn't a thoroughly convincing quashing, though. High ranking officials in office aren't supposed to be deposed, except when there is a showing of extraordinary circumstances, for two reasons. It's disruptive, and it interferes with the deliberative processes of government.
These concerns go away, however, when you leave government. As the Federal Circuit said, "There appears to be no substantial prejudice to Starr in postponing the deposition of Chairman Bernanke, if one occurs, until after he leaves his post. The deadline for discovery should, if necessary, be extended beyond the current close on December 20, 2013, for that purpose."
I'm not sure that Bernanke's deliberative process will actually tell the Starr plaintiffs very much about their case. With takings claims, the focus is on what the government did, and whether that constituted a taking, rather than on why it did it. A deposition might offer some details on whether the government was imposing a cost on particular people that should have been borne ratably by the taxpayers, which is what the takings clause is supposed to protect (Starr would probably like Bernanke to say that the government zeroed out AIG shareholders to punish them for failing to make sure their firm was being operated cautiously, for example). But again, the question is whether, not why.
It does mean, however, that Bernanke can be pretty sure of at least one thing when he leaves the Fed. He'll soon be under oath, testifying about the reasons why the AIG bailout was structured the way it was.
This will be an outsource - first, to Steve Davidoff's column on the Company That Would End Fraud On The Market (it is Haliburton, with advice from Wachtell Lipton):
The company has petitioned the Supreme Court to overturn the decision in the Basic case, arguing that its standard should never have been adopted. A group of former commissioners at the Securities and Exchange Commission and law professors represented by the New York law firm Wachtell, Lipton, Rosen & Katz have also taken up the cause. In an amicus brief, the group argues that, in practice, the Basic case has effectively ended the reliance requirement intended by the statute, something that is not justified.
They rely on a forthcoming law review article by an influential professor, Joseph A. Grundfest of Stanford Law School. Professor Grundfest argues that the statute on which most securities fraud is based — Section 10(b) of the Exchange Act — was intended by Congress to mean actual reliance because the statute is similar to another one in the Exchange Act that does specifically state such reliance is required.
Professor Grundfest’s argument is a novel one and is likely to be disputed by the pro-securities litigation forces, but the question probably comes down to whether there are five justices who want to put a stake through the heart of securities fraud cases.
And then, to Jim Hamilton and Allen Ferrell, via Scotusblog, for a recap of the oral argument in Chadbourne and Park v. Troice. Here's Allen:
The specter of Bernie Madoff hovered over oral arguments Monday. This was appropriate to the occasion, as the Court was preoccupied with metaphysics: What does it mean for a misrepresentation to be “in connection with” a purchase or sale? The question that came up repeatedly was essentially, whether the lawyers arguing on both sides “agree that Madoff committed Rule 10b-5 securities fraud when he represented that he was purchasing securities on behalf of investors when in fact he purchased nothing.” According to at least one reading of the plaintiffs’ allegations, Stanford Investment Bank arguably acted like Madoff. The bank falsely represented to investors that they were buying an instrument (certificates of deposit) that were in some sense backed by securities — securities that did not exist (like Madoff’s securities purchases that never happened). The answer to this question is critical because if the answer is yes – Madoff did commit Rule 10b-5 securities fraud – and, yes – the alleged facts here are analogous to the Madoff situation – then it follows that the Securities Litigation Uniform Standards Act (SLUSA) precludes the state actions.
And here's Jim:
Mr. Clement said that the whole point of this fraud was to take a non-covered security and to imbue it with some of the positive qualities of a covered security, the most important of which being liquidity. And if you look at sort of the underlying brochures here that were used to market this, he continued, that is really what this fraud was all about. These CDs were offered as being better than normal CDs because we can get you your money whenever you need it.
With the possiblity of debt ceiling default arising quarterly these days, it is worth thinking through the Article III consequences of prioritizing debt payments over its other obligations. Can Treasury do that without facing a ton of big, fat, lawsuits?
Or, to put it another way, why can't it? As Felix Salmon observes:
[W]hy is Matt Yglesias so convinced that prioritization is impossible? He gives four reasons.
The first is that prioritization is illegal: “Treasury is not authorized to unilaterally decide to pay certain bills and not others”. This is true — but also a bit irrelevant. Treasury is under unambiguous Congressional orders to pay lots of bills — all of them, in fact. If it fails to pay those bills, it will be violating the law as laid down by Congress. Hence the 14th Amendment argument that the president should simply ignore the debt ceiling entirely, if it comes to that. But underneath it all, it’s hard to credit any argument which says “Treasury isn’t allowed to pay its own bonds”. If that’s what Treasury wants to do, then surely it can do so. Besides, who would even have standing to sue?
I can think of some people who would have standing to sue - they would suffer a concrete and particularized injury, caused by the government, and fairly traceable to its actions if Treasury took a dwindling pot of money, and stiffed General Dynamics on contracts due for submarine repair or whatever, while instead paying interest on maturing sovereign debt. But that doesn't mean that they could sue and win; here, I agree with Felix Salmon. The courts have found - unless Congress has provided otherwise in its statutory guidance - that managing lump sum budgets is committed to agency discretion by law. Under the logic of Lincoln v. Vigil, the leading case for this proposition, I accordingly think that lawsuits against Treasury for prioritizing debt repayments would be unlikely to succeed. As the Supreme Court said then:
Britain and the United States are increasingly matching one another stride for stride when it comes to supervision of the financial markets. Today, the meme was copying - Britain has announced a qui tam whistleblower program that may work like the one rolled out by the SEC. Earlier this year, it was about improving a flawed model; sick of being subjected to American deferred prosecution agreements, Britain came up with its own DPA scheme - and actually passed a law and went through notice and comment before doing so. And at times in the past, the model has been harmonization through a deal, which was the case for the first Basel capital adequacy accord, which only developed after the US and UK concluded a tentative arrangement on bank reserves that threatened to shut the rest of the world out of those then dominant financial markets.
These different approaches - copying, improving, negotiating - are distinctions that matter; but the consistent transmission of American rules into British financial markets is pretty interesting, given that we used to be talking about how Sarbanes-Oxley had made America distinctively bad, and Britain distinctively attractive, to public issuers.
The Fed board member finished off a speech on October 4 by laying into money market funds:
I would be remiss if I did not remind you of another, highly complementary area where reform is necessary: the money market fund sector. Money funds are among the most significant repo lenders to broker-dealer firms, and an important source of fire-sale risk comes from the fragility of the current money fund model. This fragility stems in part from their capital structures--the fact that they issue stable-value demandable liabilities with no capital buffer or other explicit loss-absorption capacity--which make them highly vulnerable to runs by their depositors. I welcome the work of the Securities and Exchange Commission on this front, particularly its focus on floating net asset values, and look forward to concrete action. Another source of fragility arises from money funds investing in repo loans collateralized by assets that they are unwilling or unable to hold if things go bad. This feature creates an incentive for them to withdraw repo financing from broker-dealers at the first sign of counterparty risk, even if the underlying collateral is in good shape.
For those reading between the lines, this "I care what the SEC is doing with MMFs" might be viewed as a threat, both to the industry and the agency. The Fed may be telling the SEC that it will step in, via the FSOC process, to regulate the funds as systemtically destabilizing (and therefore in need of SIFI designation), if the SEC doesn't sort them out itself. One thing is clear: Stein has no doubt that the funds are fraught with danger.
That's the rule that compares CEO pay to median worker pay - it is supposed to shame CEOs, but so was the rule requiring them to plain old disclose their own compensation, and look how that turned out.
Anyway, here's a nice overview from Matt Levine; I found it interesting how interested people are in this rule; the SEC said it would be regulating in this area (Dodd-Frank requires it), and:
In connection with rulemakings implementing the Dodd-Frank Act, we have sought comment from the public before the issuance of a proposing release. With respect to Section 953(b) of the Dodd-Frank Act, as of September 15, 2013, we have received approximately 22,860 comment letters and a petition with approximately 84,700 signatories.
If anything like those numbers comment on the agency's proposal, it will be pretty busy when it drafts the final rule's statement of basis and purpose. That statement must respond to "well-supposed arguments contained in public comments critical of the agency's proposed rule." A lot of comments means a long, long statement.