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.
For those of you wanting to keep tabs on the soon-to-be-final Volcker Rule, here are some important links. Here is the fact sheet (released today). Here is the board memo accompanying the final rule from yesterday. The full proposed rule as printed in the Federal Register.
In a nutshell, the rule will prohibit "banking entities" from engaging in "proprietary trading" and owning "covered entities." The meat, of course is in the definitions and exceptions. The term "banking entity" is going to basically cover any bank holding company or other insured depository institution operating in the U.S., including affiliates, subsidiaries, parent companies, etc. Nonbank financial companies are exempt from these prohibitions but may be subject to other capital requirements. Proprietary trading activites are prohibited, but market-making, risk-mitigating hedging, underwriting and trades necessary to provide liquidity are exempt. Certain investments in covered entities, hedge funds and private equity funds, are exempt. And the kicker -- executives have to certify that the bank has "taken steps" to comply with the rule, though they don't have to certify actual compliance.
So, will this take away the benefits of being a BHC for Goldman and Morgan Stanley? Maybe, though I read at least one commentator say that should these "too big to fail" entities opt out, regulators could just change the definition of "bank entity" to include "systemically important financial institutions" (SIFIs).
Hard to believe, but the Volcker Rule was proposed in 2011. Here is a great series of posts by friend of the Glom Kim Krawiec on the making of the Volcker Rule.
Finally, if you want a good read on the very profitable road from matching customer trades to proprietary trading, The Partnership: The Making of Goldman Sachs, is a very interesting read.
The multibillion dollar fine imposed by the EU for rigging the LIBOR and other rates was doled out not because the rate rigging was deemed a form of market fraud, but because it was collusive, anti-competitive conduct. Indeed, the EU doesn't have a regulator who can police that kind of fraud. Instead it has antitrust, the seminal European worry, and a font of regulation that has quite literally been used to further the European project (dethroning national champions, removing internal trade barriers, defending important European companies, like Airbus, against foreign competitors, you name it). So it's a good thing for Europe that this could be fit within the antitrust rubric.
It gives some lie to the idea that Europe hopes to become the world's regulatory superpower though (see this talk by Moravcsik, or this for an overview of that school of thought). Clearly the continents super powers are not distributed evenly.
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.
The $13 billion dollar settlement with JPMorgan over violations made by companies it bought during the financial crisis appears to be all but final. You may think it is a much-awaited example of finally getting tough with financial institutions, but you may also be wondering about the fairness of it all. Were these bankers doing things that are different from other bankers? Why aren't those other bankers paying commensurate fines? Is this like the LIBOR scandal, where many banks were involved but only one, Barclays, paid with the loss of its CEO?
It is like that. But if you want to make peace with this sort of government enforcement, here is how you do so:
- Making an example. These sorts of enforcement actions tend to amount to a form of the original meaning of the term decimation. The idea is that the dramatic punishment of a few will deter the many, which means that those singled out can expect - maybe reasonably, even as they bemoan their bad luck - severity.
- Limited resources. But building a case is difficult, and so the government is wise to concentrate on the famous, given that it cannot hope to enforce against everyone - the Wesley Snipes principle, if you like. JPMorgan is the most famous of the banks, the most in the news, and therefore the most tempting target if your goal is to maximize the impact of a necessarily limited set of enforcement actions.
- Contract misrepresentation damages. Half the settlement is not so much a fine as it is compensation to misled investors. In this sense, part of that big number is very much simply a measure of an expectancy not realized. It is that sort of remedy that you'd think would most likely be paralleled in proceedings, perhaps initiated by private parties, against other banks.
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.
Entirely unrelated: Wharton now has a section of the full-time MBAs meet in San Francisco.
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.
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.