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.
Media observers will be a little curious about the timing of an op-ed that isn't really asking for much, even though it sort of serves as a rebuke to one of the themes of the Bernie Sanders campaign. Still, Eisman, the Big Short protagonist, on why breaking up banks is a bad idea:
It’s no longer accurate to say that the large banks pose a systemic danger to the American economy. Some argue that they should be broken up solely because they are too politically powerful. Perhaps so, although that power hasn’t managed to prevent regulators from dismantling bank leverage and risk. Furthermore, no advocate of a breakup has come forward with a plan on how to do it. Large banks are global, complex, integrated institutions. Breaking them apart would be incredibly difficult, long and disruptive, and the banks might have to freeze loan growth during the process, slowing our economy even further.
He thinks that banks were too risky because they were overleveraged, but now that they are not levered up, they are safe. You will note that safety isn't the only reason to break up the banks. Apart from the politics, there's the antitrust problem, and maybe large financial institutions discourage experimentation. Moreover, maybe even low leverage banks are prone to bank runs. I'm not convinced by this, but it's always nice to see another unicausal theory of the financial crisis.
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.
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.
I weighed in with a couple of quotes on shadow banking, which Hillary Clinton thinks Bernie Sanders doesn't want to regulate, and breaking up the banks, which Sanders wants to do.
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?
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.
As Mehrsa observes, the largest problem for middle and working-class access to the benefits of banking concerns the perceived cost of catering to such small time financiers. They simply do not borrow or lend enough to make it worthwhile. One question addressed in the second half of her book concerns some alternatives to banks that might be willing to enter a market that the big national banks have largely exited, in her telling.
But of course, fixes that can market efficiently to low dollar depositors might well have some competitive advantages when it comes to high dollar depositors as well. To me, the interesting question is whether the innovation here will be one of financial technology or one that requires a regulatory blessing. Mehrsa considers microfinance, which Christine has discussed (and so I won't), or community minded banking, which looks like a triumph of hope over experience. But she also surveys debit cards, Walmart, mobile banking, and peer-to-peer lending; they all offer the prospect of inexpensive credit, or at least efficient access to the financial system, without necessarily requiring the use of algorithms or robots.
Leaving aside mobile banking and the Wealthfronts and VenMos of the world, it is worth noting that the problems for debit card issuance, by the post office or whoever, banking at Walmart, and P2P are regulatory ones, rather than technological ones. The question has been whether these institutions are enough like banks to be trusted with deposits. Much of the answer to that question is tied up in bad old competition avoidance by the already extant banks, who lobby against potential competitors. But some of it lies in the idea that few can be trusted to hold other people's money. Bank charters, as Omarova and Hockett can tell you, require the institution to act in the public interest. Other holders of funds have fiduciary obligations to the owners. And the regulatory question is whether Walmart or Joey8359 on the internet will feel the same way, or, put another way, whether we should care that they obviously will not.
I will echo the praise of the prior contributors: this is a really well-written book, packed full with insightful and accessible anecdotes, thoughtful analysis, and a strong message. Like Christine, I was particularly interested in the middle chapters, as I worked on bank lending and Community Reinvestment Act issues with the Woodstock Institute prior to law school. My former boss at Woodstock went on to work with South Shore Bank/ShoreBank, and I remember the real enthusiasm and optimism surrounding that bank and its mission. But as the book points out, ShoreBank became insolvent in 2010 after being refused TARP funding. The story of that bank's failure could be one of liberal cronyism and ideology run amok, or simply the collapse of an undiversified regional bank in the midst of an international financial breakdown.
The narrative is important and therefore contested because blame is important in this space. The facts, marshaled clearly and thoroughly by the book, are undeniable: approximately 70 million Americans do not have a bank account or access to traditional financial services. The services provided to the unbanked or underbanked are generally much more expensive and filled with costly penalties and fees. At the other end of the spectrum, banks provide services to the well-off for reasonable prices and in turn are backed by a myriad of federal and quasi-federal protections. The book makes a convincing case that our banking system is not a free market, but rather a highly-regulated market that is supported by the government. And, due to a series of changes in the law over the last century -- ones that accelerated after the 1980s -- average Americans are much more likely to be left out of traditional banking services.
So who is to blame for all this? The book essentially paints a picture of greedy banks shunning the poorer and less profitable consumers in flagrant disregard for their original, public purpose. It is Jeffersonian in its approach: smaller is better, more local is better, community is better. It is not wholeheartedly in this camp -- it acknowledges that large banks are more efficient, less vulnerable to regional conditions, perhaps better (and even cheaper) at providing certain services to certain clients. And it also recognizes that banking services for the poor may not be that profitable (not profitable?) when conducted along the same terms as applied to richer folks. But the central theme of the book, at least on my reading, is that banks have become unmoored from their public trust and are exploiting their special relationship with the government to capture the upsides of capitalism without the downsides.
So it is somewhat surprising that the book lets banks off the hook at the end by promoting a public option for banking, specifically postal banking. The idea has a lot to recommend it, beyond even the problem of underbanking. But it also raises a lot of questions. Can the post office do what community banks couldn't? Do we think post offices will do a better job of moving beyond the credit score to asses the "real" credit risks presented by each loan applicant? Does the public really trust the post office?
But my more theoretical question is this: why should we let the big banks off the hook? If the book had presented the problem of underbanking as a natural and understandable market failure, based on the inability of the poor to make traditional banking profitable for banks, then a public option would make a lot of sense. But if banks are pulling a fast one here by shirking their public responsibilities , shouldn't we make them accountable? The book's discussion of the CRA does a nice job of briefly outlining the history of the act, as well as the views of its supporters and critics. But it left me wondering whether the CRA was doomed to failure, or whether it just hadn't been implemented with the appropriate teeth. And I think this strikes at an ambivalence that underlies a lot of the book. Yes, banks are making beaucoup bucks while safely within the arms of their government protectors. At the same time, however, they are just being what they were designed to be: profit-making businesses operating within a market.
Perhaps, in the end, we'd rather solve the problem of underbanking than exact a just recompense from powerful economic and political actors. Or perhaps we can square the circle by requiring banks to fund the public option with a special bank tax or fee -- something similar to the FDIC. But I think a whole lot more people will be asking these questions thanks to Mehrsa's thoughtful, engaging, and provocative book. Congrats to her on this terrific accomplishment.
Mehrsa's fine book is an appealing combination of history and policy. On the one hand, the book reviews the way that the poor and middle-class have accessed the finance system in the United States over decades, and how that access has been a story of changing institutions. On the other, policy, hand, the book features an appealing recommendation, not for a return to the community banking days of yore, but rather for a supplementation of our current national banking system with a reanimated postal bank. While community banks, for a variety of reasons, handled the banking needs of the poor and middle class (or so she argues; I'm not entirely convinced about that), national banks are unwilling to chase small depositors, for profit lies only in servicing big ones. A postal bank might at the very least be able to provide the unbanked with debit cards, and at best might be able to give them the sorts of financial services that are now being provided by shadow banks such as payday lenders, title loan companies, and the like.
I could see assigning this book to the class of business school or law school students interested in how the banking system has changed and what it does today.
One of the things it does, and has always done, according to Mehrsa, is dependent on the government. On page 16, she posits that "government support is the only reason depositors trust banks, and without trust from depositors, banks don't exist." One of the interesting memes that I have noticed in law and finance scholarship is that, in marked contrast to corporate law scholarship, many of the authors agree with Mehrsa that finance, by some measures the largest component of the economy, is almost entirely a creature of regulation. For other examples of this sort of work see here and here. As someone interested in regulation generally, I see why I've grown particularly interested in financial regulation, though I suspect that an important component of financial intermediation is not purely an example of regulatory beneficence. Indeed, the whole regulatory arbitrage story that plagues financial oversight suggests that regulatory fixes to fundamental finance problems, like banking the unbanked, will always be challenging.
Creating a continent wide deposit insurance program is interesting because of its American antecedent. The FDIC is one of two ways that America's entirely state-regulated banking system became, in essence, entirely federalized (the other one emerged through the Fed's oversight of bank holding companies). Once you have an insurer on the hook for making your depositors whole if you disappear, you have an institution that is going to want to inspect your books and interview your executives. And the EU commissioner who proposed it is British, one of the countries least enamored of the emerging EU agencies who are taking over from local banking regulators. It is quite the rejection of federalism.
One of the amazing things that has happened in the wake of the financial crisis is that international bank regulators have moved from measuring two things - capital adequacy and the leverage ratio of banks - to measuring a lot of different things which must be computationally hard to keep in balance. In addition to the two extant measures, banks have to establish a net stabled funding ratio (NSF) designed to deal with long term assets, a liquidity coverage ratio (LCR) designed to deal with short term assets, and let's not forget the work being done in the US by the stress tests, labelled DFAST and CCAR, or Europe's MiFID.
Into the mix the Financial Stability Board has added a total loss absorbing capacity rule, or TLAC. The best way to think of this rule is as an alternative measure of the capital adequacy of very big banks, with an eye to the moment of failure; it requires banks, in addition to holding common stock and cash, to hold financial instruments like convertible bonds (or maybe plain old unsecured debt) that can be used to bail-in the bank - bail-in means that the bank looks to its creditors to provide it with resources to stabilize it, bailout means it looks to the government to provide those resources. Or, if you like, here's the FSB:
G-SIBs will be required to meet the TLAC requirement alongside the minimum regulatory requirements set out in the Basel III framework. Specifically, they will be required to meet a Minimum TLAC requirement of at least 16% of the resolution group’s risk-weighted assets (TLAC RWA Minimum) as from 1 January 2019 and at least 18% as from 1 January 2022. Minimum TLAC must also be at least 6% of the Basel III leverage ratio denominator (TLAC Leverage Ratio Exposure (LRE) Minimum) as from 1 January 2019, and at least 6.75% as from 1 January 2022.
Without going too far down this road, I think that these varied sorts of capital measurement are basically supposed to discourage regulatory arbitrage, though it also suggests how puissant big banks must be in handling their regulatory requirements. Not a place for a financial startup. TLAC is also a tax on big banks, of course, and a disincentive to become one of the thirty largest institutions in the world. Here's the WSJ with an explainer.
This all has to be adopted by the G20 at its next meeting, proving once again that in finance, the rules that really matter are set by an international, non-treaty based form of administration.
I've expressed some sympathy for the whistleblowing bank examiner Carmen Segarra in the past, and I wrote up my concerns over at DealBook. A taste of the argument:
The bank whistle-blower statute was part of the changes passed after the savings and loan crisis of the 1980s, when hundreds of financial institutions had to be “resolved” – that’s bank terminology for taken through a quick bankruptcy – by the Federal Deposit Insurance Corporation. The statute covers a “person who is performing, directly or indirectly, any function or service on behalf” of the F.D.I.C. The appeals court said that it was “frankly silly” to suggest that Fed employees were working for the F.D.I.C.
But I don’t think it is frankly silly. The purpose of the statute is to protect whistle-blowers who work at, among other places, Federal Reserve banks who bring information to light about mismanagement in a way that performs a service to the F.D.I.C. Moreover, the statute is supposed to be broadly construed.
Goldman Sachs is a bank holding company, but it does not have depositors.
Nonetheless, the F.D.I.C. is a full voting member of the Financial Stability Oversight Council, which has designated Goldman a systemically important financial institution, subject to heightened supervision and its particular attention. Moreover, the F.D.I.C. would play a role in resolving Goldman, if it came to that, under the Dodd-Frank law’s overhaul of the government’s resolution powers.
So I do think that supervising Goldman counts as performing a service to the F.D.I.C.
Do go over there and give it a look.