I've been writing some about international financial regulation this year. Here's my take on what IFR tells us about international law, which it isn't, but which in practice it, in some ways, resembles. It's up at SSRN, and I hope you'll give it a look.
In an era riddled with critiques of the relevance of classic international law, some have loudly given up on the subject, while others have placed their hopes in alternative mechanisms of global governance. One alternative is “soft law,” and nowhere is soft law more successful than in international financial regulation (IFR). Today, almost every bank of any size across the world has to keep similar amounts of money in its emergency reserve, cannot stake its future on complex derivatives or other forbidden trades, and faces oversight that, no matter where the bank is located, will be conducted in roughly similar ways, with roughly similar tools. And yet the promulgators of these rules consistently disavow their status as binding law.
These disavowals are disingenuous, and unpacking the reasons why has useful lessons for how international governance works, whether backed by treaty and custom or not. IFR works like traditional international law in three ways. It, like international law, depends on domestic institutions for implementation, although traditional international law has often sought to ignore the importance of any institution below the level of the state. IFR reminds us that the coordination of international interests comes with winners and losers, and therefore that the “mere coordination exercise” that international governance represents should not be dismissed, though traditional international law occasionally has been critiqued for that reason. And IFR emphasizes the necessarily messy way that fundamental legal principles are arrived at in international governance of any stripe -- something I call the contestation principle. These features of both hard and soft law have been overlooked by both the traditionalists and critics of international law, but process-driven insights like them have much to tell us about both hard and soft law, which may not, in some ways, be so different after all.
Should you be so inclined, you can find the paper here.
Over at DealBook, I try to forecast the most likely prominent challenges to the Consumer Financial Protection Bureau's Payday Lending Rule. Here's the start:
The new payday lending rule, once complete, will force many payday lenders out of business. That means that a legal challenge is certain, and also the courts, which worry about regulations that require bankruptcies, will take it seriously.
That is good news for challengers of the rule. The bad news is that their claims will probably fail.
Payday lenders will challenge the authority of the Consumer Financial Protection Bureau to issue the rule, the cost-benefit analysis behind the rule and the constitutionality of the consumer agency itself.
When they fail, we will know that we have a new and powerful financial regulator, one that can touch not just banks but any source of credit, including credit cards, payday lenders and other informal ways to get money.
Go give it a look!
MetLife successfully appealed its designation as a SIFI to the district court in Washington, which took an awfully searching review of the factors used by the FSOC to make the determination. The court, in the end, concluded that the council's designation was arbitrary and capricious, which means it was illegal. The most interesting part of the opinion is the part requiring the FSOC to do a cost benefit analysis before designating.
FSOC has refused to do a quantified cost benefit analysis, which is a departure for the executive branch. The White House requires agencies to conduct one before they promulgate expensive rules. That a financial regulator, where excel spreadsheets and quantified stress tests are part of the job, would refuse to do one in making a determination about the riskiness of a financial institution is a pretty interesting rebuke to those who believe that cost benefit analyses are essential components of effective regulation. But perhaps the FSOC has been listening to John Coates.
Here's what the court had to do to require a cost benefit analysis - most, um, interestingly it relied on the word "appropriate" while ignoring the word "deems" in Congress's guidance about how to do SIFI designations. Most administrative lawyers would conclude that it was up to the Council to decide whether to take costs into account in designations if the statute provides that the FSOC “shall” consider a number of factors and also “in making a designation, any other risk-related factors that the Council deems appropriate.”
But the court thought differently:
FSOC, too, has made the decision to regulate—by designating MetLife. That decision intentionally refused to consider the cost of regulation, a consideration that is essential to reasoned rulemaking. Cf. [Michigan v. Environmental Protection Agency, 135 S. Ct. 2699 (2015)] at 2707 (“Consideration of cost reflects the understanding that reasonable regulation ordinarily requires paying attention to the advantages and the disadvantages of agency decisions.”) (emphasis in original). In light of Michigan and of Dodd-Frank’s command to consider all “appropriate” risk-related factors, 12 U.S.C. § 5323(a)(2)(K), FSOC’s position is at odds with the law and its designation of MetLife must be rescinded.
I'm pretty unpersuaded by that reasoning. Cost benefit analysis may be a good idea, or it may not be, but I don't see how the courts should go around requiring it on the basis of a catch-all clause awarded discretion to the agency to add factors to an already long list of factors to be considered in SIFI designations.
I trust you all enjoyed our symposium on The Power And Independence of the Federal Reserve. There's another one starting on the (excellent) Notice and Comment blog, so do head over there for more takes on Peter Conti-Brown's book, and on assessing the place of the Fed and how it works.
My thanks to my inimitable friend and colleague David Zaring for hosting this book club and for inviting me to respond. It’s a real pleasure to be back among the Glomerati—my first venture into academic blogging was on these digital pages back in 2011, including a real-time record of my finding the primary source for the “punch bowl” metaphor that figures so prominently in my book. I still love those stories about Stanford’s Erika Wayne, equal parts document sleuth and librarian.
I wanted to write a few responses to the excellent posts from David, Matt, and Usha and in the process write a bit more about what I see as the central intellectual puzzle of Federal Reserve independence, governance, and accountability, which is this: how can such a technical field benefit from democratic processes without corrupting the entire enterprise? As I wrote, I realized I was going to end up droning on and on, so I’ll keep this a bit more limited than the quality of these responses warrant.
This framing gets at the pith of Matt’s first post. He asks, “is it okay to ‘Bork’ a Federal Reserve appointee?” This question can be broken into two—should there be a more searching assessment of Fed appointees subject to the Appointments Clause, and what is the standard at which the senatorial consent should be withheld?
On the first, I think the answer is a resounding yes, with one clarification. The more searching assessment I would hope to see would not necessarily be at the Senate level alone—we’ve had plenty of closed-door politicking on Fed appointments that have led to some extraordinary appointments and also some very regrettable decisions. On the unfortunate side, I’m thinking of Senator Shelby’s decision to block Peter Diamond from a Fed governorship because Diamond was “unqualified,” just as he received the Nobel prize in economics. I’m thinking, too, of the regrettable—and hopefully temporary—decision to “pair” Fed appointments on a partisan basis, such that Jeremy Stein (a Democrat) could only get through the Senate with Jerome Powell (a Republican), despite no partisan balancing requirement in the Federal Reserve Act. We don’t need more Senators trying to play fast and loose with Fed appointments; we need more public attention on these appointments.
An example of this that I find exactly in line with my vision of a successful public engagement on the Fed was in the summer of 2013 when the Obama Administration leaked that the president was considering Janet Yellen and Larry Summers for the Fed Chairmanship, and leaned Summers. The reaction was swift and very public: from every corner of the democracy came searching assessments of these two proto-candidates’ personalities, histories, ideologies, expertise, and more.
At the time, some lamented this attention to the Fed from outside the temple of full-time Fed watchers as corrosive and lamentable. I think they are exactly wrong. There was plenty of frivolity, gossip, and consideration of extraneous factors in the public vetting we saw in Yellen vs. Summers. But the level of public attention was also impressively substantive. My favorite example in this phenomenon was the non-ironically titled “Seventeen academic papers of Janet Yellen’s that you need to read.” (Full disclosure: I used to work indirectly for Summers at Harvard and continue to have enormous respect for him.)
To Matt’s first question, then, I would like to see more of this kind of public attention to these appointments. The authority of the Fed governors is extraordinary. It’s important that the public have a role in selecting them so that their values are as known as they can be.
To the second question—when should Senators reject a candidate?—I’ll confess something that may make my liberal friends cringe. I’m not convinced that Robert Bork himself should have been Borked. I would prefer a model of Senatorial advice and consent that looked much more like a brake on cronyism than on a sustained attack on a candidate’s (or the sponsoring Administration’s) politics. The Senators’ role, then, is to prevent presidents from rewarding their talentless but politically or financially connected friends with jobs that require policy expertise. It’s not to attempt a redo of our most essential of institutions, the quadrennial presidential election.
To take Supreme Court history (not to say the Supreme Court present) as an example, there was simply no question that Bork was qualified to sit on the court, even if his values and judicial philosophy (and beard?) were out of sync with the Democratic and perhaps American majority. But minus the beard, what about Bork was different from Antonin Scalia, who sailed through the nomination process? Not much that could be known at the time. And it’s not clear to me that the kind of judging we see in the jurist who took Bork’s place—Anthony Kennedy—is better for our democratic institutions, even as I have endorsed and celebrated some of the outcomes in cases that make Kennedy so famous.
If I were a Senator in 1987, then, I would’ve voted for Bork and then sought to campaign hard in 1988 to say that while qualified, we needed justices of a different philosophy much more likely to be sponsored by a Democratic president than a Republican one. At the same time, I would’ve felt more comfortable voting against Abe Fortas (given the air of scandal and undue proximity to President Johnson) and felt very comfortable voting against Nixon’s nomination of Harrold Carswell (about whom—in his defense—Senator Roman Hruska said “Even if he is mediocre, there are a lot of mediocre judges and people and lawyers, and they are entitled to a little representation, aren't they?”). Qualifications, not politics.
It’s the same analysis for the Fed. There are a few Governors who I think should not have been nominated given their abundant lack of anything except a connection to the President. And as mentioned, there are others who were dinged because of their perceived politics despite sterling credentials. I would want to see more public attention on the expertise and less of the politics, recognizing with Churchillian sobriety that the democratic process will lead to all kinds of regrettable excesses. It’s just better than anything else we might design to take its place.
On Matt’s other post, his hypothesis that “Fed appointees cannot have the expertise necessary to do their job without also being wed to some of the economic and banking orthodoxies that led to the 2008 financial crisis,” I say that we should have that debate. Not just in the Senate Banking Committee hearing room, but in the blogosphere, editorial pages, academic conferences, and around the water cooler. Let’s inquire about what a potential Fed Governor believes about the world and the Fed’s place in it before we hand over a vote that can influence the development of the global economy. The stakes are just too high to leave it to backroom deals. And this is the overarching point: politics is already happening in and around the Fed. To pretend otherwise is fantasy. The question is whether those politics will be little-d democratic or whether they will be something else.
David highlights the essential importance of looking beyond traditional methodological or institutional paths in trying to get a sense of how agencies work in practice. Like anyone, I’m likely to overemphasize my own methodological approach over others. For example, I am decidedly skeptical that indices of central bank independence coded on the basis of central bank charters tell us much of anything. I think the question of “independence”—to the extent it’s a coherent question at all—is better explored through the methods of narrative history rather than quantitative econometrics. But that’s the point: we need to have multiple approaches in case my view is filled with blind spots and otherwise limited—narrative history isn’t great for doing a 100-nation study, for example.
Finally, I’m delighted Usha brought in her excellent perspective on “fetishization” of independence, an article that has shaped my thinking over the years. I think she’s exactly correct. I’d even go a step further and say that the term itself is devoid of much or any analytical content. Part of my aim in this book is to prompt readerly skepticism anytime anyone—whether in defense of the Fed or in attack—invokes “independence” as the support for their proposition. As I argue at length, and as Usha makes clear in the corporate governance context, Fed independence on the ground is not what those who rely on it have supposed it to be.
Again, my thanks for taking the book seriously and providing a wonderful forum for discussing it.
Peter's book on the Fed represents, among other things, a take on how you figure out what a particular government institution is up to. You could try to do this quantitatively, especially if the part of the Fed you care about sets interest rates. What market conditions predict what the Fed is going to do? You can also do this by going big history, and critical as a matter of policy. That's what Alan Meltzer has done in his two volume history of the Fed, which processes an enormous amount of archival information - minutes, policy papers, etc - to describe what the Fed has done. These days, Meltzer often finds something to criticize. You could also try to understand it purely as a weird culture, which it very much is. Central bankers all talk to one another, only really do central banking throughout the course of their careers, have Ph.D.s in economics, and stay close to the discipline (but not too close! you write a couple of good articles, and then stick to policy with modest empirics.). It's a super insular, almost quintessentially technocratic community. Or you could simply look at its legal authority and examine its rules and orders.
I take Peter to be suggesting that none of these approaches could, if taken alone, provide you with a full picture of how the Fed works. One of the themes that runs through the book is that consideration of the law alone would lead observers to think that members of the Board of Governors are insulated and empowered, when in practice, they cycle through the Fed quickly, and presidents get to appoint many of them. The culture of the Fed, or at least Fed-watching, on the other hand, reifies the Fed chair, and the FOMC, without paying attention to the truly powerful Fed staff, who never leave, even as their leaders revolve away. Finally, Peter rejects the idea that the Fed is a technocratic exercise in the abstruse, but a place where powerful value judgments are made, and so therefore worth some measure of accountability - Matt talks about that. The Fed is much more than a vehicle for monetary policy, as we found out during the financial crisis, and encapsulates a disturbingly large number of bureaucratic actors - Peter is particularly critical of the continued existence of the regional federal reserve banks, and with good reason.
I admit that I prefer these sorts of mixed method accounts, on the assumption that more inputs probably creates a more accurate output. It does complexify things, to be sure. But the Fed is a complex beast, and pretending it is anything but is disengenously reductionist.
And they are doing well. They - implausibly, by my reading - got a judge not to dismiss claims that Anthony Chiasson's business partner had suffered due process violations, based on the taking of his property, on the fact that their hedge fund was searched based on a misstatement in an affidavit that the business partner knew about the alleged insider trading, and that the supervisors of the lawyers and investigators who brought the claim failed to rein in the unconstitutional conduct of their subordinates. The judge wants discovery.
To me, this order looks bound for a quick reversal, and, as it is a qualified immunity claim that is being rejected, it should be immediately appealable. I'm no expert on searches and seizures. But it would be reasonable to assume that the government, with reason to believe that one of the co-founders of a hedge fund was engaging in insider trading, would search the papers of the hedge fund, including those of the hedge fund's other co-founder, and if the government made a mistake in one of the affidavits supporting the search, that mistake would be immaterial. The defendants in the case are all but absolutely immune prosecutors and law enforcement officials, and the court doesn't even address that issue.
I don't think the interesting thing about the decision is the legal analysis. Instead, it's interesting:
- because Manhattan judges and its US Attorney are in a repeat-player relationship. In this order, one of those judges basically instructed the US Attorney to prepare to be deposed, which is apocalyptically out of the ordinary. It suggests that the judges are really angry about prosecutorial overreaching, or at least that one of them is.
- because this is the sort of relief that judges can uniquely order in business law enforcement. I doubt that the government will ever have to pay Level Global's owners a penny for essentially shutting it down because it thought one of its principals was an insider trader. But courts can force the government to worry about that prospect with intrusive injunctive relief like this, and angered scolding. That's a real remedy, even if the usual remedy - money damages - won't work!
Over at DealBook, I've got a column on international insurance regulation and its discontents. A taste:
The globalization of the rules that govern insurance companies has been extremely quick — too quick for the tastes of many American insurers. They are fighting back by asking for process, process and more process.
I think that the protections sought would be unnecessary, and even counterproductive. But they are classics. The insurers are asking for more notice and comment and more trial-type procedures. Administrative process, and how much of it someone should get, lacks a bit of glamour. But it is something that the government and the financial industry will always fight about.
Go give it a look!
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.
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.