Tag Archives: regulation

Regulatory Arbitrage 2.0

Gillian Tett has the latest perspective on a curious deal that Barclays did earlier this week (hat tip Brad DeLong). The deal goes something like this. Two former Barclays execs are starting a fund called Protium Finance. Protium has two equity investors who are putting in $450 million. Barclays is lending Protium $12.6 billion. Protium is using the cash to buy $12.3 billion in what we used to call toxic assets from Barclays. Protium’s 45 staff members get a management fee of $40 million per year (presumably from the equity investors, although that seems steep). Returns from the investments will be paid as follows, in this order (and this is important): (1) fund management fees; (2) a guaranteed 7% return to investors; (3) repayment of the Barclays loan; and (4) residual cash flows to the investors.

Barclays emphasized that it was not participating in regulatory arbitrage, because it is keeping the toxic assets on its balance sheet for regulatory purposes. That is, because it has a lot of exposure to those assets through its huge loan, it will continue to hold capital against those assets. So far so good.

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Boring and Exciting Finance

Taunter has a comprehensive proposal about how to regulate financial services, dividing them into Boring and Exciting.  Boring services are the following:

  • retail deposits
  • loans to retail customers, including mortgages
  • retail insurance, including annuity products
  • any custodial service beyond traditional settlement (i.e., if you hold something after T+3, you’re a custodian)

If you do any of those, then you are a Boring institution, you can do all Boring services, you face some significant regulations, and you get bailed out when necessary. If you do none of those, then you are an Exciting institution, you can do almost anything you want, and there is an ironclad rule preventing the government from bailing you out. Boring institutions cannot offer Exciting services (I think) and Exciting institutions cannot offer Boring services (that’s certain).

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The Problems with Regulatory Cost-Benefit Analysis

Mark Kleiman (hat tip Brad DeLong) says more clearly what I tried to say a while back: cost-benefit analysis of regulations has a curious way of nailng the costs and underestimating the benefits. He focuses on three points:

  1. Traditional CBA counts all dollar benefits equally, despite the fact that the marginal utility of a dollar depends a lot on who is getting it; a dollar more for a poor person provides a lot more utility than a dollar more for a rich person.
  2. Long-term or uncertain benefits, no matter how large (like preventing the inundation of every coastal city) are typically discounted down to zero.
  3. Benefits that are difficult to quantify because there is no market for them (like feeling better because you are healthy) never get counted. (This is the one I know best because it’s one of the things my wife specializes in.)

Matt Yglesias also comments.

By James Kwak

An Inside Perspective on Regulatory Capture

We received the following email from James Coffman in response to Bond Girl‘s recent guest post, “Filling the Financial Regulatory Void.” Coffey agreed to let us publish the email. As he says below, he spent 27 years in the enforcement division of the SEC.

Bond Girl’s “Filling the Financial Regulatory Void” provided insight into human deficiencies in the current financial regulatory system. But it overplays the human failings of regulators and concludes with a proposed solution that, in all likelihood, would turn out worse than the current situation. But first, in the interest of full disclosure, I should tell you that I retired two years ago from a management position in the enforcement division at the SEC after 27 years. So I was (and in my heart, I suppose I still am) a financial regulator. That background probably should be taken into account by anyone who reads this response.

There is no doubt that “regulatory capture” exists and is a meaningful factor in the recent failures of our regulatory system. Many of us in the enforcement division dealt with the problem regularly when we sought input from those in the agency who were responsible for regulating aspects of the securities markets. Over time, regulatory policies and practices had emerged that seemed to contradict the purpose if not the letter of the law. In other cases, over-arching issues (e.g., increases in fees charged by investment companies despite growth that should have resulted in economies of scale and decreasing fees) simply were not addressed in any meaningful way.

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The Problem with Disclosure

Felix Salmon has a good example of why disclosure (the preferred consumer-protection regime of free-market conservatives and bankers) doesn’t work, courtesy of Ryan Chittum. The topic is no-interest balance transfers offered by credit card companies.

As Salmon points out, most people probably realize what the game is. That is, most people know that banks aren’t in the business of lending money for free; they know that the bank is betting that it can raise the interest rate before they pay off the balance. It’s possible that you will end up getting a free loan: “If you’re smart and disciplined and lucky, you might be able to game the system and pay no interest at all on that balance. Bank of America, for its part, does its very best to make you think that you’ll be able to do just that, essentially getting one over on The Man.” But the bank knows it has the numbers on its side; and most consumers know it too, because they know that’s the only reason the bank would make the offer.

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Who Should Hide Behind the Regulatory Shield?

This guest post was contributed by Ilya Podolyako, a recent graduate of the Yale Law School, where he was co-chair of the Progressive Law and Economic Policy reading group with James Kwak.

The development of the news coverage of high-frequency trading has been quite interesting. The story started out with a criminal complaint that Goldman Sachs lodged against Sergey Aleynikov, a former employee who allegedly stole some secret computer code from the Goldman network before departing for a new job in Chicago. Incidentally, Mr. Aleynikov appeared to be headed to Teza Technologies, a company recently started by Mikhail Malyshev, who had previously been in charge of high frequency and algorithmic trading at Citadel, a Chicago-based hybrid fund. Immediately after the report leaked, Citadel began investigating Mr. Malyshev’s departure and filed a lawsuit to prevent him from getting his nascent business off the ground. From these facts, some reporters inferred that the surprisingly public maneuvers of two notoriously secretive finance giants vis-à-vis seemingly routine personnel matters showed that Aleynikov had tapped into the gold mine of precious proprietary trading software.

That was two weeks ago. At this point, the story has crescendoed. The New York Times ran a report on high frequency trading. The Economist published a piece on the same topic. Senator Schumer (D-NY) requested that the SEC investigate the matter and the agency acquiesced.

The cynical perspective on these events is that both Schumer’s and Mary Schapiro’s moves with respect to algorithmic trading show that the issue is a red herring. As the argument goes, neither of these actors would touch the practice if it actually underpinned Goldman’s record profits or Citadel’s outstanding performance in 2004-2006. If, however, banning the practice would eliminate a few small hedge funds and create the appearance of revising market frameworks without threatening the big players (a regulatory brush fire of sorts), high-frequency trading would form the perfect political target.

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The Rise and Rise of Jamie Dimon

As Simon pointed out earlier, Jamie Dimon has been getting a lot of good press recently. The New York Times portrayed his recent rise to prominence as not only the CEO of American’s number one bank (at least, the number one bank that has not recently been compared to a vampire squid), but as a player in Washington and, according to at least one quip, the man Barack Obama turns to on financial questions:

Now that Mr. Obama is in the White House, Mr. Dimon has been prominent when the president wants to talk to big business.

During one such meeting in late March, as Citigroup’s chairman, Richard D. Parsons, was trying to explain banks and lending, the president interrupted with a quip: “All right, I’ll talk to Jamie.”

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