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.

But the majority of regulators I worked with were critics of the problem of “capture,” not victims. Much of the problem arose from decades of deregulation dating back to the beginning of the Reagan administration. Elected deregulators appointed their own kind to head regulatory agencies and they, in turn, removed career regulators from management positions and replaced them with appointees who had worked in or represented the regulated industries. These new managers and, in many cases,the people they recruited and promoted, advanced or adhered to a regulatory scheme that, at least with respect to the most important issues, advanced the interests of the regulated.

Bond Girl is right, the industry “captured” the regulators and the regulatory system. But not in the passive sense that true regulators over time came to identify too closely with the interests of the regulated. This is not a case of financial regulators falling victim to the Stockholm syndrome. The vast majority of capture resulted from intentional efforts by the finance industry to advance their narrow interests at all costs and defeat meaningful regulation. Unfortunately, we live in a country that can be bought from the top down and the finance industry exploited the situation very successfully. But do not blame the regulators. Career regulators are as much the victims of these events as the public’s economic welfare.

The creation of paid social entrepreneurs to perform regulatory functions will not enhance regulation nor reduce “capture”. I’ve sued too many CPA’s over the years for bad audits to believe the answer lies in creating a new class of auditors. Audit clients often “capture” their auditors. The result is bad audits resulting in uncorrected and undisclosed financial fraud. The victims are always the shareholders and the market. Besides, using money to “incentivize” a new, private class of regulators plays directly into the hands of the finance industry. No matter what the regulatory fee structure may be, government will never be in a position to compete with the financial industry when it comes to “incentivizing” regulators-for-hire.

We need to look elsewhere for solutions to the problems that hamper our financial regulatory system.

  • First, we need to look at the structure of the finance industry. Commercial banks got into trouble in large part because they warehoused (often off the books) toxic securities underwritten by their investment banking counterparts within the holding company structure. Similar abuses in the past resulted in separating investment banking from commercial banking. We should try it again. Insurance should be split off as well.
  • Second, no institution should be allowed to become too big to fail. Those that have already achieved that status should be broken up.
  • Third, we must put in place an effective financial consumer protection agency which can counteract the worst consumer practices of a too powerful industry.
  • Fourth, investment banks should be made to eat what they kill. Public ownership of investment banks coincided with the industry’s decline into extremely reckless risk taking. Investment bankers should be required to own a significant percentage of the equity in the institutions in which they work (something approaching 50%, to pick a number). Having a significant portion of their net worth tied up in such stock would provide an incentive to carefully identify and measure risk. It should also reduce outsized compensation for investment bankers.
  • Fifth, there should be greater limits placed on the ability of political appointees to oust career regulators. Make capture more difficult.
  • Sixth, more financial products and firms should be subject to government registration and reporting.
  • Seventh, regulators should not be forced to wear conflicting hats. One cannot promote an industry while protecting the public from it. Don’t ask regulators to be industry cheerleaders. Limits can be placed on regulators to ensure that they not act without consideration of the impact of their actions. But over-regulation is not what got us in this position. Cheerleaders purporting to be regulators did.
  • Finally, the government should adopt a bonus plan for regulators, run by regulators (who would rotate off after short, fixed terms, to prevent back-scratching among board members) to provide incentives for regulators to excel at the job of regulation. Recognized, protected and incentivized regulators will resist capture.

By James Coffman

Update: Bond Girl responds.

Update 2: I (James) had the author’s name wrong – it should be Coffman, not Coffey.

147 thoughts on “An Inside Perspective on Regulatory Capture

  1. Maybe the U.S. needs a civil service that is largely independent of elected representatives?

    One comment on point #4… Just because employees own most of a company does not imply they have a significant fraction of their personal net worth in it. And the latter is what you really want. Probably not practical to legislate it, though.

    Overall, fantastic post. Can we put Mr. Coffey in charge, please?

  2. With an attitude like that, how do you expect to exploit the lucrative revolving door of government service?

  3. Thanks, Mr. Coffey, for your perspective, and further thanks for your years of service. One of the key things that separates a functional government from a dysfunctional one is a group of so-called “bureaucrats” who act out of a sense of responsibility to the institutions and government they represent. Both the “revolving door” and the constant attacks on “bureaucrats” from the right over the last 30 years have made it much more difficult for these people to function effectively.

  4. Excellent article by a career SEC regulator. Political appointees and influence is the toxic waste in the system
    complementing the CDOs on the banksters balance sheets.

  5. First: Great idea. How about Narrow/Limited Banking?
    Second: Great idea. Let’s tax the size of banks.
    Third: Great idea. One is currently proposed.
    Fourth: Great idea. Let’s end Limited Liability.
    Fifth: Great idea.
    Sixth: Great idea.
    Seventh: Great idea.
    Finally: Great idea.

    Here’s a terrific post from Buiter:

    A very good post. Thanks.

  6. I would add another: “Require that regulators be banned from going to work for their charges forever following completion of their regulatory role.” In my mind this is Timmy Geithner personified…career public servant who knows full-well his road to riches for his family runs straight through 85 Broad, Pimco, etc. He is pre-emptively bribed. See: Greenspan. While I’m sure Pimco values his insightful fixed income investment advice, more important is the signaling effect (“look here, Ben, see what awaits you!”) to the regulators in place now.

  7. I appreciate the sentiments presented in this post, and even more so that Mr. Coffey had the courage to write it.

    But – and I am truly, truly trying not to be mean here – the suggestion that our path can be reversed by reinforcing existing institutions seems quaint and idealistic. No one in power, regardless of political persuasion, wants to protect “career regulators.” No one. When Obama has a question about the financial industry, he calls Jamie Dimon. Think about that for a second. We have an entire culture that does not respect what you do. People may think bankers are greedy and evil, but they also think they are smarter than everyone else.

    What we have is not just the replacement of career regulators with cronies. It is a decision not to meddle in the affairs of financial institutions at all. I’ve managed money at one of the major financial institutions made notorious by this crisis, and it wears on you if you are an even remotely honest person. Most of the problems people view en masse, they do not see the day-to-day stuff that a career regulator never sees because government has let the securities industry go. Compliance officers see it, but let me tell you where they stand with respect to the man with the sapphire cufflinks.

    The financial industry is running circles around the whole system of regulation in this country, and it amazes me the degree to which people do not understand the sheer magnitude of this problem. Add all you want to the ranks of career regulators. The White House is actually debating whether or not a guy at one of these firms is going to receive a $100 million bonus for last year. We are so far beyond “let’s improve the current system” it is terrifying.

  8. BG
    I think he has a point. To assume that nearly all of the regulators are corrupted/corruptible is really a stretch, comparable to thinking of all soldiers as baby killers. From the bankster’s perspective, it is much easier (and cheaper) to have the politicians (that you own) install corrupt supervisors than to corrupt the rank and file of cops.

    For example, look at how the W Bush administration handled environmental enforcement. They didn’t rescind the laws, they cut funding for the litigators. Voila! Pollution is still illegal, but the cops can’t afford to patrol.

    Too long, so summary: His explanation of capture passes Occam’s Razor – it is the simplest answer. Clearly there is corruption. I think that the regulator failure is the same political disease as has corrupted the legislators.

  9. Compliance officers see it, but let me tell you where they stand with respect to the man with the sapphire cufflinks.

    Please do tell Ms. Bond. What exactly does the compliance officer do and say while blinded by the sapphire light?

  10. It is clear that point #2 alone will solve much of this problem. If no financial institution is too big to fail, even lax regulation should not have as significant an impact as it does now. Conversely, any solution that does not address too-big-to-fail will not accomplish much.

    For the political establishment, taking on the too-big-to-fail institutions is anything but a profitable enterprise. So I am not very optimistic about this.

  11. I believe that “Finally, the government should adopt a bonus plan for regulators, run by regulators … to provide incentives for regulators to excel at the job of regulation.” is contradicted by “government will never be in a position to compete with the financial industry when it comes to “incentivizing” regulators-for-hire” (regardless of who hires the regulators).
    A good solution must appeal to the selfish self-interest of the regulators to succeed against the malign influence of the financial industry, and BG’s proposal addresses this.
    Perhaps we should envision BG’s solution taking this form: not idealistic, well-intentioned, well-mannered social entrepreneurs, but Dog the Bounty Hunter (armed with a CPA, and pursuing _really_ big game). Would a Madoff have gotten an easy pass from the savvy sorts with more experience on 125th Street than Wall Street?

  12. Due to a misdiagnosis of the 1929 stock market crash, the US creates a huge regulatory and enforcement structure, the SEC, to prevent investor and securities fraud and stock market crashes. In the subsequent 75 years, investor and securities fraud continues, including Enron, Madoff and many other similarly notorious cases over the period. Many of the SEC protections, such as insider trading, are common law rights recognized prior to the creation of the 1933 and 1934 Acts and the SEC.

    Contractual legal rights are a powerful mechanism for protecting the rights of parties to commercial transactions. In fact, most transactions are based on contractual protections as opposed to regulatory protections. Shareholders and other interested private parties, and not the SEC, often sue to enforce their legal rights in securities transactions, when courts have recognized their right to sue to protect themselves.

    While the contra-factual of life without 75 years of an SEC is difficult to envision, the existence of the SEC did not prevent major securities and investor fraud. Additionally, the SEC is always requesting more funding and staffing to investigate and litigate fraud. It is unclear that the 33 and 34 Acts have decreased fraudulent activities.

    Unlike banking, where FDIC insurance creates moral hazard, distorts the risk reward relationship of bank investments and makes the government (and the FDIC) an interested and potentially aggrieved party, the SEC is not in a similar relationship to the parties and transactions it supervises.

    Maybe in a market economy as enormous and as complicated as the US capital markets and economy, it is impossible to have an adequate regulatory supervisory structure. It might be better to allow private participants to negotiate and protect themselves on a transaction level. The SEC is always chasing the fraud after it has happened. Is that worth the expense and false expectation of investor and securities protection?

  13. Bond Girl, I agree with you on so many things, but on the matter of the Phibro “bonuses”, why should Andrew Hall’s claim on Citigroup (effectively a carried interest in the performance of a pool of capital) be in any way subordinated to all of Citi’s other obligations, EVERY SINGLE ONE of which has been paid off at par?

    If the government had not stepped in, Citi would have blown up and Andrew would have had to get in line to collect. Who knows what haircut, if any, he would have experienced (among other things, accrued comp should be a priority claim above the bonds). But the fact is that the government, in its infinite wisdom, decided not to let Citi fail.

    Why should an employee make a concession no bondholder was asked to make?

  14. #4 might be interesting, but I’m not sure it accomplishes what you think it accomplishes.

    Since you broke up the commercial and investment banks in #1, you now have standalone investment banks. If 50% of the equity capital of the banks has to come from the current employees, that means the absolute maximum book equity in an investment bank is 2x the net worth of its employees in aggregate.

    That is far too little capital to run a full range of capital markets functions. So what you are really saying is that you don’t want these lines of business to exist any more, and you would prefer investment banks revert to the advisory-centered businesses they were in the days of private partnerships. Is that progress?

    As for the idea that banks would take fewer risks or pay employees differently in a private context, I don’t think the behavioral economics bear that out. The utility that supplies your power probably has negligible employee ownership, at least as compared with Goldman Sachs, yet it almost certainly pays its employees less. And do you think it would operate its plants with a higher degree of safety if the CEO owned more of the company? You could as well argue that if it had higher employee ownership it would cut corners to goose its ROE.

    Bankers will take as much risk as possible because in expectation risk is correlated with return. It is the regulator’s role to place binding limits on this level of risk and shut down firms that violate it, as well as allow firms to fail to make clear the consequences of a mistake. Given the last nine months, I would say the entire financial regulatory system has proven itself a failure.

  15. JC:
    “Much of the problem arose from decades of deregulation dating back to the beginning of the Reagan administration.”

    “We have an entire culture that does not respect what you do.”

    All of this goes back to ideology, and the strategic support of a specific economic paradigm in the political sphere… The regulatory infrastructure pre-1980 bought us 20 years of extra time. Not bad, really. Creating institutions that can insulate against a mass shift in public opinion (and a dominant paradigm in the social sciences) for longer than 2 decades simply is asking a lot.

    This does not mean we should not rebuild these institutions… 20 years is better than nothing. Maybe we can try to improve, perhaps borrow some “checks and balances” wisdom from the writers of the Constitution. But if Obama continues to manage his Presidency so poorly, the opportunity to move to a more neutral and pragmatic policy stance will be lost for another three decades.

    The lunatic fringe is already finding its voice again, arguing (as do many here) that the problem wasn’t insufficient govt. intervention, but rather too much…

    And here we have SJ making the aggressively populist argument that the key to fixing our country is to “break the power of the oligopolistic elite”… So much for the hope of moderate transition, especially with a President so fearful of writing his own legislation that he shifts everything to Congress and consistently cedes the initiative on every critical national debate to a parochial, nepotistic, gridlocked Congress.

    I’m feeling particularly pessimistic today. Those who rally for revolution rarely find it as delightful as they expect.

  16. We are rapidly moving to the world you envison.

    The result will be a decrease in investment due to increased costs of protection and due diligence (and general mistrust, since the system affords no legal recourse against corporations that can easily evade enforcement).

    It will mean that small companies will have difficulty finding financing because they can’t convince anyone they are above-board.

    SJ complains of the increasing size of the finance sector… so, do you think that moving to a de-regulated world would increase or decrease rent seeking effort? What about effort to deter rent-seeking behavior?

  17. you sound like you came from that part of the agency where those I call rogues and admire them for being so like to gather.
    But “rogues” will have no impact as long as sneering against rule abiding and enforcing bureaucrats no matter how stupid or ignorant is the it-fashion of the day.

    “Elected deregulators appointed their own kind to head regulatory agencies and they, in turn, removed career regulators from management positions and replaced them with appointees who had worked in or represented the regulated industries.”

    sounds eerily familiar to somebody from a corporation completely of the private business kind. Seems to be the favoured tactic of getting those old inhibiting principles and morals sidelined.

    ” to own a significant percentage of the equity in the institutions in which they work”
    according to Michael Lewis at AIGFP they were expected to buy stock for 50 % of their boni. Can it be that the amount was too small to care?

  18. “We have an entire culture that does not respect what you do.”

    and it gets reinforced day after day after day by sneering thoughtless supposed to be witty and sophisticated side remarks in even the most off-topic contexts from presumably top-notch journalists

  19. “constant attacks on “bureaucrats” from the right”

    the “left” are also very very good at it
    – they like to sprinkle it through essays/reportages on any kind of topic in order to insert a bit of humour, make it lighter, signal that they are of the laid-back easy-going kind

  20. well, one major reason why our tax inspectors are very effective and trustworthy and feared is BECAUSE they can look forward to a very well remunerated second career
    the more they have established a very widely spread reputation that they are the ones who sniff out every fraud and mistake the better their prospects after quitting government service and become a free lance tax consultant.

    but maybe compensations in finance are so out of whack with the rest of life that they could bribe their way into the design/decision making no matter what either through glamour or cash or connections into est

  21. how would “Dog the Bounty Hunter” get good at bounty hunting? if you want to hunt in a complicated entangled interacting environment you must hone your skills by constantly exchanging ideas how a really weird brain might find a really weird wedge to game the system

    High Noon Solitary Hero could maybe land a headline generating hit here and there but that’s about it
    It takes a bureaucrat to sniff out bureaucrats …

  22. One of the things that has surprised me about Obama is his willingness to appoint people that were responsible for a lot of this mess in the first place. (This is one of the reasons I keep saying that this is not just a story of Republican deregulation.)

    For example, Obama appointed Gary Gensler to head the CFTC, which in the administration’s plan will somehow share responsibility for the OTC derivatives market with the SEC. The same Gary Gensler who as Treasury undersecretary for Larry Summers back in the 90s advocated (against Brooksley Born) for the Commodities Futures Modernization Act, which provided “legal certainty” for OTC derivatives contracts by exempting them from oversight. (Incidentally, he was also a partner at Goldman Sachs.)

  23. Great post. What is probably not emphasized enough if at all, is that there are many knowledgeable folks who are honest and not bribable.

    Take Elizabeth Warren, the Harvard law prof and an expert in consumer rights who chairs the TARP oversight committee appointed by Congress. She’s honest, tough but civil, and a terrific communicator. Appointees like this are not found everywhere, but they certainly do exist and would come forward if asked.

    Sheila Bair is another one. She is independent and based on her track record a capable FDIC administrator.

    And the young man from Massacusetts who understood what Bernie Madoff was doing. These folks, probably to a man or woman, do and would serve their country if asked.

    Finally, our regulatory agencies are already full of these folks. Advancement from within should be the default.

  24. Boy do we ever need whistle blowers from the inside. This article is extremely refreshing to see. We are the system. People like you and me. There are far to many selfish destructive interests at play in the market. We need a serious flush to move forward. If not, we ourselves will be flushed away by their unbridled greed. So..are to be complicit in our own destruction? Nay i say.

  25. I keep waiting for somebody explaining how the breaking up of the TBTF’s would affect foreign policy

    If I were a “sinister powerful” financial wizard in a country which is a big creditor of the US could I get wet dreams of empire from the prospect that the US might actually do it?

    a guy ldescribed as US-lover/admirer who manages a portfolio of a sizable chunk for the Chinese said in an interview to the question of the hurt it would inflict on China (and the “normal” Chinese) if it sold its $-stuff “yes in the middle term” – it is the word middle that set my alarms on red

    It’s a pity I will not be alive anymore when the archives of the black-mailing eachother conversations will be opened but maybe such subtle public hints suffice to generate compliance

    and if you think I read too many novels:
    remember the very short interval between the mood “let Iceland fail” and “Iceland will be helped” when one could read of Russian willingness to step in (nice location if you eye the Arctis). Here is the latest representation of the Iceland-saga by its prime-minister, an island full of victims and noble willing self-sacrificers just as exclusively that now as it used to be an island of daring investors in the best Viking tradition.
    – Michael Lewis report about his visit on the island reads like a short version of Knut Hamsun’s novel “August” describing the ruin of a village that got very rich for a while because herrings had decided they would prefer that part of the coast (amazing that a writer like that could in old age fall for the Nazis)

  26. I keep waiting for somebody explaining how the breaking up of the TBTF’s would affect foreign policy

    Was anyone paying attention when B of A diverted TARP funds meant to shore up balance sheets into creating a major stake in a Chinese bank?

  27. Some specific agency suggestions if you want this thing to have some legs:

    1) The regulatory agency needs to be self-funding through fees, so that Congress cannot issue threats in conventional spending legislation.

    2) Strong anti-revolving door policy, written in law

    3) Strong full disclosure and conflict of interest policy for employees

    4) Specific mission statement that does not include health of the industry it’s regulating (no “benevolent” regulator”) – Coffey covers this

    5) All political appointees do NOT serve at the whim of the President. Like the Fed, the institution is run by a governing board with long, overlapping appointments. For example, a board of 5, one person appointed every 3 years, 15 year appointments.

    The board selects all the senior members of the agency, who in term hire the rest of the agency in accordance with civil service rules

    6) A standing advisory committee consisting of 1/5 agency members, 2/5 consumer group representatives, and 2/5 financial firm representatives is required to publicly consult on major policy decisions or changes to rules

    7) The agency’s powers should be specifically delimited, but should also include a broad statement giving it authority to expand its scope to cover its mission statement. Expansion of scope should be conducted on the advice of an advisory committee to help the agency extract information from the private sector (and avoid the isolation that can result from insulation).

    8) Private consumer groups and others (even individuals) should be specifically granted standing to sue the agency for non-enforcement, including class action suit. Possibly even allow collection of reasonable monetary compensation, which will be made up through a temporary fee levy that must be administered on the offenders by the agency.

    I’m skeptical any of this will happen, but an institution with these properties would complement the policy initiatives Mr. Coffey raises above.

  28. I’m glad that Jim pointed out the end of the partner model (and a shift toward publicly held investment banks) was a precursor to the crisis. This is a point that I think hasn’t been made enough; would a partnership have levered as much as 30:1 if the decision makers stood to lose everything in the event of insolvency?

  29. I missed that one and if I had come across it its implications maybe meaningless to me but that’s exactly the kind of info-bits which “turn me on”

  30. and wouldn’t it be exciting, great, real fun to be able to work for such an outfit
    no, I intend no irony my mouth got all watery imagining the work atmosphere such an outfit would greatly favour

  31. When he first appointed Summers, I figured that was to signal stability to the financial markets during the crisis. But then Geithner… (I keep hoping for a suprise) and now Gensler (with no sign of a panic).

    This is all very hard to reconcile with Candidate Obama… especially when on the budget side we have people like Peter Orszag (who is new blood). And especially when Candidate Obama managed to win mostly with support from small donations (which really calls into question the big-money-donations arguments).

    I’ll admit, I just don’t get it. And I find it increasingly hard to defend the fellow against detractors (some of whom are thoughtful and reasoned, but many of whom truly are wingnuts).

  32. It extends beyond the right – economics has, for a long time, constructed and employed models that privilege an understanding of individuals as narrowly self-interested. This has, in turn, informed our view of regulators: Bond Girl’s analysis is largely an update and application of public choice theories, which see regulators as beholden to private interests. It is this strand of cynical analysis that has motivated the deregulation that Coffey mentions.

    Coffey’s perspective is refreshing, but it is not exceptional. There are many reasons to take a more positive view of regulators ( and of democratic politics ( What’s needed is a new theory of regulation that can incorporate socially interested motives without denying the important problems associated with capture. Form some ideas:

  33. Totally agree Mitch. What galls me is that the very bankers who live in a coddled and taxpayer protected world then lecture us all about the efficacy of ‘the market’ … as if they knew what that was. A banking crisis of the kind we just had should have produced at least one destitute ex-banker who was personally bankrupt. Instead all we got was vapid articles describing how a few guys were aggrieved that their wives had to cut back on the daily fresh cut flowers. Some market! Some risk!

  34. Unless you have a plan to offer pay parity with the institutions being regulated, why would anyone work there? Do you really want to spend fifteen years of your life being fired on from all sides in exchange for the compensation of a second-year analyst?

  35. I would love to believe in the legions of faithful public servants waiting to step in and clean up this mess, who are motivated and sophisticated enough (something we haven’t really touched on here) to take on the banks. And it really would take legions of such people, not just the occasional Elizabeth Warren.

    But we need to get real here about what our institutions have become and start calling the populist lip service for what it is.

    I’ve pretty much lost all patience with the idea of regulatory reform because it is so easy to see the gulf between what is said and what is actually done. The thing is, this really isn’t even about principles anymore (does one favor more or less government, etc.). Our nation has effectively taken out the world’s largest option ARM to pay for this crisis – and just like speculating homebuyers we are hoping something happens in the meantime to transform our economic circumstances. If tradition holds, a large chunk of that will come due about the time of our next crisis. Our idealism might be very expensive.

  36. do not underestimate the perverted incentives which fire up us challenge addicts who feel comfortable in the freedom of a life style that doesn’t tempt burglars

  37. Good point.

    The issue is not that Hall is going to be collecting a big bonus from a bailed out bank. It’s that the bank was bailed out. This was done, not despite the fact that those responsible would get paid, but because of it. And this is one of the reasons we should not be bailing out banks. It is precisely the kind of moral hazard that bailouts promote.

    Andrew Hall should be an example of why we must break these banks up so that we don’t have to bail them out.

  38. The underlying assumption is that these entities will be forced to manage risk themselves, or fail.

    But the political reality, as the past year has clearly shown, is that the actual choice they will have to make is to manage risk or have the public pay for it when they don’t.

    I suppose the public, which for the most part doesn’t seem to care enough to figure this out, doesn’t really have much room to complain.

  39. It’s certainly is enough to make one pessimistic. Obama is a smart guy, but he’s clearly needing to defer to someone here, and maybe just doesn’t have enough time to figure out who that someone should be.

    At any rate, it seems highly unlikely that something meaningful will get done. It’s amazing really, that, after the enormous amounts of taxpayer money shoveled into the system, there is almost zero outrage or even interest shown by anyone. And yet 25% of the population is outraged over a potential modest increase in the budge from universal coverage.

    I suppose this shouldn’t be surprising either, as banking stuff is complex. And it’s a lot easier to loot complex systems that no one understands.

    I am glad to have dual American/Irish citizenship. It’s starting to look like it might be useful.

  40. when did George Soros turn to charity? before or after he almost wrecked the British Pound?

    hopefully, if we keep bashing Andrew Hall, he’ll feel compelled/inspired to open his German castle full of modern art to the public

    – seems to be in pleasant travelling distance from here, no inner city hastle to overcome to get there

  41. wasn’t there a point when the public stormed hedge fund village somewhere near NY and then a guy in the NYT said but I am a simple hard working guy nothing special exactly like you after he had had to flee from his house watching the police disperse the pitchforks – I have no idea if his excuse was legitimate or not I just read that it took the heat out of it all

    I’m all against pitchforks, they progress to easily to guillotines, but “all you need is love” or similar schmaltz singing sit-ins might tempt me

  42. consolation for the non-Irish
    the American “occupiers” reserved some quite nice better treatment for themselves regarding residence permits and work permits, had them still in 1975 when Germany had been a sovereign state for 20 years and I can’t imagine that they have given up any of them in the meantime. Fortunately in some respects Americans are really smart and do not treat money or advantages as if they were garbage.

  43. In seventy-five years the SEC has accomplished only one thing: made it virtually impossible for small companies to raise capital. It has allowed accounting and disclosure to become Orwellian truths. Not even those with advanced training in law, economics and finance can understand the financial statements of large public companies. Seventy trillion in derivatives exposure is buried somewhere on those balance sheets, and we still have no idea where.

    In the brokerage business, the SEC has allowed the giant firms to run untrammeled boiler rooms. Enforcement was always limited to the ranks of penny brokers, which were legislated out of existence in 1990.

    Regulators are generally professionals of weaker credentials who need somewhere to start on the road to personal success. Within a few months after arrival in a Government post they discover most of their brethren are short on both competence and ambition. They push papers across the desk for a few months (or a few years) and then move on to something else.

    This letter sounds very noble but, as always, the devil is in the details.

  44. forgot
    warning to all dreaming of abroad, especially of presumably once and for all civilized Europe

    in the 30s some of the US-desperate got lured by the promise of life in a workers’ paradise to emigrate to the SU – most of them ended in the GULAG

    my bet is on America somehow managing to make it once again – just wish Obama’s rhetoric wouldn’t remind me so much of those McKinsey guys

  45. Perhaps we need to give regulators some skin in the game too? ;-) Shouldn’t someone be fired if they miss a problem?

    I think the most important suggestion here is ending “too big to fail”. That concept has got to go (any entity that is TBTF is TBTE), but I doubt that Congress or even the White House is willing to take this on. We would have to have publicly financed campaigns, as in AZ, ME, and CT, first, and how likely is that?

    If a TBTF fix were possible, it might be something like this. The FDIC fund for financial takeovers needs to be large enough to handle the largest financial institution in the country. The gap in funds created by the largest institution from the second largest should be covered entirely by the largest institution (so no one would want to be out ahead). The gap between the second and third covered entirely by the second, and so on, until a point is reached where normal statistics apply. This discourages a given institution from becoming large, or if already large, from being larger. The takeover fund contribution would be based upon an estimate of the takeover cost estimate according to a standard set by the regulatory agency; any new risk taking beyond the funded amount would require an increase in the takeover fund prior to the risk taking.

    There are also a lot of technical details in Stern and Feldman’s TBTF book that need to be implemented, but what is there is not enough.

  46. “It would be fun too to find some photos”

    sh..t – access is only via password provided at the conference – maybe a secretary can’t resist helping out … though drunk guys somehow look all the same but thanks for unveiling what Mont Pelerin really stands for

    some time ago the woman who is making headlines around the world now with her campaign poster showing her décolletage next to Angela Merkel’s décolletage went to one of those Hayek adoration seminars and afterwards spilled the most appalling nonsense on the blog “die Achse des Guten” (the axis of good where they post the photo proudly in the left-hand upper corner – the idea that Angela Merkel allowed this confusenik to use her photo alongside her own drives me nuts and I thought voting CDU this time around felt kind of acceptable – at least Merkel seems to be able to impose some discipline and some restraint on our Länder(states)-sovereigns

  47. no, I just wanted to say that Europe is always good for a surprise to those who trust its promises

    as we have always been quite ingenious in coming up with new variations of previously unthinkable atrocious behaviour it is not likely that we would resort to a has-been-model – that would be contrary to our style

    I attribute the well-behaviour of Europe during the last more than 64 years to the fact that we have become constantly better off during that time while America’s military kept us safe
    – that makes people generous and mild in judgment – if this well-offness should break down my guess is that the hunt will be open again (and I thank all the benevolent powers of the world for the good luck to have had all that unbelievable long time of peace) – it is hard to estimate how hard the crisis has hit us because the short working hours subsidies keep companies from laying people off, but just during the last two days I have been told of three bankruptcies from perfectly honest very competent business men I know, one of them a carpenter

    PS: just realized the other day – the US never had anything like the Black Death or the thirty year war – the worst you had in that area was the flue after WW1 and the Civil War (were Indian deaths of new infections as bad as further south?) – blessed land you live in – treat it well

  48. Gary Gensler VS Brooksley Born. There are innately different traits between these two.

    Or, even more strikingly, between Paul Moore the whistleblower and his former boss former Sir James Crosby, promoted to head of the UK’s financial watchdog .

    I wonder if by talking in terms of incentives, mission statements, etc. we’re not sometimes overly reliant on economists’ homo-economicus view of human nature. Is there anything worth tapping into, by letting go of that perspective?

  49. I do think one can conceive of an institutional structure which would suffice – simplifying the financial structure alone might reduce the required legions to merely maniples.

    Yet even the provision of a few hundred highly competent and motivated public servants is non-trivial. Yet they do exist… Not, however, in MBA programs.

    I would suggest heavily recruiting from PhD programs. The social sciences generate an abundance of PhDs, while the academic job market remains thin. Many of these are quite good, and highly motivated to go up against big finance. To augment their ranks, the agency could sponsor ~10 four year fellowships a year, with the provision that graduates work at least 6 years in the agency.

    There’s already a successful model. ROTC.

  50. So you are saying that we should have a smaller, simpler financial industry to accommodate the abilities of regulators? And presumably limit the complexity of financial instruments to what regulators can keep up with?

  51. As a former government employee (OSHA inspector) I have got to say that I knew many people in that agency, and others, who were extraordinarily competent and hardworking. Yeah, sure, we could have made more money in private enterprise–but we had a lot more fun in law enforcement. The trade off, for most of us, was worth it.

  52. Has it been addressed to its core?

    I’m going by StatsGuy:

    [Mission statements], [disclosure of interest] etc. All this probably already exists in some form or another at the SEC and FSA. It does matter the least if the guy at the top of the echelon is turning a blind eye on what’s going on.

    History shapes (all) individuals while (a few) individuals shape history, and Gordon tilted history to the wrong side by picking Crosby rather than Moore.

    Sure, we can dilute the power of the few who make history, and turn it over to institutions or [governing boards]. In the case of the Fed that already operates that way, however, the view of economics was of wisdom in name only.

    Besides, we might miss another Theodore Roosevelt. We might have to wait for things to get uggly, though, before Teddy comes out in our current president…

  53. Mr. Coffey makes a point about the difference between the mercenary regulator for hire and the authentic regulator that is attempting to maintain principles of stability and order. Internal coherance goes first. This is true in every model of corruption from small town police and judges, through third world sham political machines to the crony politics of market influence in complex potical circles of major cities all the way up through the centers of consolidated power politics at national and international levels. In turn, financing has always been necessary to capture and maintain power whether it is to build a war chest for a standing army or supply the resources to the production of a political military machine. Power corrupts and absolute power corrupts absolutely…so what is it that is new? Well the problem is that se think the system is static. It then becomes easy to hold it constant and act as if it failed to stop a flailing system. But the idea of “regulatory capture” (as I understand it) is a product of Chicago School Economic theory which created a blueprint for subverting the regulatory system and actually rubber stamped it as idealistic capitalism. Maximizing profits and optimizing advantages under rational choice theory codeified this practice as sanctimonious idealism reinforced by pseudo science and laced with Swiss financed Nobel prize stature for legitimation. What Mr. Coffey has demonstrated with his honest testimonial is that the regulators didn’t fail, the flailing business centers rigged the system itself just like every organized crime syndicate would do. They just went a step farther. They not only captured the decision making positions and neutralized the operative regulators, but they also neutralized the very laws that provided the regulators some tools to work with and do their job. People like Mr. Coffey have something to tech us all, the least of which is how to repair the actual process and make it work. I doubt if one browe beated regulator is going to have the answer, but I think there should be a careful polling of the rank and file to find the pool of potential directions needed. For one I would say there needs to be a central reulating body of Governorship that is elected for life (no swithching between interests). For a second it is pretty clear that we need an internal affairs unit with prosecuting power to regulate the regulators and give the hones ones a mode of corrective action. Thirdly there needs to be a review board open to scrutiny by a free press to publish open assessments and critical opinion. Finally, conflicts of interest can not be the rule of order. In concluding, however, it seems to me that the Bond Girl attitude of regulators “mettling” in the affairs of the Financial Service Sector; on the presumption of some degree of relative honesty being impinged on unfairly;…on the commercially successful indoctrination that we all agree that the financial capital is loaded down with the smartest guys in the room (“smarter than everone else?…REALLY!) tHESE ARE ALL PART AND PARCEL TO THE BRAINWASHED PROBLEM OF ARROGANT SUPREMACY IN THE FINANCIAL SECTOR THAT ALLOWS THESE SAME PEOPLE THINK THEY ARE JUSTIFIED IN FACILITATING THE WEALTH INDUSTRY BY EVERY MEANS POSSIBLE…BECAUSE THE ENDS DO JUSTIFY THE MEANS IN THEIR THINKING.

  54. Sorry; some keyboard laden mistakes of fatigue and the comment above was posted anonymous and before I could correct some unintended hi-caps. The above comment comes unde my heading.
    The final verdict is that we need not throw out the baby with the bathwater. The idea of institutional regulation is solid and proven. Take it decade by decade in evaluations. You will have to pay special attention from the time of the late 70s when corrupting the system became part of big money strategy. The truth is that we have an ancient system created at the beginnings of the 2oth century which was pounded for more than three decades to turn finance into a wild west show. You can’t blame the old system when it was never upgraded to handle 21st century crooks, con artists, and backed by a mesmerizing intelligencia which even today get branded as smarter than eveyone else. I for one would like to hear from more of the old school regulators like Mr. Coffey than these newly appointed Financial wizzards. Regulators may well redeem the system with more honesty and intelligence than we have encouraged them to share. Its all a matter of judging who ws bought already and who is being honest. And in our culture…THAT’S THE PROBLEM!

  55. Merkel is boss of the CDU (Christian-Democratic-Union) and KAS is a foundation (donation/charity) of that party. All our parties operate such outfits. Unfortunately I have never been interested enough to figure out exactly why but would guess offhand it is to channel money away from the tax office.
    and their language sure is woolly enough to be discouraging
    So even though tax law probably demands that Stiftungen (Charities) have to be independent from their donors I am convinced that if the people at KAS wanted to displease Merkel, they would have to be stronger than her.
    I have found a site from where I could start looking into German Stiftungen and the first link they offer leads to a Stiftung with unfortunately a very meager excerpt in English but which claims its roots lie in the Fuggerei – therefore I guess if you wanted to get a feel for the inanities of charities in Germany you had to dig into a history of almost 500 years of entanglements.
    here is the e-mail of KAS’ press-woman
    they are said to be very generous with mailing information material so if a prof with his students would like to start a project looking into the German Stiftungswesen they may be helpful – even just a suggestion what they have to offer you in the US or for a stay in Germany should bring results because right from the gut whenever I read something about them they sound like an ad-agency for the party

  56. “there should be a careful polling of the rank and file to find the pool of potential directions needed”
    I cannot count the number of times I have sat at a table as one of the rank and file to be polled
    – whatever you may have uttered will be if at all be implemented in a very distorted but still recognizable form and often make things rather worse than better but now your colleagues are angry at you for suggesting to “them” that which produced such “nice” result.

    you mis-read Bond Girl

  57. That certainly has to be part of the answer…

    I’m simply suggesting we attack the issue from both directions. Take down the complexity somewhat (which many here have argued isn’t buying us much other than more rent seeking opportunities). And build up significant institutional capacity while insulating the regulatory agency from political pressure and creating an instutional environment that is self-reinforcing.

    But, on the whole, even if everything I describe was done in 1934, I doubt it would have stopped the current catastrophe. Just bought us another 10-15 years. Still, that’s an extra 10-15 years.

    In terms of altering the ideological paradigm, we need to recognize that paradigms are resilient. Ideas and models almost always trump facts, unless reality is SO inconsistent with the paradigm that it loses credibility. And even then, those paradigms get recreated 60 years later by a bunch of apologists who try to recreate history to suit their vision (e.g. govt. intervention made the Great Depression worse; if the government hadn’t tried to stop it, it wouldn’t have happened/been that bad).

    I think Mark Thoma was was absolutely correct on the pathological sociology of the economics field over the past 20-30 years. From the Lucas Roundtable, he writes:

    “It was because policymakers couldn’t and didn’t take seriously the possibility that a crisis and meltdown could occur. And even if they had seriously considered the possibility of a meltdown, the models most people were using were not built to be informative on this question. It simply wasn’t a question that was taken seriously by the mainstream.

    Why did we, for the most part, fail to ask the right questions? Was it lack of imagination, was it the sociology within the profession, the concentration of power over what research gets highlighted, the inadequacy of the tools we brought to the problem, the fact that nobody will ever be able to predict these types of events, or something else?

    It wasn’t the tools, and it wasn’t lack of imagination. As Brad DeLong points out, the voices were there—he points to Michael Mussa for one—but those voices were not heard. Nobody listened even though some people did see it coming. So I am more inclined to cite the sociology within the profession or the concentration of power as the main factors that caused us to dismiss these voices.

    We need to take a close look at how the sociology of our profession led to an outcome where people were made to feel embarrassed for even asking certain types of questions. People will always be passionate in defense of their life’s work, so it’s not the rhetoric itself that is of concern, the problem comes when factors such as ideology or control of journals and other outlets for the dissemination of research stand in the way of promising alternative lines of inquiry.”

    (via Money Illusion blog)

  58. It is not an issue of “throwing the baby out with the bathwater.” I would absolutely agree that our financial regulatory institutions were effective over the course of many decades (but that is based on apophatic reasoning). However, the financial system was a completely different animal back then.

    Most of the suggestions for reform posed on this site are tantamount to 1) let’s build a time machine to take our financial system back to the 1970s, back when things were simple, and then our regulatory institutions will be able to be relevant and effective again, and (perhaps as an insurance policy against capture?) 2) let’s create another regulatory entity to safeguard the interests of consumers (i.e., determine which financial products should be available and how much corporations can profit from them). You may get the latter, and time will tell how effective it will be.

    It humors me that people say the self-enforcing protocol that I’ve proposed would create something worse than what we have now because, 1) frankly, I do not know what could possibly be worse than what we have now (we have regulatory agencies that are so captured and so inept that they cannot even identify when major players are completely falsifying all of their records), and 2) trying to unwind the behemoth that finance has become just for the sake of having something simpler will probably have more than a few economic consequences that no one here has legitimately explored.

  59. StatsGuy
    thank you for this

    “those paradigms get recreated 60 years later by a bunch of apologists who try to recreate history to suit their vision”

    I think that’s all one has to keep in mind and what too often is forgotten because Bush/Cheney-bashing is more fun – if one wants to explain the way the Iraq- and Afghan-wars are fought look for the hubris*) of:
    we know better now, look they (in those cases the Brits of old) made all those stupid mistakes

    – both wars have a lot to recommend them to long term benefits for empire (life is good to “normal” people under the umbrella of the current empire) but not when conducted with hubris
    – of course I prefer the compassion rising mantras en vogue today very much to the hate creating ones of old but they have the side effect of forcing the military to fight with their hands tied behind their backs and strategies really crashing the enemy for that kind of fighting have still to emerge

    *) the old Greeks connected hubris to jealousy of the gods who would then strike in fury

  60. I think there is something fundamentally absurd about being so wed to existing insitutions that our solution to a problem allows those institutions to be the constraint on growth going forward.

  61. …only to the extent that it is lesser than the absurdity of tearing down past institutions to pave the way for growth that is illusionary.

    Nor do I (yet) accept the tautalogical argument that newly designed institutions _must_ fail because the dilapidated and deliberately-weakened institutions of the past did fail.

    Moreover, I doubt that the structure you present would remain any more stable in the face of a destructive paradigm shift, national infrastructure mismanagement, grotesque federal deficits, massive trade deficits, and petty uncoordinated power-grabs by international central banks. 70 years since 1935 is a long time…

    But I do concede that your recommendations are better than what we have right now. There are two semi-stable equillibria: strong regulation, and (openly) weak regulation. Having weak regulation but pretending it is strong regulation describes our current state of affairs, and it is disastrous.

  62. I agree with much of Jim Coffey writes but as I recently wrote to the FT (in one of my soon 900 unpublished letters in a row) it is not a question of capture, but of rapture.

    The real problem though is no that the regulators were captured but that they were rapture by the silly idea that they could control for risks with their capital requirements for banks based on a vaguely defined default risk and have the credit rating agencies do the risk-surveillance for them.

    So raptured were they that even two years into the crisis they seem still as enamored with that idea as the first day it crossed their naïve and gullible minds.

    Having still to read, almost on a daily basis, serious frowns declaring about “risk-weighted” bank assets, as if those risk-weights were God sent and really meant something, drives me crazy.

  63. Seventy plus years ago my grandfather in Mississippi used to plow his corn fields with a mule. One day someone asked grandpa what was the hardest part of plowing with a mule. Grandpa replied, “Getting his attention” Someone then asked, “how do you get his attention grandpa?” Grandpa replied, “You hit him in the head with a two-by-four”

    I don’t think our problem is figuring out how to fix a broken public-private financial system whose goal is simply to allocate resources to maintain the long term viability of our nation. The question is “how do we get their attention?”

  64. If I might add –

    If you try to plow a corn field wit a mule & you don’t have his attention, you’re wasting your time.

  65. “how do we get their attention?”

    fastest, easiest most reliable method:
    make yourself useful, promise a profit, a benefit etc.

    making them publicly accountable doesn’t help as long as their peer group considers those hearings/interviews ridiculous BS a nuisance that comes with the job like autograph hunters are probably for movie stars

    any threat/consequence that doesn’t cost them the membership to their peer group is appeasement for the public

  66. BG’s objections to Mr. Coffey’s point don’t stand up to this question, “So what?”

    First, that his recommendations are “quaint and idealistic” is irrelevant. This response is patronizing, which attitude is typical of financial industry participants (among which which Bond Girl admits to being) toward others. Their idealism actually recommends them. Perhaps, President Roosevelt’s ideas seemed “quaint and idealistic” to J. P. Morgan in 1934. So what?

    Second, the fact that Obama calls Dimon is actually a major part of the problem; it’s downright frightening, unless you are in a position of authority or on the course toward such a position in in that industry. Her observation of this fact is empirical confirmation of the problem that needs to be rectified. “Obama calls Dimon”; so what? That was Mr. Coffey’s point. Obama should be calling Geithner, Bernanke, Blair, the head of the OCC or the head of the SEC for guidance.

    Third, to what does your pronoun, “they” refer in the final sentence of your second paragraph? If to the bankers, then, so what? The rest of us know that they are not. We’ve seen this battle before and it could go either way.

    Fourth, Mr. Coffey doesn’t allege that the replacement of career regulators by political appointees and their hires is intrinsically damaging. That would be absurd and inconsistent with his recommendations; a President could appoint a conscientious, smart, driven department head who would institute a hiring policy that encourages the hiring of smart, diligent regulators whose purpose is to manage the rules of that particular game so as to have the best chance of optimizing the outcomes for the society as a whole rather than a small group of industry players. Or, a President could appoint the types of department heads who intend to manage a department whose purpose is as you suggest. Part of Mr. Coffey’s message is that, since the beginning of the Reagan administration, career regulators have been replaced by more and more cronies of the appointees of elected officials. The principal, damaging result of this process has been that the appointees and their hires have driven the regulatory institutions to exactly the position you describe – ignoring the behavior of bankers and their lobbyists. Another point he makes is that this outcome was intended by its perpetrators and that it required two and a half decades and three Administrations to accomplish. Let me add that this is exactly how this kind of transition from one ideology to another is always achieved, whether in business, academia or politics.

    Fifth, “the fact that the financial industry is running circles around the whole system of regulation in this country” does not constitute an argument against Mr. Coffey’s analysis or proposals. It actually supports them and serves as confirmation that we need to return to a system and body that resembles the “quaint and idealistic” regulatory system we had before Reagan began to dismantle and defund it.

    Sixth, compliance officers within the institutions are handicapped, indeed. After all, compliance is a cost center, not a revenue center. This observation constitutes another observation that actually supports Mr. Coffey’s position. The financial institutions have demonstrated conclusively that they can’t regulate themselves, and the accountants can’t regulate their clients. As a former commercial banker, I have experienced a sound compliance environment that resulted from conscious decisions by smart, honest senior bank officials to create and maintain it after the bank nearly failed in the early 1970s. However, the threat of regulatory action always played an material role in our behavior.

    I share your horror at the current situation. The forces that want to maintain the status quo are smart, powerful and ruthless. Today, they appear to hold the high ground. The battle, though, is not over. We must keep the pressure on our elected officials and we must provide them the support they need by assuring them that if they carry the fight to the White House and their peers, we’ll vote for them in the next primary and the next election. If they don’t, we’ll find someone else to support.

  67. I have re-read BGs post and I find her reply loaded with the bitter overtones of a very disappointed professional
    if Mr. Coffey feels patronized I hope he would tell us

  68. BondGirl’s point is well-taken. The 21st century financial cat is out the bag. If you want to regulate it, you need some serious firepower. Coffey’s suggestions are probably necessary, but not sufficient.

  69. Just to elaborate on the key point in BondGirl’s post: “It is a decision not to meddle in the affairs of financial institutions at all.”

    The main issue is that we are not subjecting the things that should be scrutinized to the right kind of scrutiny. It is not happening for the reaon BondGirl suggests.

    Furthermore, due to the internationalization of finance, coordinated regulation needs to be done in every last country in the world. For every PhD in financial mathematics, there needs to be a corresponding PhD in mathematics in a regulatory agency capable of calling them on their BS. For every team of accountants in a corporation, there needs to be a larger team of auditors to find the fraud. And so forth. Doing this is a brobdignagian task in today’s financial environment, and requires either a total overhaul of how regulation works, or a complete restructuring of how finance works (paying attention to the economic dislocations this might cause). It is easy to see how someone might be discouraged that it can be done at all given the current prevailing attitudes.

  70. Just to illustrate your point Mr. Obama has an op-ed in the NYT of today

    some time after 2001 or a couple of years later I found a long piece by Hillary Clinton laying out her arguments in favour of new health insurance
    – while reading it I kept shaking my head “but this is not going to work, this is an illusion and so on” but when I compare my feeling then to my feeling when reading President Obama’s Op-Ed of today Hillary Clinton’s piece felt like at least being based on some solid assumptions.
    The piece in the NYT is the promise of lots of lofty stuff with no indication of how that is supposed to come into being – maybe people should get together, look at ideas the early socialists had (they must have had some) and organise their own health insurance the same way the old socialists organised their shopping and education societies.

  71. I believe the strategy is to persuade people they are getting health care reform while simultaneously creating new profit centers for the insurance companies. Republicans will cooperate by screaming bloody murder, “socialism”, etc. which will make it seem like Obama really is proposing health care reform.

    Once the American people have been faked out, in the next round of reforms the debaters will point to how they were misled before and how they expect to be misled in the same way again. They won’t be. They’ll be misled in a slighly different way.

  72. Angels, Pinhead. Pinhead, Angels.

    Get rid of the garbage, and we get rid of the need to regulate the garbage, and purveyors thereof.

    Whatever us lumpen decide we want, we need to solve the “Who watches the watchers?” problem. This will probably require a new class of society, raised and educated separately, in a transparent environment (Nannycams!). We will watch as they grow up being taught values like: We are all worthy. We are all in this together. Violence is not to be tolerated. Corruption is not to be tolerated. A “baseline” needs to provide: 1) Food for all 2) Protection from violence for all 3) A home for all 4) Education for all 5) Healthcare for all 6) Two bags of salt and vinegar chips for all (shh… just a bargaining chip)

    Then set them loose and let them audit the hell out of this screwed up little blue marble, all the while keeping a close eye on them. 20 year terms, and then reward them with a home in the location of their choosing.

    Don’t want to compete on a truly level playing field? Then go away. We’ll grant you and your peers your own independent country where you can kill, starve, and generally dominate each other until there’s only one of you left. We will then send in a reporter to ask you, as you sit on a smoldering heap of bodies and tangible assets whether it was worth it or not.

  73. Jakob Fugger — So he sets up a charity to house poor Catholic folk, but also lends money to both sides when he finances wars. And he pays off electors to put Charles V on the throne (Emperors have thrones, right?) Sounds awfully familiar!

    Sounds like he was more concerned with looking good than with being good.

    Thank you for the information on the foundations. I will pass on emailing Uta for the time being. They probably wouldn’t appreciate any substantive poking around.

  74. maybe we lumpen (I like that word though the real lumpen had it a lot tougher than probably most of us do) just have to treat the people whom we want to protect us and our rights with respect again
    stop ridiculing them (if you do not study hard, you end up in Iraq) for being not hip enough, not cool enough, not laid back enough
    maybe we should start revering the stuffy upright uncorruptible boring guy/girl until they start getting out of hand then we must start promoting the laid back cool dare devils again

  75. you wouldn’t have to let them know that your poking around is substantive, seeming to admire them should give you much better results

    and as to the Fuggers – all those charitable people – and I can see no change today – excepting of course the people who actually do the charitable work – where being good in itself was the goal. It is the prestige and good for the needy if they can make a case the alleviation of which brings prestige to the “good”

    to cheer you up just listen to Quentin Skinner on Macchiavelli

  76. You’re giving me little quasi-academic goosebumps. A couple of weeks ago I was surprised and fascinated with another ancient housing project that was run by the Catholic Church. Uh, it was only yesterday that I was becoming reacquainted with Macchiavelli.

  77. do you remember which other Catholic Housing it was?

    I haven’t been into the Fuggers in a long time, to learn from you it was Catholic somehow sounds strange to me – In my mind they are stored under protestant – but maybe that was later. Maybe I should dig into them again but for now Constaninople has fallen to Mehmet II and I go back to Sicily volume 2 and then on to the history of Venice. In between I gulped down two of Donna Leon’s – she really is good at how these invisible threats run through a society that is modern and feudal at the same time.

    listen to Skinner – he has a voice grating on the ear, but he is so full of enthusiasm, sounds like kind of jumping up and down with it while he talks that I can’t get enough of him – if you like him I’ll post you more links – for now here he is on Hobbes

  78. Sorry. I’ve been wracking this addled brain to try to remember, but it’s still blocked out. (Maybe in Rome?)
    I’ll let you know when it floats back up.

    Didn’t CDU start off Catholic as well, and then build up its base with protestants?

  79. Dante “For every PhD in financial mathematics, there needs to be a corresponding PhD in mathematics in a regulatory agency capable of calling them on their BS.”

    Where have you been? It is exactly having placed ourselves in the hands of some PhD’s who have never walked the streets and that could not comprehend what some mortgage brokers could be up to if they have the incentives and the AAA camouflage that got us in this mess.

    Any PhD in banking not capable of expressing what he is doing in words that a college graduated bank cashier understands should be shown the door.

  80. WordPress doesn’t seem to be cooperating. Here it is again, a little more useable:

    Here this looks credible as to Fuggers & Catholicism:

    Jacob Fugger reportedly learned double entry bookkeeping from the Medicis on a trip to Venice.

    Medici’s themselves were all about Catholicism: They produced three popes and a number of cardinals.

    [This post has been certified aspersion-free]

  81. Come on everyone this is not rocket science. I’m just a working blue collar union carpenter and I understand what occurred in our current melt down. First dismantle Glass-Steagal, then create Gramm-Leach-Bliley and viola-Ponzi Scheme. The last virgin financial sector left to be ravaged by the Streeters was the home mortgage market sector. They have been salivating for years to get a piece of that action. What they did to enable it was the same boiler room and bucket shop operations (read derivitives) in the late 1920’s leading right up to the Great Depression. First, quit splitting hairs on what caused our current problems by trying to lay blame. Second, recognize that which is contributing to the productivity of our country and what is only enabling the enrichment of a few that are on the”inside”. Then encourage long term growth and development back into Wall Street for the better of our Countries and the Earth’s future. Do that by writing into law that what Wall Street breaks they have to fix. No more socialized losses and private profits. Sure they can crap shoot all they want. But, no more crap shooting with “other peoples money”. The fed is partial to blame for its easy money policies under Greenspan with his “wink,wink” to Wall Street while lecturing about irrational exuberance and sitting on his hands watching the train wreck coming down the rails. We have had two major examples of what not to do in the last 100 years. Whats so hard about removing the manure from the barn? Its easy to locate. You just roll up your sleeves and do it.

  82. Appeals to futility are easy to make when some luke warm generalization from a paricular experience is used to validate it, but it is faulty reasoning and a self confirming (circular /tautological) position. It explains nothing. To admit that a culture and climate of hostility reinforces the inability to operate correctly in regulatory procedures only points to a corrupted environment that needs internal compliance office for accountability and credibility. There are two concerns being addressed. One is the primary flaw or corruption in the regulatory agencies as people in the context of doing their jobs. It is a cheap trick of finance to rank on these people and call them second rate authorities as an excuse to dismiss them. It seems the end product of getting rid of the regulator is really the ultimate objective. This becomes obviously distorted in a serious conflict of interest on the question of incentive. The second level is one of institutional structuring and restructuring. The deregulatory hostility of the past decade has clearly had a heavy impact. This requires assessments and I would still argue that individuals like Charles and Mr. Coffey have the credibility in the clarity of intentionality they display. It is true that three card monty is difficult to follow, and with the exponential factors involved in the “creative engineering” of derivatives it does not surprise me that unpopular demoralized regulators would find it difficult to follow the money (as the saying goes). But that is the current design to “exotic” (give me a break…)instruments. Ask Michael Milken. It’s not so much that these wealth palaces are so lofty (too big to be bothered) its that the lack of enforcement on fraud and deception has made them too big to put in jail. Now the whole economy has been turned into one BIG DERIVITIVE and frankly we the people are left with a major decision. Do we ask the Regulators for some protective truth or do we continue to believe that the Financial Market system will eventually trickle down on us with pennies from heaven. When the BGs of the system start explaining to us what they know about corruptuion and unethical behavior it will be a windfall of wisdom on how to correct the system. But until that time comes I will put my interests in trusting the honesty of regulators that sound credible. In this case, Mr. Coffey is coming through pretty clearly and maybe it will start a trend. That trend, of course, depends largely on weather they have our “attention” and our total support and appreciation. Keep the Faith! If we can’t pull the mask off the bad guys, let’s at least pull the wool off of our own eyes.

  83. Gosh, I love a good debate. It’s time to reform regulatory practices, obviously. This debate should be had by a very large group of specialists, and should result in meaningful statute and regulation. My greatest concern is that, like our tax laws, we will try to build an amendment which tries to tweak what we already have. I am in favor of starting over completely from scratch. This would work best for regulation, health care, tax laws, etc. You can’t tweak such amazingly complex things and expect anything like good results. Both Mr. Coffey and Bond Girl have laudable ideas, both also somewhat idealistic. We need a fresh start and soon.

  84. this is going way of topic – are you on another Forum where we can continue? As you seem to be hung up on Catholics I am very interested. This is the CDU Funny they do not mention the CSU Christian Social Union their “sisterparty” prominently. Public perception sees the CSU which is active only in Bavaria where the CDU is not but there having regularly over 50 % as the real Catholic one. On election day CDU+CSU are counted as one. Also funny that they do not say something prominently about their relation to the Zentrum of Weimar

    this tells a much better story than the party-site

    thanks for the links – yes I am amazed again and again how interconnected those old guys were and how much they travelled
    and the popes were all about power, i.e. for a German Kaiser to be legitimate he had to be crowned by the pope – and German Kaisers fought all kinds of battles with ever shifting allegiances in Italy for and against the pope and the pope had Constantinople sacked in the name of the right dogma thus doing half the Ottomans job etc. etc.

    Most of what we experience today has always been like that but my gut tells me that there is also some game-changer involved and I’d like to get a feel for what that is – when the tech-bubble burst I did not have this uncomfortable feeling of having entered another aera.

    Merkel is the daughter of a protestant clergyman …
    no matter how few of us still go to church they are still all over the place

  85. “has made them too big to put in jail.”

    hopefully you have not hit the nail on the head there because it has been successfully before and probably not just this once …

    really, this book should be back in print, those guys started as nomadic sword fighters for hire, became too big to be dismissed and ended up with Sicily, the corn basket, as their kingdom.
    One day I had a streak of luck and got my copy for about 25.–

  86. Alexander is said to have dealt with the Gordian knot in one stroke of his sword – he even got his empire but after his death it all went to pieces and the fighting lasted a long time

    by which I mean to say the idea to start from scratch is just as idealistic …
    I sincerely wish it weren’t so …

  87. All the SEC has accomplished in 75 years is to make capital raising by small companies virtually impossible? We have more public companies than anywhere else on earth. The SEC provides for public, semi-public and so-called private options. The primary requirement is disclosure, together with an industry that will underwrite and investors that will buy. The process is not perfect but is the best balance between capital-raising and investor protection available. And it can be improved.

    Jake is right that the accounting and disclosure rules are inadequate in many regards. This, in part, is the result of polital interference and the power of money as wielded by issuers and auditors in a deregulatory environment. It shouldn’t be permitted to continue.

    As for enforcement being limited to penny brokers, I can tell you from experience that you are far off the mark on this one as well. In 27 years, I and my staff brought well over 200 enforcement actions. They included Mike Milken, Coopers & Lybrand, Merrill Lynch, Reliance Group Holdings, Gruntal, Kemper Financial Services,Arthur Anderson LLP, Tyco, Dennis Kozlowski, Time Warner, Cendant, portfolio managers at Fidelity, enough CPAs to start a medium sized audit firm and scores of others, more than a few of whom spent time as guests of federal or state governments. Not a penny broker in the bunch, although we brought our share of minor league manipulation cases.

    Finally, your characterization of regulators is a disservice to the scores of bright, dedicated and yes, well-educated young professionals I’ve worked with over the years at the SEC. Most do move on after a number of years, but not because “their bretheren are short on both competence and ambition.” Most often it is because Uncle Sam doesn’t pay enough for a professional with a family to live decently in D.C. or N.Y. And most I know who left will tell you they would have stayed if they could afford to and that their years at SEC enforcement were the most challenging, rewarding and fun of their careers. And they continue to say that despite the comments of folks like you, Jake.

  88. Good grief! I’m glad so many have responded. I’d just make a few comments in response to BG’s reply.

    First, their are people who repsect regulators. Not many in your industry, I know, but there are millions. I hear it every day.

    It is no surprise that the financial industry considers us bureaucratic pinheads. I’ve known it for years. I’ve sat across the table from too many bankers, traders and brokers not to have come to that conclusion. That will always be the case. You folks keep score with dollars while others of us use a different measure of value. That is why we cannot rely on self-regulation. Nor, as I noted, can we rely on well-intentioned regulators alone. We need to amend the structure of the industry to attack the concentration of power, provide economic disincentives and achieve some measure, albeit small, of protection of the public’s economic interests.

    Our markets should not be a playground for the fortunate few, even if they do believe themselves to be the best and the brightest. These markets are among America’s most important resources and they must be structured in a manner that enhances their success while minimizing the threat they pose to the overall economy.

  89. Charles: thank you for your professional guidance. Please check the threaded stream on

    it’s a start! We really need some due diligence and we can’t get that if we are going to use knee jerk political rhetoric and mixed messages about nationalistic indoctrinations. Facts; Truth, and Justice will prevail if the American professional business sector (the smartest people on the earth) will simply get up and start to demand truth, accountability and credability as standards we are proud to uphold. There is no doubt that our financial system will not work from the back room or from offshore hidden black markets (or shades thereof;) but it has hit critical mass and only our PRACTICAL professional people really know the answers from the ground up. It is time to get rid of the NEOsyndicate that has emerged as the self appointed gatekeeper of American health, wealth and prosperity. People need to pull together and I believe they will… if more forward thinking professionals like you can form an informed consensus to challenge this current fiasco of policy stealth, misinformation and unregulated profiteering.

  90. Well, that is kind of the point. I think there is a tendency for people to think that market participants dismiss regulators because market participants are just jerks (which I’ll concede is somewhat true). But market participants develop this impression because experience shows they have nothing to fear. Exactly how often are even small players held accountable? There are plenty of small banks that are going under from toxic assets now, and that is the market holding them accountable, not the regulator that should have prevented this in the first place. This is true all the way from the fraudulent mortgage broker to Goldman Sachs’ program trading platforms. They aren’t all dealing with the top-ranked people at the regulatory agencies who are most clearly captured, so where do they get this impression?

    You say many people respect regulators. What does that mean to you? That they respect your noble intentions? It’s not hard to find like-minded people when you say you hate bankers. But have any of them ever called you highly effective?

    I actually think most market participants would like for everyone to be held to some standards. But in the absence of an effective regulator, they are thrown into a dog-eat-dog world and they end up playing accordingly.

    To give you an example, I had a conversation some time ago with a friend in investment banking. One player in his area was undercutting everyone else’s business by pitching a synthetic fixed rate debt product. The fellow pitching it was telling people they had a traditional fixed rate product and that at no point in history had anyone in this arrangement ever had a change in their debt service expenses. My friend tried to make the biggest stink ever about this product, even managing to obtain marketing materials. No one did anything. What does he say to me? Looks like we are going to have to get into the derivatives business otherwise they are going to steal all our clients.

    This kind of arrangement probably will not be captured under the current reforms, likely by design. The SEC for the longest time did not even want to touch derivatives. When problems arose they didn’t say this is dynamite, give us this authority. They said, we do not have this authority so don’t complain to us about it. I do not find that noble and righteous one bit. You could argue that they thought their hands were tied from a legal perspective, but they certainly did not make a stink about it. Right now, I am watching countless municipalities getting burned even to the point of bankruptcy by derivatives. This problem has been known for several years, and the only agency that was aggressive in investigating fraudulent behavior was the IRS. I continue to wonder why the SEC has not filed a complaint against JP Morgan with respect to Jefferson County. I guess I do not actually wonder.

    I really could carry on all day about ways in which these agencies have failed to anticipate problems. I can’t fathom putting them in charge of hundreds of trillions of dollars’ worth of highly complex transactions that are already outstanding. Would placing a career regulator at the top of these agencies lead to Dimon and Blankfein getting their skulls knocked? Highly unlikely. People know that, accept it as a given, and that is why our markets are the playground for the few. You aren’t going to get policymakers on your side because they want to be on the winning side. To create a winning side, you need to start with some players that have actual credibility in the marketplace to even have a chance.

  91. I’d add one more item to your list, call it an Sunshine Provision

    Enhanced Financial Statement Disclosure.

    In addition to the agonizing process the FASB and IASB will continue to through to define broad concepts and principles, I think the regulator should be empowered to demand immediate and specific disclosure from all regulated entities about specific items, especially in times of extreme market disruptions.

    For example, just before the Lehman collapse trying to determine the total CDS settlement, as well as trying to determine where the exposure lay was nearly impossible to find.

    Except that it wasn’t. DTCC had almost all of the exposure information at its fingertips. As settlement day approached they issued a press release providing some comforting summary numbers. For weeks prior to the release no one could assess the potential impact and everyone was extremely anxious. Settlement day came and it went as DTCC had reported,

    Since the information was readily available, the regulator should have demanded it, and simultaneously disclosed it to the markets.

    In addition he should have ordered all regulated entities to publicly disclose their exposure

    I don’t think DTCC had a civic reseponsibility to release the details, but I do think regulators have a right to demand the info and disclose it to all market participants to use as they see fit.

  92. Not everyone failed to anticipate problems. Many of us saw this train wreck coming. The problem was that no one in a position of authority would listen because it would upset their sponsors, which includes, no doubt, your employer.

    BG, you can rattle on and on about how ineffective regulators are and how little they see or recognize. There is more than a grain of truth to your observations. But that is a result in large part of at least two phenomena: hostility at the top to regulation and a refusal to step in where needed; and the failure of folks in your industry, like you, to bring matters to the attention of the staff at regulatory agencies. The fact is that you folks are in a lot better position to see abuses than government employees. But that is no reason to believe yourselves superior and regulators inferior. And don’t cite Madoff to me as a reason for your silence. The SEC screwed up, no question about it. But a few more words from the industry side may have changed the outcome. Just as police need tips, so do other cops on the beat. Those of you fortunate and smart enough to occupy positions in the industry should try–much more than you do now–to ensure that the regulatory system is effective, and it can only be effective if all the the financial community pitches in to help. I know it won’t happen, you are all too busy making money and building relationships, no matter with whom, to recognize a civic obligation. It is easy to criticize the regulaotory system, keep quite about the wrongdoing you witness and allow the predictions of regulatory failure to become a self-fulfilling prophecy. But you protest too much. As Dylan said, “negativity won’t pull you through.”

    If you can’t report on your fellow financiers maybe you could volunteer to work for the SEC for a period. Regulators need the insight of insiders. Cancel that next ski trip and teach a seminar at the SEC enforcement division. You will be surprised at the response and the brain-power of the staff.

    And by the way, the fact that many people respect SEC regulators, despite Bernie, is more important to you than me. If they didn’t, you would soon be out of a job because folks would stop investing. While it may give me a sense of satisfaction, it gives you a paycheck every week. Be careful about what you preach.

  93. I was a whistle blower. It’s much more likely to happen in an economy with really low unemployment. The law might be on the side of the whistle blower, but you get royally hosed anyway. It is not an easy thing to do, and usually nobody follows the first one because the hosing is public for everyone else to see. Retaliation and harassment is utterly illegal, but that’s how it works. If you are expecting whistle blowers to step forward, don’t hold your breath.

  94. Upon much reflection, I think we have more in common than we are letting on and that we are all just upset at the general mess that this has become.

    I absolutely agree that market participants are in a better position than regulators to know what is wrong, and that is a shame. I have actually tried to draw attention to abusive behavior on my blog, and I receive a lot of emails about it from bankers and from journalists that have learned things. Emails, not public comments. I have a sense that most people do not speak up about unethical/illegal/questionable behavior because they know it will not go anywhere and at they end of the day they still want to have a career. Not that this is much of an excuse, but it is a reality.


  96. I was a whistleblower too, repeating over and over again that giving so much importance in the guidance of the markets to some few credit rating agencies doomed us, sooner or later, to massively follow these over a cliff…. But no one listened to my whistle… because they wanted to believe…. Just like you all fools apparently want to keep on believing , because still today, two years into the crisis, our regulators still put their trust in the credit rating agencies… talk about voodoo regulations!

  97. There is a fashion of speaking in a generally degrading/fun making way about public servants/governmetn employees
    – it is always OK to declare public servants/government employees superfluous private companies would be much much better at it they are stupid, incompetent and what have you etc. etc.

    – only when it comes to securing that the ownership of your land or your house is properly recorded and kept on records you are quite glad they are there but you never think of acknowledging that there are parts you wouldn’t want to miss (I assume that land deals are publicly recorded in the US also)
    – Mind you I am trying to describe a general tenor in the commentariat

    What I am aiming at is that there is a whole culture of sneering at them without ever taking the trouble to look into the why they have to impose such arduous procedures, i.e. take history into account

    I am glad Crowley refused to apologize – because I have been too often at the receiving end of those “entitled” and it all felt so very familiar (mind you the part that race relationships in the US may have played or not is quite alien to me)

  98. all you have to keep in mind is what happened to Orson Welles after Citizen Kane
    if somebody like him could be shut down almost all over the world which fate awaits one of the faceless

  99. as to relations between foxes and henhouses

    foxes are capable of operating quite differently depending on the head fox

    the following two examples are at the end of a spectrum of possibilities and I do in no way want to hint that Mr. Coffman has at any time been operating even near any of those two scenarios – to me he rather reads like quite a number of helplessly honest and decent colleagues I was lucky to have over the decades and for all they tried never quite managed to get things to work the way they wanted it except for the intervals when a right guy was at the top

    the ultimate proof are probably all the old Nazis who became reliable public servants often defending the rules of democracy with the same vigour they had fought for adherence to Aryan supremacy

    the more simple and much more common example is that even employees having proved again and again that they may be completely useless if not harmful one day and the next day are all diligence and dependability and team work – the only thing having changed in the meantime is the boss

  100. Silke says “- it is always OK to declare public servants/government employees superfluous private companies would be much much better at it they are stupid, incompetent and what have you etc. etc.”

    Absolutely right and that is why even those libertarians normally out there checking up on excessive government involvement did not say anything… fooled by the fact that the credit rating agencies were private. Truth is that these libertarians aren´t neither what they used to be. How can they not see that the credit rating agencies are just outsourced government bureaucrats?

  101. Per
    I hope I understand you correctly that you mean to say that the private AAA-raters were innocent without trial while public servants were guilty without trial

  102. Yes Silke, close enough. Private AAA raters were considered to be infallible while public servants are considered fallible. What would the world at that point of time have said if the regulators instead of using private credit agencies proposed to use public credit rating officials? All hell would have broken out. But, please, do not get me wrong I dislike imposed credit rating agencies, whether public or private, just the same.

  103. It was meant to be a response to BG’s post about Madoff, which followed a post in which she acknowledged what I firmly believe: our positions are closer than we will admit. We all played a part in the evolution of this mess (usually passive but we knew what was coming) and we will all need to reexamine the regulatory system and our own roles it it if we have any hope of preventing it from happening again. For a moment, and just a moment, I thought peace had broken out.

  104. Very well worth watching. I’ve compiled a summary:
    2 primary questions:
    1) Why do we have repeated intensifying crises?
    2) What can white collar criminology contribute to our understanding?

    Example of the insanity of the system : Excerpt of an email typed by a top boss at S&P (rating agency) to a subordinate regarding a mortgage backed security:
    “It is totally unreasonable to request loan level tape. It is your responsibility to provide a credit estimate”. Explanation: in a trillion $ industry.
    i) Buyers did no credit check (they trusted the rating agencies)
    ii) Rating agencies did no credit check yet gave AAA ratings to massive credit risk instruments e.g. sub-prime.
    iii) The seller who packaged loans into a security didn’t even have the loan files that would have allowed to do a credit check.
    iv) Could do regulator have done a viable stress test in this context?

    2 criminalogy aspects:
    1) Control fraud : Crimes led by a CEO who uses a seemingly legitimate business as a weapon of fraud. 2 measures:
    – 80% loss for mortgage fraud comes from control fraud
    – Greater losses than all property crimes combined.
    2) Criminogenics: What system of incentives generates massive fraud?

    Flashback: Subprime crisis of 1991/2 a.k.a the “savings and loans” crisis. Why don’t people remember it? Because the regulators stopped it. Lethal Combination
    i) Loaning to people who can’t pay you back, but have to pay higher interest (liar loans).
    ii) Extreme leverage
    If fraud is not punished, it gives fraudsters an advantage and pushes the honest businesses out, leading to an epidemic, a bubble. By the end, 40% of mortgage loan were sub-prime. Eventually bubble bursts. Trust is lost, the markets shut down.

    2) Average CEO lifespan is 3 years. In this short period aggressive exec compensation if hits profit targets. Aggressions dynamics. How not to go into sub-prime? Bad ethics drives good ethics out of the market.

    Firewalls that have failed:
    a) Corporate Governance
    b) External control : auditors, regulators. More effective to subordinate than destroy. IndyMac (7th largest) sold $80 billion of liar lones in 2006. Regulator couldn’t see it?!
    c) Regulation. 4 ways it can be subordinated:
    i) None (as was the case in sub-prime)
    ii) Deregulation
    iii) De-supervision
    iv) Capture Regulators do the bidding of industry

    Greatest paradox : The two parties to the deal were made worse off : borrowers (worse destruction of working class wealth in American history) and lenders (Banks). Who wins? The agents (as called in economics): auditors, CEOs, loan officers etc.

    Follow up conversation:

    In the 1980s regulators prosecuted aggressively resulting in 1000 felony convictions of insiders, in the saving and loans debacle (in spite of the Keating 5). Today: the Justice department today did not investigate large non-prime lenders until spring of 2007 after 2nd market had collapse. Zero indictments since then. Example: head of supervision of Office of Thrift Supervision, through congressional hearings, who was demoted 7 levels in the savings and loans crisis (for failing to do his job) was promoted 17 yeas later to be the prime regulator for the big CA players: Wamu, Countrywide, IndyMac etc. FBI warned of an epidemic of fraud in sub-prime in 2004. However, they had already transfered, and not replaced 500 agents to national security since 9/11. Then came Enron and Worldcom, calling for 100 agents, which did not go to trial until 2006. 20 good examiners could have gone after the Achilles heels: rating agencies; only 3 of them. They did warn about fraud in the subprime market in 2004, but viewed it as a retail crime instead of wholesale crime: that’s 150 agents having to deal with 62,000 of criminal referrals. Obama receives advice from people with a record of failure, such as Geithner, who helped engineer the crisis. This is not without precedent: before becoming chairman of the Fed, Greenspan had helped recruit the Keating 5 and wrote that Lincoln savings posed no risk of loss.

    Recipe for a good regulator: backbone + intelligence + self restraint (condition for credibility). Fed does not have self restraint : it is the most opaque institution in America.

    Useful links:

  105. Comment by CityIslander on the insanity of the system.
    i) Buyers did no credit check (they trusted the rating agencies)
    ii) Rating agencies did no credit check yet gave AAA ratings to massive credit risk instruments e.g. sub-prime.
    iii) The seller who packaged loans into a security didn’t even have the loan files that would have allowed to do a credit check.
    iv) Could do regulator have done a viable stress test in this context?

    Given the tremendous exponential increase of the value in the credit rating agencies as a result of the minimum capital requirements for banks, the regulators should have known that they were setting up the credit rating agencies to be captured, sooner or later.

    Or let me phrase it differently.

    Would you like to have our financial system supervised by naïve regulators who would not be aware of the above? I guess not!

    If it is risky enough with many market agents doing credit evaluations, would you like to have that risk leveraged by having fewer participants performing these assesments? I guess not!

    A recipe for a good regulator? Someone intent on not wanting to add new risks to the risks!

  106. If I should accept the far fetched claim that “the regulators should have known that they were setting up the credit rating agencies to be captured”, that is still quite irrelevant : unless the regulators were either completely retarded or subordinated to the industry they would have seen it and changed the rules. Black makes the point that they were subordinated, with overwhelming verifiable claims, not due to the purported fatality inherent to regulators, but by design, as given in my summary:

    I’ll leave to you, therefore, to prove that they were retarded anyway or that Black’s claim that they became subordinated by design is wrong.

  107. Well since the authorized leverage for the banks hovered between 12 to 1 and 62.5 to 1 depending on the credit ratings, I cannot understand why you would qualify my “the regulators should have known that they were setting up the credit rating agencies to be captured”, as “far fetched”… that is unless you want to place undiluted responsibility of all what happened on the industry, saying no the poor regulators, they knew it, but they were “subordinated”

    I, having discussed with the regulators this issue for years, am just more prone to believe they did not understand the implications of meddling with risk… and frankly I suspect they still don’t they are just too in love with the cuteness of their minimum capital requirements structure. A paradigm is a paradigm until it completely stops being a paradigm.

    And by the way this does not mean that Black is totally wrong… you see a wrong paradigm can be used as the perfect excuse.

  108. Could you please point me to a link describing the regulatory “minimum capital requirements structure” that you are talking about?

  109. Glad to. In the following link you can find Part 2: The First Pillar ─ Minimum Capital Requirements of the Basel II regulations.

    Click to access bcbs107b.pdf

    There in 6. Claims on corporate page 18, 19 you will find for example that

    The risk weight for an AAA to AAA+ rated corporate client is 20% while the risk weight for a BBB+ client is 100% (please do not ask me why?)

    Now how does it work?

    If the bank lends $100 to an AAA this loan will only appear as $20 in risk weighted asset and since the basic capital requirement is 8 percent the banks needs only $1.6 in capital signifying an authorized leverage of (100/1.6) 62.5 to 1

    On the contrary if the $100 loan is to a BBB+ then it will appear as $100 and the bank needs $8 in equity for an authorized 12.5 to 1 leverage.

    Since bank equity costs money you can start imagining the incentives of dressing yourself up as an AAA client.

  110. @ Per Kurowski.
    Before Basel II there existed Basel I (1988), which happens to regulate credit risk. Yet the Savings an Loan crisis occurred around that time. Could it be that Basel I caused the S&L crisis as well?

  111. If I follow your logic i.e. capital requirements encourage risk taking. Then if you agree with

    “The deregulation of S&Ls gave them many of the capabilities of banks, without the same regulations as banks”

    how do you explain this?

    “many S&Ls lent far more money than was prudent, and too-risky ventures which many S&Ls were not qualified to assess.”

  112. No friend, this is where this crisis turns into a totally new animal.

    The capital requirements did not encourage “risk-taking” they encouraged “risk-adverseness” and thereby led, or better phrased, “fooled” trillions of dollars in capital that were not looking for any risk, over the cliff.

  113. Per,
    thank you – I am beginning to have the beginning of a faint understanding

    is there a readable history for a know nothing how this whole concept developed over the centuries from Florence or even earlier on?

    I’ve heard of Niall Ferguson’s Ascent of Money but he is too much of a showman to make him the kind of historian I like. But if that’s the only thing around so be it.

    How do these miraculously morphed into AAA loans show up on the balance sheets? 100 % on the left side as I was taught as a school girl, thereby in turn making Gewinn (gains) look huge? thereby ….

  114. Silke. “How do these miraculously morphed into AAA loans show up on the balance sheets? 100 % on the left side as I was taught”.

    Yes, on the left side goes the loan or the investment … but at its “mark to market” or “mark to model” value as I believe Buffet has said; and of course not at this risk-weight of 20 because the 80 are actually (usually) not lost at all…. And so on the right side the right the capital results from deducting from the total left value the value of all the liabilities.

    This is standard and for this example let us suppose first that the mark to market also gives 100 and that the bank has liabilities of 97 and so its capital is 3. And that’s when the risk-weighting kicks in. Though in fact the bank’s nominal leverage would be33.3 to 1 (100 divided by 3) the regulator views it as being only 6.6 to 1 which results from dividing the risk-weighted 20 by 3… and in this form it is reported in the financial audited statements of the banks.

    For instance in the K10 or annual result of Citibank for 2007 which you can find in this link you will

    In page 3 we find the following data: Total assets $2,187,631, Total Equity $113,598 which gives a Common stockholders’ equity to assets of 5.19% and which should indicate the CitiBank being leveraged “in the traditional sense”, total assets divided by total equity, 19.3 to 1. But, had you told the market and politicians that Citibank was leveraged 19.3 to 1 some could have experienced hiccups

    But then jump to page 75 and there you will find that the Total assets $2,187,631 are now presented for regulatory purposes as only $1,253,321 in risk adjusted assets and so now we find that Tier 1 Capital Ratio is 7.12% and Total Capital (Tier 1 and Tier 2) 10.7% . The Total Capital ratio would indicate a a leverage of only 9.3 to 1 and allowing everyone to sleep calm.

    Add to this the confusion from accounting differences and you will easily determine that there are many places where to hide responsibilities.

    Luckily the Fed kept a traditional limitation on leverage based on average outstanding assets and though quite generous at 3% signified that banks could not leverage themselves in the traditional way to more than 33 to 1 (100/3) Phew!!! But again, go to page 3 or 75, instead of writing out the traditional leverage (using the average assets) in its traditional format leverage is presented as 4.03 instead of the 24.8 to 1 that 4.03 signifies (and don’t tell me this is an innocent presentation)

    And so now in page 4 we can read the proud announcement “Citigroup maintained its “well-capitalized” position with a Tier 1 Capital Ratio of 7.12% at December 31, 2007” , which (100 divided by 7.12) would indicate a leverage of “only” 14 to 1.

    But let me also assure you that not even 1% of all the intelligent discussants of the financial regulations have the faintest idea of these “small details”… among others because they have not even read the regulations. Not only do they find them boring to read but it is also so much more media effective to attack the oligarchs.

  115. Absolutely! But they never discriminated between risks as the current ones do. Never did these requirements tell a banker if you lend to an ordinary guy you can leverage the bank 12 to 1 but if you lend to an AAA you can go to 62 to 1! It is this regulatory interference that created real havoc in the markets risk allocation systems.

  116. Per,
    great great thank you!

    I will read and re-read your explanation religiously every morning with coffee until I’ll have it firmly installed in my little grey cells – for now I just got from it, that I was right when I started to feel very very cold last year when I heard NYTs Gretchen Morgenson say about City-Bank that its accountants didn’t know what was on their books

    all the accountants I have worked with were always exceedingly proud of knowing exactly what was on their books (and able to explain it with only paper and pencil)

  117. @ Per Kurowski

    The reliance on NRSOs ratings in assessing capital requirements dates back to the 1970s (Net Capital Rule). In this sense, Basel I, represent an attempt at harmonization, in an increasingly international context, rather than a revolution.

    Anyway, the problem with your argument is that you are confusing, intentionally or not, the letter of the law with its application. The mandate to implement the law was grossly and intentionally neglected by top administrators appointed by the Bush administration under the deceitful (or naive) principle that markets self regulate.

    So even if/as the law contained perverse incentives, which tens of articles by regulators or congress acknowledge over a 15 years span , it is quite irrelevant in a context where enforcement was being colonized e.g.

    “In the summer of 2003, leaders of the four federal agencies that oversee the banking industry gathered to highlight the Bush administration’s commitment to reducing regulation. They posed for photographers behind a stack of papers wrapped in red tape. The others held garden shears. Gilleran, who succeeded Seidman as OTS director in late 2001, hefted a chain saw.”

    “OTS adopted an aggressively deregulatory stance toward the mortgage lenders it regulated. It allowed the reserves the banks held as a buffer against losses to dwindle to a historic low. By September 2006, when the housing market began declining, the capital reserves held by OTS-regulated firms had declined to their lowest level in two decades, less than a third of their historical average, according to financial records.”

    It is the same people that promoted de-regulation and a lighter supervisory framework and missed the warning signs of the crisis that are unscrupulously telling us today that regulation such as Basel, with its devastating incentives, is the prime culprit.

    It is also the same people that blame the failure of FEMA during Katrina on the impotence inherent to Federal goverment when its director’s only claim to any supervisory credentials was to head an Arabian horse breeding assocation…

  118. Silke. “all the accountants I have worked with were always exceedingly proud of knowing exactly what was on their books (and able to explain it with only paper and pencil)”

    And I hold exactly the same (well almost, there are exceptions of course… Parmalat, Enron Madoff comes to my mind) but in this particular problem we are not really facing an accountancy problem but an interpretation problem.

    You see the bank accountant records a $100 loan to Joe and a $100 to AAA rated Bill and it is the regulator who based on the opinions of the credit rating agencies has arbitrarily decided that while the loan to Joe signifies a risk of $100 for the bank, the loan to Bill is only a $20 risk exposure.

  119. The reliance on NRSOs ratings in assessing capital requirements dates back to the 1970s (Net Capital Rule).

    Yes and indeed some of the risk-weights evolved almost on case by case basis in the US. An in fact it was the OCC and the Fed that sort of gave in to the idea that for instance “supersenior” tranches needs only to be risk weighted at 20% if they had the AAA rating but they and everyone were a bit uncomfortable with it.

    It was when the Delphi Oracle of Finance the Basel Committee incorporated these concepts fully in Basel II and gave it is complete legitimacy that all levees broke down and responsibility for this extreme act of irresponsibility diluted so much that perhaps we will never know who to blame.

    And by the way I am not so sure what you want to imply with “unscrupulously (in) telling us today that regulation such as Basel, with its devastating incentives, is the prime culprit”. I have been in the front of this criticism for many years now and this does not for one second imply that I condone a shoddy regulatory job… or that I carry a hidden agenda. This is my name and my comments and articles are all on my blog.

    It is like if when you write “The mandate to implement the law was grossly and intentionally neglected by top administrators appointed by the Bush administration under the deceitful (or naive) principle that markets self regulate” that I would then imply you are more interested in the political outcome of this crisis than in achieving a better financial sector…and we would not like that, would we?

  120. Your last sentence hardly qualifies as grammatically correct, but from what I suspect its intent was, it’s reasoning strikes me as a bit simplistic. It’s a testament to your courage, therefore, that you’re willing to represent yourself as you are, using your actual name. Good luck, and good bye.

  121. Per,
    once upon a time Americans were proud of being so polite to never ever criticize a person for mistakes in using their language

    we admired them for it
    … and turned to the British for help/criticism when we wanted to get better at it

  122. Oh no grammatical problem at all, grammar is what you need to be understood and from the answer, it is clear that I was understood.

    I am sorry, if I am graying the issue, but my concern with what is coming out from Basel goes much deeper than this current crisis. Cheers!

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