By Simon Johnson
At the heart of the currently proposed legislation on financial reform (e.g., the Dodd bill and what we are expecting on derivatives from the Senate Agriculture committee), there is a simple premise: Key decisions about exact rules going forward must be made by regulators, not Congress. This is obviously the approach being pushed for capital requirements, but it is also the White House’s strong preference for any implementation of the Volcker Rule – first it must be studied by the systemic risk council (or similar body) and only then (potentially) applied.
Treasury insists that Congress is not capable of writing the detailed rules necessary for a complex financial system – only the regulators can do this. This is either a mistake of breathtaking proportions, or an indication that the ideology of unfettered finance continues to reign supreme.
The regulators who got us into our current mess include Ben Bernanke (a Republican from the Greenspan tradition of financial regulation), John Dugan (also a Republican, who makes Bernanke look progressive), and of course Alan Greenspan himself.
If legislation can only empower regulators then, given regulators are only as strong a newly elected president wants them to be, the approach in the Dodd bill simply will not work.
There is still a feasible alternative, based on a different approach – that proposed by Representative Paul Kanjorski (chairman of the Capital Market Subcommittee of the House Financial Services Committee) and adopted as an amendment in the House bill.
This amendment will allow federal regulators to preemptively break up large financial institutions that – for any reason – pose a threat to financial or economic stability in the United States. (Yes, there is a weak version of this idea currently in the Dodd draft, but it is very weak – allowing regulators to act “only as a last resort”; see p.3 of the official bill summary.)
Representative Kanjorski has exactly the right idea, but we need to go a step further – because we cannot at this point reasonably expect regulators to implement properly. Remember, in the Catch-22 type nature of these issues, the regulators can easily say: Implicit in Congress’s decision not to mandate a break-up, will infer a congressional intent that no institutions currently meet the criteria.
The reality is this. As documented in 13 Bankers (see Chapter 7), six banks currently fit the Kanjorski criteria – they are, by any definition, “too big to fail.” Congress should mandate their break-up rather than leaving this to the judgment of regulators.
We can discuss the best language and exact terms but the broader point is that we need change by statute, not “after further study.”
Even if you trust and believe in the new-found regulatory zeal of our current regulators, Senator Dodd and all other Democrats should be concerned that the next president may be a free market Republican who will appoint regulators captured by Wall Street.
The Dodd legacy should be to break the doom loop for future generations. It would be unwise to let that legacy depend on the judgment of regulators to be named later.
The Baseline Scenario 
The Chinese I Ching’s symbol for today’s financial services culture is “fire on the mountain.” Such a fire burns to the top, runs out of fuel and extinguishes itself. Today’s financial crisis will evolve into a new beginning. The top of the mountain is near. When it is exhausted a new and more honest culture will arise from the ashes.
We really ought to move onto the topic of that new beginning and let the present destructive forces burn themselves out. The sooner the fuel is gone the better off we will all be.
This is either a mistake of breathtaking proportions, or an indication that the ideology of unfettered finance continues to reign supreme.
Hmm, now that’s a tough one…
(Of course it is a “mistake”, but such mistakes arise out of the criminal ideology.)
This amendment will ALLOW federal regulators to preemptively break up large financial institutions that – for any reason – pose a threat to financial or economic stability in the United States.
My emphasis.
As Simon points out, that’s the scam. Making “regulation” discretionary is one of the most common tricks. In Massachusetts vs. EPA the Bush administration argued that the EPA has no authority to regulate greenhouse gases but that, failing that, such authority would be optional. I think anyone can easily figure out whether or not they would exercise such an option.
So there we see how “resolution authority” in any manifestation will be a scam, and how this allegedly more proactive version of it is also designed to be ineffectual.
Also, according to this
http://www.creditwritedowns.com/2009/11/the-kanjorski-amendment-trojan-horse-and-prompt-corrective-action.html
the Kanjorski amendment would actually hobble existing authority by letting failed banks sue to prevent the FDIC from seizing them.
Apr. 10, 2010 – Globe&Mail – excerpt
“It no longer matters who’s to blame, but what plans the United States – and other governments….. put in place for the next crisis. And there will be a next time, unless the human instinct for repeating past mistakes has somehow been repealed. There will always be banks that do dumb things, usually because they’ve given their employees strong incentives to do them, and run into trouble and collapse. The goals should be to prevent it from happening frequently, to mitigate the damage to the economy when it does happen, and to make the investors pay the cost.
The blame game is fun, and maybe there’s something cathartic about watching fallen titans like Chuck Prince say they’re sorry. But in the crisis post-mortem, it’s far more important that the people who govern the world’s largest economy restore something that’s fundamental to healthy capitalism: the ability to fail.”
http://tinyurl.com/ye7s4na
“Treasury insists that Congress is not capable of writing the detailed rules necessary for a complex financial system – only the regulators can do this. This is either a mistake of breathtaking proportions, or an indication that the ideology of unfettered finance continues to reign supreme.”
Congress has already accepted the idea that it is incapable of writing detailed regulations. It lets the lobbyists do that for them. :(
The argument above fails the laugh test. (1) environmental and banking law is an apples and oranges comparison; (2) In “Massachusetts v. EPA” SCOTUS determined that the EPA has the authority to regulate greenhouse gases generally and carbon dioxide specifically.
Russ advocates the silly notion that the same failed argument, authority or jurisdiction, would somehow not be advanced in a judicial rather than administrative venue.
You should have to stuck to copy and paste as your referenced link is at least on point.
The solution to this crisis is not found in venue or new law.
The solution is reality. Let the banks fail and pursue criminal actions against the executives, exactly as was done in Enron, Worldcom, Tyco, Global Crossing, Adelphia, Madoff etc.
If we have learned anything in more than 200 years of jurisprudence it would be that law is no deterrent to the creativity of a criminal.
“That’s a tough one…”
Heh. “It’s a dessert topping! It’s a floor wax!”
So you’re feeling vindictive because I shamed you on the other thread? That’s not constructive – it leads to such nonsense as this:
Russ advocates the silly notion that the same failed argument, authority or jurisdiction, would somehow not be advanced in a judicial rather than administrative venue.
Please specify where, either here or in a single other of the hundreds of comments I’ve made here, I ever “advocated” anything remotely like that. Or in anything else I’ve ever written.
All I said here, for the benefit or anyone to whom the Kanjorski scam might sound plausible, is that the discretion function is proof that the whole thing is not meant to function at all.
The solution is reality. Let the banks fail and pursue criminal actions against the executives, exactly as was done in Enron, Worldcom, Tyco, Global Crossing, Adelphia, Madoff etc.
If we have learned anything in more than 200 years of jurisprudence it would be that law is no deterrent to the creativity of a criminal.
Based on that it sounds like you agree with what I’ve always said. But like I said the other day, your reading comprehension doesn’t seem to be the best. I guess your hurt feelings are fogging up your thoughts.
Oh geez, yes, I’m totally shamed and vindictive to an anonymous internet poster.
Thanks for proving each of my points, especially the laugh test. And no you don’t merit a full response.
I must apologize for not reading any but your cheap shot personal attack on me on the ‘Love him, Hate him” blog and your stupid notion posted here.
I’ll just go back to ignoring you.
Dan Palanza wrote”
“The Chinese I Ching’s symbol for today’s financial services culture is “fire on the mountain.” Such a fire burns to the top, runs out of fuel and extinguishes itself.”
Sounds like you are describing the growing Chinese bubble. .
This amendment will allow federal regulators to preemptively break up large financial institutions that – for any reason – pose a threat to financial or economic stability in the United States.
How does this amendment help if the regulators can’t be trusted? (and they can’t)
Don’t be taken in by this artful slight of hand. Only a legally mandated risk segregation (Glass-Steagall) and/or size limits is going to be effective. Giving regulators discretion to take pre-emptive action is meaningless because they will NEVER exercise that authority.
Pre-emptive breakup/resolution authority is a straw man as much as “consumer protection” when administered by the Fed. Regulators can not effectively control or regulate TBTF financial firms. Period.
In my research on US financial regulation in history one aspect keeps recurring- the need to segregate financial operations so that those necessary for industry and commerce are supported while others must be left to sink or swim. How one segregates is a matter of some debate, that they should be segregated is only debated during manic phases.
My sense is that those left to sink or swim only perform their public service of price discovery (something we could have used more of over the past few years) in that environment. Liquidity support of such firms (much less capital assistance) distorts their sense of risk.
Price discovery is further enhanced when concentration of influence is kept below some threshold. The fewer firms in any market, the more price discovery becomes price enforcement.
Yes, yes, yes.
We must break up the TBTFs.
We must end the era of the fox guarding the hen-house.
That Obama supports the pillagers and criminals, he will NEVER get my vote again, even if that means I don’t vote for any Presidential candidate.
TBTF banks is one thing. They should be broken up, sure. But so should be TBTF derivatives, or shadow banking strategies.
What we have now is publicly financed private finance, and we keep the whole thing in place, because it is Too Big To Fail. But the entire system is Too Big, Too Failed, Too Unfair. The private fractional reserve system leverage from public money has got to go. it’s a question of democracy. Moreover, it’s a question of fair capitalism, directed towards real industry, and the real world, not just towards the plutocracy.
It’s not just a question of a few banks. I wrote an entire essay on this: http://patriceayme.wordpress.com/2010/04/06/final-solution-for-banks/
PA
Dave Lewis wrote:
“Price discovery is further enhanced when concentration of influence is kept below some threshold.”
Price discovery
“The price discovery process is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers.”
http://en.wikipedia.org/wiki/Price_discovery
“There will always be banks that do dumb things, usually because they’ve given their employees strong incentives to do them, and run into trouble and collapse…. unless the human instinct for repeating past mistakes has somehow been repealed.”
:-(
OK let me say one thing—ONE THING VERY VERY IMPORTANT—–IF DUGAN IS STILL INSIDE THE SYSTEM WE CAN’T TRUST ANYTHING THEY DO—-DUGAN IS A CRUX OF THE PROBLEM—DUGAN IS HAVING ANAL LOVEMAKING WITH THE ABA—DUGAN SCREAMS EVERYTIME HE THRUSTS INTO THE ORIFICE OF THE ABA. So Dugan needs to be removed from his job. PERIOD
Can you hear Dugan scream everytime the ABA asks???? It’s a type of ecstasy for him. Dugan counts the dollars the ABA put in his bank account as he (Dugan) sings the banks’ song.
Dugan’s rectum is tired now from all the thrusts from the American Banker’s Association.
Non government sponsored banks could only invest their deposits. To get leverage, and create money, as needed for socially worthy investments, worthy for the entire economy, although too risky for private banks without government support, national banks ought to be used (with bonuses for investment officers).
PA
Though probably for entirely different reasons I totally and completely agree with Simon Johnson that… “Treasury insists that Congress is not capable of writing the detailed rules necessary for a complex financial system – only the regulators can do this” is a mistake of breathtaking proportions.
Finance is a much more complex issue than what our typical financial regulator or banker will ever dream to understand and so the regulations have to be as simple and straightforward as possible so that they interfere the least with the markets and so the markets to can understand them and do the best with them.
It was, allowing the takeover of our financial regulations by a club of mutual admirers like the one of the Basel Committee which created the possibilities for them to impose on the banks their ludicrous system of capital requirements based on what some human fallible credit rating agencies opined, that got us in this mess.
Porn is unnecessary.
Having read about TBTF financial institutions, it appears that their international reach makes them unassailable. Too bad there isn’t more international cooperation in finance. Regulators in concerned countries could jointly cut down these TBTF institutions. The recent inernational finance conference (Stockholm?) that was so ineffective is the exception that proves the rule.
And if this column is ruined by contributors, it’s a shame. Some don’t want anything good.
Clearly we all know the principles to advocate. Simon, you are a clear and consistent voice on this. Unfortunately, we all (who share similar cynicism) are virtually certain that the oligarchs will win this round, but it is still early in the fight. There is an outside chance we will get something as strong as Kanjorski’s amendment. But anything allowing for an opt out for regulators is certain to sit there unused until it is, alas and once again, too late. The regulators are subject to restraint, even when it would seem to the rest of us that this is uncalled for. After all, in a pinch, they are making decisions (or indecisions, unfortunately) which have vastly negative global consequences if made incorrectly. There is still a very long way back from the most recent collapse, and if we watch Angelides commission at work, it is so obvious that even through prodding and prying, we are finding it hard to get the necessary answers and admissions.
Woe are we. There is no political will (read willingness) for finding a truly meaningful, prudent, intelligent solution for reforming a Wall Street still so completely out of control. Maybe the answer will come in the form of a Grecian domino which could echo around the world very soon (placing vast amounts of other dominoes in motion at high speed — oops, can you say more toxic derivatives looming).
Sounds like Occam’s Razor for finance. I totally agree with the themes of simplicity and clarity. Most regulation is overly detailed and muddy (mostly because this allows for blatant obfuscation to appear much less blatant and even excusable — see the CFR on taxation regulations as a perfect example, although the CFR is rife with such examples).
Matt Tiabbi has an amazing piece in Rolling Stone:
http://www.rollingstone.com/politics/story/32906678/looting_main_street/print
The corruption of Wall Street is so endemic and has been ignored for so long, it is hard
to believe the US is civilized. Bribes and unfettered looting of tax payer funds have destroyed Jefferson County, probably for at least a generation. If regulators and Congress are not paying attention to this, why bother with reform? What good is another shaft of laws everyone ignores?
Rather like health care I would think. Going forward, companies with employees numbering over fifty must have a designated, special room (other than a rest room) for women to use breast pumps. It’s hard to believe that whoever proposed that wasn’t too embarrassed; worse that it is now the law.
Thanks.
“The destruction of Jefferson County reveals the basic battle plan of these modern barbarians, the way that banks like JP Morgan and Goldman Sachs have systematically set out to pillage towns and cities from Pittsburgh to Athens. These guys aren’t number-crunching whizzes making smart investments; what they do is find suckers in some municipal-finance department, corner them in complex lose-lose deals and flay them alive. In a complete subversion of free-market principles, they take no risk, score deals based on political influence rather than competition, keep consumers in the dark — and walk away with big money. “It’s not high finance,” says Taylor, the former bond regulator. “It’s low finance.” And even if the regulators manage to catch up with them billions of dollars later, the banks just pay a small fine and move on to the next scam.
This isn’t capitalism. It’s nomadic thievery.”
Matt Tiabbi – Rolling Stone:
http://www.rollingstone.com/politics/story/32906678/looting_main_street/print
Of course we cannot grant regulators discretion with regard to breaking up TBTF institutions. They will not do it. Look no further than the recent action by the Fed that allowed at least 18 banks to manipulate their balance sheets in order to create the false appearance that they were reining in risk. Investors, analysts and, presumably, the SEC rely on those financial statements. If the statements were in fact bogus, all three were misled, including those who purchased securities issued by these institutions at the behest of the Fed. These are not actions of a regulator. They are the actions of a partner in crime.
What does this suggest about the other actions the Fed and regulators purportedly are taking to reduce risk in the banking industry? How real is the capital information they are putting out? How reliable is anything the banks or the Fed puts out? How many other ways have financial statement been manipulated by means of off-books accounting known only to the banks and their primary regulator? These aren’t regulators who have been captured. These are regulators that have been purchased.
Matt Tiabbi of Rolling Stone rightly concludes “This isn’t capitalism. It’s nomadic thievery.” In just the same way anyone should be able to conclude “This has nothing to do with financial regulations but only with nomadic thievery” And which makes me reflect on the many concerns when this thievery hits close to home, Birmingham Alabama, compared to the little it matters when affecting faraway countries.
Let me ask. In developing countries our local communities do not have many with the expertise to defend them on issues like the ones covered by Matt Tiabbi, but sure you must have plentiful of that available, for instance in your universities. Where were they when you really needed them?
Matt Tiabbi, and I am no fan of his, because what he does is more seeding hate than nurturing solutions, should do an investigative job on who of the thousands of Monday morning quarterbacks now out there screaming and shouting, ever uttered a word of warning to the Birmingham Alabama’s of this world.
In my country, Venezuela, I at least went out publicly against many of these “financial concoctions”… not that it helped a lot to stop them… but at least I have a much cleaner conscience.
Per Kowalski Said:
“Let me ask. In developing countries our local communities do not have many with the expertise to defend them on issues like the ones covered by Matt Tiabbi, but sure[ly] you must have plentiful of that available, for instance in your universities. Where were they when you really needed them?”
The only watchdogs that would have caught these shenanigans, before computers, were the book-keepers. These contracts that Tibbi is referring to would never post balanced in a proper book-keeping framework. The only possible balanced entry scheme would be to post the contracts into a joint venture partnership among the parties to the contract. This approach, if anyone knew it is essential, would have exposed the fraud even to a rookie accountant.
Sadly, there is no human book-keeper today to catch the fraud. And the computer code that is doing the supposed book-keeping is bogus. The programmers who wrote the code do not understand book-keeping’s basic definitions.
They simply don’t understand the book-keeper’s institution, which is fundamentally unchanged since the middle-ages. What changed 50 years ago is that software developers failed to learn the book-keeper’s craft before they wrote their code. They left holes one can drive a truck through as we are now seeing.
The fraud is as alive and well today as it was in the time frame of the fraudulent contracts that Tiabbi is studying. It will be with us until the book-keeping framework is properly understood and programmed into code.
Only a proper framework will teach the regulator how to regulate. And, finally, that the programmers are ignorant of the book-keeper’s discipline is one fact, but it is the economists who are running today’s financial show, and they are more ignorant of book-keeping’s essential role than the programmers are.
What is happening is a social science tragedy, of which our universities are the least informed of all. College and Graduate School trained economists and accountants are this tragedy’s living proof.
Per wrote:
“Matt Tiabbi, and I am no fan of his, because what he does is more seeding hate than nurturing solutions…”
How strange a comment. Tiabbi is a reporter. He wrote about a ponzi scheme that should have cost $250 million that finally cost $3 billion, refinanced 21 times, bribing locals, and other bankers, destroying a community for at least a generation — and that is “seeding hate…?”
That is illegal. Simple. Period.
And, maybe, somehow, Per implies, if Tiabbi’d suggest throwing university profs into the mix that wouldn’t just increase the crime? I think not. I’m sure there are at least a couple of univ profs who would wink-wink at anything to soak up a little graft, themselves. Esp. if there was no downside.
Jail is the answer here. And fines. And professional humiliation.
And, yes, some basic bookkeeping would help.
I am saddened that Simon doesn’t advocate, like Elizabeth Warren, for simpler reforms. And criminal prosecutions
The greedy are not going to stop being what they are and we will never come up with enough scotch tape and bandaids they won’t work around.
Another reform possibility would be to change the entire pay structure within banking. Pay salaries, attract caretaker and protector mentalities and stop allowing the worst among us to reward themselves for their greed at the expense of the public.
But the reforms need to be simple, unambiguous. Repeal old laws, then re-write new ones. The scotch tape and bandaid approach to already confusing, impossible to understand laws and regulations, is only a game for Wall Street.
And Matt Tiabbi is a fine writer as well as a good investigative reporter. “Seeding hate,” indeed! ….smile. I’d like a hundred of him. …….Lady in Red
I did not say that this article was not a good investigative article… but have you read other pieces of Matt Tiabbi? I quote from just this:
“The destruction of Jefferson County reveals the basic battle plan of these modern barbarians, the way that banks like JP Morgan and Goldman Sachs have systematically set out to pillage towns and cities from Pittsburgh to Athens. These guys aren’t number-crunching whizzes making smart investments; what they do is find suckers in some municipal-finance department, corner them in complex lose-lose deals and flay them alive. In a complete subversion of free-market principles, they take no risk, score deals based on political influence rather than competition, keep consumers in the dark — and walk away with big money.”
Are those the words of someone out there to construe a solution or more the words of someone wanting to torch it all?
Where on earth does Matt Tiabbi get that only taking risks, using no political influence, informing the consumers about everything and walking away with just reasonable and modest profits, is all that free markets are about? If he believes that then he is even more naïve than what Greenspan has admitted to be.
I am not suggesting “throwing university profs into the mix” I am talking about people having the decency and fortitude to speak out in time. Are you telling me that no one in the communities described by Tiabbi could have seen what was going wrong? If that’s it then we are talking about issues quite different from financial reforms.
And I do favor “professional humiliation”… but why does Tiabbi not ask where were for example all the conscious and expert Simon Johnsons of this world when they were really needed? I mean before the crisis?
And I do wholeheartedly agree with “But the reforms need to be simple, unambiguous. Repeal old laws, then re-write new ones. The scotch tape and bandaid approach to already confusing, impossible to understand laws and regulations, is only a game for Wall Street.”
“Treasury insists that Congress is not capable of writing the detailed rules necessary for a complex financial system – only the regulators can do this. This is either a mistake of breathtaking proportions, or an indication that the ideology of unfettered finance continues to reign supreme.”
I’ll blame the ideology. I can believe that most of the Congress doesn’t have the expertise to write detailed rules for the financial system. But this is precisely why Congress has commitees. At the very least, the senior members of such commitees have the expertise to write detailed rules, at least as much as any regulator.
I can’t wait to buy 13 Bankers. From what I’ve gathered are the main points, Johnson & Kwak have correctly analysed the continuing dangers in our banking system. Just subscribe to The Baseline Scenario to see the depth and concern these economics writers post on a daily basis.
I have recommended the book and positions from their
blog on my blog. 13 Bankers should b e required reading for Congress and everyone else around the Beltway.
Amber Ladeira
amberladeira.blogspot.com