This will be a somewhat long and technical blog entry and you are given a pass to ignore reading this one if you are so inclined. -- steve
First, President Obama cannot easily change the duties of current regulatory agencies without input from the privately-owned Federal Reserve, Congress and the industry trade associations which supply a large amount of campaign funding and support to both sides of the aisle.
Second, like all bureaucratic institutions, the prime directive regarding self-preservation of the bureacracy and its leadership will motivate both overt and covert actions to retain or gain power, influence and funding.
Third, and most importantly, those who are apparently in charge of overseeing the regulatory reform process are either career bureaucrats or former financial industry players who are engaged in revolving door government service at the behest or with the best wishes of their former employers. These people operate on an agenda heavy on personal, professional and political objectives which may have little or nothing to do with actually protecting the consumer from rapacious financial institutions or the government’s tax collection mechanism.
Whether or not this regulatory reform will actually protect the financial institutions, the consumers and the taxpayers is yet to be determined.
The basic and oft-stated reason for reform …
The reason for the regulatory reform is the same one that has been historically given through the preceding years: it is necessary to avoid another financial crisis. In fact the Federal Reserve was founded on the premise that its creation was necessary to prevent future asset bubbles, depressions and severe disruptions to unemployment. And judging the Federal Reserve’s performance on these criteria, one finds that they have failed badly in their stated mission; with some arguing that they actually caused the last two major financial problems, the dot-com bubble and the real estate bubble, with their interest rate policies.
The real reasons for reform …
Simply put, the public needs and demands a reason for the suffering that they are now experiencing during this financial catastrophe and wants to hold someone or something responsible for their pain.
On the other side, elected officials want to be seen as responsive to the public’s needs, proactive in solving the current problem and insuring that a similar problem does not arise in the future. But beyond that, they want to be absolved of any personal or political blame for the catastrophe which is clearly the fault of governmental policies and the lack of prudent and timely regulatory oversight.
And on the political front, the first law of Rahm Emanuel, “never waste a good crisis,” kicks in; what a wonderful time to consolidate and extend our political power and pursue our ideological agenda.
With this being said, let us look at some of the more significant regulatory reforms being proposed …
“Create a Financial Services Oversight Council
1. We propose the creation of a Financial Services Oversight Council to facilitate information sharing and coordination, identify emerging risks, advise the Federal Reserve on the identification of firms whose failure could
pose a threat to financial stability due to their combination of size, leverage, and interconnectedness (hereafter referred to as a Tier 1 FHC), and provide a forum for resolving jurisdictional disputes between regulators.
a. The membership of the Council should include:
(i) the Secretary of the Treasury, who shall serve as the Chairman;
(ii) the Chairman of the Board of Governors of the Federal Reserve System;
(iii) the Director of the National Bank Supervisor;
(iv) the Director of the Consumer Financial Protection Agency;
(v) the Chairman of the SEC; (vi) the Chairman of the CFTC;
(vii) the Chairman of the FDIC; and
(viii) the Director of the Federal Housing Finance Agency (FHFA).
b. The Council should be supported by a permanent, full-time expert staff at Treasury. The staff should be responsible for providing the Council with the information and resources it needs to fulfill its responsibilities.
2. Our legislation will propose to give the Council the authority to gather information from any financial firm and the responsibility for referring emerging risks to the attention of regulators with the authority to respond.”
This is a bullshit measure that does little more than to create another fully-staffed and fully-funded bureacracy to create further diffuse blame and create additional political chaos.
My suggestion: forget the staffs and park the agency heads around a conference table once a week or once a month to give progress reports, report potential problems and hash out solutions. Without staff and additional layers of highly-paid and unproductive lawyers to throw a monkey-wrench into the process.
“Implement Heightened Consolidated Supervision and Regulation of All Large, Interconnected Financial Firms
1. Any financial firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed (Tier 1 FHC) should be subject to robust consolidated supervision and regulation,
regardless of whether the firm owns an insured depository institution.2. The Federal Reserve Board should have the authority and accountability for consolidated supervision and regulation of Tier 1 FHCs.
3. Our legislation will propose criteria that the Federal Reserve must consider in identifying Tier 1 FHCs.
4. The prudential standards for Tier 1 FHCs – including capital, liquidity and risk management standards – should be stricter and more conservative than those applicable to other financial firms to account for the greater risks that their potential failure would impose on the financial system.
5. Consolidated supervision of a Tier 1 FHC should extend to the parent company and to all of its subsidiaries – regulated and unregulated, U.S. and foreign. Functionally regulated and depository institution subsidiaries of a Tier 1 FHC should continue to be supervised and regulated primarily by their
functional or bank regulator, as the case may be.The constraints that the Gramm-Leach-Bliley Act (GLB Act) introduced on the Federal Reserve’s ability to require reports from, examine, or impose higher prudential
requirements or more stringent activity restrictions on the functionally
regulated or depository institution subsidiaries of FHCs should be removed.6. Consolidated supervision of a Tier 1 FHC should be macroprudential in focus. That is, it should consider risk to the system as a whole.
7. The Federal Reserve, in consultation with Treasury and external experts, should propose recommendations by October 1, 2009 to better align its structure and governance with its authorities and responsibilities.”
Here I must point out a significant conflict of interest which mandates that this approach will be neither prudent nor effective.
One, the Federal Reserve is not a public or government agency, but in actuality is a private institution owned and operated for the benefit of its member banks.
Two, the government and the public will be hard-pressed to breach its current level of secrecy to force more transparency in their actual operations.
And three, like other quasi-governmental institutions which bridge private/public/governmental structures (e.g. Fannie Mae, Freddie Mac), there are divided loyalties and an enhanced potential for wrong-doing, self-dealing and political corruption based on conflicting needs to protect consumers, protect the taxpayer, protect the government and protect the individual member banks who actually own the Federal Reserve.
My suggestion: either eliminate the Federal Reserve as a quasi-governmental regulatory agency or federalize the Federal Reserve. That is, make it a branch of the United States Department of the Treasury.
“Strengthen Capital and Other Prudential Standards For All Banks and BHCs
1. Treasury will lead a working group, with participation by federal financial
regulatory agencies and outside experts that will conduct a fundamental reassessment of existing regulatory capital requirements for banks and BHCs, including new Tier 1 FHCs. The working group will issue a report with its
conclusions by December 31, 2009.2. Treasury will lead a working group, with participation by federal financial regulatory agencies and outside experts, that will conduct a fundamental reassessment of the supervision of banks and BHCs. The working group will
issue a report with its conclusions by October 1, 2009.3. Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value and to prevent compensation practices from providing incentives that could threaten the safety and soundness of supervised institutions. In addition, we will support legislation requiring all public companies to hold non-binding shareholder resolutions on the compensation packages of senior executive officers, as well as new requirements to make compensation committees more independent.
4. Capital and management requirements for FHC status should not be limited to the subsidiary depository institution. All FHCs should be required to meet the capital and management requirements on a consolidated basis as well.
5. The accounting standard setters (the FASB, the IASB, and the SEC) should review accounting standards to determine how financial firms should be required to employ more forward-looking loan loss provisioning practices that incorporate a broader range of available credit information. Fair value accounting rules also should be reviewed with the goal of identifying changes that could provide users of financial reports with both fair value information and greater transparency regarding the cash flows management expects to receive by holding investments.
6. Firewalls between banks and their affiliates should be strengthened to protect the federal safety net that supports banks and to better prevent spread of the subsidy inherent in the federal safety net to bank affiliates.”
First and foremost, imposing a short deadline of October 1, 2009 to provide reports, conclusions and recommendations for a significant overhaul of our financial regulatory system is not only imprudent and ludicrous, it is dangerous. More time must be given to this serious matter, the manner of its implementation and potential unintended consequences.
Second, has anybody noticed that we operate on the basis of a fractional banking system whereby outsized leverage is conferred upon those who are required to keep only a minimal amount of their reserves on hand and in a relatively liquid form.
Third, While I agree with the fact that excessive executive compensation should not threaten the soundness of a bank, this is a feel-good socialistic move that threatens the independence of the private sector to act in its own best interests. Say what you will about Angelo Mozilo who left Countrywide with hundreds of millions of dollars, the fact remains that he created billions of dollars worth of wealth for investors in Countrywide. While Mozilo’s gross compensation number might appear large to an average employee or to members of the public, it is quite in line with the value he created for the corporation.
Fourth, I am all for extending the financial regulations past the actual depository institution to the parent holding company.
Fifth, our accounting standards are bullshit. We need to remember that the Financial Accounting Standards Board issued the accounting rules that allowed Enron and today’s current financial institutions to hide assets and growing amounts of risk in “off balance sheet” vehicles and engage in suspicious “notional” accounting which masked the true condition of the financial institution from the regulators, the institutional counterparties, the investors an the public. And even more damaging, we saw these same people issue accounting standards which changed “mark-to-market” standards to “mark-to-magic” standards in order to accommodate financial institutions which were then able to display a profit or smaller loss in the first quarter of 2009 – with nothing substantial changing except the accounting rule. The fact that the SEC wants to adopt the European “loosey-goosey” rules system which is less onerous than the current GAAP (Generally Accepted Accounting Principles) points to the political nature of this undertaking.
Sixth, if I understand what they are saying, the Government Guarantees like FDIC deposit insurance should not be extended to other entities other than the regulated institution itself. Which is somewhat bogus as the FDIC has already compromised its primary mission of insuring investor deposits in depository institutions by guaranteeing the GMAC bond issuance.
My suggestion: Steadily increase capital reserve requirements to start reducing the leverage inherent in the fractional banking system. I will not call for a return to the concept of Greenback Treasury Notes instead of Federal Reserve Notes (although both are backed with the full faith and credit of the United States and the Greenbacks would allows us to reduce the national debt in a more expeditors manner.)
Get the government out of compensation arrangements between executives and their corporate boards. Improve oversight, transparency and the fiduciary duties of the Board of Directors, but leave your “feel good” socialist interference out of the equation.
Get rid of the artificial accounting rules which allow financial institutions and corporations to keep multiple sets of books and mask their true financial condition by employing accounting tricks. Hold public auditors and accountants responsible for the advice, especially when it supports management’s manipulation of the true financial condition. Eliminate some of the more onerous provisions of Sarbanes-Oxley (Public Company Accounting Reform and Investor Protection Act of 2002) except for executive sign-offs and responsibility for true and correct reporting.
And restrict the mission of the FDIC to its original function, dealing with insuring investor deposits and dealing with failing or unsound financial institutions.
“Close Loopholes in Bank Regulation
1. We propose the creation of a new federal government agency, the National Bank Supervisor (NBS), to conduct prudential supervision and regulation of all federally chartered depository institutions, and all federal branches and agencies of foreign banks.
2. We propose to eliminate the federal thrift charter, but to preserve its interstate
branching rules and apply them to state and national banks.3. All companies that control an insured depository institution, however organized, should be subject to robust consolidated supervision and regulation at the federal level by the Federal Reserve and should be subject to the nonbanking activity restrictions of the BHC Act. The policy of separating banking from commerce should be re-affirmed and strengthened. We must close loopholes in the BHC Act for thrift holding companies, industrial loan companies, credit card banks, trust companies, and grandfathered ‘nonbank’ banks.”
OK, but why not simply combine the Office of Thrift Supervision (OTS), the Comptroller of the Currency (OCC), NCUA (National Credit Union Administration) and other bank/thrift/credit regulators into the the National Bank Supervisor for significant cost savings?
“Eliminate the SEC’s Programs for Consolidated Supervision
The SEC has ended its Consolidated Supervised Entity Program, under which it had been the holding company supervisor for companies such as Lehman Brothers and Bear Stearns. We propose also eliminating the SEC’s Supervised
Investment Bank Holding Company program. Investment banking firms that seek consolidated supervision by a U.S. regulator should be subject to supervision and
regulation by the Federal Reserve.”
The Securities and Exchange commission has proven to be a toothless tiger, prosecuting a Martha Steward while overlooking credible and written evidence of a Bernard Madoff. Their duties should be eliminated, combined with the Commodities Futures Trading Commission under the banner of a new, combined regulatory agency.
“Require Hedge Funds and Other Private Pools of Capital to Register
All advisers to hedge funds (and other private pools of capital, including private equity funds and venture capital funds) whose assets under management exceed some modest threshold should be required to register with the SEC under the Investment Advisers Act. The advisers should be required to report information on the funds they manage that is sufficient to assess whether any fund poses a
threat to financial stability.”
Register my ass, hedge funds and large pools of capital should be regulated as are any other financial institutions which pose a systemic risk to the system or to the public. These hedge funds often act as unregulated banks and mutual funds, so I cannot think of any compelling reason to keep them from being regulated as such. Except for the political considerations of screwing with wealthy individuals with political clout. Since these are the institutions which are purchasing significant corporations, they do pose a systemic risk of sorts and should be regulated.
“Reduce the Susceptibility of Money Market Mutual Funds (MMFs) to Runs
The SEC should move forward with its plans to strengthen the regulatory framework around MMFs to reduce the credit and liquidity risk profile of individual MMFs and to make the MMF industry as a whole less susceptible to
runs. The President’s Working Group on Financial Markets should prepare a report assessing whether more fundamental changes are necessary to further reduce the MMF industry’s susceptibility to runs, such as eliminating the ability of a MMF to use a stable net asset value or requiring MMFs to obtain access to reliable emergency liquidity facilities from private sources.”
What is this bullshit? Why should the government treat money market funds any different from mutual funds or any other investment. Just because some funds invested in other than money-market instruments, albeit with synthetic triple-A “investment grade” ratings, is no reason to treat these institutions any different from any other investment. If there is a run and redemptions outrun liquidity, it is not the American taxpayer that needs to pick up the slack. Sell them FDIC insurance, but do not provide any form of special treatment for the MMFs.
“Enhance Oversight of the Insurance Sector
Our legislation will propose the establishment of the Office of National Insurance within Treasury to gather information, develop expertise, negotiate international
agreements, and coordinate policy in the insurance sector. Treasury will support proposals to modernize and improve our system of insurance regulation in accordance with six principles outlined in the body of the report.”
By all means have at it. Define what constitutes insurance, demand actuarial sound and prudent reserves, eliminate cross-collateralizations, demand prudent investments and do not confer any special advantage on the insurance industry. And while you are at it, why not take a look at the mortgage insurance industry as well … known for outrageous profits and overcharging customers for little or no additional protection not already conferred by previous insurance policies and title examinations.
“Determine the Future Role of the Government Sponsored Enterprises (GSEs)
Treasury and the Department of Housing and Urban Development, in consultation with other government agencies, will engage in a wide-ranging initiative to develop recommendations on the future of Fannie Mae and Freddie Mac, and the Federal Home Loan Bank system. We need to maintain the
continued stability and strength of the GSEs during these difficult financial times. We will report to the Congress and the American public at the time of the President’s 2011 Budget release.”
We need to de-politicalize these institutions and perhaps break them into a number of competing, private companies. We can no longer allow Congress to treat these entities as their private piggy bank and purveyor of social reform.
“ESTABLISH COMPREHENSIVE REGULATION OF FINANCIAL MARKETS
A. Strengthen Supervision and Regulation of Securitization Markets
1. Federal banking agencies should promulgate regulations that require originators or sponsors to retain an economic interest in a material portion of the credit risk of securitized credit exposures.
This sounds like the promotion of the European covered bonds plan.
2. Regulators should promulgate additional regulations to align compensation of
market participants with longer term performance of the underlying loans.
Again with the socialist executive “salary and benefit” reform.
3. The SEC should continue its efforts to increase the transparency and standardization of securitization markets and be given clear authority to require robust reporting by issuers of asset backed securities (ABS).
Eliminate the SEC in favor of a combined SEC/CFTC regulator and demand the creation of a transparent marketplace and trading system for MBS (Mortgage Backed Securities)/ ABS (Asset Backed Securities/ CDOs (Collateralized Debt Obligations and CDSs (Credit Default Swaps)
4. The SEC should continue its efforts to strengthen the regulation of credit
rating agencies, including measures to promote robust policies and procedures that manage and disclose conflicts of interest, differentiate between structured and other products, and otherwise strengthen the integrity of the ratings process.
Clean up the slush-pit that Ratings Agencies have become, escrow ratings software and impose risk stress exams on those algorithms to determine if they truly provide valuable information to investors. Make the ratings agencies responsible for mis-ratings securities and other financial products. Again, add this regulatory function to a combined SEC/CFTC agency.
5. Regulators should reduce their use of credit ratings in regulations and supervisory practices, wherever possible.
Create alternative tests of soundness.
B. Create Comprehensive Regulation of All OTC Derivatives, Including Credit Default Swaps (CDS) All OTC derivatives markets, including CDS markets, should be subject to comprehensive regulation that addresses relevant public policy objectives:
(1) preventing activities in those markets from posing risk to the financial system;
(2) promoting the efficiency and transparency of those markets;
(3) preventing market manipulation, fraud, and other market abuses; and
(4) ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties.
Again, the answer is a combined SEC/CFTC agency with an enhanced portfolio, staffed by professionals instead of political hacks with law degrees.
“Harmonize Futures and Securities Regulation
The CFTC and the SEC should make recommendations to Congress for changes
to statutes and regulations that would harmonize regulation of futures and
securities.D. Strengthen Oversight of Systemically Important Payment, Clearing, and Settlement Systems and Related Activities We propose that the Federal Reserve have the responsibility and authority to conduct oversight of systemically important payment, clearing and settlement systems, and activities of financial firms.
E. Strengthen Settlement Capabilities and Liquidity Resources of Systemically Important Payment, Clearing, and Settlement Systems
We propose that the Federal Reserve have authority to provide systemically important payment, clearing, and settlement systems access to Reserve Bank accounts, financial services, and the discount window.
Nothing new, novel or outstanding about the above issues.
PROTECT CONSUMERS AND INVESTORS FROM FINANCIAL ABUSE
A. Create a New Consumer Financial Protection Agency
1. We propose to create a single primary federal consumer protection supervisor
to protect consumers of credit, savings, payment, and other consumer financial products and services, and to regulate providers of such products and services.2. The CFPA should have broad jurisdiction to protect consumers in consumer financial products and services such as credit, savings, and payment products.
3. The CFPA should be an independent agency with stable, robust funding.
4. The CFPA should have sole rule-making authority for consumer financial
protection statutes, as well as the ability to fill gaps through rule-making.5. The CFPA should have supervisory and enforcement authority and jurisdiction over all persons covered by the statutes that it implements, including both insured depositories and the range of other firms not
previously subject to comprehensive federal supervision, and it should work with the Department of Justice to enforce the statutes under its jurisdiction in federal court.6. The CFPA should pursue measures to promote effective regulation, including
conducting periodic reviews of regulations, an outside advisory council, and
coordination with the Council.7. The CFPA’s strong rules would serve as a floor, not a ceiling. The states should have the ability to adopt and enforce stricter laws for institutions of all types, regardless of charter, and to enforce federal law concurrently with
respect to institutions of all types, also regardless of charter.8. The CFPA should coordinate enforcement efforts with the states.
I can hardly believe it – more government bureacracy and bullshit. My recommendation, you want this type of structure, simply add the Federal Trade Commission which already has a measure of oversight over financial institutions to the SEC/CFTC umbrella and create a comprehensive consumer protection agency. This will eliminate duplicative staff, reduce costs and provide overall better public service with more accountability. Since the FTC does a measurably better job in protecting the public than the SEC and the CFTC, let them take the lead.
My take …
The rest of the document contains duplicative, overlapping and generalized prescriptions. All to enlarge the size of government with new bureaucracies which will, in my humble opinion, do little or nothing to prevent the next financial catastrophe. Extending the power of the private Federal Reserve and encouraging a closer interdependency with the Treasury Department is unwise.
The misuse of borrowed money (leverage), faux insurance (credit default swaps) and the use of derivatives are at the very heart of the current financial debacle.
Derivatives, pieces of paper conveying ownership of a particular cash flow from the underlying collateral, are sometimes necessary to expand marketplace liquidity. But like a pyramid scheme deeper than a few layers, they can become unwieldy, prone to catastrophic performance under adverse economic circumstances and cannot be valued without the use of sophisticated computer programs and the ability and willingness of a fiscally sound counterparty to purchase the paper. And when the Wall Street Wizards combine derivatives, create new derivatives out of whole cloth or attempt to hedge derivative risk using other derivative products, the ball may come crashing down.
The appropriate question should not be so much which agency is going to oversee the creation and marketing of derivatives, but if derivatives are appropriate to use as investment vehicles, under what circumstances and which audience. Merely restricting the use of derivatives for the wealthy or the financially sophisticated is to give rise to the same inequities introduced by the government when they allowed hedge funds to function as unregulated financial institutions.
In fact, there is no valid reason why the regulation of derivatives should be divided between the Securities and Exchange Commission and the Commodities Futures Trading Commission. In fact, both entities should be combined under a single regulatory structure to eliminate bureaucratic waste, improve information flow and coordinate enforcement activities.
For those wishing to read the full document in context, and do further research, the links can be found in the Research Links section below.
Bottom line …
It all depends on the character, competence and clarity of those we entrust to undertake regulatory supervision with a guide to protecting the public and insuring a fair and level playing field. Unfortunately, the very same people who are complicit and complacent in this current financial calamity are the same ones who are proposing the solution to the problem. The real issues is that I am not so sure that they are not the problem and their efforts will be both self-serving and politically oriented.
As with everything Obama, everything is described as historic and the words do not match the deeds. We need to watch this sausage being made – untasteful as it may seem – and call bullshit when our elected officials and their minions overstep the bounds of prudence and sound governance.
The one wild card remaining is the United States Constitution. Considering that only enumerated powers were granted to the federal government, the rest being granted to the individual states and reserved for the people, many of these regulatory actions may be unconstitutional and an unwarranted extension of the government’s power over “we the people.”
The one word that I did not find in this 89-page document was “preemption.” The claim that federally-chartered or regulated entities could bypass more restrictive state consumer protection laws at will. Something that may be missing as the government's (through the OCC) claim that federally-chartered financial institutions were not subject to state regulation is currently before the United States Supreme Court.
And of course, nothing in this document implies or calls for punishing those who were complicit in the current financial crisis. In fact, it is likely that many criminals will escape prosecution not only because their cases may dropt through the cracks during regulatory agency transitions – but because most of them are now paid employees of the government.
The last word: be well, be safe and take care of yourself and your family first.
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OneCitizenSpeaking: Saying out loud what you may be thinking …
Research Links …
White Paper: Financial Regulatory Reform
Fact Sheets:
- Requiring Strong Supervision And Appropriate Regulation Of All Financial Firms
- Strengthening Regulation Of Core Markets And Market Infrastructure
- Strengthening Consumer Protection
- Providing The Government With Tools To Effectively Manage Failing Institutions
- Improving International Regulatory Standards And Cooperation
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Warning: This post originated from a suspicious source which appears to be a non-English speaker and refers to a debt counseling service (I have redacted the actual address) which could be a Phishing attempt to gain acces to your non-public personal information for the purposes of identity theft. Never trust Internet communications from financial institutions -- even though they look legitimate and seem to have valid web or e-mail addressed. Call your local branch to respond. -- steve
Posted by: debt management advice | June 18, 2009 at 05:48 AM