June 18, 2009
The New Financial Plan
Some of the details of the administration's new financial plan are out. Any newspaper has a summary. A few observations:
1) The big winner is not the Fed, as reported, but the Chairman of the Fed. They are different. The Federal Reserve System is 12 banks, owned and capitalized by otherbanks. The Presidents of these banks serve, along with the Chairman of the Fed, appointed by the President, on several very exclusive committees. The Chairman of the Fed dominates the committee that engages in monetary policy, binding the banks, and otherwise works with Treasury on general economic planning. The Chairman of the Fed will now, apparently, regulate risk taking by all major financial institutions in the United States. The irony: The Chairman of the Fed created the cheap money that fueled the housing bubble. It is like SOX: the winners were the accountants, accumulating massive new fees under SOX, when they had misbehaved in the first place, failing to audit correcting telecom and technology companies.
2) The elephant in the room not mentioned is the rating agencies. The rating agencies were necessary to the housing bubble, overrating risky MBS securities so that banks could buy them and even use them for capital requirements.
3) The Chairman of the Fed will have quasi- Chapter 11, receivership and conservatorship power over a large part of the financial system. Chapter 11 comes with rules, this power is very open-ended and, as has been the very recent practice, is likely a vehicle for government intervention, not orderly winding up or reorganization.
4) The Chairman of the Fed will now have multiple and potentially conflicting assignments. These "hybrid" government agencies do not work well. Fannie and Freddie had function creep and were part of the reason for the housing bubble.
5) The proposal is too narrow. The next bubble will be in some other commodity or asset class. The proposal focuses on asset securitization systems, yesterdays news and to which many in the market have wised up. A bubble needs 1) Cheap money 2) A weak link, a sucker who takes risk she does not price correctly and 3) Those who shuffle risk. Those who shuffle risk use the cheap money to pass risk, taking fees, on to the weak link until the true extent of the risk is discovered. The cheap money for the recent housing bubble came from the Fed, the shufflers were those in the securitization process, and the weak link were those investors that relied on incompetentt rating agenices to qualify risk. The proposal relies on the Fed and Treasury to accurately monitoror risk, something neither in the last crisis, which means we have added a new weak link ("Treasury thinks we are fine.") and have not repaired the old weak link, rating agenciess. A broader solution? Competition among rating agenciess and auditors and other certifiers of risk; claw backs on salary among the risk shufflers; heightened anti-fraud prosecutions.
6) It does not solve our central politcal problem. In the housing bubble we witnessed elected politicians putting pressure on government housing agencies to relax lending limits. We will see this again. The government proposal gives mulitple government actors the power and direction largely to say "no" to private actors and again elected politicans will attempt inevitably to influence those decisions to aim local constituents. Barney Franks successful efforts to secure TARP money for a badly run, tiny Boston bank will seem to pale in comparison.
7) This is not a "light touch."
June 18, 2009 | Permalink
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In fairness to the proposal, credit reporting agencies are mentioned. In particular, regulation of conflicts of interest in credit reporting agencies is mentioned, and perhaps more importantly, federal regulators are to give decreased importance to credit reporting agencies.
Previously, an investment grade bond rating from a credit reporting agency was a fast track to IPO approval from the SEC for publicly offered debt securities. The implication of the new proposal is that this will no longer be the case -- something that reduces the market value of the work product of credit reporting agencies a great deal. Normally, these days, debt security issuers pay good money to have their issues rating in significant part because they want regulatory fast track approval.
Posted by: ohwilleke | Jun 18, 2009 11:06:58 AM
Excellent critique and a wise counter proposal in 5 and a wise observation in 6., in my opinion.
Posted by: Steve | Jun 19, 2009 8:46:24 AM