Systemic Risk Council Has Arrived Just in Time

JPMorgan Chase's acknowledgement this spring of $2 billion or more in credit derivative losses raised concerns that big banks still place wild bets.

While $2 billion was said to be but a blip on JPMorgan's computer displays, and the trades occurred in London, news reports in late June that losses may tally as much as $9 billion suggest that in essence JPMorgan continues operating a hedge fund inside the bank with federally insured deposits.

With all the publicity, financial services professionals may well coin a new term of art for being outfoxed at reckless hedging, say "it got Saba-ed," when a smaller, nimbler, brainier rival like Saba Capital Management profits handsomely from a dominant bank's out of control bets.

The Dodd-Frank Act created the Financial Stability Oversight Council (FSOC) to identify, forewarn and address systemic risk, and the Office of Financial Research (OFR) to glean intelligence from data so taxpayers might be spared bailing out too-big-to-fail banks again. But JPMorgan's immensely costly and highly complex credit derivative trades underscore that two years after passage of Dodd-Frank, neither FSOC nor OFR is up and running well enough to address systemic risk.

It would seem that it's all by design. Too big to fail banks, the institutions that the Dodd-Frank legislation sustains, appear to be running out the clock on President Obama, betting that Mitt Romney, should he be nominated and elected, will restore the salad days of Bush 43.

Now, the Systemic Risk Council, a voluntary private-sector group, has come forward to address languishing systemic risk regulation. Launched by the Pew Charitable Trusts and CFA Institute, the council sets achievable goals, notably: requiring stronger capital at the nation's largest firms; speeding up agreement among regulators to put the Volcker Rule into practice; and finalizing rules for over-the-counter derivatives. I am hopeful that the council will animate FSOC enforcement and OFR analysis to enable regulatory certainty.

The question at hand is whether anyone in power will listen to the SRC, and, if they do, whether public policy will be implemented to yield regulatory certainty so investment can transpire.

Several factors suggest the SRC has a higher probability for securing adoption of its goals than other elite, public interest organizations.

Institutional heft is one reason. The council's widely respected chairwoman, former Federal Deposit Insurance Corp. chief Sheila Bair; senior advisor Paul Volcker; and influential members, including top banking executives, lawmakers and regulators, command consideration – whoever wins the presidential election.

While Governor Romney may address commerce with a more laissez-faire approach than President Obama, he nonetheless recognizes that certainty promotes confidence, investment and capital accumulation. Obama's re-election would create momentum for implementing SRC regulatory correctives.

"It's certainty, stupid" represents another likelihood SRC will succeed with its measurable, specific, applied goals. The SRC's timing could not be better. Uncertainty's over. No one, except the political and commercial elites profiting from uncertainty, has patience with it any longer. Uncertainty's just too expensive for too many people in too many places. 

The SRC could also encourage the FSOC and OFR to implement a comprehensive risk detection system that draws out risk-related information in near real time with available intellectual property and information technology. (Full disclosure: I work as an advisor to Marketcore, a firm that offers such IP). Robust technology would render obsolete the information asymmetries that too big to fail banks manipulate to sustain their market power and to exploit their dominance over financial markets. As importantly, such tools would allow the too big to fail banks to clear the toxic assets that are clogging their books and retarding investment and protracting uncertainty.

By empowering OFR analysis and FSOC moxie to take on systemic risk, the Systemic Risk Council will promote effective market administration to stimulate investment and growth through regulatory certainty.

Hugh Carter Donahue, an adjunct professor of history at Rowan University in Glassboro, N.J., specializes in public policy and regulation. He is an advisor to Marketcore, a Westport, Conn., firm that licenses technology patents to the financial services and insurance industries.