-
Three nominees to the Federal Reserve Board are set to underscore the growing attention the central bank is paying to financial stability concerns amid its two other mandates of employment and price stability.
March 12 -
Central banks' highly accommodative monetary policies in recent years have heightened the possibility that a geopolitical crisis in the Ukraine and elsewhere could eventually pose a systemic threat, according to a new paper by Federal Financial Analytics.
March 12 -
Regulators should demand more derivatives disclosures in forthcoming living wills. Having banks disclose the risk factors in their risk measurement models would help regulators understand if banks are well capitalized for unexpected losses.
March 12
With sharp insight and the cynicism natural to a Chicago politician, Rahm Emanuel famously pronounced in 2008, "
For those who wanted to greatly expand the power of government over banks and nonbank financial institutions and markets, especially to expand the discretionary power of unelected agencies; to do so outside the control of the Congress and the judiciary; and to move the financial sector toward bureaucratically directed, rather than market, outcomes, the financial crisis of 2007-9 was indeed a great opportunity. Unfortunately for the economy and private sector job growth, the political actors most definitely did not let the crisis go to waste.
So we got the Dodd-Frank Act of 2010. Dodd-Frank is part of a predictable pattern, as were the previous overreactions to various corporate scandals. The Sarbanes-Oxley Act of 2002, remember, was supposed to assure the identification and management of risk. It didn't work. Neither will Dodd-Frank. Two other major banking crises during our careers were the real estate bust of 1974-76 and the multiple disasters of 1980-1992. In each case, Congress responded by piling on more burdensome laws and regulations. Each time, it failed to prevent the next crisis.
Nonetheless, we are all stuck with the most recent expansion of regulatory power and bureaucratic discretion, largely unencumbered by legal limits and definitions. Take, for example, the all-purpose regulatory expansion rationale, the fuzzy idea of "systemic risk" and its cousin "
To address systemic risk, whatever it is, Dodd-Frank created the Financial Stability Oversight Council - a big committee of regulators, mostly bank regulators, chaired by the Secretary of the Treasury. It turns out that "systemic risk" means whatever a majority of FSOC says it means. Who besides big banks might be a "Systemically Important Financial Institution"? Whoever a majority of the FSOC says is one.
As Humpty Dumpty asserts in Through the Looking Glass, "A word means just what I choose it to mean." When Alice wonders how that can be, Humpty explains, "The question is who is to be master that's all." Asset managers and insurance companies threatened with being branded as SIFIs now feel they are in a Through the Looking Glass world and are discovering the real question is: Who is to be master that's all.
Consider that Fannie Mae is bigger than JPMorgan Chase, but unbelievably, FSOC does not consider Fannie a SIFI. Freddie Mac is bigger than Citigroup, but neither is Freddie a SIFI. Unleveraged asset managers are probably SIFIs, we are told, but the infinitely leveraged Fannie and Freddie, which continue to distort the housing market and create
Speaking of the Federal Reserve, its power has been greatly increased as a major bureaucratic winner in Dodd-Frank. It becomes a key regulator not only of bank holding companies, but of any company of any industry which gets the SIFI label (in addition to exchanges deemed "Systemically Important Financial Market Utilities"), whether the Fed knows anything about the business or not.
Thus the Fed, which utterly failed to recognize the housing bubble, which failed to anticipate the massive resulting bust, which failed to forecast the following steep recession, is going to tell SIFIs how to run their business. The credulity of Congress, when legislating in the wake of a crisis and applying Emanuel's maxim, appears unlimited.
We need to acknowledge the fact made clear by the long history of banking crises: Regulators are not capable of preventing crises by turning banks into government-controlled bureaucracies. Not only are banks then inhibited from taking the commercial risks sufficient to support economic growth, but government control brings with it procyclical regulations like "fair value" accounting; egregious excesses like so-called "disparate impact" suits; and credit allocation to politically favored classes of loans, like residential mortgages and loans to governments. On this last point, consider the credit allocation entailed by the Fed's huge monetary expansion: mortgages and government bonds.
There is little, if anything, fundamentally new in the art of banking in the last 200 years. Dodd-Frankish mountains of regulation, and especially the suffocating regulatory burden now loaded on community banks, are not the answer. We know failures will continue to occur. Good banks diversify their risks on both the asset and liability sides, establish robust internal checks and balances, and maintain strong equity and prudent reserves to cover the mistakes they will inevitably make. Good regulators promote precisely these principles, attempt to provide countercyclical rather than procyclical context, and are ready to adjust to the regulatory mistakes that they inevitably will make.
We need an approach focused on these fundamentals. But that is not what we have got. The promoters of mountains of regulation used the most recent crisis far too well.
William M. Isaac, former chairman of the Federal Deposit Insurance Corp., is a senior managing director at FTI Consulting and the nonexecutive chairman of Fifth Third Bancorp. Alex J. Pollock is a resident fellow at the American Enterprise Institute and former president and CEO of the Federal Home Loan Bank of Chicago. The views expressed are their own.