It has been less than three years since the global financial system nearly imploded, and even now much of the global economy has not fully recovered. Which makes it all the more shocking that a collective amnesia has already set in about what we’ve just been through and why it happened.
Having succeeded in beating back the more radical ideas for limiting its size, its pay and its speculative excess, the financial services industry is now waging a campaign to undermine what is left of the reform process. Flush with windfall profits from the Federal Reserve’s loose monetary policy and riding a convenient wave of anti-government sentiment, it aims to weaken new regulations and intimidate those who enforce them.
That’s not to say a number of the industry’s concerns are not valid. But their declarations of good-faith negotiation are undercut by the cynical and intellectually dishonest way in which they have chosen to play the Washington game.
Having complained, for example, that the uncertainty surrounding financial regulatory reform was depressing economic growth and job creation, their big beef now — parroted, obligingly, by every Republican on Capitol Hill — is that regulators are moving too quickly to clarify policy and issue regulations.
Having bitterly resisted efforts to consolidate agencies and remove overlapping jurisdiction, their new complaint is that the regulatory structure is cumbersome and has no clear lines of authority.
The industry warns endlessly that more regulation and higher capital standards will drive business to more hospitable regulatory environments overseas — and then turns around and pushes to weaken overseas regulations even further.
Despite its professed concern for the quality of regulation, the industry declines to take a stand against Republican efforts to dramatically cut funding for financial regulatory agencies. Nor has it used its influence to overcome the determined opposition of Senate Republicans to anyone the Obama administration might nominate to the top jobs in those agencies, many of which have been vacant for months.
For those of you who just tuned in, there are two heavyweight fights going on between the industry and the regulatory reformers.
One fight concerns trading of swaps and other derivatives, which until now was either loosely regulated or not at all. Under the new Dodd-Frank law, this trading is supposed to migrate to regulated exchanges where prices will be posted, position limits will be set, traders will be required to post collateral and dealers will have to maintain minimum capital requirements.
In Congress, banks and other dealers bitterly resisted these common-sense reforms for one simple reason: They would cut into what have been sizable profits. Having lost that battle, they are working overtime to weaken and delay the rules issued under the new law, once again claiming that it is not they who will suffer from this government overreach, but farmers and manufacturers and other “end users” who will have to pay more to use derivatives markets to hedge their business risks.
Never mind that Congress has provided an exemption for struggling “end users” such as BP and Cargill. In the hyperbolic tale spun by industry lobbyists, this common-sense regulation designed to prevent another financial crisis will instead prevent end users such as BP and Cargill from creating hundreds, thousands, even millions of jobs. So far, regulators have generally held their ground, but this 10-round bout has just begun.
The second slugfest concerns the question of which financial institutions will be judged to be so “systemically important” — SIFIs in the new argot — that they will be subject to heightened regulation by the Federal Reserve. When people speak of “too big to fail,” this is what they’re talking about.
Bringing a “systemic” approach to financial regulation was central to the reform effort, and the key to bringing the “shadow banking system” under regulatory scrutiny. The focus was to be on institutions that, because of their size or leverage or interconnectedness to other financial institutions, might bring down other institutions if they were to fail. The idea is to give these entities special attention and require them to maintain slightly higher levels of capital to offset their lower cost of borrowing and act as a cushion against potential losses.
Congress declared that any bank holding company with more than $50 billion in assets would automatically get the SIFI designation (since the crisis, all the major investment banks, along with two of the largest insurance companies, received charters as bank holding companies). But for non-bank institutions — hedge funds, asset managers, private-equity firms and other insurance companies — the decision was left to a new council of regulators headed by the Treasury secretary.
As you might expect, those institutions have lobbied furiously to avoid being inducted into this “exclusive” club, apparently to good effect. According to numerous officials involved in the process, it seems the only non-bank financial institutions likely to be designated will be GE Capital, the financial arm of General Electric, and perhaps the rescued insurer, AIG. The industry is so confident about its prospects that the chief executive of BlackRock, an asset management firm with $3.5 trillion under management, recently assured analysts that his firm would probably be spared.
I have no idea what the right number of systemically important non-bank financial institutions should be, but I can assure you it is greater than two.
It is hard to believe that a cash squeeze on a highly leveraged, $20 billion hedge fund could not set in motion the kind of panic selling that leads to contagion. Could not a crash in commercial real estate prices suddenly require a couple of giant life insurers to have to raise large amounts of new capital, prompting a run by policyholders across the industry to cash in their policies? And what would happen when rumors crossed the wires of a giant asset manager heavily invested in derivatives that suddenly plunged in value, forcing the firm to dump billions of dollars in common stock to meet collateral calls? If the financial system can be shaken by the threat that a single money-market fund might “break the buck,” as happened in fall 2008, why are regulators rushing to declare that virtually no non-bank financial institution, no matter how large, poses systemic risk?
From a purely political standpoint, it’s also hard to understand why the Treasury secretary would cave so early and so easily on a key issue while the industry is actively engaged in undermining him on the rest of the regulatory reform effort. I’ve never bought the line that Tim Geithner is a Wall Street patsy, but there are times when he does a pretty good imitation. He should have learned by now that this industry responds to every act of accommodation with another kick to the shin, and responds to kicks to the shin with accommodation. Hardball is the only game these guys know how to play.
One of the more common arguments you hear from industry executives is that their firm, or category of firm, or size of firm shouldn’t be regulated — or “punished,” as they often put it — because it didn’t cause the financial crisis or never required a bailout. Such arguments ignore the reality of systemic failures.
When the government stepped in to rescue Bear Stearns and Citigroup and AIG, it wasn’t just rescuing those particular firms — it was rescuing the whole financial system that could otherwise have come crashing down behind them. Hedge funds, asset managers, small community banks, derivatives dealers — they were all part of that same system. They lent each other money, bought each other’s securities, hedged each other’s risks, invested in and lent money to the same markets. If the system had collapsed, they all would have suffered serious and lasting damage, whatever their size or market niche.
The financial crisis was, above all, a collective failure. That industry leaders have already forgotten that lesson — or even worse, that they never learned it — is the reason it is so important now to finish the work of reforming and strengthening financial regulation.