Washington Post Columnist
Wednesday, February 24, 2010; 11:00 AM
Washington Post business columnist Steven Pearlstein will be online Wednesday, February 24 at 11:00 a.m. ET to discuss regulatory reform, on an issue on which there appears to be a good chance for a breakthrough after a long stalemate. By early next week, Pearlstein says, look for Sens. Chris Dodd of Connecticut and Bob Corker of Tennessee to unveil a creative bipartisan proposal that will hit all the right notes in terms of both policy and politics and will have the best shot at Senate passage.
Read today's column: Senators, finally, near an attractive deal on financial regulation.
A transcript follows.
FINRA???: How does the regulatory reform bill impact FINRA? Does it speak to their responsiblities? Will they get any added jurisdiction?
Steven Pearlstein: Have no idea, really. Didn't get into that detail with people.
Evanston, Ill.: Your article last week mentioned the need for the president to roll up his sleeves and take leadership on even a possibly unpopular issue to regenerate his stock of political capital. Do you foresee financial reform as such a political victory? What about a foreign policy issue - like nuclear weapons policy with START negotiations and the upcoming Nuclear Posture Review?
Steven Pearlstein: I do think financial reform is that kind of issue, and is one that is particularly amenable to presidential participation leading to a victory. This is complicated, but no where near as complicated politically as health care. There are very few broad political risks in this bill -- it is all about special interests.
Knoxville, Tenn.: Will the new financial regulatory agency have a name or will it be a merger of the OCC, OTS and or FDIC?
Steven Pearlstein: Don't know the name, but it will combine existing functions of OCC, OTS and Fed, with the federal oversight of state chartered banks all moving to the FDIC, which now shares that responsibility with the Fed.
Tampa, Fla.: As a former Treasury Dep't attorney who worked on the thrift bailouts in the '80s and '90s, I worry about having a single agency charged with protecting consumers and ensuring bank soundness.
The two are incompatible. Agencies such as the OCC (Office of the Comptroller of the Currency) charged with ensuring bank soundness equated that with bank profitability. OCC opposed EVERY consumer protection effort by both state and federal regulators. OCC would have allowed banks to sell crack to school children if it boosted bank profits and capital.
Consider that the current Comptroller, John Dugan, has bitterly opposed all efforts aimed at protecting consumers. The risk is that the head of any agency charged with the conflicting mandates of consumer protection and bank soundness will be another John Dugan and eviscerate consumer protection efforts.
Should such an agency be created, the banks will push hard for to capture it by placing a true believer in bank soundness in charge of the agency, and by tweaking the agency's mandate to put soundness ahead of consumer protection. Should this happen, we will be back to square one: sleazy practices are profitable, profits increase capital, and frak the consumer.
Steven Pearlstein: These are all risks, no doubt about it. Here's the way I think about it.
First, you can write the legislation in such a way that the new agency is new, which means that to the best of your ability, you create a new structure, new culture, new mandate and hope to leave behind the old ways of thinking.
Second, you make it explicit that there is a dual mandate and that the head of the agency has to take them both seriously and that the system doesn't automatically and in every instance default toward boosting bank profits at all costs. You can also insist on more transparency in bank supervision so that the sunlight disinfects a bit.
Third, at the end of the day, what matters most is not structure but people. If George Bush appoints the head of an independent consumer agency, then it does nothing -- nothing -- for four or eight years. Look at the Consumer Product Safety Commission, or OSHA. On the other hand, if Barack Obama appoints the head of a new agency with dual responsibilities and a separate consumer division, then you can pretty much bet that consumer protection will be taken very seriously by the bank supervision authorities. So elections matter more than structure.
One reason for passing a bill, by the way, is that it will finally free the Treasury to fire Dugan, which they should have done a year ago, and make a clean break of things.
Lefty from Princeton: I don't know enough to comment on your column today although, as usual, what you say makes sense. I do, however, have 3 simple minded questions I would like answered.
Credit Default Swaps - Why should a party be allowed to take out insurance on a financial instrument in which they have no material interest? I cannot take out fire insurance on your house.
Mortgages - Why should a bank be allowed to sell its end of a mortgage? If I contract to paint your house, I can't sell my end to the 10 year old around the corner.
Futures - Why should a speculator be allowed to buy a futures contract when they have no intention or ability to take delivery of the commodity?
Steven Pearlstein: All good questions. I'm with you on credit default swaps -- I don't see a socially or economically useful purpose that is sufficient to offset the volatility and short-term market distortions they can cause and the way they can contribute to contagion.
The ability to securitize mortgages does lower the interest rates we all pay. Done correctly, I don't see that as a problem with one exception: you take a mortgage from a company with good customer service, and it gets sold to one with lousy service. There ought to be some sort of service standards set and enforced by an independent body, like underwriters laboratory, and if you buy a mortgage promising B level service, then it should be able to be sold only to a company that offers comparable service.
Futures, there should be no uncovered shorting of securities -- that is, you can't short it unless you have borrowed it. The reason is that you get a situation where there are more short sales then there are actual securities to short, and this does have an effect on the price of the underlying security. It is not, as the industry argues, like betting in the stands that doesn't effect the game. That is a big lie.
Mount Rainier, Md.: Mr. Pearlstein, From your column today, this quote really stuck out:
"The compromise hammered out between Dodd and Corker would establish a single regulator of federally chartered banks with a dual mission and an independent source of funding , based on my conversations with several key players. One division would promulgate and enforce rules to protect consumers; the other would fulfill the traditional role of supervising banks for safety and soundness. Supervisors from both divisions would participate in the periodic reviews of bank operations, and any conflicts between the two would be resolved by the head of the agency. "
Haven't we tried that with the FAA and the Federal Reserve? A nd isn't that model part of the reason that both airlines and the financial industry are in such dire straits?
Steven Pearlstein: No, that is not the current model. The agencies may have some responsibilities under one law for consumer protection, and other responsibilities under another law for safety and soundness, but there has been no attempt in the existing law to explicitly give a dual mandate where the two values are given equal weight and conflicts and need to be resolved at the highest level. There is a lot you can do in the language of the law to force bank examiners to behave differently. They aren't stupid and they aren't venal and while they have unconsciously adopted the mindset of the people they are regulating, a new law and a new director can change that in the course of a couple of years. As for capture, it is always a risk, as we know from bitter experience.
Washington, D.C.: Read your regulatory bill column with interest. Are you at all concerned that lawmakers are focusing on the most recent crisis, rather than evaluating the situation as a whole? So much of the trouble in the most recent crisis was caused by regulations and practices that came about because of previous crises (such as market-value accounting, risk-based capital, and securitization, which were encouraged by regulators as a solution to the S&L crisis). This is a pattern that repeats itself throughout history, and I'm concerned that Congress has deep incentives to address the crisis already past in a way that sets up the next crisis.
Steven Pearlstein: Such is life. It is hard for people to anticipate how to prevent the next crisis because, well, if it were predictable, then it wouldn't happen and it wouldn't be a crisis. So the thing to do is to think broadly and fundamentally about what went wrong-- about culture and incentives and checks and balances and transparency -- and less about trying to regulate away the very specific thing that went wrong last time.
Ballston: I'm a little confused by your column. I get that there would be one regulator and two divisions (one for safety and soundness and one for consumer protection). But who is that regulator? The OCC? The FDIC? (I'm assuming the Fed is out of the running). Or is Dodd just going back to one super regulator here and stripping the FDIC and Fed of banking supervision (as he did in the bill last year)?
Steven Pearlstein: The idea is that it is a new agency. In reality, it will be built around the existing OCC, which isn't perfect but reflects the reality that the work has to be done and that is where there are the most people who already know how to do the work. You can't really start from scratch, since experienced bank examiners don't grow on trees. But I'd hope that they structure the transition so that it really forces a shakeup in the culture and forces top managers to have to reapply for their jobs.
Franconia, Va.: What reform?
-TBTF codified and explicit -Volcker rule taken off table
Our greatest deficit is leadership.
Steven Pearlstein: One thing I can assure you is that TBTF will not be codified in the Senate -- no way. Both sides are really determined about that, and frankly they don't care what the Treasury or the Fed think about that. For them, that is the number one issue, and frankly I don't blame them. Now there are silly ways to go about that and intelligent ways, but the idea that there are a group of institutions that will be declared too big to fail -- no way. That's a non-starter.
As for Volcker rules being taken off the table, it won't be legislatively mandated for the most part, but they will surely give the regulator authority to set limits and require higher capital standards and limit use of regulatory capital. Writing a Volkcker rule, as it turns out, is quite difficult. These things are no longer so cut and dry, and there is a real issue of making false distinctions that will drive even more financial intermediation away from regulated banks and to largely unregulated entities.
Houston, Tex.: Hi Steve, Do you think there is any justification for the investment banks to continue to have access to the Fed discount window?
In 2009, Goldman Sachs paid just $6.5 billion interest compared to over $31 billion in interest payments in 2008. Their effective interest rate on borrowings of over $500B is an incredible 1.3%
It looks as if GS is funding almost their entire balance sheet using Fed funds - unless there are private investors happy to lend money to a high risk company at less than the Treasury rate.
Correct me if I'm wrong, but far from being punished for the financial crisis, the remaining investment banks seem to have been handed a subsidy from the taxpayers worth tens of billions every year.
Steven Pearlstein: Outside of a crisis, there is no reason that an investment bank should have regular access to the Fed window. Which is why Goldman Sachs may not continue to be a commercial bank when all this is over.
Bank lending: So we found out that bank lending was down sharply in 2009. I suspect that both sides of the stimulus debate will take this as evidence that they are right -- the Chicago school will say but for the stimulus that money would have been lent, and Keynesians will say the drop in lending proves the stimulus was necessary.
Is there any way to resolve this rationally?
Steven Pearlstein: Bank lending is down because (1) demand is down (2) because banks have rightly been forced to operate with less leverage and (3) because banks have been forced to operate with more reserves and liquidity cushions and (4) banks have set higher standards for making loans of all types. This isn't really an ideological matter.
On Leadership: Are you going to see Richard II or Henry V?
Steven Pearlstein: I saw them both just as they opened. Really spectacular, particularly Henry V.
New York: Steve: I can't envision any reasonably successful bill that takes more than a modicum of input from industry. The securities industry has repeatedly shown an inability to police itself and prevent itself from doing stupid things. My line of thought is every time a proposal or bill comes up and I hear that Goldman Sachs is against the bill, I'm automatically for the bill. Maybe I'm angry or simplistic, but I can't imagine that the American people should agree to get ripped off any more.
Steven Pearlstein: Yes, it is a bit simplistic. You don't have to trust them to listen to them and make your own independent judgments about whether something might be practical or have unintended side effects or be important or not important. Sometimes paranoids really do have enemies and people who have lousy motives or track records can still speak the truth.
Arlington, Va.: The Republicans have been pretty successful lately at blocking all legislation and then blaming the Democrats for not getting anything done. Why would they support financial regulation if they can block it, blame the Democrats, and pick up seats in November?
Steven Pearlstein: Because they run the risk of NOT picking up seats in November when Democrats run very tough TV ads showing that they were the big defenders of Wall Street and its sleezy, bonus-driven culture. Mitch McConnell as the bought-and-paid-for protector of Gordon Gekko.
Washington, D.C.: When it comes to financial institutions, couldn't regulation be achieved by real-time data monitoring?
In other words, could the system be condensed to a set of standardized data elements where norms are pre-set, and irregularities are flagged in the software?
Steven Pearlstein: No.
New York City: I have a semi-related question about economics. I've heard it been said by some respected business leaders that if a fraction of the brain power than went into development financial products such as CDS, CDO went into engineering or science, we could have developed electric cars or cured cancer. Now maybe that might be a slight exaggeration, but the point is well taken.
So with Wall Street dangling huge sums of money around, how do you motivate people to do something which certainly doesn't seem as lucrative, but might benefit us all to a much larger degree?
Steven Pearlstein: Its a big problem. It is the result of a market failure in which companies in one industry, finance, earn profits that are much higher than in others because of imperfect competition, and labor markets in one industry, finance, that have more winner-take-all characteristics than other parts of the labor markets. If I were king, I'd send the antitrust police in to Wall Street and tell them not to come back until there was real price competition. That's the root cause of the problem. It's not because these finance guys are so productive or creating so much value to the economy. In economic terms, it's pure rent.
Mt. Lebanon, Pa.: Chrid Dodd couldn't recognize financial wrongdoing if he tripped over a manhole cover and fell into the New York City sewer system.
So.. a lame duck U.S. Senator is going to come down from the mountain top carrying tablets of stone with reform etched on them?
We'll see financial reform in Nigeria before we see it here.
I won't hold my breath, unless I'm near open financial district manholes..
Thanks much. HLB
Steven Pearlstein: Now, now.
Chevy Chase, Md.: How do the new regulations affect the shadow banking system, specifically the market for subprime mortgages, which was fueled by investment houses like Bear Sterns channeling money to mortgage brokers and generating high-risk mortgages which were then repackaged and sold by the investment houses?
Steven Pearlstein: There are a number of provisions in the various bills dealing with this, including regulation of mortgage originators (that's the consumer agency stuff) whether at regulated banks or elsewhere; requirements that originators keep some of the risk of mortgages even after selling them; reforms of the rating agencies so their ratings bear some semblance to reality; tougher risk management guidelines for regulators; lower leverage and higher capital standards for places like Bear Stearns, along with greater transparency of off-book entities. In other words, quite a lot, actually.
Alexandria, Va.: Mr. Pearlstein, So is it your opinion that President Obama's call to limit bank size and their ability to buy and sell financial instruments with their own funds was mainly a bargaining maneuver? Or do you think that the Dodd/Corker proposal might include some restrictions? Thanks.
Steven Pearlstein: I didn't say he meant it as a bargaining maneuver. I think he proposed them to quell a public backlash against the White House for being too cozy with Wall Street. But the effect has been that it certainly got the attention of Wall Street and convinced them their interest was no longer in stalling and dragging out the reform process, but bringing it to a conclusion, even if it means making some concessions that they were previously unwilling to make.
Arlington, Va.: How realistic is it for the president to say he won't allow costs to go up in X industry? For example, I will ban premiums from going up, I will ban foreclosures, etc. Doesn't basic economics, as well as our experiment with price fixing in the past show that this is often going to lead to a massive failure?
Steven Pearlstein: It is something you have to look at quite suspiciously and critically, I agree.
Simple question: Steven, I'm not well versed enough in economics or financial regulations to contribute to your main theme today, but I have a question that has been bugging me for some time now.
Bank loan activity: way off. New home sales: at record lows.
If you're running a bank and you have a bunch of customers with mortgages who are no longer able to make payments at their current level, would you not be better off rewriting the mortgage to create a payment schedule they can meet, instead of foreclosing on the house and trying to find someone else to buy it in today's market?
Steven Pearlstein: You might or might not be better off, depending on how much you would get by foreclosing on the house and selling it. But your point is a valid one -- in most instances, banks would be better off by lowering principal and interest than in foreclosing. Unfortunately, the banks don't really own most of these mortgages. They may be servicing them, but they don't own most of them, and the servicing agreements don't give them a whole lot of lattitude in this regard. Also, bankers are just constitutionally averse to writing down principal because it sets a bad precedent. They want borrowers to be fearful of losing their homes, otherwise they might get the idea that they can withhold payments and get a better deal very easily.
Liberal Democrats who insist that the only solution is to micromanage the financial services industry from Washington.: Could you be more specific and identify the left-of-center Senators and Congressmen who have impeded financial regulation reform?
Steven Pearlstein: Some want federal regulators to have to approve of any new product that any bank offers, even if it is only slightly different than a previously approved product. That would meet my definition of micromanaging, as opposed to setting out broad guidelines for what kinds of things are prohibited.
For example, I will ban premiums from going up: Simply look at health care costs in any other industrialized country which average HALF of ours per person.
Steven Pearlstein: You can control premiums but if you don't control the underlying medical expenses, all you're likely to get is bankrupt insurance companies. They could do a better job at jamming the providers, but there are limits to their market power.
The ability to securitize mortgages does lower the interest rates we all pay. : Could you please explain how this works? Since the rating agencies seem to be unable to evaluate these securities, how can you know they lower rates?
Steven Pearlstein: Basically, by spreading risk that any one mortgage will go bad by allowing investors to buy a small piece of a large package of mortgages, people are willing to lend for a lower return. That's how securitization lowers rates. It works -- really.
all you're likely to get is bankrupt insurance companies. : And this is bad, why? Perhaps then we will get companies that can control their overhead, reduce compliance costs and pay their executives reasonanble compensation.
Steven Pearlstein: No, you get no insurance company, no executives, no overhead, no compliance costs and no competition for the ones that hang on the longest.
Oklahoma City: The Fed has made a full court press recently to articulate why supervision should remain at the central bank in order to conduct monetary policy and serve as lender of last resort. Those arguments seem to make much sense to me. I wonder why they aren't impacting the proposal...seems like the senators are just looking for a scapegoat and the Fed is convenient.
Steven Pearlstein: The idea that we should make the structure and quality of bank regulation a secondary focus because what's really important is that the Fed have better information with which to conduct monetary policy -- well, that just doesn't sound very wise to me. The Fed can have all the information it wants from banks, directly or indirectly through supervisers. Nobody is suggesting otherwise. What we are suggesting is that the Fed is not a very good bank supervisor -- they don't believe in disclosure, they coddle and, if necessary, bail out the the big banks because they are deathly afraid of causing a bank run and, in the larger scheme of things, bank regulation is an after-thought at the Fed, which cares most about monetary policy. So why not let them focus on doing what they do best, and leave bank regulation to a tougher, more focused agency that takes as its primary mission the protection of taxpayers and depositors and consumers, all of which the Fed's top officials really couldn't give a damn about, when push comes to shove.
Cleveland, Ohio: When the Volcker rule was announced, it was packaged as a ban on prop trading and a ban on commercial banks lending or investing to hedge funds and private equity. Where does the ban on lending to or investing in hedge funds now stand?
Steven Pearlstein: Bans on lending to hedge funds or private equity funds would be a very radical step, and probably not necessary. I don't think Volcker actually had that in mind. Owning them, on the other hand, strikes me as reasonable.
No, you get no insurance company, no executives, no overhead, no compliance costs and no competition for the ones that hang on the longest. : Sounds good to me. Then I won't have to move to Canada.
Steven Pearlstein: I suggest Nova Scotia or Prince Edward Island.
Rewriting Loan Terms: I understand bankers reluctance to rewrite loans that includes reductions in principle. Homeowners, and I'm one of them, need to be held to their decisions just as the banks need to be. What if the solution only included extending the mortgage life to 50 years or so? Most of early mortgage payments are interest anyway, so this could bring the monthly payment amounts way down while preserving obligations.
Steven Pearlstein: That's one option that a number of banks have played with.
Denver, Colo.: What's happening with the extension of fiduciary duty to stockbrokers?
Steven Pearlstein: Not sure. Industry obviously opposes it, but I suspect there will be steps in that direction.
Reston, Va.: Steven,
Are trustbusters (probably using that term incorrectly) going to be a part of this?
IE, when will we break up the too big to fail banks?
Steven Pearlstein: They're not gonna break them up. That's a populist fantasy. They may make them less profitable, and then the banks decide to break themselves up, however.
Steven Pearlstein: That's all the time for today, folks. I'll be away next week, but let's resume on March 10. "See" you then.
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