Washington's Systemically Incompetent Regulators
The Obama administration's New Foundation for financial regulatory reform aims to "provide the government with the tools it needs to manage financial crises." In framing the discussion in terms of "new tools" the proposal implicitly repeats the Great Lie of last year's bailouts: Namely, regulators lacked sufficient powers to manage the crises.
The perversity of the proposal is evident in the enumeration of powers requested. Under the plan, regulators would be given the authority over bank holding companies to establish receivership, provide loans, purchase assets, guarantee liabilities, or make equity investments. But Lehman went bankrupt, AIG received a loan, Bear's assets were purchased, Goldman's liabilities were guaranteed, scores of banks have been placed in receivership and hundreds have received capital. One searches the document in vain for a substantive request for a new authority.
This absence is not surprising since the proposal itself is more a regulatory power grab than a serious discussion of past failures. Given how much discussion there has been about the overlapping jumble of regulatory authority, it was surprising to see the following recommendation put forward.
"The authority to decide whether to resolve a failing firm under the special resolution regime should be vested in Treasury, which could invoke the authority only after consulting with the President and only upon the written recommendation of two-thirds of the members of the Federal Reserve Board and two-thirds of the members of the FDIC Board. But, if the largest subsidiary of the firm (measured by total assets) is a broker-dealer, then FDIC Board approval is not required and two-thirds of the commissioners of the SEC must approve. If the failing firm includes an insurance company, the Office of National Insurance within Treasury will provide
consultation to the Federal Reserve and FDIC Boards on insurance specific matters."
That certainly should streamline things going forward.
An honest reckoning would examine why regulators, whose chief weapon in times of crisis is the ability to close failed institutions, failed to use this tool to shutter large institutions during the crises.
Most curious about the proposed "New Foundation" is the lack of a new foundation. Where we might hope to see a clear framework for extraordinary intervention we get a catalogue of powers needed by regulators. The fact that the powers requested have already been used, to horrible effect, does not seem to make anyone in the Administration blush.
The proposal's biggest failure is the absence of any serious thinking about which powers should be used in what circumstances. How to decide between, for instance, receivership and capital injections?
"We propose that, in choosing among available tools, Treasury should consider the effectiveness of an action for mitigating potential adverse effects on the financial system or the economy, the action's cost to the taxpayers, and the action's potential for increasing moral hazard."
So in the future we'll either let ‘em fail or we won't.
The thrust of the proposal is a blanket request for the authority to employ a mix of powers and the discretion to decide at the time what is best to "reduce systemic risks." The Administration seems to want to institutionalize the seat-of-the-pants approach that caused so much turmoil last fall.
Congress should reject this request for complete discretion. There is a strong argument to be made that the biggest cause of last fall's debacle was the discretionary nature of the decision-making process. John B. Taylor makes the point in his recent book, Getting Off Track, pointing out that the federal government exacerbated the crisis by "supporting certain financial institutions and their creditors but not others in an ad hoc way, without a clear and understandable framework."
Bears Stearns failed, Fannie and Freddie got rescued, Lehman was allowed to fail, Washington Mutual failed, AIG got rescued. None of it made sense at the time; none of it makes sense in retrospect. One searches the Administration's proposal for some clues about how things might have been done differently. There are none. We are left with the impression that they prefer to make up the rules as they go.
Rather than a New Foundation, we need competent regulators who can close down failed institutions with minimal collateral damage. Last fall, Treasury Secretary Henry Paulson clearly had no idea how to do this. The team of Paulson, Geithner and Fed Chairman Bernanke was terrorized by the threat of systemic collapse, but their haphazard approach to the bailouts terrorized the markets even more.
The regulators who botched things so badly then should not be given more authority. They should be given simple and direct mandates on how to do their jobs properly in the future.
