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CONGRESS, HOLD YOUR HORSES! SURE, EVERYONE except the perps favors better regulation on Wall Street. But we need more efficient and intelligent policing than what the current House and Senate financial-reform bills offer.
The aptly named Richard Vigilante, who recently co-wrote a book called Panic with Minneapolis-based hedge-fund legend Andrew Redleaf, suggests this approach: Force all firms managing other people's money to publish their investment positions in detail before the market opens; this would include hedge funds. Then, the short sellers could punish ineptness before it spreads by betting heavily against a particular institution's stupid decisions.
"Bankers would hate it. It's their worst nightmare," says Vigilante, whom I met with at Firehook bakery on Washington's Farragut Square. If the system had been in place in 2006, short sellers would have stamped out the smoldering subprime mania before it had a chance to spread, he asserts.
His suggestion is both brilliant and a model of simplicity -- it could protect consumers against all kinds of risky financial products -- but it will never become reality.
Bankers would scream about the need to protect their proprietary-trading information. And, as was the case with health-insurance "reform," Congress is bent on ramming a bill, no matter how flawed, through the legislative sausage works in order to mollify an uncommonly angry electorate before Nov. 2. To entertain new ideas at this juncture, even good ones, would upset the ambitious timetable.
Like health care, the new financial regulatory regime is built atop the cracked masonry of the old one. The same flatfoots who were on patrol when the subprime caper went down will be given larger beats to walk. They will be overseen by a brain trust, a Council of Regulators, culled from their ranks, who, like chemical sniffers, would seek to uncover systemic threats to the volatile financial system. In fact, COR is the core of the whole scheme.
There is convincing evidence in a recent exchange of letters between Treasury Secretary Timothy Geithner and Elizabeth Warren, head of the Congressional Oversight Panel, that the council concept is flawed. (COP was established in 2008 to keep lawmakers informed of the effectiveness, or lack thereof, of the financial bailout in particular and financial regulation in general.) The letters reveal that regulatory and investment experts at Treasury, relying on findings by the esteemed Federal Reserve, decided on Dec. 29, 2008, to invest $2.4 billion in taxpayer funds in CIT Group, a top lender to small businesses. CIT faced huge liquidity woes, but the regulatory brain trust decided it was viable, and that the huge investment in unsecured preferred stock would pay off. On Nov. 1, CIT declared bankruptcy, wiping out us taxpayers.
Warren's initial inquiry into the CIT debacle is dated Nov. 25, 2009. Geithner's response is dated Jan. 13, 2010. (The letters are on the panel's Website, http://cop.senate.gov/learnmore; open "Panel Correspondence," then click on the dates). The council in this case was an investment committee in Treasury's Office of Financial Stability, created by then-secretary Hank Paulson's Treasury to oversee its financial-bailout program.
At the time of the CIT decision, the office was led by Neel Kashkari, one of Paulson's Goldman Sachs protégés. (Kashkari left Treasury in 2009 to labor for Pimco.) His staff was a pantheon of top regulators from the International Monetary Fund, Treasury, the Fed and the Office of the Comptroller of the Currency. They approved investments in more than 700 institutions. Two others besides CIT failed: UCBH Holdings, a large Chinese-American bank in San Francisco, which cost taxpayers $299 million; and Pacific Coast National Bancorp, of San Clemente, Calif., which cost $4.1 million. As of April 1, 39 banks had repaid the Treasury, providing an investment return of 8.9%, according to SNL Securities of Charlottesville, Va. But the Congressional Budget Office estimates taxpayers will lose $109 billion of bailout funds.
Vigilante and Redleaf say a major cause of the financial crisis was lack of reliable data. Some banks were indeed broke, but no bank could prove it wasn't broke, they say. Wall Street and the regulators had permitted sophisticated computer programs to usurp human judgment about investment risk.
Says Vigilante: "Markets currently remain uninformed. Information is not migrating out, because banks keep crucial parts of their balance sheets private." But now, as quasipublic institutions, he says, they should have to reveal more. "Americans shouldn't have to bank in the dark."
I LEFT SOME OF YOU IN THE DARK myself in a March 29 column. I wrote that the expiration of the Bush tax cuts next year would raise the rates on capital gains and dividends to 20%, from 15%. In fact, dividends are taxed as ordinary income. The maximum rate on them will be 39.6%, up from the current 35%, an astute reader noted.
E-mail: jim.mctague@barrons.com
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