Paulson’s Cosmetic, Cynical Financial Regulation "Reform"

Why is it that the media feels compelled to take pronouncements from government officials more or less at face value? By now, they ought to know that if someone from the Bush Administration is moving his lips, odds are it’s a lie.

Today’s object lesson is the so-called financial services regulatory reform plan announced by Treasury Secretary Hank Paulson. Both the Journal and Times treat his proposals as significant. Their headlines, respectively: “Sweeping Changes in Paulson Plan,” and “Treasury’s Plan Would Give Fed Wide New Power.”

There is less here than meets the eye, and what is here is guaranteed not to be implemented during the remaining months of the Bush presidency. And that of course is precisely the point of this exercise. Appear to be doing something and dump the mess in the lap of your successor.

To the details. Remember where we are: we’ve had years of misguided confidence that investment banks could be left to their own devices, that the wonders of the originate-and-distribute model meant Things Were Different This Time. Specifically, the powers that be believed that risks were so widely spread and diversified that the financial system was now much more resistant to systemic shocks. We’ve seen what a crock that idea was.

So although no one has come up with a detailed reform plan, it’s clear that the old model is badly tarnished. Since we have demonstrated that losses from investment banking risk-taking will be socialized, curbs need to be put on them. Otherwise, the very presence of a put to the government will guarantee untoward speculation and poor allocation of capital. In addition, continued taxpayer funded rescues of institutions with egregiously well-paid staff would eventually result in bankers’ heads on pikes.

A number of ideas have been proposed: tougher capital requirements; restrictions on the use of off-balance sheet entities; driving more trading on to exchanges; limiting the risk-taking of institutions that are big enough to be systemically important (say allowing them to risk only a certain portion of capital in hard-to-value, volatile, or illiquid products); pro-cyclical capital charges; addressing poor incentives; improving transparency and disclosure.

But would any of the measures proposed by Paulson have prevented our crisis-in-motion? No.

What Paulson offered up instead what a plan for some consolidation of financial services industry regulatory oversight. This isn’t useless; it would help prevent regulatory/supervisory arbitrage and allow for more consistent implementation of any new regulation. But to pretend that bureaucratic consolidation is tantamount to reform is dishonest. But the New York Times parrots the Administration’s story line:

The proposal is part of a sweeping blueprint to overhaul the nation’s hodgepodge of financial regulatory agencies, which many experts say failed to recognize rampant excesses in mortgage lending until after they set off what is now the worst financial calamity in decades.

In reality, the biggest single culprit was a lack of willingness of major regulators, in particular the Fed, to intervene in a securitization process that, as long as it beefed up housing prices, was seen to be virtuous. A secondary factor was that the Federal government, largely through favorable court rulings, has for the most part stripped states of the power to regulate financial services firms. Yet many states have been far more aggressively pro-consumer than the Feds; usury laws, now gutted, existed only at the state level, as did the tougher versions of predatory lending laws. Ironically, had the states been more in the driver’s seat (which is a less rather than more consolidated regulatory approach), the mortgage crisis might have been severely blunted (it might not have been attractive to design and market the more aggressive subprime products if they would have been permissible only in certain states). But the Federal government has long had a regulatory bias that favors industry profits over consumer protection.

Yes, as we’ll detail, Paulson did add a couple of bells and whistles that were a slight nod to the need to reform. But some had already been served up (and we had deemed them wanting); one is severely misguided.

To the guts of the Paulson program. From the Journal:

Mr. Paulson’s plan will include merging some agencies, such as the Securities and Exchange Commission with the Commodity Futures Trading Commission, while broadening the authority of others, such as the Federal Reserve, which appears to be a winner under the proposal. Mr. Paulson is expected to recommend that the central bank play a greater role as a “market stability regulator,” with broader authority over all financial market participants.

Mr. Paulson is also expected to call for the Office of Thrift Supervision, which regulates federal thrifts, to be phased out within two years and merged with the Office of the Comptroller of the Currency, which regulates national banks. One reason is that there is very little difference these days between federal thrifts and national banks…..

In addition to some of the short- and medium-term changes, Treasury officials have also designed what they believe to be an “optimal structure” of financial oversight. It would create a single class for federally insured banks and thrifts, rather than the multiple versions that now exist. It would also create a single class of federally regulated insurance companies and a federal financial-services provider for other types of financial institutions.

A market stability regulator, which would likely be the Fed, would have broad powers over all three types of companies. A new regulator, called the Prudential Financial Regulatory Agency, would oversee the financial regulation of the insurance and federally insured banks. Another regulator, the Business Regulatory Agency, would oversee business conduct at all the companies.

Note also that the SEC would be merged with the Commodity Futures Trading Commission.

“Market stability regulator” is a dangerous bit of Newspeak. This is code for the fact that the Fed’s role as chief bailout agency will be formalized. And when Japanese regulators there spoke about promoting market stability, that meant protecting industry incumbents, usually by somehow limiting competition and therefore improving profits.

And this program sounds as if it is replacing a hodgepodge now fractured by type of institution (thrifts vs. national banks vs. securities firms) with a smaller number of regulators that will be fragmented functionally. The idea of the Business Regulatory Agency is utter hogwash. How do you oversee business conduct separate and apart from supervisor audits? This agency is bound to be toothless, which is probably the point. And if I read this correctly, we will have the new Prudential Financial Regulatory Agency and the Fed (n the cases of banks with significant trading operations)regulating the same institution, which can lead to either overlapping mandates (which generates conflicts) or supervisory gaps.

Now to the elements that involve some bona fide regulation. Again from the Journal:

A key part of the blueprint is aimed at fixing lapses in mortgage oversight. Mr. Paulson plans to call for the creation of a new entity, called the Mortgage Origination Commission, according to an outline of the Treasury Department’s plan, which was first reported by the New York Times. This new entity would create licensing standards for state mortgage companies. This commission, which would include representatives from the Fed and other agencies, would scrutinize the way states oversee mortgage origination.

Also related to mortgages, Mr. Paulson is expected to call for federal laws to be “clarified and enhanced,” resolving any jurisdictional issues that exist between state or federal supervisors. Many of the problems in the housing market stemmed from loans offered by state-licensed companies. Federal regulators, too, were slow to create safeguards that could have banned some of these practices.

We had noted before that the merit of mortgage licensing idea depended not on the licensing standards itself (do you really think making brokers take courses and sit an exam is going to lead to better behavior?) but on the standards for conduct, monitoring procedures, and enforcement. Paulson hasn’t mentioned any of those. Similarly, it isn’t clear how deeply the federal authoriites can get into interfering with, um, overseeing the states on mortgage origination. Since deeds are recorded locally, and contracts are a state law matter, Washington’s influence may be limited.

In keeping with notion that the Fed is underwriting the financial system, the Paulson plan gives lip service to the idea the the central bank should have enhanced regulatory powers. However, the proposals are remarkably vague. From the executive summary:

First, the current temporary liquidity provisioning process during those rare circumstances when market stability is threatened should be enhanced to ensure that: the process is calibrated and transparent; appropriate conditions are attached to lending; and information flows to the Federal Reserve through on-site examination or other means as determined by the Federal Reserve are adequate. Key to this information flow is a focus on liquidity and funding issues. Second, the PWG should consider broader regulatory issues associated with providing discount window access to non-depository institutions.

This says the Fed should be able to send inspectors into an institution once it has started propping it up. That is tantamount to shutting the barn gate after the horse is in the next county. The Fed should be supervising any institution that it might have to bail out, period. And the idea that the Fed can effectively examine an organization that it hasn’t previously overseen is utter bullshit. Do you think the Fed has any ability to monitor Bear?

Despite its overly generous warm-up, the New York Times does point out the many shortcomings of this plan:

While the plan could expose Wall Street investment banks and hedge funds to greater scrutiny, it carefully avoids a call for tighter regulation.

The plan would not rein in practices that have been linked to the housing and mortgage crisis, like packaging risky subprime mortgages into securities carrying the highest ratings.

The plan would give the Fed some authority over Wall Street firms, but only when an investment bank’s practices threatened the entire financial system.

And the plan does not recommend tighter rules over the vast and largely unregulated markets for risk sharing and hedging, like credit default swaps, which are supposed to insure lenders against loss but became a speculative instrument themselves and gave many institutions a false sense of security.

Congress would have to approve almost every element of the proposal….Mr. Paulson’s proposal is likely to provoke bruising turf battles in Congress among agencies and rival industry groups that benefit from the current regulations.

And the real kicker:

The bulk of the proposal, however, was developed before soaring mortgage defaults set off a much broader credit crisis, and most of the proposals are geared to streamlining regulation.

In other words, this isn’t even rearranging the deck chairs on the Titanic; it’s keeping the ship on full throttle with a only slight change in course.

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  1. Gu Si Fang

    I wonder what people’s incentives are here, specifically those arising from monetary revenue – aka seigniorage. Since more than 90% of money creation is made by private banks, they get a large share of the seigniorage. So capital requirements are put in place to limit their rent-seeking.

    Then SIV’s and conduits are created, in an attempt to increase one’s share through leverageing. A new set of rules could be set up to regulate them. Will this remove the incentive and the rent-seeking behaviors? Probably not. As long as banks will be money producers, we can expect them to actively work around any rule we can come up with.

    “If you would persuade, you must appeal to interest rather than intellect.” (from B.Franklin’s Poor Richard’s Almanack)

  2. TallIndian

    The Bushies are planning to give the FED Chairman and the Sec Tsy the right to use public funds (in any way they see fit) to bail out favored investment banks via ‘loans’.

    This is actually big and I hope Congress shoots this down.

  3. Richard Kline

    Personally, I am in favor of a larger, public super-auditor for banks and bank like institutions, with a very wide purview. —But explicitly _not_ under control of the Fed: We need a two-key systems for the vault here.

    The biggest reason we are where we are now is that while the Fed had considerable regulatory powers to prevent over-leverage of all kinds in the US financial system, St. Alan the Mendacious refused to used them, both nonfeasantly and misfeasantly. Greenspan did everything possible to egg on credit-creation at unheard of levels by players both under and outside of his immediate regulatory ambit. The whole SIV system, for example, semi-legalized or not was a blatant end run around statutory capital reserve requirements for the commercial banking system. It was apparent to many observers that dotcom was a bubble by ’96—but Greenie wouldn’t cut off the gas. The mortgage sitution was described as a bubble several years before it began to hiss; Alan smiled, and babbled his usual. The equities bubble we have now—we’re not calling it that but we will once it goes *splatt*—was a no-brainer for Our Guy.

    Much of the problem is that the Fed faces an inherent conflict of interest. On the one hand, it manages interest rates so as to grow the banking system; that was it’s original brief. It also, tacitly, props up the equities system in recent decades, and is expected to do so by all major players. On the other hand, the Fed supervises bank conduct, i.e. supposedly pulls in the chain. Greenspan abused his dual role, out of arrogance more than malfeasence I think but that’s debatable, and others in his position will eventually do the same; the temptations are manifest, and will be more so the more power is concentrated in The Benevolent Chairman’s hands. Let’s leave managing the money supply, growing the banking system, and orchestrating nationalizations with the Fed. But let’s get the auditors a powerful statutory authority _well insulated from the Executive Branch and Congress_ with a mandate to enforce competence and prudence. Of course the regulator and the Fed would have to work hand in hand, but what better way to keep them both honest than by countervailing mandates? Checks and balances, what?

  4. Richard Kline

    Along the lines of the preceding comment, let’s talk principles for a reshaped financial system regulatory process. Once we know what we want, we’ll know what _policies_ will and won’t get us there. Here’s what’s on my mind:

    —The Fed manages the money supply, and has a brief to merge, nationalize, or otherwise contain financial institution failures. Well and good.

    —A Federal Financial Regulator (let’s get that third word in here) has a brief to audit the books of any shop moving large amounts of capital onshore. What that entails can be kicked around, but anyone offering big debt should have to talk to Mr. Bill about it with the understanding that they have to have a means to reasonably pay it off and the books to prove it. (This means YOU, hedgies all.) Debt like instruments such as stock options and all the rest have to be worked into the mix.

    —If we move to a system where no institution too big to fail can be allowed to fail, for the public good, we should bar institutions in principle from becoming large enough to endanger the public good if and when the crap out. This is blackest heresy to American capital, but may actually make our economic system work better: huge firms arguably are inefficient, and manifestly disporportionately reward their management and senior owners to the disadvantage of absolutely everyone else in society. Many mid-size banks and insurers, but NO behemoths. Syndicates of mid-size groups are another matter; we don’t to that in Bananamerica, but this is something we should consider at a deeper level.

    —If some positions of financial institutions are sufficiently large that they are capable of electrocuting the financial system as a whole, they should be barred from creation as a matter of law with heavy penalties for illegal adventures. How many derivatives or securities are ‘too many’ for any one firm to own or manage can be debated, but we should have a firm upper limit here. The potential for a collapse of Bear Sterns to create a toxic shock event for the financial system as a whole is an indication of gross _regulatory_ incompetence in our dear country. Let’s get smart. As a society, we get nothing from such concentration of risk except the potential to be poked in the eye with a sharp stick. So let’s put cormorant collars on the wannabe plutocrats when they are only millionaire size.

    —We have just GOT to bar usury anc comparable financial practices. There are plenty of legitimate profits to be made from lendging and trading money. There are no excuses, none, for exploiting the disadvantages and at times the stupidity of others for financial gain.

    Add to this list if and as you wish, but let’s get a background list together on this, folks.

    Oh, and if the present Administration offers nothing but spin and vapor as far as solutions go on all this, I for one breath a sigh of relief and accept that: whatever they touch they break. If the mediocrities, loons, and carpetbaggers in office now do nothing but put one thumb in either end and grin for ten months, that’s the best they have to offer us so let’s take it. Plan for solutions that can begin to get traction a year from now; till then, we ride it out, sez I.

  5. Anonymous

    this nonsense “reporting” has been going on for years but more so in the last 25. News divisions and hard news reporting requires analysis. Corporate media is about the bottom line. Just get the talking points, regurgitate them and call them news. All one has to do is listen to CNBC and you’ll quickly get the idea.

  6. Anonymous

    All one has to do to prevent our current mess from repeating is change executive compensation. No more immediate payout of all pay and bonuses (cash, options, stock, whatever) while shifting risk into the future. Tie executive pay and bonuses to future Company performance, i.e., payouts over time provided future performance targets are met (or avoided). That would reign in a lot of the excessively risky behavior with no additional regulation required. If CEOs and other executives have skin in the game, they’ll have sufficient reason to change.

  7. njdoc

    “Regulation” is an amusing word. The Fed has ignored it’s regulatory power for years, yet now it gets more. If the point of “regulation” is to get financial institutions to no behave recklessly, than more of the same will not work. The great market regulator is loss of MONEY! As the Fed is acting as a taxpayer backed stop loss for various and sundry financial institutions, why should they change their behaviors to any large degree. This is just more deception for the masses so as they can be “perceived” to be doing something. If the Fed’s position is that these financial institutions cannot fail and cannot mark to market their derivatives, than it is nothing more than a marketing campaign by the government.

  8. Anonymous

    As noted here a number of times, even well-designed regulations won’t work if the regulators won’t enforce them, or if they actively seek to undermine existing regulations. See the March 22 entry on Paul Krugman’s blog for the attitude of banking regulators under the Bush Administration.

  9. Anonymous

    The following line from the Bloomberg article is a bright red flag that Paulson’s proposal is as worthless as teets on a male warthog.

    “The Securities Industry and Financial Markets Association, Wall Street’s biggest lobbying group, praised Paulson’s proposals.”

    I infer from that line that these proposals will further erode the capability of regulators.

    What a great idea to use fear in a crisis to propose an idea that benefits the few over the many. This is just a twist on the “9/11 to Iraq invasion” playbook. The mainstream media appears to buying into it hook, line and sinker.

  10. Mencius Moldbug

    Of course, no one is considering the one regulation that would actually work: moving to an accounting model that requires financial intermediaries to match the maturities of their assets and liabilities.

    Instead the choice is between more cowbell and more or less the same cowbell. The cowbell being a system in which a fiat issuer, the Fed, insures maturity mismatchers in exchange for requiring them to make only “good” loans.

    The definition of “good” is now 100,000 pages long and expanding at an unholy clip. The good news is that we’ll soon have a new way to put a man into space: print out the definition of a good loan, and sit on it.

  11. Anonymous

    Note that the report also “recommends” that the PWG be formally granted extensive new powers to intervene in the financial markets whether or not any of the new agencies are created. These powers would also be extended to include power to intervene in the banking system for the first time. I read this as an attempt to retroactively bless the actions already taken by the “Plunge Protection Team” in connection with the Bear Stearns takeover. Hopefully Sens. Grassley and Baucus will see this for what it is and bring the details out in the open in the planned hearings of the Finance Comittee so that the full extent of the actions taken by public officials in this case can be seen and understood for the overzealous power grab that they were.

  12. Yves Smith

    Anon of 4:01 PM,

    Agreed, I wish I could watch the hearings (April 3), but I have meetings that day. As reader Lune pointed out in an earlier post, unlike executive comp, where Congress has no say and could only score points with the press, this is a power of the purse issue, and that power lies with the legislative branch. They legitimately have say and could (hopefully will) clip this crowd’s wings. They want any rescue money to be spent on homeowners, not banks that couldn’t manage liquidity or took on too much risk. And Bernanke could if not reined in, spend a good deal of their dough before they finalized any program. This should be great theater.

  13. Yves Smith

    Richard Kline,

    For the record, the Fed having any interest in equity market prices is nowhere in any of the Fed’s enabling legislation. That posture was strictly a Greenspan creation, and it wasn’t evident until after the dot-com crash. Yes, he backed off his 1996 “irrational exuberance” remark, and the Wall Street Journal in May 2000 reported that he had Fed economists studying stock market prices (I nearly hit the roof when I read that), but belief in the Internet boom was so strong in some quarters and Greenspan was revered back then, so no one wanted to lift the curtain and see what was really going on.

    In earlier posts (see “How Greenspan Diminished the Fed” for an example), I’ve quoted former Fed chairman William McChesney Martin, who famously that the job of the Fed was to take the punch bowl away just when the party was getting good, and criticized Greenspan for abandoning that posture.

    Foreign readers are welcome to correct me, but I am pretty certain that the ECB, BoJ, Bank of England, and Australia’s Reserve Bank do not consider their job to have anything to do with the equity markets. This is strictly Greenspan’s very damaging, unauthorized creation.

  14. Anonymous

    This type of grandstanding by Bush with Paulson is amazingly political, because Dodd called for Paulson to testify on Bear Stearns, and in a show of upmanship, Bush calls SIFMA for a speech and then is sending Paulson out to act as if he’s on top of things, before the Senate hearing.

    Pure soap opera denial at this point, with SIFMA trying to frontrun any action by Dodd and Dodd up for election and not doing well, thus Dodd needs to look like he is on top of things.

    Meanwhile, Bear Stearns accounting fraud which was being watched by FBI seems to be a non-issue now and under the table, as if The FBI is on top of things.

    Meanwhile, Helicopter Ben prepares to be grilled by Dodd as well as Cox and of course they all have scripts being written and fine tuned by SIFMA, as they all practice what to say for the sound bites.

    My only wish, is that in this script, we see just a hint or sniff of a power struggle where someone will say something not on the script which will turn this drama into a cliffhanger, where Bear Stearns, Paulson and ben are caught in lies as they snear like captured dogs.

  15. Anonymous

    You did a wonderful job of refuting the Paulson document. But to treat it as a serious attempt at improving regulation is a mistake. It is a product of an administration that has demonstrated only contempt for lawful process on a national and international level. I expect it is out of some respect for Paulson. I wonder how persons like Paulson, Mukasey, Powell and Rice got to support the “dark side”; I even imagine something darkly potent gotten from Skull and Bones initiations.
    It is a shame that so much urgently needed actions needs be delayed till January. Financial regulation is another example.

  16. Anonymous

    What I find fascinating is that the Federal Reserve has explicitly stated on the record that “they do not target asset prices” when setting monetary policy.

    When asset values were rising, they steadfastly clung to this principle. Yet now that asset values are falling, we have emergency rate cuts when stocks plunge and overall aggressive rate cutting to try to support home prices.

    You cannot insist on non-interference when asset prices rise (and bubbles form) and then later intervene to prop up asset prices when the bubble has burst. This is an asymmetric policy response. Where is the logic here?

    Greenspan and Bernanke represent sheer madness disguised in sober and convoluted academic verbiage.

  17. Yves Smith

    Anon of 8:29 PM,

    I can’t speculate as to the others, but Paulson has long had a taste for the dark side. He was John Erlichman’s assistant 1972-1973. As you no doubt know, Erlichman was convicted of conspiracy, obstruction of justice and perjury for his role in the Watergate scandal. Paulson previously worked as a staffer at the Pentagon during Vietnam. another dubious undertaking (1970-1972, by then pretty much the entire country was against the war).

  18. Anonymous

    politics and corruption in realtime versus politics and corruption on the raido (in The Great Deprssion).

  19. Richard Kline

    So Yves,

    I well understand that the Fed has NO statutory authority whatsoever to support equities or other assets, and moreover that Fed spinmeisters ‘vigourously deny’ doing so, in any way, at any time. —But we all know that the Fed does this, and I’m not talking conspiracy white noise on this. A few days ago, you had a thread going here with various anonymous posters mentioning hints and observations on how such actions have been or might be done, though no one has come out and said up front what the mechanism is. For good reason: the authorities don’t want anyone to be able to piggyback on their interventionary moves, so they keep their hand close to the vest on this. But it is clear that this has been going on throughout Greenspan’s tenure and since: it was his major innovation as Chair. Personally, I thought he started doing it as far back as ’91 during the S & L meltdown. There were days that the markets should have had a good washout, but got a mysterious early bounce to burn the shorts and brake the process. I suspect that this was something Uncle Alan came up with after ’87 re: how to stop a market crash when it was at the tipping point rather than after it was turned over. Of course he didn’t and the Fed doesn’t have the authority; what’s that got to do with it? The Fed didn’t have any authority for the BSC manuevere. The Fed is expected to maneuvere creatively, statutes be damned, and does. This is the real reason for the lack of transparency at the Fed; it allows them to intervene suddenly and effectively without the markets (always) anticipating and profiting from such actions. If we knew what they were doing, smart money would negate it. I think that you know this.

    Bear in mind, of course, that I don’t manage money for a living; I’m just an interested observer. But does the Fed game the markets to preserve price _gains_?: Yes, I believe so. What I suspect is that they have a standing order with several of the major i-banks and commercials to buy a set program to a set level if they get ‘the overnight code call,’ with the Fed standing for any losses. Remember, the Fed and the SEC are the regulators, so if they sign off on an under the table move, all is good. What is more to the point is that the major players have adapted to an expectation that ‘the powers that be’ will act to brake serious gappage. Free markets?: that’s for the amateurs. This is a paramutual system for the Big Boys, and they like it that way, so who’s going to run crying foul on it?

    Whether or not the Fed ‘should’ intervene to prop up asset price gains is a more complicated question. This is rigging the roulette wheel, of course, and that’s, well . . . unethical. Look, we know that the top level of the financial system, including the Treasury and the Fed play by their own rules. Again, I’m not pushing ‘conspiracy’ puffery on this; this is simply an evident fact. The ‘rules’ are for public consumption, but the insiders play a different game. If asset prices at any time DO crash, as we see now from these bizarro in-securities widely held, many banks and bank-like institutions can and will go bust. Is it cheaper and more efficient for the powers that be to game the system to avoid that outcome (assuming they can), or to play by the mom and pop rules and so pay ten times as much to clean up the mess? St. Alan sold everybody else at the top that he could prevent most crashes, so everyone has stood back and let this go on. Of course, this makes big gains for the plutocracy on the way up, and leaves the public to pay for the shoveling out of the rubble on the way down, but again Greenspan did this successfully three times—’87, ’91, and ’98—so he thought he was too smart to lose in ’01. Now, BenBer and the rest are desperate to keep _multiple_ crashes from happening at once, so yes, they will game the markets, junk mark-to-market reporting, ignore the insolvency of the monolines, and many, many other things that, in the mom and pop world, ‘aren’t supposed to be permissible.’ The Fed, the Treasury, and other central banks play by different rules. If they succeed, they know they will be praised; if they fail, they know they will be dismissed, and it will be someone else’s problem. But they also know that they will never be prosecuted or investigated. I mean, for what? If a private player did this, that might be actionable; if the regulators do this, it’s . . . what, tell me again? I’m not saying I like it, but.

    . . . Of course this has allowed the public authorities to baloon credit, cut regulation out of the loop, and prevent market adjustments to the point where we have a great chance to have all gaskets blow at once. This is what happens when smart guys think they can beat the system: they do so until their cumulative risks _kill_ the system.

  20. Yves Smith


    Apologies if my earlier post sounded a bit tart. I simply didn’t want readers who might not know the score to think that there was any interpretation of the Fed’s charter, even a terribly creative one, that should give it any interest in the equity markets.

    I have long been saying (as in before 1999) that Greenspan would go down in history as the worst Fed chairman. We’ve had the vast misfortune of not only having him enjoy a very long tenure. but having his time in office overlap with that of the worst President.

    As for could the Fed defend its actions if they ever came to light… The idea that the government was manipulating the markets (oh, for whose benefit?) would make the Teapot Dome look like a walk in the park. That would put us deeply in banana republic land. The idea that we had dared tell other countries how to run their markets when ours was a fraud would eliminate whatever standing we have left. Although, at this point, I think the only power we have is our nukes and an economic mutual-assured-destruction threat (“if we really tank, your Treasuries are worth zilch, and your populace will revolt that you let your country’s savings go up in smoke”).

    And let’s say the operation worked as you suggested, some kind of coded message sent to the IBs. That means the IBs can extort the Fed by threatening to reveal their market manipulation, if such exists. Not very clever.

  21. Richard Kline

    So Yves,

    No offense taken at all; rather the reverse. I understood your purposes as ‘editorial’ in function in commenting on my post. The problem was that _I_ hadn’t been clear on the issue of the Fed’s standing—none—to manipulate equities, necessitating your remark. You do a good job here at NC in using good sense to referee nonsense rather than throwing darts at ideas you may not like, one reason why I’ve felt comfortable posting here. I took the opportunity of my reply to comment on the Fed’s presumed equities interventions since I missed the previous thread (I, too, have an odd schedule). I hope I’m contributing to the discussion rather than just soaking up pixels.

    On ‘how does the Fed do it,’ I wouldn’t be surprised if this was entirely automated. Someone high up at several big dealers gets a code on his/her Blackberry, and just issues a standard order to buy to a specified number for a highly compartmentalized ‘Mr. Big’ account. The regulators all know what this is, and don’t mess with it. Historically, the big banks openly did this themselves at times of crises, buying shares to make markets and prevent asset price freefalls. But by ’87 the numbers got too big, and the banks weren’t prepared to risk mega-losses trying to do this. . . . Sooo, to my hypothesis the Fed agreed to backstop any losses, and set up a system to coordinate—and control—the action. I have no firm opinion on whether Greenspan approached the dealers or vice versa; probably St. Alan, as he had the background. Doesn’t matter really. I also assume that appropriate committee chairs in Congress are _fully briefed_ on the existence of this mechanism, one reason whey we have never heard any Congressional fulminations, nor will we. But really, in Japan public or quasi-public authorities bought equities _massively_ at the time of their crash. I don’t doubt that the ECB has something lined up if they need to. . . . People lie about sex and money, let’s face it; they more they have, typically the more they lie. : )

    It is true that the big dealers participating in such a mechanism, if it exists as I suspect, could blackmail the Fed. However, who do you think gets to keep the profits on those options when we get these whiplash market upswings? Natch. They’re paid off, so they are too deeply implicated to _ever_ squeal. It’s much like the illegal wiretapping we see in the last few years: yeah, everybody knows this shouldn’t happen, but in the end the government will find a way to (quasi) legally cover the Big Teles who played along—but nobody wants to bring the ugly copulations to light if they can possibly avoid it.

    . . . The US has NO moral standing to lecture or advise any other country on their financial system. It’s not like everything is rotten here. The formal rules for securities dealing are pretty good, we’ve made some progress on restraining insider dealing, yadda yadda, yadda. The point is that the Big Fish rots from the head.

    Truly, I’ve been watching the last twenty years of financial shenannigans in this, my native land, with horrified fascination. I have actually read moderately extensively on how monetary regime changes have occurred in the modern past since, say 1500 CE when the financial system we use now could be said to have been solidly begun. There is typically a ‘largest single player’ whose currency is the standard international reserve, especially once currency regimes became more standardized and reliable after 1600. Every single player has ultimately destroyed _themselves_, often by being overextended at the time a major war crushed their revenues, but also by the simple fact that every one has exploited their ‘most favored player’ advantage to get overextended beyond any reasonable factor in their actual economic circumstances in the first place. It’s the Peter Principle applied to international fianance: call it the Thaler Principle, why don’t we. The US has just done exactly that. Myself, I suspect it’s the collapse of the dollar that will get us, sometime in the next twelve months. But it could be an equities crash. Hard to say. But we have so gamed the system, and exploited our golden dollar past all rationality that we have, assuredly, killed the golden goose. It’s upright, but toxic shock has killed it, and we will soon notice that it isn’t breathing, regardless of the iron lung the Fed has clamped around our banking system. Oh well, I like to write poetry, and I enjoy rice and beans, so I’ll stay happy one way or the other.

  22. Mickslam

    Hi all,

    This is my first comment here so I hope I avoid being an idiot.

    I regard this as the first offer from the investment banking community as it exists today. If you read through everything, it really doesn’t do anything that they haven’t wanted for years. They are even taking the teeth out of the SEC for the most part.

    However, I think they did make one crucial mistake. They admit early on that the system cannot be regulated with rules aimed at specific products or institutions, but would rather be better served with an objectives-based approach. Then the document goes on to lay out very modest objectives.

    The admission that the objectives matter and are crucial to regulating the marketplace leaves the door wide open to proper regulation if there is another failure. If Lehman or JP need a guided nationalization, not only will it be clear the IBs and others are taking significant risk that could destroy the world economy but that pre-emptive powers are needed to avoid these catastrophies. As the objectives-based approach is already on the table, we can expect definintions like those of a security to apply broadly across all instruments.

    As a result, this opening bid for weak regulation has high odds of leading to significant, properly constructed regulation. Note that this will happen after Bush is out of the white house.

    Also, Yves, I agree fully about Greenspan. In 30 years and forever after, his reputation will be worse than Hoovers.

  23. Anonymous

    Anon 9:44,

    But didn’t you hear?

    Greenspan said this was “an accident waiting to happen”.

  24. jest

    if they really wanted reform, they would ban the fed from cutting interest rates to 1% for a year.

    chris cox should be fired.
    heckuva job, chris.

    also, don’t the banks own the fed? if so, does it make sense for the regulator to be owned by those it oversees?

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