Dizard: Financial Industry Reform is in Limbo

One of our beefs has been the lack of any progress, even interesting trial balloons, on the financial firm reform front. And that’s a serious problem.

Economists like to point to the Great Depression as the textbook example that fiscal stimulus works. FDR launches a bunch of spending plans, and voila, by 1936, the economy looked vastly better, but then in 1937, efforts to balance the budget put the growth back in reverse gear.

I’m not convinced the story is that simple. The Depression also included a lot of specific reforms and innovations, some of which were bad ideas and ditched, like the National Recovery Act. But measures like the securities laws of 1933 and 1934, and Federal deposit insurance were important in restoring faith in badly tarnished industries. And the Japanese example also suggests that stimulus without cleaning up the banking industry is ineffective.

John Dizard takes up many of our pet themes: the wrong people are in charge, the Fed lacks the inclination and skills to be an uber finance regulator. It is not a pretty picture.

From the Financial Times:

For all the camera-ready shouting and calm exchanges concerning the risks exposed by the financial crisis, there is one risk that gets no attention: the risk of putting weak people in positions of leadership.

I’ve been calling around to get a sense of the progress being made on structural reforms of the US securities markets. The answer is: very little, if any….

The financial system has a peacetime officer corps in a wartime situation. The people in positions of responsibility are principally interested in preserving their careers and avoiding public embarrassment. There are rare and important exceptions, such as Paul Volcker, who has nothing to prove about his integrity, and who is past any need to advance his career.

To identify what has to be done to put securities markets, banking and regulation on a sound basis for the future, the people at the top might have to admit to the specifics of their own past mistakes. They would also need a command of detail of the workings of the financial system that they have avoided acquiring over the years, since it was much more advantageous to spend one’s time scheming and toadying.

This is a naturally occurring aspect of human nature, but it is usually kept in check by periodic crises, which thin the herd and force the survivors to adapt. The “great moderation”, also known as periodic monetary bail-outs, in developed countries for the past couple of decades has prevented that process.

Let’s consider a specific issue, the reform of the leading US ratings agencies…So what are the federal regulators, and Congress, actually doing about ratings agency reform?

Not much. The crucial agency is the Securities and Exchange Commission….According to a securities industry person who has had intensive contact with the SEC lately, its staff are preoccupied with damage control. “They’re not thinking about ratings reform, they’re thinking about keeping their jobs. The Bernie Madoff fiasco has them in shell shock.”

Mary Schapiro, the new chairman of the SEC, has said that the ratings agencies’ conflicts should be looked into, but that suggests a rather long time horizon to revive confidence in the system.

Sean Egan, whose Egan-Jones rating agency is one NRSRO that is paid by the investors, not the issuers, is frustrated by the slow progress in the reform process. “You have to back up to why the markets are frozen, and the answer is a lack of credibility in risk assessment,” Mr Egan says…

There is a widespread assumption that the Federal Reserve is available as a universal, supreme regulator of all financial risk. However, the Fed staff are preoccupied with figuring out the details of the various “temporary” support programmes. Not many of them have operating experience in financial markets; they were employed to take the long view on monetary policy, not for the tactical execution of investment programmes. Those are very different disciplines.

Congressional leaders know that. Democratic and Republican senators share a high degree of scepticism about the ability of the Fed, effectively, to redesign and then run the financial world.

In the past, there were Wall Streeters of both parties with sufficient weight and creditability to identify problems and put together solutions. Not now. All we need to end the remaining illusions, is, I believe, one more big trauma. Auto companies?

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  1. Anonymous

    Since the fall of the Soviet Union, the corporate world has had no enemy to fear. The biggest communist country on Earth is the richest capitalist country on Earth.

    There is no one to seize their lands, their properties, their wealth. There is no one to arrest them, or execute them.

    In such a world, corporations have no loyalty, because they fear nothing. They are the kings of our time.

    Bring back the devil.

    When they hear his footsteps once more, the wealthy will stop playing gods and the government will take its sword back from the fallen.

  2. Anonymous

    Well, you can make a difference Yves.

    You’ve named Volcker, as a restrained agent of change. So make a list of all the guilty.

    Quite frankly, I know the list. But none of them will be fired or voted out in the near term. These people feel they (and their families) are so wealthy and well-connected they can never ever ever ever feel pain or discomfort.

    Nobles Oblige is dead.

    We are ruled by indifferent sociopaths on Prozac. It may very well be they will steer us into further harm to skim off every last penny from out coffers.

  3. Anonymous

    The “high-fallutin’ language” needs to quit. Who cares about the Soviet Union or whoever Nobles Oblige is? I’d rather try to discuss the problem and point out the actual glaring wrongs and then gather real evidence instead of a bunch of philosophical bullcrap.

  4. D H ♥

    I always liked the American Liberty League

    In the year of its founding, 1934, the League was accused by Smedley Butler of being involved in a fascist Business Plot to overthrow President Franklin Delano Roosevelt. Butler was a famously anti-capitalist retired Marine Corps general and strong supporter of President Roosevelt. According to Butler’s congressional testimony, the League was founded intentionally as a para-military coup vehicle, an ‘American version’ of the 1930s French Croix de Feu. Butler said that he was approached to lead a group of 500,000 veterans to take over the functions of government. The final McCormack-Dickstein Committee report recounted Butler’s allegations on the existence of the plot, but no prosecutions or further investigations followed. His accusations were discounted; largely because he was the least likely ex-military figure in America to lead a pro-capitalist anti-Roosevelt coup-d’etat.

    What happened to the good ol’ days?

    “The Best Things in Life are Free”

  5. Anonymous

    When Franklin Roosevelt took office, Sen. Carter Glass had already drafted legislation (Glass-Steagal) that awaited only a President who would not veto it. But it is not clear that we have even one member of Congress today competent to draft comparable legislation. (With all due respects to the estimable Rep. Frank, Congress has not had the requisite expertise in banking matters since the defeat of Rep. Jim Leach in 2006.) Paul Volcker released his Group of Thirty framework at a press conference on Jan 15, with the most meager of press coverage. (http://www.group30.org/pubs/pub_1460.htm). Is the Administration following up on this? We hear nothing on the subject.

    For all the hoopla surrounding the Stimulus package, realistically we cannot expect it to have the desired effect until financial markets resume something resembling normal operations. This will require, at a minimum that the credit markets have been untangled, and that a new regulatory regime is in place. Secy. Geithner is certainly working very hard to accomplish the first, but when exactly can we expect action on the second?

  6. Anonymous

    “Who cares about the Soviet Union or whoever Nobles Oblige is? “

    You’re on an finance blog spouting ignorance?

    You are the worst kind of dumb person -a dumb person who is blissfully ignorant of their own mediocrity an low IQ. You seem to be proud of your ignorance (how old are you? 22 years old? One of the new self absorbed Twitter fiends that snort Prozac?

    I suggest a Fox News message board if you wish to find kindred souls.

  7. cap vandal

    There definitely needs to be reform of the ratings agencies. They really blew up on structure finance, which was a huge cash cow. That cow has left the barn, so I’m not worried that they are going to be stamping AAA on another batch of CDO^2.

    However, since the summer, they have gotten religion and are trying to save themselves by trying to look less wimpish. Further, there is absolutely no upside in them being optimistic today (as opposed to when they were collecting fees for the structured crap).

    In addition, when they use either common stock price or the potential of a ratings downgrade to require additional capital AS A RATING CRITERIA, then they get into a recursive loop where they cause the outcome they are warning about.

    Right now, they have absolutely no incentive to upgrade anything, even if it is warranted.

    The real moment of truth will come with the Treasury program to jump start securitization. If they are the buyers, I can’t see why they need to pay the rating agencies. Or the investment banks either, more then a nominal fee for the paperwork.

  8. charlie

    I’m starting to think the stimulus package is just a placeholder while we wait for inflation to kick in and work its magic. If you don’t see serious pressure for new regulation by Congress NOW you won’t see it in a year. We can keep the car companies in Zombie status for at least 1-2 years before they finally implode.

  9. Markel

    Actually, I think Barney Frank is the most movable object in the barricade to reform, and his district is the best lever to move him. Large parts of the district are very liberal, very educated. While they loves them some Frank big time, it wouldn’t be hard to get them to agitate on the issue.

  10. Swedish Lex

    A brief European perspective:

    1. Elections will be held to the European Parliament in June and the EU’s executive, the EC Commission, will get new top management (Commissioners) appointed by the Member States and the newly elected European Parliament during the secon half of the year. Thus a year full of transitions that will render effective action more difficult.

    In addition, the EU changes Presidency every six months. The French did a good job during the second half of last year but the current Presidency, the Czechs are way behind the curve.

    2009 is thus not a good year for handling the deepest recession in 50 years.

    On the bright side, however, the EU is making what it can. Today we will see the publication of a Report written by a committee of experts regarding reform of supervision. The Report will be part of the EU’s package of proposals that will be table ahead of G 20 in April.

  11. Anonymous

    If those with authority wait until a semblance of normalcy in the financial industry to try implement reforms, we’ll hear “hey, things are OK now, no need for reform.” Of course, they aren’t particularly interested in reform to begin with, to put it mildly.

    For years now it’s been becoming increasingly clear that we’ll have to run out of capacity for bailouts before these wasteful, foolish and unjust efforts stop. At that point the crisis will get bad enough to lead to reform.

    I think whether or not such an inflection point will be after a complete collapse in confidence in the full faith and credit of the US govt and the Fed is impossible to predict because it depends on whether there are as yet unobserved limits on the extent of irresponsibility and recklessness the authorities are willing to exhibit.

  12. MyLessThanPrimeBeef

    I like it when a politician is man enough to admit he made a mistake.

    That’s honesty.

    I like it even better when a politican will admit the problem is over his head and would just resign…even if he just took office a few weeks ago.

    That’s complete honesty.

  13. Anonymous

    So many politicians and decision makers seem so focused on the details of short term survival that there appears to be very few people taking a step back and saying what the actual wider problems were and what the solutions are. There were fundamental problems which were deep seated in society and politicians are keen to avoid addressing these because the problems extend to them. My take on the problems would be as follows.

    1 Securitisation encouraged incorrect pricing of risk and insurance.
    2 Ratings Agencies risk modelling was wrong and ultimately politicians meddled with them.
    3 Regulators and accountants failed to regulate and ensure proper capital buffers.
    4 Company employee remunerations encouraged risk taking.
    5 Companies became solely focused on share holder profits rather than building and sustaining a business and helping the communities in which they are involved with.
    6 Government became focused on revenue and how it could be spent to gain votes rather than structural integrity of society and its well being.
    7 Society focused on excuses rather than accountability and took the short cut in not dealing with issues.

    Notice that I don’t separate banks out from any other companies as I think many big businesses and government are guilty of the same faults as banks. What I can’t see is government going into the securitisation and monoline business as being any kind of long term solution other than to crowd out. What I do see is a bunch of people who took every short cut possible to keep the merry go round going.

    Banks took the short cut and did not perform due diligence on every loan and it is costing them now. Ratings agencies took the short cut and did not model worse case scenarios and now people have lost confidence in them. Regulators failed to really investigate or put proper thought into risk and capital and now they have lost the confidence of people. Accountancy firms took the short cut and did not check the accounts properly and now nobody believes them. Every walk of life seems to have been about taking the short cut and skimping on the work.

    Its not more legislation, checks or rules that is needed just more and better ones and for people to actually be held accountable. Sorting out non recourse mortgages seems like a good place to start as this triggered the revealing of the under lying problems.

    I just don’t see at the moment the leadership needed to dismantle and rebuild some of the institutions involved especially since they along with the politicians have a vested interest in avoiding this.

  14. Max

    “Congress has not had the requisite expertise in banking matters since the defeat of Rep. Jim Leach in 2006.”

    Jim Leach would be unlikely to draft a bill like Glass-Steagall. He was one of the sponsors of Gramm-Leach-Bliley in 1999, which largely undid the protections instituted by Glass-Steagall.

    Relying on the people who got us into this mess to get us out of it is a bad strategy. (And yes, that’s what Obama has unfortunately been doing so far.)

  15. robert

    I watch FOX news- I also watch CNN and MSNBC and NBC and ABC and CBS. New is news and you make of it what you want. Better to get the opposite slant than always watching news that has you nodding yes in agreement.

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