Guest Post: Supercop or Superflop?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

On Friday, the head of the Securities and Exchange Commission said that she favors a new proposal for federal regulators sharing oversight of companies that pose financial risks to the economy:

SEC Chairman Mary Schapiro said she’s “inclined toward” the idea floated this week by the head of the Federal Deposit Insurance Corp. for a new “systemic risk council” to monitor large institutions against financial threats. The council would include the Treasury Department, Federal Reserve, FDIC and SEC, according to the proposal by FDIC Chairman Sheila Bair.

Congress and the Obama administration are working to craft an overhaul of U.S. financial rules to prevent a repeat of the crisis that plunged markets worldwide into distress.

Speaking to the Investment Company Institute, the mutual fund industry’s biggest trade group, Schapiro said she is concerned about an “excessive concentration of power” over financial risk in a single agency.

Some key lawmakers have proposed that the Fed alone assume the role of systemic regulator.

But Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, said this week he is “more attracted to the council idea” than having a single regulator play that role.

Policymakers want to replace the “too big to fail” model used by the government as it rushed in to rescue huge financial institutions caught up in the global crisis last fall.

Regulators are calling for a new system of supervision that prevents institutions from taking on excessive risk and becoming so large their failure would threaten the financial system.

At the same time, Schapiro on Friday reaffirmed her position that the SEC must play a key role as an independent watchdog protecting investors in the new system of financial regulation.

“There is a need for a regulator entrusted with responsibility for our capital markets,” she said. For the SEC, “independence is indispensable.”

Staking out the SEC’s position in the sweeping overhaul of the financial rule book that Congress and the administration have begun, Schapiro said it “would be a disaster” for that supervision over the markets to be split among various agencies.

Schapiro, an Obama appointee who became head of the SEC in January, stressed to the audience of mutual fund executives how hard Americans have been hit by the worst economic crisis in 70 years.

Around 92 million Americans entrust $9 trillion of their savings to mutual funds, and retirement savings plans were devastated by the stock market slide beginning last fall. The market has been on an upward swing since early March, rising more than 25 percent from 12-year lows, but the climb back remains steep and investors are rattled.

“The SEC is acting aggressively” to become a stronger and more agile regulator to help restore investor confidence, Schapiro said. The agency is revamping and strengthening its enforcement program, she said, and already this year has stepped up the number of actions taken against investment fund managers and others alleged to have violated securities laws.

On Tuesday, the SEC filed civil fraud charges against Reserve Management Co. Inc. and its two top executives, alleging they withheld key facts from investors when its $60 billion money-market fund “broke the buck” last fall after Lehman Brothers filed for bankruptcy protection. The Primary Fund, which had invested $785 million in Lehman’s debt, saw the value of its assets fall to 97 cents per investor dollar put in — below the dollar-for-dollar level needed to fully repay investors.

New York-based Reserve Management said it “intends to defend itself vigorously” against the SEC’s allegations.

About $46 billion, or about 90 percent of fund assets, have been returned to investors, the company has said. Schapiro said Friday the SEC is working to recover more money for them.

In the wake of the episode, the SEC is considering how regulation of money-market mutual funds could be tightened to better protect investors, she said.

The Investment Company Institute has proposed its own tightened rules for money funds. They include toughened requirements to screen money fund investments for safety, and to ensure that fund companies can return cash on demand to investors — even if redemption orders come in a panic-induced rush. The industry is rejecting private insurance to protect investors against losses, and opposes easing current requirements that money funds hold at least $1 in assets for each investor dollar put in.

Schapiro called the trade group’s proposals “helpful,” but has said the SEC’s eventual rule changes are likely to go further.

On Saturday, news broke that the Obama administration wants the Federal Reserve to be the financial supercop:

The Federal Reserve could become the supercop for “too big to fail” companies capable of causing another financial meltdown under a proposal being seriously considered by the White House.

The Obama administration told industry officials on Friday that it was leaning toward making such a recommendation, according to officials who attended a private one-hour meeting between President Barack Obama’s economic advisers and representatives from about a dozen banks, hedge funds and other financial groups.

Treasury Secretary Timothy Geithner and other officials made it clear they were not inclined to divide the job among various regulators as has been suggested by industry and some federal regulators. Geithner told the group that one organization needs to be held responsible for monitoring systemwide risk.

“Committees don’t make decisions,” said Geithner, according to one participant.

Officials from the Treasury Department and National Economic Council, which hosted the meeting, told participants that the Fed was considered the most likely candidate for the job, according to several officials who attended or were briefed on the discussions.

The administration officials said a legislative proposal would likely be sent to Capitol Hill in June with the expectation the House Financial Services Committee, led by Rep. Barney Frank, D-Mass., would consider the measure before the Independence Day recess.

The officials requested anonymity because the meeting had not been publicly announced and they were not authorized to discuss it.

A Treasury Department statement provided to The Associated Press on Friday confirmed Geithner’s position that he wants a “single independent regulator with responsibility for systemically important firms and critical payment and settlement systems.”

A spokesman said Geithner also is open to creating a council to “coordinate among the various regulators, including the systemic risk regulator.”

The Fed itself hasn’t taken a position on whether it should have the job, although Chairman Ben Bernanke has said the Fed would have to be involved in any effort to identify and resolve systemwide risk.

It is interesting to see how the we are getting two sets of messages here – one on federal regulators sharing oversight and the other proposing that the Fed be the “finance supercop”.

No matter who is in charge of overseeing systemic risk, federal regulators need to attract more qualified employees who are able to connect the dots and dig further into every aspect of systemic risk. The regulators will also need to work with their counterparts across the world.

Importantly, if you regulate the banks but ignore hedge funds, private equity funds, private real estate funds, insurance companies and last but not least, pension funds, the supercop proposal will become a superflop idea.

I will back later today or tomorrow to discuss my thoughts on the “W” recovery.

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  1. wintermute

    The incredible irony here is that the Federal Reserve is itself the largest single-point of systemic risk. Far bigger than AIG or JP Morgan Chase or Citigroup.

    In the current crisis they are determined to return the system to the debt-fuelled growth state that existed in 2005. To do this they are inflating their balance sheet from $800bn to anywhere from $2tn to $4tn. Most of their Tier 1 asset-base of Treasuries exchanged by RMBS, CMBS, CDOs and other distressed and toxic financial products. They are also debasing the dollar with quantitative easing – which is much higher than the headline figure because of Fannie, Freddie and Ginnie Agencies purchases.

    If they succeed in this reflation – it will only set the scene for a truly catastrophic bust later next decade. The Fed is systemic risk personified.

  2. Edwardo

    Mark my words, there will be no success in re-inflating the bubble economy. Why? Because the necessary energy inputs to sustain the constant growth model ARE NOT THERE! And perhaps the great irony with respect to that fact is that the energy inputs will not be there prospectively, at least in part, because the global economic contraction shuttered discovery and development projects.

    The other reason is that Peak Energy is as real as heart attack. Before the recent economic contraction many of us who follow the bouncing Peak Energy Ball, said that a depression would by the world time from exceptionally high energy prices. And so it has. But to quote Joe Louis before he fought and beat the fleet of foot (and hand) Billy Conn, “He can run, but he can’t hide.”

    That is the position the planet is in, even at our globally subdued present. Peak Energy will make it impossible for the planet to resume business as usual. In fact, we will be lucky if we have much business at all in due course.

  3. X

    This is truly appalling. A regulator to supervise too-big to fail institutions? What happened to breaking them up? I only saw one skimpy sentence there that could be interpreted as breaking them up. It sounds like instead they plan to preserve the current too-bigs in their too-big form while possibly stopping new too-bigs from developing. That is the worst of all possible worlds. It grants collective monopoly to those firms who have already captured the government (surprise, surprise, huh?). I cannot believe anything other than that their regulator will serve the purpose of spotting problems soon enough to rob us little by little to cover their losses instead of allowing an acute crisis necessitating the type of all-at-once grand theft that even we debt-serf Americans might stand up to if done too often.

    It is completely unacceptable to have any too-bigs left after this crisis. If only one reform were done, the single most important would be to end up with financial institutions that can fail when they fail.

    I love how they act like good regulation is complex or difficult. Creating complex regulation only creates opportunity to game the system. Really, how much regulation do we need beyond the return of interest rate caps and separation of investment banking? Add in rules that prohibit cycling back and forth between financial institutions and the government institutions that regulate them and that is pretty much everything.

    But of course that can’t happen because sufficiently capped interest will not allow the financial sector to suck up 40% of profits in the economy. Imagine if we once again capped interest (I mean the allowed spread over prime) at a point where it is only possible to profit by loaning to people who can repay the principle. That solves so many problems plus it is easy to understand and enforce.

    That is the last thing the banks and their buddies in government would want though, obviously. It would necessitate the financial sector returning to a reasonable size and force us to deal with the problems of the working poor who use those high-interest loans to make up for inadequate wages. Those two things are the pillars of modern society to our ruling class and they will probably go to the mat to defend the status quo.

    This is a tipping point. Reasonable living conditions for many Americans and the most fervent desires of the ruling class are incompatible. This tension must be resolved at some point in the reasonably near future.

  4. DownSouth


    I’m almost through reading Kevin Phillips’ American Theocracy. This quote from the book pretty well sums up his thesis:

    Reckless dependency on shrinking oil supplies, a milieu of radicalized (and much too influential) religion, and a reliance on borrowed money–debt, in its balooning size and multiple domestic and international deficits–now consititute the three major perils to the United States of the twenty-first century.~

    Most intriguing for me is the role radicalized religion has played and continues to play in all this. However, I believe wintermute’s comment is most gemane to this thread, so I would like to elaborate on his comment that the “incredible irony here is that the Federal Reserve is itself the largest single-point of systemic risk.”

    I agree completely. But I would take that statement one step farther. For the systemic risk is not just economic (the risk of default), but political as well.

    Perhaps Niebuhr was the first to warn of the political dangers of an “expert” governing class such as that which constitutes the Federal Reserve Board:

    The conception that what society needs and, if intelligent enough, will be able to secure, is “trained and experienced specialists” to perform the “expert functions” of government, betrays an additional class prejudice, the prejudice of the intellectual, who is so much the rationalist, that he imagines the evils of government can be eliminated by the expert knowledge of specialists. Any kind of government must of course avail itself of the specialised knowledge of experts. But the idea that such expert knowledge can ever guarantee the impartiality and justice of a state is to overestimate the impartiality of reason in general and the reason of experts in particular. Politics are given their general direction by the pressure of interest of the groups which control them; the expert is quite capable of giving any previously determined tendency both rational justification and efficient detailed application. Such is the inclination of the human mind for beginning with assumptions which have been determined by other than rational considerations, and building a superstructure of rationally acceptable judments on them, that all this can be done without any conscious dishonesty.~

    –Reinhold Niebuhr, Moral Man & Immoral SocietySome 60 years later Daniel Yankelovich reiterated a similar warning in Coming to Public Judgment: Making Democracy Work in a Complex World. He cautioned of what he called the “culture of technical control”–imperialistic, arrogant and anti-democratic—and the “creeping expertism” that had gained such influence over our social, economic and political life.

    And now, given the recent history of the Federal Reserve and this latest grab for power, the prescience of Niebuhr’s and Yankelovich’s warnings have been confirmed.

    Phillips recounts the history of the Federal Reserve’s response to the 2000-2002 stock market crash:

    Nothing similar had ever ever been engineered before. Instead of a recovery orchestrated by Congress and the White House and aimed at the middle- and bottom-income segments, this one was directed by an appointed central banker, a man whose principal responsibility was to the banking system. His relief, targeted on financial assets and real estate, was principally achieved by monetary stimulus. This in itself confirmed the massive realignment of preferences and priorities within the American system.

    Such was Greenspan’s success. But if debt expansion per se was one large, gray cloud in the sky, the perception of a rebubbling of the economy was another. Nothing comparable had ever been tried. Critics such as stephen Roach, Robert Shiller, and to an extent former Federal Reserve Board chairman Paul Volcker argued in varying degrees that the effect of Fed policy was to inflate a new real-estate and credit bubble on top of the older Nasdaq-centered froth. Roach, the chief economist at Morgan Stanley, described the Fed chairman as a “serial bubble blower.” By 2004 others spoke about an echo bubble or a double bubble or even referred to Greenspan as Chairman Bubbles. The expansion of debt was huge, indisputable, and a topic of spirited national conversation.

    Likewise huge and indisputable but almost never discussed were the powerful political economics lurking behind the stimulus: the massive rate-cut-driven post-2000 bailout of the FIRE sector, with its ever-climbing share of GDP and proximity to power. No longer would Washington concentrate stimulus on wages or public-works employment. The Fed’s policies, however shrewd, were not rooted in an abstraction of the national interest but in pursuit of its statutory mandate to protect the U.S. banking and payments system, now inseparable from the broadly defined financial-services sector. To this end, the 2001-2003 rate cuts extended a more than two-decade pattern, relentless under Greenspan, of slapping large green liquidity Bank-Aids on any financial wound that might get infected….

    [B]y the end of the [20th] century it became clear that the federal government had…pick[ed] finance to be the ascendant sector in the U.S. economy and figuratively shrugg[ed] as American manufacturing lost its markets, profits, and prime political access. The electorate, of course, never got to vote on a decision that never had to be made formally. The financial sector, in fact, was already the statutorily designated constituency of Washington’s second-most powerful officeholder—the chairman of the Federal Reserve Board—whose mandate was to supervise and regulate banks, implement monetary policy, and maintain a strong official payments system. Here the reader may want to turn back to figure 6, on page 267, with its portrait of how U.S. manufacturing slid and finance took control, staking the American future on a sector with no record of sustaining earlier global economic hegemonies. The Federal Reserve Board was the principal architect.

    So backstopped, the ascendant financial sector enjoyed the best of two seemingly contradictory worlds. On one hand, the Federal Reserve Board and sometimes the Treasury Department were available to rescue banks, bondholders, critical currencies, and even hedge funds too big to fail. Yet at the same time the financial-services industry enjoyed the cumulating benefit of three decades of deregulation: minimal regulatory restraint (of which the Fed was a principal, though not the only, architect).

    This triumph of neo-laissez-faire, as we will see, was almost as important as the government bailouts. Dereguation of financial services had been under way since 1980, but by the late 1990s the industry was like a long-distance runner coming down onto the flats for the last mile. The finish line—the promise of nearly unfettered financial capitalism, and devil take the hindmost—was so close the panting chief executives could see it.~

    It’s appalling to see what is being done in the name of science, in the name of the “science” of economics. Kings and priests of old, who used religion to legitimate their power, would undoubtedly be envious.

  5. Hugh

    This is a tough one. I think a single systemic risk regulator would be able to cave to industry demands faster than a council. On the other hand, a council’s capacity for inaction even in the face of the obvious can not be underestimated.

    It is like when you are putting lipstick on a pig, should it be red or pink? So hard to say.

  6. Anonymous Jones

    DownSouth — I am consistently fascinated by your Niebuhr quotes. Keep them coming. I never imagined that quotes from theology scholars could add so much to the discussion on this blog. I’m digging into to some of the texts now. Thank you.

  7. MrM

    The Fed has passed the stress test performed on it by the banks and now it is being rewarded.

    The banks, wanting to capitalize on their recent victories against the public and to lock in their power grip, will not allow any other body except the “tried and true” Fed to be in a formal position to regulate the largest of them.

    “The Federal Reserve Bank – regulation of the banks, for the banks and by the banks”

  8. Doc Holiday

    This is a serious question: Are those Timmy’s hands in the photo or is someone under the table (giving advice)? Just curious yah know… like dude, the hands seem surrealc’est la vie

  9. tom a taxpayer

    Doc – Timmy the Wall Street puppet is showing “Ben the blind” a magic trick: “Guess which hand has the $800 billion TARP money?” Ben guesses “the right hand”. Tim: “Nope”. Ben guesses “the left hand”. Tim: “Nope. Take my hand, Ben, and I’ll lead you to the toilet to show you how the $800 billion disappeared like magic.”

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