Fed Disqualifies Itself as Systemic Risk Regulator

If anyone had any doubts as to whether the Federal Reserve should assume the role of systemic risk regulator, a comment in the Financial Times by Board of Governors member Kevin Warsh, based on a speech he is to give later today, puts the matter firmly to rest. No matter how logically positioned a central bank may be to assume this job, Warsh’s remarks illustrate that the Fed has learned nothing from the crisis, and is still in the thrall of neoclassical economics ideology, which is blinding it to facts on the ground.

Warsh argues, incredibly, that industry structure is not a problem. Huh? We have an oligopoly of twenty firms or less that control the international debt markets that are critical to modern commerce. That is a major and thorny problem. Central bankers may not be prepared to admit that publicly, but I don’t think clever obfuscation is what what we are getting from Warsh.

This is the beginning of the critical part of his Financial Times comment:

We must resurrect market discipline as a complement to prudential supervision. Otherwise, the spectre of government support threatens to confuse price signals and create a class of institutions that operate under different rules of the game.

Yves here. This section alludes to the misguided faith in living wills as a solution. That “market discipline” can work ONLY IF the “connectedness” of firms is reduced. The repo market is nearly as large as the traditional banking system. Repos are a major way the major capital markets firms are enmeshed (repos typically provide around 50% of the financing of a broker-dealer). Credit default swaps are another mechanism that can produce cascading counterparty defaults. The derivatives “reform” bill will have only a small portion of credit default swaps clear centrally, only blunting rather than solving this problem.

And even that is less than ideal. Look at what happened at Lehman and Bear. Even though the net worths of the top echelon were diminished by their firms’ failures, they still made enormous amounts of money. Failure of their business does not leave key decision-makers impoverished. The old partnership model, where the owners were jointly and severally liable (meaning if the firm went broke, creditors could go after their personal assets) worked well. The industry’s love affair with risk dates from the mid-1980s, when all major investment banks save Goldman had become public companies (and Goldman’s business mix shifted radically towards trading after it went public in 1999). Back to Warsh:

First, stakeholders need better, more timely information about financial institutions.

Yves. Help me, this is Greenspan 2.0, the idea that market can remedy all ills (and he went on in this vein in the 1990s, that regulation should seek to produce the cost of capital that the markets would). How, pray tell, are “stakeholders” going to enforce “market discipline” on systemically important firms? They can’t even discipline the management of garden variety public companies, witness burgeoning CEO pay. We hae a massive governance problem with public companies: liquid, anonymous markets for shares create two very bad side effects. First, it is extremely costly and difficult to pressure management (and worse, they get to spend the company’s money fighting you). It’s much easier simply to sell your shares, which is what most unhappy investors do. And mere share sales rarely exert much pressure. And with average holding periods for stocks well under a year, can most shareholders rightly be considered investors?
SecondMoreover, even if shareholders did want to act like investors, public disclosure is inherently deficient, and more so in financial services than in most fields of enterprise. A company simply cannot disclose competitively sensitive information, like the success of its R&D initiatives, planned acquisitions or product development.

And what would “stakeholders” need to make intelligent decisions about a financial firm, so as to impose “market discipline”? They’d need to know how risky it was. To determine that, they’d need to have access to its trading positions on a pretty real time basis. That also just happens to be the very most competitively sensitive information a leveraged, active trading operation possesses. So Warsh’s “market discipline by stakeholders” construct is unadulterated garbage.

But it gets worse:

Second, reforms must encourage robust competition. Smaller, dynamic companies, properly supervised, should be able to take market share. This is the way to level the playing field, far better than bullying or co-opting the largest, most interconnected institutions. But this won’t happen if policy divides those that are too big to fail from those that are not. It won’t happen if select incumbents have permanent funding advantages. And it won’t happen if policy preferences deter would-be competitors from taking on the big guys.

Yves here. Does Warsh know absolutely nothing about this industry? Look at the history over the last 25 years. Smaller, dynamic companies have NOT taken market share. The only ones that have gained ground on traditional investment banks were behemoth commercial banks who used their balance sheets and the fact that they had some experience in trading (admittedly plain vanilla product like foreign exchange, but at least it was a place to start). It took JP Morgan and Citbank more than a decade to make meaningful headway (and if you went from when they started those initiatives, in the early 1990s, and did an NPV from then to now, I bet it’s still not very pretty. Five or ten years of investment with no meaningful payoff is not an attractive proposition). Some banks made faster progress in the 1990s by getting in at close to the ground floor in the derivatives business, which favored players with large balance sheets.

Even as of 1985, the story of capital markets businesses was simple: huge barrier to entry. You need to be able to trade positions in the Pacific, European, and US time zones. You need a high minimum level of infrastructure, which includes solid risk management tools (well as solid as they get…..). You need a lot of capital. You need to be an attractive enough platform to attract and retain “talent” (I hate that word, it is not “talent” per se, but staff with very narrow skills that are well nigh impossible for outsiders to acquire).

And scale and integration is an issue in these businesses. Look at the fate of Lehman. It fit the profile of a smaller, dynamic player. Its dynamism led it to focus narrowly on an area where it thought it could be competitive, real estate, in the hope it could have higher returns and grow its way into being better able to compete with the industry leaders. We know how that movie ended.

You need 100% of the minimum infrastructure to be competitive in these businesses. That infrastructure has high fixed costs. It is pretty hard to be half pregnant. If you only have 50% or 60% of the transaction volume of the leading firms, you have inferior economics. You have to be satisfied with earning a lot less than the big dogs, or push into riskier businesses to try to improve returns. Or maybe you get lucky and get in on the ground floor of a new business area, but “innovations” are so transparent in this industry, it isn’t realistic to think you can preserve a first or early mover advantage (indeed, Goldman historically did well by being a fast copier rather than an innovator).

And consider further: these businesses are so large that all the incumbents are public. In the old days, when commercial banks fought their way up the industry food chain, investors would tolerate the long and seemingly futile investments. No one has those time horizons any more.

Back to Warsh:

Third, it is up to financial institutions to demonstrate that they can fail without a need for extraordinary government support. Simplifying corporate forms and structures so companies can quickly be unwound, particularly across borders, would be a welcome development. In a global economy, big is not bad. But greater dispersion of assets and liabilities demands unprecedented international co-operation. Policy co-ordination with other major countries is needed.

Yves here. Huh? Yes, Lehman’s 100+ legal entities were a bit de trop, but any bank or securities firm is going to need local licenses and local corporate entities, at a minimum, one would assume one per country in which it has a securities or banking license. And there may be valid reasons (aside from tax optimization) to have more than one per county.

Bankruptcy is a profoundly local affair. Warsh’s turn of phrase, ” up to financial institutions to demonstrate that they can fail without a need for extraordinary government support” is very peculiar. How does someone “prove” that? Harvey Miller, the most highly respected bankruptcy lawyer in the US, per Andrew Ross Sorkin’s account, said it would take two weeks to prepare a (proper) US bankruptcy filing for Lehman. Bear went down in a mere ten days. How much of a BK filing is generic versus needs to be updated is beyond me, but the need for two weeks suggests you need a fair bit of reasonably current information. And Miller specifically stated:

I’ve been a trustee of broker-dealers, little cases, and the effect of their bankruptcies on the market was significant. Here you want to take one of the largest financial companies, one of the biggest issuers of commercial paper, and put it in bankruptcy in a situation where this has never happened before. What you are going to do now is take liquidity from the markets. The markets will collapse. This will be Armageddon.

Yves here. Miller had the clearest view of what would happen. He was not even consulted before the Lehman BK. There is not much evidence from Warsh’s remarks that he or anyone at the Fed has talked to lawyers in the US or other jurisdictions to see if its streamlining idea buys as much benefit as the Fed believes it will.

Warsh’s remarks seem to be politically driven. Bear was bailed out, and there was a huge hue and cry afterwards. Freddie and Fannie were put into conservatorship, which led to more complaints about rescues. So the Bush administration needed to prove its cojones, that it was willing to let someone go bust, and Lehman, which was not as big a credit default swaps market participant as Bear, was deemed dispensable. That proved to be a mistake, at a minimum in the way it was executed. So then we’ve had a reaction against that, a “No More Lehmans” policy.

But the public is still very unhappy about bailouts. So since rescues are now looking unacceptable, the powers that be now want to be able to allow big firms to fail. But this seems implausible without the very structural reform that Warsh dismisses. For one, Citi, with its massive foreign deposits, will not be allowed to go bust, so unless that wee problem is addressed, we already have a rather large exception to this living wills policy (even if Citi is made to go through the motions like everyone else).

The real question is, the next time a big US firm goes asunder (which it will, the cheap liquidity the Fed is providing in combination with a lack of meaningful checks on risk-taking guarantees it at some point) will the Fed and Treasury feel compelled to test these living wills in a crisis or will they cobble together a rescue? Warsh’s remarks leave me convinced that the odds are high that whatever the decision is, it will be made to prove the wisdom of past Fed conduct, and will therefore be the wrong one.

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  1. fresno dan

    ideology or (I don’t want to be mean, so I will not say stupidity) a lack of studying? Of course, if you won’t even look through the telescope, its hard to convince someone that the sun doesn’t revolve around the earth…uh, which is the belief system or frame of reference or … ideology.
    yeah, ideology.

  2. RueTheDay

    Truly amazing.

    I had hope when people like Posner and Greenspan were abandoning the libertarian free-market “religion”.

    However, like all religions, it is showing amazing resilience in the face of empirical evidence that its god is false.


  3. craazyman

    Yo Kevin! There’s a bunch of Pakistani taxi drivers in Long Island City with doctorates in economics who will work cheap. If we properly supervise them, do you think could they take market share from the do-do birds at the Fed? Or would that market have high barriers to entry? Ha ha ha. Think you can hit 60 up Park Ave. at 4 am while a drunk debutante pukes in your back seat, then clean up afterward? I think you just did. boowhahahahahahahahah! But it still smells. bowhahahahahah!

  4. dlr

    I think you are being too kind by assuming Walsh is simply a slow learner. By now it seems like a more parsimonious explanation would be that he, (and the rest of the federal reserve) are colluding together with the banks to deliberately defraud the American people – and are willing to act stupid and short sighted to cover up this fact.

    If you ask me, the nonsense they are spouting is a classic BIG LIE. They have worked backwards from what it would be convenient for them to believe to justify what they want to do. All it has to be is superficially plausible. And all they need, for political cover, is to spout it off always and everywhere like they sincerely believe it is true.

  5. Moshi

    Kevin Warsh is the worst of the many awful legacies of the Bush administration still haunting DC. Do not waste your time trying to make sense of his ramblings. Pray he is marginalized or brush up on the impeachment process.

  6. joebek

    The assumption underlying much of the critique of neoclassical economics and of various regulatory schemes is that market crashes are bad. They are proof of the dominance of irrationality in market economies and that market based economies need to subject to Weberian rationalizing bureaucracy. But what if markets are beyond reason and emotion? What if they are more like volcanoes? Does it make sense to try to stop the volcano from erupting? Maybe we should concentrate on simply on designing rescue and recovery operations? If we were to consider markets to be like volcanoes then we might expect that all the major banks and investments houses and insurance companies would have been swept away, GDP would have collapsed and unemployment would have skyrocketed. What kind of rescue operations would be appropriate in that context? Certainly, in that context no one would be quibbling about very aggressive short term taxes on property(without exception) to fund rescue operations, unemployment insurance, medical vouchers for the indigent, food stamps, etc.

    1. DownSouth

      That’s typical Libertarian-Austrian-Neoliberal claptrap.

      It’s tantamount to saying we shouldn’t have any traffic laws or enforcement, and should instead concentrate on emergency services for the dead and maimed when some drunk driving 90 MPH goes plowing into a crowd of pedestrians.

      1. bob

        My run for governor of MA against Mitt Romney was based on a little of this.

        For 6 months there would be no speed limit. But, if you were caught in the left hand lane not passing anyone, 2 years in jail.

        Similar draconian rules for a right turn into the left lane.

        Alas, the insurance agencies and auto repair lobby conspired to keep me down. I had to leave the state in shame.

    2. Francois T

      “But what if markets are beyond reason and emotion?”

      Sure! I can posit quite a few hypotheses of the same kind:
      What if Spartacus had a Piper Cub?
      What if homeopathy really worked?
      What if gravity was not pulling objects down but pushing’em from above?
      What if…the Republicans stopped filibustering?
      What if…Democrats located their spine?

      1. Skippy

        What if gravity was not pulling objects down but pushing’em from above?

        See dark flows/matter

        I lol’ed at all the above thanks.

  7. bena gyerek

    who needs to be subject to market discipline? institutions or management? walsh seems to be one of many commentators that wilfully conflates the two. institutions are systemically important, not management. but it is management that responds to screwed up moral hazard incentives, not institutions. so the solution is one that underwrites systemically important financial institutions while punishing any management that gets them into trouble.

    1. dlr

      Here, here!! EVERY CEO and EVERY BOARD MEMBER of the banks and insurance companies, and etc, should have been forced out the door. And with no golden parachute either Bare minimum requirement.

      The fact that they were allowed to retain their positions is the part of this whole thing that stinks the most.

      1. dlr

        If Paulson had forced the CEO’s and the Board Members of the ‘first round TARP banks’ to resign, I would have believed the whole payoff was completely legitimate and honest. If he had even just forced JUST THE CEO’s to resign I would have gone back to sleep.

        Leaving them in charge proved to me, without a doubt, that the whole thing was a crooked payoff right from the get go. It is an outrage that someone who needs a 25Billion dollar bailout of federal money is left in their position.

  8. liberal

    joebeck wrote, Certainly, in that context no one would be quibbling about very aggressive short term taxes on property(without exception)…

    Actually, agressive permanent taxes on one form of property—land—would prevent many if not all bubbles.

  9. Sasher

    Kohn, Warsh, Plosser, Mishkin, Bernanke – how many people with the right last names and connections can we jam into the Fed without the populace noticing? I think we should have 100% of the Fed with just people who go to the same club,s pray in the same house of worship and read the same economic books (some even write them!).

    This is absolutely disgusting!! Aren’t there any other doctorates and people with intelligence from the rest of America? Do we have to dip into the same discredited basterds to pick our next Fed governors?

  10. David Merkel

    Warsh is at best overrated as a thinker. I rarely take him seriously. Tanta would use him as the butt of jokes with the “mortgage pig.”

    But since the Fed creates the bubbles, it should be held responsible for them. Otherwise, we would need to create an “Anti-Fed” to deflate what the Fed inflates.

  11. i on the ball patriot

    Good read – nice overview!

    Market competition, free markets ideology, etc., is all nonexistent decoy bullshit. The government has been purchased here, regulation dismantled for the benefit of the few at the top, and the structure of finance has been radically changed in the last forty years.

    Simplifying it for person on the street …

    Regarding that corrupt and deceptive structural change, here is a helpful metaphor that might get drawn up visually to simplify the complexity of the deceptions involved and to better inform the masses of why their crumb supply is being reduced, or said another way, why they are now being so heavily cannibalized …

    Picture this – a smooth running parallel circuit of vanilla greed banks …

    Imagine it is as if the preexisting structure was set up as a nice little circuit of vanilla greed banks, all happily wired in parallel, with wire mains of sufficient capacity to supply funds from the big battery of the taxpayer to the individual banks. To keep the circuit running smoothly, the treasury, the fed, and the congress, acted in concert as a regulator, and controlled the flow of funds from the taxpayer battery to the individual banks in this parallel circuit of banks. It was a relatively efficient circuit.

    Now picture this – a not so smooth rewired combination series parallel circuit …

    The wealthy ruling elite (fill in your own villain here), through an array of various deceptive means, hijacked the government and took control of the fed, the treasury, and the congress, and had the existing simple fairly well regulated parallel circuit described above drastically rewired.

    Through their machinations they created a new combination series parallel circuit with twenty or so much bigger banks wired in series, with high capacity wires, right off the tax payer charged battery. This series string of big banks now fed the simple smoothly running parallel circuit of smaller banks. They also increased the wire size of the mains of that parallel section of the circuit, but not the feeder wires to the individual smaller banks in that parallel circuit, to insure that the big banks would always have maximum flow of funds.

    The effect of this new circuit was twofold;

    1. If any of the big banks failed the whole circuit went dead (too big to fail), but smaller banks could fail and the funds from the tax payer battery would keep flowing to the big guys and the other smaller banks.

    2. The big banks, by acting in concert, could now, in the aggregate, control the entire circuit to;

    a. Allow a free flow pass through of funds to create cheap credit and a huge global bubble — which they certainly did.

    b. Pop the bubble by creating grossly over leveraged counterfeit derivative products that would effectively rattle, shake, and instill trillions of dollars of mistrust in the new system circuit, and at the same time have the effect of; frightening consumers into a savings mode and further depressing the popped bubble economy, and, also make the smaller banks unwilling to lend for lack of good investments in the now fully depressed environment (green shoot bullshit aside).

    c. Allow them, the big banks, to further drain the taxpayer charged battery by engaging in greater unregulated speculative schemes so as to create a rinse and repeat condition until the tax payer battery goes completely dead.

    These two simple visuals, juxtaposed, properly labeled, and explained, would show the value of regulation and honest government. They would also allow for the discussion of;

    • Whether or not speculative bullshit banking should be mixed with utility banking?
    • Whether or not we even need a fed?
    • Do we even need vanilla greed banking?
    • Is our electoral process effectively capable of expressing the will of the people?
    • Etc. ?

    Deception is the strongest political force on the planet.

    1. JTFaraday

      No doubt if I read too much Hofstadter, I would call this description a conspiracy theory. However, it kind of gets to the point of my discomfort with the simple dichotomy “regulated” vs “free market.”

      Maybe the financial sector is government regulated, just regulated in a new and unfamiliar way, one that secures a something like a government supported aristocratic class. Not so much unregulated as “rewired,” as you say.

      I also think it’s unlikely that a regulatory regime that sought to protect the public will ever cover every single little thing that finance sector workers can come up with to secure their own compensation, and that a regulatory regime that seeks to protect the public probably needs to impose the kind of “free market” discipline on these employees that investment banks had when they were partnerships. They need to be governed in such a way that looting the institution on a short term basis and sticking somebody else with the mess is clearly not in their self interest.

      I also fear that once you start asserting that the government should be fully regulating the industry, then any failure is then the government’s “fault,” and the public gets put on the hook for it. I’m not saying you can’t try to regulate them in the public interest, but I also think they need to be submitted to so-called traditional “free market discipline” knowing that at the end of the day they will “innovate” outside the lines because that’s exactly what they do. WHEN they do, they should be held liable for what results.

      1. i on the ball patriot

        JTFaraday …

        If you understand the circuit metaphor then you can see that what is needed is to throttle down the shit CDS and other useless products in the big bank series circuit (that are still affecting and wreaking havoc in the credit flow of the parallel wired smaller banks), and at the same time put those big banks back in that parallel circuit arrangement.

        The only way to do that is to regain control of the hijacked regulator portion of the circuit — the fed, the treasury, and the congress.

        The big bank series circuit represents the newer pernicious greed, the old, and still existing parallel circuit of smaller banks, represents the old fashioned vanilla greed. They, the smaller vanilla greed banks, need to get their shit together and consolidate their efforts to mount political opposition so as cut the balls off the big guys that are stealing their lunch. But they are still mired down in a fantasy history and think that this is just another boom bust cycle. It is not …

        … and here we get into the question of the driving forces of the crisis; are they, ‘just incompetent hacks‘, that are unwittingly driving the train off the tracks, or; is there an intentional, “ruling elite conspiracy’, that is willfully driving the train off the tracks to; consolidate global central bank power, eliminate the high resource consuming middle class globally by shutting down its credit supply, create a two tier ruler and ruled world with a new cheaper to operate and maintain law enforcement as overseer class, and, make fantastic geopolitical gains.

        Look at Iceland, Greece, and now what has happened in Italy with BAC funds being impounded for selling more fraudulent derivative products …


        Let’s hope the Italians do a little jingle mail jubilee and shoot some of these BAC gangsters to boot!

        What ever your beliefs as to the causes the key to any remedial measure in rewiring the circuit is to regain control of the sell out scum bag politicians.

        It is my belief that to do so will take an election boycott as a ‘vote of no confidence’ in this entire government. A major problem is that the people themselves have to be unwound from the intensified brainwashing they have been subject to in the past forty years. Like the vanilla greed banks they are also running on an old history and give their faith in government inspired in the past to the new devious neocon scum bags that have hijacked and now control the government. They are fast awakening as their crumbs are being cut off.

        Deception is the strongest political force on the planet.

  12. Doc Holiday

    Warsh argues, incredibly.. Ok, stop there.

    That person, whose name I shall not speak is a retarded dumbass who was given his job because he was a well connected social butterfly — thus I assume he is involved in collusion, but probably too stupid to actually be involved in corruption — because I assume he very busy playing with his makeup kit … and if yah wanna go back in time and go into that bag of dung, just look up his qualifications on Wiki … I mean obviously he is qualified to be a spoiled brat ….. ah shit, this does bring up bad memories .. thanks Yves (is this your post …. ) it’s all coming back …. ahh, yes, Warsh will take Bernananake’s place at the Fed and things will go from a double-dip recession to a place in the future where …. I lost my vision … sorry but either it’s a black hole in the future with extra thick darkness, or maybe as Bob Dylan said, “it’s not dark yet — but it’s getting there”.

    Amen and out

    I was gonna say something about Dixie Lee on the FCIC and something stupid about youth and in-experience … but somehow that doesn’t work here … nevermind.

    “Well, I’ve been to London and I been to gay Paris
    I’ve followed the river and I got to the sea
    I’ve been down on the bottom of the world full of lies
    I ain’t lookin’ for nothin’ in anyone’s eyes
    Sometimes my burden is more than I can bear
    It’s not dark yet but it’s gettin’ there.”

    1. Yves Smith Post author

      Yes, I recall you were a VERY early critic of Warsh. But he has been very low profile heretofore…

  13. Sasher

    I don’t think it’s more than a coincidence that the same old boy network keeps grabbing at Fed governorships. I think it’s time people started speaking out (about the unspeakable evil) that is shutting out the wonderful diversity of people and opinions we have in this country. We need more diversity in the Fed and the media. It is not by sheer coincidence that the media is supporting Bernanke and the Fed and turds like Plosser, Mishkin and Warsh. I say we open up this “Club” to more members!

    1. JTFaraday

      Well, sure, except look at all effort the D-Party faithful put into getting someone with the “funny” name “Obama” in the White House, to the dismay of the other camp who was dead set on a Wellesly grad.

      Meanwhile, if you thought Obama’s stint as editor of the Harvard Law Review would bring diversity of opinion to his Admin, you were likewise disappointed. When criticized for his financial team, Obama said it straight out–the diversity is him.

      Evidently, change is going to require more than just rotating the headshots.

  14. Consider This

    Considering Warsh’s resume and lack of experience in the financial markets, Warsh’s commentary is to be expected.

  15. alex

    Doc Holiday says: “Warsh … was given his job because he was a well connected social butterfly”

    You got that right. From wikipedia:

    “Warsh’s nomination drew some criticism … he was an attorney, rather than a trained economist and had no prior Fed experience. At the time, former Fed vice chairman Preston Martin said it was “not a good idea” and that if he had a voice in the Senate, he would vote no. However, Warsh impressed colleagues, especially Fed Chairman Ben Bernanke, with his insights and political savvy …”

    Typical Bush appointment – all connections, no relevant expertise. And Bernanke was impressed by him? That’s the final nail in the coffin.

    The whole idea of the Fed being apolitical is absurd. The governors are presidential appointments, but of course defenders of the status quo duck that by pretending they’re non-partisan technocrats. Right … and I’m the Queen of Hearts.

    Lastly it’s conveniently overlooked that the Fed’s actions are supposed to be for everyone’s benefit, not just the banksters. The Fed exists only because congress chose to delegate its Constitutional power to regulate the value of money.

  16. scharfy

    Sniping at free market principles for the recent credit collapse is a ploy for statists to introduce ineffective “solutions”. There is a better way.

    Sound, simple, sane regulatory reform and freemarket enterprise are not mutually exclusive. However, unlike the stauts quo, they must be SIMPLE and ENFORCEABLE. In a nutshell, if is doesn’t fit on about a page or so, and can’t be understood by the layperson, not useable in my view.

    Using the US Constitution as a proxy, the language must be able to stand the test of time, and a judge must be able to look at it and rule on it, and effective enforcement must occur. The founding fathers wrote a document that has held up quite nicely, the same care must be taken in reform. We can’t just add a wing to the SEC called the CDO dept.

    I work at a place where the free market and strict regulation coexist quite nicely (the CME) and existing rules are clear, clean, and don’t stifle innovation. Rather they evolve with the times.

    Moreover, when a violation occurs – it is STRICTLY enforced. So moral hazard is at a minimum. Nothing’s perfect, but in my world, if you trade outside of your CLEARLY STATED parameters, you will be frozen by your clearing house, and fined, then expelled by the exchange.

    Watching the FED fuel credit bubbles, then attempt to regulate them is the mind numbing height of stupidity.

    Free market? I think not.

      1. scharfy

        $500,000 in political donations fiscal 2006.

        0 dollars in bailout money, though

        but i get your point… nothings perfect

        1. scharfy

          point being, the CME, which trades derivatives, functioned quite well through the 100 year storm, and didn’t require a dime of taxpayer dough.

          There are some lessons there i would say.

          Of course we have politicians on our payroll, its America…

    1. liberal

      “Using the US Constitution as a proxy, the language must be able to stand the test of time…”

      While I’m a big fan of the Constitution and the Enlightenment principles of the Founders, you’re off-base here. The language of the Constitution institutionalized slavery. It didn’t stand the test of time; cf this little thing called “The American Civil War.”

  17. William Mitchell

    The Fed should not be the systemic risk regulator, precisely BECAUSE it is overrun with Ayn Rand acolytes and unaccountable to the executive branch.

    The Fed’s independence gives a president political cover he should not have in a systemic crisis. POTUS would be able to claim the Fed blew it, and there was nothing he could do about it.

    If systemic risk were instead measured by a separate agency within the executive branch, then the president is directly politically exposed to a systemic wipeout. This aligns incentives in the right way.

    1. Kevin de Bruxelles

      Naw — Yves used it correctly. “Un peu de trop” means “a bit much” or “a bit too much”. The thing is though you really don’t hear the “de”. Using the whole French phrase would have been more elegant but then she would have lost too many readers who are not used to seeing French phrases. At least “a bit de trop” has the same rhythm.

      If you say “un peu trop …” then you have to finish the phrase with an adverb. “Un peu trop loin” or “un peu trop cuit” or even “un peu trop bu” (pop that last one into YouTube and see what you get!). But that would not match the way the phrase was used in the post.

    2. Travis

      Naw, actually if you are using it colloquially or in an everyday spoken sense of the phrase, for emphasis, for understatement or overstatement, as she certainly was, then it is just: un peu trop. As in: un peu trop bu = drank a little too much = I got really drunk. If you set up the sentence in English and then switch to French you are putting emphasis on the “little bit to much.” I do not think she meant to say that in this case the number of entities was really just a little bit more than could be justified in some technical sense. En tout cas, c’était un peu trop cave.

  18. MacroStrategy Edge

    Warsh served on the President’s Working Group on Finacial Markets, which was set up by Reagan under executive order after the 1987 stock market swoon. One does not need to reach for the tinfoil hat to realize this bunch is suspect.

    I may have this wrong, but I also think I remember coming across a few places where Warsh may have advocated free banking on more than one occassion in the past, which would be consistent with his comments on regulation in this speech.

    The blind spot on the failure of market discipline – which of course was not the only failure in the last financial crisis – is simply astounding. The human mind has an enormous capacity for denial that does not always serve our evolution well.

  19. Cedric Regula

    Methinks they call for “market discipline”, then ban short selling, because clearly the shorts punished the banks, once there was a sufficient chink in their armour, and that was of course bad for the industry, which had no choice then but kill the economy.

    I wonder if they give IQ tests to these people. Score above a 100, and you have to find a different profession?

  20. K Ackermann

    This is a devistating analysis.

    It makes me fantasize what it would be like to have someone with Yves pragmatism, and clear view of reality on the levers of power.

    How fast could the ship be turned around?

  21. bob

    “Third, it is up to financial institutions to demonstrate that they can fail without a need for extraordinary government support.”

    How do you prove this?

    Building codes come to mind here. You don’t construct a building to be able to survive what ever might happen to it. The best you can do is design a system that tries to get everyone out of it, and then contain it so it doesn’t get any worse.

    There are very simply way too many variables involved to model it before hand. Most knowledge is gained in the past tense, things that went wrong. At that point it is not economically possible to tear down every building, they have to work it into the new ones, or do very costly and labor intensive work to bring the old buildings to code. This takes decades.

    Not quick enough.

  22. snarkman

    Pray tell, what does this link have to do with Warsh? Nothing. And who is the guy writing it? Even if this were a related letter, which is isn’t, it’s a letter from a guy shilling a business idea. So who are you shilling for? Warsh, this company, or both?

  23. Eggolas

    Snarkman, you missed the connection.

    Warsh wrote:

    “We must resurrect market discipline as a complement to prudential supervision.”

    Indeed, that was also the focus of several government responses in the past two years, including:

    1. The Presidential Working Group Report, March 2008;

    2. The Amendments to the Capital Requirements Directive (EU) of May 2009; and

    3. The recent request for public consultation by the European Central Bank on how to restart securitization.

    All three of these focused on how to bring market discipline back to the securitization industry so that not only could investors perform due diligence to avoid future problems, but also to give them the ability to value and price securities. Without that, the buyers remain on strike as evidenced by the G30 report issued Jan 15, 2009, particularly in Core Recommendation IV.

    The FDIC link is indeed from someone who is looking to make a business from solving the credit crisis. You can go back to Bloomberg News stories in December 2007 to see that the solution has been consistent (Caroline Salas’ article).

    I am not shilling for a business idea. For the past 2-1/2 years I have been writing and speaking to people that the solution to the credit contraction that was coming was to unfreeze securitization by giving the buy side the same information that Wall Street had — loan level detail on a daily basis.

    Several news stories of late have focused on that issue. A most interesting one was the recent WSJ article on GS and Senderra (Goldman Subprime Fallout Hits Home in South Carolina, Jan 21, 2010).

    In my estimation, the solution to this credit contraction is and has been to restart securitization by bringing the buyers back to the market. The FDIC submission explains what went wrong and what needs to be done to accomplish that task. It’s easy to obfuscate the issue. Wall Street has been doing to for over 2 years in their attempt to preserve the ability to earn billions of dollars from opacity and an asymmetrical information advantage (kudos to Stiglitz of course).

    But hey, you can always be on the side of preserving opacity and the economic ruin that it created. Maybe you’re on Wall Street.

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