We have pointed out more than once that a major impediment to reform of the financial services industry is that a small number of firms control infrastructure crucial to modern capitalism:
1. Credit is essential to any society beyond the barter stage
2. Debt markets are now at least as important in providing credit as traditional lending, by a lot of measures, even more so
3. A handful of firms are crucial because they operate the debt markets
4. These firms are deeply enmeshed. If one goes, the others are at risk of failure, which will take down the entire debt markets apparatus.
The banksters understand this situation full well, that they have a knife at the throat of the economy, and they will fiercely resist any efforts to disarm them. And note that the enmeshed-ness is one of the sources of their leverage (no pun intended). If single firms could be
taken out and shot wound down, the firms collectively would have much less power. The interconnectedness of the players, via their credit exposures to each other (most importantly but not limited to the repo and credit default swaps markets) makes “reforms” like living wills of dubious value. Unless the tight coupling is substantially reduced, these living wills remain fig leaves for political and regulatory inaction.
Put it this way: if banks can forestall a not very ambitious reform program by huffing and puffing about “destablizing markets” when the financial markets are on comparatively sound footing, do you think anyone, in bona fide financial crisis, will take the risk of putting down a significant player in an untested wind-down protocol? A bailout is the less risky course of action (although some ancillary operations might be hived off of a floundering firm to improve the optics).
Recall what took place during the Bernanke confirmation process. There was a point where opposition was significant, and there was a hope of getting a thumbs-down, particularly since conventional MSM outlets like the Wall Street Journal were making particularly articulate cases (as in going through his record as Fed governor as well as chairman, and arguing that his role in causing the crisis was much more significant than widely appreciated).
In addition, the claims that a no vote on Bernanke would be detrimental were wildly exaggerated. He would still have remained a Fed governor; the spectrum of opinion within the Fed is not terribly wide; the idea that a new Fed chairman would pursue radically different (as opposed to merely somewhat different) policies was a chimera. A vote against Bernanke was necessary for accountability, and a shot across the Fed’s bow on how it defined its constituency (as in a warning that its cognitive capture by the banking industry was no longer acceptable).
But what did we see around the time of the vote? Statements that a vote against Bernanke would “destabilize markets” and, lo and behold, markets fell appreciably when the nomination looked to be in doubt. And senators appeared to get the message. A number of senators who voted for Bernanke went so far as to explain their vote in terms of “I’m not wild about this, but oh, no, we don’t dare cross the markets.”
So the ability to get the markets to fall on cue when regulators are threatening to do things that are inconvenient has now become a critical source of power for the financial services industry.
On the Bernanke vote, do we have any reason to think that pension funds, insurance companies, endowments, retail investors, or mutual funds would have had a strong point of view either way on Bernanke, strong enough lead them to take action? Unlikely.
It has hit the point where the Administration has tried to use the same threat, which given the fact pattern above, must strike industry participants as truly comic. From the New York Times:
As part of a regulatory overhaul adopted in December, the House voted to create a freestanding Consumer Financial Protection Agency. Since then, the financial services industry has been largely unified in trying to reduce the proposed agency’s independence, as well as the scope of its powers.
The lobbying effort has been so fierce that the Treasury secretary, Timothy F. Geithner, called a meeting on Thursday with representatives of the United States Chamber of Commerce, the American Bankers Association and six other groups, at which he warned that failure to pass a regulatory overhaul could destabilize the markets.
Yves here. There are so many ways to interpret Geithner’s threat that I am not certain where to begin. Is this merely an effort to trump the industry’s usual nuclear option? The problem is that that his remark is not credible, at least in the short term, which is all that seems to matter these days in the US (yes, failure to pass reforms will perpetuate the underlying bad incentives and behaviors that generated the crisis, but that does not seem to be the argument Geithner was making). Does anyone really think that not having an independent consumer financial protection agency (something I favor) is going to roil markets? No.
Or (being cynical) was the use of that threat a deliberate effort to signal the Administration’s powerlessness? “Yes, I summoned you all, and I as Treasury Secretary must engage in some Kabuki theater to show we really really wanted this to pass, and that we really really gave it the good old college try. But you and I know you guys really have the upper hand.”
Now if we were back in the days of Johnson or Nixon, when the government was not ashamed of exercising its authority, the conversation would have been very different. Someone like Geithner would have hoped and prayed a lobbyist would invoke the “destabilize markets” threat, and would have responded these lines (no doubt more iron fist in velvet glove than this rendition, but the underlying message would have been the same):
Do I hear that you are threatening the government and the hardworking citizens of this country with a self-serving action of creating a market rout which will cause losses to investors solely to preserve your privileged and perquisites? I’ve heard this threat before, and I’ve seen it happen, and we are no longer willing to tolerate this sort of abuse.
Let me discuss how many legal violations that involves. Collusive action to manipulate markets, a probable violation under antitrust law. Mail and wire fraud. To the extent it involves equities or regulated options and futures exchanges, market manipulation. And given that all your clients operate only by the grace of various Federal and State licenses, I am sure we can add to the list. Given the repeated threats and consistent market declines after threats like these have been made, we can compel your client to divulge internal information.
The point here is that if you having made this threat gives us reason to believe you plan to engage in market manipulation should we proceed with our program. So you tell your clients this: we will engage in a full bore discovery process of any down market moves that appear to be an effort to undermine financial regulatory reform. We will post the results of trading activities, internal communications, meeting records, all the details in a public forum so as to leverage our resources. As you know, our colleagues in the EU right now are not very happy with the conduct of US firms either, so I am highly confident that we can obtain their cooperation in getting the same kind of information from your clients’ overseas operations. And I am sure you understand full well your clients will not come out looking very pretty from this level of scrutiny.
Do not try telling me that this sort of investigation will hurt your clients’ relationship with their customers. Whether we take action is entirely at their discretion. I have no sympathy for arguments that we might damage your clients’ precious customer franchises when they seek to place their interests over that of the US as a whole.
You go back and tell your client if they are not on this bus, they will be under the bus.
Yves here. So now I have to wonder whether Geithner having tried a clearly not credible “destabilize the markets” threat was to give the industry cover for its past bullying….Nah, I’m clearly too cynical.