According to the Financial Times, Treasury Secretary Timothy Geithner is trying to duck the assignment given the Financial Stability Oversight Council under the Dodd Frank legislation, namely, that of identifying “systemically important” financial institutions:
Tim Geithner, the Treasury secretary, has questioned the feasibility of identifying financial institutions as “systemically important” in advance of a crisis, just as the regulatory council he chairs is supposed to start doing precisely that…
People familiar with the discussion said that Mr Geithner was pointing out why it was important for regulators to retain discretion over the designation and that it was unwise to prescribe hard objective metrics because that would allow institutions to wriggle out of the designation…
Several people familiar with plans for the systemic designation said they did not expect a broad category of non-banks to be included. Officials have a strong preference for the consequences for systemically important institutions to be agreed internationally at the Basel committee to avoid giving overseas companies an advantage.
Note this take was precipitated by a new SIGTARP report that offered rather mild criticism of the bailout of Citigroup last fall, including that it was done ad hoc, based on qualitative considerations. We’ll discuss that report separately.
Of course, Geithner does seem to have a history of being slow to complete tasks assigned to him, and with the benefit of hindsight, there is usually an ulterior motive. For instance, when he took the Treasury Secretary role, his first task was to come up plan for how to deal with the floundering financial system, and it was appallingly bad. As we said then:
I cannot recall a major US policy initiative being met with as much immediate revulsion as the so-called Geithner plan…the man has a deadline to come up with a proposal, yet puts off presenting it twice (the “oh he has to work on the stimulus bill” is as close to “the dog ate my homework” as I have ever seen in adult life)….
This isn’t like trying to go the moon (which was a government initiative, lest we forget). There are plenty of models and lots of good proposals.
But it turns out the foot dragging was to allow him to come up with a way not to have to take out any of the floundering big banks (remember, Citi and BofA were clearly on the ropes). So Geithner resistance is usually a sign that he is caught between an actual or perceived obligation (in this case, the requirements of the FSOC) and doing the will of his financial masters.
Analytically, there is a really simple way to deal with the problem: be more inclusive in which players get put on the list and update it often to reflect changing market conditions. The “we don’t know who is important until the tide starts going out” is dubious. The usual argument for this is Lehman, that the fact that the authorities let it fail was a sign they didn’t recognize how damaging a collapse might be. But that’s not exactly accurate. Bear, which was a smaller player with the same profile, heavily exposed to real estate, was rescued, and the officialdom labored mightily to save Lehman only to see the deal collapse at the 11th hour. The failure was one of imagination and planning: they figured the industry could be pressured into a rescue of some sort, they missed to how Fuld has undermined the effort with his inept fundraising efforts (he managed to undo a deal with the Korean Development Bank) and had no Plan B.
And if financial regulators had done their jobs in the wake of the Bear collapse, priority number one would have been to understand who was exposed to the CDS market (that was the pressing reason for the bailout) and those roads would have led to AIG.
In other words, preparation of that sort of list is meant to force the FSOC to do its job. Now admittedly, identifying systemically important players is only one axis of risk, but that’s no reason to shirk the task. The Treasury devised a list of banks it subjected to stress tests; conceptually, how is this process any different?
It is noteworthy that Economics of Contempt posted on November 29 of last year that Treasury had “gotten the ball rolling” on identifying systemically important nonbank financial firms (a specific task set forth in Dodd Frank in some detail). But the page at Treasury to which he linked has been deleted. (I also searched for “systemically important” nonbank on the Treasury site from October 1 to November 30 in case the document had merely been renamed, this was the only remotely possible candidate, given that the removed document was a .pdf, and it does not seem to fill the bill).
Yet, ironically, the Bank of England, in its April 2007 Financial Stability report, discussed at some length the nature of risk posed by the growing role of “large complex financial institutions”:
The structure of the UK financial system has been changing in recent years as the major UK banks(1) have made greater use of financial markets to generate revenues, obtain funding for lending and manage credit risk. UK banks are syndicating more loans, securitising more of their on balance sheet assets and are engaging in more credit derivatives activity. There has been a gradual shift towards an ‘originate and distribute’ business model. This may point to more effective management by the major UK banks of their funding liquidity and credit risks, as on balance sheet exposures are increasingly likely to be hedged or held in the form of liquid, tradable assets. But it also exposes the major UK banks to the risk that liquidity is withdrawn from credit markets, where this is supported by LCFIs(2) and other financial institutions, including hedge funds. The major UK banks are further exposed tomarket and liquidity risks through their trading activities, which have grown rapidly in recent years
The Bank of England even dared to identify them:
LCFIs include the world’s largest banks, securities houses and other financial intermediaries that carry out a diverse and complex range of activities in major financial centres. The group of LCFIs is identified currently as: ABN Amro, Bank of America, Barclays, BNP Paribas, Citi (formerly Citigroup), Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase & Co., Lehman Brothers, Merrill Lynch, Morgan Stanley, RBS, Société Générale and UBS.
So what is Geithner’s real reluctance? It’s not hard to understand. The FSOC ought to make life miserable for any systemically important firm. Designating an institution as a systemically important means the authorities will have a lot of explaining to do if it gets in trouble on their watch. So it should regulate intrusively, insist on stringent valuations of asset and liabilities, and understand the markets to which is it heavily exposed.
Of course, no firm will want this sort of proctological treatment, and that’s the point. Being TBTF should carry burdens as well as privileges, and having the government breathe down your neck now seems a small price to pay for being able to inject a drip needle into the US taxpayer every time you screw up on a large enough scale.
In other words, preparing and keeping this list will accomplish something Dodd Frank intended: to keep the minders and their charges under scrutiny. That is evidently something both camps are keen to evade.