Perry Mehrling: Volcker Alliance Describes How Regulatory Silos, and Also Intellectual Silos, Hold Back Financial Reform

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By Perry Mehrling, a professor of economics at Barnard College. Originally published at his website

A month ago, the Volcker Alliance issued a report intended to address a central issue that had been purposely left to one side in the Dodd-Frank reform legislation, namely the inadequacy of the regulatory system that will be tasked with implementing any future financial reform.  Titled “Reshaping the Financial Regulatory System:  Long Delayed, Now Crucial”, the report got respectful notice in the financial press, but then quickly dropped from sight.  (Disclaimer:  I am listed in the acknowledgements, and I did attend and speak at a small meeting with Volcker and his team in New York last January, but my topic was the Volcker Rule, not the regulatory system.)

That’s a shame.  The report is short, informative, and readable, and deserves more sustained attention.  Even the appendices are short, careful, readable summaries of much longer background research papers.  I’m going to assign this report in my on-campus course next fall.

A single blog post today however suggests that attention may now be beginning to be paid.  That’s a good thing.  Let me now try to push the conversation to the next level.

At first glance the report seems like just one more call for consolidation of a fragmented bank regulatory structure, and indeed it does call for such consolidation under a single Prudential Supervision Authority.  But it does much more than that.

Significantly, the new PSA would also encompass “the prudential supervisory functions of the SEC and the CFTC with respect to broker-dealers, swap dealers, DCOs, clearing members, FCMs, and MMFs.”  In other words, the goal is to include the key institutional infrastructure of the market-based credit system, aka the shadow banking system, under the same roof as the traditional banking system.  (The report includes a handy translation of its many abbreviations in Appendix D.)

This animating goal, to bring the structure of the regulatory system into line with the actual structure of our modern financial system, comes through in other recommendations as well.  The recommendations on oversight and surveillance, while focused on protecting from political influence the work of the Financial Stability Oversight Council and the Office of Financial Research (both new entities established by Dodd-Frank), also clearly asserts authority over market-based credit:  “the ability to require new or enhanced prudential standards and safeguards on all activities and practices that could pose a threat to systemic stability even if conducted outside the present sphere of prudential regulation.”  And the recommendation on investor protection and capital market conduct would consolidate the SEC with the CFTC, in long-overdue recognition that securities and derivative markets are today completely intertwined, indeed substitutes for one another.

Volcker’s concern is that regulatory silos have resulted in “regulatory gaps, loopholes, and inefficiencies”, and that seems obviously true, indeed a cynic might say it is a feature, not a bug.  My own concern is the way these regulatory silos have reproduced and reinforced intellectual silos in our understanding of how the financial system works.  To Volcker’s call for reform of the regulatory system, I would add a call for reform of the intellectual system, and along much the same lines that Volcker recommends.

The market-based credit system is fundamentally about money market funding of capital market lending, and therein lies the intellectual challenge.  Like Volcker’s Prudential Supervisory Authority, we need to bring the infrastructure of the shadow banking system into our intellectual fold on the same basis as the infrastructure of the traditional banking system.

This is not just a matter of appreciating that overnight repo is in many ways similar to a bank deposit liability, though that is a good start.  It is also about bringing into intellectual view all the other entities Volcker lists:  “broker-dealers, swap dealers, DCOs, clearing members, FCMs, and MMFs”.  (Okay, DCO=”derivatives clearing organization”, FCM=”futures commission merchant”, and MMF=”money market fund”.)  These are in effect the  key market making institutions where prices are formed, both the price of money market funding and the price of risky capital market lending.

Supposing that Volcker’s proposal became law tomorrow, the mere institutional fact of unifying the regulatory apparatus would, I submit, force rapid progress to overcome the intellectual silos as well.  The problem though is that, without that intellectual progress, Volcker’s proposal is very unlikely to become law any time soon.  We are stuck in a bad equilibrium, where regulatory and intellectual silos support one another.  Our challenge is to set our eyes on the good equilibrium, where both the regulatory system and the intellectual system connect with the actual reality of the modern credit system.

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  1. Chauncey Gardiner

    Excellent post. Agree that those who occupy regulatory silos and intellectual silos have and will likely continue to impede efforts to meaningfully reform the financial system absent the political will to change. Those who sponsor and fund the individuals who occupy senior positions in those “silos”, and their political and economic ideology, are also likely to again lead us to future systemic breakdowns absent such change. Taking massive private wealth that has been accumulated as a result of control fraud, racketeering, securities fraud, monopolies, and corporate stock buybacks and highly leveraged acquisitions with zero interest money out of the political system is a necessary precondition to successfully dismantling these silos IMO. The stakes are very high, and I expect resistance from those who view their interests as lying in perpetuating the regulatory and legal status quo will continue.

    Hats off to Paul Volcker and the Volcker Alliance. I was previously unaware of their existence. Golly, I wonder why?

  2. susan the other

    Reshaping the Financial Regulatory System. The Volcker Alliance. What a good read. The unregulated derivatives market is such a nightmare, I thought they were never going to get their act together. But this shows they have. Don’t faint. So now they are recommending to combine the SEC with the CFTC into a new agency – the Investor Protection and Capital Market Conduct oversight. Bringing commodities, futures, and their hybrid – derivatives – under the same supervision as securities. This should have been done long ago. And some other tidbits to insure the independence of the Fed and the financial system: Let the Sec of Treasury sit in on the big oversight meetings but have no vote. Completely eliminate the OCC – that will go a long way toward eliminating regulatory capture. This study even used the F word! And they were quite capable of defining things clearly. They complained about the too-fast evolution of new products which blur the line between futures and securities (that’s gotta be the definition of a derivative, no?). I wish they had proffered a few more definitions, like the difference between an unregulated commodity and a very regulated currency and how one can destroy the other. Maybe because there is no middle ground. Wouldn’t this awareness require trading to stop when it gets irrational? I also think they should have talked more about the overlap of finance and insurance. Anyway, the new SEC-CFTC is a good direction.

  3. Russell Scott Day/Transcendia

    So then for the time being what can be done to prevent Derivatives and Credit Default Swaps from having insurance from AIG? – or whatever name some legacy insurer is using.
    What I want to see stopped is the extension of insurance to financial instruments unworthy of being underwritten.
    The US Citizenry was put in the position of the Reinsurer, of the company that was supposed to be the biggest and best, and have all losses end with it.
    From my point of view the bankers and traders with few real ways to support the economy work only in their own narrow interests ridding on the extension of insurance to products no one but themselves benefit from trading.

  4. craazyman

    Shlt I can’t believe this post only got 4 comments in 2 days. I guess not everybody’s cut out to ponder and debate prudential financial regulatory supervision. maybe everybody’s either too cynical by now to even pay attention OR they just say Fukk it and figure “No matter how bad it gets, I’ll be one step ahead of the asteroid with a huge put option trade or an appropriately timed precious metals leveraged long position.” OR both! Then you just lay back and say “Whoa”, just imagining how good it’ll be to do nothing and waste every second of the day utterly and without the slightest trace of meaning, and think of all the ways you’ll quit the job, just how bad the shouting will get. hahahaha. Anyway, I guess there’s only a very small subset of humanity that can actually pay attention to this topic long enough to get out a few sentences. Of those, only a small percentage will remain conscious for an entire conversation. That’s maybe 38 people out of 6 billion on earth. You guys, you guys are the only ones who can get this right. So all the rest of us, we’re counting on you not to blow it!

    1. craazyboy

      Well, I liked the post, but it’s one of those wonky topics where what can you say? The only thing I can think of is “Sure, if Volker thinks it’s good – let’s do it. Absolutely. Will something bad happen without an OCC? Not a chance! Someone rubber stamp this thing. Volker Rule Uber Alles! Full Speed Ahead – Damn The Torpedoes!”

      Sounds a bit like cheerleading, I know, but’s it’s all I can come up with.

    2. Lambert Strether

      When the next recession comes along, and this recovery is not only crappy but quite long in the tooth, NC is going to look pretty good, having called out the next generation of perps for some time now.

  5. Chris Hall

    I took Prof. Mehrling on line course. He understands how the world money markets work and how important they are in the global market. He also understands the weaknesses of the system. If he is recommending Congress enact what the Volcker group is proposing then we should do it.
    There is a tax policy we should also enact to improve the stability of our economy. Go to for more information.

  6. TheCatSaid

    It’s such a no-brainer. What else can one say?

    Is putting energy into trying to change a corrupt, captured, dead-in-the-water system the best use of our energy?

    Shouldn’t we be trying to create new, better ways of interacting, right now, wherever we see the opportunity?
    “TINA” is the big lie we’re meant to internalize.

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