It seems, nothing has changed that would shield us from another financial meltdown brought on by the banks. This article was published a couple of days ago about the culture of banking regulators at the Fed and being too cozy with the banks they regulate. They essentially, don’t want to piss off the banks. A former Fed employee, a bank regulator who was stationed at Goldman Sachs, made recordings of her meetings and interactions with her bosses at the Fed. Fascinating stuff.
The recording is from a radio-type podcast from American Life. It’s over an hour but well worth listening to. At first, I was a little put off by the editorializing of Carmen Segarra’s recordings. Too much describing of the recordings by the host rather than the actual recordings. But as it presses on, it does seem credible. The most interesting part is toward the end when they highlight a conflict of interest. A larger energy company is buying a smaller one. Goldman Sachs is employed as an adviser to the smaller company, yet owns huge shares of the larger company. This turns into a huge back and forth between Segarra and her bosses and eventually leads to her being fired.
One thing the story dances around because it can’t come out and just say it is that many regulators later go on to work for the banks that they’re regulating. As a result, the regulators are constantly thinking about how their actions will affect their future employment prospects which results in the kind of soft shoeing you see in the recordings.
I listened to most of this on NPR today, and they spent quite a bit of time discussing Regulator Capture, and the flow of people between government and the private sector. I think that covers it pretty well.
It’s true that regulatory capture, etc., is a problem, but I disagree that nothing has changed. Maybe regulations could have gone further, but the Dodd Frank law and the Basel III accords really has made things different for banks:
More capital required
Much more liquidity required
Proprietary trading is mostly eliminated
Relying on external ratings is disallowed
More institutions subject to regulations and oversight
There are more changes as well. It’s simply not true that nothing has changed. Will there never be another crisis? Of course there will be. But the financial system is definitely safer than it was leading up to the crisis.
I recommend the book “The Divide” by Matt Taibbi, for anyone interested in this topic. One of the observations in the book is around the idea of “Collateral Damage” (based on the Holder Memo). This means federal prosecutors will assess what would happen if a big bank were found guilty of malfeasance of some kind. They do this assessment BEFORE prosecuting, no matter what laws have been broken. They want to know what damage may be done to the economy if a company is found guilty (e.g. loss of jobs, a la Arthur Anderson). This is where “Too big to fail” was born. Small banks are fair game, tho.
This assessment is done, and then negotiations take place with the offending firms, and they are let-off with a fine, and not forced to admit wrongdoing, and no one goes to jail. Without any skin in the game, the same banksters will rip us off again - there is no incentive to play by the rules. The bankers and the regulators are very much still deep in bed together.
But if the regulators, whose job it is to deduce the banks are violating those new regs, are too close to those banks to make those deductions? That was kind of the point of the story. If you looked at the story, you noticed how the Fed regulators bent over backwards to try to say Goldman had a company-wide conflict of interest policy and browbeat Segarra to fall in line with that, even though she clearly disagreed. She eventually relented.
Now, if we take one of the new Dodd-Frank regs of requiring more capital. What if a bank told their regulators, “hey, we have more capital because of XYZ”, and the regulators, due to regulator capture, simply agrees with them. The banks still get what they want and essentially nothing has changed.
Probably because they were taking on a high profile, controversial topic and wanted to stick scrupulously to statements that they could rigorously support and defend. When it comes down to issues of judging motivation and intention, things are always murkier. They provided enough bricks to lay out the case that regulators were motivated by future job opportunities to softshoe but left it up to the listeners to build the wall.
I’d say that regulatory capture is definitely an issue for every industry and regulator, but if she thinks that’s how it really works at banks, she’s just wrong. Banks and other regulated financial institutions may get leeway at the margins, but there’s no way they are going to say, “Hey, we have enough capital” and that’s that.
During the lead-up to the crisis, there was certainly fraud, but the rules themselves were lax enough that the crisis could have happened, with or without regulatory capture. Mortgage companies like Countrywide were lightly regulated, now they fall fully under the regulations. Securities firms like Lehman and insurance companies like AIG were not covered by banking regulations at all, now they would be. The new regulations have gone a long way towards getting rid of big parts of the shadow banking system.
Remember in my scenario where the bank says, “hey we have enough capital because of XYZ”? Well “XYZ” refers to an accounting maneuver (or trick). Say, the bank transfers an asset from one division to another, or counts the value of an asset they might manage but don’t own, or whatever else a clever accountant might do. Which would make the question of whether the bank truly has enough capital highly subjective and debatable. The regulators right now are too likely to side with the banks view.
What counts as capital is pretty clearly delineated in the regulations. I’m saying that you’re wrong about how that works, and that’s not what happened during the build-up to the crisis anyway. AIG, for example, wasn’t regulated as a bank at all, so the division writing the huge credit default swaps wasn’t required to hold capital like a bank would. They were acting like a bank without the bank regulations. Countrywide was acting like a bank without the bank regulations, since they were a mortgage company, not a bank.
That’s all new and it give the bank regulators many more powers over insurance companies, mortgage companies, and other entities acting like banks.
Anyway, you’re just not correct that a bank can put some fake assets into some off-balance sheet entity and the regulators will accept that as capital.
There is surely some regulatory capture, but not like you’re envisioning. Not even close.
This is FAR from my area of expertise. I know in my own tax experience, “capital” is a pretty flexible thing but it seems pretty mundane to argue over what it is or isn’t. My point is, in areas that ARE debatable, whether capital or anything else, regulators are more likely to take the banks view of things. Which gives the banks leave to engage in the same or similar risky practices that led to the meltdown.