"Financial Reform, or Another Reason to Dis Bankers?"

Sydney M. Williams

Thought of the Day

“Financial Reform, or Another Reason to Dis Bankers?”

June 23, 2010

Congress is intent on getting a financial reform bill on the President’s desk before the 4th of July. It is ironic that the day we celebrate our Independence may well be spent tightening regulations under which we live. Of course, there is little question that bank reform is needed. In the course of the financial crisis, a few banks fell into the abyss; others only peered over the precipice. Bank’s required capital ratios did not include off balance sheet assets, nor were they able to fully reflect their myriad derivatives operations. Raising bank’s capital requirements makes good sense. Borrowing short and lending long is, of course, the business of banks, but with narrow spreads the temptresses of proprietary trading desks became impossible to ignore.

At the same time, shareholders, managements and employees all demanded more money, so risk levels were lifted, for we were living a Panglossian life where nothing ever went wrong – until it did.

We now have financial reform bills that have, separately, passed the House and the Senate and must be reconciled before being presented to the President. In another bit of irony, the Senators and Representatives who have responsibility for shepherding the bills are generally those who have been the principal beneficiaries of the lobbying efforts of the banks and financial institutions effected. (As an aside, these all-too-comfortable relations between regulator and regulated are, in my opinion, another compelling argument for term limits. An apple for the teacher is one thing, a sack full of cash quite another.)

According to yesterday’s New York Times, there are three remaining unresolved issues: How to regulate derivatives trading; restrictions (if any) on banks investing or trading their own funds, and whether stronger “buffers” should be required against unexpected losses.

Derivatives, in my opinion, should be traded on sun-lit exchanges, with counter-parties clearly delineated. In terms of the second issue, personally I am a fan of reinstating Glass-Steagall, but that seems unlikely. Of course that problem and the third would not be issues if management were required to have substantial ownership in their banks – stock not options – and if the banks were deemed not too big to fail. Government should make the rules, which should be clear and concise, and they should enforce them. Businesses (including banks), investors and speculators should be allowed to succeed and/or fail. A bank that is too big to fail is too big.

An article in Tuesday’s Wall Street Journal reported that the Federal Reserve on Monday adopted rules that will give regulators power over the compensation for thousands of bank employees from senior management to traders. The rationale is to prevent bank employees from taking undue risk, placing the bank at risk. Since the Federal government insures deposits, they should set parameters as to how those particular liabilities are invested. But as for the banks own assets, could not the same end be achieved, as mentioned in the previous paragraph, with requiring significant management equity ownership in their bank and explicit guarantees that the bank would not be saved, should it fail through self-inflicted errors, either ones of omission or of commission? When the boss’s capital is on the line, rogue traders, knowing they would be watched more closely and fired more quickly, would exercise more caution.

Deals have apparently been reached for issues such as debit card fees, which are collected by merchants and rebated to banks – about $15.8 billion last year according to Tuesday’s New York Times. However, the Fed has decided that the fees would apply only to those banks with more than $10 billion in assets – about 120 banks who control about two-thirds of debit card transactions. While smaller banks will undoubtedly take more share, the impacted banks are sure to offset the decline in debit card fees by raising fees for other products. Whatever happens, the consumer is unlikely to be a winner.

White House officials have said they do not want special, one-off deals, such as the one Senator Blanche Lincoln is attempting to arrange for Arvest Bank in Arkansas, largely owned by the Walton family. The Administration should stand fast.

The President sees himself as the author of sweeping social legislation – a man for the ages who will bring redemption to millions of Americans who have suffered, during the past decade, from a miasma of capitalism. A health care bill, the consequences of which are making people increasingly nervous as they learn more of its impact, has been signed into law. Financial reform looks like it will be next and, like the health care bill, is of sufficient length most people, including legislators, will be unable to anticipate its consequences. BP’s disastrous spill in the Gulf will be used to hasten a cap-and-trade bill. The complexities of these bills are such that they primarily serve to make large headlines, provide job opportunities for lawyers, while generally restricting individual freedom and choice.

Greed dominated the actions of too many bankers over the past few years, but it should not be forgotten that much of what they did was under regulators who chose not to regulate, and Congressmen who looked piously toward the sky while extending outward their palms toward these same bankers. To treat the industry as a Jezebel from Sodom or Gomorrah risks losing many of the industrious and creative people who populate the industry. Reform should truly make things better and safer, not just add another layer of regulation. As David Brooks put it so well in his column yesterday in the New York Times: “If your policies undermine personal responsibility by separating the link between effort and reward, voters will punish you for it.”

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I will be out until Tuesday of next week, hiking in New Hampshire’s White Mountains with one of my sons, two grandchildren and a few friends. If all goes well, weather and legs permitting, we will climb the northern Presidentials. Hiking a steep and rocky trail, placing one foot in front of the other, will consume my daily thoughts.