Banks' sleight of hand could lead to regulatory slippage

By focusing attention on the shadow banking system, bank chiefs might be deploying a diversionary tactic to block regulatory reforms.

Emboldened by strong revenues and profits, and maybe confident that time has dimmed outraged memories, banks are becoming more confrontational. The risk is that their influence on policymaking leads to regulatory slippage before the new rules are fully in place.

Late last year, Lloyds Banking Group said in its evidence to the UK’s Independent Commission on Banking that new regulation “may make matters worse rather than better”. Barclays even asserted that banks should be “free to pursue” whatever business model they wanted.

In January, Jamie Dimon, chief executive of J.P. Morgan Chase, reflected the mood among top bankers at the Davos World Economic Forum when he attacked poor and excessive regulation, and whinged about “banker bashing”.

Peter Sands, chief executive of Standard Chartered, warned of the dangers of over-regulation and complained that “wildly complicated” and “irrelevant” rules could hurt economic growth and hinder economic recovery.

Their complaints are targeted at the extensive controls, restrictions and oversights imposed by last summer’s Dodd-Frank Act in the US, legislation still being formulated in Europe and the UK, attempts to coordinate measures by the G20-sponsored Financial Stability Board and by the lifting of capital requirements stipulated by Basel III rules.

The intention of erecting new regulatory frameworks and creating stronger supervisory regimes is obviously to prevent future systemic financial crises, and address the issue of financial institutions that are “too big to fail” and become a burden the taxpayer must bear.

With so much at stake, bankers, not surprisingly, have found plenty to get worked up about. The danger is that well-meaning criticisms will get swamped by self-interest and turn the dialogue into a filibuster. Maybe that’s already happened.

To take one example, critics have argued that the Dodd-Frank Act fails to provide for Federal Reserve assistance for important non-bank financial institutions, does nothing to reform key firms such as Fannie Mae and Freddie Mac, and doesn’t offer a roadmap for the resolution of future problems in other parts of the shadow banking system, such as money market funds.

On the other hand, the act sets up a council that can decide whether a non-bank financial firm is systemically important, then regulate it and even break it up.

But, complaints have focused on the perceived inadequacy of these provisions.

During the past six months, heads of leading US banks have taken turns to warn that the next crisis could take place among unregulated or loosely regulated sectors. Post-crisis reforms might create “non-bank monsters”, in the words of Jamie Dimon. Goldman Sachs, among others, has joined the chorus.

Gary Cohn, president of Goldman Sachs, told the Financial Times earlier this year that he worries that, in the next cycle, “as the regulatory pendulum swings, we are going to have to use taxpayer money to bail out unregulated businesses.”

These could well be genuine anxieties, but their simultaneous gripes about over-regulation of their own institutions suggest that this is a sleight of hand. In fact, it seems that they are worried that business will be taken away from them, and that they will be unable to compete on a level playing field. Reduce regulation is the implied message.

This targeting of non-bank financial institutions is resonant of the plaintive wails made by bankers several years ago. The result was the dismantling of rules designed to contain risk, restrain speculative excesses and protect depositors, as well as prevent systemic collapse.

In particular, the repeal of the Glass-Steagall Act in 1999, which ended the Depression-era separation of commercial and investment banking, came after intensive lobbying by banks, which argued that they had to compete on an unlevel playing field with all those non-bank financial institutions that could profit from the growth of capital markets and innovative financial instruments. They too wanted a share. So, instead of bringing those “shadow” banks within the regulatory framework, US legislators simply knocked down the edifice.

The repeal of Glass-Steagall was the harbinger of a host of other deregulatory measures that made up what Simon Johnson, a professor at MIT and former chief economist of the IMF, described as “The Quiet Coup”, in the Atlantic magazine in May 2009.

These included the Securities and Exchange Commission’s agreement in 2004 to cut capital requirements for the big five investment banks, paving the way for the huge increases in leverage they then deployed; and the congressional ban on regulation of credit default swaps, aggressively supported by Lawrence Summers, deputy secretary at the US Treasury Department — who had also advocated the ditching of Glass-Steagall.

A mix-and-match of regulatory bodies, understaffed, underpaid and — as free-market zealots remind us — also under-qualified (otherwise they would be players not referees) failed to update the rules to keep up with the pace of financial innovation. Johnson even suggests this was intentional.

At the international level, Basel II allowed banks, in effect, to measure the riskiness of their own assets in partnership with the barely disinterested credit rating agencies.

The net result was an anarchic regime of deregulation and “unregulation”, in tune with the laissez-faire ideology of leading bankers, US Treasury officials, and, of course, Federal Reserve chairman Alan Greenspan, inspired by the creed of Ayn Rand and her brand of “Objectivism”.

Deregulation and toothless supervision was wholly consistent with the dominant culture: markets knew best, pesky rules were obstacles to individual enterprise and collective growth. Every event, every legal lacuna, offered banks a money-making opportunity. The more, the merrier, and regulators, directed by ideologues in government, acted as milch cows.

The danger now is that well-meaning discussions turn into a self-serving filibuster, and that Dodd-Frank and other legislation might be diluted. Dimon’s comments, if representative among the great and the good — or the rich and shifty — arouse suspicions that they are, especially when attention is simultaneously directed at non-bank financial firms.

It’s important to watch for that sleight of hand.

¬ Haymarket Media Limited. All rights reserved.

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