Panic

David Brooks Joins Morgenson in Noticing the Real Problem with Dodd/Frank

Who regulates the regulators?

In the wake of Gretchen Morgenson’s terrific column yesterday we just didn’t think the New York Times could ever make us happier. Then they do it again. I won’t rehash David’s column here. Go read it.

We will just say that on the question of solutions,  David, like Morgenson has gone in a sub-optimal direction.

But we are trying to get in touch to persuade him to take the “revelation not regulation” pledge.

For Gretchen Morgenson to come right out and say, at length and in detail, that the current approach to financial reform is mostly a reaffirmation of the status quo is a huge development. Morgenson is respected by everyone (she is also the single-most-quoted source in PANIC). It will be very hard to represent opposition to this bill as sucking up to the banks with people of her stature saying this kind of thing.

That’s what we have been saying all along about both the Dodd and Frank bills as well as lame Republican compromises—they are  not so much evil as irrelevant; they change nothing.

Before the crash we had vague consensus among the regulators that the banks should do: exactly what they were doing—including mortgage backed securities, which the regulators loved.

Under Dodd/Frank we would have a formal consensus of the Council of Regulators that the banks should do: exactly what they are doing.

Before we had no plan for “resolving” the simultaneous failure of several-trillion-dollar mega banks.

Now we have a hopelessly inadequate plan: let the FDIC do it, despite zero evidence that the FDIC or any government agency is capable of pulling off such a complex  maneuver under pressure.

Last time round, from at least the fall of Bear Sterns in March 2008 onward,  the government had its own auditors and risk managers sitting in the executive suites of every one of the major banks. And yet the government still had no plan by September, which is how it ended up throwing $700 billion in taxpayer bailouts at the problem.

Under Dodd,  a $50 billion kiddie pool raised from the banks is supposed to be enough to keep the taxpayers off the hook.

Under the old system, consumer protection became a paramount concern of banking regulation, trumping safety and soundness. That’s how we got zero-percent-down liar’s loans. What we now call “predatory lending” used to be the fight against redlining.

Under the new system some new consumer protection fad—not predatory lending, which is now evil—would be allowed to trump safety and soundness.

Finally, under the old system Congress retained essentially direct supervision of Fannie and Freddie, ignoring the recommendations of a toothless regulator and swearing  up and down it would not let the twins become a systemic danger.

Under the new system Congress retains essential control of Fannie and Freddie and says it will get around to addressing the problem someday.

Still, precisely because the current approach is an irrelevant reaffirmation of the status quo, rather than evil in a new and clever way, it doesn’t need to be killed. All Congress needs to do is add one reform that actually will work. Morgenson, like Prof. Kling over at Cato, suggests breaking up the banks—just don’t let them be too big to fail. We don’t really care about that; but it also won’t solve the problem. U.S. History shows that lots of little banks failing can be every bit as disastrous as  few big banks going down.

Our solution, as always, is not to break up the banks but open them up. Make them publish a detailed, line by line, listing of their holdings—every stock, bond, option, swap, derivative, conventional loan and what have you, on and off balance sheet—not less than once a week, so investors will know which banks own garbage and which have the good stuff. Such a policy in place in 2004 would have reduced the mortgage crisis to a speed bump and certainly would have kept it from morphing into a banking crisis.

Republicans should not obstruct the Dodd/Frank bill and align themselves with the defenders of the megabanks. They should ask for one little thing in return for their support; better markets. President Obama in his speech lined up behind Dodd, Frank and the misguided belief that regulators can actually grasp what the megabanks are doing. There is very little evidence that this is true.

The glaring and disheartening reality is that last time around the regulators endorsed and often required every one of the practices that led to the crisis. Complex mortgage backed securities, which were at the heart of the crisis, with their bogus AAA ratings (conveyed by government-regulated ratings agencies), were mass produced in such huge volume largely because the regulators had blessed them as the safest of all possible bank investments, short of U.S. Treasuries.

That’s why we have proposed the one truly radical reform that would have prevented both the mortgage crisis and the crash and would do far more to prevent future catastrophes: Require “Full Disclosure of Assets” from every U.S. financial institution managing other people’s money.

Markets need information. Markets failed two years ago because for many years they were denied the information they needed to make good decisions, to separate good mortgages from bad, good banks from bad, and shift capital accordingly. For too long American banks have operated in the shadows, their inner workings hidden not from regulators (who have an invincible legal right to examine every line in the banks’ books) but from citizens and investors.

The Democrats want better regulators. That’s a Democrat thing. Republicans should be asking for their thing: better markets.

With the raw data public—every stock, every bond, every long, every short, every hedge, every swap—the short sellers and curmudgeons of the financial world would keep the banks on the straight and narrow and create an early warning system that would run rings around the regulators.

Let’s build redundancy into the system. Let the government regulators save us if they can, but with full disclosure of assets we can all check their work. That’s the best protection we can have.

Frank Luntz is a smart guy and a great “messager” but neither skill was required to state the obvious: The Dodd bill like the Frank bill massively reaffirms the status quo: regulators and bankers behind closed doors deciding which bank practices are safe and sound and which are risky and reckless—and getting it wrong as often as right.

The old regulators virtually wrote the script that led to the crash and the bailout. It is reasonable to expect they will do it again. And since bailing out a clutch of megabanks cost almost $1 trillion last time, there’s no way the $50 billion kiddy pool created by the Dem bills will forestall future bailouts.

QED: Luntz is right the Dem bill = more bailouts in the future.

What we would love to see is for Luntz to get behind the one really tough-on-the-banks but pro-market reform the GOP should be going for: No more banking in the dark. Require every bank, every financial institution that manages other people’s money to disclose every investment position, every asset, and every liability not less than once a week, between market close on Friday and market open on Monday morning.

Not accountants’ summaries. The raw data. Every stock, every bond, every long, every short, every hedge, every swap. All of it. Collectively millions and millions of lines of data.

If that data had been public in 2004 the short-sellers of the world would have cut off the worst banks making the worst loans and the mortgage crisis would have been a speed bump.

So let the Dems set up their grand high council of regulatory poo-bahs. We hope it works. But just in case they do again exactly what they did before, let’s back up the poo-bahs with 100 million citizen investors armed with the truth.

We’ve been pushing this idea everywhere: Fox, Barron’s, NRO, the New York Times. But the audience that really needs to hear it is Luntz’s audience: Republican lawmakers who need to be truly and righteously tough on bad banks, while staying true to free market principles.

Go with it Frankie baby, and don’t say we never gave you anything. Add Content…

Democrat Solutions? Republican Solutions? Let’s have both.

The President’s speech was a lot like the Dodd and Frank bills themselves. To the extent one believes that regulators numbering, practically speaking, in the dozens for any one of these giant firms, can actually get a firm grasp on what the megabanks are doing, what they own and what they owe, or reliably distinguish risky and reckless practices from safe and sound, then the President’s vision has a chance of succeeding. We certainly don’t want to get in the way of his trying. By all means, give the regulators the tools they ask for and let them do their best.

It’s just that there is so very little evidence that they can succeed. The glaring and disheartening truth is that last time round the regulators endorsed and often required every one of the practices that led to the crisis. Even the staggeringly complex mortgage backed securities at the heart of the crisis, with their bogus AAA ratings (conveyed by government-regulated ratings agencies) were mass produced in such huge volume largely because the regulators had blessed them as the safest of all possible bank investments, short of U.S. Treasuries.

Still, some version of the Dodd/Frank bill will become law within weeks or days. Republicans should not obstruct that effort. On the contrary they should offer their full support. Better regulation is one possible answer to the problem. But in return Republicans should ask for one little thing.

The Democrats want better regulators. That’s a Democrat thing. Republicans should want better markets; that’s our thing. And the way to get better markets is to give them better information. Markets failed two years ago because for many years markets were denied the information they needed to make good decisions, to separate good mortgages from bad, good banks from bad, and shift capital accordingly.

For too long the American banks have operated in the shadows, their inner workings hidden not from regulators (who have an invincible legal right to examine every line in the banks’ books) but from citizens and investors. That’s why we have proposed the one truly radical reform that would have prevented both the mortgage crisis and the crash and would do far more to prevent future catastrophes: Require every significant financial institution in the U.S., any firm managing other people’s money, to disclose every investment position, every asset, and every liability not less than once a week, between market close on Friday and market open on Monday morning.

We don’t mean mere accountants’ summaries. We mean the raw data. Every stock, every bond, every long, every short, every hedge, every swap. All of it. Collectively millions and millions of lines of data.

At first it would be too much data even to be useful. But as the short sellers and curmudgeons, the rag and bone shops of the financial world gradually absorbed the data and constituted massive parallel processing systems over months and years we bet the result would be an early warning system that would run rings around the regulators and do far more to keep the banks on the straight and narrow than any grand high council or regulatory poo-bahs.

No, we say not one word against the grand high council. Let them commence their duties this minute. But let’s give them some help. Let’s back up dozens, nay hundreds, of regulators with millions of citizen investors. Let’s build redundancy into the system. Let the government save us if it can. But in the end letting our fellow citizens back into the game is the best protection we can have.

Richard was on with a Christian radio host, Craig Roberts (KFAX, San Francisco) last night, pitching our full disclosure, no-more-secret-banking proposal. Show went well. Then two minutes after Richard gets off the air the KFAX producer calls him and says, “Craig loves the idea so much that he’s come up with a slogan for you: ‘We Don’t Need Regulation, We Need Revelation!’”

We love it, so that’s the new slogan. It can be shortened in handy ways too, like ‘revelation not regulation’ which makes it all the better.

Spread the word!

AR & RV

PANIC coauthor Richard Vigilante talked to Fox Business:

Are the plaintiffs in the Goldman case crybabies?

Snippet: “What was Goldman supposed to disclose: that the guy on the short side was smarter — like way, way, way smarter — than Goldman’s clients on the long side?”

Read the rest on The Corner at NRO.

Snip: Our “proposal for tougher financial regulation…sounds interesting and is very much worth reading.” But he does quibble with our “overtoughly tough” words for Frank and Dodd.

Check it out here.

Michael Barone asks the right questions, we offer the right answer

If Republicans had three House members or one Senator as smart as Michael the GOP would be unstoppable this fall.

No such luck.

Barone, writing today, on financial reform is right on all three points he raises in his piece.

First, Republicans must offer their own agenda on financial reform and their reforms have to be tougher and more effective than Democrats’.

Fortunately, as he points out, that would not be so hard. The great Democrat reform, crafted by two of the greatest bank-whores ever to disgrace the halls of Congress, Frank and Dodd, does nothing but hit the replay button on the past 20 years. The “council of financial regulators” perpetuates the cozy club of big bankers and big regulators that got us here in the first place. And, as Barone points out, the new FDIC-managed “resolution authority” would not only officially write too-big-to-fail into federal law, it would place that authority in the hands of an agency that gives no evidence of knowing how to shut down trillion dollar banks without blowing up the world.

Finally, Barone is right also that the consumer financial protection agency, which the GOP is spending so much energy and political capital opposing, is mostly a distraction at the moment. The consumer agency is bad in theory, maybe worse than Barone seems to think. But for the next decade or so it is unlikely to do much harm. For the couple decades preceding the crisis, the “pro-consumer” position was to give every citizen with a pulse and a plausible grievance a mortgage regardless of ability to pay, i.e. what we now call “predatory lending.” To be pro-consumer was to be hostile to bank safety. These days and for the foreseeable future, the pro-consumer fashion is to favor conservative lending. The nation can live with that.

What Barone does not offer is a suggestion for a Republican reform.

We’ve got one. We’ve been pushing it like crazy. And with help from someone like Michael it might catch on.

Any Republican solution must rest on three insights.

I. Yes, markets did fail. Financial markets should have disciplined the banks, depriving them of the funding to make bad mortgages and they didn’t.

II. Markets failed because the reigning ideology of Wall Street, backed to the hilt by the regulators and long-standing government policies favoring bank secrecy, deprived investors of the information they needed to assess the banks’ behavior. Worse, banks and regulators alike actively (and not always unwittingly) supplied disinformation to the market. Essentially every central bank and every government of the developed economies, for instance, agreed to favor banks that held impossibly complex mortgage backed securities over banks that held traditional mortgages. As Nicole Gelinas has pointed out, one reason there was such a huge market for these supposedly AAA mortgage securities was that regulators regarded them as the safest of all possible bank investments. The Basel group, which coordinates bank regulation internationally, actively encouraged banks to adopt maddeningly complex and unverifiable “risk management” algorithms in place of traditional credit analysis. Weeks before Citigroup began write-downs that would eventually total more than $40 billion, it’s “Value at Risk” algorithm told the world Citi was at risk for losing no more than $100 million. Regulators cheered; markets were blindsided.

III. The way to make markets work is to give them the information they need. Here is a simple but radical proposal that banks would hate (they do not hate the Dodd bill) but supports real capitalism and would have prevented the recent crisis:

Make the banks disclose everything they own, every stock, bond and derivative, every mortgage or commercial loan, not in an accountant’s summary but line by line, millions of lines of data for the big banks, every Monday morning before markets open.

Had such a policy been in place in 2004, the mortgage crisis would have been a speed bump and the banking crisis never would have happened. The reason the banks got in trouble is that neither bank executives nor their investors had a good handle on what the banks actually owned.

As defaults began to mount in 2004 it was just barely possible, albeit with a good deal of work, to sort good mortgage securities from bad, to identify those that were suffering lots of defaults and those that were pretty sound. John Paulson, a great American, made billions doing just that and helped contain the crisis by doing so.

What was not possible was to figure out which banks owned which mortgage securities. We could sort good securities from bad, but not good banks from bad.

The result was that for years investors took both good and bad banks at their word (backed by the regulators and the ratings agencies. After all if the Fed or the FDIC lets a bank keep operating, it must be OK, right?) Then when panic struck, investors fled all the banks, staging a modern version of a run. To this day we do not know for sure whether Bear or Lehman or even Merrill were “really” broke or simply ripped limb from limb by an angry mob.

Full disclosure would have achieved two things:

First, banks making or buying too many bad mortgages would have seen their funding dry up, probably by early 2005. Since most of the worst loans, the loans that really broke the banks, were written from late 2005 through early 2007, the mortgage crisis itself would have been reduced to a speed bump.

Second, even if the mortgage crisis had not been averted, bank creditors would have been able calmly to sort the sheep from the goats rather than creating a general panic and turning the mortgage crunch into a banking collapse.

We work in the investment industry. The one legitimate objection we can foresee to our proposal is that it would unfairly disadvantage banks compared to other investment firms. Fine. Apply the rule to everyone. Require any firm that either manages other people’s money, or at least $10 million of its own, to disclose all its investments as well, every Monday morning. We’d love to operate in such an open market. Secrecy favors cretins, cravens and crooks; smart honest firms would thrive under our plan.

Nor does our proposal violate any legitimate privacy concerns. The lien holder on a mortgage is already a matter of public record: our disclosure rule would just make it easier to review a particular banks’ loans by having them listed in one place. As for the public securities held in a bank’s portfolio, there is not and never has been any possible justification for concealing the ownership of publicly traded securities. Secrecy invites corruption.

No modern bank is a pure free market institution any more than lawyers, officers of the court, are free market players. Both live off the power and wealth of government. And government has no right to privacy.