Policies and new laws in the UK are as often, or perhaps more so, inspired by examples set in the USA than in the European Union. There is an economic logic to the UK copying new developments in the USA alongside political treaty necessity to comply with EU rules. In the case of financial regulation, the UK Conservative Party is minded to copy US thinking. There are always problems with borrowed policies helicoptered in from other jurisdictions and cultures, however close to our own. One such problem is politicians relying on solutions arrived at only intuitively, unchecked, untested, relying on what looks good flashed across the Atlantic or the English Channel - and sometimes relying on sound-bite ideas merely because they make good media headlines. One such intuitive assumption is that it should be possible to copy the USA if it turns its own clock back to split investment banking from
narrow banking ('traditional banking'), an idea linked to 'narrow-thinking' in many legislators' minds that regulation of banks is merely about consumer and taxpayer protection - as if by splitting the banks we can ensure that only one side of finance is safe, the part that matters to 'ordinary' customers, consumers, taxpayers, while the other part may safely prosper or curl up and die to no great effect on the real world of the real economy? This is wishful thinking. However ugly high finance seems today, giving it two faces or two heads will not solve the the fact that all of finance is part of the same economy.
The idea of a return to narrow-banking is strenuously resisted by Europe's 'universal' banks even more strongly than on Wall Street. The UK is currently in two minds about this, but looks like resisting the idea at first sight too, but that may change if there is a change in government - if we believe Conservative election-speak?
The UK is arguably politically and economically somewhere betwixt and between USA federalism and EU federalism. Some politicians and other policy-makers would like to see the UK government system become more like that of the USA with a Presidential Executive and two elected legislative chambers, whether or not within a more federalist EU system. Similarly, there are those who cannot but look to the USA's system of regulatory agencies and seek to ape that too. UK and USA policy-makers dominated the creation of the G20 agenda for global financial regulation. There is no doubt that UK and USA responses to the credit crunch have been highly coordinated - so why not have the same (US) regulatory systems? All countries are striving to comply with Basel II capital Accord rules and laws.
How regulation is organised is, however, a movable feast in both form and content. Changes are being tabled to recombine some responsibilities and separate out others. What new regulatory jigsaw emerges in the USA and UK, may depend on how keen both major parties in each country are to woo populist gut-feel instincts of Main Street while at the same time leveraging (some say 'blackmailing') campaign funds out of Wall Street and The City - made so much easier in the USA now that there are no limits following The Supreme Court's decision to class all paid-for private funding of political parties (directly and indirectly) under the constitutional right to
free speech - the result is that the policy debate may pull more strongly than before in a number of directions - the marketplace of ideas is also a financial marketplace and now no more appropriately so than in financial regulation. US policy-making, whether in foreign affairs, health, banking, or anything else, is market-led, market-driven, more so than ever. Moral and ethical choices, however technical, let the market decide! In the somewhat less self-confident UK this may mean letting the US market decide?
A fortnight after the FSA's Hector Sants announced a new structure to beef up financial stability supervision and provide a combined overview of all major retail and wholesale risks, The Conservative Party said it would abolish the FSA. On 19th July 2009, George Osborne, shadow chancellor, announced his intention to turn the FSA into a
Consumer (Financial) Protection Agency within the Bank of England, while reserving the idea of creating an copy of the USA's SEC out of the FSA's securities regulatory role covering financial intermediaries - no mention of insurance and other non-bank financial sector firms. Consumer Protection is only a small part of what the FSA does, which is mainly to clarify and enforce European law in financial regulation. It appeared as if the Conservatives had taken their understanding of what the FSA does merely from a cursory reading of newsprint?
Despite FSA CEO Hector Sants' resignation in January 2010, and many objections to the Conservative plan from other quarters, there is so far no sign of Osborne thinking again? Let's recall what he said and then let's see what the Arianna Huffington said about the same idea in the USA.
Osborne said retail banks engaging in risky investment activity would have to set aside "very large amounts of money" as an insurance policy to protect the taxpayer from the cost of a bail-out in the event of a failure. [This was already happening, but he goes further to suggest splitting and breaking up the big banks.] He said certain "risky" investment banking activities "cannot really easily sit with taking retail deposits", [But stopped short of saying banks with investment banking alongside narrow-banking operations would be split]. He said such things were "best done internationally"... "If we just did it in Britain we would see the industry either leave this country or people get round the rules." [The UK Government and EU governments and regulators have ruled out splitting banks according to
The Volcker Rule that President Obama is keen to see implemented as a law restricting the banks' prop trading or splitting traditional (narrow) banking from investment banking - a return to pre-1999 Glass-Steagal?
This is based on the idea that banks risked insolvency because they minimised their capital to divert funds to investment trading on the banks' own account (proprietary trading) and on top of that over-borrowed to speculate more. Research by the FSA however shows that only 13% of banks' losses came from 'prop trading' while 70% was from asset write-downs in 'structured products'. Because 'structured products' are predominantly the buying and selling of slices of banks' loan-books and because this enormous many-$trillion market failed to develop into a liquid secondary cash market (and therefore grew massively as a derivatives market) it remained arguably within what could be defined as traditional banking related? To understand banks' insolvency problems, it cannot be done by picking on certain markets only; the answer needs a full double-entry balance sheet treatment to show how the credit crunch impacts liabilities (bank borrowings and deposits) as well as assets (loans and investments).
The crisis can also be defined by extreme bias (too much concentration in certain assets, especially mortgages) that compromised risk diversification in banks' balance sheets that in the case of the largest banks should balance traditional risk exposure across the whole of the economy and trading exposure across all of the markets - not chasing after where profits appear most bonus-friendly, not altogether unlike children chasing balloons in the playground.
Regulators can be divided between micro-prudential (single firm) and macro-prudential (all firms together) regulators, such as between FSA and Bank of England, or FDIC+SEC and The Federal Reserve. Taking a
diversified all risks combined view is not helped by the idea of splitting regulators according to different financial markets. The Sunday Times reported that Mr Osborne may float the idea of a separate markets regulator, like the US SEC, or the UK's LSE role before the FSA was set up by Labour, in addition to the Federal Reserve and Bank of England's supervisory role of systemic risk (
macro-economic financial market risk). Osborne has said he believes some banks were allowed to become too big - and he could set out plans to allow the Bank of England to break up banks whose size threatens the stability of the wider economy. In the UK, six banks have 85% of the domestic banking market, but five banks are especially large because of their multinational global presence, only one of whom, RBS, is fully (85% state ownership)in the power of the UK to break-up and shrink. It could also seek to break up LBS (43% state ownership), which is mainly a domestic UK bank, but it has options to wriggle free by buying its way out of that and by offering competition safeguards by keeping operations of its two banking licenses separate in cross-selling and geographically - maybe? Both of these banks have been scrutinised by the European Commission and the disposals agreed are not major. The combined disposals amount to roughly 10% of the UK banking market.
The thinking that inspired the idea of making the FSA's regulation of banks into an internal division of the Bank of England was inspired by similar ideas in the USA now gaining more traction as Tim Geithner recognises on behalf of President Obama that he has to make his actions more appealing to Main Street, which means being seen to punish the banks overtly somewhat harder.
and media comments suggesting that the credit crunch in general and individual bank failures in particular were in large measure due to regulatory responsibility falling between the legs of a three-legged stool, HM Treasury, Bank of England and the FSA, and in USA Treasury, Fed Reserve and FDIC and a host of others. It was claimed that too many regulatory authorities result in everyone's failure to coordinate and share information and see the catastrophe coming. This begs an answer to the question: was there information that if combined would have provided advance warning sufficient to prompt decisive action?" Most experts, including myself, would answer NO for reasons that are institutional as well as technical. Advance warnings were available in macro-economic forecasts but these were not readily linkable to macro-financial events because the central bankers did not have such models. It was not possible to access the equivalent of an engineering map such as of the US grid to determine probable failure. A few Keynesian models such as The levy Model could and did do this,but the results were lost in the cacophony of other voices.
There were fears and concerns and warnings expressed by central banks, but these largely went unheeded until it was too late. Therefore the central banks could only respond decisively, mainly after the crisis broke in the Summer of '07, and, in my view, the US and UK authorities did a brilliant a job and continue to do so.
At least with FSA and Bank of England separate, micro-prudential and macro-prudential issues are in the open, clear and distinct. If the FSA becomes merely a division of the central bank will conflicting perspectives merely be hidden within one institution, especially if micro-prudential actions always have to negotiate for approval first from the macro-prudential central bankers? This is the issue highlighted in the USA where moves are afoot to abolish the FDIC (already part of the Federal Reserve) by making it a more junior integral part of the Fed within a wider Consumer Credit Protection Agency.
In both the UK and the USA the thinking is partly that and partly 'taxpayer protection' when in both countries in fact not only bank depositors but also taxpayers have been protected - although how taxpayers are protected has not been made clear by the politicians and central banks, even if it is clear to me. They do not like to publicly expose how off-budget and off-balance sheet government and central bank accounting works - that part of governments' and central banks' financial funding that is floated on asset swaps and repos but hidden from public view 'below the line' like most of an iceberg.
One idea announced in October 2009 is 'living wills' - a form of self-assisted euthanasia now adopted on both sides of the Atlantic inspired by the FSA to be supervised by the G20 Financial Stability Board FSB. Thirty giant financial institutions have been chosen by the FSB (set up by G20 in Summer of 2009) for cross-border systemic-risk oversight and are especially tasked to write "living wills" that outline global wind-down plans in the aftermath of a solvency crisis. The banks are:-
N.America: Goldman Sachs (GS), JPMorgan (JPM), Bank of America (BAC), Royal Bank Of Canada (RY); -
U.K.: HSBC (HBC), Barclays (BCS), Royal Bank of Scotland (RBS), Standard Chartered (SCBFF.PK);-
C.Europe: UBS (UBS), Credit Suisse (CS), Societe Generale, BNP Paribas (BNPQY.PK), Santander (STD), BBVA (BFR), Unicredit, Banca Intesa, Deutsche Bank (DB), ING Group (ING);-
Japan: Mizuho (MFG), Sumitomo Mitsui, Nomura (NMR), Mitsubishi UFJ Financial Group (MTU); and
Insurers: AXA (AXA), Aegon (AEG), Allianz (AZ), Aviva (AV), Zurich, Swiss Re.
Banks will be required to draw up "living wills" - the global 30 most likely to cause a meltdown in the financial system, and within UK more than the top banks will have to set aside extra capital under new proposals by the FSA. To address the "too big to fail" concern, banks must demonstrate how they could be wound up without taxpayer bailouts. This is tricky, because the ratings agencies have warned that would lead to downgrades if banks could no longer be able to rely on lenders of last resort? The Government's City minister Lord Myners referred to "morbid wills", adding that
Too big to fail is a moral hazard that has an adverse affect on competition and the effective operation of markets. The popular view of markets is that they are interconnected and self-regulating like cogs in a fine watch. If the cogs have got jammed, mechanism over-wound, speeding or slowing recorded time, it must be because of some external interference like government or central banks' over-borrowing or cheap money. It is also believed by many that just as a watch tells the time, markets tell us where economies are and where they are heading to. The truth is that today's markets are like watches that have been taken apart nationally and globally. How they function is in some disarray. Market practitioners are not constrained by some super-prevailing hidden hand logic, but as easily moved to over-reaction and opportunism, counting on public fickleness and fearfulness, as driven by media comment and politicians' statements, and, of course, only as professionally ethical as their own greed versus fear will condone.
It is perhaps out of such cynical disappointment with the hitherto idealised view of market mechanisms that regulators now want banks to plan and fund their funerals in advance. Living wills are to function in 3 ways: 1. Pre-resolution: to allow banks to restructure operations before they get insolvent; 2. For when in resolution, have blueprints for break-up to help the authorities; 3. Post-resolution; funds to smooth problems in the aftermath of a bank's failure. Essentially, this is a funded manual of how to unwind insolvency problems painlessly without recourse to public funds. But, if a bank can provide that, the question arises why it has to fail, especially if a large part of the planned 'self-assisted euthanasia', as I call it, banks would also need to set aside more and better-quality capital. Banks have to choose and organise their coffins (let's say 'caskets') and leave taxpayers only with memories not an unpaid bill.
The idea is that "
Systemically important banks will require a further increment of capital and the most risky aspects of banking will need the support of a multiple of the existing capital requirements – a process which will itself lead to a significant reduction in the profitability of 'casino banking' and its ability to pay high bonuses," said government minister Lord Myners, adding, "
Long term, the impact of this approach is that it should provide incentives for firms to dismantle corporate or capital structures that might have been developed to exploit tax or regulatory arbitrage".
In my view, there is a balance sheet illogicality about this. The idea sounds intuitively promising, but the cost-benefit impact on banking and the macro-economy is not computable, and won't be for at least a few more years, not until regulators have macro-financial models to test the scenarios.
Coming on top of introducing new regulations (that collectively some call "Basel III"), institutional reorganisation to regulators is disruptive for minimal, hard to calculate benefits - should therefore not be an urgent priority.
In the USA, the FDIC is very clear about government support by insisting that banks have to pledge collateral in sufficient assets to more than cover the value of the support. But, in the USA as in the UK, the reality of how banks are supported; how the structured financial aid works is being lost in political grandstanding to reorganise the regulators, as if that is the problem. Let's consider the US critique.
FROM WWW.HUFFINGTONPOST.COM BY ARIANNA HUFFINGTON - to which I have added some pictures.
Update: The Consumer Financial Protection Agency continues to be a moving target for opponents of financial reform. The latest cave in compromise proposal being floated by Senate Banking chairman Chris Dodd now has the agency being housed within the Federal Reserve. An earlier "compromise" would have placed it in the Treasury Department. The end result is the same: a toothless regulator lacking the authority to enforce the consumer protection rules it writes.
Original Post:A
"doom loop." That's what Andy Haldane, executive director of financial stability for the Bank of England, warned last fall would happen if serious financial reform wasn't enacted.
Well, we appear to be a step closer to that "doom loop" with the leak this weekend of Senate Banking Committee Chairman Chris Dodd's plan for a seriously watered-down Consumer Financial Protection Agency.
Back in June, President Obama released a proposal calling for the creation of a Consumer Financial Protection Agency that would be "independent," with "broad authority" and the power to "combat the worst abuses in mortgage markets." The agency, Treasury Secretary Tim Geithner said, would "have an independent seat at the table in our financial regulatory system." Well, that was before the banking lobby went into action. A couple of hundred million dollars later, and we're left with this punch-to-the-gut of reform, from the top-line summary of Dodd's plan: "the independent agency proposal would be dropped." Seven words dirtier than George Carlin ever uttered. Instead, according to the Dodd plan, the agency would be housed within the Treasury Department and called the Bureau of Financial Protection. And that's not the only compromise.
Senate banking Committee led by senator Dodd.
Here's how the eviscerated entity would work, as laid out by HuffPost's Ryan Grim:
Each time the agency wanted to write a rule, it would have to consult with bank regulators. The agency would then have to respond to the objections of each and every bank regulator in the Federal Register. If the bank regulator was still unsatisfied, it could appeal to the 'systemic regulator,' whose mission is to protect the safety and soundness of the banking industry. Anytime a new rule is proposed, bank lobbyists argue that it will be burdensome and make the system less safe and sound. If the systemic regulator agreed with the banks -- as they often do -- then the consumer protection rule would be voided. Notably, the consumer protection agency has no veto power over any rules issued by bank regulators, which demonstrates which regulator will be superior. The first concern is the banks.So much for "independence" and "broad authority." The proposal will no doubt be very popular with the banks that, as Sen. Dick Durbin put it, "own the place." But it's already been met with criticism from consumer groups.
"Effective reform is once again being blocked by opposition from the big banks that caused the current financial crisis, " said Heather Booth, director of Americans for Financial Reform. "The revised proposal does not provide what is needed to protect American families or the financial system as a whole."
This view was seconded by Nancy Zirkin of the Leadership Conference on Civil and Human Rights: "Big banks and abusive lenders fought responsible regulation before the crisis, and we are all paying the price. It is unacceptable for Congress to allow them to succeed again," she said.
But, then, we seem to be living in a time when the unacceptable is routinely accepted -- and written off as unavoidable.
On Saturday, Dodd told Bloomberg Television's Al Hunt that he prefers an independent agency, but said it might not be possible to reach the 60 votes needed to break the inevitable Republican filibuster. Maybe so. But how about at least trying before waving the white flag? Instead, Dodd, in the hope of attracting Republican votes, appears to have preemptively surrendered. But there's no evidence that Dodd's concession has achieved anything other than kneecapping the bill. Democrats have mastered the art of negotiating against themselves.
It's hard to believe that even the messaging-challenged Democrats could fail to frame to their advantage a bill that would prevent banks from abusing the public and engaging in the same practices that brought on the financial catastrophe taxpayers have paid so high a price for. Instead, the attitude seems to be, why even try? That's assuming, of course, that a powerful consumer protection agency is something Democrats -- including those in the White House -- think is important enough to fight for. "
Here lies the crux of the problem," write Simon Johnson and Peter Boone. "
The Obama administration lacks an inner core of smart, well-informed advisers who are deeply skeptical of big banks and eager to do whatever it takes to break a cycle that points to financial and fiscal doom."
So how likely is another ride on the doom loop of financial crises? Johnson and Boone lay out some sobering statistics: Fifteen years ago, the combined assets of our six biggest banks totaled 17 percent of our GDP. By 2006, that number was 55 percent. Right now, it stands at 63 percent. Note: those GDP ratios are modest compared to those of some European banks such as the following graphic shows with Cyprus banks (each with about $50bn assets) at the top (where Icelandic banks used to be) - the GDP ratios are a key issue for the scale support that a central bank can provide?
In the Bloomberg interview, Dodd claimed to still support the so-called Volcker Rules banning proprietary trading and capping the size of banks, as does, we're told, Obama. But Johnson and Boone argue that even the Volcker Rules wouldn't make much of a difference -- and that something much bolder is needed. "
It is still possible that the White House could go all-in against the distorted incentives at large banks and the corrupted regulatory structures that have created our 'doom loop,' and make this the central campaign issue for November," they write. "Branding opponents as supporters of too big to fail could get traction, at least if led by an articulate and impassioned president."
Well, we know he'll be articulate, but his passion for reining in the banks remains to be proven. The Senate Banking Committee is expected to take up Dodd's proposal this week. Some strong leadership from an "impassioned" Obama could shoot down this deflated trial balloon and ensure that what the committee sends to the full Senate to vote on is actually closer to what Obama called for last year -- and, indeed, closer to the stronger package, including a stand-alone consumer financial protection agency, that passed the House in December.
During last week's health care summit, President Obama very cogently explained why piecemeal health reform won't work -- connecting the dots between the need to prevent insurers from denying coverage for those with pre-existing conditions and the need for universal coverage. How about doing the same for an issue that is even more sellable to the public? Of course, reforming our broken health care system would have been sellable, too -- if the White House had not ceded the messaging playing field to the Republicans for most of the last year. The good news is, there's still plenty of time to do for financial reform what Obama should have done for health care -- go out and sell a clear and specific package. And he needs to make the point that, much like health care, doing it incrementally won't work. Leaving too-big-to-fail banks to continue doing business as they have been is like operating on a cancer patient and taking out only half the tumor -- the disease is guaranteed to come back. And eventually prove fatal.
The president can take a page from the How to Win Bipartisan Support By Playing Hardball With Your Opponents playbook used so effectively by FDR, LBJ, and Ronald Reagan. Or he can go along with the preemptive surrender strategy favored by Senate Democrats: negotiate against yourself, water down what you know is right, earn your bipartisanship merit badge... and get absolutely nothing in return.
It has taken analysts and FT a long time to catch up with the reality that Governments will be making substantial profits from bank bail-outs (or bale-outs). I've been playing that saw (or beating the drum) on that for nearly 2 years. Yet, only now have mainstream media published estimates that the US government has made over $10bn profit on banks’ repayments of TARP funds, which is only the tip of the state's profits. But, since TARP is on-budget, it is easier to state that "taxpayers might turn a profit on the unprecedented help extended to the financial sector during the crisis" -FT 8,April 2010. This is based on rates paid by Goldman Sachs and American Express for warrants received in return for the aid (annualised return of 8.5%). There is, of course, a difference between paper profits and money in the treasury coffers, between forecasting and realising profits. 
But, 8% plus fat fees plus insurance premia and much else is the international government standard rate and 5-8% is coupon paid by sequestered and swapped ABS. This $10bn is merely profits on $250bn of TARP (one third)and not all of it. Why now? There is a political backlash (however long-running) against the use of taxpayers’ funds to help companies like Citigroup, Bank of America, Goldman and Morgan Stanley. But, as in the UK, the bulk of the balance sheet aid funding has been off-budget and off-balance sheet of the Federal Reserve as too the Bank of England. Even just what is on balance sheet bodes a massive return. 
There is, of course, some insoucience here. Governemnts do not want to admit to the general public the precise methods of their remedies for fear of accusations of "funny money" and because general voters don't understand that not everything governments do is with taxpayers' money, and because they do not want the accusation that government bailed the banks to make a profit but to provide stability to the financial system. This is because, supposedly, that the government’s job is not to make money off the private sector. Ha Ha! I don't see what is wrong with that at all in the circumstances. If Government replaces private funding sources and reaps either the same returns, or higher returns by taking advantage of the distressed circumstances that is surely great either in paying down the national debt or recovering much of the budget deficit. 
The government profit-raking news coincides with a legislators' commission into the causes of the crisis that is due to three-degree Alan Greenspan, former chairman of the Federal Reserve, and Citi executives this week (week beginning 7th April). perhaps they really need a commission to publicly examine how well the general economy is being served. We know the economy blew a tyre and stopped moving up the hill. The tyre may now be fixed, but before raking over what went wrong and why, again, it is surely more vital to understand if the economy is moving again or if something else is wrong?
US Treasury says it still expects to lose $117bn on TARP, which I think is absurdly pessimistic, except that it includes investments in the motorcar industry, FM&FM and AIG. On banks the Treasury forecasts a possible loss of $76bn, but I believe that will prove profitable, as will the total.
Bank bailouts with government as disposal facilitator, guarantor, undertaker, zombie bank owner, or back-to-health nurse, is a profitable business over time.
Should the government wait another year and get maybe a $16 billions profit? On Friday, the stock closed at $4.31. At end October 2007, the stock was $38.89 paying over 5% dividend. It is surely likely to reach $10 sometime fairly soon?
A few hundred small banks have failed so far. The FDIC had 552 banks with $345.9bn in assets on its confidential problem list, of which 23 are teetering on insolvency. There were 3,400 banks supervised by The Federal Reserve before the credit crunch. The FDIC insures more than 7,000 banks.
26 banks failed in 2008 with about $400bn assets, of which the largest was WaMu with $307bn in assets (sold to Bank of America for $2bn). The second biggest was IndyMac with $31bn (sold to IMBMH for $13.9bn). Roughly 140 banks failed in 2009 with about $110bn in assets, and so far in 2010 141 banks failed, but with only $23bn assets in early 2010. 
Maybe there is another $16-20bn in Federal profit from doing so with small banks, and then another $70bn profit from selling AIG (bought 80% for $85bn) plus other holdings, leaving FM&FM (bought for $182bn topped up to $200bn) with $5tn in assets and $1.6tn debt that together reduced retained assets to $1.9tn and may now be combined into a single entity. There may be another $30bn of profit to be gained here.
The grand total is $582bn returns to The Fed of which $70-80bn is net revenue for the Federal Budget perhaps. 
