The first hearing by the House Financial Services Committee’s Oversight and Investigations Subcommittee, chaired by Rep. Patrick McHenry, a Republican realtor from North Carolina, reviewed a report the Government Accountability Office (GAO) issued last fall on the performance of the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR), two of the agencies created under the Dodd-Frank Act in an effort to enable the financial authorities to perform better than they did during the 2008 episode of the ongoing financial crisis.
After a series of regulatory failures dating back more than 40 years, the official narrative for the 2008 episode is that no one could have foreseen those events, although sometimes it seems that the only people who did not know what was coming work for the financial regulators, and none of them read the financial press. So the biggest dog in the universe swept down and ate the homework of all the financial regulators.
Much as the public was told that the reason America was attacked on Sept. 11, 2001, was that there was no Department of Homeland Security, the regulators asserted that the crisis revealed the need for a council of all the regulators to coordinate their activities and to identify current and emerging threats that could cause the next episode. (In my view, the nation is still in the 2008 crisis, and former Treasury Secretary Tim Geithner has candidly admitted that there are bound to be more crises, or episodes.) The OFR was created to gather and to analyze the data needed to inform the work of the council.
Another key part of the official narrative is that the 2008 episode was caused by something called the “shadow” banking system, a bogey that needed to be created in order to avoid admitting that the biggest banks in the country operate on the edge of insolvency, much as the savings and loan institutions (S&Ls) did in the 1980s, borrowing short and lending long with extremely thin or non-existent capital and relying on the backing of the federal safety net, as did the failed S&Ls, Fannie Mae and Freddie Mac.
A. Nicole Clowers, director of financial markets and community investment at the GAO, reported that, with the fragmented system of financial regulation still in place, the FSOC needs to develop a systemic approach to identifying new threats and to assign priorities to the threats it finds.
When it exercises its powers to identify which non-bank firms are of such systemic significance that they need to be subjected to “enhanced supervision” by the Federal Reserve, the GAO recommends that the FSOC evaluate the effects the designation has on the way these firms are perceived by the marketplace in terms of costs and benefits of the designation.
The lead Treasury witness was Amias Gerety, deputy assistant secretary of the FSOC. According to Wiki, Gerety is 31 years old, but his looks and delivery are those of a precocious middle-school student. Also testifying for Treasury was Richard Berner, who heads the OFR and has a way of taking highly technical issues and smothering them with jargon so as to make them even more obscure. A frustrated Rep. Carolyn Maloney, D-N.Y., finally asked Berner to send her something in plain English.
I tangled with him in a public forum after he presented the official narrative about how the regulators were going to use the new powers they’ve been given, rejoining during the Q&A that the regulators were allowing the biggest banks to continue to grow and to pose an even bigger threat to the financial system. The leading exponent of this view is Simon Johnson of MIT, who has documented both the growth of the “too big to fail” banks and the thinness of their capital.
As members questioned the witnesses, they presented a sharp contrast in strategy based on their respective parties. Republicans spoke rapidly and with a demanding tone as they challenged Gerety to justify actions and omissions of the FSOC and received uneven responses. Sometimes Gerety would simply repeat that the member’s question was an important one and the FSOC takes the recommendations of the GAO very seriously, while other times, he would speak directly to the point with varying degrees of effectiveness.
When Republicans asked Gerety about specific policies of individual agencies, he told them that he could not speak for any of the agencies, but the members kept asking anyway, presumably for the benefit of interested industry groups. Republicans looked better when they complained that the FSOC fails to post timely announcements of its meetings or even keep minutes, let alone disclose them. The GAO has recommended that the FSOC follow the example of the Federal Open Market Committee in making regular disclosure regarding its decisions and deliberations.
The Democrats, on the other hand, with perhaps one exception, used their time to give the Treasury witnesses a breather by asking them to repeat the points they had already made and to support the case that these are new agencies that are still improving their performance.
One example Gerety cited was the FDIC, which he said took years to establish itself after it was created during the Great Depression. (A cynic would suggest that the FDIC has never found a way to assess the banking industry sufficiently for the risk it poses and to avoid incurring huge losses that have left the FDIC in the same dodgy condition as the too big to fail banks.)
A few examples will illustrate the tone and substance of the hearing:
1. Money market mutual funds. In one of her last acts as Securities and Exchange Commission (SEC) chairman, Mary Schapiro proposed some measures to reduce the likelihood of a run on money funds like the one that occurred when the Reserve Fund “broke the buck” in the run-up to the 2008 episode. However, she was thwarted by a commissioner from her own party, Luis Aguilar, who used to work for the mutual fund lobby. The FSOC has identified this issue as a threat to the stability of the financial system and threatened to act on its own if the SEC does not.
The industry has constructed its own narrative in which there have not been runs on money funds, no remedial measures are needed beyond those already adopted and the industry presents itself and its clients as victims of the zealous SEC.
At this hearing, Rep. Mike Fitzpatrick, R-Penn., demanded to know why the FSOC was “subverting the lawful action of the SEC.” Gerety responded that the FSOC is trying to encourage a public dialogue that will lead to action by the SEC to remedy a vulnerability in the financial system.
2. Tri-party repo agreements. Rep. Maxine Waters, D-Calif., asked the Treasury witnesses to discuss remarks by Fed Governor Daniel Tarullo to the Senate Banking Committee regarding tri-party repurchase agreements. Berner responded that the FSOC has identified this as a source of risk, but there are also risks in bilateral arrangements. (Repo agreements are a principal means by which the biggest banks borrow money overnight on the basis of collateral of variable quality, then they settle in the afternoon of each business day and begin the process over again.)
Berner added that the OFR has yet to analyze the data it has collected and plans to do further work with the Fed and the FSOC.
3. Prospect of bailouts. The freshman Rep. John Delaney, D-Md., was the de facto star of the Democratic side, because he may have asked the only substantive question when he asked Gerety about the reduced cost of capital the too big to fail banks enjoy.
He then had to fence with Gerety as the witness repeated the official line that any such advantage is based on a false “perception” that these institutions are backed by the federal government. Much to Delaney’s credit, he continued to press the issue and to demonstrate his skepticism that bank bailouts have been obviated by the Dodd-Frank Act.
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