Perhaps the highlight of the 24th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies was a speech by Paul Tucker, senior fellow at both the Kennedy School and the Business School at Harvard, who served as deputy governor of the Bank of England (BOE) from 2009 to 2013.
Tucker's career at the BOE began in 1980 and he was a member of all of BOE's statutory policy committees — monetary policy, financial policy and prudential regulation — as well as of the court of directors. He also served on the G20 Steering Committee of the Financial Stability Board (FSB) and chaired its Committee on the Resolution of Cross-Border Banks that has been attacking the "too big to fail" problem, was a director of the Bank for International Settlements (BIS) and chaired the Basel Committee for Payment and Settlement Systems. He may well have been the leading financial regulator in the world.
Therefore, it was especially pertinent to hear Tucker's response to the stream of invective flowing from the financial industry against belated efforts by U.S. officials implementing the Dodd-Frank Act to determine through the Financial Stability Oversight Council (FSOC) and its Office of Financial Research (OFR) where the greatest sources of risk lie and what steps need to be taken to reduce the risk of another financial meltdown even greater than that of 2008.
Tucker addressed five points:
- Alleged damage to lending from bank regulation. Industry lobbies constantly object to stricter or more effective bank regulation on the ground that it would hamper the ability of banks to lend and restrict economic growth. Instead he argued that the big picture is that the U.S. has waited too long to contain the risks emanating from banks whose weakness has not been recognized and can lever their balance sheets at 100 to 1, whereas under stricter regulation leverage would be reduced to the still-dangerous 25 to 1.
- Scarcity of safe assets. So-called "safe assets" are mainly the debt of relatively safe sovereigns, and opponents of regulatory efforts to require a Liquidity Coverage Ratio to reduce the risk that the entire banking sector will collapse again object that there won't be enough safe assets to go around. Tucker described this as a short-term problem and advised that private investors have to learn that they can hold bonds that will have either yield or safety and liquidity, but not both.
- Liquidity risk in capital markets. Tucker observed that this is "absolutely endemic" in financial markets, along with the prospect that the Federal Reserve might assume the risk of "market maker of last resort" when private investors flee the markets.
- Regulatory arbitrage on a larger scale. Using the Volcker rule, which is intended under Dodd-Frank to restrict the ability of too big to fail banks to use their proprietary trading and market making activities that can threaten the financial stability of the global economy, Tucker warned that detailed rules are inevitably exploited by lawyers to create substitute vehicles for conducting banking activities. He agreed with this writer that big insurance companies and asset managers protesting imposition of bank-like regulation have been able to do this through devices such as variable annuities, derivatives and loans to banks.
- New risk singularities. Tucker warned that while banks became too big to fail by accident, the new clearinghouses created by Dodd-Frank are too big to fail by design and bound to fail.
(Additional materials can be found at the conference website
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