Congress remains in a month-long recess, resting from the effort expended in doing not very much. Even the naming of Post Offices is diminished by the fact that so many of them are being closed.
The positive side of the slow pace is that it allows time to reflect on issues raised by events like the July 30 appearance of former FDIC Chair Sheila Bair on C-SPAN's Washington Journal, ably interviewed by Greta Brawner.
This article will take a chunk out of the Q&A portion of the interview.
Q: An independent caller from California asked about the derivatives trade, which has shot from nothing in 1999 to over $700 trillion now.
A: Bair pointed out that $700 trillion is the so-called "notional" amount, which overstates the risk, but she acknowledged that it is "a really big number, mostly from financial institutions trading with each other," creating a lot of risk through a lot of interconnections.
Recalling the 2008 episode of the ongoing financial crisis, she stated that most of the mortgage losses were managed, but "notwithstanding the progress made since then, it is still a huge source of systemic risk and continues to be a primary focus of regulators."
Q: Not satisfied with that answer, Brawner challenged Bair over "why isn't it" in fact a primary regulatory focus?
A: Bair recalled the history of derivatives non-regulation, enabled during the Clinton administration by Federal Reserve Chairman Alan Greenspan and Treasury Secretary Robert Rubin, who pushed through legislation to prohibit regulation of derivatives, so this activity grew into a "hydra-headed monster" that is inherently destabilizing, in part because the vast bulk of trading is done by speculators who have no "insurable interest" in the assets they are betting on.
Thus, hedge funds, banks and other entities had "perverse incentives" to create instruments that would benefit from mortgage defaults and home foreclosures. She concluded that this circumstance "really hasn't been effectively dealt with yet."
My comment: Another key actor who deserves dubious credit was then-Sen. Phil Gramm, R-Texas, who guided through Congress a loophole in the Commodity Futures Modernization Act of 2000 that derivatives were not to be treated as swaps and would therefore not be regulated by the Commodity Futures Trading Commission (CFTC). This loophole became known as the "Enron exception." Gramm's wife, Wendy, joined the board and audit committee of Enron when she left the CFTC, which she chaired from 1988 to 1993.
Q: What about the Volcker rule?
A: Bair explained the rationale for limits on trading activities of banks — that the federal safety net is intended to support the real economy, not trading. However, the trading activity to be prohibited is hard to define, although "the overall principle is good." The regulation has not been finalized yet.
Q: Why not?
A: Bair noted that the bank lobbies have made the rule "quite complex" through the exceptions created by the Dodd-Frank Act.
My comment: The exceptions are for hedging and market making, on the ground that these are important functions by which banks serve their customers. However, just because they're done in the name of customers does not mean they are risk-free. Therefore, any trading activities allowed should be conducted under separately capitalized subsidiaries, rather than by the bank. This principle was established under the Gramm-Leach-Bliley Act of 1999, the same legislation that repealed the last remnants of the Glass-Steagall Act after Citigroup had already acquired Travelers in violation of Glass-Steagall. Citi took this brazen step and demanded that Congress comply. Treasury Secretary Rubin achieved this and then immediately joined the executive suite at ... Citigroup.
Q: by tweet: What was the role of the FDIC in the recovery after 2008?
A: This softball question gave Bair a chance to give her version of the 2008 episode. She lamented that the response was "too ad hoc," and it confused the market, because the regulators "had no playbook" for dealing with the large financial institutions, some of which were non-banks, such as Lehman Brothers, Bear Stearns and AIG, with a lot of the risk housed in non-bank affiliates of banks.
She candidly admitted, "We threw too much money at it." While acknowledging that Wall Street made a lot of money from the regulatory response, she defended it as stabilizing the system.
Bair went on to express pride in the FDIC's handling of small banks, but zagged back toward lamentation: "I wish we had done more in 2009 to impose some accountability on those banks, to get them to sell assets, get loans restructured and take losses. The economy would be better off if we had forced structural changes, management changes, cleaning up of balance sheets. We didn't. We left all those bad assets on their books. They kind of limped along for years. So now they're finally recovering; hopefully, we'll see more growth and better lending."
My comment: This weak, rambling apologia begs the question, why didn't the regulators have playbooks? In 1991, Congress passed the FDIC Improvement Act to give the agency more tools to make sure that the widespread regulatory failures of the 1980s would never happen again. So now the FDIC was officially "improved." Another former FDIC Chairman, William Isaac, a critic of the response to the 2008 crisis, contends that the regulators had the tools they needed; what was lacking was the political will to use them.
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