WSJ EDITORIAL: THE NEW LORDS OF FINANCE
MAY 24, 2010
The New Lords of Finance
Why Wall Street and Washington both like ‘reform.’
If you think the lobbying is intense while Congress considers financial reform legislation, wait until the President signs it. That is when the real battle will begin to shape the new rules of Wall Street.
The unifying theme of the Senate bill that passed last week and the House bill of last year is to hand even more discretion and authority to the same regulators who failed to foresee and in many cases created the last crisis. The Democrats who wrote the bill are selling it as new discipline for Wall Street, but Wall Street knows better. The biggest banks support the bill, and the parts they don’t like they will lobby furiously to change or water down.
Big Finance will more than hold its own with Big Government, as it always does, while politicians will have more power to exact even more campaign tribute. The losers are the overall economy, as financial costs rise, and taxpayers when the next bailout arrives.
This new power for Washington flows from the politically convenient Washington analysis that a lack of regulation caused the financial panic. A popular talking point among Members of Congress is that Wall Street is less regulated than a Las Vegas casino. Notwithstanding the illustrious history of the Nevada Gaming Commission, this is unfair to pit bosses.
To take one example: Washington has failed to prove that derivatives caused the crisis, yet even if one believes that they did, they were hardly unregulated. Look at the list of the largest derivatives dealers—all banks—and you’ll see institutions regulated by the Federal Reserve and the Securities and Exchange Commission. Were regulators barred from examining derivatives books? Not at all.
The Treasury Department, whose Office of Thrift Supervision regulated AIG and blessed its derivatives bets, will now gain even more power as its Secretary chairs the new Financial Stability Oversight Council under the Senate bill. The Fed, author of the loose monetary policy that created the bubble and overseer of Citigroup and its off-balance-sheet adventures, will now oversee even more institutions. The Federal Deposit Insurance Corporation, which allowed its member banks to load up on stratospheric levels of real-estate loans, will now replace bankruptcy judges in managing the collapse of a large financial firm.
These new lords of finance look an awful lot like the old lords of regulation, but with much more discretion to write the rules as they please. In a market crying out for clearer rules, Washington is about to make the standards even more opaque, as subjective regulatory judgment replaces territory once occupied by the rule of law.
Speaking of rules, the Senate bill appears at first glance to contain a tough Volcker Rule—a “Prohibition on Proprietary Trading” by banks, bank holding companies and their subsidiaries. The Senate bill’s definition of proprietary trading is expansive, covering “stocks, bonds, options, commodities, derivatives” and other financial instruments.
Interestingly, there are a few instruments exempted, such as securities issued by those government-created toxic twins of the mortgage industry, Fannie Mae and Freddie Mac. But even a carve-out that allows Wall Street to gamble on securities issued by Fannie and Freddie still bans a lot of things, right? Not necessarily.
The bill gives regulators on the Financial Stability Oversight Council the authority to immediately rewrite the law. Within six months of its enactment, the Council will complete a study of the Volcker Rule created by Congress and then “shall make recommendations regarding the definitions . . . including any modifications to the definitions, prohibitions, requirements, and limitations contained therein that the Council determines would more effectively implement the purposes of this section.”
Banking regulators will then have nine months to craft regulations based on the new law, as modified by the Council. This means that Congress’s vaunted Volcker Rule is really a Volcker Suggestion to the unelected kings of the regulatory state.
Let’s also not forget the Senate’s rendering of a “resolution process” for failing financial giants. This provision is ostensibly the reason for this entire exercise—to end the notion of too-big-to-fail banks and create a process in which regulators feel comfortable allowing failure.
Yet the discretion handed to the FDIC as the resolution overseer allows a replay of the AIG debacle, in which the company was used as a conduit to pay counterparties 100 cents on the dollar. The FDIC will now be empowered to do the exact same thing, except that it will be allowed to discriminate even further—with the discretion to give some creditors a total bailout while imposing losses on others. Think United Auto Workers versus Chrysler bond holders. The Senate bill says the FDIC can even discriminate among the same class of creditors. The “backdoor bailouts” at AIG were among the most infuriating to taxpayers, yet Washington is about to institutionalize them.
That Senate Republicans lacked the will to stop this is their biggest failure this Congress. The pending reform will not prevent future taxpayer losses but it will impose enormous costs and uncertainty on financial markets. The only outcome we know for sure is that when the next financial panic arrives, and eventually it will, the regulators and politicians writing these new rules will again blame someone else.
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