Regulatory Overreach

Why we shouldn’t allow the federal government to accumulate any more power over the financial industry (and why in fact it already has too much):

… the case for broadening regulators’ oversight to include investment banks and other financial institutions is based on three flawed assumptions.

The first is that the same factors that justify expansive powers to close banks and take control of their assets are equally applicable to investment banks and other financial institutions. But the FDIC’s interest in commercial banks is unique — because it guarantees deposits up to $250,000, the FDIC is a bank’s most important creditor and has a stake in its health as the representative of American taxpayers. The government’s stake and the need to assure that depositors do not lose access to their deposits, even temporarily, arguably justify the FDIC’s extraordinary powers. Those factors are not present with investment banks or other financial institutions.

The second flawed assumption is that our bankruptcy laws are not adequate for handling defaults by investment banks or other financial institutions. …

Contrary to the widespread myth that bankruptcy is time-consuming and ineffectual, Lehman sold its major brokerage assets to Barclays less than a week after filing for bankruptcy. It is now in the process of selling its tens of billions of dollars of less time-sensitive assets at a more deliberate pace. …

The third flawed assumption is that financial firms flirting with distress are somehow worse decision makers than federal regulators. But the opposite is likely true. If the Treasury, FDIC and Fed had authority over investment bank failures, troubled banks would have a strong incentive to negotiate for rescue loans, and their pleas would be heard by regulators influenced as much by political as financial factors. The involvement of three different regulators (and mandatory consultation with the president) would magnify this risk. With bankruptcy, in contrast, the decision of whether and when to file is made by an institution’s managers and creditors, who have the best information and their own money on the line.

[Via Professor Bainbridge], who has more thoughts.

Much of the risk taking occurring in these institutions was caused by the moral hazard of knowing (or at least being willing to bet) that the government would step in and bail them out. Particularly since many in the government were on their payroll, either through campaign contributions, sweetheart mortgage deals, or simply the incestuous revolving door between the federal bureaucracy and the institutions. Fannie Mae and Freddie Mac both seem to have been a cushy retirement home for former Democrat operatives (e.g., Franklin Raines).

And in the “gee, ya think?” category — “Dodd’s Troubles Open Debate On Congress’ Ties With Special Interests“:

Dodd has become the poster boy for critics who say the inevitable ties between long-time members of Congress and special interests are undermining efforts to revive the economy.

“He literally thinks he’s going to play a critical role from saving us from ourselves,” Christopher Healy, the Republican Party chairman in Connecticut, said of the Democratic senator.

“It’s like putting the arsonist in charge of the volunteer fire department. He knows where the fire is because he set it. But beyond that, he can’t offer much help.”

Such a debate (assuming it actually occurs) is long overdue. It should have occurred during the election campaign.

We have to break up this megatrust.

I wish that I could make Human Action and The Road To Serfdom mandatory reading on the Hill, but it would probably be beyond the IQ of many, indeed most of them.

[Late afternoon update]

Thoughts on progressive corporatism:

At this point, I think that the relevant political divide is not between the two parties. It is between the forces of Progressive Corporatism and the (much smaller) forces of The Resistance.

Or, as Virginia Postrel has noted, between dynamism and stasis. That’s the real point. Despite all the rhetoric, these people don’t want change. They are defenders of the status quo. Everything they’re doing is to prevent change. They don’t want housing values to change, they don’t want bank stock values to change, they don’t want UAW workers’ salaries to change, and (most of all) they don’t want any change in their level of power over the rest of us.

6 thoughts on “Regulatory Overreach”

  1. The problem is we are way, way past the tipping point. The backlash is going to be too little, too late (I do hope I am wrong.)

    Not enough people understand the importance of free enterprise. Most business people do not, because they do not get the primary benefit of free enterprise. Once in, they prefer it not be so competitive. They benefit by being consumers themselves who are the primary beneficiaries.

    But consumers are blinded by the flim flam artist who want to regulate. The only purpose of regulation being to direct money to their power block. Who keep the public uninformed.

  2. I wish that I could make Human Action and The Road To Serfdom mandatory reading on the Hill, but it would probably be beyond the IQ of many, indeed most of them.

    No it’s not, Rand. You are mistakenly assuming their primary motivation is altruistic; that if they learned that what they did and propose to do is bad for all the rest of us, but of course still quite good for themselves, they would nobly cease and desist.

    That doesn’t seem very likely. Human beings don’t work that way, except rarely, and most of the time in very local and personal situations.

    The difficulty with liberal fascism, the reason it’s a weed so hard to eradicate — we though we’d killed it in the 1990s! — is that (1) it is very good for those in power, and (2) it has a consistent philosophy of service to some abstract noble ideal (“The People,” “Mother Earth,” “Der Vaterland”) that folks not appropriately skeptical — both the starry-eyed optimist and the deeply cynical — can be suckered into thinking it might be worth a try.

    The people who need to read and appreciate Hayek are those who are not in power and who never will be, those who can be wooed by the siren song of the fascist shaman. Trust me. I’ll take care of you, and you can stop accepting half a loaf, the cake will be yours to eat as well as keep, et cetera.

    But an intellectual defense against the seductions of a religion is not, historically, very effective. Cerebral defenses are no match for gut-level immunity, so to speak. The best defense has tended to be a pre-existing religion already filling that emotional niche. It could be an actual religion, or it could be a pseudo-religion, something like American myths of “manifest destiny” and exceptionalism in the late 19th and early 20th centuries.

    It may be true, therefore, as Marx suggested, that the spirit of true individual liberty — free market, libertarianism, et cetera — sows the seeds of its own destruction; by weakening all religions, it reduces one’s resistance to the religion of fascism. Oh well.

  3. A few flaws I see in the article Rand linked to:

    1) The FDIC is not a creditor to banks. It is a regulator, and works for the depositors. Once the FDIC steps in, it’s just like a liquidation bankruptcy, except faster. You can’t get faster then “instant.”

    2) IndyMac won’t cost taxpayers a dime – the FDIC is funded by insurance premiums.

    3) The FDIC has been very capable of resisting calls to loan money to failing banks. TARP, which is a loan to banks, came from Treasury via the Congress and the President, not the FDIC.

    4) Nobody is claiming that the regulators make better decisions then company management. The claim is that, once the institution has failed, the FDIC’s process is exceptionally quick and smooth.

  4. A few flaws I can see in your response, Chris:

    Once the FDIC steps in, it’s just like a liquidation bankruptcy, except faster.

    And also except being less constrained, e.g. by bankruptcy law, by the existence of an appeals process, by the fact that no single judge hears all such cases. I suspect only your side is interested in sheer speed. That’s why you pass $1 trillion bills without having time to read them. The rest of us are more interested in the quality of the decision-making process, and whether it promotes Imperial Executive overreach or prudent restraint.

    the FDIC is funded by insurance premiums.

    Right. The same way subprime mortgage securities are funded by mortgage payments. What could go wrong? They won’t all default at once, right?

    What happens when the government predictors who set those insurance premium rates goof up a bit?
    This. (“FDIC may need $150 billion bailout”.) An interesting quote from the story:

    As recently as March, an internal FDIC memo estimated the cost to cover bank collapses in 2008 would be just $1 billion, dropping to $450 million in 2009. It wasn’t even close.

    The IndyMac failure alone, which happened four months after that memo was circulated, will cost the FDIC $8.9 billion — and the bill for all 12 collapses will be about $11 billion, the FDIC says.

    Now, if the means for guaranteeing deposits were varied and diverse — say, lots of private insurance companies — then some would have goofed up and underpriced the premiums, and they and their clients would be in trouble, but some others, the New York Life style insurers, would have been more cautious and would be OK. As they say, diversifying your portfolio is the best defense against bad investments.

    Since we have one insurer, the decisions it makes have critical weight. If they screw up, there’s no backstop at all — aside from the taxpayer, of course. You’re saying that so far the FDIC is OK is about as comforting and sensible as people saying two years ago that so far Fannie Mae and Freddie Mac were doing fine.

    Nobody is claiming that the regulators make better decisions then company management

    No? Haven’t been reading the news much? Or listening to the President and his cronies in Congress rail against the greed and short-sightedness of financial management, and proposing vast new regulatory oversight? If that isn’t a flat statement that these businesses would be better run by lawyers in Washington than bankers in New York, I don’t know what is.

    Of course, the proposition that lawyers in D.C. understand banking better than bankers is on its face ridiculous, so they focus on the supposed moral dimensions of the decisions. See, the bankers may know more, but they’re evil, they make wicked selfish decisions, and that’s where government can do better. People in government never make decisions based on their self-interest — they would never, just to take a random example, bail out AIG but not Lehman because AIG owed a pile of money to their former employer (Goldman Sachs) and Lehman was a tough competitor of their former employer, or because AIG was a big campaign donor. Ha ha, that stuff never happens!

  5. At one time in the not so distant past, you needed 20% down, very solid credit, -and- a verified (via tax return disclosure) income at least 300% of the prospective mortgage payment.

    Not because of regulations – but because the greedy bankers refused to issue loans where they had the slightest hint of potential failure.

    If mortgages are proceeding on that basis, all the shenanigans of reselling, bundling, rebundling, tranching, and then insuring the result (as well as creating regulations and oversight structures that then stick their fingers in their ears and chant ‘na-na-na I can’t hear you!’) would basically be pointless.

    But if you’re suing companies that fail to meet quotas of loans that -fail- to meet that criteria, you’re doomed regardless of what other structures you have in place.

    The C-SPAN video of the last several years of Fanny & Freddy regulators meeting with the top F&F execs is available on YouTube, and is truly infuriating. Particularly Franklin Raines’ comments about how “Frankly, we’re holding too much reserve – we’re so solid we shouldn’t be held to the same standards…”

  6. > 3) The FDIC has been very capable of resisting calls to loan money to failing banks.

    Geitner’s “toxic assets” plan has the FDIC putting up a huge amount of non-recourse and low-cost financing for folks to buy said assets.

    One interesting question is whether the banks themselves will be able to participate. Since the announced procedures say that they get to reject transactions for any reason, it’s becoming clear that this is intended to be a band subsidy/bailout, with some political payoff frosting. (Here’s one more clue: how would a bank benefit from buying its toxic assets under this program?)

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