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While much of the past day’s news has been focused on the Obama Administration’s populist announcement that executive pay, at the companies that accept TARP funding, will be capped at $500,000; some less noticed news with a longer term implication was being made by Paul Volcker who testified in front of the Senate Banking Committee. Volcker is the chair of President Obama’s Economic Recovery Advisory Board and the topic of the hearing was “Modernizing the U.S. Financial Regulatory System.”  The New York Times reported on his testimony here

While Volcker had been invited to testify in his role as chairman of Obama’s Economic Recovery Advisory Board, he is also the chairman of the Trustees of the Group of Thirty an influential body composed of leading financiers, academics and central bank officials from around the world. (Larry Summers, Timothy Geithner and Paul Krugman have all been listed as members in the past year)

While Volcker’s testimony was quite general it referenced the recent report of the Group of Thirty titled “Financial Reform: A Framework for Financial Stability.” The Group of Thirty report does give us a window into the thinking of the people who are likely to create the framework for modernizing the national financial regulatory system after the dust begins to settle on the current crisis.

A couple of quotes from Volcker’s testimony will help give a general sense of where the thinking of this elite group is headed:

the Report calls for “particularly close regulation and supervision, meeting high and common international standards” for institutions deemed systemically critical. It also explicitly calls for restrictions on “proprietary activities that present particularly high risks and serious conflicts of interest” deemed inconsistent with the primary responsibilities of those institutions.

On the practical level this is likely to mean an attempt to broaden and expand the Federal Reserve’s powers to supervise and regulate the whole range of non-banks that are involved in the flow of credit around the world.  

Do we think this should be done by the Federal Reserve?
If not who else would have the power and talent to keep up with the innovation and scope of the world’s financiers?
If it is to be the Federal Reserve, how do we inject the possibility of public input and oversight when the Federal Reserve is controlled by economic “libertarians” as it was during the Greenspan years?

And then:

the Report implicitly assumes that, while regulated banking institutions will be dominant providers of financial services, a variety of capital market institutions will remain active. Organized markets and private pools of capital will be engaging in trading, transformation of credit instruments, and developing derivatives and hedging strategies, and other innovative activities, potentially adding to market efficiency and flexibility.

These institutions do not directly serve the general public and individually are less likely to be of systemic significance. Nonetheless, experience strongly points to the need for greater transparency. Specifically beyond some minimum size, registration of hedge and equity funds, should be required, and if substantial use of borrowed funds takes place, an appropriate regulator should be able to require periodic reporting and appropriate disclosure.  Furthermore, in those exceptional cases when size, leverage, or other characteristics pose potential systemic concerns, the regulator should be able to establish appropriate standards for capital, liquidity and risk management.

This seems like pretty weak tea.  Remember that Timothy Geithner spent much of his time during the past five years as President of the New York Federal Reserve speaking about the need for capital and liquidity standards and the need for banks to put better risk management systems in place. But it all proved futile because of the lack of specific rules and regulations and an enforcement system with the capacity of actually holding the players accountable.  

I’m all for the Obama administration putting salary caps on the TARP recipients, but for the longer term the harder job will be creating a regulatory structure that controls or eliminates the current perverse economic incentives for companies to engage in risky behavior in the pursuit of short term profits. This behavior by everyone from the brokers to the lenders, to the investment bankers to the hedge fund managers will not be eliminated by a public scolding, but rather by creating a regulatory system which rewards long term thinking and punishes short term risk taking. In a system in which risk-taking and "innovation" have been highly rewarded, this will be no small task.

Finally Volcker’s testimony points to the critical role that the issue of financial regulation will play in the April meeting of the G-20 leaders in London. President Obama is expected to attend that meeting and it will be likely that some of the framework for the future regulation of the financial services industry that is to be coordinated internationally will begin to be fleshed out. We need grass roots people watching the details during the lead up to this meeting.

Who will watch the watchers?

Originally posted to bankbane on Thu Feb 05, 2009 at 07:09 AM PST.

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Comment Preferences

  •  Looking for some insiders at the Treasury Dept. (7+ / 0-)

    willing to let the great unwashed masses peek behind the scenes, to see what is being planned.

    "The more they spoke of honor, the more I checked my wallet."

    by bankbane on Thu Feb 05, 2009 at 07:11:50 AM PST

  •  The unfolding process needs to be visible (5+ / 0-)
    Recommended by:
    Cedwyn, bankbane, radarlady, budr, Earth Ling

    to the public.  We don't need more secret czars making policy decisions with their magic wands, to the detriment of the public good.  The proposed regulations should be in writing and posted on the tubes.

    Thank you very much for this diary.

  •  totally rec'd (0+ / 0-)

    this was interesting, in that nerdy way...

    ; P

    "Government, like dress, is the badge of lost innocence; the palaces of kings are built upon the ruins of the bowers of paradise." Thomas Paine, Common Sense

    by Cedwyn on Thu Feb 05, 2009 at 07:26:58 AM PST

    •  It's too bad (2+ / 0-)
      Recommended by:
      bankbane, Lujane

      Obama can't repeal the roll-backs of financial regulatory legislation by executive order alone. While the GOP Congresscritters will make noises about the leavings dropped to the little people in the Stimulus Bill, then fold (probably), we all know they'll fight tooth and nail for their backers on Wall Street.

      Radarlady

      •  Amen to that, but our first job (2+ / 0-)
        Recommended by:
        radarlady, Lujane

        is to make sure that there is something to fight for to begin with. Wall Street is the one place where the Dems are about as entrenched as the Republicans.

        "The more they spoke of honor, the more I checked my wallet."

        by bankbane on Thu Feb 05, 2009 at 07:58:24 AM PST

        [ Parent ]

      •  The other big problem (3+ / 0-)
        Recommended by:
        bankbane, radarlady, budr

        is that the Republicans don't see the need for effective law and regulation and the Democrats don't understand the need to let markets work within legal limits.

        •  I think that what those legal limits are (1+ / 0-)
          Recommended by:
          radarlady

          is the crux of the problem.  I understand the industry point that rule-based regulation can be too inflexible and easy to circumvent on the basis of technicalities.

          But principles-based regulation also has its own set of problems, because it largely assumes that if you set broad limits the markets will benefit us all because the individual self interest of the players will be self-correcting. That is the ideology that Greenspan acknowledged failed him.

          "The more they spoke of honor, the more I checked my wallet."

          by bankbane on Thu Feb 05, 2009 at 08:31:43 AM PST

          [ Parent ]

  •  That's my mantra (3+ / 0-)
    Recommended by:
    radarlady, budr, Earth Ling

    More nerds, fewer outraged spectators

    "The more they spoke of honor, the more I checked my wallet."

    by bankbane on Thu Feb 05, 2009 at 07:33:58 AM PST

  •  What really (0+ / 0-)

    unnerves me:  we are too leveraged for a Keynesian solution and Freedman's idea that sufficient liquidity would prevent a depression also seems to be failing.

  •  An Analogy (1+ / 0-)
    Recommended by:
    bankbane

    Perhaps one reform could be something borrowed from the environmental context.  The National Economic Policy Act (NEPA) requires that all government projects and all permits approved by the government (with certain exceptions) first go through an environmental review process.  The agency must prepare a description of the project -- or what would be permitted -- and then conduct an analysis of reasonably likely environmental effects.  The agency must then publish the analysis and open up a public comment period.  Comments the public submits during the comment period must be formally addressed.  Only after this process has been completed can the project be implemented or the permit become final.

    It would make sense to have a similar process for all new financial instruments.  They must first get approval by a responsible government agency and the approval process must include an analysis of likely adverse economic effects.  There should be a public comment period and the agency should have to respond to public comments.

    This would make sure that approvals would be fully informed as to the likely economic effects and it would also help hold the agency accountable.  No more crying, "Who coulda' thought that could happen?"

    Just a thought.

    This aggression will not stand, man.

    by kaleidescope on Thu Feb 05, 2009 at 08:47:11 AM PST

    •  Definitely an idea worth exploring (0+ / 0-)

      It's precisely any attempt to slow down  "innovation" that really gets the industry's undies in a bunch, however. The competitive advantage in the financial services industry is having a product that few other people understand. That's how the whiz kids make gazillions for their companies. So your idea of forcing them to explain themselves beforehand would strike right at the heart of that culture. Doesn't mean we shouldn't try it.

      "The more they spoke of honor, the more I checked my wallet."

      by bankbane on Thu Feb 05, 2009 at 09:08:10 AM PST

      [ Parent ]

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