Calls for more bank regulators remind me of a regulatory go-round with an erratic European bank chairman to whom I once reported. Almost eighty years old, with a failing memory and a fondness for mid-day Martinis, he once interrupted a luncheon to call his wife and ask that she send his revolver over to the bank.
At one time in his life he might have had a license to carry a firearm, but the permit had long expired. He wanted the great equalizer on this particular afternoon because the television was full of possible terror threats against financial interests, and he figured, after his second highball, that outside agitators might rush the corporate dining room.
The meal continued, and in due course his chauffeur arrived carrying a white plastic bag, which looked like it was packing lunch more than heat. The chairman removed the pistol, checked it for ammunition, and tucked it into the waistband of his Savile Row suit, as if he had made a loan against a Maltese Falcon.
News of the lock-and-load chairman circulated around the bank, and eventually reached the ears of the board of directors and the regulators, who, as part of their mandate, had to insure the fitness of the chairman to serve in his capacity. I was present when the regulators were informed that the bank had a chairman who was eighty years old, had no memory, and was loaded not just with booze but for bear.
Regulators are being celebrated everywhere today as the champions of free markets and fair competition. You might think that they had earned a track record in this regard and — for example, in this instance — would have questioned the chairman’s ability to remain in office.
Instead, even after they heard about his piece and judged his inability to understand the business of the bank, the regulators did nothing to change the composition of the board. They took the position that there was nothing that they could do, and left him on the job for another few years, during which time the gun would come and go in his briefcase, and occasionally fall on to the conference room table when he was searching for a document. It brought new meaning to the corporate phrase, “Let’s stick to our guns.”
Does my experience necessarily mean that all banking regulators, notably those charged with implementing financial reform, will be slow on the draw when it comes to cleaning up Dodge City’s balance sheets?
In general, regulators tend to be recent college graduates who are padding their resumes until going to business or law school, or they are career bureaucrats, immersed in one or two minor regulatory issues. Most miss the big picture, as nearly every regulator did in reviewing the balance sheets of A.I.G., Merrill Lynch, or Washington Mutual. For better or for worse, financial profits — to regulators challenged to understand the strike prices of futures contracts — look like magic.
The problem with entrusting them with the health of the financial system is that few, at least in my experience, understand anything about how banks, brokerage businesses, and hedge funds operate or how they make money.
As the ideal regulator, look no further than Treasury Secretary Timothy Geithner, who now is pushing financial reform as hard as he once peddled deregulation and “market solutions” for most banking problems.
Geithner owes his financial expertise to political expedience, first to that of Henry Kissinger and his associates, and later to presidents Clinton and Obama, all of whom take the view — to use the phrase of historian Richard Hofstadter — that they came to office to defend property as opposed to democracy.
Had Geithner been a claims adjuster in the arson division of Geico, he might have been less inclined to believe that Wall Street was doing “God’s work.”
Think, too, of the iconography of Goldman Sachs, which within the last three years has gone from the “culture of success” to America’s most wanted. In between, depending on the country’s mood, it was either the stock pond for Treasury secretaries or in need of a bailout. All the while, the regulators no more understood Goldman’s businesses than did their counter-parties, who were loading up on subprime while the partners went short.
Despite the high moral tone of Senator Dodd’s proposals to fit bankers with bespoke hair shirts, the challenge of the proposed new financial regulations is how Congress can dress up yet more loopholes and shop them as reforms.
What Congress will pass is lofty legislation that promises to unleash “consumer watchdogs,” with Volker Rules against proprietary trading and denunciations of derivatives, and it will extend the amount of time that homeowners can live in a house on which the mortgage is in default. Even better, members of Congress will finally have a good safe menace, Wall Street greed and ruin, to run against in November 2010.
In exchange for the effigy, many of the proposals could have been written by bank lawyers, as these “reforms” subsidize, rather than challenge, bank earnings. Banks love nothing more than a guarantor of bad loans. My feeling is that, whatever the particulars of the federal financial reform package, it will use government dollars to bailout underwater consumers and feed banking bottom lines, much the way health care reform could well have been called the Insurance Industry Full Employment Act of 2010.
Rather than buy into the prowess of regulators, time and effort should be spent in setting guidelines that will allow the market to ensure the health of good financial institutions or the failure of bad ones. The effect of most regulations, however, is to prop up speculation, if not bad banks, in the interest of preserving “the system” (which sounds a lot like Michael Corleone’s “family”).
For example, if the financial reform bill did nothing more than require that all banks and bank-like companies maintain 20 percent of their risk assets in capital that is liquid and available within seventy-two hours, it might constrain economic growth. But few banks would fail. Nor would be they be in a position to pay out fat bonuses, as most would have returns on equity like those of hardware stores.
What wiped out many banks in the recent financial crisis was inadequate capital and mismatched balance sheets. At its risk peak, Lehman had assets thirty-one times its capital, so even a small down move in markets made it insolvent. Even now, Goldman’s balance sheet is more that of a pyramid scheme than a bank.
A second proposal might mandate the close matching of all financial assets and liabilities, so that future Lehmans could not fund mortgage-backed securities (with the tenors of underlying loans extending to thirty years) using ninety-day commercial paper. Mortgages are fine if they have a cushion of capital and are match funded.
To protect credit card consumers, cap the interest charged on credit cards to five percent more than three-month interbank borrowing rates, and require that once every two years consumers “clean up” their outstanding balances. The mall will be less crowded, but the banks will not swell with bloated profits.
The limits of bank regulators could be seen even in fifteenth century Florence, where a financial reformer asked Cosimo the Elder to help stop gambling in the clergy. In response, the head of the Medici clan said: “Maybe first we should stop them from using loaded dice.”
Matthew Stevenson is the author of Remembering the Twentieth Century Limited, and editor of Rules of the Game: The Best Sports Writing from Harper's Magazine.