Money Changes Everything

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Obama adviser Daniel Tarullo, in response to a question from an AP reporter on today’s conference call, took an usual route to an answer: He agreed with the premise of the question. The reporter noted that Obama’s much-ballyhooed speech on the economy today didn’t contain any specific proposals. Hmmm, I thought to myself, that sounds like this afternoon’s Clinton talking point — this morning! Or it was at the time I was listening to the call. What was really striking, however, was Tarullo’s response: He conceeded that the speech was short on policy proposals. And that that was the point!

Sure enough, in the Clinton call afterwards, her policy adviser hammered on the lack of a “real plan” with “specifics.” Tarullo’s pre-buttal — which sort of asks voters to take a lot on trust (and hey, that’s worked for BHO so far!) — is after the jump. He essentially argues that a crisis of this magnitude can’t be solved by implementing specific proposals right away on the front end. Key quote: “Anybody who thinks we should have specificity like that, probably doesn’t understand how financial regulations evolve…People who are really knowledgeable about financial markets, no matter where they think we should end up, realize we can’t start out with specifics.”

I emailed our colleague Justin Fox for his take on it, and he said he hadn’t read the speech yet, but that “principles-based regulation is better than rules-based regulation has been very fashionable lately among economists, accounting scholars, etc. I’m not sure how you have regulation without rules, but whatever.”

In other news, I am fascinated — that may be a little bit too strong a word — by the idea of “accounting scholars.” For some reason I’m picturing monks with green eyeshades.

Q: “There are not any numbers in those six principles”

Tarullo: “I think to the contrary… I think a false specificity … that your capital requirements should be 7.25 percent [or something like that]… is just misleading… Anybody who thinks we should have specificity like that, probably doesn’t understand how financial regulations evolve… Others have already commented that he should be more specific [here he noted that he was incredulous that observers have already had the time to digest and come to a conclusion about the speech] … [But] what he’s done has laid down the starting point for specifics… one needs to listen to a wide variety of people and sources [financial instutions, consumer groups, agencies]…People who are really knowledgeable about financial markets, no matter where they think we should end up, realize we can’t start out with specifics…With those capital requirements I was refering to before… the capital required to be set aside by banks [would have] applied to the kinds of practices that are [blowing up] now, would have REDUCED the amount of capital banks had to have on hand.”

I’m trying to figure out if that last part is verifiable. UPDATE: Apparently the capital requirements that Tarullo is referring to stem from the “Basel II Accord” — according to Justin, again. I can’t claim to understand them, but those so inclined to dig further can start here. And here’s the “principles” excerpt from the speech:

First, if you can borrow from the government, you should be subject to government oversight and supervision. Secretary Paulson admitted this in his remarks yesterday. The Federal Reserve should have basic supervisory authority over any institution to which it may make credit available as a lender of last resort. When the Fed steps in, it is providing lenders an insurance policy underwritten by the American taxpayer. In return, taxpayers have every right to expect that these institutions are not taking excessive risks. The nature of regulation should depend on the degree and extent of the Fed’s exposure. But at the very least, these new regulations should include liquidity and capital requirements.

Second, there needs to be general reform of the requirements to which all regulated financial institutions are subjected. Capital requirements should be strengthened, particularly for complex financial instruments like some of the mortgage securities that led to our current crisis. We must develop and rigorously manage liquidity risk. We must investigate rating agencies and potential conflicts of interest with the people they are rating. And transparency requirements must demand full disclosure by financial institutions to shareholders and counterparties.

As we reform our regulatory system at home, we must work with international arrangements like the Basel Committee on Banking Supervision, the International Accounting Standards Board, and the Financial Stability Forum to address the same problems abroad. The goal must be ensuring that financial institutions around the world are subject to similar rules of the road – both to make the system stable, and to keep our financial institutions competitive.

Third, we need to streamline a framework of overlapping and competing regulatory agencies. Reshuffling bureaucracies should not be an end in itself. But the large, complex institutions that dominate the financial landscape do not fit into categories created decades ago. Different institutions compete in multiple markets – our regulatory system should not pretend otherwise. A streamlined system will provide better oversight, and be less costly for regulated institutions.

Fourth, we need to regulate institutions for what they do, not what they are. Over the last few years, commercial banks and thrift institutions were subject to guidelines on subprime mortgages that did not apply to mortgage brokers and companies. It makes no sense for the Fed to tighten mortgage guidelines for banks when two-thirds of subprime mortgages don’t originate from banks. This regulatory framework has failed to protect homeowners, and it is now clear that it made no sense for our financial system. When it comes to protecting the American people, it should make no difference what kind of institution they are dealing with.

Fifth, we must remain vigilant and crack down on trading activity that crosses the line to market manipulation. Reports have circulated in recent days that some traders may have intentionally spread rumors that Bear Stearns was in financial distress while making market bets against the company. The SEC should investigate and punish this kind of market manipulation, and report its conclusions to Congress.

Sixth, we need a process that identifies systemic risks to the financial system. Too often, we deal with threats to the financial system that weren’t anticipated by regulators. That’s why we should create a financial market oversight commission, which would meet regularly and provide advice to the President, Congress, and regulators on the state of our financial markets and the risks that face them. These expert views could help anticipate risks before they erupt into a crisis.

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