The Failing TARP
posted by Frank Pasquale
The more one reads about basic problems in the handling of $700 billion in emergency economic stabilization funds–and the Treasury’s stonewalling response to even the most basic questions about their disbursement–the more worries pile up. Congressional Oversight Panel chair Elizabeth Warren suggests that some basic tools designed to prevent corruption in the administration of the program are not yet apparent. That’s particularly shocking given Michael Lewis & David Einhorn’s smart commentary on the problems that sunk us into this crisis:
At every turn we keep coming back to an enormous barrier to reform: Wall Street’s political influence. [Even the Securities and Exchange Commission is] compromised by [Wall Street's] ability to enrich the people who work for it. Realistically, there is only so much that can be done to fix the problem, but one measure is obvious: forbid regulators, for some meaningful amount of time after they have left the S.E.C., from accepting high-paying jobs with Wall Street firms.
Lewis & Einhorn suggest several other solutions that I’ll quote below:
End the official status of the rating agencies. . . . There should be a rule against issuers paying for ratings. Either investors should pay for them privately or, if public ratings are deemed essential, they should be publicly provided.
Regulate credit-default swaps. . . . Until very recently, companies haven’t had to provide even cursory disclosure of credit-default swaps in their financial statements. . . . The most critical role for regulation is to make sure that the sellers of risk have the capital to support their bets.
Impose new capital requirements on banks. The new international standard now being adopted by American banks is known in the trade as Basel II. Basel II is premised on the belief that banks do a better job than regulators of measuring their own risks — because the banks have the greater interest in not failing. . . . We know how that turned out. A better idea would be to require banks to hold less capital in bad times and more capital in good times. Now that we have seen how too-big-to-fail financial institutions behave, it is clear that relieving them of stringent requirements is not the way to go. Another good solution to the too-big-to-fail problem is to break up any institution that becomes too big to fail.
[T]here’s nothing all that radical about most of these changes. A disinterested person would probably wonder why many of them had not been made long ago. A committee of people whose financial interests are somehow bound up with Wall Street is a different matter.
Reflecting on Joe Nocera’s article on failures of risk management on Wall Street, I just want to comment on the extraordinary naivete of believing that “banks do a better job than regulators of measuring their own risks — because the banks have the greater interest in not failing.” Isn’t it apparent to any self-interest maximizing, homo economicus that the game is not the bank’s success, but one’s own? Nocera marvels at how many Wall Street grandees miscalculated the acceptable levels of risk for their bank, but really, once one has a few tens of millions of dollars in the bank, what’s the downside for these guys of losing a huge bet? They are legally insulated from absorbing the losses they impose on their institution. Once they have a certain safety cushion in the bank, why should they even care if the bank continues as a going concern? Even if the they fail miserably, the atmosphere is so clubby that many still are in line for plum jobs.
Perhaps a tough Congressional investigation could counterbalance the extraordinary political influence of Wall Street. The Pecora Hearings led to confrontations like these:
As Pecora relentlessly grilled the most famous names in finance, the nation relived the 1920s boom in a collective act of national remembrance. . . . As it gained momentum, the inquiry expanded until it shined a searchlight into every murky corner of Wall Street. Pecora exposed a stock market manipulated by speculators to the detriment of small investors who could suddenly attach names and faces to their losses.
Bankers had been demigods in the 1920s, their doings followed avidly, their market commentary quoted with reverence. They had inhabited a clubby world of chauffeured limousines and wood-paneled rooms, insulated from ordinary Americans. Now Pecora defrocked these high priests, making them seem small and shabby.
Bob Kuttner called for a Pecora redux long ago. If a Senate with 59 Democrats and Chuck Grassley can’t get the job done, it may be time to resign ourselves to plutocracy.
January 6, 2009 at 8:15 am
Posted in: Economic Analysis of Law, Securities
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Responses (1)
WJR - January 6, 2009 at 7:12 pm
These are sensible reforms, but I think you’re taking the anti-finance blood lust a bit too far.
No one questions that risk management failed on Wall Street, but this doesn’t prove the converse, that regulators could do a better job than banks at measuring banks’ risks. I don’t mean to exonerate the bankers who knowingly discarded or discounted the risks of mortgage backed securities, but it’s quite possible that (1) banks are much better than regulators at assessing their own risks, and (2) banks nevertheless are capable of colossal failures in risk assessment.
Also, populism is dead, and with good reason. It doesn’t mean we should resign ourselves to plutocracy, but we should be encouraging our best and brightest to go into finance but realign their incentives (as Lewis/Einhorn suggest), so they don’t follow the same path as the last crop.
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