Treasury versus Progressives on the Financial Reform Bill, 2: Some Comments

There are a couple of narratives about the course that this financial reform bill has taken. One is that it is a “regulatory reform” bill, fixing the regulators as opposed to Wall Street. Another way of thinking about this bill is that it is the precursor to the real work that needs to be done internationally at the Basel accords. There are some idiosyncrasies in the United States financial regulation system not present elsewhere (ratings agencies, the sheer volume of subprime consumer fraud) and some specific road bumps we hit during late 2008 (lack of legal alternatives to bankruptcy for financial firms, poorly capitalized derivatives positions and lack of information) that we need to get cleaned up before all the real work gets done at Basel.

That’s the spirit in which I read EconOfContempt’s response to my posts on progressives versus Treasury on financial reform.  Most of the reformers’ demands opposed by the Treasury would be handled internationally. Tim Fernholz has a similar response to what I wrote. You should read both; I want to address a few points.

A first point is what work the word “structural” is doing in this discussion.  When I say that the Treasury didn’t push for “structural changes,” I’m blurring a few concepts, including the idea of Krugman’s Greek versus Roman metaphor for financial regulation. How robust and simple are the financial rules? There were a number of progressives who put out rules that could make domestic regulation more robust, simple and Roman–could create a floor that regulators can’t go beneath. Hence why I group things like a strong leverage cap under this category.

Because let’s be clear:  one reason we are in this mess is because Alan Greenspan believed that financial markets regulate themselves. And now we’ve put most of the regulatory apparatus for the systemically risky part of the financial markets in the Federal Reserve. And Basel is the most Greek of financial reform regimes, and lobbyists are already gunning hard against banks holding capital against liquidity mismatches, arguably the most important thing Basel needs to do that can’t be written into the law well (“Regulatory experts who work with banks say the industry as a whole is united in its concerns about the liquidity proposals”).

EoC: “So in the end, Treasury opposed the two progressive-backed structural reforms that they should have opposed, and fought for (and won) several very valuable structural reforms — e.g., CFPA, resolution authority, derivatives clearing. Somehow, though, this amounts to being ‘in favor of the status quo on Wall Street.’ Go figure.”

I’ve written a lot about the three things listed here at this blog and why I think each are a big improvement. But even given this latest success, there hasn’t always been a push for the strongest type of changes in these reforms throughout the fight. Progressives have pushed for stronger powers – see The Miller Moore Amendment for resolution – but what is most interesting is how “strong” derivatives reform will be.  What about post-trade price transparency? I’m a fan of pre-trade price transparency, but now I wonder if we’ll even get a decent post-trade price transparency out of this bill.  EoC notes that post-trade price transparency will be the next major battle in derivatives reform. (That’s an important post you should read.) The time delay in public reporting of transaction and pricing data will have major implications for price information and control of the derivatives market. This is punted, and the lobbyists who will stick around after the initial fight is over will have even more power. This could have been written stronger, but it hasn’t.

Tim notes that “including new-fangled contingent capital” might be coming after a study. (There are a lot of studies.) I see the banks fighting that tooth and nail: from the bank’s point of view, it’s a painful instrument to have to put into the market given the amount of return it would need, and short of the government forcing it I don’t see it happening. But we’ll see what comes out of the dozens of studies to be released to little fanfare years from now.


Both Tim and EoC point to this American Banker article about the Collins Amendment to say that Treasury supported the idea of the Collins amendment, but preferred to handle it at Basel.

That’s not how I read what the article says. It seems to say that the Federal Reserve is fighting what the Collins amendment does at the Basel negotiations: “But the Fed is also concerned because the [Collins amendment] hurts its bargaining position on Basel III. Late last year, the Basel Committee on Banking Supervision proposed eliminating trust-preferreds as Tier 1 capital, but agreed to continue to talk about the issue….Many said the Fed had hoped to extract some concessions from international regulators for eliminating trust-preferreds, a move that would not be possible if they were already not counted as Tier 1 capital.”

Or as The WSJ reported: “European regulators are trying to push new rules that would prohibit banks from including holdings in trust-preferred securities in their capital ratios, but several U.S. officials are trying to block this. Sen. Collins’s amendment could factor into these discussions because it might lock U.S. regulators into specific policies that are currently under negotiation.” That’s exactly what we want the amendment to do!

This is an amendment fought for by FDIC and in addition to the trust-preferred securities issue has an element of regulatory control over it. Wallace Turbeville has the best coverage of the fight between Treasury/Federal Reserve and FDIC.

Now maybe this all has been a very elaborate game of Good Cop/Bad Cop. Brad Miller, Jeff Merkley et al are screaming at Wall Street, Tim Geithner runs in the room and tells them to take a walk, and says “man you better work with me before my partners get back in here. You don’t want to deal with those bad cops; you want to deal with me, the moderate sensible cop!” (That would be pretty rad.) If so, that’s very difficult to see from the sidelines, but I could be convinced.

During the tense final days of the Senate debate, Ryan Grim reported that Larry Summers, according to a person briefed on his discussion and confirmed by a senior Democratic aide, told Senate Democrats “If you vote for cloture right now and don’t add any more amendments, we will have solved the issues that led to crisis. Had this been law, as is, in 2007, we would not have had the crisis,” (“Matt Vogel, a Summers aide, said that the quote wasn’t rendered accurately but did capture the spirit of his remarks. “He did say that if the bill had been law there would have been a totally different situation,” said Vogel. He definitely did talk about what a difference it would have made in responding to the crisis if the bill had been law then.””) That’s a bold claim to make; I hope it is true.

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One Response to Treasury versus Progressives on the Financial Reform Bill, 2: Some Comments

  1. Umm, I think you’re misunderstanding how “negotiating leverage” works, because the passage from the American Banker article demonstrates the opposite of what you claim. The problem with the Basel III consultation is that it’s structured to exclude trust-preferreds from Tier 1 capital, but include several forms of tax-advantaged European hybrid instruments. So the Fed needs to be able to say, “Fine, we’ll accept trust-preferreds being excluded from Tier 1, but only if you also agree to exclude European hybrids from Tier 1.” In other words, they need to be able to get something in return for excluding trust-preferreds from Tier 1. But because of the Collins amendment, now they can’t.

    But aside from that, why do you care so much about trust-preferreds? I mean, do you even know why you want trust-preferreds to be excluded from Tier 1 capital so badly, or is it just a reflexive hatred of anything that can be called “hybrid”? The actual debate is a subtle one, and has to do with perpetual vs. 30-year maturities, the length of deferrability, etc. — i.e., the loss absorption capacity of trust-preferreds. I could honestly care less about whether trust-preferreds are included in Tier 1, but it’s worth noting that, if anything, the financial crisis demonstrated that trust-preferreds are indeed loss absorbing. There were several trust-preferred exchanges (into common) during the crisis, which allowed the bank-issuers to absorb losses. That’s what we want from capital, no? So what, exactly, is your problem with trust-preferreds?

    And the Collins amendment isn’t about “Greek vs. Roman” either, because regulators can still change the capital level/definitions for the underlying depository institutions. So you can’t just fall back on that analogy here. You have to actually get specific.

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