“The shift to a Republican-controlled Congress in January is likely to make it more difficult for the Securities and Exchange Commission….’The greatest area of potential difficulty we face in the new Congress is with respect to the budget,’ Arthur Levitt Jr., the commission’s chairman, said in an interview last week.”
– New York Times, “Republicans May Hold Down The S.E.C. and Investor Suits”, December, 1994 (source)
“Unless the waters are crimson with the blood of investors, I don’t want you embarking on any regulatory flights of fancy.”
– Phil Gramm to SEC Chair Arthur Levitt, Wall Street Journal, reported October 2002 (source)
“Leading Republicans on the committee — including California Rep. Ed Royce, Texas Rep. Jeb Hensarling and New Jersey Rep. Scott Garrett — also say the panel will significantly ramp up oversight of agencies like the Securities and Exchange Commission in the wake of Democratic financial services overhaul…it will aim to defund ‘portions of it,’ Hensarling said.”
– Reported by Politico, October 2010 (source)
“I think funding [of Dodd-Frank, SEC, CFTC] will certainly be an area we will be revisiting.”
– Rep. Scott Garrett, R-N.J. October, 2010 (source)
Re-reading about the parallels between the 1994 GOP Congress fighting the funding and powers of the SEC and our new 2010 Republican House doing the same – this CJR post is an excellent place to start – has gotten me thinking about this kind of circle of GOP financial deregulatory life. As the 1994 triumphant GOP are cozy in their Enron and UBS funded retirement, a new child, the 112th Republican House, is lifted over a valley of cheering financial lobbyists. There’s more regulation to impede than can ever be seen, more to defund than can ever be done, but the new GOP is up to the task.
I get a few emails asking why I am so hard on the new GOP and their criticism of Dodd-Frank, especially after this post about the new Financial Services webpage. One of the main reasons is that I am disappointed. My last major surprise from the past two years was that there wasn’t a left-right team-up on financial reform after the crisis.
This was probably completely naive, but I had hopes that conservatives and libertarians, dismayed at TARP and the mess that the financial sector had become, would move to push serious reform. If they didn’t, the median voter in Congress would suddenly become a banking-friendly New Dem like Melissa Bean. I also know, in the same way that they are pushing the line that public unions are the new reason why we have 9%+ unemployment, activists on the Right are shameless about going after Democratic interest groups hard, and they may fold Wall Street into that approach.
This did not happen. To be honest, the rush to blame the CRA, of all things, was pathetic. I’m familiar with all the ideologies across all the main players on financial reform, and this just did not seem serious. Between the CRA nonsense and trying to make financial reform a Waterloo for Obama, the good GOP ideas got lost in the shuffle, and without support they couldn’t move.
Take convertible bonds, which various members on the ideological Right have argued for being a part of financial reform. In different forms, the AEI Shadow Banking committee, Christopher Papagianis at Economics 21 and the Squam Lake Working Group have written favorably about this. This went to a study.
The first step is to figure out how this is different than preferred stock, which performed horribly in the crisis. As Raj Date wrote in his excellent “Now More Absorbent! Five Principles to Make ‘Contingent Capital’ More Like Capital, and Less Contingent”:
From the point of view of senior creditors or depositors, in bad times, traditional
preferred stock, in theory, should have functioned just like contingent capital: it should not have received dividends, and it would have been subordinated to a bank’s creditors and depositors….In reality, though, hybrid capital did nothing of the kind. The preferred market failed in every important way: its pricing mechanism failed to discipline banks’ risk-taking behavior (preferred stock tended to price relatively close to more senior debt, under the tacit assumption, encouraged by issuers and Wall Street alike, that banks would protect investors); it did not adequately
absorb credit losses (banks continued to pay preferred dividends well after the magnitude of the crisis was clear); it created, instead of mitigated, systemic contagion between firms (because banks held large quantities of each other’s hybrid securities)…
Convertible bonds could easily fail. There are ways around this, like pre-writing the conversion structure, moving the debt towards traditional long investors, removing management discretion for triggers, a punitive level of conversion price, etc. Read Date’s excellent paper for more. But all of these take a bite out of the largest financial institutions. It makes these bonds more painful to issue when they are issued right – they’ll be costly to financial firms.
It quickly becomes a prisoner’s dilemma. If one party acts on this, the other party can immediately go and say “Hey Wall Street, we’ll make sure the implementation is botched in exchange for donations.” Even then, someone will always link to that Gillian Tett article about the death spiral bonds and cry out that Too Big To Fail hasn’t been stopped. Since both sides can do that, you’ll get weak implementation. With the GOP attacking regulators, regulators sure as hell aren’t going to be interested in forcing financial firms to issue a serious convertible bond as opposed to a weak one that will make no difference or may even make things worse.
I think there could have been very strong convertible bonds in this bill. There could have been a Chapter F for Financial bankruptcy upfront as the default option instead of normal bankruptcy as the default option before resolution authority would be invoked. There could have been movement on removing derivatives from bankruptcy protection. But they would have required compromise. And that’s something we didn’t see.