I want to go back to an article that I wrote early in the history of this blog, when nobody read me except a few RealMoney diehard fans — Regulating Systemic Risk From Hedge Funds. It was a critique of the “Agreement Among PWG And U.S. Agency Principals On Principles And Guidelines Regarding Private Pools Of Capital.” Yes, the “shadowy” President’s Working Group on Financial Markets. Some will call it the “Plunge Protection Team.” Well, if they are that, they are certainly not playing up to their billing. As an aside, I tend not to believe in conspiracy theories, because most bad plans of our government don’t require them. As Chuck Colson pointed out regarding the Nixon Administration and Watergate leaks — he felt that information tightness in the Nixon White House was so effective, that if a conspiracy could work, it would have worked there. (Since it didn’t work, and the information leaked out, it had a surprising effect on Colson’s life, as he concluded that the disciples of Jesus (Y’Shua) could not have conspired to steal the dead body, hide it, and fake a resurrection. But that’s another story.) Suffice it to say that I don’t think the government intervenes in the major financial markets of our country — there would be too many accounting entries to hide, and someone would have a real incentive to leak the information, or write a book about it.
Going back to my article, I tried to point out the difficulty of gathering data and analyzing it. It was also somewhat prescient as I said, “Let me put it another way: if the government wants to reduce systemic risk, let them create risk-based capital regulations for investment banks, and let them increase the capital requirements on loans to hedge funds and investment banks. Or, let the Fed change the margin requirements on stocks. These are simple things that are within their power to do now. In my opinion, they won’t do them; they are friends with too many people who benefit from the current setup. If they won’t use their existing powers, why would they ask for new ones?
We will have to wait for the next blowup for the Federal Government to get serious about systemic risk. They might not do it even then. Upshot: be aware of the companies that you own, and their exposure to systemic risk. You are your own best defender against systemic risk.”
There is another reason why they would not act then, as I had pointed out at RealMoney over the years. Bureaucrats are resistant to offering changes where if thy would get harmed if the changes led to a market panic. Once the market panic starts, they can move with greater freedom, because no one will be able to tell whether changes imposed during the panic intensified the panic or not.
So, color me skeptical on efforts to monitor and control systemic risk. It would be very hard to do effectively, and there are too many powerful interests against it. Also, it would be difficult to get the gross exposure data necessary for inhibiting crisis, because many financial instruments would have to be split in two or more pieces.
As to the articles I have read on Treasury Secretary Paulson’s plan, they divide into credulous (one, two), mixed, and skeptical/hostile (one, two). Let me simply observe that any plan for the control of systemic risk has to overcome:
- Political opposition
- Lack of effective data
- Lack of an effective model
- Lack of willingness to implement the conclusions generated by the staff/modeling
- Inter- and Intra-agency disagreements
- Data and action lags
If it is already difficult for the Fed to implement contracyclical monetary policy, just imagine how difficult it will be for them to deal with a problem that is far more tricky because of its multivariate nature. Imagine them trying to analyze the effects from currencies, commodities, operating businesses, credit, ABS, RMBS, CMBS, equity-related businesses, counterparty risk, etc. This is not trivial, and Paulson I suspect knows it all too well, which has led him to make a modest proposal that will likely not be effective, but will likely run out the shot clock for the Bush administration, leaving the issue for the next President to deal with.
The Fed is not by nature an activist institution, and it would have to become far more activist in order to effectively regulate the bulk of all financial institutions in the US. I don’t see it happening.
As an aside, I am ambivalent about Federal regulation of insurance, and this RealMoney article of mine still expresses my views adequately. Still, it would make sense to hand over oversight of financially sensitive insurers, such as the financial guarantee insurers and the mortgage insurers to the Feds, together with whoever oversees the ratings agencies. An integrated solution is preferable. (I still like my proposed name for the new regulator, “Federal Insurance Bureau” [FIB… well, it can’t be the FBI].
As for some of the fog that a regulator of investment banks would exist in, consider these two articles on hedge fund distress. What affects the hedge funds, affects the investment banks. They are symbiotic.
As a joke, given that it is the first of April, if we do get a regulator for overall financial solvency and systemic risk, I believe it should be called the Federal Office for Oversight of Leverage [FOOL]. After all, I think it is taking on a fool’s bargain.