Is the Fed About to Lose On “Systemic Risk” Legislation?

It is really fascinating to see how much people underestimate the political staying power of technocrats such as FDIC Chairman Sheila Bair and SEC Chairman Mary Schapiro. I get the distinct feeling that some senior members of the media, analysts and the banking community, still don’t see the ladies as serious players. If you bother to look at the Players’ Roster of American politics, it is clear that the ladies are very much in the ascendancy in Washington, both in government and in the lobbyist community.

Consider the movement in terms of legislation on regulatory reform. The ebb and flow of the debate is headed very much in the direction of collective, shared authority for determining when a TBTF bank or, more specifically, a non-bank company such as AIG needs restructuring. This goes directly contrary to the Geithner proposal to give this function to the Fed. Bair’s comments here about why giving the sole authority to the Fed or any single agency is a bad approach are instructive:

“The macro-prudential oversight of system-wide risks requires the integration of insights from a number of different regulatory perspectives — banks, securities firms, holding companies, and perhaps others. Only through these differing perspectives can there be a holistic view of developing risks to our system. As a result, for this latter role, the FDIC supports the creation of a Council to oversee systemic risk issues, develop needed prudential policies and mitigate developing systemic risks. In addition, for systemic entities not already subject to a federal prudential supervisor, this Council should be empowered to require that they submit to such oversight, presumably as a financial holding company under the Federal Reserve — without subjecting them to the activities restrictions applicable to these companies.”

Click here to read the entire Bair comment to the HFSC.

By making such decisions collective, inter-agency processes, the tendency at the Fed for cults of personality a la the “Greenspan doctrine” to guide decision making will be largely eliminated. Since each agency in the proposed council will have to document its decision process and maintain a public record of same, the Fed’s cultural tendency to bury such decisions and the people responsible will be at least partly thwarted.

The unilateral misuse of the resources of the FRBNY by Tim Geithner, for example, in the AIG rescue would be much more difficult in the future since the banks would have to subvert not just the Fed but a handful of other agencies that are far less secretive that the US central bank. At the very least this would be an expensive — if not impossible exercise. No doubt the folks from Goldman Sachs would rise to the challenge.

Notice too that as Chairman Bair was making here case to the Congress for a collective approach to systemic risk, Chairman Schapiro was laying down covering fire, agreeing with most of the basic points made by her counterpart at the FDIC. “Structured correctly, a credible resolution regime could force market participants to realize the full costs of their decisions and help reduce the ‘too big to fail dilemma,'” Schapiro said at a Senate Banking Committee hearing, Reuters reports.

And then we have Rep. Barney Frank, waving the bloody shirt on “naked derivatives” regarding reform of OTC derivatives just as the reform legislation is supposed to be a done deal: “The question of banning naked credit-default swaps is on the table,” Frank, a Massachusetts Democrat, said during an interview on Bloomberg Television today. The legislative proposal will be released next week, Frank said.

Hmm. Could it be that Barney’s reelection committee fund raising is below target? Maybe. Or is little Barney losing interest in reg reform since all the action is now over in the Senate?

What it all looks like to me is that the Frank proposal to give the Fed the entire world when it comes to “systemic risk” is fading. Part of my judgment is a personal assessment. For all of his bluster, Frank is really not so much smart on financial services issues as an obnoxious little child. Shifting to an “anti-derivative” position like banning naked CDS gets attention for Frank, who is every bit as affected by media envy as any national politician. Nobody would care about Frank’s personal quirks except that, well, he is chairman of the key House committee that has responsibility for financial services.

The thing to understand about Frank is that his proposals are not well considered and his colleagues and staff won’t bother to try to educate him because of his offensive personal behavior. I have watched Frank on Capitol Hill for two decades and he has always been rude and discourteous to both staff and other members, as well as careless in his research. If it sounds good with him saying it, Chairman Frank will make the proposal. That is why now, as Chairman, nobody on the staff bothers to tell Frank when his latest strokes of brilliance are off track. They just let him put out the press release and move onto the next pressing issue.

Here’s what one member told me: “If he actually were smart as reported, Barney would be looking to leverage this financial crisis into a Senate seat, where he could rave w/o danger of actually doing damage. Even as a junior Senator, Frank wouldn’t lack for attention, but he claims to dearly want to stay in the house.”

My guess is that Frank was just posturing on OTC yesterday on Bloomberg TV to remind the lobbyists to put something in the cup, but that his focus on regulatory reform is dimming as other, more attractive issues/playthings dangle in prospect.

Meanwhile, in the Senate, it is very clear from the statements of both Chris Dodd (D-CT) and Dick Shelby (R-AL) that the Fed as systemic risk regulator is DOA. With Sheila Bair and Mary Schapiro both making common cause in the name of collective responsibility, my bet is that the Congress is going to distance itself from the Geithner/Bernanke proposal and end up giving SEC and FDIC a share of authority when it comes to rescues and/or restructuring of systemically significant enterprises. The flow of opinion in the Senate has been moving away from the Fed for weeks.

In the event, score another point for Bair and Schapiro. If I could give Geithner one piece of advice, it would be “don’t mess with the ladies.”


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