TBTF Strike Back! SEC Commissioner Calls FSOC “Vast Left Wing Conspiracy“

One of the favored practices of the banking industry in recent years has been to engage in not merely shameless, but truly deranged hyperbole when anyone dares voice so much as an itty bitty threat against their prerogatives. For instance, venture capitalist Tom Perkins had a meltdown in the op-ed section of the Wall Street Journal, conflating criticism of rentier behavior among the 0.1% as an incipient Kristallnacht. Jamie Dimon in March 2009 (yes, you have the date right) had the temerity to complain about the “vilification” of Corporate America over the financial crisis. Even the weak restrictions on executive pay in the TARP produced outcries and desperate efforts to repay the TARP quickly (and the cronyistic Treasury acceded, rather than requiring TBTF banks to get their capital levels higher first).

We witnessed a new outburst of Banking Industry Persecution Complex yesterday from SEC Commissioner Michael Piwowar, who was speaking before an assembly of fellow inmates at the American Enterprise Institute. Piwowar has made it clear in previous speeches that he is opposed to provisions of Dodd Frank that call for the designation of systemically important financial institutions known in the trade as SIFIs, or among the laity, TBTF. He’s also tried claiming the Financial Stability Oversight Council is a threat to the SEC’s power. This is ludicrous since the SEC has never been a banking regulator and its influence is vastly less than that of the Fed and Treasury, and even less than that of the FDIC and OCC, which aren’t subject to Congressional appropriations. As former SEC chairman Arthur Levitt wrote in considerable detail in his memoir, Take on the Street, he’d regularly have Congresscritters, particularly Joe Lieberman, threaten to cut the SEC’s budget every time he tried getting serious about regulations. So Piwowar’s claims about the SEC’s power are either disingenuous or unhinged.

This section from a Bloomberg report makes one inclined to side with the “unhinged” diagnosis:

The U.S. Securities and Exchange Commission’s Michael Piwowar called an umbrella group of financial regulators a “vast left-wing conspiracy to hinder capital formation.”

The Financial Stability Oversight Council’s initials really stand for “Firing Squad on Capitalism,” Piwowar, 46, said yesterday in a speech at the American Enterprise Institute in Washington. He called the FSOC “The Bully Pulpit of Failed Prudential Regulators” and “The Dodd-Frank Politburo,” adding that his opinions are his own and that the pejoratives are “entirely accurate.”

Yves here. The really loopy bit is the argument that there’s a problem with access to capital in the US right now. Large companies have borrowed like mad and are sitting on cash hoards and buying back stock. Cheap and plentiful capital has allowed private equity firms to hoover up houses and engage in a new wave of acquisitions, to the point that regulators are sounding alarms about the pricing of collateralized loan obligations, vehicles used to sell these acquisition loans to investors. There’s so much liquidity right now that debt and equity valuations are strained. And did he forget Jumpstart Obama’s Bucket Shops Act, which greatly facilitates fundraising by small companies, and is utterly unaffected by anything the FSOC would do?

Nevertheless, Piwowar is not entirely wrong in calling the FSOC “failed,” but that’s because it’s done too little rather than too much. We posted on this exchange between Elizabeth Warren and Janet Yellen earlier, but it bears repeating because it illustrate one critical way in which FSOC members are punting on their obligations.

Another demonstration of Banking Industry Persecution Complex at the same conference was Scott Garrett complaining about Fed Vice Chairman Stanley Fischer’s call for regulators to add financial stability to their mandates. In fact, the Fed has always had the safety and soundness of banks as of its raisons d’etre. In the crisis, regulators learned too late that interconnectedness was a big problem, so now they have to think more about the financial system as well as individual institutions.

And again, there’s a reasoned critique: that making regulators worry about soundness puts them in a conflicted position, in that it makes it even easier for regulators to become captured, since the regulated institutions can argue that they need to be profitable (and handsomely so!) to have strong capital positions and attract good staff. Some have argues that prudential regulation should be separated from other types of regulation, rather than have central banks operate even more in the role of One Regulator Who Rules Them All.

But the funniest bit is Garrett acting as if Fischer is not on the side of TBTF banks. Pam Martens disabuses readers of that illusion in a new post:

Warren may have come down hard on the Fed at this hearing because the newly installed Fed Vice Chairman, Stanley Fischer, appeared to be out on the stump last week for keeping the biggest banks intact in a speech he delivered in Cambridge, Massachusetts last Thursday.

Fischer had this to say:

“What about simply breaking up the largest financial institutions? Well, there is no ‘simply’ in this area. At the analytical level, there is the question of what the optimal structure of the financial sector should be. Would a financial system that consisted of a large number of medium-sized and small firms be more stable and more efficient than one with a smaller number of very large firms? That depends on whether there are economies of scale in the financial sector and up to what size of firm they apply–that is to say it depends in part on why there is a financing premium for large firms. If it is economies of scale, the market premium for large firms may be sending the right signals with respect to size. If it is the existence of TBTF, that is not an optimal market incentive, but rather a distortion. What would happen if it was possible precisely to calculate the extent of the subsidy or distortion and require the bank to pay the social cost of the expansion of its activity? This could be done either by varying the deposit insurance rate for the bank or by varying the required capital ratios for SIFIs to fit each bank’s risk profile and structure. This, along with measures to strengthen large banks, would reduce the likelihood of SIFI failure–but could not be relied upon to prevent all failures.”

Fischer added: “In short, actively breaking up the largest banks would be a very complex task, with uncertain payoff.”

There were widespread fears when President Obama announced Fischer as his nominee for Fed Vice Chair that Fischer’s previous ties to Citigroup would prove problematic. Citigroup goes unmentioned in Fischer’s long speech last Thursday despite the fact that Citigroup’s insolvency in 2008 played a major role in the economic meltdown and Citigroup flunked its stress test with the Fed this year — meaning the Fed does not have confidence it could weather a major economic storm.

Yves here. It’s even worse than Martens suggests. Notice the use of the conditional in Fischer remarks, “whether there are economies of scale”? He’s too well-read an economist not to know the answer. Virtually every study ever done of bank efficiency has found that they have a slightly increasing cost curve (meaning they are less efficient) once a certain size threshold is met. And that threshold is not very large, typically at the $25 billion in assets level. This sort of study was done routinely before 2004 with consistent results. There have been far fewer done since then, no doubt because the banking industry isn’t keen to have that result get press.

Put it another way: if Fischer had a study to cite supporting his position, you can be certain he would have referred to it. And Fischer similarly has to be familiar with the work of Andrew Haldane, who has done impressive and original work that directly contradicts Fischer’s argument: that a financial system with more diversity (more types of specialized players) is much more robust than one with comparatively few players, and even worse, all offering very similar products and pursuing similar strategies.

So Piwowar’s and Garrett’s contention that TBTF banks are being picked on is wildly misplaced. Only in an echo chamber like the AEI or in bank executive suites could that idea be taken seriously. But this crowd has managed to convince itself that having banking licenses is a one-way ticket: they get all the subsidies and all the rights and should not be required to be accountable in any way. And until that mentality changes, the health of the economy will remain hostage to them.